Paragon Commercial 10Q 2017 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2017

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

For the transition period from to .

Commission file number: 001-37802

PARAGON COMMERCIAL CORPORATION

(Exact name of registrant as specified in its charter)

North Carolina	56-2278662
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

3535 Glenwood Avenue Raleigh, North Carolina	27612
(Address of principal executive offices)	(Zip Code)

(919) 788-7770

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§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 ☒ NO ☐

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

Large Accelerated Filer	☐	Accelerated Filer	☐
Non-accelerated Filer (Do not check if smaller reporting company)	☑	Smaller Reporting Company	☐
Emerging Growth Company	☑

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

Indicate by check mark whether registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ☐ NO ☒

APPLICABLE ONLY TO CORPORATE ISSUERS:

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

As of November 9, 2017, there were approximately 5,460,447 shares of the registrant’s common stock outstanding.

PARAGON COMMERCIAL CORPORATION

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2017

TABLE OF CONTENTS

			Page No.

Part I. FINANCIAL INFORMATION

Item 1. Financial Statements			3

Consolidated Balance Sheets (Unaudited) as of September 30, 2017 and December 31, 2016			3

Consolidated Statements of Income (Unaudited) for the Three and Nine Months Ended September 30, 2017 and 2016			4

Consolidated Statements of Comprehensive Income (Unaudited) for the Three and Nine Months Ended September 30, 2017 and 2016			5

Consolidated Statements of Changes in Stockholders' Equity (Unaudited) for the Nine Months Ended September 30, 2017 and 2016			6

Consolidated Statements of Cash Flows (Unaudited) for the Nine Months Ended September 30, 2017 and 2016			7

Notes to Consolidated Financial Statements (Unaudited)			8

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			33

Item 3. Quantitative and Qualitative Disclosures About Market Risk			59

Item 4. Controls and Procedures			60

PART II. OTHER INFORMATION

Item 1. Legal Proceedings			61

Item 1A. Risk Factors			61

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			63

Item 3. Defaults Upon Senior Securities			63

Item 4. Mine Safety Disclosures			63

Item 5. Other Information			63

Item 6. Exhibits			63

SIGNATURES			64

Part I. Financial Information

Item 1. Financial Statements

PARAGON COMMERCIAL CORPORATION AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS (Unaudited)

September 30, 2017 and December 31, 2016

(Balance Sheet as of December 31, 2016 is derived from Audited Financial Statements)

(In thousands, except share data)	2017	2016
Assets
Cash and due from banks:
Interest-earning	$79,445	$38,384
Noninterest-earning	3,983	4,621
Investment securities - available-for-sale, at fair value	197,159	197,441
Federal Home Loan Bank stock, at cost	12,403	8,400
Loans - net of unearned income and deferred fees	1,389,987	1,191,280
Allowance for loan losses	(9,402)	(7,909)
Net loans	1,380,585	1,183,371
Accrued interest receivable	4,840	4,368
Bank premises and equipment, net	15,296	15,642
Bank owned life insurance	34,961	34,190
Other real estate owned	3,399	4,740
Deferred tax assets	4,270	4,841
Other assets	7,584	7,769
Total assets	$1,743,925	$1,503,767

Liabilities and stockholders' equity
Deposits:
Noninterest-bearing demand	$253,511	$211,202
Interest-bearing checking and money market	865,355	742,046
Time deposits	169,277	219,007
Total deposits	1,288,143	1,172,255
Repurchase agreements and federal funds purchased	21,064	20,174
Federal Home Loan Bank advances	260,000	150,000
Subordinated debentures	18,558	18,558
Other liabilities	7,107	6,679
Total liabilities	1,594,872	1,367,666
Stockholders' equity:
Common stock, $0.008 par value; 20,000,000 shares	44	44
authorized; 5,459,982 and 5,450,713 issued and
outstanding as of September 30, 2017 and December 31, 2016
Additional paid-in-capital	80,822	80,147
Accumulated other comprehensive loss	(1,372)	(2,840)
Retained earnings	69,559	58,750
Total stockholders' equity	149,053	136,101
Total liabilities and stockholders' equity	$1,743,925	$1,503,767

See accompanying notes to these unaudited consolidated financial statements.

PARAGON COMMERCIAL CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

For the Three and Nine Months Ended September 30, 2017 and 2016

	Three months		Nine months
	ended September 30,		ended September 30,
(In thousands, except per share data)	2017	2016	2017	2016
Interest income
Loans and fees on loans	$15,241	$12,544	$42,325	$35,574
Investment securities and FHLB stock	1,501	1,214	4,369	3,802
Federal funds and other	73	97	303	218
Total Interest income	16,815	13,855	46,997	39,594
Interest expense
Interest-bearing checking and money market	1,125	966	3,326	2,659
Time deposits	472	588	1,441	1,711
Borrowings and repurchase agreements	1,376	534	3,051	1,605
Total interest expense	2,973	2,088	7,818	5,975
Net interest income	13,842	11,767	39,179	33,619
Provision for loan losses	405	391	1,214	391
Net interest income after provision for loan losses	13,437	11,376	37,965	33,228
Non-interest income
Increase in cash surrender value of bank owned life insurance	258	220	771	669
Net gain on sale of securities	-	-	-	85
Service charges and fees	75	65	205	179
Mortgage origination fees and gains on sale of loans	6	59	83	124
Net loss on sale or impairment of foreclosed assets	(311)	-	(311)	(257)
Other fees and income	246	94	523	285
Total non-interest income	274	438	1,271	1,085
Non-interest expense
Salaries and employee benefits	4,265	3,912	13,037	11,521
Furniture, equipment and software costs	418	456	1,371	1,450
Occupancy	390	362	1,122	1,048
Data processing	547	270	1,657	845
Director related fees and expenses	226	219	703	690
Professional fees	149	208	596	627
FDIC and other supervisory assessments	176	220	543	632
Advertising and public relations	228	239	746	661
Unreimbursed loan costs and foreclosure related expenses	214	172	492	383
Merger related costs	98	-	466	-
Other	663	720	2,110	2,009
Total non-interest expense	7,374	6,778	22,843	19,866
Income before income taxes	6,337	5,036	16,393	14,447
Income tax expense	2,165	1,581	5,584	4,679
Net income	$4,172	$3,455	$10,809	$9,768

Net income per common share
Basic	$0.77	$0.64	$2.00	$2.02

Diluted	$0.77	$0.64	$2.00	$2.00

See accompanying notes to these unaudited consolidated financial statements.

PARAGON COMMERCIAL CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE

INCOME (Unaudited)

Three and Nine Months Ended September 30, 2017 and 2016

	Three months		Nine months
	ended September 30,		ended September 30,
(In thousands)	2017	2016	2017	2016

Net income	$4,172	$3,455	$10,809	$9,768

Other comprehensive income items:
Securities available for sale:
Unrealized gains (losses)	(1,123)	(1,058)	1,766	2,856
Reclassification of gains recognized in net income	-	-	-	(85)
Other comprehensive income (loss)	(1,123)	(1,058)	1,766	2,771
Deferred tax expense (benefit)	(427)	(405)	685	1,057
Other comprehensive income (loss), net of tax	(696)	(653)	1,081	1,714

Cash flow hedges:
Unrealized gains (losses)	287	544	638	(1,592)
Other comprehensive income (loss)	287	544	638	(1,592)
Deferred tax (benefit) expense	104	204	251	(599)
Other comprehensive income (loss), net of tax	183	340	387	(993)

Total other comprehensive income (loss), net of tax	(513)	(313)	1,468	721

Comprehensive income	$3,659	$3,142	$12,277	$10,489

See accompanying notes to these unaudited consolidated financial statements.

PARAGON COMMERCIAL CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (Unaudited)

Nine Months Ended September 30, 2017 and 2016

				Accumulated
			Additional	Other		Total
	Common Stock		Paid-in	Comprehensive	Retained	Stockholders'
(In thousands, except share data)	Shares	Amount	Capital	Income (Loss)	Earnings	Equity
Balance at December 31, 2016	5,450,713	$44	$80,147	$(2,840)	$58,750	$136,101

Net income	-	-	-	-	10,809	10,809
Unrealized gain on securities, net of
tax expense of $685	-	-	-	1,081	-	1,081
Unrealized gain on cash flow hedges,
net of tax expense of $251	-	-	-	387	-	387
Restricted stock expense recognized	-	-	341	-	-	341
Stock options exercised	6,313	-	270	-	-	270
Issuance of stock for employee stock
purchase plan	2,956	-	64	-	-	64
Balance at September 30, 2017	5,459,982	$44	$80,822	$(1,372)	$69,559	$149,053

				Accumulated
			Additional	Other		Total
	Common Stock		Paid-in	Comprehensive	Retained	Stockholders'
(In thousands, except share data)	Shares	Amount	Capital	Income (Loss)	Earnings	Equity
Balance at December 31, 2015	4,581,334	$37	$53,147	$(886)	$45,360	$97,658

Net income	-	-	-	-	9,768	9,768
Unrealized gain on securities, net of
tax expense of $1,057	-	-	-	1,714	-	1,714
Unrealized loss on cash flow hedges,
net of tax benefit of $599	-	-	-	(993)	-	(993)
Restricted stock expense recognized	-	-	319	-	-	319
Issuance of stock for public offering	845,588	6	26,392	-	-	26,398
Issuance of restricted stock awards	17,793	1	-	-	-	1
Issuance of stock for employee stock
purchase plan	5,327	-	157	-	-	157
Balance at September 30, 2016	5,450,042	$44	$80,015	$(165)	$55,128	$135,022

See accompanying notes to these unaudited consolidated financial statements.

PARAGON COMMERCIAL CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

Nine Months Ended September 30, 2017 and 2016

(In thousands)	2017	2016
Cash flows from operating activities:
Net income	$10,809	$9,768
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization	1,008	1,072
Provision for loan losses	1,214	391
Net loss on sale or impairment of foreclosed assets	311	257
Increase in cash surrender value of life insurance	(771)	(669)
Accretion of premiums/discounts on securities, net	858	567
Net gain on sale of securities	-	(85)
Gain on disposal of property and equipment	(1)	-
Deferred tax expense (benefit)	(365)	299
Restricted stock expense	341	319
Changes in assets and liabilities:
Accrued interest receivable and other assets	351	(1,317)
Accrued interest payable and other liabilities	428	(70)
Net cash provided by operating activities	14,183	10,532
Cash flows from investing activities:
Net (increase) decrease in Federal Home Loan Bank stock	(4,003)	2,636
Purchase of securities available for sale	(13,526)	(39,434)
Proceeds from maturities and paydowns of securities available for sale	14,716	16,299
Proceeds from sales of securities available for sale	-	15,714
Net increase in loans	(198,428)	(149,296)
Proceeds from sale of foreclosed real estate	1,030	13
Proceeds from sale of property and equipment	1
Additions to bank premises and equipment	(662)	(497)
Net cash used in investing activities	(200,872)	(154,565)
Cash flows from financing activities:
Net increase in demand and money market deposit accounts	165,618	292,456
Net decrease in time deposits	(49,730)	(76,218)
Net increase (decrease) in repurchase agreements	890	(10,784)
Net increase (decrease) in FHLB and other borrowings	110,000	(69,800)
Net proceeds from sale of common stock	-	26,398
Issuance of common stock for employee stock purchase
plan and exercise of stock options	334	157
Net cash provided by financing activities	227,112	162,209
Net change in cash and cash equivalents	40,423	18,176
Cash and cash equivalents at beginning of year	43,005	55,530

Cash and cash equivalents at end of year	$83,428	$73,706

See accompanying notes to these unaudited consolidated financial statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 1 - ORGANIZATION AND OPERATIONS

On April 2, 2001, Paragon Commercial Corporation (the “Company”) was incorporated for the purpose of serving as a holding company for Paragon Commercial Bank (the “Bank”). The Company currently has no operations and conducts no business on its own other than owning the Bank and two statutory business trusts, Paragon Commercial Capital Trust I and II.

The Bank was incorporated on May 4, 1999 and began banking operations on May 10, 1999. The Bank is engaged in general commercial banking in Wake and Mecklenburg Counties, North Carolina, operating under the banking laws of North Carolina and the rules and regulations of the Federal Deposit Insurance Corporation and the North Carolina Commissioner of Banks. The Bank undergoes periodic examinations by those regulatory authorities. In addition, the Company undergoes periodic examinations by the Federal Reserve.

The Company formed Paragon Commercial Capital Trust I (“Trust I”) during 2004 in order to facilitate the issuance of trust preferred securities. Trust I is a statutory business trust formed under the laws of the state of Delaware, of which all common securities are owned by the Company. The Company formed Paragon Commercial Capital Trust II (“Trust II”) during 2006 to serve the same purpose. The junior subordinated debentures issued by the Company to the trusts are classified as debt and the Company’s equity interest in the trusts are included in other assets.

The trust preferred securities presently qualify as Tier 1 regulatory capital and are reported in Federal Reserve regulatory reports as minority interests in unconsolidated subsidiaries. The junior subordinated debentures do not qualify as Tier 1 regulatory capital.

In June 2016, the Company completed its initial public offering in which it issued and sold 845,588 shares of common stock at a public offering price of $34.00 per share. The Company received net proceeds of $26.4 million after deducting underwriting discounts and commissions of approximately $1.7 million and other offering expenses of approximately $615,000.

In addition to its headquarters and operations center in Raleigh, North Carolina, the Bank has locations in Charlotte and Cary, North Carolina.

NOTE 2 – BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements include the accounts and transactions of Paragon Commercial Corporation and Paragon Commercial Bank. All significant intercompany transactions and balances are eliminated in consolidation. Paragon Commercial Capital Trusts I and II are not consolidated subsidiaries of the Company.

The consolidated financial information included herein as of and for the three and nine month periods ended September 30, 2017 and 2016 is unaudited. Accordingly, it does not include all of the information and footnotes required by U.S. generally accepted auditing principals (“GAAP”) for complete financial statements. However, such information reflects all adjustments which are, in the opinion of management, necessary for a fair statement of the financial condition and results of operations for the interim periods. The December 31, 2016 consolidated balance sheet was derived from the Company’s December 31, 2016 audited consolidated financial statements as of and for the periods ended December 31, 2016. These unaudited interim consolidated financial statements as of and for the three and nine month periods ended September 30, 2017 and 2016 should be read in conjunction with the audited consolidated financial statements as of and for the periods ended December 31, 2016 included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016 filed with the Securities and Exchange Commission on March 21, 2017, as amended on April 28, 2017. The results of operations for the three and nine months ended September 30, 2017 are not necessarily indicative of the results to be expected for the full year ending December 31, 2017 or any other future period.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The accounting policies followed by the Company and other relevant information is contained in the notes to the audited consolidated financial statements as of and for the periods ended December 31, 2016, which are included within the Company’s Annual Report on Form 10-K as of and for the year ended December 31, 2016.

Earnings Per Common Share

Basic and diluted net income per common share have been computed by dividing net income for each period by the weighted average number of shares of common stock outstanding during each period. Diluted net income per common share reflects the potential dilution that could occur if outstanding stock options were exercised.

Basic and diluted net income per common share have been computed based upon net income as presented in the accompanying unaudited consolidated statements of income divided by the weighted average number of common shares outstanding or assumed to be outstanding as summarized below:

	Three months		Nine months
	ended September 30,		ended September 30,
	2017	2016	2017	2016
Shares used in the computation of earnings per share:
Weighted average number of shares outstanding - basic	5,410,029	5,406,867	5,399,978	4,846,574
Dilutive effect of restricted shares	11,359	32,729	10,975	35,867
Weighted average number of shares outstanding - diluted	5,421,388	5,439,596	5,410,953	4,882,441

Weighted average anti-dilutive stock options and unvested restricted shares excluded from the computation of diluted earnings per share are as follows:

	Three months		Nine months
	ended September 30,		ended September 30,
	2017	2016	2017	2016
Anti-dilutive stock options	-	80,500	-	80,500
Unvested restricted shares	36,030	38,445	36,030	38,445

Comprehensive Income

The Company reports as comprehensive income all changes in stockholders' equity during the year from sources other than stockholders. Other comprehensive income refers to all components (revenues, expenses, gains, and losses) of comprehensive income that are excluded from net income.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The Company’s only two components of other comprehensive income are unrealized gains and losses on investment securities available-for-sale, net of income taxes and unrealized gains and losses on cash flow hedges, net of income taxes. Information concerning the Company’s accumulated other comprehensive income for the nine-month period ended September 30, 2017 and for the year ended December 31, 2016, respectively is as follows:

	September 30,	December 31,
(In thousands)	2017	2016
Unrealized losses on securities available-for-sale	$(9)	$(1,775)
Deferred tax (benefit) expense	(7)	678
Other comprehensive loss, net of tax	(16)	(1,097)
Unrealized losses on cash flow hedges	(2,154)	(2,792)
Deferred tax benefit	798	1,049
Other comprehensive loss, net of tax	(1,356)	(1,743)
Total other comprehensive loss	$(1,372)	$(2,840)

The accumulated balances related to each component of other comprehensive income (loss) are as follows:

		Unpaid
	Unrealized	Unrealized
	Gains and	Gains and
	Losses on	Losses on
	Available-for	Cash Flow
	Sale Securities	Hedges	Total
Balance as of December 31, 2016	$(1,097)	$(1,743)	$(2,840)
Other comprehensive income before reclassification	1,081	387	1,468
Net current-period other comprehensive income	1,081	387	1,468
Balance as of September 30, 2017	$(16)	$(1,356)	$(1,372)

Balance as of December 31, 2015	$848	$(1,734)	$(886)
Other comprehensive income (loss) before reclassification	1,799	(993)	806
Amounts reclassified from accumulated other
comprehensive income	(85)	-	(85)
Net current-period other comprehensive income (loss)	1,714	(993)	721
Balance as of September 30, 2016	$2,562	$(2,727)	$(165)

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (the “FASB”) issued guidance to change the recognition of revenue from contracts with customers. The core principle of the new guidance is that an entity should recognize revenue to reflect the transfer of goods and services to customers in an amount equal to the consideration the entity receives or expects to receive. The guidance will be effective for the Company for reporting periods beginning after December 15, 2017. The Company will apply the guidance using a modified retrospective approach. The Company does not expect these amendments to have a material effect on its financial statements.

