BNC Bancorp (BNNC) 10-Q 2014 Q2 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)
x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2014
or
o	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    000-50128

BNC Bancorp

(Exact name of registrant as specified in its charter)

North Carolina	47-0898685
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
3980 Premier Drive, Suite 210
High Point, North Carolina	27265
(Address of principal executive offices)	(Zip Code)

Registrant's telephone number, including area code (336) 476-9200

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such

files). Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer o Accelerated filer x Non-accelerated filer o
Smaller reporting company o

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 number of shares outstanding of the registrant's common stock as of August 7, 2014 was 29,456,169.

BNC BANCORP

FORM 10-Q

TABLE OF CONTENTS

PART I - FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (Unaudited)
Consolidated Balance Sheets at June 30, 2014 and December 31, 2013	3
Consolidated Statements of Income for the three and six months ended June 30, 2014 and 2013	4
Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2014 and 2013	5
Consolidated Statements of Shareholders' Equity for the six months ended June 30, 2014 and 2013	6
Consolidated Statements of Cash Flows for the six months ended June 30, 2014 and 2013	7
Notes to Consolidated Financial Statements	9
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations	47
Item 3. Quantitative and Qualitative Disclosures About Market Risk	63
Item 4. Controls and Procedures	63
PART II - OTHER INFORMATION
Item 1. Legal Proceedings	64
Item 1A. Risk Factors	64
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	64
Item 3. Default Upon Senior Securities	64
Item 4. Mine Safety Disclosures	64
Item 5. Other Information	64
Item 6. Exhibits	64
SIGNATURES	65
EXHIBIT INDEX	66

2

BNC BANCORP AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except per share data)

	June 30, 2014 (Unaudited)			December 31, 2013
Assets
Cash and due from banks	$	58,148		$	35,474
Interest-earning deposits in other banks	78,662			72,916
Investment securities available-for-sale, at fair value	256,285			270,417
Investment securities held-to-maturity, at amortized cost (fair value of $244,137 and $236,507 at June 30, 2014 and December 31, 2013, respectively)	245,341			247,378
Federal Home Loan Bank stock, at cost	8,381			10,720
Loans held for sale	23,714			30,899
Loans:
Originated loans	1,865,024			1,704,876
Acquired loans	805,275			571,641
Less allowance for loan losses	(30,129		)	(32,875		)
Net loans	2,640,170			2,243,642
Accrued interest receivable	13,806			12,955
Premises and equipment, net	86,992			76,126
Other real estate owned:
Covered under loss-share agreements	12,631			18,773
Not covered under loss-share agreements	38,092			28,833
FDIC indemnification asset	9,783			16,886
Investment in bank-owned life insurance	88,961			78,439
Goodwill and other intangible assets, net	62,406			34,966
Other assets	59,858			51,152
Total assets	$	3,683,230		$	3,229,576
Liabilities and Shareholders' Equity
Deposits:
Non-interest bearing demand	$	464,682		$	324,532
Interest-bearing demand	1,504,397			1,299,399
Time deposits	1,155,569			1,082,799
Total deposits	3,124,648			2,706,730
Short-term borrowings	108,275			125,592
Long-term debt	101,174			101,509
Accrued expenses and other liabilities	22,297			24,415
Total liabilities	3,356,394			2,958,246
Shareholders' Equity:
Common stock, no par value; authorized 60,000,000 shares; 23,728,643 and 21,310,832 shares issued and outstanding at June 30, 2014 and December 31, 2013, respectively	209,390			168,616
Common stock, non-voting, no par value; authorized 20,000,000 shares; 5,992,213 shares issued and outstanding at June 30, 2014 and December 31, 2013, respectively	57,849			57,849
Retained earnings	51,385			41,559
Stock in directors rabbi trust	(3,181		)	(3,143		)
Directors deferred fees obligation	3,181			3,143
Accumulated other comprehensive income	8,212			3,306
Total shareholders' equity	326,836			271,330
Total liabilities and shareholders' equity	$	3,683,230		$	3,229,576

See accompanying notes to Consolidated Financial Statements.

3

BNC BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

(Dollars in thousands, except per share data)

	Three Months Ended June 30,				Six Months Ended June 30,
	2014		2013		2014			2013
Interest Income:
Loans, including fees	$	34,045	$	29,618	$	65,160		$	58,759
Investment securities:
Taxable	1,190		1,047		2,276			2,086
Tax-exempt	3,285		2,926		6,674			5,774
Interest-earning balances and other	113		84		241			207
Total interest income	38,633		33,675		74,351			66,826
Interest Expense:
Demand deposits	1,236		3,539		2,786			7,139
Time deposits	2,424		2,785		4,812			5,937
Short-term borrowings	109		134		221			171
Long-term debt	963		906		1,917			1,480
Total interest expense	4,732		7,364		9,736			14,727
Net Interest Income	33,901		26,311		64,615			52,099
Provision for loan losses	2,140		2,288		4,701			6,403
Net interest income after provision for loan losses	31,761		24,023		59,914			45,696
Non-Interest Income:
Mortgage fees	1,954		2,480		3,512			4,861
Service charges	1,478		1,034		2,826			1,960
Earnings on bank-owned life insurance	609		542		1,189			1,101
Gain (loss) on sale of investment securities, net	—		176		(565		)	(52		)
Other	1,764		1,370		3,968			3,934
Total non-interest income	5,805		5,602		10,930			11,804
Non-Interest Expense:
Salaries and employee benefits	15,312		12,728		29,021			25,533
Occupancy	2,062		1,507		4,141			3,190
Furniture and equipment	1,570		1,260		3,168			2,639
Data processing and supplies	1,065		720		1,969			1,443
Advertising and business development	685		610		1,374			1,197
Insurance, professional and other services	3,300		1,457		4,808			2,915
FDIC insurance assessments	706		780		1,411			1,446
Loan, foreclosure and other real estate owned expenses	2,359		2,876		3,721			4,894
Other	2,453		1,821		4,670			3,618
Total non-interest expense	29,512		23,759		54,283			46,875
Income before income tax expense	8,054		5,866		16,561			10,625
Income tax expense	1,921		1,199		3,944			1,679
Net Income	6,133		4,667		12,617			8,946
Less preferred stock dividends and discount accretion	—		531		—			1,060
Net Income Available to Common Shareholders	$	6,133	$	4,136	$	12,617		$	7,886
Basic earnings per common share	$	0.21	$	0.16	$	0.45		$	0.30
Diluted earnings per common share	$	0.21	$	0.16	$	0.45		$	0.30
Dividends declared and paid per common share	$	0.05	$	0.05	$	0.10		$	0.10

See accompanying notes to Consolidated Financial Statements.

4

BNC BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

(Dollars in thousands)

	Three Months Ended June 30,						Six Months Ended June 30,
	2014			2013			2014			2013
Net income	$	6,133		$	4,667		$	12,617		$	8,946
Other comprehensive income (loss):
Investment securities:
Unrealized holding gain (loss) on investments securities available-for-sale	4,032			(8,779		)	9,835			(11,883		)
Tax effect	(1,492		)	3,385			(3,639		)	4,581
Reclassification of (gains) losses recognized in net income	—			(176		)	565			52
Tax effect	—			68			(209		)	(20		)
Amortization of unrealized gains on investment securities transferred from available-for-sale to held-to-maturity	(162		)	(148		)	(496		)	(291		)
Tax effect	60			57			184			112
Net of tax amount	2,438			(5,593		)	6,240			(7,449		)
Cash flow hedging activities:
Unrealized holding gains (losses)	(1,658		)	3,709			(2,572		)	2,936
Tax effect	614			(1,430		)	952			(1,132		)
Reclassification of losses recognized in net income	—			2,333			457			4,538
Tax effect	—			(899		)	(171		)	(1,749		)
Net of tax amount	(1,044		)	3,713			(1,334		)	4,593
Total other comprehensive income (loss)	1,394			(1,880		)	4,906			(2,856		)
Total comprehensive income	$	7,527		$	2,787		$	17,523		$	6,090

See accompanying notes to Consolidated Financial Statements.

5

BNC BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (Unaudited)

Six Months Ended June 30, 2014 and 2013

(Dollars in thousands, except per share data)

	Common stock					Common stock - nonvoting			Preferred stock Series A			Preferred stock Series B			Retained earnings			Stock in directors rabbi trust			Directors deferred fees obligation			Accumulated other comprehensive income			Total
	Shares		Amount			Shares	Amount
Balance, December 31, 2012	20,462,667		$	157,541		4,187,647	$	40,688	$	30,717		$	17,161		$	30,708		$	(3,090	)	$	3,090		$	5,429		$	282,244
Net income	—		—			—	—		—			—			8,946			—			—			—			8,946
Directors deferred fees	—		—			—	—		—			—			—			71			(71		)	—			—
Other comprehensive loss, net of tax	—		—			—	—		—			—			—			—			—			(2,856		)	(2,856		)
Redemption of preferred stock	—		—			—	—		(31,260		)	—			—			—			—			—			(31,260		)
Common stock issued pursuant to:
Stock-based compensation	10,604		406			—	—		—			—			—			—			—			—			406
Dividend reinvestment plan	13,726		128			—	—		—			—			—			—			—			—			128
Conversion of preferred stock	—		—			1,804,566	17,161		—			(17,161		)	—			—			—			—			—
Cash dividends:
Common stock, $0.10 per share	—		—			—	—		—			—			(2,646		)	—			—			—			(2,646		)
Preferred stock, net of accretion	—		—			—	—		543			—			(1,060		)	—			—			—			(517		)
Balance, June 30, 2013	20,486,997		$	158,075		5,992,213	$	57,849	$	—		$	—		$	35,948		$	(3,019	)	$	3,019		$	2,573		$	254,445
Balance, December 31, 2013	21,310,832		$	168,616		5,992,213	$	57,849	$	—		$	—		$	41,559		$	(3,143	)	$	3,143		$	3,306		$	271,330
Net income	—		—			—	—		—			—			12,617			—			—			—			12,617
Directors deferred fees	—		—			—	—		—			—			—			(38		)	38			—			—
Other comprehensive income, net of tax	—		—			—	—		—			—			—			—			—			4,906			4,906
Common stock issued pursuant to:
Purchase of South Street   Financial	1,139,931		19,778			—	—		—			—			—			—			—			—			19,778
Purchase of Community   First Financial Group	1,190,763		20,128			—	—		—			—			—			—			—			—			20,128
Stock-based   compensation	76,331		929			—	—		—			—			—			—			—			—			929
Shares withheld for   payment of taxes	(17,694	)	(294		)	—	—		—			—			—			—			—			—			(294		)
Stock options exercised	41,633		457			—	—		—			—			—			—			—			—			457
Shares traded to exercise options	(23,083	)	(419		)	—	—		—			—			—			—			—			—			(419		)
Excess income tax benefit	—		27			—	—		—			—			—			—			—			—			27
Dividend reinvestment plan	9,930		168			—	—		—			—			—			—			—			—			168
Cash dividends:
Common stock, $0.10 per share	—		—			—	—		—			—			(2,791		)	—			—			—			(2,791		)
Balance, June 30, 2014	23,728,643		$	209,390		5,992,213	$	57,849	$	—		$	—		$	51,385		$	(3,181	)	$	3,181		$	8,212		$	326,836

See accompanying notes to Consolidated Financial Statements.

6

BNC BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(Dollars in thousands)

	Six Months Ended June 30,
	2014			2013
Operating activities
Net income	$	12,617		$	8,946
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses	4,701			6,403
Depreciation and amortization	2,681			2,162
Amortization of premiums, net	2,127			2,309
Amortization of intangible assets	931			522
Accretion of fair value purchase accounting adjustments	(6,925		)	(8,094		)
Acquisition-related gain	—			(719		)
Cash flow hedge expense	163			4,538
Stock-based compensation	929			406
Deferred compensation	204			363
Earnings on bank-owned life insurance	(1,189		)	(1,101		)
Loss on sale of investment securities, net	565			52
Loss on disposal of premises and equipment	15			42
Losses on other real estate owned	1,955			1,695
Gain on sale of loans (mortgage fees)	(3,512		)	(4,861		)
Origination of loans held for sale	(139,483		)	(175,967		)
Proceeds from sales of loans held for sale	136,603			198,288
(Increase) decrease in accrued interest receivable	177			(312		)
Payments received from FDIC under loss-share agreements	6,984			16,140
Decrease in other assets	1,033			6,196
Decrease in accrued expenses and other liabilities	(10,855		)	(5,968		)
Net cash provided by operating activities	9,721			51,040
Investing activities
Purchases of investment securities available-for-sale	(16,298		)	(51,238		)
Purchases of investment securities held-to-maturity	(5,269		)	(24,093		)
Proceeds from sales of investment securities available-for-sale	30,681			15,797
Proceeds from sales of investment securities held-to-maturity	3,476			—
Proceeds from maturities and payments of investment securities available-for-sale	33,226			34,153
Proceeds from maturities and payments of investment securities held-to-maturity	2,544			1,163
Redemption (purchase) of Federal Home Loan Bank stock	3,527			(2,176		)
Net increase in loans	(71,290		)	(33,085		)
Purchases of premises and equipment	(2,715		)	(4,847		)
Proceeds from disposal of premises and equipment	—			6
Investment in bank-owned life insurance	(109		)	(99		)
Investment in other real estate owned	(436		)	(1,399		)
Proceeds from sales of other real estate owned	15,520			18,276
Net cash received from acquisitions	74,418			—
Net cash provided by (used in) investing activities	67,275			(47,542		)

7

Financing activities
Net decrease in deposits	(11,045		)	(226,898		)
Net increase (decrease) in short-term borrowings	(34,277		)	79,723
Net increase (decrease) in long-term-debt	(375		)	27,345
Preferred stock redeemed, net	—			(31,260		)
Common stock issued pursuant to dividend reinvestment plan	168			128
Common stock issued from exercise of stock options	38			—
Common stock repurchased in lieu of income taxes	(294		)	—
Cash dividends paid, net of accretion	(2,791		)	(3,164		)
Net cash used in financing activities	(48,576		)	(154,126		)
Net increase (decrease) in cash and cash equivalents	28,420			(150,628		)
Cash and cash equivalents, beginning of period	108,390			234,071
Cash and cash equivalents, end of period	$	136,810		$	83,443
Supplemental Statement of Cash Flows Disclosure
Interest paid	$	10,011		$	14,132
Income taxes paid	137			502
Summary of Noncash Investing and Financing Activities
Transfer of loans to other real estate owned	$	12,482		$	14,132
Transfer of loans held for sale to loans	13,577			—
FDIC indemnification asset increase for losses, net	935			3,559
Transfer of securities from available-to-sale to held-to-maturity	—			86,526

See accompanying notes to Consolidated Financial Statements.

8

BNC BANCORP AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

NOTE 1 – BASIS OF PRESENTATION

Organization

BNC Bancorp (the “Company”) is a bank holding company for Bank of North Carolina (“BNC”), a wholly owned subsidiary, headquartered in High Point, North Carolina. BNC is a full service commercial bank providing commercial banking services tailored to the particular banking needs of the communities it serves in North and South Carolina. BNC’s primary source of revenue is derived from loans to customers, who are predominantly individuals and small to medium size businesses in BNC’s market areas.

The Company is subject to the rules and regulations of the Federal Reserve Bank. BNC is operating under the banking laws of North Carolina, and is subject to the rules and regulations of the North Carolina Commissioner of Banks and the Federal Deposit Insurance Corporation (“FDIC”). Accordingly, the Company and BNC are examined periodically by those regulatory authorities.

These consolidated financial statements and notes are presented in accordance with the instructions for Form 10-Q and, therefore, do not include all information and notes necessary for a complete presentation of financial position, results of operations and cash flow activity required in accordance with accounting principles generally accepted in the United States of America (“GAAP”). In the opinion of management, all normal recurring adjustments necessary for a fair statement of the consolidated financial position and consolidated results of operations have been made. The information contained in the consolidated financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013 should be referred to in connection with these unaudited interim consolidated financial statements.

Certain amounts in the 2013 consolidated financial statements have been reclassified to conform to 2014 presentation. These reclassifications had no effect on net income, net income available to common shareholders or shareholders' equity as previously reported.

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. On an ongoing basis, the Company evaluates its estimates, including those relating to the allowance for loan losses, determination of fair value of acquired assets and assumed liabilities, and valuation of goodwill and intangible assets.

Recently Adopted and Issued Accounting Standards

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606). This ASU was developed as a joint project with the International Accounting Standards Board to remove inconsistencies in revenue requirements and provide a more robust framework for addressing revenue issues. The ASU’s core principle is that an entity should recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which an entity expects to be entitled in exchange for those goods or services. The ASU is effective for public entities for annual and interim periods beginning after December 15, 2016. The ASU may be adopted using either a modified retrospective method or a full retrospective method and early adoption is not permitted. The Company is currently evaluating the impact of the adoption of this ASU on its consolidated financial statements.

In January 2014, the FASB issued ASU No. 2014-04, Receivables (Topic 310): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure, to clarify that an in substance repossession or foreclosure occurs upon either the creditor obtaining legal title to the residential real estate property or the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. The amendments are effective for annual periods, and interim reporting periods within those annual periods, beginning after December 15, 2014. The amendments may be adopted using either a modified retrospective transition method or a prospective transition method and early adoption is permitted. The Company does not expect the adoption of this ASU to have a material impact on its consolidated financial statements.

In July 2013, the FASB issued ASU No. 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists, to provide guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists thereby reducing diversity in practice. The amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption is permitted. The amendments are to be applied prospectively to all unrecognized tax benefits that exist at the effective date with retrospective application permitted. The adoption of this ASU did not have a material impact on the Company's consolidated financial statements.

9

NOTE 2 – ACQUISITIONS

Pending Acquisition of Harbor Bank Group, Inc.

On June 4, 2014, the Company entered into an Agreement and Plan of Merger with Harbor Bank Group, Inc., the holding company for Harbor National Bank ("Harbor"), a commercial bank with approximately $306 million in assets serving small businesses and professionals in the Charleston and Mount Pleasant area of South Carolina. Harbor operates four branches and aligns with the Company’s strategy of growth focused within existing markets.

Under the merger agreement, Harbor's shareholders will receive 0.950 shares of the Company's common stock for each share of Harbor common stock owned. The Company anticipates that the acquisition will close in the fourth quarter of 2014, subject to customary closing conditions, including regulatory approval and approval of Harbor’s shareholders.

Acquisition of Community First Financial Group, Inc.

On June 1, 2014, the Company completed the acquisition of Community First Financial Group, Inc. ("Community First"), the parent company of Harrington Bank, pursuant to the terms of the Agreement and Plan of Merger dated December 17, 2013.

Community First shareholders elected to receive 0.4069 shares of the Company's voting common stock for each share of Community First common stock, or cash in the amount of $5.90 per share. 75% percent of Community First common shares were converted into the right to receive the Company's voting common stock, while the remaining 25% were converted into the right to receive cash. As part of the closing, Community First's preferred shareholders received cash payments equal to the liquidation value of their preferred shares.

