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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

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

For the fiscal year ended December 31, 2019

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 001-10897

Carolina Financial Corporation

(Exact name of registrant as specified in its charter)

Delaware		57-1039673
(State of Incorporation)		(I.R.S. Employer Identification No.)

288 Meeting Street, Charleston, South Carolina		29401
(Address of principal executive offices)		(Zip Code)

(843) 723-7700

(Issuer’s Telephone Number)

Securities registered pursuant to Section 12(b) of the Exchange Act:

Title of Each Class		Trading Symbol		Name of each exchange on which registered
Common Stock, $0.01 par value per share		CARO		The Nasdaq Capital Market^®

Securities registered under Section 12(g) of the Exchange Act: None

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

Yes x No o

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

Yes o No x

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

Yes x No o

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

Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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 x

Accelerated filer o

Non-accelerated filer o

(Do not check if a smaller reporting company)

Smaller reporting company o

Emerging growth company o

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 the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No x

The aggregate market value of the voting and nonvoting common equity held by non-affiliates of the registrant (computed by reference to the price at which the stock was most recently sold) was $738,763,981 as of the last business day of the registrant’s most recently completed second fiscal quarter.

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

Class		Outstanding at February 19, 2020
Common Stock, $.01 par value per share		24,825,817 shares

DOCUMENTS INCORPORATED BY REFERENCE

Some of the information required by Part I and Part III is incorporated by reference from the prospectus and joint proxy statement filed by United Bankshares, Inc. and the registrant on February 13, 2020 pursuant to Rule 424(b) under the Securities Act of 1933 and Rule 14a-6 under the Securities Exchange Act of 1934.

The information required by Part III will be incorporated by reference from either the registrant’s definitive proxy statement which involves the election of directors if such proxy statement is filed not later than 120 days after the end of the fiscal year covered by this report or as an amendment to this report filed not later than the end of such 120-day period.

TABLE OF CONTENTS


		Page
PART 1
Item 1.	Business	3
Item 1A.	Risk Factors	27
Item 1B.	Unresolved Staff Comments	42
Item 2.	Properties	42
Item 3.	Legal Proceedings	42
Item 4.	Mine Safety Disclosures	42

PART II
Item 5.	Market for Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities	43
Item 6.	Selected Financial Data	45
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	47
Item 7A.	Quantitative and Qualitative Disclosures about Market Risk	79
Item 8.	Financial Statements and Supplementary Data	80
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	160
Item 9A.	Controls and Procedures	160
Item 9B.	Other Information	160

PART III
Item 10.	Directors, Executive Officers and Corporate Governance	161
Item 11.	Executive Compensation	161
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	161
Item 13.	Certain Relationships and Related Transactions, and Director Independence	161
Item 14.	Principal Accounting Fees and Services	161
Item 15.	Exhibits, Financial Statement Schedules	162

EXHIBIT INDEX		163

SIGNATURES		165

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K, including information included or incorporated by reference, contains statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 (the “Securities “Act”) and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). Forward-looking statements may relate to our financial condition, results of operation, plans, objectives, or future performance. These statements are based on many assumptions and estimates and are not guarantees of future performance. Our actual results may differ materially from those anticipated in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors which are beyond our control. The words “may,” “would,” “could,” “should,” “will,” “expect,” “anticipate,” “predict,” “project,” “potential,” “believe,” “continue,” “assume,” “intend,” “plan,” and “estimate,” as well as similar expressions, are meant to identify such forward-looking statements. Potential risks and uncertainties that could cause our actual results to differ from those anticipated in any forward-looking statements include, but are not limited to, those described below under “Item 1A- Risk Factors” and the following:

our ability to maintain appropriate levels of capital and to comply with our capital ratio requirements;

examinations by our regulatory authorities, including the possibility that the regulatory authorities may, among other things, require us to increase our allowance for loan losses or write-down assets or otherwise impose restrictions or conditions on our operations, including, but not limited to, our ability to acquire or be acquired;

changes in economic conditions, either nationally or regionally and especially in our primary market areas, resulting in, among other things, a deterioration in credit quality;

changes in interest rates, or changes in regulatory environment resulting in a decline in our mortgage production and a decrease in the profitability of our mortgage banking operations;

greater than expected losses due to higher credit losses generally and specifically because losses in the sectors of our loan portfolio secured by real estate are greater than expected due to economic factors, including, but not limited to, declining real estate values, increasing interest rates, increasing unemployment, or changes in payment behavior or other factors;

greater than expected losses due to higher credit losses because our loans are concentrated by loan type, industry segment, borrower type, or location of the borrower or collateral;

changes in the amount of our loan portfolio collateralized by real estate and weaknesses in the South Carolina, North Carolina and national real estate markets;

the rate of delinquencies and amount of loans charged-off;

the adequacy of the level of our allowance for loan losses and the amount of loan loss provisions required in future periods;

the rate of loan growth in recent or future years;

our ability to attract and retain key personnel;

our ability to retain our existing customers, including our deposit relationships;

significant increases in competitive pressure in the banking and financial services industries;

adverse changes in asset quality and resulting credit risk-related losses and expenses;

changes in the interest rate environment which could reduce anticipated or actual margins;

	·	changes in political conditions or the legislative or regulatory environment, including, but not limited to, the Dodd-Frank Act and regulations adopted thereunder, changes in federal or state tax laws or interpretations thereof by taxing authorities and other governmental initiatives affecting the banking, mortgage banking, and financial service industries;
	·	changes occurring in business conditions and inflation;

	·	increased funding costs due to market illiquidity, increased competition for funding, or increased regulatory requirements with regard to funding;
	·	discontinuation of a published LIBOR rate after 2021 and the impact to our assets and liabilities;

	·	the impact of past and future hurricanes and other natural disasters on our loan portfolio and the economic prospects of our coastal markets;
	·	our business continuity plans or data security systems could prove to be inadequate, resulting in a material interruption in, or disruption to, business and a negative impact on results of operations;

changes in deposit flows;

changes in technology;

changes in monetary and tax policies;

changes in accounting policies, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board ( “PCAOB”) and the Financial Accounting Standards Board (“FASB”);

loss of consumer confidence and economic disruptions resulting from terrorist activities or other military actions;

our expectations regarding our operating revenues, expenses, effective tax rates and other results of operations;

our anticipated capital expenditures and our estimates regarding our capital requirements;

our liquidity and working capital requirements;

competitive pressures among depository and other financial institutions;

the growth rates of the markets in which we compete;

our anticipated strategies for growth and sources of new operating revenues;

our current and future products, services, applications and functionality and plans to promote them;

anticipated trends and challenges in our business and in the markets in which we operate;

the evolution of technology affecting our products, services and markets;

our ability to retain and hire necessary employees and to staff our operations appropriately;

management compensation and the methodology for its determination;

	·	our ability to compete in our industry and innovation by our competitors;
	·	increased cybersecurity risk, including potential business disruptions or financial losses;

acquisition integration risks relating to companies we have acquired, including potential deposit attrition, higher than expected costs, customer loss and business disruption, including, without limitation, potential difficulties in maintaining relationships with key personnel and other integration related matters, and the inability to identify and successfully negotiate and complete additional combinations with potential merger or acquisition partners or to successfully integrate such businesses into the Company, including the ability to realize the benefits and cost savings from, and limit any unexpected liabilities associated with, any such business combinations;

our ability to stay abreast of new or modified laws and regulations that currently apply or become applicable to our business;

estimates and estimate methodologies used in preparing our consolidated financial statements and determining option exercise prices and stock-based compensation;

the matters noted under the heading “Cautionary Statement Regarding Forward-Looking Statements” in the prospectus and joint proxy statement filed by United Bankshares, Inc. and us on February 13, 2020, which is incorporated herein by reference.

If any of these risks or uncertainties materialize, or if any of the assumptions underlying such forward-looking statements proves to be incorrect, our results could differ materially from those expressed in, implied or projected by, such forward-looking statements. For information with respect to factors that could cause actual results to differ from the expectations stated in the forward-looking statements, see “Risk Factors” under Part I, Item 1A of this report. We urge investors to consider all of these factors carefully in evaluating the forward-looking statements contained in this report. We make these forward-looking statements as of the date of this document and we do not intend, and assume no obligation, to update the forward-looking statements or to update the reasons why actual results could differ from those expressed in, or implied or projected by, the forward-looking statements.

PART I

Item 1. Business

General Overview

Carolina Financial Corporation is a Delaware corporation that was organized in February 1997 to serve as a bank holding company. In 2017, it applied for, and received, financial holding company status from the Federal Reserve. The Company operates principally through its wholly-owned subsidiary, CresCom Bank, a South Carolina state-chartered bank. CresCom Bank operates Crescent Mortgage Company, Carolina Services Corporation of Charleston (“Carolina Services”), DTFS, Inc., CresCom Leasing, LLC and Western Carolina Holdings, LLC, as wholly-owned subsidiaries of CresCom Bank. Except where the context otherwise requires, the “Company”, “we”, “us” and “our” refer to Carolina Financial Corporation and its consolidated subsidiaries and the “Bank” refers to CresCom Bank.

CresCom Bank provides a full range of commercial and retail banking financial services designed to meet the financial needs of our customers through its branch network in South Carolina and North Carolina. Crescent Mortgage Company, headquartered in Atlanta, Georgia, is primarily a correspondent/wholesale mortgage company approved to originate loans in 48 states partnering with community banks, credit unions and mortgage brokers.

On March 18, 2017, the Company completed its acquisition of Greer Bancshares Incorporated (“Greer”), the holding company for Greer State Bank. The Company issued 1,789,523 shares of its common stock and paid $4.4 million in cash to Greer shareholders. In the transaction, the Company acquired $384.5 million in total assets, loans receivable of $194.6 million and deposits of $311.1 million. In addition, the Company assumed aggregate subordinated debt principal of $11.3 million, which at the date of acquisition had a fair value of $7.5 million.

On November 1, 2017, the Company completed its acquisition of First South Bancorp, Inc., the holding company for First South Bank (“First South”). In the transaction, the Company acquired $1.1 billion in total assets, loans receivable of $759.2 million and deposits of $952.6 million. The Company issued 4,822,540 shares of its common stock to First South shareholders. In addition, the Company assumed aggregate subordinated debt principal of $10.3 million, which at the date of acquisition had a fair value of $8.6 million.

On December 31, 2019, the Company completed its acquisition of Carolina Trust BancShares, Inc., the holding company for Carolina Trust Bank (“Carolina Trust”). In the transaction, the Company acquired $635.0 million of total assets, loans receivable of $481.0 million and deposits of $537.8 million. The Company issued 2,512,543 shares of its common stock to Carolina Trust shareholders. In addition, the Company assumed aggregated subordinated debt principal of $10.0 million, which at the date of acquisition had a fair value of $10.1 million.

As of December 31, 2019, the Company had total assets of $4.7 billion, loans receivable, net of $3.2 billion, total deposits of $3.4 billion, and total stockholders’ equity of $743.4 million.

Our main office is located at 288 Meeting Street, Charleston, South Carolina 29401.

Pending Merger with and into United Bankshares, Inc.

On November 17, 2019, the Company announced the execution of an agreement and plan of merger by and between the Company and United Bankshares, Inc. (“United”), pursuant to which, subject to the terms and conditions set forth therein, the Company will merge with and into United, with United as the surviving corporation of the merger. The agreement provides that at the effective time of the merger, the Bank will merge with and into United Bank, a wholly-owned subsidiary of United Bank, with United Bank as the surviving entity. Pursuant to the merger agreement, each outstanding share of common stock of Carolina Financial will be converted into the right to receive 1.13 shares of United common stock, par value $2.50 per share, resulting in an aggregate transaction value of approximately $1.1 billion.

United’s and United Bank’s existing charters and bylaws will remain in place following the Merger and the Bank Merger.

Pursuant to the merger agreement, as of the effective time of the merger, each outstanding Company stock option, whether vested or unvested as of the date of the merger agreement, shall, at such option holder’s election, (i) vest and convert into an option to acquire United common stock adjusted based on the 1.13 exchange ratio, or (ii) be entitled to receive cash consideration equal to the difference between (a) the option’s exercise price and (b) the volume weighted average trading price over a specified period multiplied by the number of shares of Company common stock subject to such stock option. Also, at the effective time of the merger, each restricted stock grant, restricted stock unit grant or any other award of a share of Carolina Financial common stock subject to vesting, repurchase or other lapse restriction under a Company stock plan (other than a stock option) that is outstanding immediately prior to the effective time of the merger, will fully vest in accordance with the terms of the stock plan and at the election of the holder (i) convert into the right to receive shares of United common stock based on the 1.13 exchange ratio or (ii) convert into cash in an amount equal to the volume weighted average trading price of Company common stock over a specified period multiplied by the shares of Company common stock subject to the stock award. Consummation of the merger is subject to approval of the stockholders of United and Carolina Financial, the receipt of all required regulatory approvals, as well as other customary conditions.

The foregoing description of the merger agreement does not purport to be complete and is qualified in its entirety by reference to the full text of the merger greement, a copy of which is filed as Exhibit 2.1 to this report and is incorporated herein by reference. The merger agreement has been attached as an exhibit to provide investors and security holders with information regarding its terms. It is not intended to provide any other financial information about the Company. The representations, warranties and covenants contained in the merger agreement were made only for purposes of that agreement and as of specific dates, are solely for the benefit of the parties to the merger greement, may be subject to limitations agreed upon by the parties, including being qualified by confidential disclosures made for the purposes of allocating contractual risk between the parties to the merger agreement instead of establishing these matters as facts, and may be subject to standards of materiality applicable to the parties that differ from those applicable to investors. Investors should not rely on the representations, warranties, or covenants or any description thereof as characterizations of the actual state of facts or condition of the Company. Moreover, information concerning the subject matter of the representations, warranties, and covenants may change after the date of the merger agreement, which subsequent information may or may not be fully reflected in public disclosures by the Company.

In connection with entering into the merger agreement, each of the directors of the Company have entered into a support agreement. The support agreements generally require that the stockholder party thereto vote all of his or her shares of the Company’s common stock in favor of the merger and, subject to specified exceptions, prohibit such stockholder from transferring his or her shares of Company common stock prior to the consummation of the merger. The support agreements will terminate upon the earlier of the consummation of the merger and the termination of the merger agreement in accordance with its terms. The foregoing description of the support agreements does not purport to be complete and is qualified in its entirety by reference to the form of support agreement included as Exhibit A to the merger agreement, which is filed as Exhibit 2.1 to this report and incorporated by reference herein.

United has filed a registration statement on Form S-4 with the SEC to register the shares of United’s common stock that will be issued to the Company’s stockholders in connection with the proposed merger. The definitive prospectus of United and joint proxy statement of United and the Company, filed on February 13, 2020 has been provided to the stockholders of each of United and the Company in connection with the proposed merger and is incorporated herein by reference. INVESTORS AND SECURITY HOLDERS ARE URGED TO READ THE REGISTRATION STATEMENT AND THE DEFINITIVE JOINT PROXY STATEMENT-PROSPECTUS (AND ANY OTHER DOCUMENTS FILED WITH THE SEC IN CONNECTION WITH THE PROPOSED MERGER OR INCORPORATED BY REFERENCE INTO THE JOINT PROXY STATEMENT-PROSPECTUS) BECAUSE SUCH DOCUMENTS CONTAIN IMPORTANT INFORMATION REGARDING THE PROPOSED MERGER. Investors and security holders may obtain free copies of these documents and other documents filed with the SEC on its website at www.sec.gov. Investors and security holders may also obtain free copies of the documents filed with the SEC by United on its website at www.ubsi-wv.com and by the Company on its website at www.haveanicebank.com.

This report does not constitute an offer to sell or the solicitation of an offer to buy any securities or a solicitation of any vote or approval. Before making any voting or investment decision, investors and security holders of United and the Company are urged to read carefully the entire registration statement and definitive joint proxy statement-prospectus, including any amendments thereto, because these documents contain important information about the proposed merger. Free copies of these documents may be obtained as described above.

United, the Company and certain of their directors and executive officers may be deemed participants in the solicitation of proxies from the stockholders of each of United and the Company in connection with the proposed merger. Information regarding the directors and executive officers of United and the Company and other persons who may be deemed participants in the solicitation of the stockholders of United or of the Company in connection with the proposed merger is included in the definitive joint proxy statement-prospectus for each of United’s and the Company’s special meeting of stockholders, which has been filed by United and the Company with the SEC. Information about the directors and officers of United and their ownership of United common stock can also be found in United’s definitive proxy statement in connection with its 2018 annual meeting of stockholders, as filed with the SEC on March 29, 2019, and other documents subsequently filed by United with the SEC. Information about the directors and officers of the Company and their ownership of the Company’s common stock can also be found in this Annual Report on Form 10-K, and other documents subsequently filed by the Company with the SEC. Additional information regarding the interests of such participants is included in the definitive prospectus and joint proxy statement and other relevant documents regarding the proposed merger filed with the SEC.

Available Information

We provide our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act on our website at www.haveanicebank.com under the “Investor Relations” section. These filings are made accessible as soon as reasonably practicable after they have been filed electronically with the Securities and Exchange Commission (the “SEC”). These filings are also accessible on the SEC’s website at www.sec.gov. In addition, we make available under the Investor Relations section on our website the following, among other things, (i) Code of Ethics and Whistleblower Policy and (ii) the charters of the Audit, Corporate Governance and Nominating and Compensation and Benefits Committees of our board of directors. These materials are available to the general public on our website free of charge. Printed copies of these materials are also available free of charge to shareholders who request them in writing. Please address your request to: Investor Relations, Attn: William A. Gehman III, Carolina Financial Corporation, 288 Meeting Street, Charleston, South Carolina 29401. Statements of beneficial ownership of equity securities filed by directors, officers, and 10% or greater stockholders under Section 16 of the Exchange Act are also available through our website. The information on our website is not incorporated by reference into this report.

Our Market Area

Our primary market areas are the Coastal, Midlands, and Upstate regions of South Carolina, including the Charleston (Charleston, Dorchester and Berkeley Counties), Myrtle Beach (Horry and Georgetown Counties), Columbia (Richland and Lexington Counties), and the Upstate (Greenville and Spartanburg Counties) market areas. Our primary market areas in North Carolina include Wilmington (New Hanover County), Raleigh-Durham (Durham and Wake Counties), Charlotte-Concord-Gastonia (NC and SC) and the southeastern coastal region of North Carolina (Bladen, Brunswick, Columbus, Cumberland, Duplin and Robeson Counties).

The following table presents, for each of our above-described primary market and reflecting the pro-forma franchise with acquired Carolina Trust branches, the number of branches of CresCom Bank, the approximate amount of deposits in the market areas as of June 30, 2019 and the approximate deposit market share in the market area at June 30, 2019 (the latest date for which such data is available).

	Number of		Deposits		Market
Market Name	Branches		(in millions)		Share
Charleston		8	$	708		4.1	%
Myrtle Beach		8	$	436		4.7	%
Midlands South Carolina		3	$	137		1.6	%
Upstate South Carolina		5	$	315		2.4	%
Inland North Carolina		9	$	320		4.6	%
Coastal North Carolina		4	$	145		6.4	%
Wilmington		3	$	53		0.6	%
Charlotte		12	$	519		3.6	%
Raleigh/Durham		2	$	68		0.1	%
Eastern NC		19	$	627		4.8	%

Our markets in or near Charleston, South Carolina are heavily influenced by the diverse economic mix of the Charleston region. The region is home to the Port of Charleston, one of the busiest container ports along the Southeast and Gulf Coasts, as well as a number of national and international manufacturers, including Boeing South Carolina and Robert Bosch LLC. The region also benefits from a thriving tourism industry. In addition, a number of academic institutions are located within the region, including the Medical University of South Carolina, The Citadel, The College of Charleston, Charleston Southern University, Trident Technical College and The Charleston School of Law. Charleston also hosts military installations for the U.S. Navy, Marine Corps, U.S. Air Force, U.S. Army and U.S. Coast Guard. Data obtained through SNL Financial LC projects population growth in the Charleston-North Charleston MSA of 7.65% from 2020 to 2025.

The Myrtle Beach area, also known as the Grand Strand, is a 60-mile stretch of beaches extending south from the South Carolina/North Carolina state line to Pawley’s Island and is consistently ranked as one of the top vacation destinations in the country. According to data published by the Myrtle Beach Area Chamber of Commerce, Myrtle Beach hosted an estimated over 19 million visitors in 2019 with the economy of the region dominated by the tourism and retail industries. The Myrtle Beach-Conway-North Myrtle Beach MSA is also home to Coastal Carolina University in Conway and Webster University in Myrtle Beach. Data obtained through SNL Financial LC projects population growth in the Myrtle Beach-Conway-North Myrtle Beach MSA of 9.2% from 2020 to 2025.

The Midlands market includes branches in the Columbia, South Carolina market. Columbia, the state capital of South Carolina, is located within Richland County in the center of the state between the Upstate region and the coastal cities of Charleston and Myrtle Beach. Columbia’s central location has contributed greatly to its commercial appeal and growth, and the city benefits from a diverse economy composed of advanced manufacturing, healthcare, technology, shared services, logistics, and energy. The largest employers in the Columbia market area include the U.S. Army’s Fort Jackson, the University of South Carolina, Prisma Health (formerly Palmetto Health Alliance), Blue Cross Blue Shield, and Lexington Medical Center. Data obtained through SNL Financial LC projects population growth in the Columbia MSA of 5.5% from 2020 to 2025.

The Upstate market includes banking locations in the Greenville-Spartanburg market area. Major industries in the Upstate include the automobile industry, which is concentrated primarily along the corridor between Greenville and Spartanburg around the BMW manufacturing facility in Greer, South Carolina. The Greenville Health System and Bon Secours St. Francis Health System represent the healthcare and pharmaceuticals industry in the area. The Upstate is also home to significant private sector and university-based research including research and development facilities for Michelin, Fuji and General Electric and research centers to support the automotive, life sciences, plastics and photonics industries. The Upstate also benefits from being an academic center and is home to collegiate and university education facilities such as Clemson University, Furman University, Presbyterian College, University of South Carolina-Upstate, Anderson University, Lander University, Bob Jones University, Wofford College and Converse College, among others. Data obtained through SNL Financial LC projects population growth in the Greenville-Anderson MSA of 6.1% from 2020 to 2025.

The Raleigh/Durham area is among the most visited of the United States. The largest research park in the United States is situated between Durham and Raleigh and is home to more than 250 companies including IBM, GlaxoSmithKline and Cisco Systems. The area is also home to university and research facilities of Duke University and the University of North Carolina – Chapel Hill. Data obtained through SNL Financial LC projects population growth in the Raleigh-Cary and Durham-Chapel Hill MSAs of 7.7% and 6.2%, respectively, from 2020 to 2025.

Our Wilmington and other markets in southeastern North Carolina are contiguous to South Carolina and the Grand Strand. Wilmington has a diversified economy and is a major resort area and a center for light manufacturing. The city also serves as the retail and medical center for the region. Companies in the Wilmington area produce fiber optic cables for the communications industry, aircraft engine parts, pharmaceuticals, nuclear fuel components and various textile products. According to data published by the Wilmington Chamber of Commerce, major employers in the area include General Electric, PPD, Inc., and Corning, Inc. The area also benefits from the presence of the University of North Carolina-Wilmington, which is also a major employer for the market. Data obtained through SNL Financial LC projects population growth in the Wilmington MSA of 7.1% from 2020 to 2025.

The Charlotte-Concord-Gastonia (NC and SC) market includes branches acquired in the Carolina Trust acquisition that closed on December 31, 2019. The acquisition of Carolina Trust expanded the Company’s footprint to the Charlotte-Concord-Gastonia, NC-SC MSA with 11 banking locations and a loan production office, which complemented the Company’s de novo branch in the Charlotte market. Charlotte is one of the 25 largest cities in the U.S. and is the largest city in North Carolina. Charlotte is home to more than 10 Fortune 1000 companies including Bank of America, Wells Fargo, Belk, Shutterfly, Duke Energy, Lance and Nucor. Data obtained through SNL Financial LC projects population growth in the Charlotte-Concord-Gastonia MSA of 7.0% from 2020 to 2025.

Our markets have experienced steady economic and population growth over the past 10 years, and we expect that the areas, as well as the business and tourism industries needed to support it, will continue to grow.

Competition

The banking business is highly competitive, and we experience competition in our market areas from many other financial institutions. Competition among financial institutions is based on interest rates offered on deposit accounts, interest rates charged on loans, other credit and service charges relating to loans, the quality and scope of the services rendered, the convenience of banking facilities, and, in the case of loans to commercial borrowers, relative lending limits. We compete with commercial banks, credit unions, savings institutions, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds and other mutual funds, as well as super-regional, national and international financial institutions that operate offices in our market areas and elsewhere.

We compete with these institutions both in attracting deposits and in making loans. In addition, we have to attract our customer base from other existing financial institutions and from new residents. Many of our competitors are well-established, larger financial institutions, such as Bank of America, Wells Fargo, PNC and Truist. These institutions offer some services, including extensive and established branch networks, that we do not provide. In addition, many of our non-bank competitors are not subject to the same extensive federal regulations that govern bank holding companies and federally insured banks.

Lending Activities

General. We emphasize a range of lending services, including commercial and residential real estate mortgage loans, real estate construction loans, commercial and industrial loans, commercial leases, and consumer loans. Our customers are generally individuals and small to medium-sized businesses and professional firms that are located in or conduct a substantial portion of their business in our market areas. We have focused our lending activities primarily on the professional market, including small business to medium-sized owners and commercial real estate developers.

