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

Management’s Discussion and Analysis is intended to assist readers in understanding our results of operations and changes in financial position for the past three years. This review should be read in conjunction with the consolidated financial statements and accompanying notes beginning on page 86 of this report and the supplemental financial data contained in Tables 1 through 22 included with this discussion and analysis beginning on page 68 of this report.

Overview - 2017 Compared to 2016

We reported net income per diluted common share of $1.82 in 2017, a 36.8% increase compared to 2016. The increased earnings were primarily due to the Company’s acquisitions of Carolina Bank and Asheville Savings Bank, with loans increasing 49.1% and deposits increasing 49.5% year over year.

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The following is a more detailed discussion of our results for 2017 compared to 2016:

For the year ended December 31, 2017, we reported net income available to common shareholders of $46.0 million, or $1.82 per diluted common share, an increase of 36.8% in earnings per share from the $27.3 million, or $1.33 per diluted common share, in 2016. The higher earnings in 2017 were primarily the result of the growth of the Company, including two acquisitions completed in 2017, as well as other initiatives that increased profitability.

On March 3, 2017, we acquired Carolina Bank Holdings, Inc., the parent company of Carolina Bank, which operated eight branches and three mortgage loan offices, primarily in the Triad region of North Carolina. As of the acquisition date, Carolina Bank had total assets of $682 million, including $497 million in loans and $585 million in deposits.

On October 1, 2017, we acquired ASB Bancorp, Inc., the parent company of Asheville Savings Bank, SSB, headquartered in Asheville, North Carolina, which operated through 13 branches in the Asheville area. As of the acquisition date, Asheville Savings Bank reported total assets of approximately $798 million, including $606 million in loans and $679 million in deposits.

Net interest income for the year ended December 31, 2017 amounted to $164.7 million, a 33.5% increase from the $123.4 million recorded in 2016. The increase in net interest income was primarily due to the acquisitions of Carolina Bank and Asheville Savings Bank, as well as higher amounts of loans outstanding as a result of organic growth. Also, see the section entitled “Net Interest Income” for additional information.

Our net interest margin (tax-equivalent net interest income divided by average earning assets) was 4.08% for 2017 compared to 4.03% for 2016. Asset yields have increased primarily as a result of three Federal Reserve interest rate increases during the past year. Funding costs have also increased, but to a lesser degree.

We recorded a provision for loan losses of $0.7 million in 2017 compared to a negative provision for loan losses (reduction of the allowance for loan losses) of $23,000 in 2016. The low level of provision for loan losses in both years was primarily due to stable and improving loan quality. Our nonperforming assets to total assets ratio was 0.96% at December 31, 2017 compared to 1.64% at December 31, 2016. We experienced net loan charge-offs of $1.2 million in 2017, compared to $3.7 million in 2016. Annualized net charge-offs to average loans for the year ended December 31, 2017 amounted to 0.04%, compared to 0.14% for 2016.

For the year ended December 31, 2017, noninterest income amounted to $48.9 million compared to $25.6 million for 2016. The primary reason for the increase in core noninterest income in 2017 was the acquisition of Carolina Bank and Asheville Savings Bank, as well as income derived from the Company’s SBA consulting fees and SBA loan sale gains, which began during the middle of 2016. See the section entitled “Noninterest Income” for additional information.

Noninterest expenses for the year ended December 31, 2017 amounted to $145.2 million compared to $106.8 million in 2016. The increase in noninterest expenses in 2017 related primarily to the Company’s acquisition of Carolina Bank and Asheville Savings Bank. Also impacting expenses were other growth initiatives, including continued growth of the Company’s SBA consulting firm and SBA lending division, as well as the acquisition of an insurance agency during the third quarter of 2017. See the section entitled “Noninterest Expense” for additional information.

The Company’s effective tax rate for 2017 was 32.1% compared to 34.7% in 2016. The lower effective tax rate was due to the 2017 Tax Cuts and Jobs Act, which was signed into law in December 2017. The impact to the Company of revaluing its net deferred tax liability was to reduce income tax expense by approximately $1.3 million in the fourth quarter of 2017. The Company expects to be favorably impacted in 2018 by the reduction in the federal tax rate, with a projected effective tax rate of approximately 21%.

Total assets at December 31, 2017 amounted to $5.5 billion, a 53.5% increase from a year earlier. Total loans at December 31, 2017 amounted to $4.0 billion, a 49.1% increase from a year earlier, and total deposits amounted to $4.4 billion at December 31, 2017, a 49.5% increase from a year earlier.

In addition to the growth realized from the acquisitions of Carolina Bank in March 2017 and Asheville Savings Bank in October 2017, the Company experienced strong organic loan and deposit growth during 2017. For 2017, organic loan growth (i.e. excluding loan balances assumed from Carolina Bank and Asheville Savings Bank) amounted to $228.0 million, or 8.4%. For 2017, organic deposit growth amounted to $195.1 million, or 6.6%. The strong growth was a result of ongoing internal initiatives to enhance loan and deposit growth, including the Company’s recent expansion into higher growth markets. The organic loan growth noted above has been driven by the recently-entered North Carolina markets of Charlotte, Raleigh, and the Triad.

Overview - 2016 Compared to 2015

We reported net income per diluted common share of $1.33 in 2016, a 2.3% increase compared to 2015. The increased earnings were primarily due to the Company’s growth, with loans increasing 7.6% and deposits increasing 4.8% year over year.

The following is a more detailed discussion of our results for 2016 compared to 2015:

For the year ended December 31, 2016, we reported net income available to common shareholders of $27.3 million, or $1.33 per diluted common share, an increase of 3.4% compared to the $26.4 million, or $1.30 per diluted common share, for the year ended December 31, 2015. The higher earnings were primarily the result of loan and deposit growth, as well as other initiatives that increased profitability.

Net interest income for the year ended December 31, 2016 amounted to $123.4 million, a 3.0% increase from the $119.7 million recorded in 2015. The higher net interest income was primarily due to growth in our loans outstanding. Also, see the section entitled “Net Interest Income” for additional information.

Our net interest margin (tax-equivalent net interest income divided by average earning assets) was 4.03% for 2016 compared to 4.13% for 2015. The lower margin in 2016 compared to 2015 was primarily due to lower loan yields, which were impacted by the continued low interest rate environment.

We recorded a negative total provision for loan losses (reduction of the allowance for loan losses) on our covered and non-covered loans of $23,000 in 2016 compared to a negative provision for loan losses of $780,000 in 2015. For periods prior to the third quarter of 2016, our provision for loan losses was calculated separately between covered loans and non-covered loans, with covered loans being those loans subject to FDIC loss share agreements. Upon the termination of the FDIC loss share agreements on September 22, 2016, all loans became classified as non-covered. For the year 2016, the provision for loan losses on non-covered loans did not vary significantly from 2015, amounting

to $2.1 million in 2016 compared to $2.0 million for 2015. For the portion of the year our loss share agreements were in effect in 2016, we recorded a negative provision for loan losses on covered loans of $2.1 million compared to a $2.8 million negative provision for loan losses in 2015. The lower negative provision for loan losses on covered loans in 2016 was due to lower covered loan recoveries.

Our overall provision for loan loss levels were impacted by continued improvement in asset quality. Nonperforming assets amounted to $59.1 million at December 31, 2016, a decrease of 33.8% from the $89.3 million one year earlier. Our nonperforming assets to total assets ratio was 1.64% at December 31, 2016 compared to 2.66% at December 31, 2015. Annualized net charge-offs as a percentage of average loans for the twelve months ended December 31, 2016 was 0.14% compared to 0.46% for 2015.