A summary of assets received and liabilities assumed for Community First, as well as the associated fair value adjustments, are as follows (dollars in thousands):

	As Recorded by Community First			Fair Value Adjustments				As Recorded by BNC
Assets
Cash and due from banks	$	47,330		$	—			$	47,330
Investment securities available-for-sale	12,000			—				12,000
Federal Home Loan Bank stock, at cost	293			—				293
Loans	152,885			(15,139		)	(1)	137,746
Premises and equipment	545			(131		)	(2)	414
Accrued interest receivable	436			—				436
Other real estate owned	1,419			(271		)	(3)	1,148
Core deposit intangible	—			3,624			(4)	3,624
Other assets	6,849			4,552			(5)	11,401
Total assets acquired	$	221,757		$	(7,365	)		214,392
Liabilities
Deposits	$	(191,486	)	(180		)	(6)	$	(191,666	)
Long-term borrowings	(4,560		)	—				(4,560		)
Other liabilities	(1,063		)	(205		)	(7)	(1,268		)
Total liabilities assumed	(197,109		)	(385		)		(197,494		)
Net assets acquired								16,898
Total consideration paid								26,734
Goodwill								$	9,836

10

Explanation of fair value adjustments:

(1) Adjustment for the fair value of the loan portfolio.

(2) Adjustment for the fair value of the premises and equipment.

(3) Adjustment for the fair value of the other real estate owned.

(4) Adjustment for the fair value of the core deposit intangible.

(5) Adjustment for the deferred tax asset recognized from acquisition.

(6) Adjustment for the fair value of the time deposits.

(7) Adjustment for the fair value of leases acquired.

A summary of the consideration paid is as follows (dollars in thousands):

Common stock issued (1,190,763 shares)	$	20,128
Redemption of preferred stock	850
Cash payments to common stockholders	5,756
Total consideration paid	$	26,734

With this acquisition, the Company expanded its presence in the Raleigh-Durham-Chapel Hill area of North Carolina through the addition of three branches, a low-cost base of core deposits and an experienced in-market team that enhances our ability to grow in that market. Additionally, goodwill was also created by the expected cost savings that will be recognized in future periods through the elimination of redundant operations. None of the goodwill associated with this acquisition is deductible for income tax purposes. All goodwill related to this acquisition was allocated to the banking operations reporting unit.

Acquisition of South Street Financial Corp.

On April 1, 2014, the Company completed the acquisition of South Street Financial Corp. ("South Street"), the parent company of Home Savings Bank of Albermarle, Inc., SSB, pursuant to the terms of the Agreement and Plan of Merger dated December 17, 2013.

South Street shareholders elected to receive 0.60 shares of the Company's voting common stock for each share of South Street common stock, or cash in the amount of $8.85 per share. Eighty percent of South Street's common shares were converted into the right to receive the Company's voting common stock, while the remaining 20% were converted into the right to receive cash. As part of the closing, each share of South Street's Series A Preferred Stock automatically converted into one share of South Street common stock.

A summary of assets received and liabilities assumed for South Street, as well as the associated fair value adjustments, are as follows (dollars in thousands):

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	As Recorded by South Street			Fair Value Adjustments				As Recorded by BNC
Assets
Cash and due from banks	$	39,680		$	—			$	39,680
Investment securities available-for-sale	13,000			—				13,000
Federal Home Loan Bank stock, at cost	895			—				895
Loans	188,386			(10,433		)	(1)	177,953
Premises and equipment	9,273			(361		)	(2)	8,912
Accrued interest receivable	592			—				592
Other real estate owned	12,358			(3,788		)	(3)	8,570
Core deposit intangible	—			2,387			(4)	2,387
Other assets	13,554			4,785			(5)	18,339
Total assets acquired	$	277,738		$	(7,410	)		270,328
Liabilities
Deposits	$	(236,526	)	$	(1,188	)	(6)	(237,714		)
Long-term borrowings	(12,300		)	—				(12,300		)
Other liabilities	(7,075		)	—				(7,075		)
Total liabilities assumed	$	(255,901	)	$	(1,188	)		(257,089		)
Net assets acquired								13,239
Total consideration paid								25,763
Goodwill								$	12,524

Explanation of fair value adjustments:

(1) Adjustment for the fair value of the loan portfolio.

(2) Adjustment for the fair value of the premises and equipment.

(3) Adjustment for the fair value of the other real estate owned.

(4) Adjustment for the fair value of the core deposit intangible.

(5) Adjustment for the deferred tax asset recognized from acquisition.

(6) Adjustment for the fair value of the time deposits.

A summary of the consideration paid is as follows (dollars in thousands):

Common stock issued (1,139,931 shares)	$	19,778
Cash payments to common stockholders	5,985
Total consideration paid	$	25,763

With this acquisition, the Company expanded its presence in the metropolitan Charlotte, North Carolina market through the addition of four branches, an attractive loan portfolio and an experienced in-market team that enhances our ability to grow in that market. Additionally, goodwill was also created by the expected cost savings that will be recognized in future periods through the elimination of redundant operations. None of the goodwill associated with this acquisition is deductible for income tax purposes. All goodwill related to this acquisition was allocated to the banking operations reporting unit.

The Company incurred transaction-related costs of $3.4 million and $3.9 million for the three and six months ended June 30, 2014 related to these acquisitions, which were expensed as incurred as a component of non-interest expense. Transaction-related costs primarily include severance costs, professional services, data processing fees, marketing and advertising and other non-interest expenses.

The following table presents financial information regarding the former Community First and South Street operations included in our Consolidated Statements of Income from the date of acquisition through June 30, 2014 under the column “Actual from acquisition date through June 30, 2014”. These amounts do not include direct costs as explained above. In addition, the following table presents unaudited pro-forma information as if the acquisitions of Community First and South Street had occurred on January 1, 2013 under the “Pro-forma” columns. This pro-forma information gives effect to certain adjustments, including purchase accounting fair value adjustments, amortization of core deposit and other intangibles and related income tax effects and is based on our historical results for the periods

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presented. Transaction-related costs related to the acquisition are not reflected in the pro-forma amounts. The pro-forma information does not necessarily reflect the results of operations that would have occurred had the Company acquired Community First and South Street at the beginning of 2013. Cost savings are also not reflected in the unaudited pro-forma amounts for three and six months ended June 30, 2014 and 2013, respectively (dollars in thousands).

	Actual from acquisition date through June 30, 2014		Pro-forma for three months ended June 30,				Pro-forma for six months ended June 30,
			2014		2013		2014		2013
Net interest income	$	2,837	$	36,088	$	31,937	$	72,347	$	63,768
Non-interest income	143		5,818		6,527		11,424		13,607
Net income	1,358		5,700		5,077		10,023		10,616
Net income available to common shareholders	1,358		5,700		4,546		10,023		9,556
Pro-forma earnings per share:
Basic			$	0.18	$	0.16	$	0.33	$	0.33
Diluted			$	0.18	$	0.16	$	0.33	$	0.33

Acquisition of Randolph Bank & Trust Company

On October 1, 2013, the Company completed the acquisition of Randolph Bank & Trust Company (“Randolph”) pursuant to the terms of the Agreement and Plan of Merger dated May 31, 2013. Randolph was a commercial bank with approximately $284 million in assets that served small businesses and professionals and operated six branches in the Piedmont-Triad area of North Carolina. This acquisition aligns with the Company’s strategy of growth focused within existing markets.

Randolph shareholders elected to receive 0.87 shares of the Company's voting common stock for each share of Randolph common stock, or cash in the amount of $10.00 per share. Eighty percent of Randolph common shares were converted into the right to receive the Company's voting common stock, while the remaining20% were converted into the right to receive cash. As part of the closing, Randolph preferred shareholders, including the United States Department of the Treasury (“Treasury”), received cash payments equal to the liquidation value of their preferred shares.

A summary of assets received and liabilities assumed for Randolph, as well as the associated fair value adjustments, are as follows (dollars in thousands):

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	As Recorded by Randolph			Fair Value Adjustments				As Recorded by BNC
Assets
Cash and due from banks	$	14,207		$	—			$	14,207
Investment securities available-for-sale	5,082			130			(1)	5,212
Federal Home Loan Bank stock, at cost	630			—				630
Loans	161,220			(6,973		)	(2)	154,247
Premises and equipment	4,537			811			(3)	5,348
Accrued interest receivable	800			—				800
Other real estate owned	4,844			(626		)	(4)	4,218
Core deposit intangible	—			2,676			(5)	2,676
Other assets	92,289			1,744			(6)	94,033
Total assets acquired	$	283,609		$	(2,238	)		281,371
Liabilities
Deposits	$	(260,484	)	$	(523	)	(7)	$	(261,007	)
Long-term borrowings	(6,100		)	(209		)	(8)	(6,309		)
Other liabilities	(1,291		)	—				(1,291		)
Total liabilities assumed	$	(267,875	)	$	(732	)		(268,607		)
Net assets acquired								12,764
Total consideration paid								14,037
Goodwill								$	1,273

Explanation of fair value adjustments:

(1) Adjustment for the fair value of the investment securities portfolio.

(2) Adjustment for the fair value of the loan portfolio.

(3) Adjustment for the fair value of the premises and equipment.

(4) Adjustment for the fair value of the other real estate owned.

(5) Adjustment for the fair value of the core deposit intangible.

(6) Adjustment for the deferred tax asset recognized from acquisition.

(7) Adjustment for the fair value of the time deposits.

(8) Adjustment for the fair value of the borrowings.

A summary of the consideration paid is as follows (dollars in thousands):

Common stock issued (726,634 shares)	$	9,642
Redemption of preferred stock	2,300
Cash payments to common stockholders	2,095
Total consideration paid	$	14,037

None of the goodwill associated with this acquisition is deductible for income tax purposes. All goodwill related to this acquisition was allocated to the banking operations reporting unit.

The Company has determined the above noted acquisitions each constitute a business combination as defined by FASB ASC Topic 805: Business Combinations (“ASC Topic 805”), which establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired and the liabilities assumed. The Company has recorded the assets purchased and liabilities assumed at their estimated fair value in accordance with ASC Topic 805.

The estimated fair values are subject to refinement for up to one year after the closing date of the acquisition as additional information regarding closing date fair value becomes available. During this one year period, the causes of any changes in cash flow estimates are considered to determine whether the change results from circumstances that existed as of the acquisition date or if the change results from an event that occurred after the date of acquisition.

NOTE 3 - EARNINGS PER SHARE

Basic earnings per common share is computed using the weighted average number of common shares and participating securities outstanding during the reporting period. Diluted earnings per common share is the amount of earnings available to each share of common stock during the reporting period adjusted to include the effect of potentially dilutive common shares. Potentially dilutive common shares include incremental shares issued for stock options and restricted stock awards (collectively referred to herein as “Stock Rights”). Potentially dilutive common shares are excluded from the computation of dilutive earnings per share in the periods in which the effect would be anti-dilutive.

The Company's basic and diluted earnings per share calculations are presented in the following table (dollars in thousands, except per share data):

	Three months ended June 30,				Six months ended June 30,
	2014		2013		2014		2013
Net income available to common shareholders	$	6,133	$	4,136	$	12,617	$	7,886
Weighted average common shares - basic	28,877,318		26,474,878		28,095,076		26,090,711
Add: Effect of convertible preferred stock	—		—		—		378,860
Weighted average participating common shares - basic	28,877,318		26,474,878		28,095,076		26,469,571
Effects of dilutive Stock Rights	132,597		23,132		136,776		16,529
Weighted average participating common shares - diluted	29,009,915		26,498,010		28,231,852		26,486,100
Basic earnings per common share	$	0.21	$	0.16	$	0.45	$	0.30
Diluted earnings per common share	$	0.21	$	0.16	$	0.45	$	0.30

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For both the three and six months ended June 30, 2014 and 2013, respectively, there were zero and 415,936 shares of Stock Rights excluded in computing diluted common shares outstanding.

NOTE 4 – INVESTMENT SECURITIES

The amortized cost, gross unrealized gains and losses, and estimated fair values of investment securities are presented in the following tables (dollars in thousands):

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
June 30, 2014
Available-for-sale:
U.S. Government agencies	$	8,825	$	150	$	—	$	8,975
State and municipals	180,294		7,433		1,196		186,531
Corporate debt securities	9,008		14		27		8,995
Other debt securities	12,746		—		193		12,553
Equity securities	4,277		—		68		4,209
Mortgage-backed securities:
Residential government sponsored	29,587		1,149		164		30,572
Other government sponsored	4,238		212		—		4,450
	$	248,975	$	8,958	$	1,648	$	256,285
Held-to-maturity:
State and municipals	$	216,076	$	2,793	$	3,121	$	215,748
Corporate debt securities	19,265		84		960		18,389
Other debt securities	10,000		—		—		10,000
	$	245,341	$	2,877	$	4,081	$	244,137

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
December 31, 2013
Available-for-sale:
U.S. Government agencies	$	15,720	$	4	$	663	$	15,061
State and municipals	194,224		2,704		5,665		191,263
Corporate debt securities	9,011		16		138		8,889
Other debt securities	4,727		—		347		4,380
Equity securities	979		—		57		922
Mortgage-backed securities:
Residential government sponsored	41,231		1,442		659		42,014
Other government sponsored	7,615		276		3		7,888
	$	273,507	$	4,442	$	7,532	$	270,417
Held-to-maturity:
State and municipals	$	221,378	$	379	$	10,169	$	211,588
Corporate debt securities	16,000		—		1,081		14,919
Other debt securities	10,000		—		—		10,000
	$	247,378	$	379	$	11,250	$	236,507

The amortized cost and estimated fair value of investment securities at June 30, 2014, by contractual maturity, are shown below (dollars in thousands). The expected life of mortgage-backed securities will differ from contractual maturities because borrowers may have the right to call or prepay the underlying mortgage loans with or without call or prepayment penalties. For purposes of the maturity table, mortgage-backed securities have been included in maturity groupings based on the contractual maturity.

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	Amortized Cost		Fair Value
Available-for-sale:
Due after one through five years	$	1,598	$	1,658
Due after five through ten years	19,664		19,841
Due after ten years	223,436		230,577
Total debt securities	244,698		252,076
Equity securities	4,277		4,209
	$	248,975	$	256,285
Held-to-maturity:
Due after one year through five years	$	17,079	$	16,341
Due after five through ten years	24,553		24,509
Due after ten years	203,709		203,287
	$	245,341	$	244,137

At June 30, 2014 and December 31, 2013, investment securities with an estimated fair value of approximately $250.7 million and $184.0 million, respectively, were pledged to secure public deposits and for other purposes required or permitted by law.

The following table presents a summary of realized gains and losses from the sale of investment securities (dollars in thousands):

	Three months ended June 30,				Six months ended June 30,
	2014		2013		2014			2013
Proceeds from sales	$	—	$	—	$	34,157		$	15,797
Gross realized gains on sales	$	—	$	176	$	337		$	176
Gross realized losses on sales	—		—		(902		)	(228		)
Total realized gains (losses), net	$	—	$	176	$	(565	)	$	(52	)

During the six months ended June 30, 2014, the Company sold $3.3 million of investment securities classified as held-to-maturity and recorded a realized gain of $0.1 million on this sale. These securities were state and municipal debt obligations that were downgraded by Moody's as a result of allegations of fraud and multiple pending investigations of the issuer. As a result of the downgrade of the securities, the Company's intent to hold these securities changed and management elected to divest of its interest in the downgraded securities. As the Company's intent and ability to hold the remaining held-to-maturity securities was not impacted by the sale, the Company did not reclassify the remaining securities to the available-for-sale category.

The following tables detail gross unrealized losses and fair values of investment securities aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position (dollars in thousands):

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	Less Than 12 Months					12 Months or More					Total
June 30, 2014	Number of Securities	Fair Value		Unrealized Losses		Number of Securities	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Available-for-sale:
State and municipals	3	$	2,713	$	10	23	$	51,044	$	1,186	$	53,757	$	1,196
Corporate debt securities	—	—		—		1	2,973		27		2,973		27
Other debt securities	1	4,553		193		—	—		—		4,553		193
Equity securities	2	4,209		68		—	—		—		4,209		68
Mortgage-backed securities	—	—		—		10	10,833		164		10,833		164
	6	$	11,475	$	271	34	$	64,850	$	1,377	$	76,325	$	1,648
Held-to-maturity:
State and municipals	2	$	2,509	$	38	102	$	117,505	$	3,083	$	120,014	$	3,121
Corporate debt securities	—	—		—		1	3,040		960		3,040		960
	2	$	2,509	$	38	103	$	120,545	$	4,043	$	123,054	$	4,081

	Less Than 12 Months					12 Months or More					Total
December 31, 2013	Number of Securities	Fair Value		Unrealized Losses		Number of Securities	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Available-for-sale:
U.S. Government agencies	5	$	14,583	$	663	—	$	—	$	—	$	14,583	$	663
State and municipals	47	72,821		3,647		21	27,976		2,018		100,797		5,665
Corporate debt securities	2	7,862		138		—	—		—		7,862		138
Other debt securities	1	4,380		347		—	—		—		4,380		347
Equity securities	1	922		57		—	—		—		922		57
Mortgage-backed securities	15	14,146		444		4	4,582		218		18,728		662
	71	$	114,714	$	5,296	25	$	32,558	$	2,236	$	147,272	$	7,532
Held-to-maturity:
State and municipals	150	$	162,565	$	8,325	25	$	28,238	$	1,844	$	190,803	$	10,169
Corporate debt securities	1	4,939		61		1	2,980		1,020		7,919		1,081
	151	$	167,504	$	8,386	26	$	31,218	$	2,864	$	198,722	$	11,250

All state and municipal securities in an unrealized loss position were rated as investment grade at June 30, 2014. The Company noted that, of the 125 municipal securities in an unrealized loss position for greater than 12 months, only three had an unrealized loss of greater than 5% of book value, and none of the unrealized losses were greater than 11%. The corporate debt securities are with well-capitalized and sound financial institutions. The other debt security is backed by a pool of student loan debt. The security has been in that position for less than 12 months and has an investment grade rating. The equity securities held by the Company consist of common and preferred stock that have been in an unrealized loss position for less than 12 months and there are no concerns about the long-term viability of the issuers. The gross unrealized losses reported for the mortgage-backed securities relate to investment securities issued by the Federal National Mortgage Association, the Government National Mortgage Association, or Federal Home Loan Mortgage Corporation. The Company does not intend to sell, and it is not more likely than not that the Company will be required to sell, these investment securities before the anticipated recovery of the amortized cost basis. The unrealized losses for the debt securities are caused by changes in market interest rates and not credit concerns related to the respective issuers.

The equity securities held by the Company in an unrealized loss position as of June 30, 2014 consist of publicly-traded common stock of an investment company and perpetual preferred stock of an established and well-capitalized financial institution. There are no concerns about the long-term viability of either of the issuers and the Company has the positive intent and ability to hold these securities until the anticipated recovery of value occurs.

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Based on this analysis, the Company does not consider any investment securities to be other-than-temporarily impaired at June 30, 2014.