In January 2016, the FASB amended the Financial Instruments topic of the Accounting Standards Codification (“ASC”) to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The amendments will be effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company will apply the guidance by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amendments related to equity securities without readily determinable fair values will be applied prospectively to equity investments that exist as of the date of adoption of the amendments. The Company does not expect these amendments to have a material effect on its financial statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

In February 2016, the FASB amended the Leases topic of the ASC to revise certain aspects of recognition, measurement, presentation, and disclosure of leasing transactions. The amendments will be effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently evaluating the effect that implementation of the new standard will have on its financial statements.

In March 2016, the FASB amended the Derivatives and Hedging topic of the ASC to clarify that a change in the counterparty to a derivative instrument that has been designated as the hedging instrument does not, in and of itself, require designation of that hedging relationship provided that all other hedge accounting criteria continue to be met. The amendments became effective January 1, 2017. The amendments did not have a material effect on the Company’s financial statements.

In March 2016, the FASB amended the Revenue from Contracts with Customers topic of the ASC to clarify the implementation guidance on principal versus agent considerations and address how an entity should assess whether it is the principal or the agent in contracts that include three or more parties. The amendments will be effective for the Company for reporting periods beginning after December 15, 2017. The Company does not expect these amendments to have a material effect on its financial statements.

In March 2016, the FASB issued guidance to simplify several aspects of the accounting for share-based payment award transactions including the income tax consequences, the classification of awards as either equity or liabilities, and the classification on the statement of cash flows. Additionally, the guidance simplifies two areas specific to entities other than public business entities allowing them apply a practical expedient to estimate the expected term for all awards with performance or service conditions that have certain characteristics and also allowing them to make a one-time election to switch from measuring all liability-classified awards at fair value to measuring them at intrinsic value. The amendments became effective as of January 1, 2017. The amendments did not have a material effect on the Company’s financial statements.

In June 2016, the FASB issued guidance to change the accounting for credit losses and modify the impairment model for certain debt securities. The amendments will be effective for the Company for reporting periods beginning after December 15, 2019. The Company is currently evaluating the effect that implementation of the new standard will have on its financial position, results of operations, and cash flows.

In August 2016, the FASB amended the Statement of Cash Flows topic of the ASC to clarify how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments will be effective for the Company for fiscal years beginning after December 15, 2017 including interim periods within those fiscal years. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

In December 2016, the FASB issued technical corrections and improvements to the Revenue from Contracts with Customers Topic. These corrections make a limited number of revisions to several pieces of the revenue recognition standard issued in 2014. The effective date and transition requirements for the technical corrections will be effective for the Company for reporting periods beginning after December 15, 2017. The Company will apply the guidance using a modified retrospective approach. The Company does not expect these amendments to have a material effect on its financial statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

In March 2017, the FASB amended the requirements in the Receivables—Nonrefundable Fees and Other Costs Topic of the ASC related to the amortization period for certain purchased callable debt securities held at a premium. The amendments shorten the amortization period for the premium to the earliest call date. The amendments will be effective for the Company for interim and annual periods beginning after December 15, 2018. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

In May 2017, the FASB amended the requirements in the Compensation—Stock Compensation Topic of the ASC related to changes to the terms or conditions of a share-based payment award. The amendments provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. The amendments will be effective for the Company for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. The Company does not expect these amendments to have a material effect on its financial statements.

In August 2017, the FASB issued ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities, which amends the hedge accounting recognition and presentation requirements in ASC 815, Derivatives and Hedging. The FASB’s objectives in issuing the ASU are to (1) improve the transparency and understandability of information conveyed to financial statement users about an entity’s risk management activities by better aligning the entity’s financial reporting for hedging relationships with those risk management activities and (2) reduce the complexity of and simplify the application of hedge accounting by preparers. Specifically, the guidance is designed to:

●

Create better alignment of hedge accounting with risk management activities

●

Eliminate the separate measurement and recording of hedge ineffectiveness

●

Provide improvements to presentation and disclosure

●

Simplify effectiveness assessments

●

Provide some relief to private companies by aligning the timing of effectiveness testing with the timing of the issuance of financial statements.

The amendments will be effective for Company for interim and annual periods beginning after December 15, 2018, and interim periods therein. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

Reclassifications

Certain amounts in the 2016 financial statements have been reclassified to conform to the 2017 presentation. The reclassifications had no effect on total assets, net income or stockholders' equity as previously reported.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 3 – MERGERS AND ACQUISITIONS

Proposed Merger with TowneBank

On April 26, 2017, the Company entered into an Agreement and Plan of Reorganization (the “Merger Agreement”) with TowneBank and TB Acquisition, LLC (“TB Acquisition”). Pursuant to the terms of the Merger Agreement, the Company will merge with and into TB Acquisition (the “Merger”) and the Bank will subsequently merge with and into TowneBank (the “Bank Merger” and, together with the Merger, the “Transaction”). TB Acquisition will be the surviving entity in the Merger and TowneBank will be the surviving entity in the Bank Merger.

Under the terms of the Merger Agreement, the Company’s stockholders will be entitled to receive 1.7250 shares (the “Exchange Ratio”) of TowneBank common stock for each share of the Company’s common stock. Based on TowneBank’ s closing price of $34.35 as of April 26, 2017, the day the Transaction was announced, the estimated aggregate purchase price was $323.4 million. The Transaction is expected to close in the first quarter of 2018, subject to stockholder and regulatory approval and other customary closing conditions.

NOTE 4 - INVESTMENT SECURITIES

The following is a summary of the securities portfolio by major classification at September

30, 2017 and December 31, 2016.

		Gross	Gross	Estimated
	Amortized	Unrealized	Unrealized	Fair
(In thousands)	Cost	Gains	Losses	Value
September 30, 2017
Available-for-sale:
U.S. Agency obligations	$15,153	$125	$58	$15,220
Collateralized mortgage obligations	38,729	219	185	38,763
Mortgage-backed securities	73,290	264	925	72,629
Municipal bonds	66,320	1,318	67	67,571
Other	3,676	50	750	2,976
	$197,168	$1,976	$1,985	$197,159

December 31, 2016
Available-for-sale:
U.S. Agency obligations	$17,062	$44	$163	$16,943
Collateralized mortgage obligations	42,439	300	242	42,497
Mortgage-backed securities	75,138	213	1,478	73,873
Municipal bonds	60,901	474	698	60,677
Other	3,676	29	254	3,451
	$199,216	$1,060	$2,835	$197,441

The fair values of securities available-for-sale at September 30, 2017 by contractual maturity are shown below. Actual expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

		After One	After Five		No Stated
	Within	But Within	But Within	After	Maturity
(In thousands)	1 Year	Five Years	Ten Years	Ten Years	Date	Total
U.S. Agency obligations	$-	$-	$-	$15,220	$-	$15,220
Collateralized mortgage obligations	-	-	-	38,763	-	38,763
Mortgage-backed securities	-	7,448	7,199	57,982	-	72,629
Municipal bonds	-	2,893	8,810	55,868	-	67,571
Other	-	-	1,513	-	1,463	2,976
	$-	$10,341	$17,522	$167,833	$1,463	$197,159

The following tables show 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 at September 30, 2017 and December 31, 2016.

	Less Than 12 Months		12 Months or Greater		Total
(In thousands)		Unrealized		Unrealized		Unrealized
September 30, 2017	Fair Value	Losses	Fair Value	Losses	Fair Value	Losses
Securities available-for-sale:
U.S. Agency obligations	$4,751	$58	$-	$-	$4,751	$58
Collateralized mortgage obligations	17,420	138	2,108	47	19,528	185
Mortgage-backed securities	56,516	925	-	-	56,516	925
Municipal bonds	9,042	48	1,615	19	10,657	67
Other	-	-	1,400	750	1,400	750
Total temporarily impaired
securities	$87,729	$1,169	$5,123	$816	$92,852	$1,985

	Less Than 12 Months		12 Months or Greater		Total
(In thousands)		Unrealized		Unrealized		Unrealized
December 31, 2016	Fair Value	Losses	Fair Value	Losses	Fair Value	Losses
Securities available-for-sale:
U.S. Agency obligations	$10,334	$163	$-	$-	$10,334	$163
Collateralized mortgage obligations	18,124	242	-	-	18,124	242
Mortgage-backed securities	58,825	1,478	-	-	58,825	1,478
Municipal bonds	33,110	698	-	-	33,110	698
Other	1,897	254	-	-	1,897	254
Total temporarily impaired
securities	$122,290	$2,835	$-	$-	$122,290	$2,835

he table below summarizes the number of investment securities in an unrealized loss position:

	September 30,	December 31,
Available-for-sale:	2017	2016
U.S. Agency obligations	3	5
Collateralized mortgage obligations	7	6
Mortgage-backed securities	15	13
Municipal bonds	15	53
Other	1	1
	41	78

The unrealized losses primarily relate to debt securities that have incurred fair value reductions due to higher market interest rates since the securities were purchased. The unrealized losses are not likely to reverse unless and until market interest rates decline to the levels that existed when the securities were purchased. Since none of the unrealized losses on the debt securities in 2017 or 2016 relate to the marketability of the securities or the issuer’s ability to honor redemption obligations and since management has the intent to hold these securities until maturity and believes it is more likely than not that the Company will not have to sell any such securities before a recovery of cost given the current liquidity position, none of those debt securities are deemed to be other than temporarily impaired.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table summarizes securities gains for the periods presented:

	Three months		Nine months
	ended September 30,		ended September 30,
	2017	2016	2017	2016
Gross gains on sales of securities available for sale	$-	$-	$-	$136
Gross losses on sales of securities available for sale	-	-	-	(51)
Total securities gains	$-	$-	$-	$85

Securities with a fair value of $72.6 million and $75.8 million were pledged as of September 30, 2017 and December 31, 2016, respectively, to secure repurchase agreements, lines of credit and other borrowings.

NOTE 5 - LOANS AND ALLOWANCE FOR LOAN LOSSES

Following is a summary of loans at September 30, 2017 and December 31, 2016:

	September 30,	December 31,
(In thousands)	2017	2016
Construction and land development	$75,465	$79,738
Commercial real estate:
Non-farm, non-residential	448,762	365,569
Owner occupied	221,661	186,892
Multifamily, nonresidential and junior liens	104,892	89,191
Total commercial real estate	775,315	641,652
Consumer real estate:
Home equity lines	92,285	87,489
Secured by 1-4 family residential, secured by first deeds of trust	242,655	195,343
Secured by 1-4 family residential, secured by second deeds of trust	4,425	4,289
Total consumer real estate	339,365	287,121
Commercial and industrial loans (except those secured by real estate)	178,765	170,709
Consumer and other	20,823	11,542
Total loans	1,389,733	1,190,762
Deferred loan costs	254	518
Allowance for loan losses	(9,402)	(7,909)
Net loans	$1,380,585	$1,183,371

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

A further breakdown of the make-up of the construction and land development and commercial real estate portfolio at September 30, 2017 and December 31, 2016 is as follows:

	September 30,	December 31,
(in thousands)	2017	2016
Construction and land development:
Land	$9,360	$12,595
Residential	33,596	36,253
Commercial	32,509	30,890
Total construction and land development	$75,465	$79,738

Commercial real estate:
Non-farm, non-residential:
Office	$141,928	$108,228
Industrial	31,548	36,264
Hotel/motel	33,305	28,453
Retail	205,059	165,434
Special purpose/Other	36,922	27,190
Total commercial real estate	448,762	365,569
Owner occupied :
Office	77,520	60,500
Industrial	54,809	46,876
Retail	33,035	31,085
Special purpose/Other	56,297	48,431
Total owner occupied	221,661	186,892

Multifamily, nonresidential and junior liens	104,892	89,191
Total commercial real estate	$775,315	$641,652

Loans are primarily made in the Research Triangle and Charlotte areas of North Carolina. Real estate loans can be affected by the condition of the local real estate market. Commercial and installment loans can be affected by the local economic conditions.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Changes in the allowance for loan losses for the three and nine months ended September 30, 2017 and 2016 were as follows:

				Commercial
				& Industrial
	Construction		Consumer	Loans Not
	and Land	Commercial	Real	Secured By	Consumer	Total
(In thousands)	Development	Real Estate	Estate	Real Estate	& Other	Loans
Three months ended September 30, 2017
Beginning balance	$403	$4,241	$2,026	$2,135	$116	$8,921
Provision for loan losses	(81)	163	147	175	1	405
Loans charged off	-	-	-	(11)	-	(11)
Recoveries	80	2	-	5	-	87
Net (chargeoffs) recoveries	80	2	-	(6)	-	76
Ending balance	$402	$4,406	$2,173	$2,304	$117	$9,402

Nine months ended September 30, 2017
Beginning balance	$486	$3,719	$1,901	$1,727	$76	$7,909
Provision for loan losses	(311)	657	272	542	54	1,214
Loans charged off	-	-	-	(20)	(13)	(33)
Recoveries	227	30	-	55	-	312
Net (chargeoffs) recoveries	227	30	-	35	(13)	279
Ending balance	$402	$4,406	$2,173	$2,304	$117	$9,402

Three months ended September 30, 2016
Beginning balance	$406	$3,278	$1,887	$2,307	$108	$7,986
Provision for loan losses	(64)	128	204	147	(24)	391
Loans charged off	-	-	-	(682)	-	(682)
Recoveries	58	3	1	168	-	230
Net (chargeoffs) recoveries	58	3	1	(514)	-	(452)
Ending balance	$400	$3,409	$2,092	$1,940	$84	$7,925

Nine months ended September 30, 2016
Beginning balance	$509	$3,156	$2,046	$1,786	$144	$7,641
Provision for loan losses	(404)	194	39	632	(70)	391
Loans charged off	-	-	-	(682)	(1)	(683)
Recoveries	295	59	7	204	11	576
Net (chargeoffs) recoveries	295	59	7	(478)	10	(107)
Ending balance	$400	$3,409	$2,092	$1,940	$84	$7,925

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The balance in the allowance for loan losses and the recorded investment in loans by portfolio segment are based on the impairment method as of September 30, 2017 and December 31, 2016 and were as follows:

				Commercial
				& Industrial
	Construction		Consumer	Loans Not
	and Land	Commercial	Real	Secured By	Consumer	Total
(in thousands)	Development	Real Estate	Estate	Real Estate	& Other	Loans
September 30, 2017
Allowance for Loan Losses:
Individually evaluated for impairment	$-	$-	$37	$787	$-	$824
Collectively evaluated for impairment	402	4,406	2,136	1,517	117	8,578
Total ending allowance	$402	$4,406	$2,173	$2,304	$117	$9,402

Loans:
Individually evaluated for impairment	$114	$303	$352	$2,020	$-	$2,789
Collectively evaluated for impairment	75,351	775,012	339,013	176,745	20,823	1,386,944
Total ending loans	$75,465	$775,315	$339,365	$178,765	$20,823	$1,389,733

(in thousands)
December 31, 2016
Allowance for Loan Losses:
Individually evaluated for impairment	$-	$-	$223	$286	$-	$509
Collectively evaluated for impairment	486	3,719	1,677	1,442	76	7,400
Total ending allowance	$486	$3,719	$1,900	$1,728	$76	$7,909

Loans:
Individually evaluated for impairment	$125	$836	$1,121	$1,139	$-	$3,221
Collectively evaluated for impairment	79,613	640,816	286,000	169,570	11,542	1,187,541
Total ending loans	$79,738	$641,652	$287,121	$170,709	$11,542	$1,190,762

Loans are charged down or off as soon as the Company determines that the full principal balance due under any loan becomes uncollectible. The amount of the charge is determined as follows:

● If unsecured, the loan must be charged off in full.