For the year ended December 31, 2016, noninterest income amounted to $25.6 million compared to $18.8 million for the year ended December 31, 2015. The increases in noninterest income are primarily the result of the following strategic initiatives:

Partially offsetting the above-noted increases in noninterest income was higher indemnification asset expense in 2016 compared to 2015. Indemnification asset expense relates to write-offs of an indemnification asset associated with two FDIC loss share agreements. For 2016, the Company recorded $10.3 million in indemnification asset expense compared to $8.6 million in 2015. The 2016 amount includes a $5.7 million charge associated with the early termination of the loss share agreements that occurred in September 2016.

Noninterest expenses for the year ended December 31, 2016 amounted to $106.8 million compared to $98.1 million recorded in 2015. The primary reason for the increase was the costs associated with the growth initiatives previously discussed.

Total assets at December 31, 2016 amounted to $3.6 billion, a 7.5% increase from a year earlier. Total loans at December 31, 2016 amounted to $2.7 billion, a 7.6% increase from a year earlier, and total deposits amounted to $2.9 billion at December 31, 2016, a 4.8% increase from a year earlier.

The $192 million increase in our loans at December 31, 2016 compared to a year earlier is primarily related to ongoing internal initiatives to drive loan growth, including our expansion into higher growth markets.

Total deposits increased $136 million at December 31, 2016 compared to December 31, 2015, which was driven by a $175 million increase, or 8.3%, in checking, money market and savings accounts. Retail time deposits declined by $99 million, or 15.8%, over this same period, while deposits obtained from brokers increased $60 million, or 78.6%.

For the periods presented until the September 2016 termination of the FDIC loss share agreements, the Company’s results of operations were significantly affected by FDIC loss share agreements related to two FDIC-assisted failed

bank acquisitions. In the discussion above and in the accompanying tables, the term “covered” is used to describe assets that were included in FDIC loss share agreements, while the term “non-covered” refers to the assets not included in a loss share arrangement. As previously discussed, all loss share agreements were terminated in the third quarter of 2016 and thus the entire loan portfolio is now classified as non-covered. Certain prior period disclosures will continue to present the breakout of the loan portfolio between covered and non-covered.

Certain covered loans continued to have an unaccreted discount associated with them at the time of transfer to non-covered status. Such loans that experience favorable changes in credit quality compared to what was expected at the acquisition date, including loans that pay off, will continue to result in positive adjustments to interest income being recorded over the life of the respective loan – also referred to as loan discount accretion.

For periods prior to the termination, because favorable changes in covered assets resulted in lower expected FDIC claims, and unfavorable changes in covered assets resulted in higher expected FDIC claims, the FDIC indemnification asset was adjusted to reflect those expectations. The net increase or decrease in the indemnification asset was reflected within noninterest income, with the net impact being that pretax income was generally only impacted by 20% of the income or expense associated with provisions for loan losses on covered loans, discount accretion, and losses from covered foreclosed properties.

Outlook for 2018

We generally believe that the outlook for 2018 is favorable. We expect the national economy, as well as our local economies, to continue to improve, with unemployment rates remaining at low levels. We believe that the recent tax reform is likely to result in future economic growth, and the lower statutory tax rate will benefit our Company.

The Federal Reserve has increased short-term interest rates by 125 basis points since late 2015, with more increases projected. Longer-term interest rates, while still low, have begun to increase. Generally, higher interest rates can be favorable for banks like us. We are able to earn higher yields on our interest-earning assets, while our funding costs may reprice at a lag to the interest rate changes in the market, and potentially not to the full amount of the rate increases. However interest rates on loans continue to be impacted by intense competition, and we are beginning to experience pressure on the rates we pay on deposits. Thus the stability of our net interest margin is uncertain.

With several consecutive years of significantly improved trends of nonperforming assets and lower loan charge-offs compared to the recessionary years, we again recorded low levels of provisions for loan losses in 2017, which brought our overall allowance for loan loss level down significantly following the elevated amounts we maintained during and immediately following the recession. As stated in Note 20 to the consolidated financial statements, from January 1, 2018 through February 28, 2018, we have recorded net loan recoveries of $3.3 million. With other asset quality measures expected to remain stable, we currently expect our levels of provisions for loan losses to remain low in 2018.

Excluding our two whole-bank acquisitions in 2017, we experienced solid organic loan and deposit growth in 2017. Our local economies have continued to improve, and we experienced positive results from our recent expansion into the larger and higher growth markets in North Carolina. With our expanded market areas due to acquisitions and other strategic initiatives, we expect to experience continued loan and deposit growth in 2018.

Critical Accounting Policies

The accounting principles we follow and our methods of applying these principles conform with accounting principles generally accepted in the United States of America and with general practices followed by the banking industry. Certain of these principles involve a significant amount of judgment and may involve the use of estimates based on our best assumptions at the time of the estimation. The allowance for loan losses, intangible assets, and the fair value and discount accretion of acquired loans are three policies we have identified as being more sensitive in terms of judgments and estimates, taking into account their overall potential impact to our consolidated financial statements.

Allowance for Loan Losses

Due to the estimation process and the potential materiality of the amounts involved, we have identified the accounting for the allowance for loan losses and the related provision for loan losses as an accounting policy critical to our consolidated financial statements. The provision for loan losses charged to operations is an amount sufficient to bring the allowance for loan losses to an estimated balance considered adequate to absorb losses inherent in the portfolio.

Our determination of the adequacy of the allowance is based primarily on a mathematical model that estimates the appropriate allowance for loan losses. This model has two components. The first component involves the estimation of losses on individually evaluated “impaired loans.” A loan is considered to be impaired when, based on current information and events, it is probable we will be unable to collect all amounts due according to the contractual terms of the original loan agreement. A loan is specifically evaluated for an appropriate valuation allowance if the loan balance is above a prescribed evaluation threshold (which varies based on credit quality, accruing status, troubled debt restructured status, purchased credit impaired status, and type of collateral) and the loan is determined to be impaired. The estimated valuation allowance is the difference, if any, between the loan balance outstanding and the value of the impaired loan as determined by either 1) an estimate of the cash flows that we expect to receive from the borrower discounted at the loan’s effective rate, or 2) in the case of a collateral-dependent loan, the fair value of the collateral.

The second component of the allowance model is an estimate of losses for all loans not considered to be impaired loans (“general reserve loans”). General reserve loans are segregated into pools by loan type and risk grade and estimated loss percentages are assigned to each loan pool based on historical losses.  The historical loss percentages are then adjusted for any environmental factors used to reflect changes in the collectability of the portfolio not captured by historical data.

The reserves estimated for individually evaluated impaired loans are then added to the reserve estimated for general reserve loans. This becomes our “allocated allowance.” The allocated allowance is compared to the actual allowance for loan losses recorded on our books and any adjustment necessary for the recorded allowance to absorb losses inherent in the portfolio is recorded as a provision for loan losses. The provision for loan losses is a direct charge to earnings in the period recorded. Any remaining difference between the allocated allowance and the actual allowance for loan losses recorded on our books is our “unallocated allowance.”

Purchased loans are recorded at fair value at the acquisition date. Therefore, amounts deemed uncollectible at the acquisition date represent a discount to the loan value and become a part of the fair value calculation. Subsequent decreases in the amount expected to be collected result in a provision for loan losses with a corresponding increase in the allowance for loan losses. Subsequent increases in the amount expected to be collected are accreted into income over the life of the loan and this accretion is referred to as “loan discount accretion.”