Certain credit risks are inherent in making loans. These include prepayment risks, risks resulting from uncertainties in the future value of collateral, risks resulting from changes in economic and industry conditions, and risks inherent in dealing with individual borrowers. We attempt to mitigate repayment risks by adhering to internal credit policies and procedures. These policies and procedures include officer and customer lending limits, with approval processes for larger loans, documentation examination, and follow-up procedures for any exceptions to credit policies. Our loan approval policies provide for various levels of officer lending authority. When the amount of aggregate loans to a single borrower exceeds the maximum senior officer’s lending authority, the loan request will be considered by the management loan committee, or MLC, which is comprised of five members, all of whom are part of the senior management team of the Bank. The MLC meets weekly to approve loans with total loan commitment relationships generally exceeding $2.5 million. The loan authority of the MLC is equal to two-thirds of the legal lending limit of the Bank which is equivalent to the in-house loan limit. Total credit exposure above the in-house limit requires approval by the majority of the board of directors. We do not make any loans to any director, executive officer of the Bank, or the related interests of each, unless the loan is approved by the full Board of Directors of the Bank and is on terms not more favorable than would be available to a person not affiliated with the Bank.

Our lending activities are subject to a variety of lending limits imposed by federal law. In general, the Bank is subject to a legal limit on loans to a single borrower equal to 15% of the Bank’s capital and unimpaired surplus. This legal lending limit will increase or decrease as the Bank’s level of capital increases or decreases. Based upon the capitalization of the Bank at December 31, 2019, the maximum amount we could lend to one borrower was $89.6 million. However, our internal lending limit without board of director approval at December 31, 2019 was $59.7 million. The board of directors will adjust the internal lending limit as deemed necessary to continue to mitigate risk and serve the Bank’s clients. We are able to sell participations in our larger loans to other financial institutions, which allow us to manage the risk involved in these loans and to meet the lending needs of our clients requiring extensions of credit in excess of these limits.

The following is a description of the risk characteristics of the material loan portfolio segments:

Residential Mortgage Loans and Home Equity Loans. We generally originate and hold short-term and long-term first mortgages and traditional second mortgage residential real estate loans. Generally, we limit the loan-to-value ratio on our residential real estate loans to 80%. Loans over 80% LTV generally require private mortgage insurance. We offer fixed and adjustable rate residential real estate loans with terms of up to 30 years. We also offer a variety of lot loan options to consumers to purchase the lot on which they intend to build their home. The options available depend on whether the borrower intends to begin building within 12 months of the lot purchase or at an undetermined future date. We also offer traditional home equity loans and lines of credit. Our underwriting criteria for, and the risks associated with, home equity loans and lines of credit are generally the same as those for first mortgage loans. Home equity loans typically have terms of 10 years or less.

Commercial Real Estate. Commercial real estate loans generally have terms of five years or less, although payments may be structured on a longer amortization basis. We evaluate each borrower on an individual basis and attempt to determine their business risks and credit profile. We attempt to reduce credit risk in the commercial real estate portfolio by emphasizing loans on owner-occupied office and retail buildings where the loan-to-value ratio, established by independent appraisals, generally does not exceed 80%. We also generally require that a borrower’s cash flow exceed 120% of monthly debt service obligations. In order to ensure secondary sources of payment and liquidity to support a loan request, we typically review all of the personal financial statements of the principal owners and require their personal guarantees.

Real Estate Construction and Development Loans. We offer fixed and adjustable rate residential and commercial construction loan financing to builders and developers and to consumers who wish to build their own home. The term of construction and development loans generally is limited to 18 months, although payments may be structured on a longer amortization basis. Most loans will mature and require payment in full upon the sale of the property. We believe that construction and development loans generally carry a higher degree of risk than long-term financing of existing properties because repayment depends on the ultimate completion of the project and usually on the subsequent sale of the property. We attempt to reduce risk associated with construction and development loans by obtaining personal guarantees and by keeping the maximum loan-to-value ratio at or below 65%-80% of the lesser of cost or appraised value, depending on the project type. Generally, we do not have interest reserves built into loan commitments but require periodic cash payments for interest from the borrower’s cash flow.

Commercial Loans. We make loans for commercial purposes in various lines of businesses, including the manufacturing industry, service industry, and professional service areas. Commercial loans are generally considered to have greater risk than first or second mortgages on real estate because they may be unsecured, or if they are secured, the value of the collateral may be difficult to assess and more likely to decrease than real estate.

Equipment loans typically will be made for a term of 10 years or less at fixed or variable rates, with the loan fully amortized over the term and secured by the financed equipment. Generally, we limit the loan-to-value ratio on these loans to 75% of cost. Working capital loans typically have terms not exceeding one year and usually are secured by accounts receivable, inventory, or personal guarantees of the principals of the business. For loans secured by accounts receivable or inventory, principal will typically be repaid as the assets securing the loan are converted into cash, and in other cases principal will typically be due at maturity. Trade letters of credit, standby letters of credit, and foreign exchange will generally be handled through a correspondent bank as agent for the Bank.

The Company’s primary markets are generally concentrated in real estate lending. However, in order to diversify our lending portfolio, the Company purchases nationally syndicated commercial and industrial loans. These loans typically have terms of seven years and are generally tied to a floating rate index such as LIBOR or prime. To effectively manage this line of business, the Company has an experienced senior lending executive who leads a team with relevant experience to manage this area of this segment of the loan portfolio. In addition, the Company engaged a consulting firm that specializes in syndicated loans to assist in monitoring performance analytics. Syndicated loans are grouped within commercial business loans.

The Bank originates leases, primarily on equipment utilized for business purposes with terms that generally range from 12 to 60 months and include options to purchase the leased equipment at the end of the lease. Most leases provide 100% of the cost of the equipment and are secured by the leased equipment. The Company requires the leased equipment to be insured and that we be listed as a loss payee and named as an additional insured on the insurance policy. We manage credit risk associated with our lease financing loan class based upon the dollar amount of the lease and the level of credit risk. We follow a formal review process that entails analysis of the following factors: equipment value/residual value, exposure levels, jurisdiction risk, industry risk, guarantor requirements, and regulatory compliance. As of December 31, 2019 and December 31, 2018, there were approximately $16.8 million and $23.1 million in lease receivables outstanding. Lease receivables are grouped within commercial business loans.

Consumer Loans. We make a variety of loans to individuals for personal and household purposes, including secured and unsecured installment loans and revolving lines of credit. Consumer loans are underwritten based on the borrower’s income, current debt level, past credit history, and the availability and value of collateral. Consumer rates are both fixed and variable, with negotiable terms. Our installment loans typically amortize over periods up to 72 months. Although we typically require monthly payments of interest and a portion of the principal on our loan products, we will offer consumer loans with a single maturity date when a specific source of repayment is available. Consumer loans are generally considered to have greater risk than first or second mortgages on real estate because they may be unsecured, or, if they are secured, the value of the collateral may be difficult to assess and more likely to decrease in value than real estate.

Mortgage Operations

Mortgage Activities and Servicing. Our correspondent/wholesale mortgage banking operations are conducted through our mortgage origination subsidiary, Crescent Mortgage Company. Mortgage activities involve the purchase of mortgage loans and table funded originations for the purpose of generating gains on sales of loans and fee income on the origination of loans and is included in mortgage banking income in the accompanying consolidated statements of operations. While the Company originates residential one-to-four family loans that are held in its loan portfolio, the majority of new loans are generally sold pursuant to third-party market guidelines through Crescent Mortgage Company. Generally, residential mortgage loans are sold and, depending on the pricing in the marketplace, servicing rights are either sold or retained. The level of loan sale activity and its contribution to the Company’s profitability depends on maintaining a sufficient volume of loan originations and margin. Changes in the level of interest rates and the local economy affect the volume of loans originated by the Company and the amount of loan sales and loan fees earned.

Loan Servicing. We retain the rights to service a portion of the loans we sell on the third-party market, as part of our mortgage banking activities, for which we receive service fee income. In addition, at certain times we may purchase rights to service from third parties. These rights are known as mortgage servicing rights, or MSRs, where the owner of the MSR acts on behalf of the mortgage loan owner and has the contractual right to receive a stream of cash flows in exchange for performing specified mortgage servicing functions. These duties typically include, but are not limited to, performing loan administration, collection, and default activities, including the collection and remittance of loan payments, responding to customer inquiries, accounting for principal and interest, holding custodial (impound) funds for the payment of property taxes and insurance premiums, counseling delinquent mortgagors, modifying loans and supervising foreclosures and property dispositions. We subservice the duties and responsibilities obligated to the owner of the MSR to a third party provider for which we pay a fee.

Deposit Products

We provide a range of deposit services, including noninterest-bearing demand accounts, interest-bearing demand and savings accounts, money market accounts and time deposits. These accounts generally pay interest at rates established by management based on competitive market factors and management’s desire to increase or decrease certain types or maturities of deposits. Deposits continue to be our primary funding source. At December 31, 2019, deposits totaled $3.4 billion, an increase from deposits of $2.7 billion at December 31, 2018. Excluding the impact of deposits acquired from Carolina Trust, deposits increased $152.4 million since December 31, 2018. The increase in deposits since December 31, 2018 relates to continued efforts to fund our balance sheet growth with core deposits through business development.

Emerging Growth Company

On December 31, 2018, our status as an “emerging growth company”, as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), terminated because the market value of our common stock held by non-affiliates exceeded $700 million on June 30, 2018. As an “emerging growth company,” we took advantage of some reduced disclosure and other requirements that were otherwise applicable generally to public companies. With the filing of the 2018 Form 10-K, we began providing the information required from “large accelerated filers” as defined in Rule 12b-2 under the Exchange Act in periodic reports required under the Exchange Act. As a result, the information that we provided to our stockholders prior to the 2018 Form 10-K may be different from the information provided by other public reporting companies.

Employees

As of February 20, 2020, we had 880 total employees, including 836 full-time employees.

SUPERVISION AND REGULATION

Both the Company and the Bank are subject to extensive state and federal banking laws and regulations that impose restrictions on and provide for general regulatory oversight of their operations. These laws and regulations generally are intended to protect consumers and depositors and not stockholders. The following summary is qualified by reference to the statutory and regulatory provisions discussed. Changes in applicable laws or regulations may have a material effect on our business and prospects. Our operations may be affected by legislative changes and the policies of various regulatory authorities. We cannot predict the effect that fiscal or monetary policies, economic control or new federal or state legislation may have on our business and earnings in the future.

The following discussion is not intended to be a complete list of all the activities regulated by the banking laws or of the impact of those laws and regulations on our operations. It is intended only to briefly summarize some material provisions.

Recent Legislative and Regulatory Initiatives

Banking statutes, regulations and policies are continually under review by Congress, state legislatures and federal and state regulatory agencies. In addition to laws and regulations, state and federal bank regulatory agencies may issue policy statements, interpretive letters and similar written guidance applicable to the Company and its subsidiaries. Any change in the statutes, regulations and regulatory policies applicable to us, including changes in their interpretation or implementation, could have a material effect on our business and organization.

Both the scope of the laws and regulations and the intensity of supervision to which we are subject have increased in recent years in response to the financial crisis, as well as other factors such as technological and market changes. Regulatory enforcement and fines have also increased across the banking and financial services sector. Many of these changes have occurred as a result of the Dodd-Frank Act and its implementing regulations, most of which are now in place. The Company expects that its business will remain subject to extensive regulation and supervision.

The Dodd-Frank Wall Street Reform and Consumer Protection Act

The Dodd-Frank Wall Street Reform and Consumer Protection Act which was signed into law in 2010 (the “Dodd-Frank Act”), among other things, changes the oversight and supervision of financial institutions, includes new minimum capital requirements, creates a new federal agency to regulate consumer financial products and services and implements changes to corporate governance and compensation practices. The Dodd-Frank Act is focused in large part on the financial services industry, and contains a number of provisions that will affect us, including:

Minimum Leverage and Risk-Based Capital Requirements. Under the Dodd-Frank Act, the Federal banking agencies are required to establish minimum leverage and risk-based capital requirements on a consolidated basis for all insured depository institutions and bank holding companies, which can be no less than the currently applicable leverage and risk-based capital requirements for depository institutions. As a result, the Bank will be subject to at least the same capital requirements and must include the same components in regulatory capital.

Deposit Insurance Modifications. The Dodd-Frank Act modified the FDIC’s assessment base upon which deposit insurance premiums are calculated. The new assessment base equals our average total consolidated assets minus the sum of our average tangible equity during the assessment period. The Dodd-Frank Act also permanently raised the standard maximum insurance amount to $250,000.

Creation of New Governmental Authorities. The Dodd-Frank Act created various new governmental authorities such as the Financial Stability Oversight Council and the Consumer Financial Protection Bureau (the “CFPB”), an independent regulatory authority housed within the Board of Governors of the Federal Reserve System (the “Federal Reserve”). The CFPB has broad authority to regulate the offering and provision of consumer financial products. The CFPB officially came into being on July 21, 2011, and rulemaking authority for a range of consumer financial protection laws (such as the Truth in Lending Act, the Electronic Funds Transfer Act and the Real Estate Settlement Procedures Act, among others) transferred from the Federal Reserve and other federal regulators to the CFPB on that date. The Dodd-Frank Act gives the CFPB authority to supervise and examine depository institutions with more than $10 billion in assets for compliance with these federal consumer laws. The authority to supervise and examine depository institutions with $10 billion or less in assets for compliance with federal consumer laws will remain largely with those institutions’ primary regulators. However, the CFPB may participate in examinations of these smaller institutions on a “sampling basis” and may refer potential enforcement actions against such institutions to their primary regulators. The CFPB also has supervisory and examination authority over certain nonbank institutions that offer consumer financial products. The Dodd-Frank Act identifies a number of covered nonbank institutions, and also authorizes the CFPB to identify additional institutions that will be subject to its jurisdiction. Accordingly, the CFPB may participate in examinations of the Bank, which currently has assets of less than $10 billion, and could supervise and examine our other direct or indirect subsidiaries that offer consumer financial products or services. In addition, the Dodd-Frank Act permits states to adopt consumer protection laws and regulations that are stricter than those regulations promulgated by the CFPB, and state attorneys general are permitted to enforce consumer protection rules adopted by the CFPB against certain institutions.

The Dodd-Frank Act also authorized the CFPB to establish certain minimum standards for the origination of residential mortgages, including a determination of the borrower’s ability to repay. Under the Dodd-Frank Act, financial institutions may not make a residential mortgage loan unless they make a “reasonable and good faith determination” that the consumer has a “reasonable ability” to repay the loan. The Dodd-Frank Act allows borrowers to raise certain defenses to foreclosure but provides a full or partial safe harbor from such defenses for loans that are “qualified mortgages.” On January 10, 2013, the CFPB published final rules to, among other things, specify the types of income and assets that may be considered in the ability-to-repay determination, the permissible sources for verification, and the required methods of calculating the loan’s monthly payments. Since then the CFPB made certain modifications to these rules. The rules extend the requirement that creditors verify and document a borrower’s “income and assets” to include all “information” that creditors rely on in determining repayment ability. The rules also provide further examples of third-party documents that may be relied on for such verification, such as government records and check-cashing or funds-transfer service receipts. The rules took effect January 10, 2014. The rules also define “qualified mortgages,” imposing both underwriting standards - for example, a borrower’s debt-to-income ratio may not exceed 43% - and limits on the terms of their loans. Points and fees are subject to a relatively stringent cap, and the terms include a wide array of payments that may be made in the course of closing a loan. Certain loans, including interest-only loans and negative amortization loans, cannot be qualified mortgages.

Executive Compensation and Corporate Governance Requirements. The Dodd-Frank Act requires public companies to include, at least once every three years, a separate non-binding “say on pay” vote in their proxy statement by which stockholders may vote on the compensation of the company’s named executive officers. In addition, if such companies are involved in a merger, acquisition, or consolidation, or if they propose to sell or dispose of all or substantially all of their assets, stockholders have a right to an advisory vote on any golden parachute arrangements in connection with such transaction (frequently referred to as “say-on-golden parachute” vote). Other provisions of the Dodd-Frank Act may impact our corporate governance. For instance, the Dodd-Frank Act requires the SEC to adopt rules:

	·	prohibiting the listing of any equity security of a company that does not have an independent compensation committee; and
	·	requiring all exchange-traded companies to adopt claw-back policies for incentive compensation paid to executive officers in the event of accounting restatements based on material non-compliance with financial reporting requirements.

The Dodd-Frank Act also authorizes the SEC to issue rules allowing stockholders to include their own nominations for directors in a company’s proxy solicitation materials. Many provisions of the Dodd-Frank Act require the adoption of additional rules to implement the changes. In addition, the Dodd-Frank Act mandates multiple studies that could result in additional legislative action. Governmental intervention and new regulations under these programs could materially and adversely affect our business, financial condition and results of operations.

Regulatory Capital Requirements

Regulatory capital rules released by the federal bank regulatory agencies in July 2013 and fully-phased in as of January 1, 2019, referred to as Basel III, impose higher minimum capital requirements for bank holding companies and banks. The Basel III rules apply to all national and state banks and savings associations regardless of size and bank holding companies and savings and loan holding companies with more than $1 billion in total consolidated assets. We collectively refer to these organizations herein as “covered” banking organizations. In certain respects, the rules impose more stringent requirements on “advanced approaches” banking organizations—those organizations with $250 billion or more in total consolidated assets, $10 billion or more in total foreign exposures, or that have opted in to the Basel II capital regime.

Specifically, we are required to maintain the following minimum capital levels:

	·	a Common Equity Tier 1 (“CET1”) risk-based capital ratio of 4.5%;
	·	a Tier 1 risk-based capital ratio of 6%;
	·	a total risk-based capital ratio of 8%; and
	·	a leverage ratio of 4%.

Under Basel III, Tier 1 capital is redefined to include two components: CET1 capital and additional Tier 1 capital. The new and highest form of capital, CET1 capital, consists solely of common stock (plus related surplus), retained earnings, accumulated other comprehensive income, and limited amounts of minority interests that are in the form of common stock. Additional Tier 1 capital is primarily comprised of non-cumulative perpetual preferred stock, Tier 1 minority interests and grandfathered trust preferred securities. The rules permit bank holding companies with less than $15 billion in total consolidated assets to continue to include trust preferred securities and cumulative perpetual preferred stock issued before May 19, 2010 in Tier 1 capital, but not in CET1 capital, subject to certain restrictions. Tier 2 capital generally includes the allowance for loan losses up to 1.25% of risk-weighted assets, qualifying preferred stock, subordinated debt and qualifying Tier 2 minority interests, less any deductions in Tier 2 instruments of an unconsolidated financial institution. Cumulative perpetual preferred stock is included only in Tier 2 capital. Accumulated other comprehensive income (“AOCI”) is presumptively included in CET1 capital and often would operate to reduce this category of capital. The rules provided for a one-time opportunity at the end of the first quarter of 2015 for covered banking organization to opt-out of much of this treatment of AOCI. We made this opt-out election and, as a result, will retain the pre-existing treatment for AOCI.

In addition, in order to avoid restrictions on capital distributions or discretionary bonus payments to executives, a covered banking organization must maintain a “capital conservation buffer” on top of its minimum risk-based capital requirements. This buffer must consist solely of Tier 1 common equity, but the buffer applies to all three measurements (CET1 capital, Tier 1 capital and total capital). The capital conservation buffer was phased in incrementally over time, becoming fully effective on January 1, 2019, and consists of an additional amount of common equity equal to 2.5% of risk-based assets.

On December 21, 2018, the federal banking agencies issued a joint final rule to revise their regulatory capital rules to (i) address the upcoming implementation of a new credit impairment model, the Current Expected Credit Loss, or CECL model, and accounting standard under GAAP; (ii) provide an optional three-year phase-in period for the day-one adverse regulatory capital effects that banking organizations are expected to experience upon adopting CECL; and (iii) reduce the use of CECL in stress tests beginning with the 2020 capital planning and stress testing cycle for certain banking organizations that are subject to stress testing. We expect to recognize a one-time cumulative-effect adjustment to our allowance for loan losses as of the beginning of the first quarter of 2020, the first reporting period in which the new standard is effective.

In November 2019, the federal banking regulators published final rules implementing a simplified measure of capital adequacy for certain banking organizations that have less than $10 billion in total consolidated assets. Under the final rules, which went into effect on January 1, 2020, depository institutions and depository institution holding companies that have less than $10 billion in total consolidated assets and meet other qualifying criteria, including a leverage ratio of greater than 8%, off-balance-sheet exposures of 25% or less of total consolidated assets and trading assets plus trading liabilities of 5% or less of total consolidated assets, are deemed “qualifying community banking organizations” and are eligible to opt into the “community bank leverage ratio framework.” A qualifying community banking organization that elects to use the community bank leverage ratio framework and that maintains a leverage ratio of greater than 9% is considered to have satisfied the generally applicable risk-based and leverage capital requirements under the Basel III rules and, if applicable, is considered to have met the “well capitalized” ratio requirements for purposes of its primary federal regulator’s prompt corrective action rules, discussed below. The final rules include a two-quarter grace period during which a qualifying community banking organization that temporarily fails to meet any of the qualifying criteria, including the greater-than-9% leverage ratio requirement, is generally still deemed “well capitalized” so long as the banking organization maintains a leverage capital ratio greater than 8%. A banking organization that fails to maintain a leverage capital ratio greater than 8% is not permitted to use the grace period and must comply with the generally applicable requirements under the Basel III rules and file the appropriate regulatory reports. We do not have any immediate plans to elect to use the community bank leverage ratio framework but may make such an election in the future.

Volcker Rule

Section 619 of the Dodd-Frank Act, known as the “Volcker Rule,” prohibits any bank, bank holding company, or affiliate (referred to collectively as “banking entities”) from engaging in two types of activities: “proprietary trading” and the ownership or sponsorship of private equity or hedge funds that are referred to as “covered funds.” Proprietary trading includes the purchase or sale of principal of any security, derivative, commodity future, or option on any such instrument for the purpose of benefitting from short-term price movements or realizing short-term profits. In December 2013, our primary federal regulators, the Federal Reserve and the FDIC, together with other federal banking agencies and the SEC and the Commodity Futures Trading Commission, finalized a regulation to implement the Volcker Rule.

Exceptions apply, however. Trading in U.S. Treasuries, obligations or other instruments issued by a government sponsored enterprise, state or municipal obligations, or obligations of the FDIC is permitted. A banking entity also may trade for the purpose of managing its liquidity, provided that it has a bona fide liquidity management plan. Trading activities as agent, broker or custodian; through a deferred compensation or pension plan; as trustee or fiduciary on behalf of customers; in order to satisfy a debt previously contracted; or in repurchase and securities lending agreements are permitted. Additionally, the Volcker Rule permits banking entities to engage in trading that takes the form of risk-mitigating hedging activities.

The covered funds that a banking entity may not sponsor or hold an ownership interest in are, with certain exceptions, funds that are exempt from registration under the Investment Company Act of 1940 because they either have 100 or fewer investors or are owned exclusively by “qualified investors” (generally, high net worth individuals or entities). Wholly-owned subsidiaries, joint ventures and acquisition vehicles, foreign pension or retirement funds, insurance company separate accounts (including bank-owned life insurance), public welfare investment funds, and entities formed by the FDIC for the purpose of disposing of assets are not covered funds, and a bank may invest in them. Most securitizations also are not treated as covered funds.

As issued on December 10, 2013, the regulation treated collateralized debt obligations backed by trust preferred securities as covered funds and accordingly subject to divestiture. In an interim final rule issued on January 14, 2014, the agencies exempted collateralized debt obligations, or CDOs, issued before May 19, 2010, that were backed by trust preferred securities issued before the same date by a bank with total consolidated assets of less than $15 billion or by a mutual holding company, and that the bank holding the CDO interest had purchased before December 10, 2013, from the Volcker Rule prohibition. This exemption does not extend to CDOs backed by trust-preferred securities issued by an insurance company.

Tax Cuts and Jobs Act

On December 22, 2017, the Tax Cuts and Jobs Act (the “Tax Act”) was signed into law. The Tax Act includes a number of provisions that impact us, including the following:

Tax Rate. The Tax Act replaces the graduated corporate tax rates applicable under prior law, which imposed a maximum tax rate of 35%, with a reduced 21% flat tax rate. Although the reduced tax rate generally should be favorable to us by resulting in increased earnings and capital, it will decrease the value of our existing deferred tax assets. Generally accepted accounting principles (“GAAP”) require that the impact of the provisions of the Tax Act be accounted for in the period of enactment. Accordingly, the Company’s net income for the year ended December 31, 2017 was reduced by approximately $239,000, primarily due to a lower valuation of deferred income taxes. See “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operation – Results of Operations – Income Tax Expense.”

Employee Compensation. A “publicly held corporation” is not permitted to deduct compensation in excess of $1 million per year paid to certain employees. The Tax Act eliminates certain exceptions to the $1 million limit applicable under prior to law related to performance-based compensation, such as equity grants and cash bonuses that are paid only on the attainment of performance goals. As a result, our ability to deduct certain compensation that may be paid to our most highly compensated employees will now be limited.

Business Asset Expensing. The Tax Act allows taxpayers immediately to expense the entire cost (instead of only 50%, as under prior law) of certain depreciable tangible property and real property improvements acquired and placed in service after September 27, 2017 and before January 1, 2023 (with an additional year for certain property). This 100% “bonus” depreciation is phased out proportionately for property placed in service on or after January 1, 2023 and before January 1, 2027 (with an additional year for certain property).

Interest Expense. The Tax Act limits a taxpayer’s annual deduction of business interest expense to the sum of (i) business interest income and (ii) 30% of “adjusted taxable income,” defined as a business’s taxable income without taking into account business interest income or expense, net operating losses, and, for 2018 through 2021, depreciation, amortization and depletion. Because we generate significant amounts of net interest income, we do not expect to be impacted by this limitation.

Proposed Legislation and Regulatory Action

From time to time, various legislative and regulatory initiatives are introduced in Congress and state legislatures, as well as by regulatory agencies. Such initiatives may include proposals to expand or contract the powers of bank holding companies and depository institutions or proposals to substantially change the financial institution regulatory system. Such legislation could change banking statutes and the operating environment of the Company in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. We cannot predict whether any such legislation will be enacted, and, if enacted, the effect that it, or any implementing regulations, would have on the financial condition or results of operations of the Company. A change in statutes, regulations or regulatory policies applicable to the Company or the Bank could have a material effect on the business of the Company.