● If secured, the outstanding principal balance of the loan should be charged down to the net realizable value of the collateral.

Loans are considered uncollectible when:

● No regularly scheduled payment has been made within four months unless fully secured and in the process of collection.

● The collateral value is insufficient to cover the outstanding indebtedness and it is unlikely the borrower will have the ability to pay the debt in a timely manner.

● The loan is unsecured, the borrower files for bankruptcy protection and there is no other (guarantor, etc.) support from an entity outside of the bankruptcy proceedings.

Impaired loans totaled $2.8 million and $3.2 million at September 30, 2017 and December 31, 2016, respectively. Included in the $2.8 million at September 30, 2017 are $579,000 of loans classified as troubled debt restructurings (“TDRs”). Included in the $3.2 million at December 31, 2016 are $1.3 million of loans classified as TDRs. A modification of a loan’s terms constitutes a TDR if the creditor grants a concession to the borrower for economic or legal reasons related to the borrower’s financial difficulties that it would not otherwise consider. All TDRs are considered impaired.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table provides information on performing and nonperforming TDRs as of September 30, 2017 and December 31, 2016:

	September 30,	December 31,
(In thousands)	2017	2016
Performing TDRs:
Commercial real estate	$-	$520
Consumer real estate	-	338
Commercial and industrial loans	297	297
Total performing TDRs	297	1,155

Nonperforming TDRs:
Construction and land development	114	125
Consumer real estate	168	58
Total nonperforming TDRs	282	183
Total TDRs	$579	$1,338

During the first nine months of 2017, two of the six loans totaling $339,000 that were designated TDRs as of December 31, 2016 were paid off. The largest of these was a $338,000 residential real estate loan. The second was a $1,000 residential lot loan. In addition to the two paid-off notes, another commercial real estate loan totaling $519,000 previously designated as a TDR was refinanced by the Bank during the second quarter of 2017 and is no longer considered a TDR as the loan was refinanced at market terms. The three remaining TDRs as of September 30, 2017 are all performing as agreed.

The Bank added one new TDR loan in February 2017, a $115,000 business loan secured by residential property due to a restructure of the loan payment terms in response to the borrower’s financial difficulties. That loan continues to perform as agreed since restructure.

In order to quantify the value of any impairment, the Company evaluates impaired loans individually. At September 30, 2017, the Company had $2.8 million of impaired loans. The detail of loans evaluated for impairment as of September 30, 2017 is presented below:

		Unpaid
		Contractual
	Recorded	Principal	Allocated
September 30, 2017	Investment	Balance	Allowance
Loans without a specific valuation allowance:
Construction and land development	$114	$163	$-
Commercial real estate	303	303	-
Loans with a specific valuation allowance:
Consumer real estate	352	419	37
Commercial and industrial loans	2,020	2,051	787
Total	$2,789	$2,936	$824

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

At December 31, 2016, the Company had $3.2 million of impaired loans. The detail of loans evaluated for impairment as of December 31, 2016 is presented below:

The average recorded investment balance of impaired loans for the three- and nine-month periods ending September 30, 2017 and 2016 are as follows:

	Three months ended September 30,
	2017		2016
	Average	Interest	Average	Interest
(In thousands)	Balance	Income	Balance	Income
Construction and land development	$185	$-	$130	$-
Commercial real estate	309	7	867	10
Consumer real estate	427	5	947	7
Commercial and industrial loans	1,723	39	2,149	18
Total	$2,644	$51	$4,093	$35

	Nine months ended September 30,
	2017		2016
	Average	Interest	Average	Interest
(In thousands)	Balance	Income	Balance	Income
Construction and land development	$164	$7	$229	$-
Commercial real estate	483	16	2,398	37
Consumer real estate	528	19	951	15
Commercial and industrial loans	1,508	53	2,802	48
Consumer and other	-	-	20	-
Total	$2,683	$95	$6,400	$100

hen the Company cannot reasonably expect full and timely repayment of principal and interest of its loan, the loan is placed on nonaccrual status. The Company will continue to track the contractual interest for purposes of customer reporting and any potential litigation or later collection of the loan but accrual of interest for the Company’s financial statement purposes is to be discontinued. Subsequent payments of interest can be recognized as income on a cash basis provided that full collection of principal is expected. Otherwise, all payments received are to be applied to principal only. At the time of nonaccrual, past due or accrued interest is reversed from income.

Loans over 90 days past due at the end of any calendar month will be placed on nonaccrual status. Loans that are less delinquent may also be placed on nonaccrual status if full collection of principal and interest is unlikely.

The following table presents the recorded investment in nonaccrual loans by portfolio segment as of September 30, 2017 and December 31, 2016:

	Nonaccrual
	September 30,	December 31,
(In thousands)	2017	2016
Construction and land development	$114	$125
Commercial real state	-	783
Consumer real estate	352	-
Commercial and industrial loans	-	60
Total	$466	$968

Loans past due or 90 days past due and still accruing at September 30, 2017 were $149,000. There were no loans 90 days or more past due and accruing interest at December 31, 2016.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table presents the aging of the recorded investment in past due loans as of September 30, 2017 and December 31, 2016 by portfolio segment:

			Greater
	30 - 59	60 - 89	than 90
	Days	Days	Days		Total
(in thousands)	Past	Past	Past	Non-	Past		Total
September 30, 2017	Due	Due	Due	Accrual	Due	Current	Loans
Construction and land development	$-	$-	$-	$114	$114	$75,351	$75,465
Commercial real estate	-	-	��-	-	-	775,315	775,315
Consumer real estate	-	-	-	352	352	339,013	339,365
Commercial and industrial loans	149	-	-	-	149	178,616	178,765
Consumer and other	-	-	-	-	-	20,823	20,823
Total	$149	$-	$-	$466	$615	$1,389,118	$1,389,733

			Greater
	30 - 59	60 - 89	than 90
	Days	Days	Days		Total
(in thousands)	Past	Past	Past	Non-	Past		Total
December 31, 2016	Due	Due	Due	Accrual	Due	Current	Loans
Construction and land development	$-	$-	$-	$125	$125	$79,613	$79,738
Commercial real estate	-	-	-	-	-	641,652	641,652
Consumer real estate	-	-	-	783	783	286,338	287,121
Commercial and industrial loans	-	-	-	60	60	170,649	170,709
Consumer and other	-	-	-	-	-	11,542	11,542
Total	$-	$-	$-	$968	$968	$1,189,794	$1,190,762

redit Quality Indicators

The Company utilizes a nine-point grading system in order to evaluate the level of inherent risk in the loan portfolio as part of its allowance for loan losses methodology. Loans collectively evaluated for impairment are grouped by loan type and, in the case of commercial and construction loans, by risk rating. Each loan type is assigned an allowance factor based on risk grade, historical loss experience, economic conditions, overall portfolio quality including delinquency rates and commercial real estate loan concentrations (as applicable). As risk grades increase, additional reserves are applied stated in basis points in order to account for the added inherent risk.

The Company categorizes all business and commercial purpose loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by setting the risk grade at the inception of a loan through the approval process. A certain percentage of loan dollars is reviewed each year by a third party loan review function. The risk rating process is inherently subjective and based upon management’s evaluation of the specific facts and circumstances for individual borrowers. As such, the assigned risk ratings are subject to change based upon changes in borrower status and changes in the external environment affecting the borrower. The Company uses the following definitions for risk ratings:

●

Risk Grade 1 – Minimal - Credits in this category are virtually risk-free and are well-collateralized by cash-equivalent instruments. The repayment program is well-defined and achievable. Repayment sources are numerous.

●

Risk Grade 2 – Modest - Loans to borrowers of significantly better than average financial strength or loans secured by readily marketable securities. Earnings performance is consistent and primary and secondary sources of repayment are well established. The borrower exhibits excellent asset quality and liquidity with very strong debt servicing capacity and coverage. Company management has depth, is experienced and well regarded in the industry.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

●

Risk Grade 3 – Average - Loans in this category are to borrowers of satisfactory financial strength. Earnings performance is consistent. Primary and secondary sources of repayment are well defined and adequate to retire the debt in a timely and orderly fashion. These borrowers would generally exhibit satisfactory asset quality and liquidity. They have moderate leverage and experienced management in key positions.

●

Risk Grade 4 – Acceptable - Loans in this category are to borrowers involving more than average risk which contain certain characteristics that require some supervision and attention by the lender. Asset quality is acceptable, but debt capacity is modest. Little excess liquidity is available. The borrower may be fully leveraged and unable to sustain major setbacks. Covenants are structured to ensure adequate protection. Management may have limited experience and depth. This category includes loans which are highly leveraged transactions due to regulatory constraints and also includes loans involving reasonable exceptions to policy.

●

Risk Grade 5 - Acceptable with Care - A loan in this category is sound and collectible but contains considerable risk. Although asset quality remains acceptable, the borrower has a smaller and/or less diverse asset base, very little liquidity and limited debt capacity. Earnings performance is inconsistent and the borrower is not strong enough to sustain major setbacks. The borrower may be highly leveraged and below average size or a lower-tier competitor. There might be limited management experience and depth. These loans may be to a well-conceived start-up venture but repayment is still dependent upon a successful operation. This category includes loans with significant documentation or policy exceptions, improper loan structure, or inadequate loan servicing procedures and may also include a loan in which strong reliance for a secondary repayment source is placed on a guarantor who exhibits the ability and willingness to repay or loans which are highly leveraged transactions due to the obligor’s financial status.

●

Risk Grade 6 - Special Mention or Critical - Loans in this category have potential weaknesses which may, if not checked or corrected, weaken the asset or inadequately protect the Company’s credit position at some future date. These may also include loans of marginal quality and liquidity that if not corrected may jeopardize the liquidation of the debt and the Company’s credit position. These loans require close supervision and must be monitored to ensure there is not a pattern of deterioration in the credit that may lead to further downgrade. These characteristics include but are not limited to:

Repayment performance has not been demonstrated to prudent standards;

Repayment performance is inconsistent and highly sensitive to business and operating cycle swings;

Fatal documentation errors and;

Performing as agreed without documented capacity or collateral protection.

●

Risk Grade 7 – Substandard - A substandard loan is inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified as substandard 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.

●

Risk Grade 8 – Doubtful - Loans classified doubtful have all the weaknesses inherent in loans classified substandard, plus 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. However, these loans are not yet rated as loss because certain events may occur which would salvage the debt. Among these events are:

Injection of capital;

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Alternative financing;

Liquidation of assets or the pledging of additional collateral.

The ability of the borrower to service the debt is extremely weak, overdue status is constant, the debt has been placed on nonaccrual status and no definite repayment schedule exists. Doubtful is a temporary grade where a loss is expected but is presently not quantified with any degree of accuracy. Once the loss position is determined, the amount is charged off. There were no loans rated as doubtful as of September 30, 2017 or December 31, 2016.

●

Risk Grade 9 – Loss - Loans classified Loss are considered uncollectable and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value but rather that it is not practical or desirable to defer writing off the worthless loan even though partial recovery may be affected in the future. Probable loss portions of doubtful assets should be charged against the allowance for loan losses. Loans may reside in this classification for administrative purposes for a period not to exceed the earlier of thirty days or calendar quarter-end. There were no loans rated as loss as of September 30, 2017 or December 31, 2016.

As of September 30, 2017 and December 31, 2016 and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:

	Risk Grade
(in thousands)	1	2	3	4	5	6	7	Total
September 30, 2017
Construction and land development	$-	$1,472	$1,227	$30,850	$41,767	$35	$114	$75,465
Commercial real estate	-	268	275,662	382,339	99,836	16,641	569	775,315
Consumer real estate	47	32,336	154,330	113,894	37,355	1,051	352	339,365
Commercial and industrial loans	1,334	1,065	24,234	113,343	35,664	218	2,907	178,765
Consumer and other	940	3,260	2,617	12,826	1,180	-	-	20,823
Total	$2,321	$38,401	$458,070	$653,252	$215,802	$17,945	$3,942	$1,389,733

	Risk Grade
(in thousands)	1	2	3	4	5	6	7	Total
December 31, 2016
Construction and land development	$-	$1,005	$911	$22,901	$54,601	$195	$125	$79,738
Commercial real estate	-	539	223,549	311,711	87,443	18,500	-	641,652
Consumer real estate	50	19,247	130,748	102,137	33,013	1,143	783	287,121
Commercial and industrial loans	2,133	1,525	32,304	104,019	29,035	556	1,137	170,709
Consumer and other	1,160	730	1,086	7,392	1,174	-	-	11,542
Total	$3,343	$23,046	$388,598	$548,160	$205,266	$20,394	$2,045	$1,190,762

NOTE 6 - OFF-BALANCE SHEET RISK

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 and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of conditions established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company, upon extension of credit is based on management’s credit evaluation of the borrower. Collateral obtained varies but may include real estate, stocks, bonds, and certificates of deposit.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

A summary of the contract amounts of the Company’s exposure to off-balance sheet credit risk as of September 30, 2017 and December 31, 2016 is as follows:

	September 30,	December 31,
(In thousands)	2017	2016
Financial instruments whose contract amounts
represent credit risk:
Undisbursed lines of credit	$264,514	$216,769
Standby letters of credit	5,337	3,904
Total	$269,851	$220,673

NOTE 7 - DERIVATIVES AND FINANCIAL INSTRUMENTS

To mitigate exposure to variability in expected future cash flows resulting from changes in interest rates, in May 2013 the Company entered into two forward swap arrangements (the “Swaps”) whereby the Company would pay fixed rates on two short-term borrowings at some point in the future for a determined period of time. For both agreements, the Company would renew advances with the Federal Home Loan Bank (“FHLB”) for 3-month terms as a primary funding source and pay the prevailing 3-month rate. The first swap, a “2-5 Swap”, was a $20 million agreement whereby 2 years from the May 2013 execution date, the Company would begin to swap out the 3-month FHLB advance pricing at that date for a fixed rate of 1.964% for a period of 5 years. The second swap, a “3-5 Swap”, was similar in terms except that it was a $30 million agreement whereby 3 years from the May 2013 execution date, the Company would begin to swap out the 3-month FHLB advance pricing at that date for a fixed rate of 2.464% for a period of 5 years.

The Company designated the forward-starting interest rate swaps (the hedging instruments) as cash flow hedges of the risk of changes attributable to the benchmark 3-Month LIBOR interest rate risk for the forecasted issuances of FHLB advances arising from a rollover strategy. The Company intended to sequentially issue a series of 3-month fixed rate debt as part of a planned roll-over of short-term debt for the next seven to eight years.

In September 2014, as a result of continued increasing fixed rate exposure, the Company determined that an additional strategy was needed and, as a result, exited from the Swaps for a deferred gain of $372,000. In their place, the Company purchased three interest rate caps with a strike price of 3-month LIBOR at 0.50% and a five-year term. The instruments hedged were $100 million of FHLB borrowings maturing quarterly on the same reset dates. The Company executed three separate agreements between $30 million and $35 million maturing between August 2019 and October 2019.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table reflects the cash flow hedges included in the consolidated balance sheets as of September 30, 2017 and December 31, 2016:

	September 30, 2017		December 31, 2016
	Notional	Fair	Notional	Fair
(In thousands)	Amount	Value	Amount	Value
Included in other assets:
Cap 1 - maturing August 2019	$35,000	$794	$35,000	$1,011
Cap 2 - maturing September 2019	35,000	821	35,000	1,045
Cap 3 - maturing October 2019	30,000	737	30,000	929
	$100,000	$2,352	$100,000	$2,985

Remaining amortization of the premium on the interest rate caps is as follows:

(In thousands)
2017	$508
2018	2,247
2019	1,752
	$4,507

The Company recorded $474,000 and $257,000 for the three-month periods ended September 30, 2017 and 2016, respectively, in amortization associated with the interest rate caps. The Company recorded $1.3 million and $598,000 for the nine-month periods ended September 30, 2017 and 2016, respectively, in amortization associated with the interest rate caps. Those expenses are reflected in the consolidated statements of income as a component of borrowings and repurchase agreements interest expense.

Remaining amortization of the gain associated with the exit of the Swaps is as follows:

(In thousands)
2017	19
2018	74
Thereafter	147
	$240

The Company realized $19,000 and $50,000 in gains on the Swaps during the three- and nine-month periods ended September 30, 2017, respectively, shown as a reduction of borrowings and repurchase agreements interest expense.