Within the purchased loan portfolio, loans are deemed purchased credit impaired at acquisition if the bank believes it will not be able to collect all contractual cash flows. Performing loans with an unamortized discount or premium that are not deemed purchased credit impaired are considered to be purchased performing loans. Purchased credit impaired loans are individually evaluated as impaired loans, as described above, while purchased performing loans are

evaluated as general reserve loans. For purchased performing loan pools, any computed allowance that is in excess of remaining net discounts is a component of the allocated allowance.

Although we use the best information available to make evaluations, future material adjustments may be necessary if economic, operational, or other conditions change. In addition, various regulatory agencies, as an integral part of their examination process, periodically review our allowance for loan losses. Such agencies may require us to recognize additions to the allowance based on the examiners’ judgment about information available to them at the time of their examinations.

For further discussion, see “Nonperforming Assets” and “Summary of Loan Loss Experience” below.

Intangible Assets

Due to the estimation process and the potential materiality of the amounts involved, we have also identified the accounting for intangible assets as an accounting policy critical to our consolidated financial statements.

When we complete an acquisition transaction, the excess of the purchase price over the amount by which the fair market value of assets acquired exceeds the fair market value of liabilities assumed represents an intangible asset. We must then determine the identifiable portions of the intangible asset, with any remaining amount classified as goodwill. Identifiable intangible assets associated with these acquisitions are generally amortized over the estimated life of the related asset, whereas goodwill is tested annually for impairment, but not systematically amortized. Assuming no goodwill impairment, it is beneficial to our future earnings to have a lower amount assigned to identifiable intangible assets and higher amount of goodwill as opposed to having a higher amount considered to be identifiable intangible assets and a lower amount classified as goodwill.

The primary identifiable intangible asset we typically record in connection with a whole bank or bank branch acquisition is the value of the core deposit intangible, whereas when we acquire an insurance agency or a consulting firm, as we did in 2016 and 2017, the primary identifiable intangible asset is the value of the acquired customer list. Determining the amount of identifiable intangible assets and their average lives involves multiple assumptions and estimates and is typically determined by performing a discounted cash flow analysis, which involves a combination of any or all of the following assumptions: customer attrition/runoff, alternative funding costs, deposit servicing costs, and discount rates. We typically engage a third party consultant to assist in each analysis. For the whole bank and bank branch transactions recorded to date, the core deposit intangibles have generally been estimated to have a life ranging from seven to ten years, with an accelerated rate of amortization. For insurance agency acquisitions, the identifiable intangible assets related to the customer lists were determined to have a life of ten to fifteen years, with amortization occurring on a straight-line basis. For the SBA consulting firm we acquired in 2016, the identifiable intangible asset related to the customer list was determined to have a life of approximately seven years, with amortization occurring on a straight-line basis.

Subsequent to the initial recording of the identifiable intangible assets and goodwill, we amortize the identifiable intangible assets over their estimated average lives, as discussed above. In addition, on at least an annual basis, goodwill is evaluated for impairment by comparing the fair value of our reporting units to their related carrying value, including goodwill. We have three reporting units – 1) First Bank with $221.4 million in goodwill, 2) First Bank Insurance with $7.4 million in goodwill, and 3) SBA activities, including SBA Complete and our SBA lending division, with $4.3 million in goodwill. If the carrying value of a reporting unit were ever to exceed its fair value, we would determine whether the implied fair value of the goodwill, using a discounted cash flow analysis, exceeded the carrying value of the goodwill. If the carrying value of the goodwill exceeded the implied fair value of the goodwill, an impairment loss would be recorded in an amount equal to that excess. Performing such a discounted cash flow analysis would involve the significant use of estimates and assumptions.

In our 2017 goodwill impairment evaluation, we concluded that the goodwill for each of our reporting units was not impaired.

We review identifiable intangible assets for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Our policy is that an impairment loss is recognized, equal to the difference between the asset’s carrying amount and its fair value, if the sum of the expected undiscounted future cash flows is less than the carrying amount of the asset. Estimating future cash flows involves the use of multiple estimates and assumptions, such as those listed above.

Fair Value and Discount Accretion of Acquired Loans

We consider the determination of the initial fair value of acquired loans and the subsequent discount accretion of the purchased loans to involve a high degree of judgment and complexity.

We determine fair value accounting estimates of newly assumed assets and liabilities in accordance with relevant accounting guidance. However, the amount that we realize on these assets could differ materially from the carrying value reflected in our financial statements, based upon the timing of collections on the acquired loans in future periods. Because of inherent credit losses and interest rate marks associated with acquired loans, the amount that we record as the fair values for the loans is generally less than the contractual unpaid principal balance due from the borrowers, with the difference being referred to as the “discount” on the acquired loans. For non-impaired purchased loans, we accrete the discount over the lives of the loans in a manner consistent with the guidance for accounting for loan origination fees and costs.

For purchased credit-impaired (“PCI”) loans, the excess of the cash flows initially expected to be collected over the fair value of the loans at the acquisition date (i.e., the accretable yield) is accreted into interest income over the estimated remaining life of the loans using the effective yield method, provided that the timing and the amount of future cash flows is reasonably estimable. Accordingly, such loans are not classified as nonaccrual and they are considered to be accruing because their interest income relates to the accretable yield recognized under accounting for PCI loans and not to contractual interest payments. The difference between the contractually required payments and the cash flows expected to be collected at acquisition, considering the impact of prepayments, is referred to as the nonaccretable difference.

Subsequent to an acquisition, estimates of cash flows expected to be collected are updated periodically based on updated assumptions regarding default rates, loss severities, and other factors that are reflective of current market conditions. If there is a decrease in cash flows expected to be collected, the provision for loan losses is charged, resulting in an increase to the allowance for loan losses. If the Company has a probable increase in cash flows expected to be collected, we will first reverse any previously established allowance for loan losses and then increase interest income as a prospective yield adjustment over the remaining life of the loan. The impact of changes in variable interest rates is recognized prospectively as adjustments to interest income.

Merger and Acquisition Activity

As previously discussed, in January 2016, we acquired an insurance agency in Sanford, North Carolina, and in May 2016, we acquired a firm specializing in origination and servicing of SBA loans. In July 2016, we exchanged our seven bank branches located in Virginia to another community bank in return for six of their North Carolina branches. In 2017, we completed two full-bank acquisitions – Carolina Bank and Asheville Savings Bank. Also in 2017, we completed the acquisition of another insurance agency headquartered in Albemarle, North Carolina.

See Note 2 to the consolidated financial statements for additional information regarding these acquisitions.

FDIC Indemnification Asset

As previously discussed, in 2009 and 2011, we acquired substantially all of the assets and liabilities of two failed banks in FDIC-assisted transactions. For each transaction, we entered into two loss share agreements with the FDIC, which provided the Bank significant loss protection from losses experienced on the loans and foreclosed real estate. One of these loss share agreements expired in July 2014 and one agreement expired in April 2016. On September 22, 2016,

we reached a mutual agreement with the FDIC to terminate all loss share agreements, with all future losses and recoveries associated with these failed bank assets being fully borne by the Bank.

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As derived from the table above, in 2017, our total loans outstanding increased $1.3 billion, or 49.1%. The loan growth from acquisitions is due to our acquisition of Carolina Bank in March 2017, which had $497.5 million in loans on the date of acquisition, and our acquisition of Asheville Savings Bank in October 2017, which had $606.2 million in loans on the date of acquisition. Carolina Bank operated through eight branches predominately in the Triad region of North Carolina, and Asheville Savings Bank operated through 13 branches in the Asheville area of North Carolina. We expect these acquisitions to complement our strategic initiatives in these attractive and high-growth markets. Internal growth in our loan portfolio amounted to $228.0 million, or 8.4%. Internal loan growth has been primarily

driven by our recent expansion into high-growth markets and the hiring of experienced bankers in these areas. We expect continued growth in our loan portfolio for 2018.