NOTE 5 – LOANS AND ALLOWANCE FOR LOAN LOSSES

Major categories of loans are presented below (dollars in thousands):

	June 30, 2014						December 31, 2013
	Originated		Acquired (1)		Total		Originated		Acquired (1)		Total
Commercial real estate	$	1,101,695	$	343,432	$	1,445,127	$	1,014,633	$	318,023	$	1,332,656
Commercial construction	197,872		47,670		245,542		202,140		42,420		244,560
Commercial and industrial	134,113		36,439		170,552		139,567		29,372		168,939
Leases	16,701		—		16,701		16,137		—		16,137
Total commercial	1,450,381		427,541		1,877,922		1,372,477		389,815		1,762,292
Residential construction	34,121		8,316		42,437		29,636		2,798		32,434
Residential mortgage	369,818		363,019		732,837		294,660		173,263		467,923
Consumer and other	10,704		6,399		17,103		8,103		5,765		13,868
	$	1,865,024	$	805,275	$	2,670,299	$	1,704,876	$	571,641	$	2,276,517

(1) Amount includes $158.9 million and $187.7 million of acquired loans covered under FDIC loss-share agreements at June 30, 2014 and December 31, 2013, respectively. The unpaid principal balance for acquired loans covered under FDIC loss-share agreements was $163.6 million and $195.4 million at June 30, 2014 and December 31, 2013, respectively.

Covered loans acquired will be reimbursed for a substantial portion of any future losses on them under the terms of the FDIC loss-share agreements. The covered loans are reported in loans exclusive of the expected reimbursement from the FDIC. Covered loans are initially recorded at fair value at the acquisition date. The covered loans are and will be subject to the Company’s internal and external credit review and monitoring. Prospective losses incurred on covered loans are eligible for partial reimbursement by the FDIC. Subsequent decreases in the amount expected to be collected result in a provision for loan losses, an increase in the allowance for loan losses, and a proportional increase to the FDIC indemnification asset for the estimated amount to be reimbursed. Subsequent increases in the amount expected to be collected result in the reversal of any previously-recorded provision for loan losses and related allowance for loan losses and decreases to the FDIC indemnification asset, or accretion of certain fair value amounts into interest income in future periods if no provision for loan losses had been recorded.

A portion of the fair value discount on acquired covered loans has an accretable yield associated with those loans that is accreted into interest income over the estimated remaining life of the loans. The remaining non-accretable difference represents cash flows not expected to be collected. The following table details changes in the carrying amount of covered acquired loans and accretable yield for loans receivable for the six months ended June 30, 2014 and year ended December 31, 2013 (dollars in thousands):

	2014						2013
	Accretable Yield			Carrying Value			Accretable Yield			Carrying Value
Balance at beginning of period	$	(6,058	)	$	187,661		$	(12,895	)	$	248,930
Reductions from payments and foreclosures, net	—			(31,398		)	—			(70,042		)
Reclass from non-accretable to accretable yield	(171		)	171			(968		)	968
Accretion	2,462			2,462			7,805			7,805
Balance at end of period	$	(3,767	)	$	158,896		$	(6,058	)	$	187,661

The Company evaluates loans acquired with evidence of credit deterioration in accordance with the provisions of ASC Topic 310-30: Loans and Debt Securities Acquired with Deteriorated Credit Quality ("ASC 310-30"). Credit-impaired loans are those loans showing evidence of credit deterioration since origination and it is probable, at the date of acquisition, the Company will not collect all contractually required principal and interest payments. Generally, the acquired loans that meet the Company’s definition for nonaccrual status fall within the definition of credit-impaired covered loans. The following table presents loans acquired during the six months ended June 30, 2014, at acquisition date, accounted for under ASC Topic 310-30 (dollars in thousands):

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Contractually required payments receivable	$	40,012
Contractual cash flows not expected to be collected (non-accretable)	(7,885		)
Expected cash flows	32,127
Interest component of expected cash flows	(3,397		)
Fair value of loans acquired	$	28,730

The acquisition date unpaid balance of loans acquired during the six months ended June 30, 2014 that did not have credit deterioration was $307.1 million, with an estimated fair value of $287.0 million. The discount of $20.1 million will be amortized on a level-yield basis over the economic life of the loans.

The Company has the ability to borrow funds from the Federal Home Loan Bank (“FHLB”) and from the Federal Reserve Bank. At June 30, 2014 and December 31, 2013, real estate loans with carrying values of $936.2 million and $759.2 million, respectively, were pledged to secure borrowing facilities from these institutions.

The Company has adopted comprehensive lending policies, underwriting standards and loan review procedures, which are reviewed on a regular basis.   Each class of financing receivable detailed below is subject to risks that could have an adverse impact on the credit quality of the loan portfolio.

Commercial real estate loans

Commercial real estate loans consist primarily of loans secured by nonresidential (owner-occupied and/or non-owner occupied) real estate, multifamily housing, retail strip centers and hotels. Commercial real estate is primarily dependent on successful operation or management of the property in order to generate sufficient cash to repay the outstanding debt. While these loans are normally secured by commercial buildings for office, storage and warehouse space, it is possible that the liquidation of the collateral will not fully satisfy the obligation. High unemployment, generally weak economic conditions or oversupply of properties may result in customers having to provide rental rate concessions to achieve adequate occupancy rates.

Commercial construction loans

Commercial construction loans, including land development loans, are highly dependent on the supply and demand for commercial real estate in the markets served by BNC as well as the demand for newly constructed residential homes and lots that customers are developing. Continuing deterioration in demand could result in significant decreases in the underlying collateral values and make repayment of the outstanding loans more difficult for customers.

Commercial and industrial loans and leases

Each commercial loan or lease is underwritten based primarily upon the customer’s ability to generate the required cash flow to service the debt in accordance with the contractual terms and conditions of the loan agreement. A complete understanding of the borrower’s businesses including the experience and background of the principals is obtained prior to approval. Collateral securing these loans is primarily business assets such as inventory or accounts receivable. To the extent that the principals or other parties provide personal guarantees, the relative financial strength and liquidity of each guarantor is assessed. Common risks include general economic conditions within the markets BNC serves, as well as risks that are specific to each transaction, including demand for products and services and reductions in the fair value of collateral.

Residential construction loans

Residential construction loans are made to established homebuilders and are typically secured by 1-4 family residential property.

Residential mortgage loans

Each residential mortgage loan is underwritten using credit scoring and analysis tools. These credit scoring tools take into account factors such as payment history, credit utilization, length of credit history, types of credit currently in use, and recent credit inquiries. The borrowers' debt-to-income ratio, sources of income and employment history, among other factors, are also evaluated as part of the underwriting process. To the extent that the loan is secured by collateral, the likely value of that collateral is evaluated. Common risks to each class of non-commercial loans include risks that are not specific to individual transactions such as general economic conditions within the markets BNC serves, particularly unemployment and potential declines in real estate values. Personal events such as disability or change in marital status also add risk to residential mortgage loans. Second mortgage loans and home equity lines of credit generally involve greater credit risk than first mortgage loans because they are secured by mortgages that are subordinate to the first mortgage on the property.  If the borrower is forced into foreclosure, the Company will not receive any proceeds from the sale of the property until the first mortgage has been satisfied.

At June 30, 2014, second mortgage loans and home equity lines of credit for which the Company did not own or service the related first mortgage loans totaled approximately $241.9 million, which represented approximately 98% of the total second liens held by the

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Company.  Since substantially all first mortgage loans originated by the Company are eligible for sale in the secondary market, and the Company typically does not service the related first mortgage loans if they are sold, the Company may be unable to track the delinquency status of the related first mortgage loans and whether such loans are at risk of foreclosure by others.  The Company monitors the increased credit risk associated with second mortgage loans and home equity lines of credit for which the Company does not own or service the related first mortgage loans as part of the overall management of the relationship. If the Company identifies significant deterioration in a borrower’s credit quality, the Company may freeze the borrower’s ability to make additional principal draws under the home equity lines of credit.

Home equity lines of credit are offered as “revolving” lines of credit which have a 15 year maturity and draw period. Borrowers are able to choose scheduled monthly interest-only payments during the term of the line or monthly payments of 1.5% of the outstanding prinicpal, along with associated interest. The full principal amount is due at maturity as a lump-sum balloon payment under the interest-only payment option.  At June 30, 2014, approximately 98% of the home equity lines of credit were paying scheduled monthly interest-only payments. At maturity, home equity loans are re-underwritten based on our current underwriting standards and updated appraisals are obtained.  Our underwriting criteria includes analysis of the loan amount in relation to the borrower's total mortgage debt, in addition to normal credit underwriting guidelines.  If the borrower qualifies under our current underwriting standards, the loans are either renewed, converted to conventional second mortgage loans that are fully amortizing, or refinanced along with the existing first mortgage into a new first mortgage loan.  Borrowers may be required to repay a portion of the outstanding principal balance to qualify for such renewals.

The following table summarizes the maturity dates of our home equity lines of credit as of June 30, 2014 (dollars in thousands):

2014	$	3,319
2015	3,249
2016	5,421
2017	6,093
2018	8,620
Thereafter	221,025
	$	247,727

Consumer and other loans

Consumer and other loans include loans secured by personal property such as residential real estate, automobiles, marketable securities, other titled recreational vehicles including boats and motorcycles, as well as unsecured consumer debt. The value of underlying collateral within this class is especially volatile due to potential rapid depreciation in values since date of loan origination in excess of principal repayment. Consumer loan collections are sensitive to job loss, illness and other personal factors.

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An analysis of the allowance for loan losses for the three and six months ended June 30, 2014 and 2013 is presented below (dollars in thousands):

2014	Commercial real estate			Commercial construction			Commercial and industrial			Leases			Residential construction			Residential Mortgage			Consumer and other			Total
Allowance for loan losses:
Balance March 31, 2014	$	13,518		$	5,667		$	3,260		$	74		$	244		$	7,818		$	299		$	30,880
Charge-offs	(492		)	(1,564		)	(495		)	—			—			(1,374		)	(72		)	(3,997		)
Recoveries	372			767			309			—			3			506			13			1,970
Provision (1)	(965		)	498			390			(20		)	(87		)	2,289			35			2,140
Change in FDIC indemnification asset (1)	(346		)	(184		)	(133		)	—			—			(203		)	2			(864		)
Balance June 30, 2014	$	12,087		$	5,184		$	3,331		$	54		$	160		$	9,036		$	277		$	30,129
Balance December 31, 2013	$	14,752		$	6,738		$	3,137		$	56		$	213		$	7,730		$	249		$	32,875
Charge-offs	(2,078		)	(3,144		)	(1,749		)	—			—			(2,438		)	(164		)	(9,573		)
Recoveries	510			1,316			422			—			13			648			22			2,931
Provision (1)	(898		)	697			1,590			(2		)	(60		)	3,238			136			4,701
Change in FDIC indemnification asset (1)	(199		)	(423		)	(69		)	—			(6		)	(142		)	34			(805		)
Balance June 30, 2014	$	12,087		$	5,184		$	3,331		$	54		$	160		$	9,036		$	277		$	30,129

2013	Commercial real estate			Commercial construction			Commercial and industrial			Leases			Residential construction			Residential Mortgage			Consumer and other			Total
Allowance for loan losses:
Balance March 31, 2013	$	12,531		$	10,054		$	3,547		$	—		$	345		$	11,536		$	135		$	38,148
Charge-offs	(318		)	(4,805		)	(900		)	—			—			(3,092		)	(214		)	(9,329		)
Recoveries	868			801			193			—			16			90			10			1,978
Provision (2)	880			(498		)	718			—			17			842			329			2,288
Change in FDIC indemnification asset (2)	(1,070		)	1,445			(17		)	—			(1		)	(603		)	20			(226		)
Balance June 30, 2013	$	12,891		$	6,997		$	3,541		$	—		$	377		$	8,773		$	280		$	32,859
Balance December 31, 2012	$	15,718		$	9,807		$	3,578		$	18		$	593		$	10,441		$	137		$	40,292
Charge-offs	(1,725		)	(7,924		)	(2,239		)	—			—			(5,671		)	(226		)	(17,785		)
Recoveries	872			835			286			—			21			233			15			2,262
Provision (2)	(365		)	2,360			1,935			(18		)	(235		)	2,391			335			6,403
Change in FDIC indemnification asset (2)	(1,609		)	1,919			(19		)	—			(2		)	1,379			19			1,687
Balance June 30, 2013	$	12,891		$	6,997		$	3,541		$	—		$	377		$	8,773		$	280		$	32,859

(1) The provision for loan losses includes the "net" provision on covered loans after coverage provided by FDIC loss-share agreements, which totaled $0 and $(0.3) million for the three and six months ended June 30, 2014, respectively. This resulted in an increase in the FDIC indemnification asset of $(0.9) million and $(0.8) million, which is the difference between the net provision on covered loans and the total additions to the allowance for loan losses allocable to the covered loan portfolio of $(0.9) million and $(1.1) million for the three and six months ended June 30, 2014, respectively.

(2) The provision for loan losses includes the "net" provision on covered loans after coverage provided by FDIC loss-share agreements, which totaled $(0.1) million and $0.4 million for the three and six months ended June 30, 2013, respectively. This resulted in a (decrease) increase in the FDIC indemnification asset of $(0.2) million and $1.7 million, which is the difference between the net provision on covered loans and the total additions to the allowance for loan losses allocable to the covered loan portfolio of $(0.3) million and $2.1 million for the three and six months ended June 30, 2013.

The following table provides a breakdown of the recorded investment in loans and the allowance for loan losses based on the method of determining the allowance:

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	Commercial real estate		Commercial construction		Commercial and industrial		Leases		Residential construction		Residential Mortgage		Consumer and other		Total
Balances as of June 30, 2014:
Specific reserves:
Impaired loans	$	1,965	$	139	$	43	$	—	$	45	$	1,110	$	12	$	3,314
Purchase credit impaired loans	2,155		375		166		—		—		1,670		12		4,378
Total specific reserves	4,120		514		209		—		45		2,780		24		7,692
General reserves	7,967		4,670		3,122		54		115		6,256		253		22,437
Total	$	12,087	$	5,184	$	3,331	$	54	$	160	$	9,036	$	277	$	30,129
Loans:
Individually evaluated for impairment	$	31,022	$	9,118	$	913	$	—	$	353	$	10,973	$	118	$	52,497
Purchase credit impaired loans	97,528		15,202		5,658		—		—		56,921		1,655		176,964
Loans collectively evaluated for impairment	1,316,577		221,222		163,981		16,701		42,084		664,943		15,330		2,440,838
Total	$	1,445,127	$	245,542	$	170,552	$	16,701	$	42,437	$	732,837	$	17,103	$	2,670,299
Balances as of December 31, 2013:
Specific reserves:
Impaired loans	$	3,209	$	1,595	$	43	$	—	$	35	$	1,361	$	10	$	6,253
Purchase credit impaired loans	2,979		691		552		—		—		1,833		23		6,078
Total specific reserves	6,188		2,286		595		—		35		3,194		33		12,331
General reserves	8,564		4,452		2,542		56		178		4,536		216		20,544
Total	$	14,752	$	6,738	$	3,137	$	56	$	213	$	7,730	$	249	$	32,875
Loans:
Individually evaluated for impairment	$	33,950	$	12,877	$	1,525	$	—	$	356	$	14,037	$	165	$	62,910
Purchase credit impaired loans	100,290		18,460		6,649		—		16		50,825		1,917		178,157
Loans collectively evaluated for impairment	1,198,416		213,223		160,765		16,137		32,062		403,061		11,786		2,035,450
Total	$	1,332,656	$	244,560	$	168,939	$	16,137	$	32,434	$	467,923	$	13,868	$	2,276,517

The following tables present information related to impaired loans, excluding purchased impaired loans (dollars in thousands):

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	Impaired Loans - With Allowance						Impaired Loans - With No Allowance
June 30, 2014	Recorded Investment		Unpaid Principal Balance		Allowances for Loan Losses Allocated		Recorded Investment		Unpaid Principal Balance
Originated:
Commercial real estate	$	19,568	$	19,525	$	1,920	$	11,512	$	11,507
Commercial construction	1,256		1,250		125		7,823		7,804
Commercial and industrial	864		851		42		—		—
Residential construction	353		352		45		—		—
Residential mortgage	6,223		6,202		1,074		4,544		4,533
Consumer and other	119		118		12		—		—
Total originated	28,383		28,298		3,218		23,879		23,844
Acquired (non-covered):
Commercial real estate	487		485		44		608		1,708
Commercial construction	137		136		14		59		131
Commercial and industrial	53		53		1		5		4
Residential mortgage	848		932		37		3,098		3,590
Consumer and other	—		—		—		—		—
Total acquired (non-covered)	1,525		1,606		96		3,770		5,433
Acquired (covered):
Commercial real estate	—		—		—		1,123		1,135
Commercial construction	—		—		—		419		430
Commercial and industrial	—		—		—		33		66
Residential mortgage	—		—		—		5,510		5,502
Total acquired (covered)	—		—		—		7,085		7,133
Total loans	$	29,908	$	29,904	$	3,314	$	34,734	$	36,410

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	Impaired Loans - With Allowance						Impaired Loans - With No Allowance
December 31, 2013	Recorded Investment		Unpaid Principal Balance		Allowances for Loan Losses Allocated		Recorded Investment		Unpaid Principal Balance
Originated:
Commercial real estate	$	16,261	$	16,228	$	3,164	$	17,129	$	17,116
Commercial construction	7,239		7,218		1,582		5,536		5,902
Commercial and industrial	934		932		42		3		—
Residential construction	357		355		35		—		—
Residential mortgage	8,529		8,513		1,333		3,719		3,699
Consumer and other	104		104		10		37		37
Total originated	33,424		33,350		6,166		26,424		26,754
Acquired (non-covered):
Commercial real estate	490		489		45		557		565
Commercial construction	142		141		14		—		—
Commercial and industrial	185		185		1		406		648
Residential mortgage	636		636		27		1,236		1,528
Consumer and other	—		—		—		24		21
Total acquired (non-covered)	1,453		1,451		87		2,223		2,762
Acquired (covered):
Commercial real estate	—		—		—		173		183
Commercial construction	—		—		—		400		414
Commercial and industrial	—		—		—		3		35
Residential mortgage	—		—		—		5,788		5,877
Total acquired (covered)	—		—		—		6,364		6,509
Total loans	$	34,877	$	34,801	$	6,253	$	35,011	$	36,025

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The following table presents information related to the average recorded investment and interest income recognized on impaired loans, excluding purchased impaired loans (dollars in thousands):

	Three months ended June 30,
	2014				2013
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
Impaired loans with allowance:
Commercial real estate	$	20,363	$	194	$	23,271	$	215
Commercial construction	1,585		18		6,837		50
Commercial and industrial	661		6		531		4
Residential construction	353		3		435		3
Residential mortgage	4,442		27		13,284		76
Consumer and other	85		1		50		—
Total impaired loans with allowance	$	27,489	$	249	$	44,408	$	348
Impaired loans with no allowance:
Commercial real estate	$	13,167	$	77	$	11,502	$	102
Commercial construction	8,290		45		10,732		8
Commercial and industrial	772		—		579		1
Residential construction	—		—		—		—
Residential mortgage	14,365		66		10,627		15
Consumer and other	—		—		16		—
Total impaired loans with no allowance	$	36,594	$	188	$	33,456	$	126

	Six months ended June 30,
	2014				2013
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
Impaired loans with allowance:
Commercial real estate	$	20,819	$	399	$	14,945	$	272
Commercial construction	2,865		55		7,060		91
Commercial and industrial	1,103		16		305		4
Residential construction	359		6		338		5
Residential mortgage	6,022		71		11,202		124
Consumer and other	96		1		25		—
Total impaired loans with allowance	$	31,264	$	548	$	33,875	$	496
Impaired loans with no allowance:
Commercial real estate	$	13,067	$	115	$	15,180	$	276
Commercial construction	7,708		82		9,987		32
Commercial and industrial	549		—		623		4
Residential construction	—		—		—		—
Residential mortgage	12,816		111		10,120		44
Consumer and other	28		—		50		—
Total impaired loans with no allowance	$	34,168	$	308	$	35,960	$	356

For the three and six months ended June 30, 2014 and 2013, the amount of interest income recognized within the period that the loans were impaired was primarily related to loans modified in a troubled debt restructuring (“TDR”) that remained on accrual status. For the

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three and six months ended June 30, 2014 and 2013, the amount of interest income recognized using a cash-basis method of accounting during the period that the loans were impaired was not material.