The Company anticipates little to no ineffectiveness in this hedging relationship as long as the terms are matched at each forecasted debt issuance. The Company notes that the actual interest cost incurred at each rollover will be a function of market rates at that time. However, the Company is only hedging the benchmark interest rate risk in each rollover.

The Company does not use derivatives for trading or speculative purposes.

NOTE 8 - FAIR VALUE OF FINANCIAL INSTRUMENTS

Fair value is a market-based measurement and is defined as the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date. The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the asset or owes the liability. In general, the transaction price will equal the exit price and, therefore, represent the fair value of the asset or liability at initial recognition. In determining whether a transaction price represents the fair value of the asset or liability at initial recognition, each reporting entity is required to consider factors specific to the transaction and the asset or liability, the principal or most advantageous market for the asset or liability, and market participants with whom the entity would transact in the market.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Outlined below is the application of the fair value hierarchy applied to the Company’s financial assets that are carried at fair value.

Level 1 – Inputs to the valuation methodology are quoted prices for identical assets or liabilities in active markets. An active market for the asset or liability is a market in which the transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis. As of September 30, 2017, the types of financial assets and liabilities the Company carried at fair value hierarchy Level 1 included marketable equity securities with readily available market values.

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. As of September 30, 2017, the types of financial assets and liabilities the Company carried at fair value hierarchy Level 2 included agency bonds, collateralized mortgage obligations, mortgage backed securities, municipal bonds and derivatives.

Level 3 – Inputs to the valuation methodology are unobservable and significant to the fair value measurement. Unobservable inputs are supported by little or no market activity or by the entity’s own assumptions. As of September 30, 2017, the Company valued certain financial assets including one corporate subordinated debenture, measured on both a recurring and a non-recurring basis, at fair value hierarchy Level 3.

The Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs.

Fair Value on a Recurring Basis

The Company measures certain assets at fair value on a recurring basis, as described below.

Investment Securities Available-for-Sale

Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include U.S. agencies, mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Derivative Assets and Liabilities

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 held or issued for risk management purposes as Level 2. As of September 30, 2017 and December 31, 2016, the Company’s derivative instruments consist solely of interest rate caps.

Below is a table that presents information about assets measured at fair value on a recurring basis at September 30, 2017 and December 31, 2016:

		Fair Value Measurements Using
		Quoted Prices	Significant
		in Active	Other	Significant
		Markets for	Observable	Unobservable
(In thousands)	Total	Identical Assets	Inputs	Inputs
Description	Fair Value	(Level 1)	(Level 2)	(Level 3)
September 30, 2017
Securities available-for-sale:
U.S. Agency obligations	$15,220	$-	$15,220	$-
Collateralized mortgage obligations	38,763	-	38,763	-
Mortgage-backed securities	72,629	-	72,629	-
Municipal bonds	67,571	-	67,571	-
Other	2,976	1,463	-	1,513
	197,159	1,463	194,183	1,513
Interest rate caps	2,352	-	2,352	-
Total assets at fair value	$199,511	$1,463	$196,535	$1,513

December 31, 2016
Securities available-for-sale:
U.S. Agency obligations	$16,943	$-	$16,943	$-
Collateralized mortgage obligations	42,497	-	42,497	-
Mortgage-backed securities	73,873	-	73,873	-
Municipal bonds	60,677	-	60,677	-
Other	3,451	1,951	-	1,500
	197,441	1,951	193,990	1,500
Interest rate caps	2,985	-	2,985	-
Total assets at fair value	$200,426	$1,951	$196,975	$1,500

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The table below summarizes the Company’s activity in investment securities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the nine months ended September 30, 2017.

	Level 3
	Investment
(In thousands)	Securities
Balance at December 31, 2016	$1,500
Purchases	-
Unrealized gain	13
Balance at September 30, 2017	$1,513

Fair Value on a Nonrecurring Basis

The Company measures certain assets at fair value on a nonrecurring basis, as described below.

Impaired Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures the impairment. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. Impaired loans require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When current appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3. Impaired loans totaled $2.8 million and $3.2 million at September 30, 2017 and December 31, 2016, respectively.

Other Real Estate Owned

Other real estate owned, which includes foreclosed assets, is adjusted to fair value upon transfer of loans and premises to other real estate. Subsequently, other real estate owned is carried at the lower of carrying value or fair value.

At the date of transfer, losses are charged to the allowance for credit losses. Subsequent write-downs are charged to expense in the period they are incurred.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Below is a table that presents information about assets measured at fair value on a nonrecurring basis at September 30, 2017 and December 31, 2016:

		Fair Value Measurements Using
		Quoted Prices	Significant
		in Active	Other	Significant
		Markets for	Observable	Unobservable
(In thousands)	Total	Identical Assets	Inputs	Inputs
September 30, 2017	Fair Value	(Level 1)	(Level 2)	(Level 3)
Impaired loans	$1,965	$-	$-	$1,965
Other real estate owned	3,399	-	-	3,399
Total	$5,364	$-	$-	$5,364

		Fair Value Measurements Using
		Quoted Prices	Significant
		in Active	Other	Significant
		Markets for	Observable	Unobservable
(In thousands)	Total	Identical Assets	Inputs	Inputs
December 31, 2016	Fair Value	(Level 1)	(Level 2)	(Level 3)
Impaired loans	$2,712	$-	$-	$2,712
Other real estate owned	4,740	-	-	4,740
Total	$7,452	$-	$-	$7,452

For Level 3 assets and liabilities measured at fair value on a recurring or nonrecurring basis as of September 30, 2017 and December 31, 2016, the significant unobservable inputs used in the fair value measurements were as follows:

	September 30, 2017 and December 31, 2016
	Valuation	Significant	Significant
	Technique	Observable Inputs	unobservable Inputs
Impaired loans	Appraisal value	Appraisals and/or sales of	Appraisals discounted 5% to 10% for
	or discounted	comparable properties	sales commissions and other holding costs
	cash flows	or discounted cash flows	or discounted cash flows

Other real estate owned	Appraisal value/	Appraisals and/or sales of	Appraisals discounted 5% to 10% for
	Comparison sale/	comparable properties	sales commissions and other holding costs
	Other estimates

The Company provides certain 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 instrument. Accordingly, certain financial instruments and all nonfinancial instruments are excluded from disclosure. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:

Cash and Due from Banks

The carrying amounts for cash and due from banks approximate fair value because of the short maturities of those instruments.

Federal Home Loan Bank Stock

The carrying value of Federal Home Loan Bank stock approximates fair value based on the redemption provisions of such Federal Home Loan Bank stock.

Bank-Owned Life Insurance

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

Loans

The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.

Deposits

The fair value of demand deposits is the amount payable on demand at the reporting date. The fair value of time deposits is estimated by discounting expected cash flows using the rates currently offered for instruments of similar remaining maturities.

Accrued Interest

The carrying amount is a reasonable estimate of fair value.

Short-Term Borrowings and Long-Term Debt

The fair values are based on discounting expected cash flows using the current interest rates for debt with the same or similar remaining maturities and collateral requirements.

Financial Instruments with Off-Balance Sheet Risk

With regard to financial instruments with off-balance sheet risk, it is not practicable to estimate the fair value of future financing commitments.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table presents the estimated fair values and carrying amounts of the Company’s financial instruments, none of which are held for trading purposes, at September 30, 2017 and December 31, 2016:

	September 30, 2017
	Carrying	Fair Value
(In thousands)	Amount	Total	Level 1	Level 2	Level 3
Financial assets:
Cash and due from banks	$83,428	$83,428	$83,428	$-	$-
Investment securities available-for-
sale	197,159	197,159	1,463	194,183	1,513
Loans, net	1,380,585	1,380,737	-	1,378,772	1,965
Accrued interest receivable	4,840	4,840	4,840	-	-
Federal Home Loan Bank stock	12,403	12,403	-	-	12,403
Bank-owned life insurance	34,961	34,961	-	34,961	-
Interest rate caps	2,352	2,352	-	2,352	-
Financial liabilities:
Non-maturing deposits	1,118,866	1,118,866	-	1,118,866	-
Time deposits	169,277	169,349	-	169,349	-
Accrued interest payable	483	483	483	-	-
Repurchase agreements and
federal funds purchased	21,064	21,064	-	21,064	-
FHLB Advances and other borrowings	260,000	260,003	-	260,003	-
Subordinated debt	18,558	14,302	-	14,302	-

	December 31, 2016
	Carrying	Fair Value
(In thousands)	Amount	Total	Level 1	Level 2	Level 3
Financial assets:
Cash and due from banks	$43,005	$43,005	$43,005	$-	$-
Investment securities available-for-
sale	197,441	197,441	1,951	193,990	1,500
Loans, net	1,183,371	1,184,621	-	1,181,909	2,712
Accrued interest receivable	4,368	4,368	4,368	-	-
Federal Home Loan Bank stock	8,400	8,400	-	-	8,400
Bank-owned life insurance	34,190	34,190	-	34,190	-
Interest rate caps	2,985	2,985	-	2,985	-
Financial liabilities:
Non-maturing deposits	953,248	953,248	-	953,248	-
Time deposits	219,007	219,038	-	219,038	-
Accrued interest payable	294	294	294	-	-
Repurchase agreements and
federal funds purchased	20,174	20,174	-	20,174	-
FHLB Advances and other borrowings	150,000	149,997	-	149,997	-
Subordinated debt	18,558	14,197	-	14,197	-

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 9 – SUPPLEMENTAL CASH FLOW DISCLOSURE

	For the nine months
	ended September 30,
(In thousands)	2017	2016
Supplemental Disclosures of Cash Flow Information:

Interest paid	$7,629	$6,072

Income taxes paid	$5,570	$4,485

Supplemental Schedule of Noncash Investing and Financing Activites:

Change in fair value of securities available-for-sale, net of taxes	$1,081	$1,714

Change in fair value of cash flow hedges, net of taxes	$387	$(993)

NOTE 10 – SUBSEQUENT EVENTS

Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements.

Nonrecognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date. Management has reviewed events occurring through the date the financial statements were available to be issued and no subsequent events occurred requiring accrual or disclosure.

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

Paragon Commercial Corporation (the “Company” or “Paragon”) is a bank holding company incorporated under the laws of North Carolina and headquartered in Raleigh, North Carolina. The Company conducts its business operations primarily through its wholly owned subsidiary, Paragon Bank (the “Bank”), a full-service, state-chartered community bank with 3 locations in Raleigh, Charlotte and Cary, North Carolina. Paragon Bank provides banking services to businesses and consumers across the Carolinas.

Because the Company has no material operations and conducts no business on its own other than owning its subsidiaries, the discussion contained in this management’s discussion and analysis concerns primarily the business of Paragon Bank. For ease of reading and because the financial statements are presented on a consolidated basis, Paragon Commercial Corporation and Paragon Bank are collectively referred to herein as “the Company,” “we”, “our”, or “us”, unless otherwise noted.

Management’s discussion and analysis is intended to assist readers in understanding and evaluating the financial condition and consolidated results of operations of the Company. This discussion and analysis includes descriptions of significant transactions, trends and other factors affecting the Company’s operating results for the three- and nine-month periods ended September 30, 2017, and 2016, as well as the financial condition of the Company as of September 30, 2017 and December 31, 2016. This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements included in this report and the audited consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2016 filed with the Securities and Exchange Commission (“SEC”) on March 21, 2017, as amended on April 28, 2017. The results of operations for the three and nine months ended September 30, 2017 are not necessarily indicative of the results to be expected for the full year ending December 31, 2017 or any other future period.

Forward-Looking Information

This periodic report on Form 10-Q contains certain “forward-looking statements” that represent management’s judgments concerning the future and are subject to risks and uncertainties that could cause the Company’s actual operating results and financial position to differ materially from those projected in the forward-looking statements. These statements are included throughout this report and relate to, among other things our business strategy, goals, and expectations concerning our market position, future operations, margins, profitability, liquidity, and capital resources. Additional statements regarding the proposed merger with TowneBank relate to, among other things, the timing of the proposed merger and whether the proposed merger will occur; the benefits, results and effects of the proposed merger; and the combined company's plans, objectives, expectations, costs, and the effect on earnings per share. Such forward-looking statements can be identified by the use of forward-looking terminology such as “may,” “will,” “anticipate,” “should,” “would,” “project,” “future,” “strategy,” “believe,” “contemplate,” “expect,” “estimate,” “continue,” “intend,” “seeks,” or other similar words and expressions of the future.

Risks and other factors that could cause actual results to differ materially from those expected include the following:

● costs and difficulties related to the proposed merger, including, among other things, the integration of our business with TowneBank, the inability to retain key personnel, competitive response to the proposed merger, or potential adverse reactions to changes in business or employee relationships could be more significant than we anticipate, resulting in higher costs or reduced benefits;

● failure of the merger to be completed on the proposed terms and schedule, or at all;

● business uncertainties and contractual restrictions during the pendency of the merger and management distraction;

● risks associated with any change in management, strategic direction, business plan, or operations;

● local economic conditions affecting retail and commercial real estate;

● disruptions in the credit markets;

● changes in interest rates;

● adverse developments in the real estate market affecting the value and marketability of collateral securing loans made by the Company;

● the failure of assumptions underlying loan loss and other reserves; and

● competition and the risk of new and changing regulation.

Additional factors that could cause actual results to differ materially are discussed in the Risk Factors section of this report and in the Company’s other filings with the SEC. The forward-looking statements in this report speak only as of the date hereof, and the Company does not assume any obligation to update such forward-looking statements, except as may otherwise be required by law.

GAAP Reconciliation and Management Explanation of Non-GAAP Financial Measures

Some of the financial measures included in this report are not measures of financial performance recognized by GAAP. These non-GAAP financial measures are “tangible stockholders’ equity,” “tangible book value per share,” “tangible average equity to tangible average assets,” and “efficiency ratio.” Our management uses these non-GAAP financial measures in its analysis of our performance and because of market expectations of use of these ratios to evaluate the Company. Management believes each of these non-GAAP financial measures provides useful information about our financial condition and results of operation. As noted below, the efficiency ratio shows the amount of revenue generated for each dollar spent and provides investors with a measure of our productivity. We also believe the presentation of tangible stockholders’ equity, tangible book value per share, tangible equity to risk-weighted assets and tangible average equity to tangible average assets would provide investors with a clear picture of our assets and equity. However, because the Company has not consummated any merger transactions and does not use any derivatives that might give rise to an intangible asset, there is no difference in tangible equity or assets and GAAP equity or assets.

● “Efficiency ratio” is defined as total non-interest expense less merger related costs divided by adjusted operating revenue. Adjusted operating revenue is equal to net interest income (taxable equivalent) plus non-interest income, adjusted to exclude the impacts of gains and losses on the sale of securities and gains and losses on the sale or write-down of foreclosed real estate. We believe the efficiency ratio is important as an indicator of productivity because it shows the amount of revenue generated by our core operations for each dollar spent. While the efficiency ratio is a measure of productivity, its value reflects the attributes of the business model we employ.

	Three-Month Period		Nine-Month Period
	Ended September 30,		Ended September 30,
(Dollars in thousands)	2017	2016	2017	2016
Efficiency Ratio
Non-interest expense	$7,374	$6,778	$22,843	$19,866
Merger related expenses	98	-	466	-
	$7,276	$6,778	$22,377	$19,866

Net interest taxable equivalent income	$14,114	$12,026	$39,969	$34,371
Non-interest income	274	438	1,271	1,085
Less gain on investment securities	-	-	-	(85)
Plus loss on sale or writedown of foreclosed real
estate	311	-	311	257
Adjusted operating revenue	$14,699	$12,464	$41,551	$35,628

Efficiency ratio	49.50%	54.38%	54.98%	55.76%

Executive Overview of Recent Financial Performance

●

Net income available to common stockholders totaled $4.2 million, or $0.77 per diluted common share, in the third quarter (“Q3”) of 2017, which was an increase of $717,000 or 21% year-over-year from $3.5 million, or $0.64 per diluted share, in Q3 2016.

●

Return on average assets equaled 0.99% in Q3 2017 compared to 0.95% in Q3 2016 while return on average equity equaled 11.34% in Q3 2017 compared to 10.35% for the same period in 2016.

●

The efficiency ratio, which represents operating expenses to total operating revenues, improved to 49.50% in Q3 2017 from 54.38% in Q3 2016.

●

The Company had net recoveries of charged-off loans of $76,000 in Q3 2017, compared to $452,000 in Q3 2016.

●

Annualized net loan growth was 15% in Q3 2017, resulting from net loan originations during the quarter of $50.1 million.