On May 24, 2018, President Trump signed into law the “Economic Growth, Regulatory Relief and Consumer Protection Act” (the “Regulatory Relief Act”), which amends parts of the Dodd-Frank Act, as well as other laws that involve regulation of the financial industry. While the Regulatory Relief Act keeps in place fundamental aspects of the Dodd-Frank Act’s regulatory framework, it does change the regulatory framework for depository institutions with assets under $10 billion, such as the Bank, and for large depository institutions with assets over $50 billion. The legislation includes a number of provisions which are favorable to bank holding companies with total consolidated assets of less than $10 billion, such as the Company, and also makes changes to consumer mortgage and credit reporting regulations and to the authorities of the agencies that regulate the financial industry. A number of the provisions included in the Regulatory Relief Act require the federal banking agencies to either promulgate regulations or amend existing regulations, and it will likely take some time for these agencies to implement the necessary changes.

The following is a brief summary of select provisions of the Regulatory Relief Act.

Modified Process for Designating Systemically Important Financial Institutions. The Regulatory Relief Act changes which bank holding companies will be designated as a systemically important financial institution (“SIFI”). Prior to passage of the Regulatory Relief Act, all bank holding companies with assets exceeding $50 billion were automatically designated as SIFIs and were subject to the enhanced prudential standards (“EPS”) of the Dodd-Frank Act, which required these bank holding companies to undergo special stress tests, develop resolution plans, and maintain certain levels of liquidity and financial capacity to absorb losses. The Regulatory Relief Act raised the $50 billion SIFI threshold to $250 billion, but staggered the application of this change for certain institutions, based on size. Upon enactment, bank holding companies with total consolidated assets of less than $100 billion are no longer subject to the EPS of the Dodd-Frank Act. Bank holding companies with total consolidated assets of more than $100 billion but less than $250 billion will no longer be subject to such requirements, beginning 18 months after the date of enactment. Because the Regulatory Relief Act does not amend the regulations that the federal banking agencies have promulgated to implement the EPS, it will likely take some time for these agencies to amend their regulations to account for the new thresholds included in the Regulatory Relief Act.

Many of the changes in the Regulatory Relief Act amend provisions of Dodd-Frank Act that apply at the bank holding company level, but not to subsidiary national banks or other insured depository institutions. The Office of the Comptroller of the Currency, or the OCC, and the FDIC have adopted their own counterparts to some EPS for the bank subsidiaries that they regulate, including recovery and resolution planning. The OCC and the FDIC will need to address whether they intend to take similar measures under their regulations and guidance to align asset thresholds with what is reflected in the Regulatory Relief Act.

Provisions that are Favorable to Regional Banks. There are a number of provisions in the Regulatory Relief Act that will have a favorable impact on community banks such as the Bank. These are briefly referenced below.

Elimination of Company-Run Stress Tests. The Regulatory Relief Act exempts all banking organizations with less than $250 billion in total consolidated assets from the current requirement to conduct company-run stress tests.

Increase in Asset Threshold for Requirement to Establish a Risk Committee. The Regulatory Relief Act raises the asset threshold for the requirement that a publicly-traded bank holding company establish a risk committee from $10 billion to $50 billion or more in total consolidated assets.

Short Form Call Reports. The Regulatory Relief Act requires the federal banking agencies to promulgate regulations allowing an insured depository institution with less than $5 billion in total consolidated assets (and that satisfies such other criteria as determined to be appropriate by the agencies) to submit a short-form call report for its first and third quarters of a calendar year.

Consumer Protection Enhancements. The Regulatory Relief Act includes various provisions to address consumer protection challenges facing the credit reporting industry and borrowers in certain credit markets, specifically markets including active duty service members, veterans, and student loan borrowers. The Regulatory Relief Act subjects credit reporting agencies to additional requirements, including requirements to generally provide fraud alerts for consumer files for at least one year and to allow consumers to place security freezes on their credit reports. The Regulatory Relief Act also allows consumers to request that information related to a default on a qualified private student loan be removed from a credit report if the borrower satisfies the requirements of a loan rehabilitation program offered by a private lender. The Regulatory Relief Act prohibits lenders from declaring automatic default in the case of death or bankruptcy of the co-signer of a student loan and requires lenders to release cosigners from obligations related to a student loan in the event of the death of the student borrower. In addition, credit reporting agencies will be required to exclude certain medical debt from veterans’ credit reports.

Carolina Financial Corporation

The Company owns 100% of the outstanding capital stock of the Bank, and therefore is required to be and is registered as a bank holding company under the federal Bank Holding Company Act of 1956 (the “BHCA”). As a result, the Company is primarily subject to the supervision, examination and reporting requirements of the Federal Reserve under the BHCA and its regulations promulgated thereunder. Moreover, as a bank holding company of a bank located in South Carolina, the Company also is subject to the South Carolina Banking and Branching Efficiency Act.

Permitted Activities. Under the BHCA, a bank holding company is generally permitted to engage in, or acquire direct or indirect control of more than 5% of the voting shares of any company engaged in the following activities:

	·	banking or managing or controlling banks;
	·	furnishing services to or performing services for our subsidiaries; and
	·	any activity that the Federal Reserve determines to be so closely related to banking as to be a proper incident to the business of banking.

Activities that the Federal Reserve has found to be so closely related to banking as to be a proper incident to the business of banking include:

	·	factoring accounts receivable;
	·	making, acquiring, brokering or servicing loans and usual related activities;
	·	leasing personal or real property;
	·	operating a non-bank depository institution, such as a savings association;
	·	trust company functions;
	·	financial and investment advisory activities;
	·	conducting discount securities brokerage activities;
	·	underwriting and dealing in government obligations and money market instruments;
	·	providing specified management consulting and counseling activities;
	·	performing selected data processing services and support services;
	·	acting as agent or broker in selling credit life insurance and other types of insurance in connection with credit transactions; and
	·	performing selected insurance underwriting activities.

A bank holding company that meets specified conditions, including that its depository institutions subsidiaries are “well capitalized” and “well managed,” can opt to become a “financial holding company.” On June 20, 2017, an election submitted by the Company to become a financial holding company was declared effective by the Federal Reserve Bank of Richmond. As a financial holding company, we are now permitted to engage in a broader array of activities that are financial in nature or incidental or complimentary to financial activities, including insurance underwriting, sales and brokerage activities, providing financial and investment advisory services, underwriting services and limited merchant banking activities.

The Federal Reserve has the authority to order a bank holding company or its subsidiaries to terminate any of these activities or to terminate its ownership or control of any subsidiary when it has reasonable cause to believe that the bank holding company’s continued ownership, activity or control constitutes a serious risk to the financial safety, soundness or stability of it or any of its bank subsidiaries.

Change in Control. Two statutes, the BHCA and the Change in Bank Control Act (the “CBCA”), together with regulations promulgated under them, require some form of regulatory review before any company may acquire “control” of a bank or a bank holding company. Under the BHCA, control is deemed to exist if a company acquires 25% or more of any class of voting securities of a bank holding company; controls the election of a majority of the members of the board of directors; or exercises a controlling influence over the management or policies of a bank or bank holding company. In guidance issued in 2008, the Federal Reserve has stated that it would not expect control to exist if a person acquires, in aggregate, less than 33% of the total equity of a bank or bank holding company (voting and nonvoting equity), provided such person’s ownership does not include 15% or more of any class of voting securities. Prior Federal Reserve approval is necessary before an entity acquires sufficient control to become a bank holding company. Natural persons, certain non-business trusts, and other entities are not treated as companies (or bank holding companies), and their acquisitions are not subject to review under the BHCA. State laws generally, including South Carolina law, require state approval before an acquirer may become the holding company of a state bank.

Under the CBCA, a person or company is required to file a notice with the Federal Reserve if it will, as a result of the transaction, own or control 10% or more of any class of voting securities or direct the management or policies of a bank or bank holding company and either if the bank or bank holding company has registered securities or if the acquirer would be the largest holder of that class of voting securities after the acquisition. For a change in control at the holding company level, both the Federal Reserve and the subsidiary bank’s primary federal regulator must approve the change in control; at the bank level, only the bank’s primary federal regulator is involved. Transactions subject to the BHCA are exempt from CBCA requirements. For state banks, state laws, including that of South Carolina, typically require approval by the state bank regulator as well.

Source of Strength. There are a number of obligations and restrictions imposed by law and regulatory policy on bank holding companies with regard to their depository institution subsidiaries that are designed to minimize potential loss to depositors and to the FDIC insurance funds in the event that the depository institution becomes in danger of defaulting under its obligations to repay deposits. In accordance with Federal Reserve policy, the Company is required to act as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances in which it might not otherwise do so. Under the Federal Deposit Insurance Corporate Improvement Act of 1991, or FDICIA, to avoid receivership of its insured depository institution subsidiary, a bank holding company is required to guarantee the compliance of any insured depository institution subsidiary that may become “undercapitalized” within the terms of any capital restoration plan filed by such subsidiary with its appropriate federal banking agency up to the lesser of (i) an amount equal to 5% of the institution’s total assets at the time the institution became undercapitalized, or (ii) the amount which is necessary (or would have been necessary) to bring the institution into compliance with all applicable capital standards as of the time the institution fails to comply with such capital restoration plan.

Under the BHCA, the Federal Reserve may require a bank holding company to terminate any activity or relinquish control of a non-bank subsidiary, other than a non-bank subsidiary of a bank, upon the Federal Reserve’s determination that such activity or control constitutes a serious risk to the financial soundness or stability of any depository institution subsidiary of a bank holding company. Further, federal bank regulatory authorities have additional discretion to require a bank holding company to divest itself of any bank or non-bank subsidiaries if the agency determines that divestiture may aid the depository institution’s financial condition.

In addition, the “cross guarantee” provisions of the Federal Deposit Insurance Act, (“FDIA”), require insured depository institutions under common control to reimburse the FDIC for any loss suffered or reasonably anticipated by the FDIC as a result of the default of a commonly controlled insured depository institution or for any assistance provided by the FDIC to a commonly controlled insured depository institution in danger of default. The FDIC’s claim for damages is superior to claims of stockholders of the insured depository institution or its holding company, but is subordinate to claims of depositors, secured creditors and holders of subordinated debt (other than affiliates) of the commonly controlled insured depository institutions.

The FDIA also provides that amounts received from the liquidation or other resolution of any insured depository institution by any receiver must be distributed (after payment of secured claims) to pay the deposit liabilities of the institution prior to payment of any other general or unsecured senior liability, subordinated liability, general creditor or stockholder. This provision would give depositors a preference over general and subordinated creditors and stockholders in the event a receiver is appointed to distribute the assets of the Bank.

Further, any capital loans by a bank holding company to a subsidiary bank are subordinate in right of payment to deposits and certain other indebtedness of the subsidiary bank. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank at a certain level would be assumed by the bankruptcy trustee and entitled to priority payment.

Capital Requirements. The Federal Reserve imposes certain capital requirements on the bank holding company under the BHCA, including a minimum leverage ratio and a minimum ratio of “qualifying” capital to risk-weighted assets. These requirements are essentially the same as those that apply to the Bank and are described below under “CresCom Bank.” Subject to our capital requirements and certain other restrictions, we are able to borrow money to make a capital contribution to the Bank, and these loans may be repaid from dividends paid from the Bank to the Company. We are also able to raise capital for contribution to the Bank by issuing securities without having to receive regulatory approval, subject to compliance with federal and state securities laws.

Dividends. Since the Company is a bank holding company, its ability to declare and pay dividends is dependent on certain federal and state regulatory considerations, including the guidelines of the Federal Reserve. The Federal Reserve has issued a policy statement regarding the payment of dividends by bank holding companies. In general, the Federal Reserve’s policies provide that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the bank holding company appears consistent with the organization’s capital needs, asset quality, and overall financial condition. The Federal Reserve’s policies also require that a bank holding company serve as a source of financial strength to its subsidiary banks by standing ready to use available resources to provide adequate capital funds to those banks during periods of financial stress or adversity and by maintaining the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks where necessary. Further, under the prompt corrective action regulations, the ability of a bank holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized. These regulatory policies could affect the ability of the Company to pay dividends or otherwise engage in capital distributions.

In addition, since the Company is a legal entity separate and distinct from the Bank and does not conduct stand-alone operations, its ability to pay dividends depends on the ability of the Bank to pay dividends to it, which is also subject to regulatory restrictions as described below in “CresCom Bank – Dividends.”

South Carolina State Regulation. As a South Carolina bank holding company under the South Carolina Banking and Branching Efficiency Act, we are subject to limitations on sale or merger and to regulation by the South Carolina Board of Financial Institutions (the “SCBFI”). We are not required to obtain the approval of the SCBFI prior to acquiring the capital stock of a national bank, but we must notify them at least 15 days prior to doing so. We must obtain approval from the SCBFI prior to engaging in the acquisition of branches, a South Carolina state chartered bank, or another South Carolina bank holding company.

CresCom Bank

The Bank’s primary federal regulator is the FDIC. In addition, the Bank is regulated and examined by the SCBFI. Deposits in the Bank are insured by the FDIC up to a maximum amount of $250,000 per depositor, per ownership category, pursuant to the provisions of the Dodd-Frank Act.

The SCBFI and the FDIC regulate or monitor virtually all areas of the Bank’s operations, including:

	·	security devices and procedures;
	·	adequacy of capitalization and loss reserves;
	·	loans;
	·	investments;
	·	borrowings;
	·	deposits;
	·	mergers;
	·	issuances of securities;
	·	payment of dividends;
	·	interest rates payable on deposits;
	·	interest rates or fees chargeable on loans;
	·	establishment of branches;
	·	corporate reorganizations;
	·	maintenance of books and records; and
	·	adequacy of staff training to carry on safe lending and deposit gathering practices.

These agencies, and the federal and state laws applicable to the Bank’s operations, extensively regulate various aspects of our banking business, including among other things, permissible types and amounts of loans, investments, and other activities, capital adequacy, branching, interest rates on loans and deposits, maintenance of reserves and the safety and soundness of our banking practices. See additional discussion related to Basel III above.

All insured institutions must undergo regular on-site examinations by their appropriate banking agency. The cost of examinations of insured depository institutions and any affiliates may be assessed by the appropriate federal banking agency against each institution or affiliate as it deems necessary or appropriate. Insured institutions are required to submit annual reports to the FDIC, their federal regulatory agency, and state supervisor when applicable. The FDIC has developed a method for insured depository institutions to provide supplemental disclosure of the estimated fair market value of assets and liabilities, to the extent feasible and practicable, in any balance sheet, financial statement, report of condition or any other report of any insured depository institution. The federal banking regulatory agencies prescribe, by regulation, standards for all insured depository institutions and depository institution holding companies relating, among other things, to the following:

	·	internal controls;
	·	information systems and audit systems;
	·	loan documentation;
	·	credit underwriting;
	·	interest rate risk exposure; and
	·	asset quality.

Prompt Corrective Action. As an insured depository institution, the Bank is required to comply with the capital requirements promulgated under the Federal Deposit Insurance Act and the prompt corrective action regulations thereunder, which set forth five capital categories, each with specific regulatory consequences. Under these regulations, the categories are:

	·	Well Capitalized — The institution exceeds the required minimum level for each relevant capital measure. A well capitalized institution (i) has a total risk-based capital ratio of 10% or greater, (ii) has a Tier 1 risk-based capital ratio of 8% or greater, (iii) has a CET 1 risk-based capital ratio of 6.5% or greater, (iv) has a leverage ratio of 5% or greater, and (v) is not subject to any order or written directive to meet and maintain a specific capital level for any capital measure.
	·	Adequately Capitalized — The institution meets the required minimum level for each relevant capital measure. No capital distribution may be made that would result in the institution becoming undercapitalized. An adequately capitalized institution (i) has a total risk-based capital ratio of 8% or greater, (ii) has a Tier 1 risk-based capital ratio of 6% or greater, (iii) has a CET 1 risk-based capital ratio of 4.5% or greater, and (iv) has a leverage ratio of 4% or greater.
	·	Undercapitalized — The institution fails to meet the required minimum level for any relevant capital measure. An undercapitalized institution (i) has a total risk-based capital ratio of less than 8%, (ii) has a Tier 1 risk-based capital ratio of less than 6%, (iii) has a CET 1 risk-based capital ratio of less than 4.5%, or (iv) has a leverage ratio of less than 4%.
	·	Significantly Undercapitalized — The institution is significantly below the required minimum level for any relevant capital measure. A significantly undercapitalized institution (i) has a total risk-based capital ratio of less than 6%, (ii) has a Tier 1 risk-based capital ratio of less than 4%, (iii) has a CET 1 risk-based capital ratio of less than 3%, or (iv) has a leverage ratio of less than 3%.
	·	Critically Undercapitalized — The institution fails to meet a critical capital level set by the appropriate federal banking agency. A critically undercapitalized institution has a ratio of tangible equity to total assets that is equal to or less than 2%.

If the applicable federal regulator determines, after notice and an opportunity for hearing, that the institution is in an unsafe or unsound condition, the regulator is authorized to reclassify the institution to the next lower capital category.

If the FDIC determines, after notice and an opportunity for hearing, that a bank is in an unsafe or unsound condition, the regulator is authorized to reclassify the bank to the next lower capital category (other than critically undercapitalized) and require the submission of a plan to correct the unsafe or unsound condition.

If a bank is not well capitalized, it cannot accept brokered deposits without prior regulatory approval. In addition, a bank that is not well capitalized cannot offer an effective yield in excess of 75 basis points over interest paid on deposits of comparable size and maturity in such institution’s normal market area for deposits accepted from within its normal market area, or national rate paid on deposits of comparable size and maturity for deposits accepted outside the bank’s normal market area. Moreover, the FDIC generally prohibits a depository institution from making any capital distributions (including payment of a dividend) or paying any management fee to its parent holding company if the depository institution would thereafter be categorized as undercapitalized. Undercapitalized institutions are subject to growth limitations (an undercapitalized institution may not acquire another institution, establish additional branch offices or engage in any new line of business unless determined by the appropriate federal banking agency to be consistent with an accepted capital restoration plan, or unless the FDIC determines that the proposed action will further the purpose of prompt corrective action) and are required to submit a capital restoration plan. The agencies may not accept a capital restoration plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution’s capital. In addition, for a capital restoration plan to be acceptable, the depository institution’s parent holding company must guarantee that the institution will comply with the capital restoration plan. The aggregate liability of the parent holding company is limited to the lesser of an amount equal to 5.0% of the depository institution’s total assets at the time it became categorized as undercapitalized or the amount that is necessary (or would have been necessary) to bring the institution into compliance with all capital standards applicable with respect to such institution as of the time it fails to comply with the plan. If a depository institution fails to submit an acceptable plan, it is categorized as significantly undercapitalized.

Significantly undercapitalized categorized depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become categorized as adequately capitalized, requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. The appropriate federal banking agency may take any action authorized for a significantly undercapitalized institution if an undercapitalized institution fails to submit an acceptable capital restoration plan or fails in any material respect to implement a plan accepted by the agency. A critically undercapitalized institution is subject to having a receiver or conservator appointed to manage its affairs and for loss of its charter to conduct banking activities.

An insured depository institution may not pay a management fee to a bank holding company controlling that institution or any other person having control of the institution if, after making the payment, the institution would be undercapitalized. In addition, an institution cannot make a capital distribution, such as a dividend or other distribution that is in substance a distribution of capital to the owners of the institution if following such a distribution the institution would be undercapitalized. Thus, if payment of such a management fee or the making of such would cause a bank to become undercapitalized, it could not pay a management fee or dividend to the bank holding company.

As of December 31, 2019, the Bank was deemed to be “well capitalized.”

Standards for Safety and Soundness. The Federal Deposit Insurance Act also requires the federal banking regulatory agencies to prescribe, by regulation or guideline, operational and managerial standards for all insured depository institutions relating to: (i) internal controls, information systems and internal audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) interest rate risk exposure; and (v) asset growth. The agencies also must prescribe standards for asset quality, earnings, and stock valuation, as well as standards for compensation, fees and benefits. The federal banking agencies have adopted regulations and Interagency Guidelines Prescribing Standards for Safety and Soundness to implement these required standards. These guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. Under the regulations, if the FDIC determines that the Bank fails to meet any standards prescribed by the guidelines, the agency may require the Bank to submit to the agency an acceptable plan to achieve compliance with the standard, as required by the FDIC. The final regulations establish deadlines for the submission and review of such safety and soundness compliance plans.

Regulatory Examination. The FDIC also requires the Bank to prepare annual reports on the Bank’s financial condition and to conduct an annual audit of its financial affairs in compliance with its minimum standards and procedures.

Transactions with Affiliates and Insiders. The Company is a legal entity separate and distinct from the Bank and its other subsidiaries. Various legal limitations restrict the Bank from lending or otherwise supplying funds to the Company or its non-bank subsidiaries. The Company and the Bank are subject to Sections 23A and 23B of the Federal Reserve Act and Federal Reserve Regulation W.

Section 23A of the Federal Reserve Act places limits on the amount of loans or extensions of credit by a bank to any affiliate, including its holding company, and on a bank’s investments in, or certain other transactions with, affiliates and on the amount of advances to third parties collateralized by the securities or obligations of any affiliates of the bank. Section 23A also applies to derivative transactions, repurchase agreements and securities lending and borrowing transactions that cause a bank to have credit exposure to an affiliate. The aggregate of all covered transactions is limited in amount, as to any one affiliate, to 10% of the Bank’s capital and surplus and, as to all affiliates combined, to 20% of the Bank’s capital and surplus. Furthermore, within the foregoing limitations as to amount, each covered transaction must meet specified collateral requirements. The Bank is forbidden to purchase low quality assets from an affiliate.

Section 23B of the Federal Reserve Act, among other things, prohibits an institution from engaging in certain transactions with certain affiliates unless the transactions are on terms substantially the same, or at least as favorable to such institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.

Regulation W generally excludes all non-bank and non-savings association subsidiaries of banks from treatment as affiliates, except to the extent that the Federal Reserve decides to treat these subsidiaries as affiliates.

The Bank is also subject to certain restrictions on extensions of credit to executive officers, directors, certain principal stockholders, and their related interests. Such extensions of credit (i) must be made on substantially the same terms, including interest rates and collateral requirements, as those prevailing at the time for comparable transactions with unrelated third parties and (ii) must not involve more than the normal risk of repayment or present other unfavorable features.

On December 27, 2019, the federal banking agencies issued an interagency statement explaining that such agencies will provide temporary relief from enforcement action against bank or asset managers, which become principal shareholders of banks, with respect to certain extensions of credit by banks that otherwise would violate Regulation O, provided the asset managers and banks satisfy certain conditions designed to ensure that there is a lack of control by the asset manager over the bank. This temporary relief will apply while the Federal Reserve, in consultation with the other federal banking agencies, considers whether to amend Regulation O.

Dividends. The Company’s principal source of cash flow, including cash flow to pay dividends to its stockholders, is dividends it receives from the Bank. Statutory and regulatory limitations apply to the Bank’s payment of dividends to the Company. As a South Carolina chartered bank, the Bank is subject to limitations on the amount of dividends that it is permitted to pay. Unless otherwise instructed by the SCBFI, the Bank is generally permitted under South Carolina state banking regulations to pay cash dividends of up to 100% of net income in any calendar year without obtaining the prior approval of the SCBFI. The FDIC also has the authority under federal law to enjoin a bank from engaging in what in its opinion constitutes an unsafe or unsound practice in conducting its business, including the payment of a dividend under certain circumstances.

Branching. Federal legislation permits out-of-state acquisitions by bank holding companies, interstate branching by banks, and interstate merging by banks. The Dodd-Frank Act removed previous state law restrictions on de novo interstate branching in various states in which we operate. This change effectively permits out-of-state banks to open de novo branches in states where the laws of such state would permit a bank chartered by that state to open a de novo branch.

Anti-Tying Restrictions. Under amendments to the BHCA and Federal Reserve regulations, a bank is prohibited from engaging in certain tying or reciprocity arrangements with its customers. In general, a bank may not extend credit, lease, sell property, or furnish any services or fix or vary the consideration for these on the condition that (i) the customer obtain or provide some additional credit, property, or services from or to the bank, the bank holding company or subsidiaries thereof or (ii) the customer may not obtain some other credit, property, or services from a competitor, except to the extent reasonable conditions are imposed to assure the soundness of the credit extended. Certain arrangements are permissible: a bank may offer combined-balance products and may otherwise offer more favorable terms if a customer obtains two or more traditional bank products; and certain foreign transactions are exempt from the general rule. A bank holding company or any bank affiliate also is subject to anti-tying requirements in connection with electronic benefit transfer services.

Community Reinvestment Act. The Bank is subject to certain requirements and reporting obligations under the Community Reinvestment Act, (or “CRA”), which requires federal banking regulators to evaluate the record of the Bank in meeting the credit needs of its local community, including low- and moderate-income neighborhoods. The CRA further requires these criteria to be considered in evaluating mergers, acquisitions, and applications to open a branch or facility. Failure to adequately meet these criteria could impose additional requirements and limitations on our Bank. On May 21, 2018, the “as of” date of its most recent examination, the Bank received a “satisfactory” CRA rating.

The Gramm-Leach-Bliley Act, (or “GLBA”), made various changes to the CRA. Among other changes, CRA agreements with private parties must be disclosed and annual CRA reports must be made available to a bank’s primary federal regulator. A bank holding company will not be permitted to become a financial holding company and no new activities authorized under the GLBA may be commenced by a holding company or by a bank financial subsidiary if any of its bank subsidiaries received less than a satisfactory CRA rating in its latest CRA examination.

In December 2019, the FDIC and the Office of the Comptroller of the Currency proposed changes to the regulations implementing the CRA, which, if adopted will result in changes to the current CRA framework. The Federal Reserve did not join the proposal.