In 2016, our total loan growth was 7.6%. As derived from the table above, we experienced internal growth in our non-covered loan portfolio of $196.8 million, or 8.1%. We terminated our FDIC loss share agreements on September 22, 2016 and thus, all loans were transferred to non-covered status on that date.

During 2017, we experienced an increase in total deposits of $1.5 billion, or 49.5%. In 2017, we acquired $585.4 million in deposits from the Carolina Bank acquisition and $679.1 million in deposits from the Asheville Savings Bank acquisition. Net internal deposit growth amounted to $195.1 million, or 6.6%. We experienced internal growth of $191.2 million in our core deposit accounts, compared to net declines of $50.4 million in our retail time deposits, excluding brokered and internet deposits. Total brokered deposits amounted to $239.7 million at December 31, 2017, which is a 75.6% increase from the $136.5 million outstanding a year earlier. We increased our reliance of brokered deposits in 2017 to assist in funding the strong organic loan growth we experienced during 2017.

During 2016, we experienced a net increase in total deposits of $136.1 million, or 4.8%. Net internal deposit growth amounted to $159.0 million, or 5.7%, which was partially offset by the impact of our branch exchange in which we sold $23 million more in deposits than we purchased. Our internal growth arose from significant growth in our low-cost core deposit accounts (checking, money market and savings), which was partially offset by declines in our time deposit accounts. We experienced internal growth of $173.9 million in our core deposit accounts, compared to net declines of $74.9 million in retail time deposits, excluding brokered deposits. Total brokered deposits amounted to $136.5 million at December 31, 2016, which is a 78.6% increase from the $76.4 million outstanding a year earlier. We increased our holding of brokered deposits in 2016 in order to fund the strong loan growth experienced.

Our overall liquidity was substantially the same at December 31, 2017 compared to a year earlier. Our liquid assets (cash and securities) as a percentage of our total deposits and borrowings was 20.0% at December 31, 2017 compared to 19.8% at December 31, 2016.

At December 31, 2017, our nonperforming assets to total assets ratio was 0.96% compared to 1.64% at December 31, 2016. The decrease is primarily due to improved economic conditions, on-going resolution of nonperforming assets and improving credit quality.

Distribution of Assets and Liabilities

Table 7 sets forth the percentage relationships of significant components of our balance sheet at December 31, 2017, 2016, and 2015.

Our balance sheet mix has remained relatively stable over the past three years. On the asset side, there have been no significant changes, with net loans comprising 73%-74% of total assets and interest-earning assets ranging from 88%-91%. Intangible assets increased from 2% of total assets in 2015 and 2016 to 5% as of December 31, 2017, primarily as a result of our two whole-bank acquisitions in 2017, in which we recorded a total of $153.9 million in goodwill and $18.6 million in other intangible assets.

On the liability side, in 2016 and 2017, we obtained additional borrowings to help fund the loan growth that we experienced during those years that increased its percentage from 5% to 7%. Deposits decreased from 84% of total liabilities and shareholder’s equity at December 31, 2015 to 80% at December 31, 2017.

Shareholders’ equity increased from 10% of total liabilities and shareholders’ equity at December 31, 2015 and 2016 to 12% at December 31, 2017 due to the common stock issued in connection with our 2017 acquisitions.

Securities

Information regarding our securities portfolio as of December 31, 2017, 2016, and 2015 is presented in Tables 8 and 9.

The composition of the investment securities portfolio reflects our investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of income. The investment portfolio also provides a balance to interest rate risk and credit risk in other categories of the balance sheet while providing a vehicle for the investment of available funds, furnishing liquidity, and supplying securities to pledge as required collateral for certain deposits. We obtain fair values for the vast majority of our investment securities from a third-party investment recordkeeper, who specializes in securities purchases and sales, recordkeeping, and valuation. This recordkeeper provides us with a third-party report that contains an evaluation of internal controls that includes testwork of securities valuation. We further test the values we receive by comparing the values for a significant sample of securities to another third-party valuation service on a quarterly basis.

Total securities amounted to $461.8 million, $329.0 million, and $320.2 million at December 31, 2017, 2016, and 2015, respectively. The increase in securities in 2017 was partially due to $49.4 million in securities acquired in the acquisition of Carolina Bank in March 2017. Also, we sold $95.0 million in securities that we acquired from Asheville Savings Bank in October 2017 and then subsequently purchased $150 million in mortgage-backed securities in the fourth quarter of 2017. The increase in securities in 2016 was primarily due to purchases of mortgage-backed securities.

The majority of our “government-sponsored enterprise” securities carry one maturity date, often with an issuer call feature. At December 31, 2017, of the $13.9 million (carrying value) in government-sponsored enterprise securities, $6.4 million were issued by the Federal Home Loan Bank system, $5.0 million were issued by Fannie Mae, and the remaining $2.5 million were issued by Freddie Mac.

Nearly all of our $359.0 million in total mortgage-backed securities have been issued by Freddie Mac, Fannie Mae, Ginnie Mae, or the Small Business Administration, each of which are government-sponsored corporations. Included in the mortgage-backed securities at December 31, 2017, were commercial mortgage-backed securities of $48.6 million that were issued by Ginnie Mae. We have one insignificant “private label” mortgage-backed security that was purchased for Community Reinvestment Act purposes. Mortgage-backed securities vary in their repayment in correlation with the underlying pools of mortgage loans.

At December 31, 2017, our $34.2 million investment in corporate bonds was comprised of the following:

We have concluded that any unrealized losses associated with our corporate bonds are due to interest rate considerations and not due to credit concerns.

We held $118.5 million in securities held to maturity at December 31, 2017, which had a fair value that exceeded their carrying value by $0.5 million. Approximately $63.8 million of the securities held to maturity are mortgage-backed securities that have been issued by either Freddie Mac or Fannie Mae. The remaining $54.7 million in securities held to maturity are comprised almost entirely of municipal bonds issued by state and local governments throughout our market area. We have only two municipal bonds with a denomination of $2 million or greater and we have no significant concentration of bond holdings from one government entity, with the single largest exposure to any one entity being $6.5 million. Management evaluated any unrealized losses on individual securities at each year end and determined them to be of a temporary nature and caused by fluctuations in market interest rates, not by concerns about the ability of the issuers to meet their obligations.

At December 31, 2017, 2016, and 2015, net unrealized losses of $2.2 million, $3.1 million and $1.2 million, respectively, were included in the carrying value of securities classified as available for sale. Management evaluated any unrealized losses on individual securities at each year end and determined them to be of a temporary nature and caused by fluctuations in market interest rates and the overall economic environment, not by concerns about the ability of the issuers to meet their obligations. Net unrealized losses (net of applicable deferred income taxes of $0.5 million, $1.1 million, and $0.5 million) have been reported as part of a separate component of shareholders’ equity (accumulated other comprehensive income) as of December 31, 2017, 2016, and 2015, respectively.

The weighted average taxable-equivalent yield for the securities available for sale portfolio was 2.63% at December 31, 2017. The expected weighted average life of the available for sale portfolio using the call date for above-market callable bonds, the maturity date for all other non-mortgage-backed securities, and the expected life for mortgage-backed securities, was 4.9 years.