Proposed Merger with TowneBank

Analysis of Results of Operations

Third Quarter 2017 compared to Third Quarter 2016

During the three-month period ended September 30, 2017, the Company had net income of $4.2 million compared to net income of $3.5 million for the same period in 2016. Basic and diluted net income per share for the quarter ended September 30, 2017 were both $0.77 compared with basic and diluted net income per share of $0.64 each for the same period in 2016. Income during the third quarter of 2017 was negatively impacted by merger-related costs of $98,000 as well as $405,000 in additional loan loss provisions related to loan growth. The third quarter of 2016 had no merger-related costs but a loan loss provision of $391,000 was recorded.

Year-to-Date 2017 compared to Year-to-Date 2016

During the nine-month period ended September 30, 2017, the Company had net income of $10.8 million compared to net income of $9.8 million for the same period in 2016. Basic and diluted net income per share for the nine months ended September 30, 2017 were both $2.00 compared with basic and diluted net income per share of $2.02 and $2.00, respectively, for the same period in 2016. Income during the nine-month period ended September 30, 2017 was also negatively impacted by merger-related costs of $466,000 as well as $1,214,000 in additional loan loss provisions related to strong loan growth. The same period in 2016 had no merger-related costs but a loan loss provision of $391,000.

As discussed in greater detail below, the improvements in the results of operations for the three and nine months ended September 30, 2017, compared to the respective periods of 2016, reflect the benefit of balance sheet growth period over period as well as continued credit improvement.

Net Interest Income

Third Quarter 2017 compared to Third Quarter 2016

Like most financial institutions, the primary component of earnings for the Company is net interest income. Net interest income is the difference between interest income, principally from loans and investment securities portfolios, and interest expense, principally on customer deposits and borrowings. Changes in net interest income result from changes in volume, spread and margin. For this purpose, volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities, spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities, and margin refers to net interest income divided by average interest-earning assets. Margin is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities, as well as by the levels on non-interest bearing liabilities and capital.

Net interest income increased by $2.1 million to $13.8 million for the three months ended September 30, 2017. The Company’s total interest income was impacted by an increase in interest earning assets. Average total interest-earning assets were $1.62 billion in the third quarter of 2017 compared with $1.38 billion in the same period in 2016. The yield on those assets was 4.20% in the third quarter of 2017 compared to 4.07% for the same period in 2016. The improvement in yield was primarily the result of a shift in asset composition from lower yielding short-term investments and cash into loans and an increase in market rates. Meanwhile, average interest-bearing liabilities increased by $184 million from $1.12 billion for the three months ended September 30, 2016 to $1.30 billion for the same period ended September 30, 2017. The Company’s cost of these funds increased by 17 basis points year over year to 0.91% from 0.74% in the third quarter of 2016 primarily as a result of the Federal Reserve’s increase in rates impacting the cost of the Company’s borrowings at the FHLB. During the three-month period ended September 30, 2017, the Company’s net interest margin was 3.47% and net interest spread was 3.29%. In the third quarter of 2016, net interest margin was 3.47% and net interest spread was 3.33%.

The following table summarizes the major components of net interest income and the related yields and costs for the quarterly periods presented.

	For the Three Months Ended September 30,
	2017			2016
	Average		Average	Average		Average
(Dollars in thousands)	Amount	Interest	Rate	Amount	Interest	Rate
Loans, net of allowance (1)	$1,359,440	$15,241	4.45%	$1,135,448	$12,544	4.40%
Investment securities (2)	214,564	1,773	3.28%	186,060	1,473	3.15%
Other interest-earning assets	41,471	73	0.70%	56,573	97	0.68%
Total interest-earning assets	1,615,475	17,087	4.20%	1,378,081	14,114	4.07%
Other assets	65,717			74,443
Total assets	$1,681,192			$1,452,524

Deposits:
Interest-bearing checking accounts	$229,064	205	0.36%	$186,369	167	0.36%
Money markets	547,391	920	0.67%	491,805	799	0.65%
Time deposits less than $100,000	11,065	32	1.16%	11,208	29	1.04%
Time deposits greater than or
equal to $100,000	162,916	440	1.07%	243,150	559	0.91%
Borrowings	351,634	1,376	1.55%	185,211	534	1.15%
Total interest-bearing liabilities	1,302,070	2,973	0.91%	1,117,743	2,088	0.74%
Noninterest-bearing deposits	226,173			190,745
Other liabilities	5,737			10,558
Stockholders' equity	147,212			133,478
Total liabilities and stockholders'
equity	$1,681,192			$1,452,524

Net interest income/interest rate
spread (taxable-equivalent basis) (3)		$14,114	3.29%		$12,026	3.33%

Net interest margin (taxable-
equivalent basis) (4)			3.47%			3.47%

Ratio of interest-bearing assets to
interest-bearing liabilities	124.07%			123.29%

Reported net interest income
Net interest income (taxable-equivalent
basis)		$14,114			$12,026
Less:
Taxable-equivalent adjustment		272			259
Net interest income		$13,842			$11,767

(1) Loans include nonaccrual loans.

(2) Yields related to investment securities exempt from income taxes are stated on a taxable-equivalent basis assuming a federal income tax rate of 30.0 percent. The taxable-equivalent adjustment was $272,000 and $259,000 for the 2017 and 2016 periods, respectively.

(3) Net interest spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.

(4) Net interest margin represents annualized net interest income divided by average interest-earning assets.

Changes in interest income and interest expense can result from variances in both volume and rates. The following table presents the relative impact on tax-equivalent net interest income to changes in the average outstanding balances of interest-earning assets and interest-bearing liabilities and the rates earned and paid on such assets and liabilities.

	Three Months Ended
	September 30, 2017 vs. 2016
	Increase (Decrease) Due to
(Dollars in thousands)	Volume	Rate	Total
Interest income
Loans, net of allowance	$2,481	$216	$2,697
Investment securities	226	74	300
Other interest-earnings assets	(26)	2	(24)
Total interest income (taxable-
equivalent basis)	2,681	292	2,973

Interest expense
Deposits:
Interest-bearing checking accounts	38	-	38
Money markets	91	30	121
Time deposits less than $100,000	-	3	3
Time deposits greater than or
equal to $100,000	(185)	66	(119)
Borrowings	481	361	842
Total interest expense	425	460	885

Net interest income increase/
(decrease)(taxable equivalent basis)	$2,256	$(168)	2,088

Less:
Taxable-equivalent adjustment			13
Net interest income increase			$2,075

Year-to-Date 2017 compared to Year-to-Date 2016

Net interest income increased by $5.6 million to $39.2 million for the nine months ended September 30, 2017. The Company’s total interest income was impacted by an increase in interest earning assets. Average total interest-earning assets were $1.55 billion for the nine-month period ended September 30, 2017 compared with $1.31 billion in the same period in 2016. The yield on those assets was 4.14% in 2017 compared to 4.12% for the same period in 2016. The increase in yield was primarily the result of higher rates in the marketplace. Meanwhile, average interest-bearing liabilities increased by $155.2 million from $1.08 billion for the year-to-date period ended September 30, 2016 to $1.24 billion for the same period ended September 30, 2017. The Company’s cost of these funds increased from 0.74% for the year-to-date period ended September 30, 2016 to 0.84% for the same period ended September 30, 2017. The increase was primarily as a result of the Federal Reserve’s increase in rates impacting the cost of the Company’s borrowings at the FHLB. During the nine-month period ended September 30, 2017, the Company’s net interest margin was 3.46% and net interest spread was 3.29%. For the same period in 2016, net interest margin was 3.51% and net interest spread was 3.38%.

The following table summarizes the major components of net interest income and the related yields and costs for the quarterly periods presented.

	For the Nine Months Ended September 30,
	2017			2016
	Average		Average	Average		Average
(Dollars in thousands)	Amount	Interest	Rate	Amount	Interest	Rate
Loans, net of allowance (1)	$1,280,453	$42,325	4.42%	$1,075,390	$35,574	4.42%
Investment securities (2)	211,639	5,159	3.26%	185,721	4,554	3.28%
Other interest-earnings assets	52,950	303	0.77%	46,832	218	0.62%
Total interest-earning assets	1,545,042	47,787	4.14%	1,307,943	40,346	4.12%
Other assets	66,030			81,939
Total assets	$1,611,072			$1,389,882

Deposits:
Interest-bearing checking accounts	$226,040	631	0.37%	$165,655	515	0.42%
Money markets	538,274	2,695	0.67%	432,362	2,144	0.66%
Time deposits less than $100,000	11,270��	92	1.09%	11,496	89	1.04%
Time deposits greater than or
equal to $100,000	180,343	1,349	1.00%	255,407	1,622	0.85%
Borrowings	283,648	3,051	1.44%	219,461	1,605	0.98%
Total interest-bearing liabilities	1,239,575	7,818	0.84%	1,084,381	5,975	0.74%
Noninterest-bearing deposits	223,713			180,623
Other liabilities	5,114			12,790
Stockholders' equity	142,670			112,088
Total liabilities and stockholders'
equity	$1,611,072			$1,389,882

Net interest income/interest rate
spread (taxable-equivalent basis) (3)		$39,969	3.29%		$34,371	3.38%

Net interest margin (taxable-
equivalent basis) (4)			3.46%			3.51%

Ratio of interest-bearing assets to
interest-bearing liabilities	124.64%			120.62%

Reported net interest income
Net interest income (taxable-equivalent
basis)		$39,969			$34,371
Less:
Taxable-equivalent adjustment		790			752
Net interest income		$39,179			$33,619

(1) Loans include nonaccrual loans.

(2) Yields related to investment securities exempt from income taxes are stated on a taxable-equivalent basis assuming a federal income tax rate of 30.0 percent. The taxable-equivalent adjustment was $790,000 and $752,000 for the 2017 and 2016 periods, respectively.

(3) Net interest spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.

(4) Net interest margin represents annualized net interest income divided by average interest-earning assets.

	Nine Months Ended
	September 30, 2017 vs. 2016
	Increase (Decrease) Due to
(Dollars in thousands)	Volume	Rate	Total
Interest income
Loans, net of allowance	$6,777	$(26)	$6,751
Investment securities	635	(30)	605
Other interest-earning assets	28	57	85
Total interest income (taxable-
equivalent basis)	7,440	1	7,441

Interest expense
Deposits:
Interest-bearing checking accounts	188	(72)	116
Money markets	525	26	551
Time deposits less than $100,000	(2)	5	3
Time deposits greater than or
equal to $100,000	(476)	203	(273)
Borrowings	469	977	1,446
Total interest expense	704	1,139	1,843

Net interest income increase/
(decrease)(taxable equivalent basis)	$6,736	$(1,138)	5,598

Less:
Taxable-equivalent adjustment			38
Net interest income increase/
(decrease)			$5,560

Provision for Loan Losses

Third Quarter 2017 compared to Third Quarter 2016

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.

In determining the loss history to be applied to its ASC 450 loan pools within the allowance for loan losses, the Company uses net charge-off history for the most recent five consecutive years. Since each of the five past years contain a declining amount of charge-offs coupled with a large number of recoveries, the impact of the Company’s improvement in historical credit quality has resulted in a continually declining balance of reserves as a percentage of the loan portfolio.

The following table summarizes the changes in the allowance for loan losses for the three months ended September 30, 2017 and 2016:

(In thousands)
Three months ended September 30, 2017
Beginning balance	$8,921
Provision for loan losses	405
Loans charged off	(11)
Recoveries	87
Net recoveries	76
Ending balance	$9,402

Three months ended September 30, 2016
Beginning balance	$7,986
Provision for loan losses	391
Loans charged off	(682)
Recoveries	230
Net chargeoffs	(452)
Ending balance	$7,925

The Company recorded $405,000 in provision for loan losses in the third quarter of 2017 and recorded a provision for loan losses of $391,000 during the same period in 2016. The increase in the provision for 2017 was the result of rapid loan growth during the quarter.

Year-to-Date 2017 compared to Year-to-Date 2016

The following table summarizes the changes in the allowance for loan losses for the nine months ended September 30, 2017 and 2016:

(In thousands)
Nine months ended September 30, 2017
Beginning balance	$7,909
Provision for loan losses	1,214
Loans charged off	(33)
Recoveries	312
Net recoveries	279
Ending balance	$9,402

Nine months ended September 30, 2016
Beginning balance	$7,641
Provision for loan losses	391
Loans charged off	(683)
Recoveries	576
Net chargeoffs	(107)
Ending balance	$7,925

The Company recorded $1.2 million in provision for loan losses in the first nine months of 2017 and recorded a provision of $391,000 for loan losses during the same period in 2016. The increase in the provision for 2017 was primarily the result of rapid loan growth in 2017.

Non-Interest Income

The following table provides a summary of non-interest income for the periods presented.

	Three months		Nine months
	ended September 30,		ended September 30,
(In thousands)	2017	2016	2017	2016
Non-interest income
Increase in cash surrender value of bank owned
life insurance	$258	$220	$771	$669
Net gain on sale of securities	-	-	-	85
Service charges and fees	75	65	205	179
Mortgage origination fees and gains on sale of loans	6	59	83	124
Net loss on sale or impairment of foreclosed assets	(311)	-	(311)	(257)
Other fees and income	246	94	523	285
Total non-interest income	$274	$438	$1,271	$1,085

Third Quarter 2017 compared to Third Quarter 2016

Non-interest income for the quarter ended September 30, 2017 was $274,000, a decrease of $164,000 from $438,000 for the same period in 2016. The primary reason for the decrease was a $311,000 loss on other real estate in 2017. There were no such losses in the same period of 2016.

Year-to-Date 2017 compared to Year-to-Date 2016

Non-interest income for the nine months ended September 30, 2017 was $1,271,000, an increase of $186,000 from $1,085,000 for the same period in 2016. The primary reason for the increase was a significant increase of $238,000 in other non-interest income as a result of additional distributions of minority partnership income.

Non-Interest Expenses

The following table provides a summary of non-interest expenses for the periods presented.

	Three months		Nine months
	ended September 30,		ended September 30,
(In thousands, except per share data)	2017	2016	2017	2016
Non-interest expense
Salaries and employee benefits	$4,265	$3,912	$13,037	$11,521
Furniture, equipment and software costs	418	456	1,371	1,450
Occupancy	390	362	1,122	1,048
Data processing	547	270	1,657	845
Director related fees and expenses	226	219	703	690
Professional fees	149	208	596	627
FDIC and other supervisory assessments	176	220	543	632
Advertising and public relations	228	239	746	661
Unreimbursed loan costs and foreclosure related expenses	214	172	492	383
Merger related expenses	98	-	466	-
Other	663	720	2,110	2,009
Total non-interest expense	$7,374	$6,778	$22,843	$19,866

Third Quarter 2017 compared to Third Quarter 2016

Non-interest expense increased period over period by $600,000, or 8.8%, to $7.4 million for the three-month period ended September 30, 2017, from $6.8 million for the same period in 2016. The following are highlights of the significant changes in non-interest expense in the third quarter of 2017 compared to the third quarter of 2016.

●

Personnel expenses increased $353,000 to $4.3 million due primarily to the addition of temporary personnel to compensate for the departure of employees who have left the Company due to the proposed merger with TowneBank.

●

Data processing expense increased $208,000 to $547,000 from $339,000 in the third quarter of 2017. This was due primarily due to an increase in core processing related expenses associated with the growth of the Company.

●

The Company had merger-related expenses of $98,000 in the third quarter of 2017 as a result of the April 26, 2017 announcement of the proposed merger with TowneBank.

Year-to-Date 2017 compared to Year-to-Date 2016

Non-interest expense increased period over period by $3.0 million, or 15.0%, to $22.8 million for the nine-month period ended September 30, 2017, from $19.9 million for the same period in 2016. The following are highlights of the significant changes in non-interest expense in the first nine months of 2017 compared to the same period in 2016.

●

Personnel expenses increased $1.5 million to $13.0 million due primarily to the addition of temporary personnel to compensate for the departure of employees who have left the Company due to the proposed merger with TowneBank.

●

The Company had merger-related expenses of $466,000 in the first nine months of 2017 as a result of the proposed merger with TowneBank. There were no such costs in the same period of 2016.

●

Data processing expense increased by $498,000 primarily due to an increase in core processing related expenses associated with the growth of the Company.

Provision for Income Taxes

Income tax expense was $2.2 million in the third quarter of 2017 and $1.6 million for the same period in 2016. The Company’s effective tax rate for the third quarter of 2017 was 34.2%, compared to 31.4% for the same period in 2016. The increase in effective tax rate was primarily due to a larger portion of the quarter-over-quarter growth coming from taxable instruments such as loans compared to nontaxable instruments and to nondeductible merger-related costs incurred in the third quarter of 2017.