Financial Subsidiaries. Under the GLBA, subject to certain conditions imposed by their respective banking regulators, national and state-chartered banks are permitted to form “financial subsidiaries” that may conduct financial or incidental activities, thereby permitting bank subsidiaries to engage in certain activities that previously were impermissible. The GLBA imposes several safeguards and restrictions on financial subsidiaries, including that the parent bank’s equity investment in the financial subsidiary be deducted from the bank’s assets and tangible equity for purposes of calculating the bank’s capital adequacy. In addition, the GLBA imposes new restrictions on transactions between a bank and its financial subsidiaries similar to restrictions applicable to transactions between banks and non-bank affiliates.

Consumer Protection Regulations. Activities of the Bank are subject to a variety of statutes and regulations designed to protect consumers. Interest and other charges collected or contracted for by the Bank are subject to state usury laws and federal laws concerning interest rates. The Bank’s loan operations are also subject to federal laws applicable to credit transactions, such as:

	·	the Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;
	·	the Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;
	·	the Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;
	·	the Community Reinvestment Act, encourages banks to help meet the credit needs of their entire community, including low- and moderate-income areas consistent with safe and sound lending practices;
	·	the Fair Credit Reporting Act of 1978, as amended by the Fair and Accurate Credit Transactions Act and Regulation V, as well as the rules and regulations of the FDIC, governing the use and provision of information to credit reporting agencies, certain identity theft protections and certain credit and other disclosures;
	·	the Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;

	·	the Real Estate Settlement Procedures Act and Regulation X, which governs aspects of the settlement process for residential mortgage loans.
	·	the Military Lending Act and Service Members Civil Relief Act both protect active duty members and their families from certain lending practices in consumer credit and provide meaningful benefits for Service Members; and
	·	the rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws.

The deposit operations of the Bank also are subject to:

	·	the Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; and
	·	the Electronic Funds Transfer Act and Regulation E, which governs automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services.
	·	the Expedited Funds Availability Act, Regulation CC, establishes time limits the bank must follow for making check deposits available for withdrawal or transfer; and
	·	the Truth in Savings Act and Regulation DD, which requires depositary institutions to provide certain consumer disclosures.

Anti-Money Laundering. As a financial institution, the Bank must maintain anti-money laundering programs that include established internal policies, procedures, and controls; a designated compliance officer; an ongoing employee training program; and testing of the program by an independent audit function. The Company and the Bank are also prohibited from entering into specified financial transactions and account relationships and must meet enhanced standards for due diligence and “knowing your customer” in their dealings with foreign financial institutions and foreign customers. Financial institutions must take reasonable steps to conduct enhanced scrutiny of account relationships to guard against money laundering and to report any suspicious transactions, and recent laws provide law enforcement authorities with increased access to financial information maintained by banks. Anti-money laundering obligations have been substantially strengthened as a result of the USA Patriot Act, as described below. Bank regulators routinely examine institutions for compliance with these obligations and are required to consider compliance in connection with the regulatory review of applications. The regulatory authorities have been active in imposing cease and desist orders and money penalty sanctions against institutions that have not complied with these requirements.

USA PATRIOT Act/Bank Secrecy Act. The USA PATRIOT Act, amended, in part, the Bank Secrecy Act and provides for the facilitation of information sharing among governmental entities and financial institutions for the purpose of combating terrorism and money laundering by enhancing anti-money laundering and financial transparency laws, as well as enhanced information collection tools and enforcement mechanics for the U.S. government, including: (i) requiring standards for verifying customer identification at account opening; (ii) rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering; (iii) reports by nonfinancial trades and businesses filed with the U.S. Treasury Department’s Financial Crimes Enforcement Network for transactions exceeding $10,000; and (iv) filing suspicious activities reports if a bank believes a customer may be violating U.S. laws and regulations and requires enhanced due diligence requirements for financial institutions that administer, maintain, or manage private bank accounts or correspondent accounts for non-U.S. persons. The rule was further enhanced in 2018 by requiring the identification of beneficial owners of each legal entity customer. Bank regulators routinely examine institutions for compliance with these obligations and are required to consider compliance in connection with the regulatory review of applications.

The Office of Foreign Assets Control, (or “OFAC”), which is a division of the Treasury, is responsible for helping to ensure that United States entities do not engage in transactions with “enemies” of the United States, as defined by various Executive Orders and Acts of Congress. OFAC has sent, and will send, our banking regulatory agencies lists of names of persons and organizations suspected of aiding, harboring or engaging in terrorist acts. If the Bank finds a name on any transaction, account or wire transfer that is on an OFAC list, it must freeze such account, file a suspicious activity report and notify OFAC. The Bank has appointed an OFAC compliance officer to oversee the inspection of its accounts and the filing of any notifications. The Bank actively checks high-risk OFAC areas such as new accounts, wire transfers and customer files. The Bank performs these checks utilizing software, which is updated each time a modification is made to the lists provided by OFAC and other agencies of Specially Designated Nationals and Blocked Persons.

Privacy, Data Security and Credit Reporting. Financial institutions are required to disclose their policies for collecting and protecting confidential information. Customers generally may prevent financial institutions from sharing nonpublic personal financial information with nonaffiliated third parties except under narrow circumstances, such as the processing of transactions requested by the consumer. Additionally, financial institutions generally may not disclose consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing to consumers. It is the Bank’s policy not to disclose any personal information unless required by law.

Recent cyber-attacks against banks and other institutions that resulted in unauthorized access to confidential customer information have prompted the Federal banking agencies to issue several warnings and extensive guidance on cyber security. The agencies are likely to devote more resources to this part of their safety and soundness examination than they have in the past.

In addition, pursuant to the Fair and Accurate Credit Transactions Act of 2003 (the “FACT Act”) and the implementing regulations of the federal banking agencies and Federal Trade Commission, the Bank is required to have in place an “identity theft red flags” program to detect, prevent and mitigate identity theft. The Bank has implemented an identity theft red flags program designed to meet the requirements of the FACT Act and the joint final rules. Additionally, the FACT Act amends the Fair Credit Reporting Act to generally prohibit a person from using information received from an affiliate to make a solicitation for marketing purposes to a consumer, unless the consumer is given notice and a reasonable opportunity and a reasonable and simple method to opt out of the making of such solicitations.

Effect of Governmental Monetary Policies. Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the Federal Reserve have major effects upon the levels of bank loans, investments and deposits through its open market operations in United States government securities and through its regulation of the discount rate on borrowings of member banks and the reserve requirements against member bank deposits. It is not possible to predict the nature or impact of future changes in monetary and fiscal policies. The Federal Open Market Committee raised the target range for the federal funds rate by 25 basis points each on March 16, 2017, June 15, 2017 and December 14, 2017. During 2018, the rate was increased by 25 basis points each on March 22, June 14, September 27 and December 20. During 2019, the rate was decreased by 25 basis points each on August 1, September 19 and October 31. The potential for further changes in the federal funds rate depends on the economic outlook.

Insurance of Accounts and Regulation by the FDIC. The Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund of the FDIC. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC insured institutions. It also may prohibit any FDIC insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the insurance fund. The FDIC also has the authority to initiate enforcement actions against savings institutions, after giving the bank’s regulatory authority an opportunity to take such action, and may terminate the deposit insurance if it determines that the institution has engaged in unsafe or unsound practices or is in an unsafe or unsound condition.

As an FDIC-insured bank, the Bank must pay deposit insurance assessments to the FDIC based on its average total assets minus its average tangible equity. The Bank’s assessment rates are currently based on its risk classification (i.e., the level of risk it poses to the FDIC’s deposit insurance fund). Institutions classified as higher risk pay assessments at higher rates than institutions that pose a lower risk. In addition, following the fourth consecutive quarter (and any applicable phase-in period) where an institution’s total consolidated assets equal or exceed $10 billion, the FDIC will use a performance score and a loss-severity score to calculate an initial assessment rate. In calculating these scores, the FDIC uses an institution’s capital level and regulatory supervisory ratings and certain financial measures to assess an institution’s ability to withstand asset-related stress and funding-related stress. The FDIC also has the ability to make discretionary adjustments to the total score based upon significant risk factors that are not adequately captured in the calculations. In addition to ordinary assessments described above, the FDIC has the ability to impose special assessments in certain instances.

The FDIC has raised assessment rates and imposed special assessments on certain institutions during recent years to raise funds. Under the Dodd-Frank Act, the minimum designated reserve ratio for the deposit insurance fund is 1.35% of the estimated total amount of insured deposits. In October 2010, the FDIC adopted a restoration plan to ensure that the fund reserve ratio reaches 1.35% by September 30, 2020, as required by the Dodd-Frank Act. At least semi-annually, the FDIC will update its loss and income projections for the fund and, if needed, will increase or decrease assessment rates, following notice-and-comment rulemaking if required.

In addition, FDIC insured institutions are required to pay a Financing Corporation (“FICO”) assessment to fund the interest on bonds issued to resolve thrift failures in the 1980s, which expired between 2017 and 2019. The final FICO assessment was collected in March 2019.

The FDIC may terminate the deposit insurance of any insured depository institution, including the Bank, if it determines after a hearing that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. Management is not aware of any practice, condition or violation that might lead to termination of the Bank’s deposit insurance.

Incentive Compensation. The Dodd-Frank Act requires the federal bank regulators and the SEC to establish joint regulations or guidelines prohibiting incentive-based payment arrangements at specified regulated entities having at least $1 billion in total assets that encourage inappropriate risks by providing an executive officer, employee, director or principal stockholder with excessive compensation, fees, or benefits that could lead to a material financial loss to the entity. In addition, these regulators must establish regulations or guidelines requiring enhanced disclosure to regulators of incentive-based compensation arrangements. The agencies proposed such regulations in April 2011, which reflected the guidance previously issued in June 2010 by the bank regulators. However, the 2011 proposal was replaced with a new proposal in May 2016, which makes explicit that the involvement of risk management and control personnel includes not only compliance, risk management and internal audit, but also legal, human resources, accounting, financial reporting and finance roles responsible for identifying, measuring, monitoring or controlling risk-taking.

In June 2010, the Federal Reserve, the FDIC and the OCC issued comprehensive final guidance on incentive compensation policies intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The guidance, which covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking organization’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors.

The Federal Reserve will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as the Company, that are not “large, complex banking organizations.” These reviews will be tailored to each organization based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the organization’s supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.

Concentrations in Commercial Real Estate. Concentration risk exists when FDIC-insured institutions deploy too many assets to any one industry or segment. A concentration in commercial real estate is one example of regulatory concern. The interagency Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices guidance (“CRE Guidance”) provides supervisory criteria, including the following numerical indicators, to assist bank examiners in identifying banks with potentially significant commercial real estate loan concentrations that may warrant greater supervisory scrutiny: (i) total non-owner-occupied commercial real estate loans, including loans secured by apartment buildings, investor commercial real estate, and construction and land loans, represent 300% or more of an institution’s total risk-based capital and the outstanding balance of the commercial real estate loan portfolio has increased by 50% or more in the preceding three years or (ii) construction and land development loans exceed 100% of capital. The CRE Guidance does not limit banks’ levels of commercial real estate lending activities, but rather guides institutions in developing risk management practices and levels of capital that are commensurate with the level and nature of their commercial real estate concentrations. On December 18, 2015, the federal banking agencies issued a statement to reinforce prudent risk-management practices related to commercial real estate lending, having observed substantial growth in many commercial real estate asset and lending markets, increased competitive pressures, rising commercial real estate concentrations in banks, and an easing of commercial real estate underwriting standards. The federal bank agencies reminded FDIC-insured institutions to maintain underwriting discipline and exercise prudent risk-management practices to identify, measure, monitor and manage the risks arising from commercial real estate lending. In addition, FDIC-insured institutions must maintain capital commensurate with the level and nature of their commercial real estate concentration risk.

Based on the Bank’s loan portfolio as of December 31, 2019, the Bank did not exceed the 300% or the 100% guidelines for commercial real estate loans.

Item 1A. Risk Factors

Our business is subject to certain risks, including those described below. If any of the events described in the following risk factors actually occurs then our business, results of operations and financial condition could be materially adversely affected. More detailed information concerning these risks is contained in other sections of this report, including “Part I, Item 1: Business”, “Part II, Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Part I, “Cautionary Note Regarding Forward-Looking Statements.”

In addition to general investment risks and the other information contained in this Item 1A and elsewhere in this report, stockholders and investors should consider the matters described under the heading “Risk Factors” in the prospectus and joint proxy statement filed by United Bankshares, Inc. and us on February 13, 2020, which is incorporated herein by reference.

Risks Related to Our Business

Our business may be adversely affected by economic conditions.

Our financial performance generally, and in particular the ability of borrowers to pay interest on and repay principal of outstanding loans and the value of collateral securing those loans, as well as demand for loans and other products and services we offer, is highly dependent upon the business environment in the primary markets where we operate and in the United States as a whole. Unlike larger banks that are more geographically diversified, we are a regional bank that provides banking and financial services to customers primarily in South Carolina, Charlotte, and eastern North Carolina. The economic conditions in these local markets may be different from, and in some instances worse than, the economic conditions in the United States as a whole. Some elements of the business environment that affect our financial performance include short-term and long-term interest rates, the prevailing yield curve, inflation and price levels, monetary and trade policy, unemployment and the strength of the domestic economy and the local economy in the markets in which we operate. Unfavorable or uncertain economic and market conditions can be caused by declines in economic growth, business activity or investor or business confidence; limitations on the availability or increases in the cost of credit and capital; increases in inflation or interest rates; high unemployment, natural disasters; or a combination of these or other factors. While economic conditions in our local markets in South Carolina and North Carolina have improved since the end of the economic recession, However, there are continuing concerns related to, among other things, the level of United States government debt and fiscal actions that may be taken to address that debt, depressed oil prices and trade disputes and related tariffs that may have a destabilizing effect on financial markets. There can be no assurance that current economic conditions will continue or improve, and economic conditions could worsen. Economic pressure on consumers and uncertainty regarding continuing economic improvement may result in changes in consumer and business spending, borrowing and saving habits. A return of recessionary conditions or other negative developments in the domestic or international credit markets may significantly affect the markets in which we do business, the value of our loans and investments, and our ongoing operations, costs and profitability. Declines in real estate value and sales volumes and high unemployment levels may result in higher than expected loan delinquencies and a decline in demand for our products and services. These negative events may cause us to incur losses and may adversely affect our capital, liquidity, and financial condition.

Changes in U.S. trade policies and other factors beyond our control, including the imposition of tariffs and retaliatory tariffs and the impacts of epidemics or pandemics, may adversely impact our business, financial condition and results of operations.

There have been changes and discussions with respect to U.S. trade policies, legislation, treaties and tariffs, including trade policies and tariffs affecting other countries, including China, the European Union, Canada and Mexico and retaliatory tariffs by such countries. Tariffs and retaliatory tariffs have been imposed, and additional tariffs and retaliation tariffs have been proposed. Such tariffs, retaliatory tariffs or other trade restrictions on products and materials that our customers import or export could cause the prices of our customers’ products to increase which could reduce demand for such products, or reduce our customer margins, and adversely impact their revenues, financial results and ability to service debt; which, in turn, could adversely affect our financial condition and results of operations. In addition, to the extent changes in the political environment have a negative impact on us or on the markets in which we operate our business, results of operations and financial condition could be materially and adversely impacted in the future. It remains unclear what the U.S. Administration or foreign governments will or will not do with respect to tariffs already imposed, additional tariffs that may be imposed, or international trade agreements and policies. On January 26, 2020, President Trump signed a new trade deal between the United States, Canada and Mexico to replace the North American Free Trade Agreement. The full impact of this agreement on us, our customers and on the economic conditions in our primary banking markets is currently unknown. In addition, coronavirus and concerns regarding the extent to which it may spread have affected, and may increasingly affect, international trade (including supply chains and export levels), travel, employee productivity and other economic activities. A trade war or other governmental action related to tariffs or international trade agreements or policies, as well as coronavirus or other potential epidemics or pandemics, have the potential to negatively impact ours and/or our customers’ costs, demand for our customers' products, and/or the U.S. economy or certain sectors thereof and, thus, adversely affect our business, financial condition, and results of operations.

Our mortgage banking profitability could be significantly reduced if we are not able to originate and resell a high volume of mortgage loans.

Mortgage production, especially refinancing activity, typically declines in a rising interest rate environment. Because we sell a substantial portion of the mortgage loans we originate, the profitability of our mortgage banking business depends in large part upon our ability to aggregate a high volume of loans and sell them in the third-party market at a gain. Thus, in addition to our dependence on the interest rate environment, we are dependent upon (i) the existence of an active third-party market and (ii) our ability to profitably sell loans or securities into that market. As our level of mortgage production declines, the profitability from our mortgage operations will depend upon our ability to reduce our costs commensurate with the reduction of revenue from our mortgage operations.

Our ability to originate and sell mortgage loans readily is dependent upon the availability of an active third-party market for single-family mortgage loans, which in turn depends in part upon the continuation of programs currently offered by the government sponsored entities, or GSEs, and other institutional and non-institutional investors. These entities account for a substantial portion of the third-party market in residential mortgage loans. Because the largest participants in the third-party market are government-sponsored enterprises whose activities are governed by federal law, any future changes in laws that significantly affect the activity of the GSEs could, in turn, adversely affect our operations. In September 2008, the GSEs were placed into conservatorship by the U.S. government. Although to date the conservatorship has not had a significant or adverse effect on our operations, it remains unclear whether these events or further changes would significantly and adversely affect our operations. The government and others have provided options to reform the GSEs, but the results of any such reform, and their impact on us, are difficult to predict. To date, no reform proposal has been enacted. In addition, our ability to sell mortgage loans readily is dependent upon our ability to remain eligible for the programs offered by the GSEs and other institutional and non-institutional investors. Our ability to remain eligible to originate and securitize government insured loans may also depend on having an acceptable peer-relative delinquency ratio for Federal Housing Authority, or FHA, loans and maintaining a delinquency rate with respect to Ginnie Mae pools that are below Ginnie Mae guidelines.

Any significant impairment of our eligibility with any of the GSEs would materially adversely affect our operations. Further, the criteria for loans to be accepted under such programs may be changed from time-to-time by the sponsoring entity which could result in a lower volume of corresponding loan originations. The profitability of participating in specific programs may vary depending on a number of factors, including our administrative costs of originating and purchasing qualifying loans and our costs of meeting such criteria.

An increase in our nonperforming assets would adversely impact our earnings.

Our nonperforming assets may increase in future periods. Nonperforming assets adversely affect our net income in various ways. We do not record interest income on non-accrual loans or investments or on real estate owned. We must establish an allowance for loan losses that reserves for losses inherent in the loan portfolio that are both probable and reasonably estimable through current period provisions for loan losses, which are recorded as a charge to income. From time to time, we also write down the other real estate owned portfolio to reflect changing market values. Additionally, there are legal fees associated with the resolution of problem assets as well as carrying costs such as taxes, insurance and maintenance related to the other real estate owned. Further, the resolution of nonperforming assets requires the active involvement of management, which can distract them from our overall supervision of operations and other income-producing activities.

We could record other-than-temporary impairment on our securities portfolio. In addition, we may not receive full future interest payments on these securities.

We review our investment securities portfolio at least quarterly and more frequently when economic conditions warrant, assessing whether there is any indication of other-than-temporary impairment, or (“OTTI”). Factors considered in the review include estimated future cash flows, length of time and extent to which market value has been less than cost, the financial condition and near term prospect of the issuer, and our intent and ability to retain the security to allow for an anticipated recovery in market value. If the review determines that there is OTTI, then an impairment loss is recognized in earnings equal to the difference between the investment’s cost and its fair value at the balance sheet date of the reporting period for which the assessment is made, or a portion may be recognized in other comprehensive income. The fair value of investments on which OTTI is recognized then becomes the new cost basis of the investment.

At December 31, 2019, the Company had 79 individual securities available-for-sale in an unrealized loss position. The Company believes, based on OTTI evaluations, that the deterioration in the value of these securities is attributable primarily to changes in interest rates. Management believes that there are no securities other-than-temporarily impaired at December 31, 2019. The Company does not intend to sell these securities, and it is more likely than not that the Company will not be required to sell these securities before recovery of their amortized cost. Management continues to monitor these securities with a high degree of scrutiny. There can be no assurance that the Company will not conclude in future periods that conditions existing at that time indicate some or all of the securities may be sold or are other-than-temporarily impaired, which would require a charge to earnings in such periods.

A number of factors or combinations of factors could require us to conclude in one or more future reporting periods that an unrealized loss that exists with respect to our securities portfolio constitutes additional impairment that is other than temporary, which could result in material losses to us. These factors include, but are not limited to, a continued failure by an issuer to make scheduled interest payments, an increase in the severity of the unrealized loss on a particular security, an increase in the continuous duration of the unrealized loss without an improvement in value or changes in market conditions and/or industry or issuer specific factors that would render us unable to forecast a full recovery in value. In addition, the fair values of securities could decline if the overall economy and the financial condition of some of the issuers continue to deteriorate and there remains limited liquidity for these securities.

We may not be able to continue to support the realization of our deferred tax asset.

We calculate income taxes in accordance with the FASB Accounting Standards Codification (“ASC”) Topic 740, Income Taxes, which requires the use of the asset and liability method. In accordance with this, we regularly assess available positive and negative evidence to determine whether it is more likely than not that our deferred tax asset balances will be recovered from reversals of deferred tax liabilities, potential utilization of net operating loss carrybacks, tax planning strategies and future taxable income. At December 31, 2019, our net deferred tax asset was $2.5 million. We recognized the deferred tax asset because management believes, based on earnings and detailed financial projections, that it is more likely than not that we will have sufficient future earnings to utilize this asset to offset future income tax liabilities. Realization of a deferred tax asset requires us to apply significant judgment and is inherently speculative because it requires the future occurrence of circumstances that cannot be predicted with certainty. There can be no assurance that we will achieve sufficient future taxable income as the basis for the ultimate realization of our deferred tax asset and therefore we may have to establish a full or partial valuation allowance at some point in the future. If we determine that a valuation allowance is necessary, this would require us to incur a charge to operations that would adversely affect our capital position. There is no assurance that we will be able to continue to recognize any, or all, of the deferred tax asset for regulatory capital purposes.

We may be terminated as a servicer of mortgage loans, be required to repurchase a mortgage loan or reimburse investors for credit losses on a mortgage loan, or incur costs, liabilities, fines and other sanctions if we fail to satisfy our servicing obligations, including our obligations with respect to mortgage loan foreclosure actions.

We act as servicer for approximately $3.6 billion of mortgage loans owned by third parties as of December 31, 2019. As a servicer for those loans we have certain contractual obligations, including foreclosing on defaulted mortgage loans or, to the extent applicable, considering alternatives to foreclosure such as loan modifications or short sales. If we commit a material breach of our obligations as servicer, we may be subject to termination as servicer if the breach is not cured within a specified period of time following notice, causing us to lose servicing income.

In some cases, we may be contractually obligated to repurchase a mortgage loan or reimburse the investor for credit losses incurred on the loan as a remedy for servicing errors with respect to the loan. If we have increased repurchase obligations because of claims that we did not satisfy our obligations as a servicer, or increased loss severity on such repurchases, we may have a significant reduction to net servicing income within our mortgage banking noninterest income. We may incur costs if we are required to, or if we elect to, re-execute or re-file documents or take other action in our capacity as a servicer in connection with pending or completed foreclosures. We may incur litigation costs if the validity of a foreclosure action is challenged by a borrower. If a court were to overturn a foreclosure because of errors or deficiencies in the foreclosure process, we may have liability to the borrower and/or to any title insurer of the property sold in foreclosure if the required process was not followed. These costs and liabilities may not be legally or otherwise reimbursable to us. In addition, if certain documents required for a foreclosure action are missing or defective, we could be obligated to cure the defect or repurchase the loan. We may incur liability to securitization investors relating to delays or deficiencies in our processing of mortgage assignments or other documents necessary to comply with state law governing foreclosures. The fair value of our mortgage servicing rights may be negatively affected to the extent our servicing costs increase because of higher foreclosure costs. We may be subject to fines and other sanctions imposed by federal or state regulators as a result of actual or perceived deficiencies in our foreclosure practices or in the foreclosure practices of other mortgage loan servicers. Any of these actions may harm our reputation or negatively affect our home lending or servicing business.

We may be required to repurchase mortgage loans or indemnify buyers against losses in some circumstances, which could harm liquidity, results of operations and financial condition.

When mortgage loans are sold, whether as whole loans or pursuant to a securitization, we are required to make customary representations and warranties to purchasers, guarantors and insurers, including the government sponsored enterprises, about the mortgage loans and the manner in which they were originated. Whole loan sale agreements require repurchase or substitute mortgage loans, or indemnification of buyers against losses, in the event we breach these representations or warranties. In addition, we may be required to repurchase mortgage loans as a result of early payment default of the borrower on a mortgage loan. With respect to loans that are originated through our broker or correspondent channels, the remedies available against the originating broker or correspondent, if any, may not be as broad as the remedies available to purchasers, guarantors and insurers of mortgage loans against us. We face further risk that the originating broker or correspondent, if any, may not have financial capacity to perform remedies that otherwise may be available. Therefore, if a purchaser, guarantor or insurer enforces its remedies against us, we may not be able to recover losses from the originating broker or correspondent. If repurchase and indemnity demands increase and such demands are valid claims and are in excess of our provision for potential losses, our liquidity, results of operations and financial condition may be adversely affected.

If we fail to effectively manage credit risk and interest rate risk, our business and financial condition will suffer.