The following tables present an aging analysis of the recorded investment in the Company's loans (dollars in thousands):

June 30, 2014	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days Past Due		Non-Accrual		Total Past Due		Current		Total Loans
Originated:
Commercial real estate	$	736	$	—	$	—	$	6,590	$	7,326	$	1,094,369	$	1,101,695
Commercial construction	57		161		—		3,672		3,890		193,982		197,872
Commercial and industrial	—		133		—		258		391		133,722		134,113
Leases	—		—		—		—		—		16,701		16,701
Residential construction	—		—		—		—		—		34,121		34,121
Residential mortgage	497		280		—		3,840		4,617		365,201		369,818
Consumer and other	7		22		—		—		29		10,675		10,704
Total originated	1,297		596		—		14,360		16,253		1,848,771		1,865,024
Acquired (non-covered):
Commercial real estate	200		64		329		639		1,232		258,562		259,794
Commercial construction	141		77		69		56		343		36,089		36,432
Commercial and industrial	39		21		—		58		118		31,798		31,916
Residential construction	—		—		99		—		99		8,217		8,316
Residential mortgage	610		908		241		3,732		5,491		299,687		305,178
Consumer and other	81		20		—		—		101		4,642		4,743
Total acquired (non-covered)	1,071		1,090		738		4,485		7,384		638,995		646,379
Acquired (covered):
Commercial real estate	480		290		—		7,150		7,920		75,718		83,638
Commercial construction	—		—		—		1,105		1,105		10,133		11,238
Commercial and industrial	98		—		—		376		474		4,049		4,523
Residential construction	—		—		—		—		—		—		—
Residential mortgage	—		—		—		7,247		7,247		50,594		57,841
Consumer and other	4		5		—		43		52		1,604		1,656
Total acquired (covered)	582		295		—		15,921		16,798		142,098		158,896
Total loans	$	2,950	$	1,981	$	738	$	34,766	$	40,435	$	2,629,864	$	2,670,299

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December 31, 2013	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days Past Due		Non-Accrual		Total Past Due		Current		Total Loans
Originated:
Commercial real estate	$	353	$	—	$	—	$	6,044	$	6,397	$	1,008,236	$	1,014,633
Commercial construction	14		20		—		2,801		2,835		199,305		202,140
Commercial and industrial	533		10		—		245		788		138,779		139,567
Leases	—		—		—		—		—		16,137		16,137
Residential construction	—		—		—		—		—		29,636		29,636
Residential mortgage	1,417		248		—		5,102		6,767		287,893		294,660
Consumer and other	—		—		—		37		37		8,066		8,103
Total originated	2,317		278		—		14,229		16,824		1,688,052		1,704,876
Acquired (non-covered):
Commercial real estate	116		—		—		605		721		220,850		221,571
Commercial construction	50		—		—		—		50		24,039		24,089
Commercial and industrial	—		5		—		591		596		22,857		23,453
Residential construction	—		—		—		—		—		2,782		2,782
Residential mortgage	950		514		—		1,665		3,129		105,110		108,239
Consumer and other	108		1		—		24		133		3,713		3,846
Total acquired (non-covered)	1,224		520		—		2,885		4,629		379,351		383,980
Acquired (covered):
Commercial real estate	1,145		848		—		8,086		10,079		86,373		96,452
Commercial construction	201		38		—		5,111		5,350		12,981		18,331
Commercial and industrial	—		47		—		640		687		5,232		5,919
Residential construction	—		—		—		—		—		16		16
Residential mortgage	313		28		—		9,818		10,159		54,865		65,024
Consumer and other	8		2		—		90		100		1,819		1,919
Total acquired (covered)	1,667		963		—		23,745		26,375		161,286		187,661
Total loans	$	5,208	$	1,761	$	—	$	40,859	$	47,828	$	2,228,689	$	2,276,517

Credit quality indicators

The Company uses several credit quality indicators to manage credit risk in an ongoing manner. The Company's primary credit quality indicators use an internal credit risk rating system that categorizes loans and leases into pass, special mention, or classified categories. Credit risk ratings are applied individually to those classes of loans and leases that have significant or unique credit characteristics that benefit from a case-by-case evaluation. These are typically loans and leases to businesses or individuals in the classes which comprise the commercial portfolio segment. Groups of loans and leases that are underwritten and structured using standardized criteria and characteristics are typically risk rated and monitored collectively. These are typically loans and leases to individuals in the classes which comprise the consumer portfolio segment.

At least annually the Company will review all loans exceeding a certain threshold and assign a risk rating. Loans excluded from the scope of the annual review process are generally classified as pass credits until: (a) they become past due; (b) management becomes aware of a deterioration in the creditworthiness of the borrower; or (c) the customer contacts the Company for a modification or new loan. The Company uses the following definitions for risk ratings:

Special Mention. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.

Substandard. Loans classified as substandard are inadequately protected by the current net worth and payment capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

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Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loss. Loans classified as loss are considered uncollectible and are in the process of being charged-off, as soon as practical, once so classified.

The following tables present the recorded investment in the Company’s loans by credit quality indicator (dollars in thousands):

June 30, 2014	Total		Pass Credits		Special Mention		Substandard		Doubtful		Loss
Originated:
Commercial real estate	$	1,101,695	$	1,013,548	$	47,152	$	40,995	$	—	$	—
Commercial construction	197,872		181,339		9,872		6,661		—		—
Commercial and industrial	134,113		127,430		4,690		1,993		—		—
Leases	16,701		16,701		—		—		—		—
Residential construction	34,121		32,552		1,216		353		—		—
Residential mortgage	369,818		338,050		17,123		14,645		—		—
Consumer and other	10,704		10,426		196		82		—		—
Total originated	1,865,024		1,720,046		80,249		64,729		—		—
Total acquired (non-covered):
Commercial real estate	259,794		220,066		22,679		17,049		—		—
Commercial construction	36,432		25,430		6,142		4,860		—		—
Commercial and industrial	31,916		28,623		438		2,855		—		—
Residential construction	8,316		8,109		207		—		—		—
Residential mortgage	305,178		263,838		23,819		17,394		127		—
Consumer and other	4,743		4,638		105		—		—		—
Total acquired (non-covered):	646,379		550,704		53,390		42,158		127		—
Acquired (covered):
Commercial real estate	83,638		50,199		13,831		16,833		2,775		—
Commercial construction	11,238		7,097		737		2,863		541		—
Commercial and industrial	4,523		3,347		600		330		246		—
Residential construction	—		—		—		—		—		—
Residential mortgage	57,841		32,200		13,240		9,417		2,984		—
Consumer and other	1,656		1,526		87		43		—		—
Total acquired (covered)	158,896		94,369		28,495		29,486		6,546		—
Total loans	$	2,670,299	$	2,365,119	$	162,134	$	136,373	$	6,673	$	—

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December 31, 2013	Total		Pass Credits		Special Mention		Substandard		Doubtful		Loss
Originated:
Commercial real estate	$	1,014,633	$	930,554	$	37,685	$	46,394	$	—	$	—
Commercial construction	202,140		175,365		13,113		13,662		—		—
Commercial and industrial	139,567		131,658		5,411		2,498		—		—
Leases	16,137		16,137		—		—		—		—
Residential construction	29,636		28,160		1,120		356		—		—
Residential mortgage	294,660		258,042		19,234		17,384		—		—
Consumer and other	8,103		7,807		177		119		—		—
Total originated	1,704,876		1,547,723		76,740		80,413		—		—
Acquired (non-covered):
Commercial real estate	221,571		195,526		17,343		8,702		—		—
Commercial construction	24,089		21,126		922		2,041		—		—
Commercial and industrial	23,453		18,681		3,328		1,444		—		—
Residential construction	2,782		2,782		—		—		—		—
Residential mortgage	108,239		91,847		10,766		5,626		—		—
Consumer and other	3,846		3,760		62		24		—		—
Total acquired (non-covered)	383,980		333,722		32,421		17,837		—		—
Acquired (covered):
Commercial real estate	96,452		61,091		12,831		17,929		4,601		—
Commercial construction	18,331		9,756		1,397		6,751		427		—
Commercial and industrial	5,919		4,231		796		332		560		—
Residential construction	16		—		16		—		—		—
Residential mortgage	65,024		36,744		13,246		10,296		4,738		—
Consumer and other	1,919		1,726		103		90		—		—
Total acquired (covered)	187,661		113,548		28,389		35,398		10,326		—
Total loans	$	2,276,517	$	1,994,993	$	137,550	$	133,648	$	10,326	$	—

Modifications

A modification of a loan constitutes a TDR when a borrower is experiencing financial difficulty and the modification constitutes a concession.  The Company offers various types of concessions when modifying a loan; however, forgiveness of principal is rarely granted.  Commercial and industrial loans modified in a TDR often involve temporary interest-only payments, term extensions, and converting revolving credit lines to term loans.  Additional collateral, a co-borrower, or a guarantor is often requested.  Commercial mortgage and construction loans modified in a TDR often involve reducing the interest rate for the remaining term of the loan, extending the maturity date at an interest rate lower than the current market rate for new debt with similar risk, or substituting or adding a new borrower or guarantor.  Construction loans modified in a TDR may also involve extending the interest-only payment period.  Residential mortgage loans modified in a TDR are primarily comprised of loans where monthly payments are lowered to accommodate the borrowers’ financial needs for a period of time.  After the lowered monthly payment period ends, the borrower reverts back to paying principal and interest per the original terms with the maturity date adjusted accordingly.  Land loans are also included in the class of residential mortgage loans.  Land loans are typically structured as interest-only monthly payments with a balloon payment due at maturity.  Land loans modified in a TDR typically involve extending the balloon payment by one to three years, or changing the monthly payments from interest-only to principal and interest.  Home equity modifications are made infrequently and are not offered if the Company also holds the first mortgage.  Home equity modifications are uniquely designed to meet the specific needs of each borrower.  Occasionally, the terms will be modified to a standalone second lien mortgage, thereby changing their loan class from home equity to residential mortgage.

Loans modified in a TDR are, in many cases, already on nonaccrual status and partial charge-offs have in some cases already been taken against the outstanding loan balance.  As a result, loans modified in a TDR for the Company may have the financial effect of increasing the specific allowance associated with the loan.  An allowance for impaired consumer and commercial loans that have been modified in a TDR is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or the estimated fair value of the collateral, less any selling costs, if the loan is collateral dependent.  Management exercises significant judgment in developing these estimates. Once we classify a loan a TDR, the loan is only removed from TDR

29

classification under three circumstances: (1) the loan is paid off, (2) the loan is charged off or (3) if, at the beginning of the current fiscal year, the loan has performed in accordance with the modified terms for a minimum of six consecutive months and at the time of modification the loan’s interest rate represented a then current market interest rate for a loan of similar risk. 

The following tables provide a summary of loans modified as TDRs (dollars in thousands):

	Accrual		Nonaccrual		Total TDRs		Allowance for Loan Losses Allocated
June 30, 2014
Commercial real estate	$	3,903	$	2,161	$	6,064	$	349
Commercial construction	3,488		1,516		5,004		32
Commercial and industrial	535		—		535		31
Residential mortgage	6,904		556		7,460		526
Consumer and other	118		—		118		12
Total modifications	$	14,948	$	4,233	$	19,181	$	950
Total contracts	33		15		48

	Accrual		Nonaccrual		Total TDRs		Allowance for Loan Losses Allocated
December 31, 2013
Commercial real estate	$	3,986	$	1,107	$	5,093	$	767
Commercial construction	5,472		274		5,746		520
Commercial and industrial	662		—		662		36
Residential mortgage	6,545		625		7,170		476
Consumer and other	105		37		142		11
Total modifications	$	16,770	$	2,043	$	18,813	$	1,810
Total contracts	43		10		53

As of June 30, 2014 and December 31, 2013, the Company had no available commitments outstanding on TDRs.

The Company offers a variety of modifications to borrowers. The modification categories offered can generally be described in the following categories:

Rate modification - A modification in which the interest rate is changed.

Term modification - A modification in which the maturity date, timing of payments or frequency of payments is changed.

Interest only modification – A modification in which the loan is converted to interest only payments for a period of time.

Payment modification – A modification in which the principal and interest payment are lowered from the original contractual terms.

Combination modification – Any other type of modification, including the use of multiple categories above.

The following tables present new TDRs by modification category (dollars in thousands). All balances represent the recorded investment as of the end of the period in which the modification was made.

	Three months ended June 30, 2014
	Rate Modifications		Term Modifications		Interest only Modifications		Payment Modifications		Combination Modifications		Total Modifications
Residential construction	$	—	$	—	$	479	$	—	$	—	$	479

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	Three months ended June 30, 2013
	Rate Modifications		Term Modifications		Interest only Modifications		Payment Modifications		Combination Modifications		Total Modifications
Commercial real estate	$	101	$	—	$	—	$	—	$	99	$	200
Commercial construction	128		—		152		—		67		347
Commercial and industrial	—		89		—		—		—		89
Residential mortgage	452		—		686		—		202		1,340
Consumer and other	—		23		—		—		—		23
Total modifications	$	681	$	112	$	838	$	—	$	368	$	1,999

	Six months ended June 30, 2014
	Rate Modifications		Term Modifications		Interest only Modifications		Payment Modifications		Combination Modifications		Total Modifications
Commercial real estate	$	—	$	—	$	—	$	1,338	$	—	$	1,338
Residential construction	—		—		479		—		—		479
Total modifications	$	—	$	—	$	479	$	1,338	$	—	$	1,817

	Six months ended June 30, 2013
	Rate Modifications		Term Modifications		Interest only Modifications		Payment Modifications		Combination Modifications		Total Modifications
Commercial real estate	$	101	$	648	$	—	$	—	$	911	$	1,660
Commercial construction	128		—		152		—		553		833
Commercial and industrial	—		89		—		—		—		89
Residential mortgage	452		—		686		—		202		1,340
Consumer and other	—		23		—		—		—		23
Total modifications	$	681	$	760	$	838	$	—	$	1,666	$	3,945

The following tables summarize the period-end balance for loans modified and classified as TDRs in the previous 12 months for which a payment default has occurred during the three and six months ended June 30, 2014 and 2013 (dollars in thousands). The Company defines payment default as movement of the restructuring to nonaccrual status, foreclosure or charge-off, whichever occurs first.

	Three months ended June 30,
	2014		2013
Commercial real estate	$	1,210	$	—
Commercial construction	1,245		—
Residential mortgage	19		—

	Six months ended June 30,
	2014		2013
Commercial real estate	$	1,210	$	—
Commercial construction	1,245		5,906
Commercial and industrial	—		29
Residential mortgage	129		—

Loans held for sale

The Company originates certain single family, residential first mortgage loans for sale on a presold basis. Loan sale activity is summarized below (dollars in thousands):

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	Three months ended June 30,				Six months ended June 30,
	2014		2013		2014		2013
Loans held for sale	$	23,714	$	39,954	$	23,714	$	39,954
Proceeds from sales of loans held for sale	67,191		98,296		136,603		198,288
Mortgage fees	1,954		2,480		3,512		4,861

NOTE 6 – FDIC INDEMNIFICATION ASSET

The Company has recorded an indemnification asset related to loss-share agreements entered into with the FDIC wherein the FDIC will reimburse the Company for certain amounts related to certain acquired loans and other real estate owned should the Company experience a loss. Under the loss-sharing arrangements, the FDIC has agreed to absorb 80% of all future losses and workout expenses on these assets which occur prior to the expiration of the loss-sharing agreements. The Company entered into the respective loss-share agreements with the acquisitions of Beach First National Bank (“Beach First”) and Blue Ridge Savings Bank (“Blue Ridge”).

Each loss-sharing arrangement consists of one single family residential mortgage loan agreement and one commercial and other loans and other real estate owned agreement. The commercial and other loan and other real estate owned loss-share agreements provide for FDIC loss-sharing for five years from April 9, 2010 and October 14, 2011 for the purchases of Beach First and Blue Ridge, respectively, and reimbursement to the FDIC for eight years from these dates. The single family residential mortgage loan loss-share agreements provide for FDIC loss-sharing and reimbursement for recoveries to the FDIC for ten years from these dates for the purchases, and reimbursement to the FDIC for ten years from these dates.

The following table presents activity for the FDIC indemnification asset (dollars in thousands):

	Three months ended June 30,						Six months ended June 30,
	2014			2013			2014			2013
Balance at beginning of period	$	13,668		$	42,476		$	16,886		$	53,519
Accretion of present value discount, net	321			—			713			(24		)
Post-acquisition adjustments	(69		)	858			(832		)	811
Receipt of payments from FDIC	(4,137		)	(5,168		)	(6,984		)	(16,140		)
Balance at end of period	$	9,783		$	38,166		$	9,783		$	38,166

The FDIC indemnification asset is measured separately from the related covered assets and is initially recorded at fair value. The fair value was estimated using projected cash flows related to the loss-share agreements based on the expected reimbursements for losses and the applicable loss-share percentages. Cash flow projections are reviewed and updated prospectively as loss estimates related to both covered loans and covered OREO change.

NOTE 7 – GOODWILL AND OTHER INTANGIBLES

The following table presents activity for goodwill and other intangible assets for the six months ended June 30, 2014 (dollars in thousands):

	Goodwill		Other Intangibles			Total
Balance at December 31, 2013	$	28,384	$	6,582		$	34,966
Acquisitions	22,360		6,011			28,371
Amortization	—		(931		)	(931		)
Balance at June 30, 2014	$	50,744	$	11,662		$	62,406

The Company performed the annual impairment test of goodwill as of June 30, 2014. The annual impairment test indicated that the estimated fair value exceeded the carrying value (including goodwill) for the Company’s reporting unit. Therefore, a step two analysis was not required and no impairment charge was recorded.