The weighted average taxable-equivalent yield for the securities held to maturity portfolio was 2.98% at December 31, 2017. The expected weighted average life of the held to maturity portfolio using the call date for above-market callable bonds, the expected life for mortgage-backed securities, and the maturity date for all other securities, was 2.8 years.

The following table provides the names of issuers for which the Company has investment securities totaling in excess of 10% of shareholders’ equity and the fair value and amortized cost of these investments as of December 31, 2017. All of these securities are issued by government sponsored corporations.

Loans

Table 10 provides a summary of the loan portfolio composition of our total loans at each of the past five year ends.

The loan portfolio is the largest category of our earning assets and is comprised of commercial loans, real estate mortgage loans, real estate construction loans, and consumer loans. Substantially all of our entire current loan portfolio is within our 40 county market area, which is located in western, central and eastern North Carolina and three counties in northeastern South Carolina. The diversity of the region’s economic base has historically provided a stable lending environment.

As previously discussed, in our acquisitions of failed banks in 2009 and 2011, we entered into loss share agreements with the FDIC, which afforded us significant protection from losses on all loans and other real estate acquired in those acquisitions. Because of the loss protection provided by the FDIC, the financial risk of these loans became significantly different from assets not covered under the loss share agreements, and accordingly, they were presented

as “covered loans.” Loans that were not subject to the loss share agreements were presented as “non-covered loans.” All loss share agreements were terminated in 2016 and thus the entire loan portfolio is now classified as non-covered. Certain disclosures will continue to present the historical breakout of the loan portfolio between covered and non-covered.

In 2017, loans outstanding increased $1.33 billion, or 49.1% to $4.0 billion. The growth in 2017 can be attributed to the acquisitions of Carolina Bank and Asheville Savings Bank, as well as organic loan growth of $228.0 million. In 2016, loans outstanding increased $192.7 million, or 7.6% to $2.7 billion. The growth in 2016 can be attributed to the recent hiring of experienced lenders, our expansion into high-growth markets, and higher loan demand associated with a growing and recovering economy.

The majority of our loan portfolio over the years has been real estate mortgage loans, with loans secured by real estate consistently comprising 88% to 91% of our outstanding loan balances. Except for construction, land development and other land loans, the majority of our “real estate” loans are personal and commercial loans where cash flow from the borrower’s occupation or business is the primary repayment source, with the real estate pledged providing a secondary repayment source.

Table 10 presents a five-year history of loans outstanding by type. Residential real estate loans have declined from 34% of total loans at December 31, 2013 to 24% of total loans at December 31, 2017. This decline was due to a combination of factors including consumers refinancing their home loans held by the Bank with long term fixed rate loans, which we typically sell in the secondary market. Additionally, the Carolina Bank loan portfolio assumed during the year had only an 11% mix of residential real estate loans.

Commercial real estate loans as a percentage of total loans has increased steadily over the past five years and amounted to 42% of all loans at December 31, 2017. Consistent with our community banking strategy, we have placed emphases on this type of loan growth and hired a number of experienced community bankers, who have originated a significant amount of business loans secured by real estate.

Table 11 provides a summary of scheduled loan maturities over certain time periods, with fixed rate loans and adjustable rate loans shown separately. Approximately 15% of our accruing loans outstanding at December 31, 2017 mature within one year and 56% of total loans mature within five years. As of December 31, 2017, the percentages of variable rate loans and fixed rate loans as compared to total performing loans were 38% and 62%, respectively. We intentionally make a blend of fixed and variable rate loans so as to reduce interest rate risk. The mix of fixed rate loans has generally increased over the past several years because many borrowers desire to lock in an interest rate during the historically low interest rate environment that has been in effect. While this presents risk to our Company if interest rates rise, we measure our interest rate risk closely and, as discussed in the section “Interest Rate Risk” below, we do not believe that an increase in interest rates would materially negatively impact our net interest income.

Nonperforming Assets

Nonperforming assets include nonaccrual loans, troubled debt restructurings, loans past due 90 or more days and still accruing interest, and foreclosed real estate. As a matter of policy we place all loans that are past due 90 or more days on nonaccrual basis, and thus there were no loans at any of the past five year ends that were 90 days past due and still accruing interest.

Nonaccrual loans are loans on which interest income is no longer being recognized or accrued because management has determined that the collection of interest is doubtful. Placing loans on nonaccrual status negatively impacts earnings because (i) interest accrued but unpaid as of the date a loan is placed on nonaccrual status is reversed and deducted from interest income, (ii) future accruals of interest income are not recognized until it becomes probable that both principal and interest will be paid and (iii) principal charged-off, if appropriate, may necessitate additional provisions for loan losses that are charged against earnings. In some cases, where borrowers are experiencing

financial difficulties, loans may be restructured to provide terms significantly different from the originally contracted terms.

Table 12 summarizes our nonperforming assets at the dates indicated. Prior to September 2016, we presented nonperforming assets that were subject to the loss share agreements as “covered” and nonperforming assets that were not subject to the loss share agreements as “non-covered.” Our loss share agreements with the FDIC were terminated in 2016, and as such, all assets are now presented as a singled “non-covered” amount.

Due largely to the economic downturn that began in late 2007 and continued to worsen over succeeding years, we experienced significant increases in our non-covered nonperforming assets, with total non-covered nonperforming assets rising steadily from $11 million at December 31, 2007 to a peak of $146 million at September 30, 2012. Nonperforming covered assets assumed from two bank failures amounted to an additional $114 million at September 30, 2012, which resulted in a total of $260 million in nonperforming assets.

Since that time, we have benefited from improving economic conditions and also implemented a combination of strategies to reduce nonperforming assets including a 2013 loan sale, loan restructurings, discounted payoffs, and other collection strategies. As a result, we have steadily reduced our level of nonperforming assets over the years, with nonperforming assets amounting to $53.4 million at December 31, 2017. At December 31, 2017, the ratio of nonperforming assets to total assets was 0.96% compared to 1.64% and 2.66% at December 31, 2016 and 2015, respectively.

Table 12a presents our nonperforming assets at December 31, 2017 by general geographic region.

The following is the composition, by loan type, of all of our nonaccrual loans at each period end:

The nonaccrual table above generally indicates that we experienced decreases in almost all categories of nonaccrual loans, with the “real estate – mortgage – residential ( 1 - 4 family) first mortgages” category experiencing the largest decline. The decline in nonaccrual loans is due to our on-going focus to resolve our nonperforming loans and improving credit quality.

Management routinely monitors the status of certain large loans that, in management’s opinion, have credit weaknesses that could cause them to become nonperforming loans. In addition to the nonperforming loan amounts discussed above, management believes that an estimated $2.5 million of loans that were performing in accordance with their contractual terms at December 31, 2017 have the potential to develop problems depending upon the particular financial situations of the borrowers and economic conditions in general. Management has taken these potential problem loans into consideration when evaluating the adequacy of the allowance for loan losses at December 31, 2017 (see discussion below).

Loans classified for regulatory purposes as loss, doubtful, substandard, or special mention that have not been disclosed in the problem loan amounts and the potential problem loan amounts discussed above do not represent or result from trends or uncertainties that management reasonably expects will materially impact future operating results, liquidity, or capital resources, or represent material credits about which management is aware of any information that causes management to have serious doubts as to the ability of such borrowers to comply with the loan repayment terms.

We provide additional information regarding the classification status of our loans in tables contained in Note 4 to our consolidated financial statements. Those tables indicate that from December 31, 2016 to December 31, 2017 our asset quality improved, with total classified and nonaccrual loans decreasing from $98.5 million at December 31, 2016 to $79.4 million at December 31, 2017. This is consistent with our generally improving asset quality trends.