We must effectively manage credit risk. There are risks inherent in making any loan, including risks with respect to the period of time over which the loan may be repaid, risks relating to proper loan underwriting and guidelines, risks resulting from changes in economic and industry conditions, risks inherent in dealing with individual borrowers and risks resulting from uncertainties as to the future value of collateral. There is no assurance that our credit risk monitoring and loan approval procedures are or will be adequate or will reduce the inherent risks associated with lending. Our credit administration personnel, policies and procedures may not adequately adapt to changes in economic or any other conditions affecting customers and the quality of our loan portfolio. Any failure to manage such credit risks may adversely affect our business, financial condition, and results of operations.

We must also effectively manage interest rate risk. Because mortgage loans typically have much longer maturities than deposits or other types of funding, rising interest rates can raise the cost of funding relative to the value of the mortgage loan. We manage this risk in part by holding adjustable rate mortgages in portfolios and through other means. Conversely, the value of our mortgage servicing assets may fall when interest rates fall, as borrowers refinance into lower rate loans. Given current rates, material reductions in rates may not be probable, but as rates rise, then the risk increases. There can be no assurance that we will successfully manage the lending and servicing businesses through all future interest-rate environments.

New accounting standards will require us to increase our allowance for loan losses and may have a material adverse effect on our financial condition and results of operations.

The measure of our allowance for loan losses is dependent on the adoption and interpretation of accounting standards. The Financial Accounting Standards Board, or FASB, has issued a new credit impairment model, the Current Expected Credit Loss, or CECL model, which will become effective for the calendar year beginning January 1, 2020. Under the CECL model, we will be required to present certain financial assets carried at amortized cost, such as loans held for investment and held-to-maturity debt securities, at the net amount expected to be collected. The measurement of expected credit losses is to be based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement will take place at the time the financial asset is first added to the balance sheet and periodically thereafter. This differs significantly from the “incurred loss” model currently required under GAAP, which delays recognition until it is probable a loss has been incurred. Accordingly, we expect that the adoption of the CECL model will affect how we determine our allowance for loan losses and may require us to significantly increase our allowance. The Company’s preliminary evaluation indicates that adoption of the CECL model is expected to impact the Company’s consolidated financial statements, in particular the level of the reserve for credit losses over the contractual life of the loans. In addition, the guidance eliminates the current guidance for purchased credit impaired loans, and requires an increase in the allowance for loan losses and an increase in the recorded investment of purchased credit impaired loans for the nonaccretable difference.

We expect the adoption of ASU 2016-13 to result in the recognition of an incremental allowance for loan and lease losses of approximately $5.2 million as of the adoption date. Approximately $1.8 million of the incremental amount is expected to be related to the increase in the allowance for loan and lease losses related to purchased credit deteriorated loans (the “gross up”), which offsets loan marks at the adoption date. The cumulative-effect adjustment to retained earnings is expected to be approximately $2.6 million and the increase in the deferred tax asset is expected to be approximately $0.8 million. The Company does not expect any incremental allowance for credit losses on available-for-sale securities at adoption, primarily as the impairment was determined to not be credit related. The adoption of ASU 2016-13 is not expected to have a significant impact on our regulatory capital ratios.

While the guidance changes the measurement of the allowance, it does not change the credit risk of the Company’s lending and securities portfolios or the ultimate losses in those portfolios. Future adjustments to the allowance under ASU 2016-13 will depend upon the nature and characteristics of the Company’s loan portfolio, the macroeconomic conditions and other management judgments. As a result, the magnitude of any such future adjustments are difficult to predict.

A significant portion of our loan portfolio is secured by real estate, and events that negatively impact the real estate market could hurt our business.

A significant portion of our loan portfolio is secured by real estate. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. A weakening of the real estate market in our primary market areas could result in an increase in the number of borrowers who default on their loans and a reduction in the value of the collateral securing their loans, which in turn could have an adverse effect on our profitability and asset quality. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and capital could be adversely affected. Acts of nature, including hurricanes, tornados, earthquakes, fires and floods, which could be exacerbated by potential climate change and may cause uninsured damage and other loss of value to real estate that secures these loans, may also negatively impact our financial condition.

We have a concentration of credit exposure in commercial real estate and challenges faced by the commercial real estate market could adversely affect our business, financial condition, and results of operations.

As of December 31, 2019, we had approximately $1.4 billion in loans outstanding to borrowers whereby the collateral securing the loan was commercial real estate, representing approximately 43.2% of our total loans outstanding as of that date. Approximately 30.2%, or $421.8 million, of this real estate are owner-occupied properties. Commercial real estate loans are generally viewed as having more risk of default than residential real estate loans. They are also typically larger than residential real estate loans and consumer loans and depend on cash flows from the owner’s business or the property to service the debt. Cash flows may be affected significantly by general economic conditions, and a downturn in the local economy or in occupancy rates in the local economy where the property is located could increase the likelihood of default. Because our loan portfolio contains a number of commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant increase in our level of nonperforming loans. An increase in nonperforming loans could result in a loss of earnings from these loans, an increase in the related provision for loan losses and an increase in charge-offs, all of which could have a material adverse effect on our financial condition and results of operations.

The banking regulators are giving commercial real estate lending greater scrutiny, and may require banks with higher levels of commercial real estate loans to implement more stringent underwriting, internal controls, risk management policies and portfolio stress testing, as well as possibly higher levels of allowances for losses and capital levels as a result of commercial real estate lending growth and exposures.

Repayment of our commercial business loans is often dependent on the cash flows of the borrower, which may be unpredictable, and the collateral securing these loans may fluctuate in value.

At December 31, 2019, commercial business loans comprised 14.5% of our total loan portfolio. Our commercial business loans are originated primarily based on the identified cash flow and general liquidity of the borrower and secondarily on the underlying collateral provided by the borrower and/or repayment capacity of any guarantor. The borrower’s cash flow may be unpredictable, and collateral securing these loans may fluctuate in value. Although commercial business loans are often collateralized by equipment, inventory, accounts receivable, or other business assets, the liquidation of collateral in the event of default is often an insufficient source of repayment because accounts receivable may be uncollectable and inventories may be obsolete or of limited use. In addition, business assets may depreciate over time, may be difficult to appraise, and may fluctuate in value based on the success of the business. Accordingly, the repayment of commercial business loans depends primarily on the cash flow and credit worthiness of the borrower and secondarily on the underlying collateral value provided by the borrower and liquidity of the guarantor.

Further downturns or a slower recovery in the real estate markets in our primary market areas could significantly adversely impact our business.

Our primary market areas are the Coastal, Midlands, and Upstate regions of South Carolina, including the Charleston (Charleston, Dorchester and Berkeley Counties), Myrtle Beach (Horry and Georgetown Counties), Columbia (Richland and Lexington Counties), and the Upstate (Greenville and Spartanburg Counties) market areas. Our primary market areas in North Carolina include Wilmington (New Hanover County), Raleigh-Durham (Durham and Wake Counties), Charlotte-Concord-Gastonia (NC and SC) and the surrounding southeastern coastal region of North Carolina (Bladen, Brunswick, Columbus, Cumberland, Duplin and Robeson Counties).

The Company’s primary markets are heavily influenced the military, the medical industry, national and international industries, tourism, retirement living, retail and real estate. If economic conditions were to deteriorate in these markets, the industries in our markets could suffer, which could impact our business. The real estate markets experienced a significant decline in these markets in recent years and, if these economic drivers were to experience further downturns or recover more slowly than expected, real estate in the Company’s markets may experience further declines. If real estate values in our markets decline, the collateral for these loans will provide less security. As a result, the borrower’s ability to pay, or the Company’s ability to recover on defaulted loans by selling the underlying collateral, would be diminished.

Our focus on lending to small to mid-sized community-based businesses may increase our credit risk.

Most of our commercial business and commercial real estate loans are made to small business or middle market customers. These businesses generally have fewer financial resources in terms of capital or borrowing capacity than larger entities and have a heightened vulnerability to economic conditions. If general economic conditions in the markets in which we operate negatively impact this important customer sector, our results of operations and financial condition and the value of our common stock may be adversely affected. Moreover, a portion of these loans have been made by us in recent years and the borrowers may not have experienced a complete business or economic cycle. Furthermore, the deterioration of our borrowers’ businesses may hinder their ability to repay their loans with us, which could have a material adverse effect on our financial condition and results of operations.

We face strong competition for customers, which could prevent us from obtaining customers and may cause us to pay higher interest rates to attract customers.

The banking business is highly competitive, and we experience competition in our markets from many other financial institutions. We compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds, and other mutual funds, as well as other super-regional, national, and international financial institutions that operate offices in our primary market areas and elsewhere. We compete with these institutions both in attracting deposits and in making loans. In addition, we have to attract our customer base from other existing financial institutions and from new residents. Many of our competitors are well-established, larger financial institutions. These institutions offer some services, such as extensive and established branch networks, that we do not provide. There is a risk that we will not be able to compete successfully with other financial institutions in our markets, and that we may have to pay higher interest rates to attract deposits, resulting in reduced profitability. In addition, competitors that are not depository institutions are generally not subject to the extensive regulations that apply to us.

The accuracy of our financial statements and related disclosures could be affected if the judgments, assumptions or estimates used in our critical accounting policies are inaccurate.

The preparation of financial statements and related disclosure in conformity with accounting principles generally accepted in the United States requires us to make judgments, assumptions and estimates that affect the amounts reported in our consolidated financial statements and accompanying notes. Our critical accounting policies, which are included in the section captioned “Part II - Management’s Discussion and Analysis of Results of Operations and Financial Condition”, describe those significant accounting policies and methods used in the preparation of our consolidated financial statements that we consider “critical” because they require judgments, assumptions and estimates that materially affect our consolidated financial statements and related disclosures. As a result, if future events differ significantly from the judgments, assumptions and estimates in our critical accounting policies, those events or assumptions could have a material impact on our consolidated financial statements and related disclosures.

Our funding sources may prove insufficient to replace deposits and support future growth.

We rely on customer deposits, including brokered deposits, advances from the Federal Home Loan Bank of Atlanta (the “FHLB”) and the Federal Reserve, and other borrowings to fund operations. Although the Company has historically been able to replace maturing deposits and advances, if desired, no assurance can be given that we would be able to replace such funds in the future if the financial condition of the FHLB or programs sponsored by the Federal Reserve, regulatory restrictions on brokered deposits or regulatory restrictions on the pricing of local deposits or other market conditions were to change. In addition, certain borrowing sources are on a secured basis. The FHLB has become more restrictive on the types of collateral it will accept and the amount of borrowings allowed on acceptable collateral. Due to changes applied by rating agencies on bonds, changes in collateral requirements or deteriorating loan quality, outstanding borrowings could be required to be repaid, incurring prepayment penalties. Our financial flexibility will be severely constrained if we are unable to maintain access to funding at acceptable interest rates. Finally, if we are required to rely more heavily on more expensive funding sources to support future operations, our revenues may not increase proportionally to cover these costs. In addition, Crescent Mortgage Company may fund mortgage loans held for sale through a line of credit with the Bank. A decline in economic conditions could affect Crescent Mortgage Company’s ability to fund loans held for sale.

Our operating results may fluctuate based upon the results of our mortgage subsidiary, Crescent Mortgage Company.

There are a number of items that could adversely affect the volumes and margin of the Company’s mortgage banking operations. These include, but are not limited to, the Federal Reserve’s monetary policy including its quantitative easing program, aggressively low rates, reduction in prices paid by the mortgage banking aggregators, aggressive competition, the housing market recovery, the status and financial condition of the FNMA and FHLMC, potential changes in FNMA and FHLMC lending guidelines and programs, proposed changes in the FHA lending requirements, extensive regulatory changes and liquidity. Should these factors significantly impact production of mortgages, it is likely that the Company’s earnings would be adversely affected.

Our mortgage subsidiary’s operations are exposed to significant repurchase risk.

Crescent Mortgage Company is exposed to significant repurchase risk on mortgage loan production related to potential reimbursements for loans sold to third parties for borrower fraud, underwriting and documentation issues, early defaults and prepayments of sold loans. If the Company experiences significant losses related to repurchase risk, it is possible that the reserve established for such exposure is not adequate. The Company continues to receive repurchase requests. The Company evaluates each request and provides estimated reserves as necessary. We believe that the reserve related to repurchase risk is adequate to absorb probable losses; however, we cannot predict these losses or whether our reserve will be adequate. Any of these occurrences could materially and adversely affect our business, financial condition and profitability.

The value of our loan servicing portfolio may become impaired in the future.

As of December 31, 2019, the Company serviced approximately $3.6 billion of loans. At that date, our mortgage loan servicing rights were recorded as an asset with a carrying value of $25.9 million, including a temporary impairment of $3.1 million. We expect that our loan servicing portfolio will increase in the future. If interest rates decline and the actual and expected mortgage loan prepayment rates increase or other factors that cause a reduction of the valuation of our mortgage servicing asset, the Company could incur additional impairment of its mortgage loan servicing asset.

Hurricanes and other natural disasters may adversely affect loan portfolios and operations and increase the cost of doing business.

The Company operates in markets that are susceptible to hurricanes and other natural disasters. Large-scale natural disasters may significantly affect loan portfolios by damaging properties pledged as collateral, affecting the economies our borrowers live in, and by impairing the ability of the borrower to repay their loans.

Changes in prevailing interest rates may reduce our profitability.

Our results of operations depend in large part upon the level of our net interest income, which is the difference between interest income from interest-earning assets, such as loans and investment securities, and interest expense on interest-bearing liabilities, such as deposits and borrowings. Depending on the terms and maturities of our assets and liabilities, we believe it is more likely than not a significant change in interest rates could have a material adverse effect on our profitability. Many factors cause changes in interest rates, including governmental monetary policies and domestic and international economic and political conditions. While we intend to manage the effects of changes in interest rates by adjusting the terms, maturities, and pricing of our assets and liabilities, our efforts may not be effective and our financial condition and results of operations could suffer.

We are dependent on key individuals, and the loss of one or more of these key individuals could curtail our growth and adversely affect our prospects.

Jerold L. Rexroad, the Company’s President and Chief Executive Officer, has extensive and long-standing ties within our primary markets. Mr. Rexroad has substantial experience in banking operations, correspondent/wholesale mortgage operations, investment securities, and mergers and acquisitions. The services of Mr. Rexroad would be difficult to replace and our business and development could be materially and adversely affected.

David L. Morrow, the Bank’s Chief Executive Officer, also has extensive and long-standing ties within our primary markets and substantial commercial lending experience within our Charleston and Myrtle Beach markets. The services of Mr. Morrow would be difficult to replace and our business and development could be materially and adversely affected.

Fowler C. Williams, Crescent Mortgage Company’s President and Chief Executive Officer, has extensive knowledge and long-standing ties with the mortgage industry. The services of Mr. Williams would be difficult to replace and our wholesale mortgage company results could be materially and adversely affected.

M.J. Huggins, III, the Company’s Executive Vice President and Secretary, and the Bank’s President, has extensive and long-standing ties within our primary markets and substantial commercial and retail lending experience. The services of Mr. Huggins would be difficult to replace and our business and development could be materially and adversely affected.

Our success also depends, in part, on our continued ability to attract and retain experienced commercial and mortgage loan officers, as well as other management personnel. Competition for personnel is intense, and we may not be successful in attracting or retaining qualified personnel. Our failure to compete for these personnel, or the loss of the services of several of such key personnel, could adversely affect our business strategy and seriously harm our business, results of operations, and financial condition.

We are subject to extensive regulation that could restrict our activities, have an adverse impact on our operations, and impose financial requirements or limitations on the conduct of our business.

We operate in a highly regulated industry and are subject to examination, supervision, and comprehensive regulation by various regulatory agencies. The Company is subject to Federal Reserve Board regulation, and our Bank is subject to extensive regulation, supervision, and examination by our primary federal regulator, the FDIC, and by the SCBFI. Our Bank’s activities are also regulated under consumer protection laws applicable to our lending, deposit, and other activities. A sufficient claim against us under these laws could have a material adverse effect on our results of operations.

Regulation by these agencies is intended primarily for the protection of our depositors and the deposit insurance fund and not for the benefit of our shareholders. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. The Dodd-Frank Act, enacted in July 2010, instituted major changes to the banking and financial institutions regulatory regimes. The Dodd-Frank Act and other changes to statutes, regulations or regulatory policies or supervisory guidance, including changes in interpretation or implementation of statutes, regulations, policies or supervisory guidance, could affect us in substantial and unpredictable ways, including, among other things, subjecting us to increased capital, liquidity and risk management requirements, creating additional costs, limiting the types of financial services and products we may offer and/or increasing the ability of non-banks to offer competing financial services and products. Failure to comply with laws, regulations or policies could also result in heightened regulatory scrutiny and in sanctions by regulatory agencies (such as a memorandum of understanding, a written supervisory agreement or a cease and desist order), civil money penalties and/or reputation damage. Any of these consequences could restrict our ability to expand our business or could require us to raise additional capital or sell assets on terms that are not advantageous to us or our stockholders and could have a material adverse effect on our business, financial condition and results of operations. While we have policies and procedures designed to prevent any such violations, such violations may occur despite our best efforts.

We may be subject to more stringent capital requirements in the future.

We are subject to regulatory requirements specifying minimum amounts and types of capital that we must maintain. From time to time, the regulators change these regulatory capital adequacy guidelines. If we fail to meet these minimum capital guidelines and other regulatory requirements, we or our subsidiaries may be restricted in the types of activities we may conduct and we may be prohibited from taking certain capital actions, such as paying dividends and repurchasing or redeeming capital securities.

In particular, the capital requirements applicable to us under the Basel III rules become fully phased-in on January 1, 2019. We are now required to satisfy additional, more stringent, capital adequacy standards than we had in the past. While we expect to meet the requirements of the Basel III rules, we may fail to do so. Failure to meet minimum capital requirements could result in certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have an adverse material effect on our financial condition and results of operations. In addition, these requirements could have a negative impact on our ability to lend, grow deposit balances, make acquisitions or make capital distributions in the form of dividends or share repurchases. Higher capital levels could also lower our return on equity.

We face a risk of noncompliance and enforcement action with the Bank Secrecy Act and other anti-money laundering statutes and regulations.

The federal Bank Secrecy Act, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA PATRIOT Act”), and other laws and regulations require financial institutions, among other duties, to institute and maintain effective anti-money laundering programs and file suspicious activity and currency transaction reports as appropriate. The federal Financial Crimes Enforcement Network, established by the Treasury to administer the Bank Secrecy Act, is authorized to impose significant civil money penalties for violations of those requirements and has recently engaged in coordinated enforcement efforts with the individual federal banking regulators, as well as the Department of Justice, Drug Enforcement Administration and Internal Revenue Service. There is also increased scrutiny of compliance with the rules enforced by OFAC. Federal and state bank regulators also have begun to focus on compliance with Bank Secrecy Act and anti-money laundering regulations. If our policies, procedures and systems are deemed deficient we would be subject to liability, including fines and regulatory actions, such as restrictions on our ability to pay dividends, which would negatively impact our business, financial condition and results of operations. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for us.

Federal, state and local consumer lending laws may restrict our ability to originate certain mortgage loans or increase our risk of liability with respect to such loans and could increase our cost of doing business.

Federal, state and local laws have been adopted that are intended to eliminate certain lending practices considered “predatory.” These laws prohibit practices such as steering borrowers away from more affordable products, selling unnecessary insurance to borrowers, repeatedly refinancing loans and making loans without a reasonable expectation that the borrowers will be able to repay the loans irrespective of the value of the underlying property. Since 2013, the CFPB has issued several rules on mortgage lending, notably a rule requiring all home mortgage lenders to determine a borrower’s ability to repay the loan. Loans with certain terms and conditions and that otherwise meet the definition of a “qualified mortgage” may be protected from liability to a borrower for failing to make the necessary determinations. In either case, we may find it necessary to tighten our mortgage loan underwriting standards in response to the CFPB rules, which may constrain our ability to make loans consistent with our business strategies. It is our policy not to make predatory loans and to determine borrowers’ ability to repay, but the law and related rules create the potential for increased liability with respect to our lending and loan investment activities. They increase our cost of doing business and, ultimately, may prevent us from making certain loans and cause us to reduce the average percentage rate or the points and fees on loans that we do make.

We may be adversely affected by the soundness of other financial institutions.

Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and routinely execute transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks, and other institutional clients. Many of these transactions expose us to credit risk in the event of a default by a counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by the bank cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due to the bank. Any such losses could have a material adverse effect on our financial condition and results of operations.

We may be exposed to difficulties in combining the operations of acquired businesses into our own operations, which may prevent us from achieving the expected benefits from our merger and acquisition activities.

We may not be able to fully achieve the strategic objectives and operating efficiencies that we anticipate in our merger and acquisition activities. Inherent uncertainties exist in integrating the operations of an acquired business. In addition, the markets and industries in which we and our potential merger and acquisition targets operate are highly competitive. We may lose customers or the customers of acquired entities as a result of an acquisition. We may also lose key personnel from the acquired entity as a result of an acquisition. We may not discover all known and unknown factors when examining a company for acquisition during the due diligence period. These factors could produce unintended and unexpected consequences for us. Undiscovered factors as a result of an acquisition could bring civil, criminal, and financial liabilities against us, our management, and the management of those entities we acquire. In addition, if difficulties arise with respect to the integration process, the economic benefits expected to result from acquisitions might not occur. Failure to successfully integrate businesses that we acquire could have an adverse effect on our profitability, return on equity, return on assets, or our ability to implement our strategy, any of which in turn could have a material adverse effect on our business, financial condition and results of operations. These factors could contribute to our not achieving the expected benefits from our mergers and acquisitions within desired time frames, if at all.

We are subject to losses due to errors, omissions or fraudulent behavior by our employees, clients, counterparties or other third parties.

We are exposed to many types of operational risk, including the risk of fraud by employees and third parties, clerical recordkeeping errors and transactional errors. Our business is dependent on our employees as well as third-party service providers to process a large number of increasingly complex transactions. We could be materially and adversely affected if employees, clients, counterparties or other third parties caused an operational breakdown or failure, either as a result of human error, fraudulent manipulation or purposeful damage to any of our operations or systems.

In deciding whether to extend credit or to enter into other transactions with clients and counterparties, we may rely on information furnished to us by or on behalf of clients and counterparties, including financial statements and other financial information, which we do not independently verify. We also may rely on representations of clients and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. For example, in deciding whether to extend credit to clients, we may assume that a customer’s audited financial statements conform with GAAP and present fairly, in all material respects, the financial condition, results of operations and cash flows of the customer. Our financial condition and results of operations could be negatively impacted to the extent we rely on financial statements that do not comply with GAAP or are materially misleading.

Our ability to pay cash dividends is limited, and we may be unable to pay future dividends even if we desire to do so.

The Federal Reserve has issued a policy statement regarding the payment of dividends by bank holding companies. In general, the Federal Reserve’s policies provide that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the bank holding company appears consistent with the organization’s capital needs, asset quality and overall financial condition. The Federal Reserve’s policies also require that a bank holding company serve as a source of financial strength to its subsidiary banks by standing ready to use available resources to provide adequate capital funds to those banks during periods of financial stress or adversity and by maintaining the financial flexibility and capital raising capacity to obtain additional resources for assisting its subsidiary banks where necessary. In addition, under the prompt corrective action regulations, the ability of a bank holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized. These regulatory policies could affect the ability of the Company to pay dividends or otherwise engage in capital distributions.

Our ability to pay cash dividends may be limited by regulatory restrictions, by our Bank’s ability to pay cash dividends to the Company and by our need to maintain sufficient capital to support our operations. As a South Carolina chartered bank, the Bank is subject to limitations on the amount of dividends that it is permitted to pay. Unless otherwise instructed by the SCBFI, the Bank is generally permitted under South Carolina state banking regulations to pay cash dividends of up to 100% of net income in any calendar year without obtaining the prior approval of the SCBFI. If our Bank is not permitted to pay cash dividends to the Company, it is unlikely that we would be able to pay cash dividends on our common stock. Moreover, holders of our common stock are entitled to receive dividends only when, and if declared by our board of directors. Although we have historically paid cash dividends on our common stock, we are not required to do so and our board of directors could reduce or eliminate our common stock dividend in the future.

A failure in or breach of our operational or security systems or infrastructure, or those of our third party vendors and other service providers or other third parties, including as a result of cyber-attacks, could disrupt our businesses, result in the disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs, and cause losses.

We rely heavily on communications and information systems to conduct our business. Information security risks for financial institutions such as ours have generally increased in recent years in part because of the proliferation of new technologies, the use of the internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, and terrorists, activists, and other external parties. As customer, public, and regulatory expectations regarding operational and information security have increased, our operating systems and infrastructure must continue to be safeguarded and monitored for potential failures, disruptions, and breakdowns. Our business, financial, accounting, and data processing systems, or other operating systems and facilities may stop operating properly or become disabled or damaged as a result of a number of factors, including events that are wholly or partially beyond our control. For example, there could be electrical or telecommunication outages; natural disasters such as earthquakes, tornadoes, and hurricanes; disease pandemics; events arising from local or larger scale political or social matters, including terrorist acts; and as described below, cyber-attacks.

As noted above, our business relies on our digital technologies, computer and email systems, software and networks to conduct its operations. Although we have information security procedures and controls in place, our technologies, systems, networks, and our customers’ devices may become the target of cyber-attacks or information security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss, or destruction of our or our customers’ or other third parties’ confidential information. Third parties with whom we do business or that facilitate our business activities, including financial intermediaries, or vendors that provide service or security solutions for our operations, and other unaffiliated third parties could also be sources of operational and information security risk to us, including from breakdowns or failures of their own systems or capacity constraints.

While we have disaster recovery and other policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. Our risk and exposure to these matters remains heightened because of the evolving nature of these threats. As a result, cyber security and the continued development and enhancement of our controls, processes, and practices designed to protect our systems, computers, software, data, and networks from attack, damage or unauthorized access remain a focus for us. As threats continue to evolve, we may be required to expend additional resources to continue to modify or enhance our protective measures or to investigate and remediate information security vulnerabilities. Disruptions or failures in the physical infrastructure or operating systems that support our businesses and clients, or cyber-attacks or security breaches of the networks, systems or devices that our clients use to access our products and services could result in client attrition, regulatory fines, penalties or intervention, reputation damage, reimbursement or other compensation costs, and/or additional compliance costs, any of which could have a material effect on our results of operations or financial condition.