The following table presents the gross carrying amount and accumulated amortization for the Company’s core deposit intangible assets, which are the only identifiable intangible assets subject to amortization (dollars in thousands):

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	June 30, 2014			December 31, 2013
Gross carrying amount	$	15,925		$	9,914
Accumulated amortization	(4,263		)	(3,332		)
Net book value	$	11,662		$	6,582

NOTE 8 – DERIVATIVES

The Company utilizes derivative financial instruments primarily to hedge its exposure to changes in interest rates. All derivative financial instruments are recorded on the balance sheet at their respective fair values. The Company does not use financial instruments or derivatives for any trading or other speculative purposes.

The primary focus of the Company’s asset/liability management program is to monitor the sensitivity of the Company’s net portfolio value and net income under varying interest rate scenarios to take steps to control its risks. On a quarterly basis, the Company simulates the net portfolio value and net income expected to be earned over a twelve-month period following the date of simulation. The simulation is based on a projection of market interest rates at varying levels and estimates the impact of such market rates on the levels of interest-earning assets and interest-bearing liabilities during the measurement period. Based upon the outcome of the simulation analysis, the Company considers the use of derivatives as a means of reducing the volatility of net portfolio value and projected net income within certain ranges of projected changes in interest rates. The Company evaluates the effectiveness of entering into any derivative instrument agreement by measuring the cost of such an agreement in relation to the reduction in net portfolio value and net income volatility within an assumed range of interest rates. The Company also has derivatives that are a result of a service it provides to certain qualifying customers, which includes a matched book of derivative instruments offered to customers in order to minimize their interest rate risk.

Derivatives Designated as Cash Flow Hedges of Interest Rate Risk

The Company has variable rate funding which creates exposure to variability in interest payments due to changes in interest rates. In March 2013, the Company entered into a forward-starting interest rate swap transaction with a notional amount of $125 million to effectively convert $125 million of its variable-rate money market funding arrangement to fixed interest rate debt as of the forward-starting date of the swap transaction. The effective date of this interest rate swap is September 16, 2014 and the termination date is March 18, 2019. The swap transaction was designated as a cash flow hedge of the changes in cash flows attributable to changes in one-month LIBOR, the benchmark interest rate being hedged, associated with the interest payments made on the first $125 million of the Company's variable rate money market funding arrangement, which are indexed to one-month LIBOR.

During the first quarter of 2009, the Company entered into a five year interest rate derivative contract, with a notional amount of $250 million, to offset the effects of interest rate changes on an unsecured $250 million variable rate money market funding arrangement. The interest rate cap matured on February 16, 2014.

Derivatives Not Designated as Hedges

The Company utilizes derivative financial instruments, including interest rate swaps, caps and/or floors, as part of its ongoing efforts to mitigate its interest rate risk exposure and to help its commercial customers manage their exposure to interest rate fluctuations. To mitigate the interest rate risk associated with these customer contracts, the Company enters into an offsetting derivative contract position. These derivative positions are recorded at fair value on the Company’s consolidated balance sheet and, due to the matched nature of these derivative instruments, changes in fair value do not impact the Company’s earnings. At June 30, 2014 and December 31, 2013, the Company had notional amounts of $32.7 million and $31.2 million, respectively, on interest rate contracts with corporate customers and in offsetting interest rate contracts with another financial institution to mitigate the Company’s rate exposure on its corporate customers’ contracts.

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The following table presents the fair value of the Company’s derivatives (dollars in thousands):

	June 30, 2014					December 31, 2013
	Notional Amount		Balance Sheet Location	Fair Value		Notional Amount		Balance Sheet Location	Fair Value
Derivative assets:
Derivatives designated as hedging instruments:
Interest rate cap	N/A		N/A	N/A		$	250,000	Other assets	$	—
Interest rate swap	125,000		Other assets	173		125,000		Other assets	2,744
	$	125,000		$	173	$	375,000		$	2,744
Derivatives not designated as hedging instruments:
Interest rate swaps	$	29,505	Other assets	$	592	$	27,965	Other assets	$	424
Interest rate cap/floor	3,222		Other assets	21		3,256		Other assets	98
	$	32,727		$	613	$	31,221		$	522
Derivative liabilities:
Derivatives not designated as hedging instruments:
Interest rate swaps	$	32,727	Accrued expenses and other liabilities	$	613	$	31,221	Accrued expenses and other liabilities	$	522

The derivative instruments held by the Company are subject to master netting arrangements which contain a legally enforceable right to offset recognized amounts and settle such amounts on a net basis. The Company has elected to present the financial assets and financial liabilities associated with these arrangements on a gross basis in the Consolidated Balance Sheets. Cash collateral is posted by the counterparty with net liability positions in accordance with contract thresholds.

Information about financial instruments that are eligible for offset in the consolidated balance sheets is presented in the following table (dollar amounts in thousands):

							Gross Amounts Not Offset in the Consolidated Balance Sheets
	Gross Amount Recognized		Gross Amounts Offset in the Consolidated Balance Sheets		Net Amounts Presented in the Consolidated Balance Sheets		Financial Instruments		Collateral Held/Pledged		Net
June 30, 2014
Derivative assets	$	786	$	—	$	786	$	—	$	410	$	376
Derivative liabilities	613		—		613		—		613		—
Total derivative instruments	$	1,399	$	—	$	1,399	$	—	$	1,023	$	376
December 31, 2013
Derivative assets	$	3,266	$	—	$	3,266	$	—	$	930	$	2,336
Derivative liabilities	522		—		522		—		522		—
Total derivative instruments	$	3,788	$	—	$	3,788	$	—	$	1,452	$	2,336

The Company has recorded a net gain of $0.1 million, net of tax, as accumulated other comprehensive income at June 30, 2014 associated with cash flow hedging instruments and expects $1.2 million, net of tax, to be reclassified as an increase to interest expense during the next 12 months. The following table presents the losses recorded in the Consolidated Statements of Income and Consolidated Statements of Comprehensive Income, respectively, relating to derivative instruments designated as cash flow hedges (dollars in thousands, net of tax):

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	Three months ended June 30,					Six months ended June 30,
	2014			2013		2014			2013
Derivatives designated as hedging instruments:
Amount of net gains (losses) recorded in OCI (effective portion)	$	(1,044	)	$	2,279	$	(1,620	)	$	1,804
Amount of net losses reclassified from OCI to earnings (1)	—			1,434		286			2,789

(1) Amount recorded in interest expense on demand deposits in the Consolidated Statements of Income

The amounts included in accumulated other comprehensive income will be reclassified to interest expense should the hedges no longer be considered effective. No amount of ineffectiveness was included in net income for the three and six months ended June 30, 2014 and 2013. The Company will continue to assess the effectiveness of the hedges on a quarterly basis.

Counterparty Credit Risk - By entering into derivative instrument contracts, the Company exposes itself, from time to time, to counterparty credit risk. Counterparty credit risk is the failure of the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is in an asset position, the counterparty has a liability to the Company, which creates credit risk for the Company. The Company attempts to minimize this risk by selecting counterparties with investment grade credit ratings, limiting its exposure to any single counterparty and regularly monitoring its market position with each counterparty.

Credit-Risk Related Contingent Features – The Company’s derivative instruments contain provisions allowing the financial institution counterparty to terminate the contracts in certain circumstances, such as a default by the Company on its indebtedness or the failure to maintain its regulatory status as a well-capitalized institution. These derivative agreements also contain provisions regarding the posting of collateral by each party. As of June 30, 2014, the aggregate fair value of derivative instruments with credit-risk-related contingent features that were in a net liability position was $0.6 million, for which the Company has posted collateral of $2.4 million.

NOTE 9 – BORROWINGS

The following table presents the Company’s short-term borrowings (dollars in thousands):

	June 30, 2014		December 31, 2013
Repurchase agreements	$	40,765	$	27,202
Advances from FHLB	67,100		97,300
Federal funds purchased	410		1,090
Total short-term borrowings	$	108,275	$	125,592

Securities sold under agreements to repurchase generally mature within one day from the transaction date and are collateralized by either U.S. Government Agency obligations, government sponsored mortgage-backed securities or securities issued by local governmental municipalities.

The following table presents the Company’s long-term debt (dollars in thousands):

	June 30, 2014		December 31, 2013
FHLB advances	$	51,000	$	51,100
Term loan	28,500		28,875
Junior subordinated debentures	23,713		23,713
	103,213		103,688
Less: FHLB prepayment penalty	2,039		2,179
Total	$	101,174	$	101,509

The Company may purchase federal funds through unsecured federal funds lines of credit totaling $65.0 million at June 30, 2014. These lines are intended for short-term borrowings and are subject to restrictions limiting the frequency and terms of advances. These lines of credit are payable on demand and bear interest based upon the daily federal funds rate.

In addition, the Company has the ability to borrow funds from the Federal Reserve Bank of Richmond utilizing the discount window and the borrower-in-custody of collateral arrangement. At June 30, 2014, commercial loans and investment securities with carrying values

35

of $222.3 million and $2.8 million, respectively, were assigned under these arrangements. At June 30, 2014, the Company had approximately $177.3 million in borrowing capacity available under these arrangements with no outstanding balance due.

The advances from the FHLB have been made against a $466.5 million line of credit secured by real estate loans and investment securities with carrying values of $713.9 million and $10.8 million, respectively, as of June 30, 2014.

The Company was not aware of any violations of loan covenants at June 30, 2014.

NOTE 10 – ACCUMULATED OTHER COMPREHENSIVE INCOME

The following tables present the changes in accumulated other comprehensive income, net of taxes (dollars in thousands):

	Unrealized Holding Gains (Losses) on Available-For-Sale Investment Securities		Unrealized Holding Gains on Investment Securities Transferred from Available-For-Sale to Held-to-Maturity			Unrealized Holding Gains (Losses) on Cash Flow Hedging Activities			Total Accumulated Other Comprehensive Income
Balance at April 1, 2014	$	2,066	$	3,601		$	1,151		$	6,818
Other comprehensive income (loss) before reclassifications	2,540		—			(1,044		)	1,496
Amounts reclassified from accumulated other comprehensive income	—		(102		)	—			(102		)
Net current period other comprehensive income (loss)	2,540		(102		)	(1,044		)	1,394
Balance at June 30, 2014	$	4,606	$	3,499		$	107		$	8,212

	Unrealized Holding Gains (Losses) on Available-For-Sale Investment Securities			Unrealized Holding Gains on Investment Securities Transferred from Available-For-Sale to Held-to-Maturity			Unrealized Holding Gains (Losses) on Cash Flow Hedging Activities			Total Accumulated Other Comprehensive Income
Balance at January 1, 2014	$	(1,946	)	$	3,811		$	1,441		$	3,306
Other comprehensive income (loss) before reclassifications	6,196			—			(1,620		)	4,576
Amounts reclassified from accumulated other comprehensive income	356			(312		)	286			330
Net current period other comprehensive income (loss)	6,552			(312		)	(1,334		)	4,906
Balance at June 30, 2014	$	4,606		$	3,499		$	107		$	8,212

	Unrealized Holding Gains (Losses) on Available-For-Sale Investment Securities			Unrealized Holding Gains on Investment Securities Transferred from Available-For-Sale to Held-to-Maturity			Unrealized Holding Gains (Losses) on Cash Flow Hedging Activities			Total Accumulated Other Comprehensive Income
Balance at April 1, 2013	$	7,104		$	2,793		$	(5,444	)	$	4,453
Other comprehensive income (loss) before reclassifications	(5,394		)	—			2,279			(3,115		)
Amounts reclassified from accumulated other comprehensive income	(108		)	(91		)	1,434			1,235
Amounts transferred as a result of the reclassification of securities from available-for-sale to held-to-maturity	(1,219		)	1,219			—			—
Net current period other comprehensive income (loss)	(6,721		)	1,128			3,713			(1,880		)
Balance at June 30, 2013	$	383		$	3,921		$	(1,731	)	$	2,573

36

	Unrealized Holding Gains on Available-For-Sale Investment Securities			Unrealized Holding Gains on Investment Securities Transferred from Available-For-Sale to Held-to-Maturity			Unrealized Holding Gains (Losses) on Cash Flow Hedging Activities			Total Accumulated Other Comprehensive Income
Balance at January 1, 2013	$	8,872		$	2,881		$	(6,324	)	$	5,429
Other comprehensive income (loss) before reclassifications	(7,302		)	—			1,804			(5,498		)
Amounts reclassified from accumulated other comprehensive income	32			(179		)	2,789			2,642
Amounts transferred as a result of the reclassification of securities from available-for-sale to held-to-maturity	(1,219		)	1,219			—			—
Net current period other comprehensive income (loss)	(8,489		)	1,040			4,593			(2,856		)
Balance at June 30, 2013	$	383		$	3,921		$	(1,731	)	$	2,573

The following tables detail reclassification adjustments from accumulated other comprehensive income (dollars in thousands):

Component of Accumulated Other Comprehensive Income	Three months ended June 30, 2014			Affected Line Item in the Consolidated Statement of Income
Unrealized holding gains - investment securities available-for-sale	$	—		Gain (loss) on sale of investment securities, net
	—			Income tax benefit (expense)
	—			Total, net of tax
Unrealized holding gains – investment securities transferred from available-for-sale to held-to-maturity (1)	162			Interest income - investment securities
	(60		)	Income tax benefit (expense)
	102			Total, net of tax
Unrealized holding losses – cash flow hedge instruments	—			Interest expense - demand deposits
	—			Income tax benefit (expense)
	—			Total, net of tax
Total reclassifications for the period	$	102		Total, net of tax

37

Component of Accumulated Other Comprehensive Income	Six months ended June 30, 2014			Affected Line Item in the Consolidated Statement of Income
Unrealized holding gains - investment securities available-for-sale	$	(565	)	Gain (loss) on sale of investment securities, net
	209			Income tax benefit (expense)
	(356		)	Total, net of tax
Unrealized holding gains – investment securities transferred from available-for-sale to held-to-maturity (1)	496			Interest income - investment securities
	(184		)	Income tax benefit (expense)
	312			Total, net of tax
Unrealized holding losses – cash flow hedge instruments	(457		)	Interest expense - demand deposits
	171			Income tax benefit (expense)
	(286		)	Total, net of tax
Total reclassifications for the period	$	(330	)	Total, net of tax

Component of Accumulated Other Comprehensive Income	Three months ended June 30, 2013			Affected Line Item in the Consolidated Statement of Income
Unrealized holding gains - investment securities available-for-sale	$	176		Gain (loss) on sale of investment securities, net
	(68		)	Income tax benefit (expense)
	108			Total, net of tax
Unrealized holding gains – investment securities transferred from available-for-sale to held-to-maturity (1)	148			Interest income - investment securities
	(57		)	Income tax benefit (expense)
	91			Total, net of tax
Unrealized holding losses – cash flow hedge instruments	(2,333		)	Interest expense - demand deposits
	899			Income tax benefit (expense)
	(1,434		)	Total, net of tax
Total reclassifications for the period	$	(1,235	)	Total, net of tax

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Component of Accumulated Other Comprehensive Income	Six months ended June 30, 2013			Affected Line Item in the Consolidated Statement of Income
Unrealized holding gains – investment securities available-for-sale	$	(52	)	Gain (loss) on sale of investment securities, net
	20			Income tax benefit (expense)
	(32		)	Total, net of tax
Unrealized holding gains – investment securities transferred from available-for-sale to held-to-maturity (1)	291			Interest income - investment securities
	(112		)	Income tax benefit (expense)
	179			Total, net of tax
Unrealized holding losses – cash flow hedge instruments	(4,538		)	Interest expense - demand deposits
	1,749			Income tax benefit (expense)
	(2,789		)	Total, net of tax
Total reclassifications for the period	$	(2,642	)	Total, net of tax

(1) The amortization of the unrealized holding gains in accumulated other comprehensive income at the date of transfer partially offsets the amortization of the difference between the par value and fair value of the investment securities at the date of transfer. Both components are amortized as an adjustment of yield.

NOTE 11 - FAIR VALUE MEASUREMENT

ASC Topic 820, Fair Value Measurements and Disclosures, establishes a framework for measuring fair value, establishes a three-level valuation hierarchy for disclosure of fair value measurement and enhances disclosure requirements for fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels of valuations are defined as follows:

Level 1 – Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2 – Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

Level 3 – Inputs to the valuation methodology are unobservable and significant to the fair value measurement, and require significant management judgment or estimation using pricing models, discounted cash flow methodologies or similar techniques.

Fair Value on a Recurring Basis – The Company measures certain assets at fair value on a recurring basis and the following is a general description of the methods used to value such assets.

Investment Securities Available-for-Sale – The fair value of a portion of our investment in equity securities available-for-sale is determined by observing quoted prices in an active market for identical securities. As such, the Company classifies these securities as Level 1 valuation. The fair value of the remainder of our investment securities available-for-sale are determined by a third-party pricing service. The valuations provided by the third-party pricing service are based on observable market inputs, which include benchmark yields, reported trades, issuer spreads, benchmark securities, bids, offers and reference data obtained from market research publications. The valuation of mortgage-backed securities also includes new issue data, monthly payment information and “To Be Announced” prices. The valuation of state and municipal securities also include the use of material event notices. We review the prices supplied by the independent pricing service, as well as their underlying pricing methodologies, for reasonableness. At least annually, we will validate prices supplied by the independent pricing service by comparing to prices obtained from a second third-party source. The Company classifies these investment securities as Level 2 valuation.

Derivative Assets and Liabilities – The values of derivative instruments held or issued by the Company for risk management purposes are traded in over-the-counter markets where quoted market prices are not readily available. For those derivatives, the Company measures fair value using models that use primarily market observable inputs, such as yield curves and option volatilities, and include the value associated with counterparty credit risk. The Company classifies derivative instruments as Level 2 valuation.

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The following tables present information about certain assets and liabilities measured at fair value on a recurring basis (dollars in thousands):

	Total Measured at Fair Value		Fair Value Measured Using
Description			Level 1		Level 2		Level 3
June 30, 2014
Assets:
Investment securities available-for-sale:
U.S. Government agencies	$	8,975	$	—	$	8,975	$	—
State and municipals	186,531		—		186,531		—
Corporate debt securities	8,995		—		8,995		—
Other debt securities	12,553		—		12,553		—
Equity securities	4,209		945		3,264		—
Mortgage-backed securities:
Residential government sponsored	30,572		—		30,572		—
Other government sponsored	4,450		—		4,450		—
Total investment securities available-for-sale	256,285		945		255,340		—
Derivative instruments:
Interest rate swap - cash flow hedge	173		—		173		—
Interest rate swap - not designated	592		—		592		—
Interest rate cap/floor - not designated	21		—		21		—
Total derivative instruments	786		—		786		—
Total assets measured at fair value on a recurring basis	$	257,071	$	945	$	256,126	$	—
Liabilities:
Interest rate swap - not designated	$	613	$	—	$	613	$	—
Total liabilities measured at fair value on a recurring basis	$	613	$	—	$	613	$	—

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	Total Measured at Fair Value		Fair Value Measured Using
Description			Level 1		Level 2		Level 3
December 31, 2013
Assets:
Investment securities available-for-sale:
U.S. Government agencies	$	15,061	$	—	$	15,061	$	—
State and municipals	191,263		—		191,263		—
Corporate debt securities	8,889		—		8,889		—
Other debt securities	4,380		—		4,380		—
Equity securities	922		922		—		—
Mortgage-backed securities:
Residential government sponsored	42,014		—		42,014		—
Other government sponsored	7,888		—		7,888		—
Total investment securities available-for-sale	270,417		922		269,495		—
Derivative instruments:
Interest rate swap - cash flow hedge	2,744		—		2,744		—
Interest rate cap - cash flow hedge	—		—		—		—
Interest rate swap - not designated	424		—		424		—
Interest rate cap/floor - not designated	98		—		98		—
Total derivative instruments	3,266		—		3,266		—
Total assets measured at fair value on a recurring basis	$	273,683	$	922	$	272,761	$	—
Liabilities:
Interest rate swap - not designated	$	522	$	—	$	522	$	—
Total liabilities measured at fair value on a recurring basis	$	522	$	—	$	522	$	—

Fair Value on a Nonrecurring Basis – The Company measures certain assets at fair value on a nonrecurring basis and the following is a general description of the methods used to value such assets.