For the nine-month period ended September 30, 2017, income tax expense was $5.6 million compared to $4.7 million for the same period in 2016. The Company’s effective tax rate for the nine-month period ended September 30, 2017 was 34.1%, compared to 32.4% for the same period in 2016. The increase in effective tax rate was primarily due to a larger portion of the year over year growth coming from taxable instruments such as loans compared to nontaxable instruments and to nondeductible merger-related costs incurred in the third quarter of 2017.

Also, in 2017, the North Carolina state corporate income tax rate decreased from 4% to 3%.

Analysis of Financial Condition

Overview

Total assets at September 30, 2017 were $1.74 billion, an increase of $240.2 million or 16.0% over the balance as of December 31, 2016 of $1.50 billion. Interest earning assets at September 30, 2017 totaled $1.68 billion and consisted of $1.38 billion in net loans, $197.2 million in investment securities, $12.4 million in Federal Home Loan Bank of Atlanta stock, and $79.4 million in overnight investments and interest-bearing deposits in other banks. Interest earning assets at December 31, 2016 totaled $1.43 billion and consisted of $1.18 billion in net loans, $168.9 million in investment securities, $8.1 million in Federal Home Loan Bank of Atlanta stock, and $31.0 million in overnight investments and interest-bearing deposits in other banks. Total deposits and stockholders’ equity at September 30, 2017 were $1.29 billion and $149.1 million, respectively. Total deposits and stockholders’ equity at December 31, 2016 were $1.17 billion and $136.1 million, respectively.

Investment Securities

The Company's investment portfolio plays a major role in the management of liquidity and interest rate sensitivity and, therefore, is managed in the context of the overall balance sheet. In general, the primary goals of the investment portfolio are: (i) to provide a sufficient margin of liquid assets to meet unanticipated deposit and loan fluctuations and overall funds management objectives; (ii) to provide eligible securities to secure public funds as prescribed by law and other borrowings; (iii) to provide structures and terms to enable proper interest rate risk management; and (iv) to earn the maximum return on funds invested that is commensurate with meeting the requirements of (i), (ii) and (iii). The Company invests in securities as allowable under bank regulations and its investment policy. These securities include U.S. Agency obligations, U.S. government-sponsored entities, including collateralized mortgage obligations and mortgage-backed securities, bank eligible obligations of state or political subdivisions, and limited types of permissible corporate debt and equity securities.

Investment securities as of September 30, 2017 and December 31, 2016 were $197.2 million and $197.4 million, respectively. The Company’s investment portfolio at September 30, 2017 and December 31, 2016, consisted of U.S. government agency obligations, collateralized mortgage obligations, mortgage-backed securities, municipal bonds and other equity investments, and had a weighted average taxable equivalent yield of 2.93% and 2.85% at September 30, 2017 and December 31, 2016, respectively. The Company also held an investment of $12.4 million and $8.4 million in Federal Home Loan Bank Stock as of September 30, 2017 and December 31, 2016 with a weighted average yield of 4.91% and 4.64% for those periods. The FHLB stock is recorded at cost and is classified separately from investment securities on the consolidated balance sheets.

The investment portfolio decreased $282,000 during the first nine months of 2017, the net result of $13.5 million in purchases, $14.7 million of maturities and prepayments and an increase of $1.8 million in the market value of securities held available for sale.

The securities in an unrealized loss position as of September 30, 2017 continue to perform and are expected to perform through maturity, and the issuers have not experienced significant adverse events that would call into question their ability to repay these debt obligations according to contractual terms.

The following is a summary of the securities portfolio by major classification at September 30, 2017 and December 31, 2016.

	September 30, 2017		December 31, 2016
	Amortized	Fair	Amortized	Fair
(In thousands)	Cost	Value	Cost	Value
Available-for-sale:
U.S. Agency obligations	$15,153	$15,220	$17,062	$16,943
Collateralized mortgage obligations	38,729	38,763	42,439	42,497
Mortgage-backed securities	73,290	72,629	75,138	73,873
Municipal bonds	66,320	67,571	60,901	60,677
Other	3,676	2,976	3,676	3,451
Total	$197,168	$197,159	$199,216	$197,441

The following table summarizes the securities portfolio by major classification as of September 30, 2017 and December 31, 2016:

	September 30, 2017			December 31, 2016
			Weighted			Weighted
			Average Tax			Average Tax
	Amortized	Fair	Equivalent	Amortized	Fair	Equivalent
(Dollars in thousands)	Cost	Value	Yield (1)	Cost	Value	Yield (1)
U.S. government agency obligations
Due within one year	$-	$-	-	$-	$-	-
Due after one but within five years	-	-	-	-	-	-
Due after five but within ten years	-	-	-	-	-	-
Due after ten years	15,153	15,220	2.62%	17,062	16,943	2.61%
	15,153	15,220	2.62%	17,062	16,943	2.61%
Collateralized mortgage obligations
Due within one year	-	-	-	-	-	-
Due after one but within five years	-	-	-	-	-	-
Due after five but within ten years	-	-	-	-	-	-
Due after ten years	38,729	38,763	2.37%	42,439	42,497	2.43%
	38,729	38,763	2.37%	42,439	42,497	2.43%
Mortgage-backed securities
Due within one year	-	-	-	-	-	-
Due after one but within five years	7,343	7,448	2.54%	7,492	7,581	2.54%
Due after five but within ten years	7,077	7,199	2.74%	5,237	5,341	3.07%
Due after ten years	58,870	57,982	2.31%	62,409	60,951	2.13%
	73,290	72,629	2.37%	75,138	73,873	2.24%
Municipal bonds
Due within one year	-	-	-	-	-	-
Due after one but within five years	2,822	2,893	2.95%	1,734	1,771	3.23%
Due after five but within ten years	8,610	8,810	3.62%	6,078	6,087	3.22%
Due after ten years	54,888	55,868	4.05%	53,089	52,819	4.02%
	66,320	67,571	3.94%	60,901	60,677	3.92%
Other investments
Due within one year	-	-	-	-	-	-
Due after one but within five years	-	-	-	-	-	-
Due after five but within ten years	1,500	1,513	6.64%	1,500	1,500	6.77%
Due after ten years (2)	2,176	1,463	0.00%	2,176	1,951	0.00%
	3,676	2,976	2.76%	3,676	3,451	2.76%
Total securities available for sale
Due within one year	-	-	-	-	-	-
Due after one but within five years	10,165	10,341	2.65%	9,226	9,352	2.67%
Due after five but within ten years	17,187	17,522	3.53%	12,815	12,928	2.82%
Due after ten years (2)	169,816	169,296	2.88%	177,175	175,161	2.91%
	$197,168	$197,159	2.93%	$199,216	$197,441	2.85%

(1)

The marginal tax rate used to calculate tax equivalent yield was 30.0%.

(2)

Includes investments with no stated maturity date

As of September 30, 2017, the weighted average life of the Company's debt securities was 4.96 years, and the weighted average effective duration was 3.7 years.

Loans Receivable

The Company serves the credit needs of commercial and private banking clients in its markets through a range of commercial and consumer loan products. The objective of the Company's lending function is to help clients reach their goals. This is accomplished through loan products that best fit the needs of each client and are profitable to the Company. The lending process combines a thorough knowledge of each client and the local market with the high standards of the Company’s credit culture. Underwriting criteria governing the level of assumed risk and a sharp focus on maintaining a well-balanced loan portfolio play a critical role in the process.

Strict attention is placed on balancing loan quality and profitability with loan growth. The Company has established concentration limits by borrower, product type, loan structure, and industry. Commercial loans are generally secured by business assets and real estate, supported by personal guarantees as needed. Loans to private banking clients are primarily secured with personal assets and real estate.

The loan portfolio at September 30, 2017 totaled $1.39 billion and was composed of $75.5 million in construction and land development loans, $775.3 million in commercial real estate loans, $339.4 million in consumer real estate loans, $178.8 million in commercial and industrial loans, and $20.8 million in consumer and other loans. Also included in loans outstanding is $254,000 in net deferred loan costs.

The loan portfolio at December 31, 2016 totaled $1.19 billion and was composed of $79.7 million in construction and land development loans, $641.7 million in commercial real estate loans, $287.1 million in consumer real estate loans, $170.7 million in commercial and industrial loans, and $11.5 million in consumer and other loans. Also included in loans outstanding is $518,000 in net deferred loan costs.

The following table describes the Company’s loan portfolio composition by category:

	At September 30,		At December 31,
	2017		2016
		% of		% of
		Total		Total
(Dollars in thousands)	Amount	Loans	Amount	Loans
Construction and land development	$75,465	5.4%	$79,738	6.7%
Commercial real estate:
Non-farm, non-residential	448,762	32.4%	365,569	30.7%
Owner occupied	221,661	15.9%	186,892	15.7%
Multifamily, nonresidential and junior liens	104,892	7.5%	89,191	7.5%
Total commercial real estate	775,315	55.8%	641,652	53.9%
Consumer real estate:
Home equity lines	92,285	6.6%	87,489	7.3%
Secured by 1-4 family residential, secured by
first deeds of trust	242,655	17.5%	195,343	16.4%
Secured by 1-4 family residential, secured by
second deeds of trust	4,425	0.3%	4,289	0.4%
Total consumer real estate	339,365	24.4%	287,121	24.1%
Commercial and industrial loans (except those
secured by real estate)	178,765	12.9%	170,709	14.3%
Consumer and other	20,823	1.5%	11,542	1.0%
Less:
Deferred loan origination (fees) costs	254	0.0%	518	0.0%
Total loans	1,389,987	100%	1,191,280	100%
Allowance for loan losses	(9,402)		(7,909)
Total net loans	$1,380,585		$1,183,371

During the nine months ended September 30, 2017, loans receivable increased by $198.7 million, or 16.7%, to $1.39 billion as of period end. The increase in loans during the quarter is primarily attributable to new loan origination driven by the demand in the Company’s market areas.

During 2016, loans receivable increased by $175.1 million, or 17.2%, to $1.19 billion as of December 31, 2016. The increase in loans during the year is also primarily attributable to new loan origination driven by the demand in the Company’s market areas.

Maturities and Sensitivities of Loans to Interest Rates

The following table presents the maturity distribution of the Company’s loans at September 30, 2017. The table also presents the portion of loans that have fixed interest rates or variable interest rates that fluctuate over the life of the loans in accordance with changes in an interest rate index such as the prime rate:

	At September 30, 2017
		Due after one
	Due within	year but within	Due after
(in thousands)	one year	five years	five years	Total
Fixed rate loans (1):
Construction and land development	$16,952	$23,029	$9,258	$49,239
Commercial real estate	24,837	255,299	67,111	347,247
Commercial real estate owner occupied	12,963	108,778	84,561	206,302
Multifamily, nonresidential and junior liens	3,038	46,648	14,915	64,601
Home equity lines	452	149	-	601
Secured by 1-4 family residential, secured by first
deeds of trust	9,497	87,013	140,957	237,467
Secured by 1-4 family residential, secured by
second deeds of trust	148	2,754	433	3,335
Commercial and industrial loans (except those
secured by real estate)	7,368	72,876	17,472	97,716
Consumer and other	385	8,881	-	9,266
Total at fixed rates	75,640	605,427	334,707	1,015,774
Variable rate loans (1):
Construction and land development	11,583	9,461	5,068	26,112
Commercial real estate	16,862	40,315	44,338	101,515
Commercial real estate owner occupied	1,606	6,765	6,988	15,359
Multifamily, nonresidential and junior liens	1,243	19,945	19,103	40,291
Home equity lines	6,358	10,874	74,268	91,500
Secured by 1-4 family residential, secured by first
deeds of trust	2,440	1,770	863	5,073
Secured by 1-4 family residential, secured by
second deeds of trust	417	310	310	1,037
Commercial and industrial loans (except those
secured by real estate)	61,717	17,097	2,235	81,049
Consumer and other	4,576	6,812	169	11,557
Total at variable rates	106,802	113,349	153,342	373,493
Subtotal	182,442	718,776	488,049	1,389,267
Non-accrual loans (2)	53	229	184	466
Gross Loans	$182,495	$719,005	$488,233	1,389,733
Deferred origination costs				254
Total loans				$1,389,987

(1)

Loan maturities are presented based on the final contractual maturity of each loan and do not reflect contractual principal payments prior to maturity on amortizing loans.

(2)

Includes nonaccrual restructured loans.

The Company may renew loans at maturity when requested by a customer whose financial strength appears to support such renewal or when such renewal appears to be in the Company’s best interest. In such instances, the Company generally requires payment of accrued interest and may require a principal reduction or modify other terms of the loan at the time of renewal.

Past Due Loans and Nonperforming Assets

Loans are reported as past due when the contractual amounts due with respect to principal and interest are not received by the contractual due date. Loans are generally classified as nonaccrual if they are past due for a period of 90 days or more at the end of any calendar month, unless such loans are well secured and in the process of collection. If a loan or a portion of a loan is classified as doubtful or as partially charged off, the loan is generally classified as nonaccrual. Loans that are on a current payment status or past due less than 90 days may also be classified as nonaccrual if repayment in full of principal and/or interest is in doubt. Loans may be returned to accrual status when all principal and interest amounts contractually due are reasonably assured of repayment within an acceptable period of time, and there is a sustained period of repayment performance of interest and principal by the borrower in accordance with the contractual terms.

While a loan is classified as nonaccrual and the future collectability of the recorded loan balance is doubtful, collections of interest and principal are generally applied as a reduction to the principal outstanding, except in the case of loans with scheduled amortizations where the payment is generally applied to the oldest payment due. When the future collectability of the recorded loan balance is expected, interest income may be recognized on a cash basis. In the case where a nonaccrual loan had been partially charged off, recognition of interest on a cash basis is limited to that which would have been recognized on the recorded loan balance at the contractual interest rate. Receipts in excess of that amount are recorded as recoveries to the allowance for loan losses until prior charge-offs have been fully recovered.

Assets acquired as a result of foreclosure are recorded at estimated fair value in other real estate (or foreclosed assets). Any excess of cost over estimated fair value at the time of foreclosure is charged to the allowance for loan losses. Valuations are periodically performed on these properties, and any subsequent write-downs are charged to earnings. Routine maintenance and other holding costs are included in non-interest expense. Loans are classified as troubled debt restructurings (“TDR”) by the Company when certain modifications are made to the loan terms and concessions are granted to the borrowers due to financial difficulty experienced by those borrowers. The Company grants concessions by (1) reduction of the stated interest rate for the remaining original life of the debt or (2) extension of the maturity date at a stated interest rate lower than the current market rate for new debt with similar risk. The Company does not generally grant concessions through forgiveness of principal or accrued interest. The Company’s policy with respect to accrual of interest on loans restructured in a TDR follows relevant supervisory guidance. That is, if a borrower has demonstrated performance under the previous loan terms and shows capacity to perform under the restructured loan terms, continued accrual of interest at the restructured interest rate is likely. If a borrower was materially delinquent on payments prior to the restructuring but shows the capacity to meet the restructured loan terms, the loan will likely continue as nonaccrual until there is demonstrated performance under new terms. Lastly, if the borrower does not perform under the restructured terms, the loan is placed on nonaccrual status. The Company closely monitors these loans and ceases accruing interest on them if management believes that the borrowers may not continue performing based on the restructured note terms.

The following tables present an age analysis of past due loans, segregated by class of loans as of September 30, 2017 and December 31, 2016:

	30+	Non-	Total
	Days	Accrual	Past		Total
(in thousands)	Past Due	Loans	Due	Current	Loans
At September 30, 2017
Construction and land development	$-	$114	$114	$75,351	$75,465
Non-farm, non-residential	-	-	-	448,762	448,762
Owner occupied	-	-	-	221,661	221,661
Multifamily, nonresidential and junior liens	-	-	-	104,892	104,892
Home equity lines	-	184	184	92,101	92,285
Secured by 1-4 family residential, secured
by first deeds of trust	-	115	115	242,540	242,655
Secured by 1-4 family residential,
secured by second deeds of trust	-	53	53	4,372	4,425
Commercial and industrial loans (except
those secured by real estate)	149	-	149	178,616	178,765
Consumer and other	-	-	-	20,823	20,823
	$149	$466	$615	$1,389,118	$1,389,733

At December 31, 2016
Construction and land development	$-	$125	$125	$79,613	$79,738
Non-farm, non-residential	-	-	-	365,569	365,569
Owner occupied	-	-	-	186,892	186,892
Multifamily, nonresidential and junior liens	-	-	-	89,191	89,191
Home equity lines	-	194	194	87,295	87,489
Secured by 1-4 family residential, secured
by first deeds of trust	-	531	531	194,812	195,343
Secured by 1-4 family residential,
secured by second deeds of trust	-	58	58	4,231	4,289
Commercial and industrial loans (except
those secured by real estate)	-	60	60	170,649	170,709
Consumer and other	-	-	-	11,542	11,542
	$-	$968	$968	$1,189,794	$1,190,762

The table below sets forth, for the periods indicated, information about the Company’s nonaccrual loans, loans past due 90 days or more and still accruing interest, total non-performing loans (nonaccrual loans plus nonaccrual restructured loans), and total non-performing assets.