Negative public opinion surrounding our Company and the financial institutions industry generally could damage our reputation and adversely impact our earnings and our ability to make loans or to acquire deposits.

Reputation risk, or the risk to our business, earnings and capital from negative public opinion surrounding our company and the financial institutions industry generally, is inherent in our business. Negative public opinion can result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance and acquisitions, and from actions taken by government regulators and community organizations in response to those activities. Negative public opinion can adversely affect our ability to keep and attract clients and employees and can expose us to litigation and regulatory action. Although we take steps to minimize reputation risk in dealing with our clients and communities, this risk will always be present given the nature of our business.

Uncertainty relating to the London Inter-bank Offered Rate, or LIBOR, calculation process and potential phasing out of LIBOR may adversely affect us.

On July 27, 2017, the Chief Executive of the United Kingdom Financial Conduct Authority, which regulates LIBOR, announced that it intends to stop persuading or compelling banks to submit rates for the calibration of LIBOR to the administrator of LIBOR after 2021. The announcement indicates that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021. It is impossible to predict whether and to what extent banks will continue to provide LIBOR submissions to the administrator of LIBOR or whether any additional reforms to LIBOR may be enacted in the United Kingdom or elsewhere. At this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR and it is impossible to predict the effect of any such alternatives on the value of LIBOR-based securities and variable rate loans, or other securities or financial arrangements, given LIBOR’s role in determining market interest rates globally. The Federal Reserve Board, in conjunction with the Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions, is considering replacing the U.S. dollar LIBOR with a new index calculated by short-term repurchase agreements, backed by Treasury securities (“SOFR”). SOFR is observed and backward looking, which stands in contrast with LIBOR under the current methodology, which is an estimated forward-looking rate and relies, to some degree, on the expert judgment of submitting panel members. Given that SOFR is a secured rate backed by government securities, it will be a rate that does not take into account bank credit risk (as is the case with LIBOR). SOFR is therefore likely to be lower than LIBOR and is less likely to correlate with the funding costs of financial institutions. Whether or not SOFR attains traction as a LIBOR replacement tool remains in question, although some transactions using SOFR have been completed in 2019, and the future of LIBOR remains uncertain as this time. Uncertainty as to the nature of alternative reference rates and as to potential changes or other reforms to LIBOR may adversely affect LIBOR rates and the value of LIBOR-based loans, and securities in our portfolio. If LIBOR rates are no longer available, and we are required to implement substitute indices for the calculation of interest rates under our loan agreements with our borrowers, we may experience significant expenses in effecting the transition, and may be subject to disputes or litigation with customers and creditors over the appropriateness or comparability to LIBOR of the substitute indices, which could have an adverse effect on our results of operations.

From time to time we are, or may become, involved in lawsuits, legal proceedings, information-gatherings, investigations and proceedings by governmental and self-regulatory agencies that may lead to adverse consequences.

Many aspects of the banking business involve a substantial risk of legal liability. From time to time, we are, or may become, involved in or the subject of lawsuits and other legal proceedings and information-gathering requests, reviews, investigations and proceedings, and other forms of regulatory inquiry, including by bank regulatory agencies, self-regulatory agencies, the SEC and law enforcement authorities. The results of such proceedings could lead to significant civil or criminal penalties, including monetary penalties, damages, adverse judgements, settlements, fines, injunctions, restrictions on the way we conduct our business or reputational harm.

Risks Related to Our Common Stock

Our stock price may be volatile, which could result in losses to our investors and litigation against us.

Several factors could cause our stock price to fluctuate substantially in the future. These factors include but are not limited to: actual or anticipated variations in earnings, changes in analysts’ recommendations or projections, our announcement of developments related to our businesses, operations and stock performance of other companies deemed to be peers, new technology used or services offered by traditional and non-traditional competitors, news reports of trends, irrational exuberance on the part of investors, new federal banking regulations, and other issues related to the financial services industry. Our stock price may fluctuate significantly in the future, and these fluctuations may be unrelated to our performance. General market declines or market volatility in the future, especially in the financial institutions sector, could adversely affect the price of our common stock, and the current market price may not be indicative of future market prices. Stock price volatility may make it more difficult for you to resell your common stock when you want and at prices you find attractive. Moreover, in the past, securities class action lawsuits have been instituted against some companies following periods of volatility in the market price of its securities. We could in the future be the target of similar litigation. Securities litigation could result in substantial costs and divert management’s attention and resources from our normal business.

Future sales of our stock by our stockholders or the perception that those sales could occur may cause our stock price to decline.

Although our common stock is listed on the Nasdaq Capital Market under the symbol “CARO,” the trading volume in our common stock is lower than that of other larger financial services companies. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of our common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control. Given the relatively low trading volume of our common stock, significant sales of our common stock in the public market, or the perception that those sales may occur, could cause the trading price of our common stock to decline or to be lower than it otherwise might be in the absence of those sales or perceptions.

Economic and other circumstances may require us to raise capital at times or in amounts that are unfavorable to us. If we have to issue shares of common stock, they will dilute the percentage ownership interest of existing stockholders and may dilute the book value per share of our common stock and adversely affect the terms on which we may obtain additional capital.

We may need to incur additional debt or equity financing in the future to make strategic acquisitions or investments or to strengthen our capital position. Our ability to raise additional capital, if needed, will depend on, among other things, conditions in the capital markets at that time, which are outside of our control and our financial performance. We cannot provide assurance that such financing will be available to us on acceptable terms or at all, or if we do raise additional capital that it will not be dilutive to existing stockholders.

If we determine, for any reason, that we need to raise capital, our board generally has the authority, without action by or vote of the stockholders, to issue all or part of any authorized but unissued shares of stock for any corporate purpose, including issuance of equity-based incentives under or outside of our equity compensation plans. Additionally, we are not restricted from issuing additional common stock or preferred stock, including any securities that are convertible into or exchangeable for, or that represent the right to receive, common stock or preferred stock or any substantially similar securities. The market price of our common stock could decline as a result of sales by us of a large number of shares of common stock or preferred stock or similar securities in the market or from the perception that such sales could occur. Any issuance of additional shares of stock will dilute the percentage ownership interest of our stockholders and may dilute the book value per share of our common stock. Shares we issue in connection with any such offering will increase the total number of shares and may dilute the economic and voting ownership interest of our existing stockholders.

Our board of directors may issue shares of preferred stock that would adversely affect the rights of our common stockholders.

Our authorized capital stock includes 1,000,000 shares of preferred stock of which no preferred shares are issued and outstanding. Our board of directors, in its sole discretion, may designate and issue one or more series of preferred stock from the authorized and unissued shares of preferred stock. Subject to limitations imposed by law or our certificate of incorporation, our board of directors is empowered to determine:

	·	the designation of, and the number of, shares constituting each series of preferred stock;
	·	the dividend rate for each series;
	·	the terms and conditions of any voting, conversion and exchange rights for each series;
	·	the amounts payable on each series on redemption or our liquidation, dissolution or winding-up;
	·	the provisions of any sinking fund for the redemption or purchase of shares of any series; and
	·	the preferences and the relative rights among the series of preferred stock.

We could issue preferred stock with voting and conversion rights that could adversely affect the voting power of the shares of our common stock and with preferences over the common stock with respect to dividends and in liquidation.

Our securities are not FDIC insured.

Our securities, including our common stock, are not savings or deposit accounts or other obligations of the Bank, are not insured by the Deposit Insurance Fund, the FDIC or any other governmental agency and are subject to investment risk, including the possible loss of principal.

Item 1B. Unresolved Staff Comments.

None.

Item 2. Properties.

Our main office is located at 288 Meeting Street, Charleston, South Carolina 29401-1575. Including our main office, the Bank operates 73 full service branches and one loan production office located in South Carolina and North Carolina. In addition to our main office, branches, and loan production offices, we also operate the Bank’s retail mortgage division headquartered in Myrtle Beach, South Carolina, Crescent Mortgage Company, the Bank’s correspondent/wholesale mortgage subsidiary, headquartered in Atlanta, Georgia, and Carolina Services Corporation of Charleston, located in Charleston, South Carolina.

The Bank owns 38 of the branch offices, plus eight additional branch offices for which the land is leased and the building is owned. The remaining offices are subject to leases. The Company also owns the building occupied by the Bank’s retail mortgage division. For each property that we lease, we believe that, based upon current market conditions, upon expiration of the lease we will be able to extend the lease on satisfactory terms or relocate to another acceptable location. We believe these premises will be adequate for present and anticipated needs and that we have adequate insurance to cover our owned and leased premises. For additional information relating to the Company’s premises, equipment and lease commitments, see Note 7 - Premises and Equipment, net and Note 14 - Commitments and Contingencies Including Leases to our audited consolidated financial statements included elsewhere in this report.

Item 3. Legal Proceedings.

In the ordinary course of operations, we may be a party to various legal proceedings from time to time. We do not believe that there is any pending or threatened proceeding against us, which, if determined adversely, would have a material effect on our business, results of operations, or financial condition.

Item 4. Mine Safety Disclosures.

None.

PART II

Item 5. Market for Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities.

As of February 10, 2020, there were approximately 2,901 stockholders of record of our common stock. Our common stock was listed on the NASDAQ Capital Market on July 1, 2014. Under the Stock Symbol “CARO.”

We are authorized to pay dividends as declared by our board of directors, provided that no such distribution results in our insolvency on a going concern or balance sheet basis. Future dividends will be subject to board approval. As we are a legal entity separate and distinct from the Bank, our principal source of funds with which we can pay dividends to our shareholders is dividends we receive from the Bank. For that reason, our ability to pay dividends is subject to the limitations that apply to the Bank. For more information on restrictions on payments of dividends, see Note 20 - Capital Requirements and Other Restrictions included in Part II, Item 8 – Financial Statements and Supplementary Data.

(Line Graph)

	Period Ending
Index	12/31/14		12/31/15		12/31/16		12/31/17		12/31/18		12/31/19
Carolina Financial Corporation		100.00		155.59		267.81		324.78		260.41		384.09
NASDAQ Composite Index		100.00		106.96		116.45		150.96		146.67		200.49
SNL Southeast Bank Index		100.00		98.44		130.68		161.65		133.56		188.08

Prepared by S&P Global Market Intelligence, a division of S&P Global Inc.

The performance graph above compares the Company’s cumulative total return from December 31, 2014 through December 31, 2019 with the NASDAQ Composite and the SNL Southeast Bank Index, a banking industry performance index for the Southeastern United States. The Company was listed on the NASDAQ exchange on July 1, 2014. Returns are shown on a total return basis, assuming the reinvestment of dividends and a beginning stock index value of $100 per share. The value of the Company’s common stock as shown in the graph is based on published prices for the transactions in the Company’s common stock.

Issuer Purchases of Equity Securities

2019 Period	(a) Total Number of Shares Purchased		(b) Average Price Paid per Share		(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		(d) Maximum Number (or Approximate Dollar Value) of Shares that may yet be Purchased Under the Plans or Programs
January 1 - January 31		104,936	$	31.87		104,936	$	16,274,800
February 1 - February 28		11,936		34.74		11,936		15,860,092
March 1 - March 31		11,726		34.03		11,726		15,461,071
April 1 - April 30		3,810		34.99		3,810		15,327,759
May 1 - May 31		7,575		34.58		7,575		15,065,816
June 1 - June 30		18,520		34.10		18,520		14,434,284
July 1 - July 31		18,093		34.52		18,093		13,809,714
August 1 - August 31		23,742		34.00		23,742		13,002,486
September 1 - September 30		4,972		34.30		4,972		12,831,946
October 1 - October 31		9,462		34.77		9,462		12,502,953
November 1 - November 30		—		—		—		12,502,953
December 1 - December 31		—		—		—		12,502,953
		214,772				214,772

Item 6. Selected Financial Data


	For The Years Ended December 31,
	2019		2018		2017		2016		2015
	(In thousands)
Operating Data:

Interest income	$	177,116		161,058		95,087		60,914		49,604
Interest expense		37,866		27,248		13,253		8,753		6,604
Net interest income		139,250		133,810		81,834		52,161		43,000
Provision for loan losses		2,580		2,059		779		—		—
Net interest income after provision for loan losses		136,670		131,751		81,055		52,161		43,000
Noninterest income		47,110		39,896		33,916		29,297		27,679
Noninterest expense		103,092		109,208		73,445		56,040		49,199
Income before income taxes		80,688		62,439		41,526		25,418		21,480
Income tax expense		17,948		12,769		12,961		7,848		7,060
Net income	$	62,740		49,670		28,565		17,570		14,420

	At December 31,
	2019		2018		2017		2016		2015
	(In thousands)
Balance Sheet Data:

Total assets	$	4,708,873		3,790,748		3,519,017		1,683,736		1,409,669
Interest-bearing cash		91,792		33,276		55,998		14,591		16,421
Securities available-for-sale		879,235		842,801		743,239		335,352		306,474
Securities held-to-maturity		—		—		—		—		17,053
Federal Home Loan Bank stock		23,280		21,696		19,065		11,072		9,919
Loans held for sale		31,282		16,972		35,292		31,569		41,774
Loans receivable, net		3,211,416		2,509,873		2,308,050		1,167,578		912,582
Allowance for loan losses		16,521		14,463		11,478		10,688		10,141
Deposits		3,408,361		2,718,193		2,604,929		1,258,260		1,031,528
Short-term borrowed funds		437,700		405,500		340,500		203,000		120,000
Long-term debt		54,875		59,436		72,259		38,465		103,465
Stockholders’ equity		743,440		575,285		475,381		163,190		139,859


	For The Years Ended December 31,
	2019			2018			2017			2016			2015
	(Dollars in thousands)
Selected Average Balances:

Total assets	$	3,893,831			3,629,490			2,306,667			1,537,654			1,303,402
Loans receivable		2,624,667			2,388,856			1,526,109			1,035,115			827,787
Deposits		2,818,592			2,697,908			1,761,087			1,197,688			1,012,659
Stockholders’ equity		605,629			526,701			280,877			151,285			101,896

Performance Ratios:

Return on average equity		10.36	%		9.43	%		10.17	%		11.61	%		14.15	%
Return on average assets		1.61	%		1.37	%		1.24	%		1.14	%		1.11	%
Average earning assets to average total assets		90.00	%		89.62	%		90.98	%		93.56	%		91.42	%
Average loans receivable to average deposits		93.12	%		88.54	%		86.66	%		86.43	%		81.74	%
Average equity to average assets		15.55	%		14.51	%		12.18	%		9.84	%		7.82	%
Net interest margin		3.97	%		4.11	%		3.90	%		3.63	%		3.59	%
Net interest margin - tax equivalent (1)		4.02	%		4.15	%		4.02	%		3.71	%		3.68	%
Net recoveries (charge-offs) to average loans receivable		(0.02	)%		0.04	%		—			0.05	%		0.13	%
Non-performing assets to total loans receivable		0.85	%		0.53	%		0.30	%		0.58	%		0.72	%
Non-performing assets to total assets		0.58	%		0.35	%		0.20	%		0.40	%		0.47	%
Non-performing loans to total loans		0.78	%		0.47	%		0.17	%		0.48	%		0.47	%
Allowance for loan losses as a percentage of gross loans receivable (end of period) (2)		0.51	%		0.57	%		0.49	%		0.91	%		1.10	%
Allowance for loan losses as a percentage of nonperforming loans		65.44	%		123.13	%		291.84	%		190.01	%		235.73	%

	At or For The Years Ended December 31,
	2019			2018			2017			2016			2015
Per Share Data:

Book value (end of period) (3)	$	30.14			25.83			22.76			13.23			11.92
Basic earnings		2.83			2.28			1.75			1.45			1.51
Diluted earnings		2.80			2.26			1.73			1.42			1.48

Average common shares - basic		22,168,082			21,756,595			16,317,501			12,080,128			9,537,358
Average common shares - diluted		22,385,127			21,972,857			16,550,357			12,352,246			9,718,356

(1)	The tax equivalent net interest margin reflects tax-exempt income on a tax-equivalent basis.

(2)	Included in loans receivable are approximately $989.5 million, $686.4 million, and $952.2 million in acquired loans at December 31, 2019, 2018 and 2017, respectively.

(3)

Book value is calculated using outstanding common shares less unvested restricted shares.

On June 22, 2015, the Board of Directors of the Company declared a six-for-five stock split representing a 20% stock dividend to stockholders of record as of July 15, 2015, payable on July 31, 2015.

All share, earnings per share, and per share data have been retroactively adjusted to reflect these stock splits for all periods presented in accordance with generally accepted accounting principles.

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

The following discussion and analysis of our consolidated financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this report. Historical results of operations and the percentage relationships among any amounts included, and any trends that may appear, may not indicate trends in operations or results of operations for any future periods.

We have made, and will continue to make, various forward-looking statements with respect to financial and business matters. Comments regarding our business that are not historical facts are considered forward-looking statements that involve inherent risks and uncertainties. Actual results may differ materially from those contained in these forward-looking statements. For additional information regarding our cautionary disclosures, see “Cautionary Note Regarding Forward-Looking Statements” at the beginning of this report.

Company Overview

Like most community banks, we derive a significant portion of our income from interest we receive on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, both interest-bearing and noninterest-bearing. Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits and borrowed funds. In order to maximize our net interest income, we must not only manage the volume of these balance sheet items, but also the yields that we earn on our interest-earning assets and the rates that we pay on interest-bearing liabilities.

There are risks inherent in all loans, so we maintain an allowance for loan losses to absorb probable losses on existing loans that may become uncollectible. We establish and maintain this allowance by charging a provision for loan losses against our operating earnings.

In addition to earning interest on our loans and investments, we derive a portion of our income from Crescent Mortgage Company through mortgage banking income as well as servicing income. We also earn income through fees that we charge to our customers. Likewise, we incur other operating expenses as well.

Economic conditions, competition, and the monetary and fiscal policies of the federal government significantly affect most financial institutions, including the Bank. Lending and deposit activities and fee income generation are influenced by levels of business spending and investment, consumer income, consumer spending and savings, capital market activities, and competition among financial institutions as well as client preferences, interest rate conditions and prevailing market rates on competing products in our market areas.

Pending Merger with and into United Bankshares, Inc.

On November 17, 2019, the Company announced the execution of an agreement and plan of merger by and between the Company and United Bankshares, Inc., (“United”) pursuant to which, subject to the terms and conditions set forth therein, the Company will merge with and into United, with United as the surviving corporation of the merger. The merger agreement provides that at the effective time of the merger, the Bank will merge with and into United Bank, a wholly-owned subsidiary of United Bank, with United Bank as the surviving entity. Consummation of the merger is subject to approval of the stockholders of United and Carolina Financial, the receipt of all required regulatory approvals, as well as other customary conditions. Pursuant to the merger agreement, each outstanding share of common stock of Carolina Financial will be converted into the right to receive 1.13 shares of United common stock, par value $2.50 per share, resulting in an aggregate transaction value of approximately $1.1 billion. The foregoing description of the merger agreement does not purport to be complete and is qualified in its entirety by reference to the full text of the merger greement, a copy of which is filed as Exhibit 2.1 to this report and is incorporated herein by reference. United has filed a registration statement on Form S-4 with the SEC to register the shares of United’s common stock that will be issued to the Company’s stockholders in connection with the proposed merger. The definitive prospectus of United and joint proxy statement of United and the Company, filed on February 13, 2020 has been provided to the stockholders of each of United and the Company in connection with the proposed merger and is incorporated herein by reference. See “Part I, Item 1 – “Pending Merger with and into United Bankshares, Inc.”

Executive Summary of Operating Results

The following is a summary of the Company’s financial highlights and significant events in 2019:

The Company reported net income for the year ended December 31, 2019 of $62.7 million or $2.80 per diluted share, as compared to $49.7 million, or $2.26 per diluted share, for the year ended December 31, 2018.

Accretion income from acquired loans was $7.6 million for the year ended December 31, 2019 compared to $9.8 million for the year ended December 31, 2018. Provision for loan losses during the years ended December 31, 2019 and 2018 was $2.6 million and $2.1 million, respectively.

Operating earnings for the year ended December 31, 2019, which exclude certain non-operating income and expenses, increased to $67.6 million, or $3.02 per diluted share compared to $62.8 million, or $2.86 per diluted share, for the same period of 2018.

Included in net income for the year ended December 31, 2019 was a fair value loss on interest rate swaps of $3.7 million, a temporary impairment of mortgage servicing rights of $3.1 million, a gain on sale of securities of $3.9 million, a loss on early extinguishment of debt of approximately $178,000 and merger-related expenses of $2.8 million.

Included in net income for the year ended December 31, 2018 was a fair value loss on interest rate swaps of approximately $340,000, a loss on sale of securities of $1.9 million and merger-related expenses of $15.2 million.

	·	On December 31, 2019, the Company closed its acquisition of Carolina Trust BancShares, Inc. The acquisition added $481.0 million of loans receivable, gross and $537.8 million of deposits.
	·	Loans receivable, gross grew $703.6 million since December 31, 2018. Excluding the impact of loans acquired from Carolina Trust, loans receivable, gross grew $222.6 million, or 8.8% since December 31, 2018.
	·	Total deposits increased $690.2 million since December 31, 2018. Excluding the impact of deposits acquired from Carolina Trust, deposits increased $152.4 million since December 31, 2018.

Nonperforming assets to total assets were 0.58% as of December 31, 2019 compared to 0.35% as of December 31, 2018. Nonperforming loans were $25.2 million as of December 31, 2019 as compared to $11.7 million at December 31, 2018. The increase in nonperforming loans and the NPA ratio was primarily due to two fully collateralized lending relationships.

The Company reported book value per common share of $30.14 and $25.83 as of December 31, 2019 and 2018, respectively. Tangible book value per common share was $22.00 and $19.36 as of December 31, 2019 and 2018, respectively.

At December 31, 2019, the Company’s regulatory capital ratios exceeded the minimum levels currently required. Stockholders’ equity totaled $743.4 million as of December 31, 2019 compared to $575.3 million at December 31, 2018. Tangible equity to tangible assets at December 31, 2019 was 12.04% compared to 11.83% at December 31, 2018.

On December 3, 2018, the Company announced that the Board of Directors had approved a plan to repurchase up to $25 million in shares of the Company’s common stock through open market and privately negotiated transactions over the next three years. The Company began stock repurchases on December 4, 2018. During 2019, the Company repurchased approximately 215,000 shares at an average price of $33.13. Cumulatively since December 4, 2018, the Company repurchased approximately 390,000 shares at an average price of $32.01.

Operating earnings and related per share measures, as well as core deposits, tangible common equity and tangible book value per common share are non-GAAP financial measures. For reconciliations to the most comparable GAAP measures, see “Non-GAAP Financial Measures” below.

Critical Accounting Policies

We have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States and with general practices within the banking industry in the preparation of our financial statements. Our significant accounting policies are described in Note 1 to our consolidated financial statements within Item 8 “Financial Statements and Supplementary Data” elsewhere in this report.

Certain accounting policies involve significant judgments and assumptions by us that have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgment and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Because of the nature of the judgment and assumptions we make, actual results could differ from these judgments and estimates that could have a material impact on the carrying values of our assets and liabilities and our results of operations. Management has reviewed and approved these critical accounting policies and discussed them with the audit committee of the Board of Directors.

Non-GAAP Financial Measures

Statements included in this management’s discussion and analysis include non-GAAP financial measures and should be read along with the accompanying tables which provide a reconciliation of non-GAAP financial measures to GAAP financial measures. The Company’s management uses these non-GAAP financial measures, including but not limited to, core deposits, tangible book value, operating earnings, allowance for loan losses to non-acquired loans, net interest margin-core and yield on loans receivable-core to evaluate and compare the Company’s operating results from period to period in a meaningful manner.

Management believes that non-GAAP financial measures provide additional useful information that allows readers to evaluate the ongoing performance of the Company without regard to transactional activities. Non-GAAP financial measures should not be considered as an alternative to any measure of performance or financial condition as promulgated under GAAP, and investors should consider the Company’s performance and financial condition as reported under GAAP and all other relevant information when assessing the performance or financial condition of the Company. Non-GAAP financial measures have limitations as analytical tools, and investors should not consider them in isolation or as a substitute for analysis of the Company’s results or financial condition as reported under GAAP.

The following table presents a reconciliation of Non-GAAP performance measures for consolidated operating earnings and corresponding ratios:

	For the Years Ended
	December 31,
	2019			2018			2017
	(Dollars in thousands)
As Reported:
Income before income taxes	$	80,688			62,439			41,526
Tax expense		17,948			12,769			12,961
Net income	$	62,740			49,670			28,565

Average equity	$	605,629			526,701			280,877
Average assets		3,893,831			3,629,490			2,306,667
Return on average assets		1.61	%		1.37	%		1.24	%
Return on average equity		10.36	%		9.43	%		10.17	%

Weighted average common shares outstanding:
Basic		22,168,082			21,756,595			16,317,501
Diluted		22,385,127			21,972,857			16,550,357
Earnings per common share:
Basic	$	2.83			2.28			1.75
Diluted	$	2.80			2.26			1.73

Operating:
Income before income taxes	$	80,688			62,439			41,526
(Gain) loss on sale of securities		(3,891	)		1,946			(933	)
Net loss on extinguishment of debt		178			—			—
Fair value adjustments on interest rate swaps		3,659			340			(382	)
Merger-related costs		2,753			15,216			8,301
Impairment of mortgage servicing rights		3,100			—			—
Operating earnings before income taxes		86,487			79,941			48,512
Tax expense (1)		18,868			17,105			14,706
Operating earnings (Non-GAAP)	$	67,619			62,836			33,806

Average equity	$	605,629			526,701			280,877
Average assets	$	3,893,831			3,629,490			2,306,667
Operating return on average assets (Non-GAAP)		1.74	%		1.73	%		1.47	%
Operating return on average equity (Non-GAAP)		11.17	%		11.93	%		12.04	%

Weighted average common shares outstanding:
Basic		22,168,082			21,756,595			16,317,501
Diluted		22,385,127			21,972,857			16,550,357
Operating earnings per common share:
Basic (Non-GAAP)	$	3.05			2.89			2.07
Diluted (Non-GAAP)	$	3.02			2.86			2.04

(1)

Tax expense is determined using the effective tax rate adjusted to eliminate the impact of the non-operating items.