Foreclosed real estate includes primarily foreclosed properties. Total foreclosed real estate amounted to $12.6 million, $9.5 million, and $10.0 million at December 31, 2017, 2016, and 2015, respectively. Generally, we have experienced decreases in foreclosed real estate over the past several years primarily due to increased property sales activity, particularly along the North Carolina coast, which is where a significant portion of our foreclosed properties are located, and the improvement in our overall asset quality. In 2017, we acquired $3.1 million and $3.9 million of foreclosed real estate in the acquisitions of Carolina Bank and Asheville Savings Bank, respectively.

The following table presents the detail of our foreclosed real estate at each of the past two year ends:

Allowance for Loan Losses and Loan Loss Experience

The allowance for loan losses is created by direct charges to operations (known as a “provision for loan losses” for the period in which the charge is taken). Losses on loans are charged against the allowance in the period in which such loans, in management’s opinion, become uncollectible. The recoveries realized during the period are credited to this allowance. We consider our procedures for recording the amount of the allowance for loan losses and the related provision for loan losses to be a critical accounting policy. See the heading “Critical Accounting Policies” above for further discussion.

The factors that influence management’s judgment in determining the amount charged to operating expense include recent loan loss experience, composition of the loan portfolio, evaluation of probable inherent losses and current economic conditions.

We use a loan analysis and grading program to facilitate our evaluation of probable inherent loan losses and the adequacy of our allowance for loan losses. In this program, credit risk grades are assigned by management and tested by an independent third-party consulting firm. The testing program includes an evaluation of a sample of new loans, loans we identify as having potential credit weaknesses, loans past due 90 days or more, loans originated by new loan officers, nonaccrual loans and any other loans identified during previous regulatory and other examinations.

We strive to maintain our loan portfolio in accordance with what management believes are conservative loan underwriting policies that result in loans specifically tailored to the needs of our market areas. Every effort is made to identify and minimize the credit risks associated with such lending strategies. We have no foreign loans, few agricultural loans and do not engage in significant lease financing or highly leveraged transactions. Commercial loans are diversified among a variety of industries. The majority of loans captioned in the tables discussed below as “real estate” loans are personal and commercial loans where real estate provides additional security for the loan. Collateral for virtually all of these loans is located within our principal market area.

The total allowance for loan losses amounted to $23.3 million at December 31, 2017 compared to $23.8 million at December 31, 2016 and $28.6 million at December 31, 2015.

Our allowance for loan loss is a mathematical model with the primary factors impacting this model being loan growth, net charge-off history, and asset quality trends. Our allowance for loan loss model utilizes the net charge-offs

experienced in the most recent years as a significant component of estimating the current allowance for loan losses that is necessary. Thus, older years (and parts thereof) systematically age out and are excluded from the analysis as time goes on. In 2015, a prolonged period of stable and improving loan quality trends following the recession resulted in generally lower provisions for loan losses that were needed to adjust our allowance for loan losses to the appropriate amount. This had the impact of bringing our overall allowance for loan loss level on non-covered loans down to a more normalized level, amounting to 1.11% at December 31, 2015, following the elevated amounts we maintained during and immediately following the recession. The impaired loan quality trends were also the primary reason for the provision for loan losses on non-covered loans declining from $7.1 million in 2014 to $2.0 million in 2015. These same factors continued in 2016 and 2017 and were further impacted by net charge-offs that declined significantly, amounting to only $3.7 million in 2016 and $1.2 million in 2017 compared to over $10 million in the immediately preceding years.

The ratio of our allowance to total loans was 0.58%, 0.88%, and 1.13% at December 31, 2017, 2016, and 2015, respectively. The decline in this ratio from December 31, 2015 to December 31, 2016 was a result of the factors discussed above that impacted our relatively low levels of provision for loan losses. The decline in 2017 was primarily due to the acquisitions of Carolina Bank and Asheville Savings Bank, which had over $1 billion in total loans. Applicable accounting guidance did not allow us to record an allowance for loan losses upon the acquisition of loans – instead the acquired loans were recorded at their discounted fair value, which included the consideration of any expected losses. No allowance for loan losses will be recorded for the acquired loans until the expected credit losses exceed the remaining unamortized discounts – based on an individual basis for purchased credit impaired loans and on a pooled basis for performing acquired loans. See Critical Accounting Policies above for further discussion. Unaccreted discount, which is available to absorb loan losses, amounted to $26.9 million, $12.7 million, and $15.3 million at December 31, 2017, December 31, 2016, and December 31, 2015, respectively. The ratios of allowance for loan losses plus unaccreted discount were 1.24%, 1.35%, and 1.74% at December 31, 2017, December 31, 2016, and December 31, 2015, respectively.

Table 13 sets forth the allocation of the allowance for loan losses at the dates indicated. The amount of the unallocated portion of the allowance for loan losses increased in 2017 due to a higher level of allowance resulting from management qualitative analysis. The allowance for loan losses is available to absorb losses in all categories.

Management considers the allowance for loan losses adequate to cover probable loan losses on the loans outstanding as of each reporting date. It must be emphasized, however, that the determination of the allowance using our procedures and methods rests upon various judgments and assumptions about economic conditions and other factors affecting loans. No assurance can be given that we will not in any particular period sustain loan losses that are sizable in relation to the amount reserved or that subsequent evaluations of the loan portfolio, in light of conditions and factors then prevailing, will not require significant changes in the allowance for loan losses or future charges to earnings.

In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses and losses on foreclosed real estate. Such agencies may require us to recognize additions to the allowance based on the examiners’ judgments about information available to them at the time of their examinations.

For the years indicated, Table 14 summarizes our balances of loans outstanding, average loans outstanding, and a detailed rollforward of the allowance for loan losses.

Net loan charge-offs of total loans amounted to $1.2 million in 2017, $3.7 million in 2016, and $11.3 million in 2015. Net loan charge-offs of non-covered loans amounted to $1.2 million in 2017, $5.4 million in 2016, and $13.6 million in 2015. The trend of lower net charge-offs is associated with lower levels of nonperforming loans that have been impacted with improvements in the economy and real estate prices.

We recorded ($1.7 million), and ($2.3 million) in net charge-offs (recoveries) of covered loans during 2016 and 2015, respectively.

Deposits

At December 31, 2017, deposits outstanding amounted to $4.41 billion, an increase of $1.46 billion from the $2.95 billion at December 31, 2016. During 2017, we acquired Carolina Bank with $585.4 million in deposits and Asheville Savings Bank with $679.1 million in deposits. We also experienced organic growth totaling $195.1 million in 2017, with the majority of our growth occurring in noninterest-bearing checking accounts. Our higher cost retail time deposits declined by $50.4 million in 2017. Total brokered deposits amounted to $239.7 million at December 31, 2017, which is a 75.6% increase from the $136.5 million outstanding a year earlier. The increased usage of brokered deposits was necessary because of organic loan growth that exceeded deposit growth. This imbalance of growth is largely associated with our recent growth and expansion into the larger markets of North Carolina – Charlotte, Greensboro and Raleigh. When initially entering markets such as these, our experience has been that we are able to capture loan market share faster than deposit market share.

At December 31, 2016, deposits outstanding amounted to $2.95 billion, an increase of $136 million from the $2.81 billion at December 31, 2015. Similar to 2017, during 2016 we experienced strong growth in our noninterest-bearing and interest-bearing checking accounts, and declines in our higher cost time deposits.