	At September 30,	At December 31,
(Dollars in thousands)	2017	2016
Non-accrual loans	$184	$785
Restructured loans (1)	282	183
Total nonperforming loans	466	968
Foreclosed real estate	3,399	4,740
Total nonperforming assets	$3,865	$5,708

Accruing loans past due 90 days or more	$-	$-
Allowance for loan losses	9,402	7,909

Nonperforming loans to period end loans	0.03%	0.08%
Allowance for loan losses to period end
loans	0.68%	0.66%
Allowance for loan losses to
nonperforming loans	2017.60%	817.05%
Allowance for loan losses to
nonperforming assets	243.26%	138.56%
Nonperforming assets to total assets	0.22%	0.38%

(1)

Restructured loans are also on nonaccrual status.

In addition to the above, as of September 30, 2017, the Company had $2.3 million in loans that were considered to be impaired for reasons other than their past due, accrual or restructured status. In total, there were $2.8 million in loans that were considered to be impaired as of September 30, 2017. As of December 31, 2016, the Company had $2.7 million in loans that were considered to be impaired for reasons other than their past due, accrual or restructured status. In total, there were $3.2 million in loans that were considered to be impaired at December 31, 2016.

Allowance for Loan Losses

The allowance for loan losses is a reserve established through provisions for loan losses charged to expense and represents management’s best estimate of probable loan losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated losses and risk inherent in the loan portfolio. The Company’s allowance for loan loss methodology is based on historical loss experience by type of credit and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions. The Company’s process for determining the appropriate level of reserves is designed to account for changes in credit quality as they occur. The provision for loan losses reflects loan quality trends, including the levels of and trends related to past due loans and economic conditions at the local and national levels. It also considers the quality and risk characteristics of the Company’s loan origination and servicing policies and practices. Included in the allowance are specific reserves on loans that are considered to be impaired, which are identified and measured in accordance with ASC 310.

The following table presents the Company’s allowance for loan losses allocated to each category of the Company’s loan portfolio and each category of the loan portfolio as a percentage of total loans, at September 30, 2017 and at December 31, 2016.

	At September 30,		At December 31,
	2017		2016
		% of		% of
		Total		Total
(Dollars in thousands)	Amount	Loans	Amount	Loans
Construction and land development	$402	4.3%	$486	6.7%
Commercial real estate	4,406	46.9%	3,719	53.9%
Consumer real estate	2,173	23.1%	1,900	24.1%
Commercial and industrial loans (except those
secured by real estate)	2,304	24.5%	1,728	14.3%
Consumer and other	117	1.2%	76	1.0%
Total	$9,402	100.0%	$7,909	100.0%

The allowance for loan losses as a percentage of gross loans outstanding was 0.68% for September 30, 2017 and 0.66% for December 31, 2016. The change in the allowance during the period resulted from net recoveries of $76,000 and loan loss provisions of $405,000 commensurate with $199.0 million of loan growth. General reserves totaled $8.6 million or 0.62% of gross loans outstanding as of September 30, 2017, equal to December 31, 2016 when they totaled $7.9 million or 0.62% of loans outstanding. At September 30, 2017, specific reserves on impaired loans constituted $824,000 or 0.06% of gross loans outstanding compared to $509,000 or 0.04% of loans outstanding as of December 31, 2016.

The following table presents information regarding changes in the allowance for loan losses in detail for the years indicated:

	Three months ended September 30,		Nine months ended September 30,
(Dollars in thousands)	2017	2016	2017	2016
Allowance for loan losses at beginning of the period	$8,921	$7,986	$7,909	$7,641
Provision for loan losses	405	391	1,214	391

Loans charged off:
Commercial and industrial loans (except those
secured by real estate)	(11)	(682)	(20)	(682)
Consumer and other	-	-	(13)	(1)
Total charge-offs	(11)	(682)	(33)	(683)
Recoveries of loans previously charged off:
Construction and land development	80	58	227	295
Commercial real estate	2	3	30	59
Consumer real estate	-	1	-	7
Commercial and industrial loans (except those
secured by real estate)	5	168	55	204
Consumer and other	-	-	-	11
Total recoveries	87	230	312	576
Net recoveries	76	(452)	279	(107)
Allowance for loan losses at end of the period	$9,402	$7,925	$9,402	$7,925

Ratio of net recoveries during the period
to average loans outstanding during
the period	0.01%	-0.16%	0.02%	-0.01%

While the Company 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 determinations regarding the allowance.

Management believes the level of the allowance for loan losses as of September 30, 2017 and December 31, 2016 is appropriate in light of the risk inherent within the Company’s loan portfolio.

Other Assets

At September 30, 2017, non-earning assets totaled $74.3 million, a decrease of $1.8 million from $76.1 million at December 31, 2016. Non-earning assets at September 30, 2017 consisted of: cash and due from banks of $4.0 million, premises and equipment totaling $15.3 million, foreclosed real estate totaling $3.4 million, accrued interest receivable of $4.8 million, bank owned life insurance, or BOLI, of $35.0 million and other assets totaling $7.6 million, with net deferred taxes of $4.3 million.

At December 31, 2016, non-earning assets totaled $76.1 million. Non-earning assets at December 31, 2016 consisted of: cash and due from banks of $4.6 million, premises and equipment totaling $15.6 million, foreclosed real estate totaling $4.7 million, accrued interest receivable of $4.4 million, bank owned life insurance of $34.2 million and other assets totaling $7.8 million, with net deferred taxes of $4.8 million.

As of September 30, 2017, the Company had an investment in bank owned life insurance of $35.0 million, which increased $771,000 from December 31, 2016. The increase in BOLI was due to an increase in cash surrender value. Since the income on this investment is included in non-interest income, the asset is not included in the Company’s calculation of earning assets.

Deposits

Deposits gathered from clients represent the primary source of funding for the Company’s lending activities. Commercial and private banking deposit services include non-interest and interest bearing checking accounts, money market accounts, and to a limited extent, IRAs and CDs. Interest rates for each account type are set by the Company within the context of marketplace factors, current deposit needs, and a keen awareness of maintaining a strong margin.

Total deposits at September 30, 2017 were $1.29 billion and consisted of $253.5 million in non-interest-bearing demand deposits, $865.4 million in interest-bearing checking and money market accounts, and $169.3 million in time deposits. Total deposits increased by $115.9 million from $1.17 billion as of December 31, 2016. Non-interest-bearing demand deposits increased by $42.3 million from $211.2 million as of December 31, 2016. Interest-bearing and money market accounts increased by $123.3 million from $742.0 million as of December 31, 2016. Time deposits decreased by $49.7 million during the nine-month period ended September 30, 2017 from $219.0 million as of December 31, 2016. The increase in deposits was primarily due to a focus on growing core customer deposits and demand in the markets in which the Bank operates.

The table below provides a summary of the Company’s deposit portfolio by deposit type.

	As of
	September 30,	December 31,
Composition of Deposit Portfolio	2017	2016
Non-interest bearing	19.7%	18.0%
Interest-bearing checking accounts	22.0%	19.7%
Money markets	45.2%	43.7%
Time deposits	13.1%	18.6%
Total	100.0%	100.0%

The following table shows historical information regarding the average balances outstanding and average interest rates for each major category of deposits:

	For the Three-Month Period Ended September 30,
	2017			2016
	Average	% of	Average	Average	% of	Average
(Dollars in thousands)	Amount	Total	Rate	Amount	Total	Rate
Interest-bearing checking accounts	$229,064	19.5%	0.36%	$186,369	16.6%	0.36%
Money markets	547,391	46.5%	0.67%	491,805	43.8%	0.65%
Time deposits	173,981	14.8%	1.08%	254,358	22.6%	0.92%
Total interest-bearing deposits	950,436	80.8%	0.67%	932,532	83.0%	0.66%
Noninterest-bearing deposits	226,173	19.2%	-	190,745	17.0%	-
Total deposits	$1,176,609	100.0%	0.54%	$1,123,277	100.0%	0.55%

	For the Nine-Month Period Ended September 30,
	2017			2016
	Average	% of	Average	Average	% of	Average
(Dollars in thousands)	Amount	Total	Rate	Amount	Total	Rate
Interest-bearing checking accounts	$226,040	19.2%	0.38%	$165,655	15.8%	0.42%
Money markets	538,274	45.6%	0.67%	432,362	41.4%	0.66%
Time deposits	191,613	16.2%	1.01%	266,903	25.5%	0.86%
Total interest-bearing deposits	955,927	81.0%	0.67%	864,920	82.7%	0.67%
Noninterest-bearing deposits	223,713	19.0%	-	180,623	17.3%	-
Total deposits	$1,179,640	100.0%	0.54%	$1,045,543	100.0%	0.56%

The overall mix of deposits has shifted to a higher percentage of non-interest demand deposits and interest-bearing demand with reductions in the percentage of deposits held in time deposit accounts. The Company believes its deposit product offerings are properly structured to attract and retain core low-cost deposit relationships. The average cost of deposits was 0.54% in the third quarter of 2017 compared to 0.55% in the third quarter of 2016 due to changes in deposit mix. The average cost of deposits was 0.54% for the nine-month period ended September 30, 2017 compared to 0.56% in the third quarter of 2016 due to changes in deposit mix.

Short-Term and Long-Term Debt

The Company uses short-term borrowings and long-term debt to provide both funding and, to a lesser extent, regulatory capital. As of September 30, 2017, the Company had $260.0 million in short-term debt, which consisted solely of FHLB advances compared to an outstanding balance of $150.0 million at year-end 2016. The increase in short-term debt was due to the Company’s rapid loan growth during the first nine months of 2017 and paying off the Brokered CDs as they matured.

The Company had outstanding $18.6 million in junior subordinated debentures as of September 30, 2017 and December 31, 2016. These junior subordinated debentures were issued to Paragon Commercial Trust I and Paragon Commercial Trust II in connection with the issuance of trust preferred securities on May 18, 2004 and May 30, 2006, respectively. Additional information regarding the junior subordinated debentures can be found in Note 7 of the Company’s 2016 audited consolidated financial statements, which are included within the Company’s Annual Report on Form 10-K as of and for the year ended December 31, 2016.

Stockholders’ Equity

Total stockholders’ equity at September 30, 2017 was $149.1 million, an increase of $13 million from $136.1 million as of December 31, 2016. The change in stockholders’ equity principally represents net income to common stockholders for the nine months ended September 30, 2017 of $10.8 million and other comprehensive income of $1.5 million related to net increasing values in the Company’s available for sale investment securities portfolio and its cash flow hedges.

Liquidity

Market and public confidence in the Company’s financial strength and in the strength of financial institutions in general will largely determine the Company’s access to appropriate levels of liquidity. This confidence depends significantly on the Company’s ability to maintain sound asset quality and appropriate levels of capital resources. The term “liquidity” refers to the Company’s ability to generate adequate amounts of cash to meet current needs for funding loan originations, deposit withdrawals, maturities of borrowings and operating expenses. Investment portfolio principal payments and maturities, loan principal payments, deposit growth, brokered deposit sources, available borrowings from the FHLB, and various federal funds lines from correspondent banks are the primary sources of liquidity for the Bank. Management measures the Bank’s liquidity position by giving consideration to both on- and off-balance sheet sources of, and demands for, funds on a daily and weekly basis.

Liquid assets (consisting of cash and due from banks, interest-earning deposits with other banks, federal funds sold and investment securities classified as available for sale) represented 13.1% and 12.1% of total assets at September 30, 2017 and December 31, 2016, respectively.

The Bank has seen a net reduction in wholesale funding, maintaining liquidity sufficient to fund new loan demand and to reduce part of its wholesale funding. When the need arises, the Bank has the ability to sell securities classified as available for sale, sell loan participations to other banks, or to borrow funds as necessary. The Bank has established credit lines with other financial institutions to purchase up to $102.5 million in federal funds and had no borrowings as of September 30, 2017 or December 31, 2016. Also, as a member of the Federal Home Loan Bank of Atlanta, the Bank may obtain advances of up to 30% of assets, subject to our available collateral. The Bank had an available borrowing line at September 30, 2017 of $492.4 million at the FHLB, secured by qualifying loans. As of that date, the Bank had $260.0 million outstanding on the line and available borrowing capacity of $232.4 million. In addition, the Bank may borrow up to $155.2 million at the Federal Reserve discount window and has pledged loans for that purpose. As another source of short-term borrowings, the Bank also utilizes securities sold under agreements to repurchase. At September 30, 2017, borrowings of securities sold under agreements to repurchase were $21.1 million.

At September 30, 2017, the Bank had undisbursed lines of credit of $264.5 million, and letters of credit of $5.3 million. The Bank believes that its combined aggregate liquidity position from all sources is sufficient to meet the funding requirements of loan demand and deposit maturities and withdrawals in the near term.

Total deposits were $1.29 billion and $1.17 billion as of September 30, 2017 and December 31, 2016, respectively. Time deposits, which are the only deposit accounts that have stated maturity dates, are generally considered to be rate sensitive. Time deposits represented 13.1% and 18.6% of total deposits at September 30, 2017 and December 31, 2016, respectively. Other than brokered time deposits, management believes most other time deposits are relationship-oriented. While competitive rates will need to be paid to retain these deposits at their maturities, there are other subjective factors that will determine their continued retention.

Management believes that current sources of funds provide adequate liquidity for the Company’s current cash flow needs. The Bank’s parent company maintains minimal cash balances. Management believes that the current cash balances plus taxes receivable will provide adequate liquidity for the Company’s current cash flow needs.

Contractual Obligations

During the second quarter of 2017, the Company amended its original lease on its Cary location. The new lease added another 2,600 square feet of additional space on the second floor of the building at 5000 Valleystone Drive, Cary, NC. The lease term is 66 months.

The following table presents the Company's significant fixed and determinable contractual obligations by payment date. The payment amounts represent those amounts contractually due to the recipient. The table excludes liabilities recorded where management cannot reasonably estimate the timing of any payments that may be required in connection with these liabilities.

	September 30, 2017
	1 Year	Over 1 to	Over 3 to	More Than
(In thousands)	or Less	3 Years	5 Years	5 Years	Total
Time deposits	$103,207	$49,233	$16,837	$-	$169,277
Short term borrowings	260,000	-	-	-	260,000
Subordinated debentures	-	-	-	18,558	18,558
Operating leases	796	924	547	3,981	6,248
Total contractual obligations	$364,003	$50,157	$17,384	$22,539	$454,083

Capital

Our management seeks to maintain adequate capital to support anticipated asset growth, operating needs and unexpected risks, and to ensure that the Company and the Bank are in compliance with all current and anticipated regulatory capital guidelines. Our primary sources of new capital include retained earnings and proceeds from the sale and issuance of capital stock or other securities.

On July 2, 2013, the Federal Reserve, and on July 9, 2013, the FDIC, adopted a final rule that implemented the Basel III changes to the international regulatory capital framework, referred to as the “Basel III Rules.” The Basel III Rules apply to both depository institutions and their holding companies. The Basel III Rules, which became effective for both the Company and the Bank on January 1, 2015, include new risk-based and leverage capital ratio requirements which refined the definition of what constitutes “capital” for purposes of calculating those ratios. The minimum capital level requirements applicable to the Company and the Bank under the Basel III Rules are: (i) a common equity Tier 1 risk-based capital ratio of 4.5 percent; (ii) a Tier 1 risk-based capital ratio of 6 percent; (iii) a total risk-based capital ratio of 8 percent; and (iv) a Tier 1 leverage ratio of 4 percent for all institutions. Common equity Tier 1 capital consists of retained earnings and common stock instruments, subject to certain adjustments.

The Basel III Rules also establish a “capital conservation buffer” of 2.5 percent above the new regulatory minimum risk-based capital requirements. The conservation buffer, when added to the capital requirements, result in the following minimum ratios: (i) a common equity Tier 1 risk-based capital ratio of 7.0 percent, (ii) a Tier 1 risk-based capital ratio of 8.5 percent, and (iii) a total risk-based capital ratio of 10.5 percent. The new capital conservation buffer requirement began to be phased in beginning in January 2016 at 0.625 percent of risk-weighted assets and will increase by that amount each year until fully implemented in January 2019. An institution will be subject to limitations on certain activities including payment of dividends, share repurchases and discretionary bonuses to executive officers if its capital level is below the buffer amount.