	At December 31,
	2019			2018
	(Dollars in thousands)
Core deposits:
Noninterest-bearing demand accounts	$	668,616			547,022
Interest-bearing demand accounts		651,577			566,527
Savings accounts		218,786			192,322
Money market accounts		590,916			431,246
Total core deposits (Non-GAAP)		2,129,895			1,737,117

Certificates of deposit:
Less than $250,000		1,159,978			875,749
$250,000 or more		118,488			105,327
Total certificates of deposit		1,278,466			981,076
Total deposits	$	3,408,361			2,718,193

	At December 31,
	2019			2018
	(Dollars in thousands)
Tangible book value per share:
Total stockholders’ equity	$	743,440			575,285
Less intangible assets		(200,880	)		(144,054	)
Tangible common equity (Non-GAAP)	$	542,560			431,231

Issued and outstanding shares		24,777,608			22,387,009
Less nonvested restricted stock awards		(112,549	)		(117,966	)
Period end shares used for tangible book value		24,665,059			22,269,043

Total stockholders’ equity	$	743,440			575,285
Divided by period end shares used for tangible book value		24,665,059			22,269,043
Common book value per share	$	30.14			25.83

Tangible common equity (Non-GAAP)	$	542,560			431,231
Divided by period end shares used for tangible book value		24,665,059			22,269,043
Tangible common book value per share (Non-GAAP)	$	22.00			19.36

Recent Accounting Standards and Pronouncements

For information relating to recent accounting standards and pronouncements, see Note 1 to the audited consolidated financial statements within Item 8 “Financial Statements and Supplementary Data.”

Results of Operations

Summary

2019 compared to 2018

The Company reported net income available to common stockholders of approximately $62.7 million, or $2.80 per diluted share, for the year ended December 31, 2019, compared to $49.7 million, or $2.26 per diluted share for the year ended December 31, 2018. Operating earnings, which exclude certain non-operating income and expenses, for the year ended December 31, 2019 increased 7.6% to $67.6 million, or $3.02 per diluted share, from $62.8 million, or $2.86 per diluted share, for the year ended December 31, 2018. Operating earnings and related per share measures are non-GAAP financial measures. For a reconciliation to the most compared GAAP measure, see “Non-GAAP Financial Measures”.

2018 compared to 2017

The Company reported net income available to common stockholders of approximately $49.7 million, or $2.26 per diluted share, for the year ended December 31, 2018, compared to $28.6 million, or $1.73 per diluted share for the year ended December 31, 2017. Our 2018 and 2017 results include pretax merger related expenses of $15.2 million and $8.3 million, respectively. Operating earnings, which exclude certain non-operating income and expenses, for the year ended December 31, 2018 increased 85.9% to $62.8 million, or $2.86 per diluted share, from $33.8 million, or $2.04 per diluted share, for the year ended December 31, 2017. Operating earnings and related per share measures are non-GAAP financial measures. For a reconciliation to the most compared GAAP measure, see “Non-GAAP Financial Measures”.

Details of the changes in the various components of net income are further discussed below.

Net Interest Income and Margin

Net interest income is a significant component of our net income. Net interest income is the difference between income earned on interest-earning assets and interest paid on interest-bearing liabilities. Net interest income is determined by the yields earned on interest-earning assets, rates paid on interest-bearing liabilities, the relative balances of interest-earning assets and interest-bearing liabilities, the degree of mismatch, and the maturity and repricing characteristics of interest-earning assets and interest-bearing liabilities.

2019 compared to 2018

For the years ended December 31, 2019 and 2018, our net interest income was $139.3 million and $133.8 million, respectively. The increase in net interest income is a result of the increase in average interest-earning assets balances. The increase in average earnings assets for the year ended December 31, 2019 is primarily the result of increased balances of loans receivable as well as higher available-for-sale securities. Average loans receivable increased $235.8 million from 2018 to 2019, primarily attributable to organic loan growth. Average yields on loans receivable, net increased from 5.54% for the year ended December 31, 2018 to 5.60% for the year ended December 31, 2019.

2018 compared to 2017

For the years ended December 31, 2018 and 2017, our net interest income was $133.8 million and $81.8 million, respectively. The increase in net interest income is a result of the increase in average interest-earning assets balances. The increase in average earnings assets for the year ended December 31, 2018 is primarily the result of increased balances of loans receivable as well as higher available-for-sale securities. Average loans receivable increased $862.7 million, or 56.5%, from 2017 to 2018, primarily attributable to the Greer and First South acquisitions as well as organic loan growth. Average yields on loans receivable, net increased 0.40% from December 31, 2017 to 5.54% for the year ended December 31, 2018.

The following table sets forth information related to our average balance sheet, average yields on assets, and average costs of liabilities for the periods indicated (dollars in thousands). We derived these yields or costs by dividing income or expense by the average balance of the corresponding assets or liabilities. We derived average balances from the daily balances throughout the periods indicated. During the same periods, we had no securities purchased with agreements to resell. Nonaccrual loans are included in earning assets in the following tables. Loan yields reflect the negative impact on our earnings of loans on nonaccrual status. The net capitalized loan costs and fees, which are considered immaterial, are amortized into interest income on loans.

	For The Years Ended December 31,
	2019								2018								2017
				Interest		Average						Interest		Average						Interest		Average
	Average			Earned/		Yield/			Average			Earned/		Yield/			Average			Earned/		Yield/
	Balance			Paid		Rate			Balance			Paid		Rate			Balance			Paid		Rate
	(Dollars in thousands)
Interest-earning assets:
Loans held for sale	$	24,271			1,039		4.28	%		22,149			963		4.35	%		23,199			885		3.81	%
Loans receivable, net (1)		2,624,667			146,882		5.60	%		2,388,856			132,289		5.54	%		1,526,109			78,415		5.14	%
Interest-bearing cash		21,063			444		2.11	%		25,628			479		1.87	%		31,715			350		1.10	%
Securities available for sale		811,028			27,424		3.38	%		795,100			26,222		3.30	%		504,555			14,836		2.90	%
Federal Home Loan Bank stock		19,739			1,203		6.09	%		17,744			1,004		5.66	%		11,032			496		4.50	%
Other investments		3,490			124		3.55	%		3,437			101		2.94	%		2,108			105		4.98	%
Total interest-earning assets		3,504,258			177,116		5.05	%		3,252,914			161,058		4.95	%		2,098,718			95,087		4.53	%
Noninterest-earning assets		389,573								376,576								207,949

Total assets	$	3,893,831								3,629,490								2,306,667

Interest-bearing liabilities:
Demand accounts		573,745			2,506		0.44	%		564,282			3,121		0.55	%		319,190			817		0.26	%
Money market accounts		442,076			4,647		1.05	%		459,774			3,048		0.66	%		374,770			1,747		0.47	%
Savings accounts		183,843			1,000		0.54	%		201,741			630		0.31	%		89,598			170		0.19	%
Certificates of deposit		1,017,795			18,953		1.86	%		910,433			11,928		1.31	%		622,424			6,653		1.07	%
Short-term borrowed funds		365,429			8,328		2.28	%		316,189			6,064		1.92	%		176,169			1,888		1.07	%
Long-term debt		48,688			2,432		5.00	%		59,465			2,457		4.13	%		58,539			1,978		3.38	%
Total interest-bearing liabilities		2,631,576			37,866		1.44	%		2,511,884			27,248		1.08	%		1,640,690			13,253		0.81	%
Noninterest-bearing deposits		601,133								561,678								355,105
Other liabilities		55,493								29,227								29,995
Stockholders’ equity		605,629								526,701								280,877

Total liabilities and Stockholders’ equity	$	3,893,831								3,629,490								2,306,667

Net interest spread							3.61	%							3.87	%							3.72	%
Net interest margin		3.97	%							4.11	%							3.90	%

Net interest margin (tax-equivalent) (2)		4.02	%							4.15	%							4.02	%
Net interest income				$	139,250								133,810								81,834

(1)	Average balances of loans receivable, net include nonaccrual loans.

(2)	The tax equivalent net interest margin reflects tax-exempt income on a tax-equivalent basis.

2019 compared to 2018

Our net interest margin was 3.97%, or 4.02% on a tax-equivalent basis, for the year ended December 31, 2019 compared to 4.11%, or 4.15% on a tax equivalent basis, for the year ended December 31, 2018. The decrease in margin from period to period is the result of an increase in the cost of funds as well as lower purchase accounting accretion. The increase in rates paid on interest-bearing liabilities is primarily due to repricing because of the increases in the prime rate during 2018 in addition to increased competition in our markets for deposits to fund strong loan growth.

The yield on loans receivable during the year ended December 31, 2019 reflects accretion income from loans purchased in acquisitions of $7.6 million (22 bps to NIM) and early payoff fees of approximately $704,000 (2 bps to NIM) compared to accretion income of $9.8 million (32 bps to NIM) and early payoff fees of $1.0 million (3 bps to NIM) for the year ended December 31, 2018. Excluding accretion income from acquired loans and early payoff fees, net interest margin-core (Non-GAAP) for the year ended December 31, 2019 was 3.78% compared to 3.80% for the year ended December 31, 2018.

Our net interest spread, which is not on a tax-equivalent basis, was 3.61% for the year ended December 31, 2019 as compared to 3.87% for the same period in 2018. The net interest spread is the difference between the yield we earn on our interest-earning assets and the rate we pay on our interest-bearing liabilities. The 26 basis point decrease in net interest spread is a result of the 10 basis point increase in yield on interest-earning assets as well as a 36 basis point increase in rates paid on interest-bearing liabilities.

2018 compared to 2017

Our net interest margin was 4.11%, or 4.15% on a tax-equivalent basis, for the year ended December 31, 2018 compared to 3.90%, or 4.02% on a tax equivalent basis, for the year ended December 31, 2017. The increase in margin from period to period is the result of a shift to higher yielding earning assets as well as an increase in yield on securities available for sale and loans receivable, net of the increase in cost of funds. Average loans receivable comprised 73.4% of interest earning assets for the year ended December 31, 2018 compared to 72.7% for the year ended December 31, 2017. The yield on loans receivable during the years ended December 31, 2018 and 2017 reflects accretion income from loans purchased in acquisitions of $9.8 million and $4.3 million, respectively.

Our net interest spread, which is not on a tax-equivalent basis, was 3.87% for the year ended December 31, 2018 as compared to 3.72% for the same period in 2017. The net interest spread is the difference between the yield we earn on our interest-earning assets and the rate we pay on our interest-bearing liabilities. The 15 basis point increase in net interest spread is a result of the 42 basis point increase in yield on interest-earning assets as well as a 27 basis point increase in rates paid on interest-bearing liabilities.

The increase in the rate realized on loans is primarily the result of variable rate loans repricing as a result of the increases in the prime rate.

Rate/Volume Analysis

Net interest income can be analyzed in terms of the impact of changing interest rates and changing volume. The following tables set forth the effect which the varying levels of interest-earning assets and interest-bearing liabilities and the applicable rates have had on changes in net interest income for the periods presented.

	For The Years Ended December 31,
	2019 vs. 2018												2018 vs. 2017
	Increase (decrease)									Net			Increase (decrease)									Net
	due to						Rate/			Dollar			due to						Rate/			Dollar
	Volume			Rate			Volume			Change			Volume			Rate			Volume			Change
	(In thousands)
Loans held for sale	$	91			(16	)		1			76			(46	)		118			6			78
Loans receivable, net		13,197			1,534			(138	)		14,593			47,777			9,544			(3,447	)		53,874
Interest-bearing cash		(96	)		50			11			(35	)		(114	)		196			47			129
Securities available-for-sale		539			677			(14	)		1,202			9,582			2,843			(1,039	)		11,386
FHLB stock		122			86			(9	)		199			380			206			(78	)		508
Other investments		2			21			—			23			39			(70	)		27			(4	)
Interest income		13,855			2,352			(149	)		16,058			57,618			12,837			(4,484	)		65,971

Demand accounts	$	41			(667	)		11			(615	)		1,356			1,677			(728	)		2,305
Money market accounts		(186	)		1,716			69			1,599			564			905			(167	)		1,302
Savings accounts		(97	)		426			41			370			350			247			(137	)		460
Certificates of deposit		1,999			5,619			(593	)		7,025			3,773			2,196			(695	)		5,274
Short-term borrowed funds		1,122			1,320			(178	)		2,264			2,685			2,675			(1,185	)		4,175
Long-term debt		(538	)		420			93			(25	)		38			448			(7	)		479
Interest expense	$	2,341			8,834			(557	)		10,618			8,766			8,148			(2,919	)		13,995
Net interest income											5,440												51,976

	For the Years Ended December 31,
	2017 vs. 2016
	Increase (decrease)									Net
	due to						Rate/			Dollar
	Volume			Rate			Volume			Change
	(In thousands)
Loans held for sale	$	(213	)		79			19			(115	)
Loans receivable, net		25,229			4,496			(1,447	)		28,278
Interest-bearing cash		23			270			(18	)		275
Securities available-for-sale		5,206			883			(310	)		5,779
Securities held-to-maturity		—			—			(217	)		(217	)
FHLB stock		141			(27	)		8			122
Other investments		(27	)		62			16			51
Interest income		30,359			5,763			(1,949	)		34,173

Demand accounts	$	429			323			(169	)		583
Money market accounts		466			645			(172	)		939
Savings accounts		85			52			(26	)		111
Certificates of deposit		1,459			415			(91	)		1,783
Short-term borrowed funds		898			917			(436	)		1,379
Long-term debt		(631	)		255			81			(295	)
Interest expense	$	2,706			2,607			(813	)		4,500
Net interest income											29,673

Provision for Loan Loss

We have established an allowance for loan losses through a provision for loan losses charged as an expense on our consolidated statements of operations. We review our loan portfolio periodically to evaluate our outstanding loans and to measure both the performance of the portfolio and the adequacy of the allowance for loan losses.

Following is a summary of the activity in the allowance for loan losses during the years ended December 31, 2019, 2018 and 2017.

	For the Years Ended
	2019			2018			2017
	(In thousands)
Balance, beginning of period	$	14,463			11,478			10,688
Provision for loan losses		2,580			2,059			779
Loan charge-offs		(1,235	)		(872	)		(272	)
Loan recoveries		713			1,798			283
Balance, end of period	$	16,521			14,463			11,478

2019 compared to 2018

The Company experienced net charge-offs of approximately $522,000 for the year ended December 31, 2019 and net recoveries of $926,000 for the year ended December 31, 2018. Provision for loan losses of $2.6 million was recorded during 2019 primarily driven by organic loan growth. Provision expense for loan losses of $2.1 million was recorded during 2018. The increase in provision expense from the prior year was primarily due to loan growth and reduced recoveries in 2019. Non-performing assets were 0.58% and 0.35% of total assets at December 31, 2019 and 2018, respectively. The increase in the NPA ratio was primarily due to two fully collateralized lending relationships.

2018 compared to 2017

The Company experienced net recoveries of $926,000 for the year ended December 31, 2018 and net recoveries of $11,000 for the year ended December 31, 2017. Nonperforming assets were 0.35% as of December 31, 2018 and 0.20% as of December 31, 2017. Approximately half of the increase related to five purchased non-credit impaired loans with balances in excess of $500,000. Provision for loan losses of $2.1 million was recorded during 2018 primarily driven by organic loan growth and unknown storm related impacts in the third quarter of 2018. Provision expense for loan losses of $779,000 was recorded during 2017.

Noninterest Income and Expense

Noninterest income provides us with additional revenues that are significant sources of income. In 2019, 2018 and 2017, noninterest income comprised 21.0%, 19.8% and 26.3%, respectively, of total interest and noninterest income.

The major components of noninterest income for the Company are listed below:

	For the Years
	Ended December 31,
	2019			2018			2017
	(In thousands)
Noninterest income:
Mortgage banking income	$	19,326			15,295			15,140
Deposit service charges		6,814			7,755			4,643
Net loss on extinguishment of debt		(178	)		—			—
Net gain (loss) on sale of securities		3,891			(1,946	)		933
Fair value adjustments on interest rate swaps		(3,659	)		(340	)		382
Net increase in cash value life insurance		1,591			1,530			1,116
Mortgage loan servicing income		10,107			9,052			6,790
Debit card income, net		4,839			4,809			2,308
Other		4,379			3,741			2,604
Total noninterest income	$	47,110			39,896			33,916

2019 compared to 2018

Noninterest income increased to $47.1 million for the year ended December 31, 2019 from $39.9 million for the year ended December 31, 2018. The increase in noninterest income for the year ended December 31, 2019 over the comparable period in 2018 primarily relates to an increase in mortgage banking income due to higher mortgage origination activity and closings as well as gains on sales of securities partially offset by fair value losses on interest rate swaps.

The following table provides a break out of mortgage banking:

	For the Years Ended December 31,
	Loan Originations				Mortgage Banking Income				Margin
	2019		2018		2019		2018		2019			2018
	(Dollars in thousands)
Additional segment information:
Community banking	$	107,452		108,721		2,998		2,352		2.79	%		2.16	%
Wholesale mortgage banking		799,975		744,208		16,328		12,943		2.04	%		1.74	%
Total	$	907,427		852,929		19,326		15,295		2.13	%		1.79	%

Mortgage loan servicing income increased $1.1 million for the year ended December 31, 2019 compared to the year ended December 31, 2018. The increase in mortgage loan servicing income was primarily driven by an increase in loans serviced for the comparative periods particularly servicing acquired in late 2018.

2018 compared to 2017

Noninterest income increased to $39.9 million for the year ended December 31, 2018 from $33.9 million for the year ended December 31, 2017. The increase in noninterest income for the year ended December 31, 2018 over the comparable period in 2017 primarily relates to an increase in mortgage loan servicing income due to higher average balances of serviced loans and an increase in deposit service charges, debit card income and other noninterest income due to organic growth in addition to the impact of the First South and Greer acquisitions in 2017, partially offset by a net loss on sale of securities.

The following table provides a break out of mortgage banking:


	For the Years Ended December 31,
	Loan Originations				Mortgage Banking Income				Margin
	2018		2017		2018		2017		2018			2017
	(Dollars in thousands)
Additional segment information:
Community banking	$	108,721		86,732		2,352		2,009		2.16	%		2.32	%
Wholesale mortgage banking		744,208		824,282		12,943		13,131		1.74	%		1.59	%
Total	$	852,929		911,014		15,295		15,140		1.79	%		1.66	%

Mortgage loan servicing income increased $2.3 million for the year ended December 31, 2018 compared to the year ended December 31, 2017. The increase in mortgage loan servicing income was primarily driven by an increase in loans serviced for the comparative periods.

The following table sets forth for the periods indicated the primary components of noninterest expense:

	For the Years
	Ended December 31,
	2019			2018			2017
	(In thousands)
Noninterest expense:
Salaries and employee benefits	$	53,822			53,517			37,827
Occupancy and equipment		16,902			15,961			10,347
Marketing and public relations		1,614			1,330			1,417
FDIC insurance		502			1,090			721
Recovery of mortgage loan repurchase losses		(400	)		(600	)		(900	)
Legal expense		438			422			507
Other real estate expense (income), net		422			(13	)		54
Mortgage subservicing expense		2,872			2,468			1,986
Amortization of mortgage servicing rights		5,721			4,206			2,966
Impairment of mortgage servicing rights		3,100			—			—
Amortization of core deposit intangible		2,910			3,139			1,037
Merger-related expenses		2,753			15,216			8,301
Other		12,436			12,472			9,182
Total noninterest expense	$	103,092			109,208			73,445

2019 compared to 2018

Noninterest expense decreased to $103.1 million for the year ended December 31, 2019 from $109.2 million for the year ended December 31, 2018. The decrease in noninterest expense is primarily the result of a decrease in merger-related expenses year over year. Noninterest expense for the year ended December 31, 2019 also included a temporary impairment of mortgage servicing rights of $3.1 million. The Company does not hedge the mortgage servicing rights positions and the impact of falling long-term interest rates increased prepayment speed assumptions driving down the value of the MSR asset.

2018 compared to 2017

Noninterest expense increased to $109.2 million for the year ended December 31, 2018 from $73.4 million for the year ended December 31, 2017. The increase in noninterest expense is primarily the result of an increase in salaries and employee benefits and occupancy and equipment as well as merger related expenses related to the acquisitions of First South and Greer during 2017. Merger related expenses totaled $15.2 million for the year ended December 31, 2018 as compared to $8.3 million for the year ended December 31, 2017.

Income Tax Expense

2019 compared to 2018

Our effective tax rate was 22.2% for the year ended December 31, 2019, compared to 20.4% for the year ended December 31, 2018. The increase in the effective tax rate from period to period reflects lower interest income on municipal securities, lower tax benefits related to excess stock-based compensation and the impact of certain non-deductible merger related expenses in 2019.

2018 compared to 2017

Our effective tax rate was 20.4% for the year ended December 31, 2018, compared to 31.2% for the year ended December 31, 2017. The decrease in the effective tax rate from period to period reflects a reduction in the federal income tax rate from 35% to 21% as enacted in the 2017 Tax Cuts and Jobs Act on December 22, 2017. In addition to the lower federal tax rate, the decrease in the effective tax rate from period to period reflects an increase in interest income on municipal securities during 2018 and tax benefits related to excess stock-based compensation.

Balance Sheet Review

Investment Securities

Our primary objective in managing the investment portfolio is to maintain a portfolio of high quality, liquid investments yielding competitive returns. We are required under federal regulations to maintain adequate liquidity to ensure safe and sound operations. We maintain investment balances based on a continuing assessment of cash flows, the level of current and expected loan production, current interest rate risk strategies and the assessment of the potential future direction of market interest rate changes. Investment securities differ in terms of default, interest rate, liquidity and expected rate of return risk.

At December 31, 2019, our securities portfolio, excluding FHLB stock and other investments, was $879.2 million or approximately 18.7% of our assets. Our available-for-sale securities portfolio included municipal securities, US agency securities, collateralized loan obligations, corporate securities, mortgage-backed securities (agency and non-agency), and trust preferred securities with a fair value of $879.2 million and an amortized cost of $868.2 million resulting in a net unrealized gain of $11.0 million.

At December 31, 2019, the Company acquired approximately $50.2 million in available-for-sale securities from Carolina Trust.

As securities are purchased, they are designated as held-to-maturity or available-for-sale based upon our intent, which incorporates liquidity needs, interest rate expectations, asset/liability management strategies, and capital requirements. We do not currently hold, nor have we ever held, any securities that are designated as trading securities.

The amortized costs and the fair value of our investments are as follows:

	At December 31,
	2019				2018				2017
	Amortized		Fair		Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value		Cost		Value
	(In thousands)
Securities available-for-sale:
Municipal securities	$	210,810		218,968		212,215		213,714		240,904		247,350
US government agencies		23,968		23,923		24,772		25,277		11,983		12,008
Collateralized loan obligations		301,249		299,982		231,172		230,699		128,080		128,643
Corporate securities		6,940		6,988		6,915		6,960		6,891		7,006
Mortgage-backed securities:
Agency		164,114		166,714		199,518		197,520		243,075		243,595
Non-agency		150,019		151,942		158,803		157,531		94,834		95,125
Total mortgage-backed securities		314,133		318,656		358,321		355,051		337,909		338,720
Trust preferred securities		11,114		10,718		11,066		11,100		11,208		9,512
Total securities available-for-sale	$	868,214		879,235		844,461		842,801		736,975		743,239

The Company uses prices from third party pricing services to estimate the fair value of our investment securities. While we obtain fair value information from multiple sources, we generally obtain one price/quote for each individual security. For securities priced by third party pricing services, we determine the most appropriate and relevant pricing service for each security class and have that vendor provide the price for each security in the class. We record the value provided by the third party pricing service/broker in our consolidated financial statements, subject to our internal price verification procedures, which include periodic comparisons to other brokers and Bloomberg pricing screens.

Contractual maturities and yields on our investments are shown in the following table. Municipal yields were not tax effected in the table below. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities available-for-sale are presented at fair value and held-to-maturity securities are presented at amortized cost.


	At December 31, 2019
	Less than 12 Months					One to Five Years					Five to Ten Years					Over Ten Years					Total
	Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield
	(Dollars in thousands)
Securities available-for-sale:
Municipal securities	$	681		2.78	%		6,141		2.59	%		44,003		3.21	%		168,143		3.12	%		218,968		3.13	%
US government agencies		—		—			8,050		2.07	%		13,813		2.45	%		2,060		2.56	%		23,923		2.33	%
Collateralized loan obligations		—		—			—		—			74,430		3.72	%		225,552		3.62	%		299,982		4.20	%
Corporate securities		—		—			6,988		4.28	%		—		—			—		—			6,988		4.28	%
Mortgage-backed securities:
Agency		—		—			1,113		2.76	%		16,831		2.84	%		148,770		2.55	%		166,714		2.58	%
Non-agency		—		—			3		5.38	%		1,366		2.82	%		150,573		3.54	%		151,942		3.53	%
Total mortgage-backed securities		—		—			1,116		2.77	%		18,197		2.84	%		299,343		3.05	%		318,656		3.03	%
Trust preferred securities		—		—			—		—			—		—			10,718		4.10	%		10,718		4.10	%
Total securities available-for-sale	$	681		2.78	%		22,295		2.94	%		150,443		3.35	%		705,816		3.26	%		879,235		3.46	%

For disclosures related to the Company’s evaluation of securities for OTTI, see Note 4 – Securities within Item 8. “Financial Statements and Supplementary Data.”