The nature of our deposit growth is illustrated in the table on page 52. The following table reflects the mix of our deposits at each of the past three year ends:

Our deposit mix has shifted over the past few years to a heavier concentration in transaction accounts and less concentration in time deposits. The percentages for retail time deposits have declined because of a combination of 1) customers shifting their matured time deposits into checking accounts because of a steadily shrinking gap between the interest rates that the two products pay and 2) because of satisfactory levels of liquidity and the availability of brokered deposits and borrowings, we chose not to match certain promotional time deposit interest rates being offered by local competitors.

We routinely engage in activities designed to grow and retain deposits, such as (1) emphasizing relationship banking to new and existing customers, where borrowers are encouraged and normally expected to maintain deposit accounts with us, (2) pricing deposits at rate levels that will attract and/or retain deposits, and (3) continually working to identify and introduce new products that will attract customers or enhance our appeal as a primary provider of financial services.

Table 15 presents the average amounts of our deposits and the average yield paid for those deposits for the years ended December 31, 2017, 2016, and 2015.

As of December 31, 2017, we held approximately $593.1 million in time deposits of $100,000 or more. Table 16 is a maturity schedule of time deposits of $100,000 or more as of December 31, 2017. This table shows that 70% of our time deposits greater than $100,000 mature within one year.

At each of the past three year ends, we have no deposits issued through foreign offices, nor do we believe that we held any deposits by foreign depositors.

Borrowings

Our borrowings outstanding totaled $407.5 million at December 31, 2017, $271.4 million at December 31, 2016, and $186.4 million at December 31, 2015. In 2017, 2016 and 2015, we obtained net new borrowings of $87 million, $85 million and $70 million, respectively, from a low cost funding source to help support our loan growth experienced during the years. Also, during 2017, we acquired Carolina Bank and Asheville Savings Bank. Carolina Bank had $11.5 million in low-cost borrowings, with a fair value of $11.3 million at acquisition date, and $10.3 million in trust preferred security debt, with a fair value of $7.2 million at acquisition date. Asheville Savings Bank had $20.0 million in low-cost borrowings, with a fair value of $20.0 million at acquisition date.

Table 2 shows that average borrowings were $325.9 million in 2017, $209.7 million in 2016, and $149.8 million in 2015.

At December 31, 2017, the Company had three sources of readily available borrowing capacity – 1) an approximately $936 million line of credit with the FHLB, of which $354 million and $225 million was outstanding at December 31, 2017 and 2016, respectively, 2) a $35 million federal funds line of credit with a correspondent bank, of which none was outstanding at December 31, 2017 or 2016, and 3) an approximately $109 million line of credit through the Federal Reserve Bank of Richmond’s (“FRB”) discount window, of which none was outstanding at December 31, 2017 or 2016.

Our line of credit with the FHLB can be structured as either short-term or long-term borrowings, depending on the particular funding or liquidity need, and is secured by our FHLB stock and a blanket lien on most of our real estate loan portfolio. For the year ended December 31, 2017, the average amount of FHLB borrowings outstanding was approximately $273.8 million with a weighted average interest rate for the year of 1.19%. The maximum amount of short-term FHLB borrowings outstanding at any month-end during 2017 was $354 million. For the year ended December 31, 2016, the average amount of FHLB borrowings outstanding was approximately $163 million with a weighted average interest rate for the year of 0.75%. The maximum amount of short-term FHLB borrowings outstanding at any month-end during 2016 was $225 million.

In addition to any outstanding borrowings from the FHLB that reduce the available borrowing capacity of the line of credit, our borrowing capacity was further reduced by $198 million and $193 million at December 31, 2017 and 2016, respectively, as a result of our pledging letters of credit backed by the FHLB for public deposits at each of those dates.

Our correspondent bank relationship allows us to purchase up to $35 million in federal funds on an overnight, unsecured basis (federal funds purchased). We had no borrowings under this line at December 31, 2017 or 2016. There were no federal funds purchased outstanding at any month-end during 2017 or 2016.

We also have a line of credit with the FRB discount window. This line is secured by a blanket lien on a portion of our commercial and consumer loan portfolio (excluding real estate loans). Based on the collateral that we owned as of December 31, 2017, the available line of credit was approximately $109 million. At December 31, 2017 and 2016, we had no borrowings outstanding under this line.

In addition to the lines of credit described above, we also had a total of $56.7 million in trust preferred security debt outstanding at December 31, 2017 and 2016. We have initiated three trust preferred security issuances since 2002 totaling $67.0 million, with one of those issuances for $20.6 million being redeemed in 2007. These borrowings each have 30 year final maturities and were structured in a manner that allows them to qualify as capital for regulatory capital adequacy requirements. We may call these debt securities at par on any quarterly interest payment date five years after their issue date. We issued $20.6 million of this debt on October 29, 2002 (which we called in 2007), an additional $20.6 million on December 19, 2003, and $25.8 million on April 13, 2006. The interest rate on these debt securities adjusts on a quarterly basis at a rate of three-month LIBOR plus 2.70% for the securities issued in 2003, and three-month LIBOR plus 1.39% for the securities issued in 2006.

In 2017, we assumed $10.3 million in trust preferred security debt in our acquisition of Carolina Bank. This borrowing has a 30 year final maturity and was structured in a manner that allows them to qualify for regulatory capital adequacy requirements. These debt securities are currently callable by the Company at par on any quarterly interest payment date. The interest rate on these debt securities adjusts on a quarterly basis of three-month LIBOR plus 2.00%.

Liquidity, Commitments, and Contingencies

Our liquidity is determined by our ability to convert assets to cash or to acquire alternative sources of funds to meet the needs of our customers who are withdrawing or borrowing funds, and our ability to maintain required reserve levels, pay expenses and operate the Company on an ongoing basis. Our primary liquidity sources are net income from operations, cash and due from banks, federal funds sold and other short-term investments. Our securities portfolio is comprised almost entirely of readily marketable securities which could also be sold to provide cash.

As noted above, in addition to internally generated liquidity sources, at December 31, 2017, we had the ability to obtain borrowings from the following three sources – 1) an approximately $936 million line of credit with the FHLB, 2) a $35 million federal funds line with a correspondent bank, and 3) an approximately $109 million line of credit through the FRB’s discount window.

Our overall liquidity increased in 2017 compared to 2016. Our liquid assets (cash and securities) as a percentage of our total deposits and borrowings amounted to 19.8% at December 31, 2016 to 20.0% at December 31, 2017.

We continue to believe our liquidity sources, including unused lines of credit, are at an acceptable level and remain adequate to meet our operating needs in the foreseeable future. We will continue to monitor our liquidity position carefully and will explore and implement strategies to increase liquidity if deemed appropriate.

In the normal course of business we have various outstanding contractual obligations that will require future cash outflows. In addition, there are commitments and contingent liabilities, such as commitments to extend credit, that may or may not require future cash outflows.

Table 18 reflects our contractual obligations and other commercial commitments outstanding as of December 31, 2017. Any of our $354 million in outstanding borrowings with the FHLB may be accelerated immediately by the FHLB in certain circumstances, including material adverse changes in our condition or if our qualifying collateral is less than the amount required under the terms of the borrowing agreement.