The Basel III Rules also revised the prompt corrective action framework, which is designed to place restrictions on insured depository institutions, including the Bank, if their capital levels do not meet certain thresholds. The prompt corrective action rules were modified to include a common equity Tier 1 capital component and to increase certain other capital requirements for the various thresholds. For example, under the proposed prompt corrective action rules, insured depository institutions will be required to meet the following capital levels in order to qualify as “well capitalized:” (i) a common equity Tier 1 risk-based capital ratio of 6.5 percent; (ii) a Tier 1 risk-based capital ratio of 8 percent; (iii) a total risk-based capital ratio of 10 percent; and (iv) a Tier 1 leverage ratio of 5 percent. The Basel III Rules also set forth certain changes in the methods of calculating certain risk-weighted assets, which in turn affect the calculation of risk based ratios.

If the Bank fails to meet the requirements for a “well capitalized” bank, it could increase the regulatory scrutiny on the Bank and the Company. In addition, the Bank would not be able to renew or accept brokered deposits without prior regulatory approval and the Bank would not be able to offer interest rates on its deposit accounts that are significantly higher than the average rates in the Bank’s market area. As a result, it would be more difficult to attract new deposits and retain or increase existing, non-brokered deposits. If the Bank is prohibited from renewing or accepting brokered deposits and is unable to attract new deposits, our liquidity and our ability to fund our loan portfolio may be adversely affected. In addition, we would be required to pay higher insurance premiums to the FDIC, which would reduce our earnings.

On May 18, 2004, the Company privately issued trust preferred securities having an aggregate liquidation amount of $10.0 million through Paragon Commercial Capital Trust I. On May 30, 2006, we privately issued additional floating rate trust preferred securities having an aggregate liquidation amount of $8.0 million through Paragon Commercial Capital Trust II. The proceeds provided additional capital for the expansion of the Bank. Under the current applicable regulatory guidelines, all of the trust preferred securities qualify as Tier 1 capital.

On June 21, 2016 the Company issued 845,588 shares of its common stock in an initial public offering. Of the $26.4 million in net proceeds, $3.8 million were used to pay down existing debt at the holding company, $20.5 million were contributed to the Bank as additional capital and the remaining $2.1 million was retained at the holding company level to service existing debt at the holding company level.

Regulatory capital ratios for the Bank exceeded minimum federal regulatory guidelines for a well-capitalized depository institution as of September 30, 2017 and December 31, 2016. Management expects that the Company and the Bank will continue to be in compliance with applicable regulatory capital requirements, although there can be no assurance that additional capital will not be required in the future. The Company’s and the Bank’s capital ratios as of September 30, 2017 are presented in the table below.

			Minimum Requirements To Be:
			"Adequately Capitalized"		"Well Capitalized" (2)
			for Capital Adequacy		Under Prompt Corrective
	Actual		Purposes		Actions Provisions
(Dollars in thousands)	Amount	Ratio (1)	Amount	Ratio (1)	Amount	Ratio (1)
September 30, 2017
The Company
Total risk-based capital ratio	$177,416	12.18%	$116,549	8.000%	N/A	N/A
Tier 1 risk-based capital ratio	168,014	11.53%	87,412	6.000%	N/A	N/A
Common equity Tier 1	150,014	10.30%	65,559	4.500%	N/A	N/A
Tier 1 leverage ratio	168,014	10.01%	67,160	4.000%	N/A	N/A
Tangible equity to tangible assets ratio	150,014	8.94%	N/A	N/A	N/A	N/A
Tangible equity to risk-weighted assets ratio	150,014	10.30%	N/A	N/A	N/A	N/A

The Bank
Total risk-based capital ratio	$175,053	12.02%	$116,481	8.000%	$145,601	10.000%
Tier 1 risk-based capital ratio	165,651	11.38%	87,361	6.000%	116,481	8.000%
Common equity Tier 1	165,651	11.38%	65,520	4.500%	94,641	6.500%
Tier 1 leverage ratio	165,651	9.87%	67,160	4.000%	83,951	5.000%

December 31, 2016
The Company
Total risk-based capital ratio	$164,740	13.21%	$99,778	8.00%	N/A	N/A
Tier 1 risk-based capital ratio	156,831	12.57%	74,833	6.00%	N/A	N/A
Common equity Tier 1	138,831	11.13%	56,125	4.50%	N/A	N/A
Tier 1 leverage ratio	156,831	10.05%	62,434	4.00%	N/A	N/A
Tangible equity to tangible assets ratio	138,831	9.23%	N/A	N/A	N/A	N/A
Tangible equity to risk-weighted assets ratio	138,831	11.31%	N/A	N/A	N/A	N/A

The Bank
Total risk-based capital ratio	$161,925	12.99%	$99,713	8.00%	$124,641	10.00%
Tier 1 risk-based capital ratio	154,016	12.36%	74,785	6.00%	99,713	8.00%
Common equity Tier 1	154,016	12.36%	56,089	4.50%	81,017	6.50%
Tier 1 leverage ratio	154,016	10.37%	59,405	4.00%	74,256	5.00%

Total capital ratio is defined as Tier 1 capital plus Tier 2 capital divided by total risk-weighted assets. The Tier 1 Capital ratio is defined as Tier 1 capital divided by total risk-weighted assets. Common equity Tier 1 is defined as Tier 1 capital excluding qualifying trust preferred securities divided by total risk weighted assets. The leverage ratio is defined as Tier 1 capital divided by the most recent quarter’s average total assets.

Prompt corrective action provisions are not applicable at the bank holding company level.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Management and the Board of Directors are responsible for managing interest rate risk and employing risk management policies that monitor and limit this exposure. Interest rate risk is measured using net interest income simulations and market value of portfolio equity analyses. These analyses use various assumptions, including the nature and timing of interest rate changes, yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, and reinvestment/replacement of asset and liability cash flows.

The principal objective of the Company's asset and liability management function is to evaluate the interest rate risk within the balance sheet and pursue a controlled assumption of interest rate risk while maximizing earnings and preserving adequate levels of liquidity and capital. The asset and liability management function is under the guidance of the Management Asset Liability Committee (“Management ALCO”) with direction of the Board of Directors Asset/Liability Committee (“Board ALCO”). Management ALCO meets monthly to review, among other things, funding uses and sources, the sensitivity of the Company's assets and liabilities to interest rate changes, local and national market conditions and rates. Board ALCO meets quarterly and also reviews the liquidity, capital, deposit mix, loan mix and investment positions of the Company. In addition, Board ALCO reviews modeling performed by a third party of the impact on net interest income and economic value of equity of rate changes in various scenarios as well as the impact of strategies put into place to mitigate interest rate risk. Instantaneous parallel rate shift scenarios are modeled and utilized to evaluate risk and establish exposure limits for acceptable changes in net interest margin. These scenarios, known as rate shocks, simulate an instantaneous change in interest rates and use various assumptions, including, but not limited to, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment and replacement of asset and liability cash flows.

We also analyze the economic value of equity as a secondary measure of interest rate risk. This is a complementary measure to net interest income where the calculated value is the result of the market value of assets less the market value of liabilities. The economic value of equity is a longer term view of interest rate risk because it measures the present value of the future cash flows. The impact of changes in interest rates on this calculation is analyzed for the risk to our future earnings and is used in conjunction with the analyses on net interest income.

Our interest rate risk model indicated that the Company was liability sensitive in terms of interest rate sensitivity at May 31, 2017. Since December 31, 2016, we have slightly decreased our liability sensitivity as a result of shortening the duration of the fixed rate loan and investment portfolios. The table below illustrates the impact in year one of an immediate and sustained 200 basis point increase and a 100 basis point decrease in interest rates on net interest income based on the interest rate risk model at August 31, 2017, May 31, 2017 and November 30, 2016:

Hypothetical	Estimated Resulting Theoretical Net Interest Income
shift in interest	August 31, 2017		May 31, 2017		February 28, 2017
rates (in bps)	Amount	% Change	Amount	% Change	Amount	% Change
(dollars in thousands)
200	$52,736	-3.21%	$51,743	-3.16%	$48,570	-3.31%
0	54,487	0.00%	53,429	0.00%	50,231	0.00%
(100)	54,046	-0.81%	52,907	-0.98%	49,881	-0.70%

Many assumptions are used to calculate the impact of interest rate fluctuations. Actual results may be significantly different than our projections due to several factors, including the timing and frequency of rate changes, market conditions and the shape of the yield curve. The computations of interest rate risk shown above do not include actions that management may undertake to manage the risks in response to anticipated changes in interest rates and actual results may also differ due to any actions taken in response to the changing rates.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

The Company’s management, with the participation of the Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), as of September 30, 2017. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by the Company in the reports filed or submitted by it under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and to provide reasonable assurance that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There were no changes in the Company’s internal controls over financial reporting during the period covered by this Quarterly Report that have materially affected, or are reasonably likely to materially affect, the Company's internal controls over financial reporting.

Part II. Other Information

Item 1. Legal Proceedings

In the ordinary course of operations, the Company is party to various legal proceedings. The Company is not involved in, nor has it terminated during the three or nine months ended September 30, 2017, any pending legal proceedings other than routine, nonmaterial proceedings occurring in the ordinary course of business.

Item 1A. Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2016, 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 the Company. Additional risks and uncertainties unknown to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results. Additionally, there are or will be important factors related to the proposed merger with TowneBank that could cause actual results to differ materially from anticipated results. We believe that these factors include, but are not limited to, those listed below. Capitalized terms used but not otherwise defined in this “Risk Factors” section have the meanings ascribed to them in other sections of this report.

Regulatory approvals may not be received, may take longer than expected, or may impose conditions that are not presently anticipated or that could have an adverse effect on the combined company following the Transaction.

Before the Transaction may be completed, the Company, the Bank, and TowneBank must obtain approvals from the FDIC, the Bureau of Financial Institutions of the Virginia State Corporation Commission and the North Carolina Commissioner of Banks. Other approvals, waivers or consents from regulators may also be required. In determining whether to grant these approvals the regulators consider a variety of factors, including the regulatory standing of each party. An adverse development in any party’s regulatory standing or other factors could result in an inability to obtain or a delay in receiving their approval. These regulators may impose conditions on the completion of the Transaction or require changes to the terms of the Transaction. Such conditions or changes could delay or prevent completion of the Transaction or impose additional costs on or limit the revenues of the combined company following the Transaction, any of which might have an adverse effect on the combined company following the Transaction.

Combining the companies may be more difficult, costly, or time-consuming than expected.

The Company and TowneBank have operated and, until the completion of the Transaction, will continue to operate independently. The success of the Transaction, including anticipated benefits and cost savings, will depend, in part, on TowneBank’s ability to successfully combine and integrate the businesses of TowneBank and the Company in a manner that permits growth opportunities and does not materially disrupt the existing customer relations nor result in decreased revenues due to loss of customers. It is possible that the integration process could result in the loss of key employees, the disruption of either company’s ongoing businesses or inconsistencies in standards, controls, procedures and policies that could adversely affect the combined company’s ability to maintain relationships with clients, customers, depositors and employees or to achieve the anticipated benefits and cost savings of the Transaction. The loss of key employees could adversely affect the Company’s ability to successfully conduct its business, which could have an adverse effect on the Company’s financial results and the value of the Company’s common stock. If TowneBank experiences difficulties with the integration process, the anticipated benefits of the Transaction may not be realized fully or at all, or may take longer to realize than expected. As with any merger of financial institutions, there also may be business disruptions that cause TowneBank and/or the Company to lose customers or cause customers to remove their accounts from TowneBank and/or the Company and move their business to competing financial institutions. Integration efforts will also divert management attention and resources. In addition, the actual cost savings of the Transaction could be less than anticipated.

The Transaction is subject to certain closing conditions that, if not satisfied or waived, will result in the Transaction not being completed. Termination of the Merger Agreement could negatively impact the Company.

The Transaction is subject to customary conditions to closing, including the receipt of required regulatory approvals and adoption of the Merger Agreement by the Company’s stockholders. If any condition to the Transaction is not satisfied or waived, to the extent permitted by law, including the absence of any unduly burdensome condition in the regulatory approvals, the Transaction will not be completed. In addition, either TowneBank or the Company may terminate the Merger Agreement under certain circumstances even if the Merger Agreement is adopted by the Company’s stockholders, including but not limited to, if the Transaction has not been completed on or before March 31, 2018.

If the Merger Agreement is terminated, there may be various consequences. For example, the Company’s businesses may have been impacted adversely by the failure to pursue other beneficial opportunities due to the focus of management on the Transaction, without realizing any of the anticipated benefits of completing the Transaction. Additionally, if the Merger Agreement is terminated, the market price of the Company’s common stock could decline to the extent that the current market prices reflect a market assumption that the Transaction will be completed.

The Company will be subject to business uncertainties and contractual restrictions while the Transaction is pending.

The Merger Agreement restricts the Company from operating its business other than in the ordinary course and prohibits the Company from taking specified actions without TowneBank’s consent until the Transaction occurs. These restrictions may prevent the Company from pursuing attractive business opportunities that may arise prior to the completion of the Transaction. In addition, uncertainty about the effect of the Transaction on employees and customers may have an adverse effect on the Company. These uncertainties may impair the Company’s ability to attract, retain and motivate key personnel until the Transaction is completed, and could cause customers and others that deal with the Company to seek to change existing business relationships with the Company. Retention of certain employees by the Company may be challenging while the Transaction is pending, as certain employees may experience uncertainty about their future roles with the Company. If key employees depart because of issues relating to the uncertainty and difficulty of integration or a desire not to remain with the Company, the Company’s business could be harmed.

The uncertainty caused by the pending Transaction could cause the Company’s clients and business associates to seek to change their existing business relationships with the Company. These uncertainties may impair the Company’s ability to attract, retain and grow its client base until the Transaction is complete.

The market value of the merger consideration that the Company’s stockholders will receive as a result of the Transaction may fluctuate.

If the Transaction is completed, each share of the Company’s common stock will be converted into the right to receive 1.7250 shares of TowneBank common stock, and cash in lieu of any fractional shares. The market value of the merger consideration may vary from the closing price of TowneBank common stock on the date the Transaction was announced, on the date that the proxy statement/prospectus is mailed to the Company’s stockholders, on the date of the meeting of the Company’s stockholders, on the date the Transaction is consummated, and thereafter. Stock price changes may result from a variety of factors, including general market and economic conditions, changes in the respective businesses, operations and prospects, and the regulatory situation of TowneBank and the Company. Many of these factors are beyond the control of the Company. Any change in the market price of TowneBank common stock prior to completion of the Transaction will affect the amount of and the market value of the merger consideration that the Company’s stockholders will receive upon completion of the Transaction. Accordingly, at the time of the stockholders meeting, the Company’s stockholders will not know or be able to calculate the amount or the market value of the merger consideration they would receive upon completion of the Transaction.

Further, the results of operations of the combined company following the Transaction and the market price of the combined company’s shares of common stock may be affected by factors different from those currently affecting the independent results of operations of TowneBank and the Company.

If the Transaction is not completed, the Company will have incurred substantial expenses without realizing the expected benefits of the Transaction.

The Company has incurred and will incur substantial expenses in connection with the negotiation and completion of the transactions contemplated by the Merger Agreement. If the Transaction is not completed, the Company would have to recognize these expenses without realizing the expected benefits of the Transaction.

The Merger Agreement limits the Company’s ability to pursue an alternative acquisition proposal and could require the Company to pay a termination fee of $12 million under certain circumstances relating to alternative acquisition proposals.

The Merger Agreement prohibits the Company from soliciting, initiating or knowingly encouraging certain alternative acquisition proposals with any third party, subject to exceptions set forth in the Merger Agreement. The Merger Agreement also provides for the payment by the Company to TowneBank of a termination fee in the amount of $12 million in the event that the Company or TowneBank terminates the Merger Agreement for certain specified reasons. These provisions might discourage a potential competing acquirer that might have an interest in acquiring all or a significant part of the Company from considering or proposing such an acquisition.

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 following exhibits are being filed herewith:

Exhibit No.		Description

31.1		Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2		Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1		Certification of Principal Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2		Certification of Principal Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101		Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Consolidated Balance Sheets (Unaudited) as of September 30, 2017 and December 31, 2016; (ii) Consolidated Statements of Income (Unaudited) for the Three and Nine Months Ended September 30, 2017 and 2016; (iii) Consolidated Statements of Comprehensive Income (Unaudited) for the Three and Nine Months Ended September 30, 2017 and 2016; (iv) Consolidated Statements of Stockholders’ Equity (Unaudited) for the Nine Months Ended September 30, 2017 and 2016; (v) Consolidated Statements of Cash Flows (Unaudited) for the Nine Months Ended September 30, 2017 and 2016; and (vi) Notes to Consolidated Financial Statements (Unaudited)

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

	PARAGON COMMERCIAL CORPORATION

Date: November 9, 2017	By:	/s/ Steven E. Crouse
		Steven E. Crouse
		Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)

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Paragon Commercial Inactive 10-Q2017 Q3 Quarterly report

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