Loans Held for Sale – Loans held for sale are carried at the lower of cost or market value. The fair value of loans held for sale is based on what secondary markets are currently offering for portfolios with similar characteristics. As such, the Company classifies loans subjected to nonrecurring fair value adjustments as Level 2 valuation.

Impaired Loans – The Company considers a loan impaired when it is probable that the Company will be unable to collect all amounts due according to the original contractual terms of the note agreement, including both principal and interest. Management has determined that nonaccrual loans and loans that have had their terms restructured in a troubled debt restructuring meet this impaired loan definition. For individually evaluated impaired loans, the amount of impairment is based upon the present value of expected future cash flows discounted at the loan’s effective interest rate or the estimated fair value of the underlying collateral for collateral-dependent loans, which the Company classifies as a Level 3 valuation.

Other Real Estate Owned – Other real estate owned is initially recorded at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral, which the Company classifies as a Level 3 valuation.

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The following tables present information about certain assets and liabilities measured at fair value on a nonrecurring basis (dollars in thousands):

	Total Measured at Fair Value		Fair Value Measured Using
Description			Level 1		Level 2		Level 3
June 30, 2014
Loans held for sale	$	23,714	$	—	$	23,714	$	—
Impaired loans	221,769		—		—		221,769
Other real estate owned	50,723		—		—		50,723
Total assets measured at fair value on a nonrecurring basis	$	296,206	$	—	$	23,714	$	272,492
December 31, 2013
Loans held for sale	$	30,899	$	—	$	30,899	$	—
Impaired loans	228,736		—		—		228,736
Other real estate owned	47,606		—		—		47,606
Total assets measured at fair value on a nonrecurring basis	$	307,241	$	—	$	30,899	$	276,342

The following table presents the valuation and unobservable inputs for Level 3 assets and liabilities measured at fair value on a nonrecurring basis at June 30, 2014 (dollars in thousands):

Description	Fair Value		Valuation Methodology	Unobservable Inputs	Range of Inputs
Impaired loans	$	221,769	Appraised value	Discount to reflect current market conditions and ultimate collectability	0% - 20%
Other real estate owned	$	50,723	Appraised value	Discount to reflect current market conditions	0% - 20%

Estimated fair values of financial instruments have been estimated by the Company using the provisions of ASC Topic 825, Financial Instruments (“ASC 825”), which requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques.

Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. ASC 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

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The following tables present the carrying value and estimated fair values of the Company’s financial instruments, including those that are not measured and reported at fair value on a recurring basis or nonrecurring basis (dollars in thousands):

June 30, 2014	Carrying Value		Fair Value		Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	136,810	$	136,810	$	136,810	$	—	$	—
Investment securities available-for-sale	256,285		256,285		945		255,340		—
Investment securities held-to-maturity	245,341		244,137		—		244,137		—
Federal Home Loan Bank stock	8,381		8,381		—		8,381		—
Loans held for sale	23,714		23,714		—		23,714		—
Loans receivable, net	2,640,170		2,622,745		—		2,400,976		221,769
Accrued interest receivable	13,806		13,806		—		13,806		—
FDIC indemnification asset	9,783		9,783		—		—		9,783
Investment in bank-owned life insurance	88,961		88,961		—		88,961		—
Interest rate swap derivative - cash flow hedge	173		173		—		173		—
Interest rate swap derivative - not designated	592		592		—		592		—
Interest rate cap/floor derivative - not designated	21		21		—		21		—
Financial liabilities:
Demand deposits and savings	$	1,969,079	$	1,969,079	$	—	$	1,969,079	$	—
Time deposits	1,155,569		1,159,151		—		1,159,151		—
Short-term borrowings	108,275		108,540		—		108,540		—
Long-term debt	101,174		97,382		—		97,382		—
Accrued interest payable	1,177		1,177		—		1,177		—
Interest rate swap derivative - not designated	613		613		—		613		—

December 31, 2013	Carrying Value		Fair Value		Level 1		Level 2		Level 3
Financial assets:
Cash and cash equivalents	$	108,390	$	108,390	$	108,390	$	—	$	—
Investment securities available-for-sale	270,417		270,417		922		269,495		—
Investment securities held-to-maturity	247,378		236,507		—		236,507		—
Federal Home Loan Bank stock	10,720		10,720		—		10,720		—
Loans held for sale	30,899		30,899		—		30,899		—
Loans receivable, net	2,243,642		2,266,455		—		2,037,719		228,736
Accrued interest receivable	12,955		12,955		—		12,955		—
FDIC indemnification asset	16,886		16,886		—		—		16,886
Investment in bank-owned life insurance	78,439		78,439		—		78,439		—
Interest rate swap derivative - cash flow hedge	2,744		2,744		—		2,744		—
Interest rate cap derivative - cash flow hedge	—		—		—		—		—
Interest rate swap derivative - not designated	424		424		—		424		—
Interest rate cap/floor derivative - not designated	98		98		—		98		—
Financial liabilities:
Demand deposits and savings	$	1,623,931	$	1,623,931	$	—	$	1,623,931	$	—
Time deposits	1,082,799		1,087,333		—		1,087,333		—
Short-term borrowings	125,592		126,126		—		126,126		—
Long-term debt	101,509		97,983		—		97,983		—
Accrued interest payable	1,434		1,434		—		1,434		—
Interest rate swap derivative - not designated	522		522		—		522		—

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The following methods and assumptions were used to estimate the fair value of financial instruments that have not been previously discussed:

Cash and cash equivalents - The carrying amounts reported in the balance sheets for cash and cash equivalents approximate the fair value of those assets.

Investment securities held-to-maturity - The fair value of our investment securities held-to-maturity are determined by a third-party pricing service. The valuations provided by the third-party pricing service for state and municipal securities are based on observable market inputs, which include benchmark yields, reported trades, issuer spreads, benchmark securities, bids, offers and the use of material event notices.

We review the prices supplied by the independent pricing service, as well as their underlying pricing methodologies, for reasonableness. At least annually, we will validate prices supplied by the independent pricing service by comparing to prices obtained from a second third-party source.

Federal Home Loan Bank stock - The fair value for FHLB stock is its carrying value, since this is the amount for which it could be redeemed. There is no active market for this stock and the Company, in order to be a member of the FHLB, is required to maintain a minimum investment.

Loans receivable, net - The fair values for loans are estimated using discounted cash flow analyses using interest rates currently being offered for loans with similar terms and credit ratings for the same remaining maturities, adjusted for the allowance for loan losses.

FDIC indemnification asset - The fair value for the FDIC indemnification asset is estimated based on discounted future cash flows using current discount rates.

Investment in bank-owned life insurance - The carrying value of life insurance approximates fair value because this investment is carried at cash surrender value, as determined by the insurer.

Accrued interest receivable and accrued interest payable - The carrying amount of accrued interest is assumed to approximate fair value.

Deposits - The fair values disclosed for deposits with no stated maturity (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for deposits with a stated maturity date (time deposits) are estimated using a discounted cash flow calculation that applies interest rates currently being offered on these accounts to a schedule of aggregated expected monthly maturities on time deposits.

Short-term borrowings - The carrying amount of short-term borrowings is assumed to approximate fair value.

Long-term debt – The fair value is estimated by discounting the future contractual cash flows using current market interest rates for similar debt over the same remaining term.

NOTE 12 – COMMITMENTS AND CONTINGENCIES

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, unfunded lines of credit, and standby letters of credit. These instruments involve elements of credit risk in excess of amounts recognized in the accompanying consolidated financial statements.

The Company's risk of loss in the event of nonperformance by the other party to the commitment to extend credit, lines of credit and standby letters of credit is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments under such instruments as it does for on-balance sheet instruments. The amount of collateral obtained, if any, is based on management's evaluation of the borrower. Collateral held varies, but may include accounts receivable, inventory, real estate and time deposits with financial institutions. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent cash requirements.

At June 30, 2014, the Company committed to invest up to $8.8 million, respectively, in limited partnership interests of unconsolidated entities, of which $5.9 million was unfunded at June 30, 2014.

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The following tables present the outstanding off-balance sheet financial instruments whose contract amounts represent potential credit risk (dollars in thousands):

	June 30, 2014		December 31, 2013
Commitments under unfunded loans and lines of credit	$	564,445	$	377,021
Letters of credit	6,674		7,926
Unused credit card lines	4,099		4,120
Unfunded commitments for unconsolidated investments	5,850		7,450

The Company is subject in the normal course of business to various pending and threatened legal proceedings in which claims for monetary damages are asserted. Management, after consultation with legal counsel, does not anticipate that the aggregate ultimate liability arising out of litigation pending or threatened against the Company will be material to the Company’s consolidated financial position. On an on-going basis the Company assesses any potential liabilities or contingencies in connection with such legal proceedings. For those matters where it is deemed probable that the Company will incur losses and the amount of the losses can be reasonably estimated, the Company would record an expense and corresponding liability in its consolidated financial statements.

As a result of the Company’s FDIC-assisted acquisition activity, the Company has pending litigation as a result of the Beach First and Blue Ridge acquisitions and could have potential litigation from the Carolina Federal acquisition. Any resulting losses from these proceedings would be covered by the terms of the FDIC’s loss-share indemnification agreement.

NOTE 13 – EMPLOYEE BENEFITS

The Compensation Committee of the Company's Board of Directors may grant or award eligible participants stock options, restricted stock, restricted stock units, stock appreciation rights, and other stock-based awards or any combination of awards (collectively referred to herein as “Rights”). At June 30, 2014, the Company had Rights outstanding from the 2006 BNC Bancorp Omnibus Stock Ownership and Long Term Incentive Plan (the "2006 Omnibus Plan"), the BNC Bancorp 2013 Omnibus Stock Incentive Plan (the "2013 Omnibus Plan") and the KeySource Non-Statutory and Incentive Stock Option plans (the "KeySource Plans"). At June 30, 2014, the 2013 Omnibus Plan and the KeySource Plans are the only plans that are available for future grants. At June 30, 2014, the Company had 323,967 Rights issued under the 2006 Omnibus Plan, 109,819 Rights issued and 1,350,722 Rights available for grants or awards under the 2013 Omnibus Plan, and 242,586 stock options issued and 35,607 stock options available for issuance related to the KeySource Plans.

Stock Option Awards. The fair value of each option award is estimated on the date of grant using the Black-Scholes-Merton option pricing model. The risk-free interest rate is based on the U.S. Treasury rate for the expected life at the time of grant. Volatility is based on the average volatility of the Company based upon previous trading history. The expected life and forfeiture assumptions are based on historical data. Dividend yield is based on the yield at the time of the option grant. There were no grants of options during the six months ended June 30, 2014.

A summary of the Company’s stock option activity for the six months ended June 30, 2014 is presented below (dollars in thousands, except per share data):

	Shares	Weighted Average Exercise Price per Share		Weighted Average Remaining Contractual Term (Years)	Aggregate Intrinsic Value
Outstanding at December 31, 2013	412,337	$	11.34
Exercised	41,633	11.00
Forfeited or expired	—	—
Outstanding at June 30, 2014	370,704	$	11.38	2.61	2,110
Exercisable at June 30, 2014	369,280	$	11.38	2.59	2,099
Share options expected to vest	1,424	$	9.67	5.77	11

The related compensation expense recognized for stock options was immaterial for the six months ended June 30, 2014 and 2013, respectively. At June 30, 2014, there was an immaterial amount of total unrecognized compensation cost related to non-vested stock options granted under the plans. That cost is expected to be recognized over a weighted average period of 0.86 years.

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Restricted Stock Awards. A summary of the activity of the Company’s unvested restricted stock awards for the six months ended June 30, 2014 is presented below:

	Number of Shares		Weighted Average Grant-Date Fair Value
Unvested at December 31, 2013	303,396		$	9.58
Granted	80,603		17.26
Vested	(76,331	)	11.05
Forfeited	(2,000	)	15.23
Unvested at June 30, 2014	305,668		$	11.20

The Company measures the fair value of restricted shares based on the price of the Company's common stock on the grant date, and compensation expense is recorded over the vesting period. The related compensation expense recognized for restricted stock awards for the six months ended June 30, 2014 and 2013 was $0.9 million and $0.4 million, respectively. As of June 30, 2014, there was $2.6 million of total unrecognized compensation cost related to unvested restricted stock granted under the plans. That cost is expected to be recognized over a weighted average period of 1.35 years. The grant-date fair value of restricted stock grants vested during the six months ended June 30, 2014 was $0.8 million.

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

Throughout this Quarterly Report on Form 10-Q, “the Company,” “we,” “us,” or “our” refers to BNC Bancorp and our consolidated subsidiaries, including Bank of North Carolina (sometimes referred to as “BNC” as a separate legal entity), except where the context indicates otherwise.

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, regarding the financial condition, results of operations, business plans and the future performance of the Company that are based on the beliefs and assumptions of the management and the information available to management at the time that these disclosures were prepared. Words such as “anticipates,” “believes,” “estimates,” “expects,” “forecasts,” “intends,” “plans,” “projects,” “may,” “will,” “should,” and other similar expressions are intended to identify these forward-looking statements. Such statements are subject to factors that could cause actual results to differ materially from anticipated results. Such factors include, but are not limited to, the following:

l the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, as amended, and other reforms will subject us to a variety of new and more stringent legal and regulatory requirements, including increased scrutiny from our regulators;

l changes in local, regional and international business, economic or political conditions in the regions where we operate or have significant assets;

l changes in trade, monetary and fiscal policies of various governmental bodies and central banks could affect the economic environment in which we operate;

l adverse changes in credit quality trends;

l our ability to determine accurate values of certain assets and liabilities;

l adverse behaviors in securities, public debt, and capital markets, including changes in market liquidity and volatility;

l our ability to anticipate interest rate changes correctly and manage interest rate risk presented through unanticipated changes in our interest rate risk position and/or short- and long-term interest rates;

l unanticipated changes in our liquidity position, including but not limited to our ability to enter the financial markets to manage and respond to any changes to our liquidity position;

l adequacy of our risk management program;

l increased competitive pressure due to consolidation;

l unanticipated adverse effects and integration costs of acquisitions and dispositions of assets, business units or affiliates;

l our failure to realize anticipated benefits of our acquisitions or to realize the benefits within the existing time frame; or

l our ability to integrate acquisitions and retain existing customers and attract new ones.

Management’s discussion and analysis is intended to assist readers in understanding and evaluating our consolidated financial condition and results of operations. This discussion should be read in conjunction with our consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2013.

Critical Accounting Policies

We prepare our consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amount of revenues and expenses during the reporting period. The more critical accounting and reporting policies include accounting for the allowance for loan losses, valuation of goodwill and intangible assets, and valuation of assets acquired and liabilities assumed in business combinations. Accordingly, the Company’s critical accounting policies are discussed in detail in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s Annual Report on Form

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10-K for the year ended December 31, 2013. The Company’s significant accounting policies are discussed in detail in Note 1 in the “Notes to Consolidated Financial Statements” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013. There have been no changes to the Company’s significant accounting policies during 2014. Additional disclosures regarding the effects of new accounting pronouncements are included in Note 1 “Basis of Presentation” included herein.

Overview and Executive Summary

BNC Bancorp (the "Company") was formed in 2002 to serve as a one-bank holding company for Bank of North Carolina ("BNC"), a full service commercial bank, incorporated under the laws of the State of North Carolina. Our primary sources of revenue are interest and fee income from our lending and investing activities, primarily consisting of making business loans for small to medium-sized businesses, and, to a lesser extent, from our investment portfolio. We provide a wide range of banking services tailored to the particular banking needs of the communities we serve. We are principally engaged in the business of attracting deposits from the general public and using those deposits, together with other funding from our lines of credit, to make primarily consumer and commercial loans. We target business professionals and small to mid-size business customers with credit relationships in the $250,000 to $25 million range through our 48 branches located in North and South Carolina.

Net income for the quarter ended June 30, 2014 was $6.1 million, or $0.21 per diluted share, an increase of 48.3% from net income available to common shareholders of $4.1 million, or $0.16 per diluted share, for the quarter ended June 30, 2013.

Net income available to common shareholders for the six months ended June 30, 2014 was $12.6 million, or $0.45 per diluted share, an increase of 60.0% from net income available to common shareholders of $7.9 million, or $0.30 per diluted share, for the six months ended June 30, 2013.

Two important and commonly used measures of bank profitability are return on average assets (net income as a percentage of average total assets) and return on average common shareholders’ equity (net income available to common shareholders as a percentage of average common shareholders’ equity). Our return on average assets was 0.69% and 0.57% for the three months ended June 30, 2014 and 2013, respectively. Our return on average common shareholders’ equity was 7.31% and 6.49% for the three months ended June 30, 2014 and 2013, respectively. For the six months ended June 30, 2014, our return on average assets was 0.76%, as compared to 0.54% for the comparable period of 2013. For the six months ended June 30, 2014, our return on average common shareholders’ equity was 8.30%, as compared to 6.31% for the six months ended June 30, 2013.

Total assets at June 30, 2014 were $3.68 billion, an increase of 14.0% as compared to total assets of $3.23 billion at December 31, 2013.

During the second quarter of 2014, the Company completed the previously announced acquisitions of South Street Financial Corporation in Albermarle, North Carolina (“South Street”) and Community First Financial Group, Inc. in Chapel Hill, North Carolina (“Community First”), respectively. The acquisition of South Street closed on April 1, 2014 and the acquisition of Community First was completed on June 1, 2014. The Company added seven branches as a result of these acquisitions.

In addition, during the second quarter of 2014, the Company signed an Agreement and Plan of Merger with Harbor Bank Group, Inc., the holding company for Harbor National Bank, which has approximately $306 million is assets and would expand the Company’s presence in the attractive Charleston and Mount Pleasant, South Carolina areas.

Analysis of Results of Operations

Net Interest Income

Fully-taxable equivalent (“FTE”) net interest income for the second quarter of 2014 was $35.8 million, an increase of 27.8% from $28.0 million for the second quarter of 2013. FTE net interest margin was 4.54% for the second quarter of 2014, an increase of 22 basis points from 4.32% for the second quarter of 2013.

FTE net interest income for the six months ended June 30, 2014 was $68.5 million, an increase of 23.5% from $55.5 million for the six months ended June 30, 2013. FTE net interest margin was 4.57% for the six months ended June 30, 2014, an increase of 31 basis points from 4.26% for the comparable period of 2013.