Non-marketable investments are comprised of the following and are recorded at cost which approximates fair value since no readily available market exists for these securities.

	At December 31,
	2019		2018
	(In thousands)
Community Reinvestment Act fund	$	2,405		2,334
Investment in Trust Preferred subsidiaries		1,116		1,116
Total other investments		3,521		3,450

Federal Home Loan Bank stock, at cost		23,280		21,696
Total non-marketable investments	$	26,801		25,146

Loans by Type

Since loans typically provide higher interest yields than other types of interest-earning assets, a substantial percentage of our earning assets are invested in our loan portfolio. Gross loans receivable at December 31, 2019 and 2018 were $3.2 billion and $2.5 billion, respectively.

Our loan portfolio consists primarily of loans secured by real estate mortgages. As of December 31, 2019, our loan portfolio included $2.7 billion, or 84.7%, of gross loans secured by real estate. As of December 31, 2018, our loan portfolio included $2.1 billion, or 84.8%, of gross loans secured by real estate. Substantially all of our real estate loans are secured by residential or commercial property. We obtain a security interest in real estate, in addition to any other available collateral. This collateral is taken to increase the likelihood of the ultimate repayment of the loan. Generally, we limit the loan-to-value ratio on loans to coincide with the appropriate regulatory guidelines. We attempt to maintain a relatively diversified loan portfolio to help reduce the risk inherent in concentration in certain types of collateral and business types.

As shown in the table below, loans receivable, gross grew $703.6 million since December 31, 2018. Excluding the impact of loans acquired from Carolina Trust, loans receivable, gross grew $222.6 million, or 8.8% since December 31, 2018. The growth in loan balances was primarily the result of strong organic growth in both commercial and residential lending.

The following table summarizes loans by type and percent of total at the end of the periods indicated:


	At December 31,
	2019					2018					2017
			% of Total					% of Total					% of Total
All Loans:	Amount		Loans			Amount		Loans			Amount		Loans
	(Dollars in thousands)
Loans secured by real estate:
One-to-four family	$	785,572		24.34	%		732,717		29.03	%		665,774		28.70	%
Home equity		110,016		3.41	%		83,770		3.32	%		90,141		3.89	%
Commercial real estate		1,394,626		43.20	%		1,034,117		40.96	%		933,820		40.26	%
Construction and development		442,657		13.71	%		290,494		11.51	%		294,793		12.71	%
Consumer loans		26,500		0.82	%		23,845		0.94	%		19,990		0.86	%
Commercial business loans		468,566		14.52	%		359,393		14.24	%		315,010		13.58	%
Total gross loans receivable		3,227,937		100.00	%		2,524,336		100.00	%		2,319,528		100.00	%
Less:
Allowance for loan losses		16,521					14,463					11,478
Total loans receivable, net	$	3,211,416					2,509,873					2,308,050

	At December 31,
	2016					2015
			% of Total					% of Total
	Amount		Loans			Amount		Loans
	(Dollars in thousands)
Loans secured by real estate:
One-to-four family	$	411,399		34.91	%		344,928		37.38	%
Home equity		36,026		3.06	%		23,256		2.52	%
Commercial real estate		445,344		37.80	%		341,658		37.03	%
Construction and development		115,682		9.82	%		91,362		9.90	%
Consumer loans		5,714		0.48	%		5,179		0.56	%
Commercial business loans		164,101		13.93	%		116,340		12.61	%
Total gross loans receivable		1,178,266		100.00	%		922,723		100.00	%
Less:
Allowance for loan losses		10,688					10,141
Total loans receivable, net	$	1,167,578					912,582

Maturities and Sensitivity of Loans to Changes in Interest Rates

The information in the following table is based on the contractual maturities of individual loans, including loans which may be subject to renewal at their contractual maturity. Renewal of such loans is subject to review and credit approval, as well as modification of terms upon maturity. Actual repayments of loans may differ from the maturities reflected below because borrowers have the right to prepay obligations with or without prepayment penalties.

The following table summarizes the loan maturity distribution by type and related interest rate characteristics.

	At December 31, 2019
			After one
	One Year		but within		After five
	or Less		five years		years		Total
	(In thousands)
Loans secured by real estate:
One-to-four family	$	43,586		194,817		547,169		785,572
Home equity		12,276		25,520		72,220		110,016
Commercial real estate		176,990		899,643		317,993		1,394,626
Construction and development		123,718		272,749		46,190		442,657
Consumer loans		3,168		11,105		12,227		26,500
Commercial business loans		72,100		293,312		103,154		468,566
Total gross loans receivable	$	431,838		1,697,146		1,098,953		3,227,937

Loans maturing - after one year
Variable rate loans							$	1,007,928
Fixed rate loans								1,788,171
							$	2,796,099

Nonperforming and Problem Assets

Nonperforming assets include loans on which interest is not being accrued, accruing loans that are 90 days or more delinquent and foreclosed property. Foreclosed property consists of real estate and other assets acquired as a result of a borrower’s loan default. Generally, a loan is placed on nonaccrual status when it becomes 90 days past due as to principal or interest, or when we believe, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of the loan is doubtful. A payment of interest on a loan that is classified as nonaccrual is recognized as a reduction of principal when received. In general, a nonaccrual loan may be placed back onto accruing status once the borrower has made a minimum of six consecutive payments in accordance with the loan terms. Further, the borrower must show capacity to continue performing into the future prior to restoration of accrual status. As of December 31, 2019, and December 31, 2018, the Company had $2.0 million and $0.6 million, respectively, of PCI loans that were 90 days past due and accruing.

Troubled Debt Restructurings (“TDRs”)

The Company designates loan modifications as TDRs when, for economic or legal reasons related to the borrower’s financial difficulties, it grants a concession to the borrower that it would not otherwise consider. Loans on nonaccrual status at the date of modification are initially classified as nonaccrual TDRs. Loans on accruing status at the date of modification are initially classified as accruing TDRs at the date of modification, if the note is reasonably assured of repayment and performance is in accordance with its modified terms. Such loans may be designated as nonaccrual loans subsequent to the modification date if reasonable doubt exists as to the collection of interest or principal under the restructuring agreement. Nonaccrual TDRs are returned to accrual status when there is economic substance to the restructuring, there is well documented credit evaluation of the borrower’s financial condition, the remaining balance is reasonably assured of repayment in accordance with its modified terms, and the borrower has demonstrated repayment performance in accordance with the modified terms for a reasonable period of time, generally a minimum of six months.

The following table summarizes nonperforming and problem assets, excluding purchased credit impaired loans, at the end of the periods indicated.

	At December 31,
	2019		2018		2017		2016		2015
	(In thousands)
Loans receivable:
90 days and still accruing	$	—		20		—		—		—
Nonaccrual loans-renegotiated loans		6,636		3,086		1,140		1,227		1,136
Nonaccrual loans-other		18,530		8,635		2,793		4,398		3,166
Real estate acquired through foreclosure, net		2,325		1,534		3,106		1,179		2,374
Total non-performing assets	$	27,491		13,275		7,039		6,804		6,676

Problem assets not included in non-performing assets:
Accruing renegotiated loans outstanding	$	4,473		3,327		5,324		5,216		13,212

At December 31, 2019, nonperforming assets were $27.5 million, or 0.58% of total assets. Comparatively, nonperforming assets were $13.3 million, or 0.35% of total assets, at December 31, 2018. Nonperforming loans were 0.78% and 0.47% of gross loans receivable at December 31, 2019 and December 31, 2018, respectively.

At December 31, 2018, nonperforming assets were $13.3 million, or 0.35% of total assets. Comparatively, nonperforming assets were $7.0 million, or 0.20% of total assets, at December 31, 2017. Nonperforming loans were 0.47% and 0.17% of gross loans receivable at December 31, 2018 and December 31, 2017, respectively.

Potential problem loans, which are not included in nonperforming loans, amounted to approximately $4.5 million at December 31, 2019, compared to $3.3 million at December 31, 2018. Potential problem loans represent those loans with a well-defined weakness and where information about possible credit problems of borrowers has caused management to have serious doubts about the borrower’s ability to comply with present repayment terms.

Potential problem loans, which are not included in nonperforming loans, amounted to approximately $3.3 million at December 31, 2018, compared to $5.3 million at December 31, 2017. Potential problem loans represent those loans with a well-defined weakness and where information about possible credit problems of borrowers has caused management to have serious doubts about the borrower’s ability to comply with present repayment terms.

Substantially all of the nonaccrual loans, accruing loans 90 days or more delinquent and accruing renegotiated loans for fiscal years 2019 and 2018 are collateralized by real estate. The Bank utilizes third party appraisers to determine the fair value of collateral dependent loans. Our current loan and appraisal policies require the Bank to obtain updated appraisals on loans greater than $250,000 at a minimum of every 18 months, either through a new external appraisal or an internal appraisal evaluation. Impaired loans are individually reviewed on a quarterly basis to determine the level of impairment. We typically charge-off a portion or create a specific reserve for impaired loans when we do not expect repayment to occur as agreed upon under the original terms of the loan agreement. Management believes based on information known and available currently, the probable losses related to problem assets are adequately reserved in the allowance for loan losses.

Allowance for Loan Losses

The allowance for loan losses is management’s estimate of probable credit losses inherent in the loan portfolio at the balance sheet date. Management determines the allowance based on an ongoing evaluation. Estimating the amount of the allowance for loan losses requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on non-impaired loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The allowance consists of specific and general components.

The general component covers non-impaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by major loan category and is based on the actual loss history trends for the previous 20 quarters. The actual loss experience is supplemented with internal and external qualitative factors as considered necessary at each period and given the facts at the time. These qualitative factors adjust the 20 quarter historical loss rate to recognize the most recent loss results and changes in the economic conditions to ensure the estimated losses in the portfolio are recognized in the period incurred and that the allowance at each balance sheet date is adequate and appropriate in accordance with GAAP. Qualitative factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries for the most recent twelve quarters; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations.

The specific component relates to loans that are individually classified as impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. These analyses involve a high degree of judgment in estimating the amount of loss associated with specific loans, including estimating the amount and timing of future cash flows and collateral values. Impaired loans are evaluated for impairment using the discounted cash flow methodology or based on the net realizable value of the underlying collateral. Impaired loans are individually reviewed on a quarterly basis to determine the level of impairment. See additional discussion in section “Nonperforming and Problem Assets.”

While management uses the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the valuations or, if required by regulators, based upon information available to them at the time of their examinations. Such adjustments to original estimates, as necessary, are made in the period in which these factors and other relevant considerations indicate that loss levels may vary from previous estimates. To the extent actual outcomes differ from management’s estimates, additional provisions for loan losses could be required that could adversely affect the Bank’s earnings or financial position in future periods.

There are two methods to account for acquired loans as part of a business combination. Acquired loans that contain evidence of credit deterioration on the date of purchase are carried at the net present value of expected future proceeds in accordance with ASC 310-30. All other acquired loans are recorded at their initial fair value, adjusted for subsequent advances, pay downs, amortization or accretion of any premium or discount on purchase, charge-offs and any other adjustment to carrying value in accordance with ASC 310-20.

The allowance for loan losses was $16.5 million, or 0.74% of non-acquired loans, at December 31, 2019, compared to $14.5 million, or 0.79% of total non-acquired loans, at December 31, 2018. Loans acquired in business combinations were $989.5 million and $686.4 million at December 31, 2019 and December 31, 2018, respectively. No allowance for loan losses related to the acquired loans is recorded on the acquisition date because the fair value of the loans acquired incorporates assumptions regarding credit risk. At December 31, 2019 and December 31, 2018, acquired non-credit impaired loans had a purchase discount remaining of $9.5 million and $10.9 million, respectively.

The allowance for loan losses was $14.5 million, or 0.79% of non-acquired loans, at December 31, 2018, compared to $11.5 million, or 0.84% of total non-acquired loans, at December 31, 2017. Loans acquired in business combinations were $686.4 million and $952.2 million at December 31, 2018 and December 31, 2017, respectively. No allowance for loan losses related to the acquired loans is recorded on the acquisition date because the fair value of the loans acquired incorporates assumptions regarding credit risk. At December 31, 2018 and December 31, 2017, acquired non-credit impaired loans had a purchase discount remaining of $10.9 million and $17.7 million, respectively.

The table below shows a reconciliation of acquired and non-acquired loans and allowance for loan losses to non-acquired loans:


	At December 31,
	2019			2018
	(Dollars in thousands)
Acquired and non-acquired loans:
Acquired loans receivable	$	989,534			686,401
Non-acquired loans receivable		2,238,403			1,837,935
Total loans receivable	$	3,227,937			2,524,336
% Acquired		30.66	%		27.19	%

Non-acquired loans	$	2,238,403			1,837,935
Allowance for loan losses		16,521			14,463
Allowance for loan losses to non-acquired loans (Non-GAAP)		0.74	%		0.79	%

Total loans receivable	$	3,227,937			2,524,336
Allowance for loan losses		16,521			14,463
Allowance for loan losses to total loans receivable		0.51	%		0.57	%

The Company experienced net charge-offs of approximately $522,000 for the year ended December 31, 2019 and net recoveries of $926,000 for the year ended December 31, 2018. Provision for loan losses of $2.6 million was recorded during 2019 primarily driven by organic loan growth. Provision expense for loan losses of $2.1 million was recorded during 2018. The increase was primarily due to loan growth and reduced recoveries in 2019. Non-performing assets were 0.58% and 0.35% of total assets at December 31, 2019 and 2018, respectively. The increase in the NPA ratio was primarily due to two fully collateralized lending relationships.

The Company experienced net recoveries of $926,000 for the year ended December 31, 2018 and net recoveries of $11,000 for the year ended December 31, 2017. Nonperforming assets were 0.35% as of December 31, 2018 and 0.20% as of December 31, 2017. Provision expense was $2.1 million and $779,000 for 2018 and 2017, respectively.

The following table summarizes the activity related to our allowance for loan losses for the five years ended December 31, 2019.


	For the Years Ended December 31,
	2019			2018			2017			2016			2015
	(Dollars in thousands)
Balance, beginning of period	$	14,463			11,478			10,688			10,141			9,035
Provision for loan losses		2,580			2,059			779			—			—
Loan charge-offs:
Loans secured by real estate:
One-to-four family		(293	)		(226	)		(253	)		(84	)		(1,050	)
Home equity		(78	)		(31	)		—			—			—
Commercial real estate		(380	)		(86	)		—			—			—
Construction and development		(19	)		(24	)		—			—			(90	)
Consumer loans		(320	)		(308	)		(19	)		(53	)		(20	)
Commercial business loans		(145	)		(197	)		—			(127	)		(70	)
Total loan charge-offs		(1,235	)		(872	)		(272	)		(264	)		(1,230	)
Loan recoveries:
Loans secured by real estate:
One-to-four family		174			142			4			464			576
Home equity		6			7			3			—			150
Commercial real estate		35			77			31			—			350
Construction and development		248			1,112			81			76			479
Consumer loans		165			93			45			24			38
Commercial business loans		85			367			119			247			743
Total loan recoveries		713			1,798			283			811			2,336
Net loan (charge-offs) recoveries		(522	)		926			11			547			1,106
Balance, end of period	$	16,521			14,463			11,478			10,688			10,141

Allowance for loan losses as a percentage of loans receivable (end of period)		0.51	%		0.57	%		0.49	%		0.91	%		1.10	%
Net charge-offs (recoveries) to average loans receivable		0.02	%		(0.04	)%		—			(0.05	)%		(0.13	)%

The following table summarizes an allocation of the allowance for loan losses and the related percentage of loans outstanding in each category for the five years ended December 31, 2019.

	At December 31,
	2019					2018					2017					2016					2015
	Amount		%			Amount		%			Amount		%			Amount		%			Amount		%
						(Dollars in thousands)
Loans receivable:
One-to-four family	$	3,531		24.34	%		3,540		29.03	%		2,719		28.70	%		2,636		34.91	%		2,903		37.23	%
Home equity		225		3.41	%		203		3.32	%		168		3.89	%		197		3.06	%		151		2.52	%
Commercial real estate		5,746		43.20	%		5,097		40.96	%		3,986		40.26	%		3,344		37.80	%		3,402		37.10	%
Construction and development		2,542		13.71	%		1,969		11.51	%		1,201		12.71	%		1,132		9.82	%		1,138		9.94	%
Consumer loans		392		0.82	%		352		0.94	%		79		0.86	%		80		0.48	%		27		0.56	%
Commercial business loans		3,448		14.52	%		2,940		14.24	%		2,840		13.58	%		2,805		13.93	%		2,100		12.65	%
Unallocated		637		—			362		—			485		—			494		—			420		—
Total	$	16,521		100.00	%		14,463		100.00	%		11,478		100.00	%		10,688		100.00	%		10,141		100.00	%

Mortgage Operations

Mortgage Activities and Servicing

Our wholesale mortgage banking operations are conducted through our mortgage origination subsidiary, Crescent Mortgage Company. Mortgage activities involve the purchase of mortgage loans and table funded originations for the purpose of generating gains on sales of loans and fee income on the origination of loans and is included in mortgage banking income in the accompanying consolidated statements of operations. While the Company originates residential one-to-four family loans that are held in its loan portfolio, the majority of new loans are generally sold pursuant to third party market guidelines through Crescent Mortgage Company. Generally, residential mortgage loans are sold and, depending on the pricing in the marketplace, servicing rights are either sold or retained. The level of loan sale activity and its contribution to the Company’s profitability depends on maintaining a sufficient volume of loan originations and margin. Changes in the level of interest rates and the local economy affect the volume of loans originated by the Company and the amount of loan sales and loan fees earned. Discussion related to the impact and changes within the mortgage operations is provided in “Results of Operations – Noninterest Income and Expense”. Additional segment information is provided in Note 21 - Supplemental Segment Information in the accompanying financial statements.

Loan Servicing

We retain the rights to service a portion of the loans we sell on the third party market, as part of our mortgage banking activities, for which we receive service fee income. These rights are known as mortgage servicing rights, or MSRs, where the owner of the MSR acts on behalf of the mortgage loan owner and has the contractual right to receive a stream of cash flows in exchange for performing specified mortgage servicing functions. These duties typically include, but are not limited to, performing loan administration, collection, and default activities, including the collection and remittance of loan payments, responding to customer inquiries, accounting for principal and interest, holding custodial (impound) funds for the payment of property taxes and insurance premiums, counseling delinquent mortgagors, modifying loans and supervising foreclosures and property dispositions. We subservice the duties and responsibilities obligated to the owner of the MSR to a third party provider for which we pay a fee.

We recognize the rights to service mortgage loans for others as an asset. We initially record the MSR at fair value and subsequently account for the asset at lower of cost or market using the amortization method. Servicing assets are amortized in proportion to, and over the period of, the estimated net servicing income and are carried at amortized cost. A valuation is performed by an independent third party on a quarterly basis to assess the servicing assets for impairment based on the fair value at each reporting date. The fair value of servicing assets is determined by calculating the present value of the estimated net future cash flows consistent with contractually specified servicing fees. This valuation is performed on a disaggregated basis, based on loan type and year of production. Generally, loan servicing becomes more valuable when interest rates rise (as prepayments typically decrease) and less valuable when interest rates decline (as prepayments typically increase). As discussed in detail in notes to the consolidated financial statements, we use an appropriate weighted average constant prepayment rate, discount rate, and other defined assumptions to model the respective cash flows and determine the fair value of the servicing asset at each reporting date.

The Company was servicing $3.6 billion loans for others at December 31, 2019 and $4.0 billion at December 31, 2018. Mortgage servicing rights asset had a balance of $25.9 million and $32.9 million at December 31, 2019 and December 31, 2018, respectively. The midpoint economic estimated fair value of the mortgage servicing rights was $31.4 million and $40.9 million at December 31, 2019 and December 31, 2018, respectively. Amortization expense related to the mortgage servicing rights was $5.7 million and $4.2 million during the years ended December 31, 2019 and 2018, respectively.

Below is a roll-forward of activity in the balance of the servicing assets for the years ended December 31, 2019 and 2018 respectively:


	At December 31,
	2019			2018
	(In thousands)
MSR beginning balance	$	32,933			21,003
Amount capitalized		1,368			6,283
Purchased servicing		461			9,853
Amount amortized		(5,721	)		(4,206	)
MSR Impairment		(3,100	)		—
MSR ending balance	$	25,941			32,933

Reserve for Mortgage Repurchase Losses

Loans held for sale have primarily been fixed-rate single-family residential mortgage loans under contracts to be sold in the third party market. In most cases, loans in this category are sold within 30 days of closing. Buyers generally have recourse to return a purchased loan to the Company under limited circumstances. An estimation of mortgage repurchase losses is reviewed on a quarterly basis. The representations and warranties in our loan sale agreements provide that we repurchase or indemnify the investors for losses or costs on loans we sell under certain limited conditions. Some of these conditions include underwriting errors or omissions, fraud or material misstatements by the borrower in the loan application or invalid market value on the collateral property due to deficiencies in the appraisal. In addition to these representations and warranties, our loan sale contracts define a condition in which the borrower defaults during a short period of time, typically 120 days to one year, as an early payment default, or EPD. In the event of an EPD, we are required to return the premium paid by the investor for the loan as well as certain administrative fees, and in some cases repurchase the loan or indemnify the investor. Because the level of mortgage loan repurchase losses depends upon economic factors, investor demand strategies and other external conditions that may change over the life of the underlying loans, the level of the liability for mortgage loan repurchase losses is difficult to estimate and requires considerable management judgment.

The following table demonstrates the activity for the mortgage repurchase reserve for the years ended December 31, 2019, 2018, and 2017:

	For the Years Ended
	December 31,
	2019			2018			2017
	(In thousands)

Beginning balance	$	1,292			1,892			2,880
Losses paid		—			—			(88	)
Recovery of mortgage loan repurchase losses		(400	)		(600	)		(900	)
Ending balance	$	892			1,292			1,892

For the years ended December 31, 2019 and 2018, the Company recorded a recovery for mortgage repurchase losses of $400,000 and $600,000, respectively. The recovery for mortgage loan repurchase losses is related to several factors. The Company sells mortgage loans to various third parties, including government-sponsored entities (“GSEs”), under contractual provisions that include various representations and warranties as previously stated. The Company establishes the reserve for mortgage loan repurchase losses based on a combination of factors, including estimated levels of defects on internal quality assurance, default expectations, historical investor repurchase demand and appeals success rates, reimbursement by correspondent and other third party originators, and projected loss severity. As a result of the Company’s analysis of its reserve for mortgage loan repurchase losses, the reserve was reduced accordingly.

Deposits

We provide a range of deposit services, including noninterest-bearing demand accounts, interest-bearing demand and savings accounts, money market accounts and time deposits. These accounts generally pay interest at rates established by management based on competitive market factors and management’s desire to increase or decrease certain types or maturities of deposits. Deposits continue to be our primary funding source. At December 31, 2019, deposits totaled $3.4 billion, an increase from deposits of $2.7 billion at December 31, 2018. The increase in deposits since December 31, 2018 relates to deposits acquired from Carolina Trust as well as continued efforts to fund our balance sheet growth with core deposits through business development.

The following table shows the average balance amounts and the average rates paid on deposits held by us.


	For the Years Ended December 31,
	2019					2018					2017
	Average		Average			Average		Average			Average		Average
	Balance		Rate			Balance		Rate			Balance		Rate
	(Dollars in thousands)

Interest-bearing demand accounts	$	573,745		0.44	%		564,282		0.55	%		319,190		0.26	%
Money market accounts		442,076		1.05	%		459,774		0.66	%		374,770		0.47	%
Savings accounts		183,843		0.54	%		201,741		0.31	%		89,598		0.19	%
Certificates of deposit less than $100,000		523,052		1.83	%		330,815		1.18	%		220,742		0.92	%
Certificates of deposit of $100,000 or more		494,743		1.89	%		579,618		1.38	%		401,682		1.10	%
Total interest-bearing average deposits		2,217,459		1.22	%		2,136,230		0.88	%		1,405,982		0.67	%

Noninterest-bearing deposits		601,133					561,678					355,105
Total average deposits	$	2,818,592					2,697,908					1,761,087

The maturity distribution of our time deposits of $100,000 or more is as follows:

	At December 31,
	2019		2018
	(In thousands)

Three months or less	$	143,658		126,653
Over three through six months		235,092		75,425
Over six through twelve months		114,602		110,300
Over twelve months		185,126		160,006
Total certificates of deposits	$	678,478		472,384

Borrowings

The following table outlines our various sources of short-term borrowed funds during the years ended December 31, 2019, 2018 and 2017, and the amounts outstanding at the end of each period, the maximum amount for each component during the periods, the average amounts for each period, and the average interest rate that we paid for each borrowing source. The maximum month-end balance represents the high indebtedness for each component of borrowed funds at any time during each of the periods shown. Stated period end rates are contractual rates. The average for the period rates reflect the impact of purchase accounting.

Maximum

Contractual

Month

Average for the

Ending

Period End

End

Period

At or for the year ended December 31, 2019

Balance

Rate

Balance

Rate⁽¹⁾

(Dollars in thousands)

Short-term borrowed funds

Short-term FHLB advances

437,700

1.66%-2.02%

437,700

365,429

2.28

Long-term borrowed funds

Long-term FHLB advances, due 2021 through 2029

12,114

0.88%-2.39%

27,000

16,134

1.82

Subordinated debentures, due 2026 through 2037

42,761

3.67%-6.90%

42,761

32,554

6.57

Stated

Maximum

Period

Month

Average for the

Ending

End

Period

At or for the year ended December 31, 2018

Balance

Rate

Balance

Rate⁽¹⁾

(Dollars in thousands)

Short-term borrowed funds

Short-term FHLB advances

405,500

1.05%-2.78%

405,500

316,189

1.92

CAROLINA FINANCIAL CORP 10-K