In the normal course of business there are various outstanding commitments and contingent liabilities such as commitments to extend credit, which are not reflected in the financial statements. The following table presents a summary of our outstanding loan commitments as of December 31, 2017:

At December 31, 2017 and 2016, we also had $15.2 million and $12.7 million, respectively, in standby letters of credit outstanding. We had no carrying amount for these standby letters of credit at either of those dates. The nature of the standby letters of credit is that of a guarantee made on behalf of our customers to suppliers of the customers to guarantee payments owed to the supplier by the customer. The standby letters of credit are generally for terms of one year, at which time they may be renewed for another year if both parties agree. The payment of the guarantees would generally be triggered by a continued nonpayment of an obligation owed by the customer to the supplier. The maximum potential amount of future payments (undiscounted) we could be required to make under the guarantees

in the event of nonperformance by the parties to whom credit or financial guarantees have been extended is represented by the contractual amount of the financial instruments discussed above. In the event that we are required to honor a standby letter of credit, a note, already executed by the customer, becomes effective providing repayment terms and any collateral. Over the past two years, we have had to honor only a few standby letters of credit, none of which resulted in any loss to the Company. We expect any draws under existing commitments to be funded through normal operations.

It has been our experience that deposit withdrawals are generally able to be replaced with new deposits when needed. Based on that assumption, management believes that it can meet its contractual cash obligations and existing commitments from normal operations.

We are not involved in any legal proceedings that, in management’s opinion, are likely to have a material effect on the consolidated financial position of the Company.

Capital Resources and Shareholders’ Equity

Shareholders’ equity at December 31, 2017 amounted to $693.0 million compared to $368.1 million at December 31, 2016 and $342.2 million at December 31, 2015. The two basic components that typically have the largest impact on our shareholders’ equity are net income, which increases shareholders’ equity, and dividends declared, which decrease shareholders’ equity. Additionally, any stock issuances (redemptions) can significantly increase (decrease) shareholders’ equity.

In 2017, the most significant factors that impacted our equity were 1) the issuances of $284.2 million of common stock in connection with two bank acquisitions, which increased equity, 2) the $46.0 million net income reported for 2017, which increased equity, and 3) common stock dividends declared of $8.3 million, which reduced equity. With the acquisition of Carolina Bank in March 2017, we assumed a deferred compensation plan for certain members of Carolina Bank’s board of directors that is fully funded by underlying Company stock, which was valued at $7.7 million on the date of acquisition. Subsequent to the acquisition in 2017, approximately $4.1 million of the deferred compensation was paid to the plan participants. See the Consolidated Statements of Shareholders’ Equity within the consolidated financial statements for disclosure of other less significant items affecting shareholders’ equity.

In 2016, the most significant factors that impacted our equity were 1) the $27.5 million net income reported for 2016, which increased equity, 2) common stock dividends declared of $6.5 million, which reduced equity, and 3) issuances of $5.5 million of common stock in connection with two acquisitions, which increased equity.

Also, on December 22, 2016, we exchanged 728,706 shares of preferred stock for the same number of shares of our common stock, which resulted in $7.3 million in shareholders’ equity shifting from preferred stock to common stock, but did not affect our total amount of equity. At December 31, 2017 and 2016, we have no shares of preferred stock outstanding.

In 2015, the most significant factors that impacted our equity were 1) the $63.5 million redemption of our Series B Preferred Stock issued to the U.S. Treasury in 2011 under the Small Business Lending Fund, which reduced equity (see Note 19 to our consolidated financial statements), 2) the $27.0 million net income reported for 2015, which increased equity, and 3) common stock dividends declared of $6.3 million, which reduced equity. Another factor negatively impacting equity in 2015 was a $2.7 million decrease in accumulated other comprehensive income that was caused primarily by an increase in our pension liability. The increase in the pension liability was primarily due to underperformance of our pension plan assets during 2015.

In addition to shareholders’ equity, we have supplemented our capital in past years with trust preferred security debt issuances, which because of their structure qualify as regulatory capital. This was necessary in past years because our balance sheet growth outpaced the growth rate of our capital. Additionally, we have purchased several bank branches over the years that resulted in our recording intangible assets, which negatively impacted regulatory capital

ratios. As discussed in “Borrowings” above, we currently have $56.7 million in trust preferred securities outstanding, all of which qualify as Tier I capital under both current and forthcoming regulatory standards.

We are not aware of any recommendations of regulatory authorities or otherwise which, if they were to be implemented, would have a material effect on our liquidity, capital resources, or operations.

The Company and the Bank must comply with regulatory capital requirements established by the Federal Reserve. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements.

Common Equity Tier I capital (“CET1”) is comprised of common stock and related surplus, plus retained earnings, and is reduced by goodwill and other intangible assets, net of associated deferred tax liabilities. Tier I capital is comprised of CET1 capital plus Additional Tier I capital, which for the Company includes non-cumulative perpetual preferred stock and trust preferred securities. Total capital is comprised of Tier I capital plus certain adjustments, the largest of which for the Company and the Bank is the allowance for loan losses. Risk-weighted assets refer to the on- and off-balance sheet exposures of the Company and the Bank, adjusted for their related risk levels using formulas set forth in Federal Reserve regulations.

Under the Basel III Capital Rules, the following were the initial minimum capital ratios applicable to the Company and the Bank as of January 1, 2015:

The Basel III Capital Rules include a “capital conservation buffer,” composed entirely of CET1, on top of these minimum risk-weighted asset ratios. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of CET1 to risk-weighted assets above the minimum but below the capital conservation buffer will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall. The implementation of the capital conservation buffer began on January 1, 2016 at 0.625% and will be phased in over a four-year period (increasing by that amount on each subsequent January 1, until it reaches 2.5% on January 1, 2019). Thus, when fully phased-in on January 1, 2019, the Company and the Bank will be required to maintain this additional capital conservation buffer of 2.5% of CET1, resulting in the following minimum capital ratios:

In addition to the minimum capital requirements described above, the regulatory framework for prompt corrective action also contains specific capital guidelines for a bank’s classification as “well capitalized.” The current specific guidelines are as follows:

If a bank falls below “well capitalized” status in any of these three ratios, it must ask for FDIC permission to originate or renew brokered deposits. The Bank’s regulatory ratios exceeded the threshold for “well-capitalized” status at December 31, 2017, 2016, and 2015 – see Note 16 to the consolidated financial statements for a table that presents the Bank’s regulatory ratios.

Table 21 presents our regulatory capital ratios as of December 31, 2017, 2016, and 2015. All of our capital ratios have significantly exceeded the minimum regulatory thresholds for all periods covered by this report.

In this economic environment, our goal is to maintain our capital ratios at levels at least 200 basis points higher than the “well capitalized” thresholds set for banks. At December 31, 2017, our total risk-based capital ratio was 12.50% compared to the 10.00% “well capitalized” threshold.

In addition to regulatory capital ratios, we also closely monitor our ratio of tangible common equity to tangible assets (“TCE Ratio”). Our TCE Ratio was 8.23% at December 31, 2017 compared to 8.16% at December 31, 2016.

See “Supervision and Regulation” under “Business” above and Note 16 to the consolidated financial statements for discussion of other matters that may affect our capital resources.

Off-Balance Sheet Arrangements and Derivative Financial Instruments

Off-balance sheet arrangements include transactions, agreements, or other contractual arrangements pursuant to which we have obligations or provide guarantees on behalf of an unconsolidated entity. We have no off-balance sheet arrangements of this kind other than letters of credit and repayment guarantees associated with our trust preferred securities.

Derivative financial instruments include futures, forwards, interest rate swaps, options contracts, and other financial instruments with similar characteristics. We have not engaged in significant derivatives activities through December 31, 2017 and have no current plans to do so.

Return on Assets and Equity

Table 20 shows return on average assets (net income available to common shareholders divided by average total assets), return on average common equity (net income available to common shareholders divided by average common shareholders’ equity), dividend payout ratio (dividends per share divided by net income per common share) and shareholders’ equity to assets ratio (average total shareholders’ equity divided by average total assets) for each of the years in the three-year period ended December 31, 2017.