Average interest-earning assets were $3.17 billion for the second quarter of 2014, an increase of 21.6% from $2.60 billion for the second quarter of 2013. Average interest-earning assets were $3.02 billion for the six months ended June 30, 2014, an increase of 15.1% from $2.63 billion for the first six months of 2013. The increase was due to interest-earning assets acquired from Randolph Bank & Trust ("Randolph") during the fourth quarter of 2013, as well as the assets acquired from South Street and Community First during the second quarter of 2014. The Company has also experienced significant levels of organic loan growth, particularly from our home equity line of credit campaign and commercial loan growth in the large metropolitan areas in which we do business.

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The Company’s average yield on interest-earning assets was 5.14% for the second quarter of 2014, a decrease of 31 basis points from 5.45% for the second quarter of 2013. The Company’s average yield on interest-earning assets was 5.22% for the six months ended June 30, 2014, a decrease of 17 basis points from 5.39% for the comparable period of 2013. The decrease from 2013 was primarily due to a reduction in loan accretion from our acquired loan portfolio. Loan accretion decreased by $0.7 million, or 18.6%, for the second quarter of 2014, as compared to the second quarter of 2013. For the six months ended June 30, 2014, loan accretion decreased by $0.6 million, or 8.0%, as compared to the six months ended June 30, 2013.

Average interest-bearing liabilities were $2.78 billion for the second quarter of 2014, an increase of 17.8% from $2.36 billion for the second quarter of 2013. The increase was due to an additional $450.4 million of average interest-bearing deposits, primarily from the acquisitions of Randolph, South Street and Community First. Average interest-bearing liabilities were $2.67 billion for the six months ended June 30, 2014, an increase of 11.7% from $2.39 billion for the six months ended June 30, 2013. The increase was due to an additional $271.5 million of average interest-bearing deposits, primarily from the acquisition of Randolph, South Street and Community First.

The Company’s average cost of interest-bearing liabilities was 0.68% for the second quarter of 2014, a decrease of 57 basis points from 1.25% for the second quarter of 2013. For the six months ended June 30, 2014, the average cost of interest-bearing liabilities was 0.74%, a decrease of 50 basis points from the comparable period of 2013. The decrease was primarily due to the elimination of hedging expense during the first quarter of 2014, due to the expiration of the interest rate cap. The Company incurred hedging instrument expense of $2.3 million and $4.5 million for the three and six months ended June 30, 2013, respectively, as compared to $0 and $0.2 million, respectively, for the same periods in 2014. The Company also continues to allow higher rate time deposits to expire and be replaced with lower cost funding.

The following tables set forth the major components of net interest income and the related annualized yields and rates for the three and six months ended June 30, 2014 and 2013, as well as the variances between the periods caused by changes in interest rates versus changes in volumes (dollars in thousands):

Table 1

Average Balance and Net Interest Income (FTE)

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	For the Three Months Ended June 30,
	2014						2013
	Average balance		Interest		Average Rate		Average balance		Interest		Average rate
Interest-earning assets:
Loans and leases (1)	$	2,553,931	$	33,866	5.32	%	$	2,038,918	$	29,299	5.76	%
Loans held for sale	18,558		179		3.87	%	37,303		319		3.43	%
Investment securities, taxable	124,346		1,190		3.84	%	132,556		1,047		3.17	%
Investment securities, tax-exempt (2)	371,875		5,215		5.62	%	340,745		4,644		5.47	%
Interest-earning balances and other	97,155		113		0.47	%	54,753		84		0.62	%
Total interest-earning assets	3,165,865		40,563		5.14	%	2,604,275		35,393		5.45	%
Other assets	374,893						311,929
Total assets	$	3,540,758					$	2,916,204
Interest-bearing liabilities:
Demand deposits	$	1,318,644	$	1,169	0.36	%	$	1,072,871	$	3,499	1.31	%
Savings deposits	139,153		67		0.19	%	77,341		40		0.21	%
Time deposits	1,163,864		2,424		0.84	%	1,021,098		2,785		1.09	%
Borrowings	158,288		1,072		2.72	%	189,308		1,040		2.20	%
Total interest-bearing liabilities	2,779,949		4,732		0.68	%	2,360,618		7,364		1.25	%
Non-interest-bearing deposits	402,105						272,088
Other liabilities	22,407						19,297
Shareholders' equity	336,297						264,201
Total liabilities and shareholder's equity	$	3,540,758					$	2,916,204
Net interest income and
interest rate spread			$	35,831	4.46	%			$	28,029	4.20	%
Net interest margin					4.54	%					4.32	%

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	For the Six Months Ended June 30,
	2014						2013
	Average balance		Interest		Average Rate		Average balance		Interest		Average rate
Interest-earning assets:
Loans and leases (1)	$	2,421,944	$	64,831	5.40	%	$	2,038,304	$	58,061	5.74	%
Loans held for sale	18,647		329		3.56	%	41,583		698		3.38	%
Investment securities, taxable	124,307		2,276		3.69	%	136,077		2,086		3.09	%
Investment securities, tax-exempt (2)	378,636		10,594		5.64	%	331,496		9,165		5.58	%
Interest-earning balances and other	79,963		241		0.61	%	79,665		207		0.52	%
Total interest-earning assets	3,023,497		78,271		5.22	%	2,627,125		70,217		5.39	%
Other assets	338,736						321,126
Total assets	$	3,362,233					$	2,948,251
Interest-bearing liabilities:
Demand deposits	$	1,269,349	$	2,670	0.42	%	$	1,082,747	$	7,038	1.31	%
Savings deposits	121,583		116		0.19	%	80,656		101		0.25	%
Time deposits	1,112,862		4,812		0.87	%	1,068,863		5,937		1.12	%
Borrowings	161,874		2,138		2.66	%	155,092		1,651		2.15	%
Total interest-bearing liabilities	2,665,668		9,736		0.74	%	2,387,358		14,727		1.24	%
Non-interest-bearing deposits	368,945						267,480
Other liabilities	20,939						18,180
Shareholders' equity	306,681						275,233
Total liabilities and shareholder's equity	$	3,362,233					$	2,948,251
Net interest income and
interest rate spread			$	68,535	4.48	%			$	55,490	4.15	%
Net interest margin					4.57	%					4.26	%

(1) Average outstanding balances are net of deferred costs and unearned discounts and include nonaccrual loans.

(2) Yields on tax-exempt investments have been adjusted to a fully taxable-equivalent basis. The taxable-equivalent adjustment was $1.9 million and $1.7 million for the three months ended June 30, 2014 and 2013, respectively. The taxable-equivalent adjustment was $3.9 million and $3.4 million for the six months ended June 30, 2014 and 2013, respectively.

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Table 2

Volume and Rate Variance Analysis

	Three Months Ended									Six Months Ended
	June 30, 2014 vs. 2013									June 30, 2014 vs. 2013
	Increase (decrease) due to									Increase (decrease) due to
	Volume			Rate			Total			Volume			Rate			Total
Interest income:
Loans and leases	$	7,115		$	(2,548	)	$	4,567		$	10,599		$	(3,829	)	$	6,770
Loans held for sale	(171		)	31			(140		)	(395		)	26			(369		)
Investment securities, taxable	(72		)	215			143			(198		)	388			190
Investment securities, tax-exempt (1)	430			141			571			1,311			118			1,429
Interest-earning balances and other	57			(28		)	29			1			33			34
Total interest income	7,359			(2,189		)	5,170			11,318			(3,264		)	8,054
Interest expense:
Deposits:
Demand deposits	510			(2,840		)	(2,330		)	803			(5,171		)	(4,368		)
Savings deposits	31			(4		)	27			45			(30		)	15
Time deposits	343			(704		)	(361		)	217			(1,342		)	(1,125		)
Borrowings	(190		)	222			32			81			406			487
Total interest expense	694			(3,326		)	(2,632		)	1,146			(6,137		)	(4,991		)
Net interest income increase	$	6,665		$	1,137		$	7,802		$	10,172		$	2,873		$	13,045

(1) Interest income on tax-exempt investments has been adjusted to a fully taxable-equivalent basis.

Provision for Loan Losses

During the second quarter of 2014, the Company recorded a provision for loan losses of $2.1 million, a decrease of 6.5% from $2.3 million recorded during the second quarter of 2013.

The Company recorded a provision for loan losses of $4.7 million for the six months ended June 30, 2014, a decrease of 26.6% from $6.4 million recorded during the comparable period of 2013. The provision for loan losses recorded during 2014 was for loans not covered under loss-share agreements.

Provisions for loan losses are charged to income to bring the allowance for loan losses to a level deemed appropriate by management. In evaluating the allowance for loan losses, management considers factors that include growth, composition and industry diversification of the portfolio, historical loan loss experience, current delinquency levels, adverse situations that may affect a borrower's ability to repay, estimated value of any underlying collateral, prevailing economic conditions and other relevant factors. See additional discussion under section “Analysis of Allowance for Loan Losses.”

Non-Interest Income

Non-interest income was $5.8 million for the second quarter of 2014, an increase of 3.6% from $5.6 million for the second quarter of 2013. The following table presents the components of non-interest income for the three and six months ended June 30, 2014 and 2013 (dollars in thousands):

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Table 3

Non-Interest Income

	Three Months Ended June 30,				Six Months Ended June 30,
	2014		2013		2014			2013
Mortgage fees	$	1,954	$	2,480	$	3,512		$	4,861
Service charges	1,478		1,034		2,826			1,960
Earnings on bank-owned life insurance	609		542		1,189			1,101
Gain (loss) on sale of investment securities, net	—		176		(565		)	(52		)
Other	1,764		1,370		3,968			3,934
Total non-interest income	$	5,805	$	5,602	$	10,930		$	11,804

Adjusted non-interest income was $5.8 million for the second quarter of 2014, an increase of 7.0% from $5.4 million for the second quarter of 2013. Adjusted non-interest income excludes acquisition-related gains, one-time income arising from insurance settlements and gain (loss) on sale of investment securities. As compared to the second quarter of 2013, non-interest income was positively impacted by a 42.9% increase in service charge income and a 67.6% increase on income derived from the sale of SBA loans. These increases were partially offset by a 21.2% decrease in mortgage fee income.

Non-interest income was $10.9 million for the six months ended June 30, 2014, a decrease of 7.4% from $11.8 million for the comparable period of 2013. Adjusted non-interest income was $10.7 million for the six months ended June 30, 2014, a decrease of 3.7% from $11.1 million for the first six months of 2013. During the first six months of 2014, the Company recorded $0.7 million of amortization of the FDIC loss-share receivable due to lower loss projections for the loans covered under loss-share agreements. Non-interest income was also adversely impacted by a slowdown in mortgage production, as mortgage income decreased by 27.8%. These declines were primarily offset by a 44.2% increase in service charge income and a 44.6% increase in income derived from sales of SBA loans.

Non-Interest Expense

Non-interest expense was $29.5 million for the three months ended June 30, 2014, an increase of 24.2% from $23.8 million for the second quarter of 2013. The following table presents the components of non-interest expense for the three and six months ended June 30, 2014 and 2013 (dollars in thousands):

Table 4

Non-Interest Expense

	Three Months Ended June 30,				Six Months Ended June 30,
	2014		2013		2014		2013
Salaries and employee benefits	$	15,312	$	12,728	$	29,021	$	25,533
Occupancy	2,062		1,507		4,141		3,190
Furniture and equipment	1,570		1,260		3,168		2,639
Data processing and supplies	1,065		720		1,969		1,443
Advertising and business development	685		610		1,374		1,197
Insurance, professional and other services	3,300		1,457		4,808		2,915
FDIC insurance assessments	706		780		1,411		1,446
Loan, foreclosure and other real estate owned	2,359		2,876		3,721		4,894
Other	2,453		1,821		4,670		3,618
Total non-interest expense	$	29,512	$	23,759	$	54,283	$	46,875

As a result of the Company's recent acquisitions, the Company incurred $3.6 million and $4.4 million in transaction-related expenses during the three and six months ended June 30, 2014, respectively. During the three and six months ended June 30, 2013, the Company incurred $0.3 million and $1.3 million, respectively, in transaction-related expenses. Transaction-related expenses include legal and professional fees, personnel costs, data processing expenses, and other miscellaneous expenses directly attributable to acquisition activity. Excluding transaction-related costs, adjusted non-interest expense for the second quarter of 2014 was $25.9 million, an increase of 10.5% from $23.5 million for the second quarter of 2013. The increase in adjusted non-interest expense from 2013 was due to the increased headcount and facilities caused by our acquisitions of South Street, Community First and Randolph, as well as overall growth in our Company.

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In evaluating our business and performance, we utilize adjusted non-interest income, which excludes income derived from sources that are not deemed as core business operations. We also utilize adjusted non-interest expense, which excludes transaction-related expenses directly associated with our acquisitions. These adjusted amounts are considered non-GAAP financial measures. We believe the use of these non-GAAP financial measures provides additional clarity in assessing our results. See the following table for the reconciliation of these non-GAAP financial measures with financial measures defined by GAAP for the three and six months ended June 30, 2014 and 2013 (dollars in thousands):

Table 5

Reconciliation of Non-GAAP Measures

	Three Months Ended June 30,				Six Months Ended June 30,
Adjusted Non-interest Income	2014		2013		2014			2013
Non-interest income (GAAP)	$	5,805	$	5,602	$	10,930		$	11,804
Less: Loss on sale of investment securities	—		176		(565		)	(52		)
Insurance settlement	—		—		768			—
Acquisition-related gain	—		—		—			719
Adjusted non-interest income (non-GAAP)	$	5,805	$	5,426	$	10,727		$	11,137

	Three Months Ended June 30,				Six Months Ended June 30,
Adjusted Non-interest Expense	2014		2013		2014		2013
Non-interest expense (GAAP)	$	29,512	$	23,759	$	54,283	$	46,875
Less: Transaction-related expenses	3,601		309		4,398		1,344
Adjusted non-interest expense (non-GAAP)	$	25,911	$	23,450	$	49,885	$	45,531

Income Taxes

Our income tax expense was $1.9 million and $1.2 million for the three months ended June 30, 2014 and 2013, respectively. For the six months ended June 30, 2014, our income tax expense was $3.9 million, compared to income tax expense of $1.7 million for the comparable period of 2013. The increase in income tax is a direct result of our increase in taxable income due to Company growth and acquisitions.

We generate significant amounts of non-taxable income from tax-exempt investment securities and from investments in bank-owned life insurance. Accordingly, the level of such income in relation to income before income taxes significantly affects our effective tax rate. Due to an increase in our level of taxable income relative to non-taxable income, our effective tax rate for the three months ended June 30, 2014 increased to 23.9%, as opposed to an effective tax rate of 20.4% for the three months ended June 30, 2013. Our effective tax rate for the six months ended June 30, 2014 increased to 23.8%, compared to 15.8% for the six months ended June 30, 2013.

Analysis of Financial Condition

Investment Securities

Our investment securities portfolio is intended to provide us with adequate liquidity, flexibility in asset/liability management, a source of stable income, and is structured with minimum credit exposure. Total carrying value of the Company's investment securities portfolio was $494.3 million at June 30, 2014, a decrease of 5.1% from total investment securities of $520.9 million at December 31, 2013. The vast majority of securities in the portfolio are bank-qualified taxable and tax-exempt debt instruments issued by various U.S. states, counties, cities, municipalities and school districts. We also maintain portfolios of securities consisting of CMOs issued or guaranteed by U.S. government agencies, as well as mortgage-backed securities issued or guaranteed by U.S. government agencies and corporate debt securities. Our investment securities portfolio is comprised of high quality securities that are designed to enhance liquidity while providing acceptable rates of return.

We continually evaluate our investment securities portfolio in response to established asset/liability management objectives, changing market conditions that could affect profitability, and the level of interest rate risk to which we are exposed. These evaluations may cause us to change the level of funds we deploy into investment securities, change the composition of our investment securities portfolio, and change the proportion of investments made into the available-for-sale and held-to-maturity investment categories.

Net unrealized gains in our investment securities portfolio were $6.1 million as of June 30, 2014, as compared to a net unrealized loss of $14.0 million as of December 31, 2013. This decrease in our gross unrealized loss positions was primarily due to market interest rates declining during 2014.

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At June 30, 2014, our investment securities portfolio included 323 taxable and tax-exempt debt instruments issued by various U.S. states, counties, cities, municipalities and school districts. The following table is a summary, by U.S. state, of our investment in the obligations of state and political subdivisions at June 30, 2014 (dollars in thousands):

Table 6

Obligations of State and Political Subdivisions

		Amortized Cost		Fair Value
General obligation bonds:
	Texas	$	121,468	$	123,835
	Washington	29,468		29,663
	Ohio	19,486		20,236
	California	16,334		16,777
	North Carolina	13,919		13,837
	Pennsylvania	12,936		13,372
	Kansas	10,005		10,314
	Other (21 states)	59,170		60,003
Total general obligation bonds:		282,786		288,037
Revenue bonds:
	North Carolina	35,119		35,236
	Indiana	13,979		14,463
	South Carolina	12,428		12,303
	Florida	11,503		11,644
	Other (13 states)	40,555		40,596
Total revenue bonds:		113,584		114,242
Total obligations of state and political subdivisions		$	396,370	$	402,279

Our largest exposure in general obligation bonds was 64 bonds issued by various school districts in Texas with a total amortized cost basis of $87.5 million and total fair value of $89.6 million at June 30, 2014. Of this total, $71.7 million in amortized cost and $73.2 million in fair value are guaranteed by the Permanent School Fund of the State of Texas.

The revenue sources related to our investment in revenue bonds at June 30, 2014 are summarized in the following table (dollars in thousands):

Table 7

Revenue Bonds by Source

	Amortized Cost		Fair Value
Water and sewer	$	21,652	$	22,032
Health, hospitality and nursing home	20,400		20,637
College and university	19,647		19,765
Power and electricity	12,716		12,436
Lease (abatement)	7,058		7,573
Other	32,111		31,799
Total revenue bonds	$	113,584	$	114,242

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Our largest individual exposures we had in revenue bonds at June 30, 2014 were three bonds issued by the South Carolina Public Service Authority to be repaid by future pledged power and utility revenue, and seven bonds issued by the North Carolina Medical Care Commission to be repaid by future pledged revenues generated from a leading academic healthcare system. The total amortized cost for these 10 securities was $18.9 million and the total fair value was $18.6 million at June 30, 2014.

Currently, our investments in state and political subdivisions are investment grade with all having a credit rating of either A+ or higher from Standard & Poors or A3 or higher by Moody’s. Investments in state and political subdivisions are subject to an initial pre-purchase credit assessment and ongoing monitoring. The factors considered in this analysis include capacity to pay, market and economic data, soundness of budgetary position, sources, strength, and stability of tax or enterprise revenue, review of the credit rating, as provided by one or more nationally recognized credit ratings agencies, as well as any other factors as are available and relevant to the security or issuer.  While we do not place sole reliance on the credit rating of the security, no investment in a state or political subdivision is considered for purchase unless it has an investment grade credit rating by one or more nationally recognized credit ratings agencies.  We perform additional detailed risk analysis should any security be downgraded below investment grade to determine if the security should be retained or sold.  This risk analysis includes, but is not limited to, discussions with third party municipal credit analysts and review of any changes that may affect the credit worthiness of the issuer and its ability to make timely principal and interest payments.

Our evaluation of investments in state and political subdivisions at June 30, 2014 did not uncover any facts or circumstances resulting in significantly different credit ratings than those assigned by a nationally recognized credit rating agency.

Loans

The following table presents the composition of our loan portfolio (dollars in thousands):

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Table 8

Loan Portfolio Composition

	June 30, 2014				December 31, 2013
	Amount		% of Total Loans		Amount		% of Total Loans
Originated:
Commercial real estate	$	1,101,695	41.3	%	$	1,014,633	44.6	%
Commercial construction	197,872		7.4	%	202,140		8.9	%
Commercial and industrial	134,113		5.0	%	139,567		6.1	%
Leases	16,701		0.6	%	16,137		0.7	%
Residential construction	34,121		1.3	%	29,636		1.3	%
Residential mortgage	369,818		13.8	%	294,660		12.9	%
Consumer and other	10,704		0.4	%	8,103		0.4	%
Total non-covered	1,865,024		69.8	%	1,704,876		74.9	%
Acquired (non-covered):
Commercial real estate	259,794		9.7	%	221,571		9.7	%
Commercial construction	36,432		1.4	%	24,089		1.0	%
Commercial and industrial	31,916		1.2	%	23,453		1.0	%
Residential construction	8,316		0.3	%	2,782		0.1	%
Residential mortgage	305,178		11.4	%	108,239		4.8	%
Consumer and other	4,743		0.2	%	3,846		0.2	%
Total acquired (non-covered)	646,379		24.2	%	383,980		16.8	%
Acquired (covered):
Commercial real estate	83,638		3.1	%	96,452		4.2	%
Commercial construction	11,238		0.4	%	18,331		0.8	%
Commercial and industrial	4,523		0.2	%	5,919		0.3	%
Residential construction	—		0.0	%	16		0.0	%
Residential mortgage	57,841		2.2	%	65,024		2.9	%
Consumer and other	1,656		0.1	%	1,919		0.1	%
Total acquired (covered)	158,896		6.0	%	187,661		8.3	%
Total portfolio loans	$	2,670,299	100.0	%	$	2,276,517	100.0	%

Total portfolio loans were $2.67 billion at June 30, 2014, an increase of 17.3% from 2.28 billion at December 31, 2013. Our originated loan portfolio increased by $160.1 million, or 9.4%, to $1.87 billion as of June 30, 2014, as compared to $1.70 billion at December 31, 2013. The largest drivers of the increase in the originated loan portfolio were commercial real estate loans, which includes new loan production and the completion of commercial constructions that were delayed due to weather issues experienced in the first quarter of 2014. Increases in our commercial real estate portfolio continue to be in retail centers, primarily anchored and pre-leased, and hotels across our geographic footprint. The Company implemented a home equity line of credit campaign in November 2013, which has led to over $89 million of net borrowings for the six months ended June 30, 2014 that were directly related to the campaign.

Our acquired loan portfolio was $805.3 million at June 30, 2014, an increase of 40.9% from $571.6 million at December 31, 2013. Acquired loans that are covered under loss-share agreements totaled $158.9 million at June 30, 2014, a decrease of 15.3% from $187.7 million at December 31, 2013. The increase in the acquired loans not covered by loss share is due to the $303 million in loans acquired from South Street and Community First.

Our loan policies and procedures establish the basic guidelines governing our lending operations. Generally, the guidelines address the types of loans that we seek, target markets, underwriting and collateral requirements, terms, interest rate and yield considerations and compliance with laws and regulations. All loans or credit lines are subject to approval procedures and amount limitations. These limitations apply to the borrower's total outstanding indebtedness to us, including the indebtedness of any guarantor. The policies are reviewed and approved at least annually by senior management or Loan Committee. We supplement our own supervision of the loan underwriting and

57

approval process with periodic loan audits by internal loan examiners experienced in loan review work. We have focused our portfolio lending activities on experienced and successful commercial real estate investors that have access to multiple sources of funding.

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Deposits

We provide a range of deposit services, including non-interest 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. Total deposits at June 30, 2014 were $3.12 billion, an increase of 15.4% from total deposits of $2.71 billion as of December 31, 2013. Wholesale deposits were 25.7% of total deposits at June 30, 2014, a decrease compared to 32.8% as of December 31, 2013. Transactional accounts, which are comprised of non-interest bearing and interest-bearing demand accounts, increased 21.3% during 2014 and have increased 37.8% over the past twelve months. At June 30, 2014, time deposits were 37.0% of total deposits, compared to 40.0% at December 31, 2013.

Asset Quality

Nonperforming assets, which consist of nonaccrual loans, loans 90 days or more past due and other real estate owned (“OREO”), were 2.34% of total assets at June 30, 2014, compared to 2.74% at December 31, 2013. Excluding assets covered under loss-share agreements, nonperforming assets were 1.64% of total assets as of June 30, 2014, compared to 1.52% at December 31, 2013. The following table summarizes total nonperforming assets for the past five quarters (dollars in thousands):

Table 9

Nonperforming Assets

	June 30, 2014			March 31, 2014			December 31, 2013			September 30, 2013			June 30, 2013
Nonaccrual loans:
Not covered by loss-share agreements	$	18,845		$	14,240		$	17,114		$	21,262		$	22,276
Covered by loss-share agreements	15,921			20,803			23,745			29,892			44,317
90 days or more past due:
Not covered by loss-share agreements	738			—			—			83			823
Covered by loss-share agreements	—			—			—			1			—
Other real estate owned:
Not covered by loss-share agreements	38,092			29,157			28,833			29,271			29,143
Covered by loss-share agreements	12,631			15,749			18,773			18,401			17,668
Total nonperforming assets	$	86,227		$	79,949		$	88,465		$	98,910		$	114,227
Total nonperforming assets not covered by loss-share agreements	$	57,675		$	43,397		$	45,947		$	50,616		$	52,242
Total nonperforming assets to total assets	2.34		%	2.49		%	2.74		%	3.33		%	3.90		%
Total nonperforming assets to total assets (not covered by loss-share agreements)	1.64		%	1.44		%	1.52		%	1.84		%	1.94		%
Total nonperforming loans to total portfolio loans	1.33		%	1.52		%	1.79		%	2.44		%	3.29		%
Total nonperforming loans to total portfolio loans (not covered by loss-share agreements)	0.78		%	0.67		%	0.82		%	1.12		%	1.26		%
Troubled debt restructurings not included in above	$	14,948		$	17,924		$	16,770		$	13,802		$	12,639

Our consolidated financial statements are prepared on the accrual basis of accounting, including the recognition of interest income on loans, unless we place a loan on nonaccrual basis. We account for loans on a nonaccrual basis when we have serious doubts about the ability to collect principal or interest in full. Loans are generally classified as nonaccrual if they are past due as to maturity or payment of principal or interest for a period of more than ninety (90) days, unless such loans are well-secured and in the process of collection. Amounts received on nonaccrual loans generally are applied first to principal and then to interest only after all principal has been collected.

As noted in the table above, nonaccrual loans not covered by loss-share agreements have increased by $1.7 million, or 10.1%, between December 31, 2013 and June 30, 2014. The Company acquired approximately $2.0 million, at fair value, of non-accrual loans as part of the acquisitions of South Street and Community First.

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As noted above, OREO at June 30, 2014 totaled $50.7 million, which is an increase of 6.5% from $47.6 million at December 31, 2013. This increase was primarily due to the acquisition of $9.7 million of OREO in the purchases of South Street and Community First.

The following is a summary of OREO (dollars in thousands):

Table 10

Other Real Estate Owned

	June 30, 2014		December 31, 2013
Covered under loss-share agreements:
Residential 1-4 family properties	$	3,163	$	8,578
Multifamily properties	—		22
Commercial properties	2,297		4,035
Construction, land development and other land	7,171		6,138
	12,631		18,773
Not covered under loss-share agreements:
Residential 1-4 family properties	3,779		2,202
Multifamily properties	218		—
Commercial properties	7,641		7,584
Construction, land development and other land	26,454		19,047
	38,092		28,833
Total other real estate owned	$	50,723	$	47,606

Allowance for Loan Losses

The allowance for loan losses was $30.1 million at June 30, 2014, a decrease of 8.4% from $32.9 million at December 31, 2013. This decrease was primarily due to a decrease in the allowance for loans covered under loss-share agreements, which was $4.2 million as of June 30, 2014, a decrease of $1.7 million from an allowance of $5.9 million as of December 31, 2013. The decrease in the allowance for loans covered under loss-share agreements was a direct result of the continued reduction in loans covered under loss-share agreements. The allowance for loans not covered by loss-share agreements was $25.9 million as of June 30, 2014, a decrease of $1.1 million from the allowance recorded as of December 31, 2013. Loan loss reserves for originated loans to total originated loans were 1.37% and 1.57% at June 30, 2014 and December 31, 2013, respectively.

While management considers the allowance for loan losses to be adequate based on information currently available, future additions to the allowance may be necessary due to changes in economic conditions or management’s assumptions as to future delinquencies, recoveries and losses. In addition, various regulatory agencies periodically review our loan losses and loan loss reserve methodology and there can be no assurances that the regulatory agencies will not require management to recognize additions to the allowance for loan losses based on their judgments about all relevant information utilized in the methodologies.

The Company incurred $2.5 million in net charge-off losses, which represented 0.39% of average loans, for the second quarter of 2014, compared to net charge-off losses of $4.0 million, or 0.78% of average loans, for the second quarter of 2013. Net charge-off losses decreased during the second quarter of 2014 due to a number of significant recoveries of previously charged-off loans, primarily for loans covered under loss-share agreements.

The Company incurred $6.1 million in net charge-off losses, which represented 0.51% of average loans, for the six months ended June 30, 2014, compared to net charge-off losses of $8.6 million, or 0.85% of average loans, for the six months ended June 30, 2013. Our largest source of charge-offs for loans not covered under loss-share agreements have been in acquisition and development loans for residential real estate.

The following table presents information related to the allowance for loan losses for the three and six months ended June 30, 2014 and 2013 (dollars in thousands):

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Table 11

Analysis of Allowance for Loan Losses

	Three Months Ended June 30,						Six Months Ended June 30,
	2014			2013			2014			2013
Beginning balance	$	30,880		$	38,148		$	32,875		$	40,292
Provision for credit losses:
Non-covered loans	2,355			2,350			4,916			6,000
Covered loans	(215		)	(62		)	(215		)	403
Change in FDIC indemnification asset	(864		)	(226		)	(805		)	1,687
Net recoveries (charge-offs) on loans covered under loss-share	539			(4,254		)	(695		)	(8,713		)
Charge-offs on loans not covered under loss-share:
Commercial real estate	(284		)	(98		)	(1,090		)	(518		)
Commercial construction	(1,239		)	(3,038		)	(2,508		)	(4,394		)
Commercial and industrial	(491		)	(237		)	(1,335		)	(1,513		)
Leases	—			—			—			—
Residential construction	—			—			—			—
Residential mortgage	(1,040		)	(601		)	(1,868		)	(1,393		)
Consumer and other	(67		)	(165		)	(103		)	(176		)
Total charge-offs	(3,121		)	(4,139		)	(6,904		)	(7,994		)
Recoveries on loans not covered under loss-share:
Commercial real estate	77			295			207			299
Commercial construction	49			535			255			553
Commercial and industrial	138			171			166			246
Leases	—			—			—			—
Residential construction	3			14			6			18
Residential mortgage	278			24			307			62
Consumer and other	10			3			16			6
Total recoveries	555			1,042			957			1,184
Net charge-offs on loans not covered under loss-share	(2,566		)	(3,097		)	(5,947		)	(6,810		)
Ending balance	$	30,129		$	32,859		$	30,129		$	32,859

The allowance for loan losses represents management's estimate of an amount adequate to provide for known and inherent losses in the loan portfolio in the normal course of business. We make specific allowances that are allocated to certain individual loans and pools of loans based on risk characteristics, as discussed below. While management believes that it uses the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary and results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making the determinations.

Capital Resources

At June 30, 2014, shareholders’ equity was $326.8 million, an increase of 20.5% from shareholders’ equity of $271.3 million as of December 31, 2013. The increase in shareholders’ equity is primarily due to the issuance of 2.3 million shares of common stock during the second quarter of 2014 related to the acquisitions of South Street and Community First.

We are subject to various regulatory capital requirements administered by the federal banking agencies. Capital adequacy guidelines and the regulatory framework for prompt corrective action prescribe specific capital guidelines that involve quantitative measures of our assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. Our capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. We use our capital primarily for our lending activities as well as acquisitions and expansions of our business and other operating requirements. As of June 30, 2014 and December 31, 2013, we exceeded all regulatory capital requirements to be considered “well capitalized” as such terms are defined in applicable regulations.

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Our capital adequacy ratios are set forth below:

Table 12

Capital Adequacy Ratios

	"Well Capitalized" minimum		June 30, 2014		December 31, 2013
BNC Bancorp:
Total capital (to risk weighted assets)	10.00	%	10.27	%	11.57	%
Tier 1 capital (to risk weighted assets)	6.00	%	9.22	%	10.33	%
Tier 1 capital (to average assets)	5.00	%	7.62	%	8.12	%
Bank of North Carolina:
Total capital (to risk weighted assets)	10.00	%	11.18	%	12.66	%
Tier 1 capital (to risk weighted assets)	6.00	%	10.13	%	11.41	%
Tier 1 capital (to average assets)	5.00	%	8.43	%	8.96	%

Liquidity

Market and public confidence in our financial strength and in the strength of financial institutions in general will largely determine our access to appropriate levels of liquidity. This confidence is significantly dependent on our ability to maintain sound asset quality and appropriate levels of capital resources.

Liquidity is defined as our ability to meet anticipated customer demands for funds under credit commitments and deposit withdrawals at a reasonable cost and on a timely basis, pay operating expenses, and meet regulatory liquidity requirements. Management measures our liquidity position by giving consideration to both on- and off-balance sheet sources of, and demands for, funds on a daily and weekly basis.

Sources of liquidity include cash and cash equivalents, net of federal requirements to maintain reserves against deposit liabilities, investment securities eligible for pledging to secure borrowings from dealers and customers pursuant to securities sold under repurchase agreements; investments available for sale; loan repayments; loan sales; deposits, both from our local markets and the wholesale markets; borrowings from the FHLB and Federal Reserve discount window; and borrowings from correspondent banks under unsecured overnight federal funds credit lines and secured lines of credit. We are also provided liquidity through various interest-bearing and non-interest bearing deposit accounts.

Our cash liquidity position, which includes cash and cash equivalents and investment securities, was $638.4 million at June 30, 2014, compared to $626.2 million at December 31, 2013. Supplementing customer deposits as a source of funding, we have the ability to borrow up to $466.5 million from the FHLB of Atlanta, with $118.1 million outstanding at June 30, 2014. We also have the ability to borrow from the Federal Reserve Discount Window in the amount of $177.3 million, with no outstanding balance at June 30, 2014. These amounts are based on assets currently pledged. In addition, we may purchase federal funds through unsecured federal funds guidance lines of credit totaling $65.0 million, with no outstanding balance at June 30, 2014.

We believe that our combined aggregate liquidity position is sufficient to meet the funding requirements of loan demand and deposit maturities and withdrawals in the near term.

Contractual Obligations

Refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2013 for discussion with respect to the Company’s contractual obligations. Additional disclosures about the Company’s contractual obligations are included in Note 9 “Borrowings” in the “Notes to Consolidated Financial Statements.”

Off-Balance Sheet Arrangements

In the ordinary course of business, we enter into various types of transactions that include commitments to extend credit that are not included in loans receivable, net, presented on our consolidated balance sheets. We apply the same credit standards to these commitments as we use in all our lending activities and have included these commitments in our lending risk evaluations. Our exposure to credit loss

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under commitments to extend credit is represented by the amount of these commitments. We do not expect that all such commitments will fund. See Note 12 to the accompanying Consolidated Financial Statements in Item 1 of Part I of this report.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

As described in more detail in Part II, Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2013, asset/liability management involves the evaluation, monitoring and management of interest rate risk, liquidity and funding. While the Board of Directors has overall responsibility for the Company’s asset/liability management policies, BNC’s Asset and Liability Committee monitors loan, investment, and liability portfolios to ensure comprehensive management of interest rate risk and adherence to the Bank’s policies. The Company has not experienced any material change in the risk of its portfolios of interest-earning assets and interest-bearing liabilities from December 31, 2013 to June 30, 2014.

Item 4. Controls and Procedures

As of the end of the period covered by this quarterly report, our management, together with the participation of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), conducted an evaluation of the effectiveness of our disclosure controls and procedures in accordance with Rule 13a-15 under the Securities Exchange Act of 1934 as amended (the “Exchange Act”). Based on the evaluation of our disclosure controls and procedures as of the end of the period covered by this quarterly report, our CEO and CFO concluded that, as of such date, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is (a) accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure, and (b) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

There were no changes in our internal control over financial reporting that occurred during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

Refer to Note 12 “Commitments and Contingencies” in the “Notes to Consolidated Financial Statements”.

Item 1A. Risk Factors

In addition to the other information set forth in this report and in our other reports and statements that we file with the SEC, including our quarterly reports on Form 10-Q, careful consideration should be given to the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2013, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3. Defaults Upon Senior Securities

None

Item 4. Mine Safety Disclosures

Not Applicable

Item 5. Other Information

None

Item 6. Exhibits

The exhibits listed in the accompanying exhibit index are filed as part of this quarterly report.

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SIGNATURES

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

BNC BANCORP

Date: August 11, 2014	By: /s/ Richard D. Callicutt II
	Richard D. Callicutt II
	President and Chief Executive Officer

Date: August 11, 2014	By: /s/ David B. Spencer
	David B. Spencer
	Senior Executive Vice President and Chief Financial Officer (Principal Financial Officer)

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EXHIBIT INDEX

Exhibit No.	Description
2.1	Agreement and Plan of Merger by and between Harbor Bank Group, Inc., and BNC Bancorp dated as of June 4, 2014 (incorporated by reference from Exhibit 2.1 to the registrant's Form 8-K filed on June 5, 2014).
31.1	Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32	Certification of the Chief Executive Officer and the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101	The following financial information from our Quarterly Report on Form 10-Q for the quarter ended June 30, 2014, filed on August 11, 2014, formatted in XBRL (eXtensible Business Reporting Language) includes:  (i) the Consolidated Balance Sheets at June 30, 2014 and December 31, 2013, (ii) the Consolidated Statements of Income for the three and six months ended June 30, 2014 and 2013, (iii) the Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2014 and 2013, (iv) the Consolidated Statements of Shareholders’ Equity for the six months ended June 30, 2014 and 2013, (v) the Consolidated Statements of Cash Flows for the six months ended June 30, 2014 and 2013, and (vi) Notes to Consolidated Financial Statements, tagged as blocks of text and in detail.

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