2017 Annual Report - Aquesta Bank...Murrells Inlet Office 870 B Inlet Sq Dr. PO Box 2295 Murrells Inlet, SC 29576 843.651.7111 Greenville Loan Production Office 27 Cleveland St. Suite

Cornelius Office19510 Jetton Rd.

Cornelius, NC 28031

704.892.6411

Wilmington Office901 Military Cutoff Rd.

Wilmington, NC 28405

910.794.6100

Charleston Loan Production Office4000 Faber Place Dr.

Suite 300

North Charleston, SC 29405

843.242.1555

www.aquesta.com

Main Office 19510 Jetton Road

Cornelius, NC 28031

704.439.4343

Brawley Rd Branch1078 Brawley School Rd.

Mooresville, NC 28117

704.439.1450

Williamson Rd Branch 837 Williamson Rd.


704.439.1440

Davidson Branch 568 Jetton St.

Davidson, NC 28036

704.439.4350

Huntersville Branch 9906 Knockando Ln.

Huntersville, NC 28078

704.439.1430

Southpark Branch 4519 Sharon Road

Charlotte, NC 28211

704.804.7930

Wilmington Branch 901 Military Cutoff Rd Wilmington, NC 28405

910.782.3830

Surf City Office214B N. Topsail Dr.

Surf City, NC 28445

910.794.6100

Murrells Inlet Office870 B Inlet Sq Dr.

PO Box 2295

Murrells Inlet, SC 29576

843.651.7111

Greenville Loan Production Office27 Cleveland St. Suite 103

Greenville, SC 29601

864.979.7117

Stock Symbol: AQFH

2017 Annual ReportProviding vision for the future

Consolidated Financial Statements

December 31, 2017 and 2016 (with Independent Auditor’s Report thereon)

TABLE OF CONTENTS Page No. Letter to Shareholders ...................................................................................................... 2 Independent Auditor’s Report ........................................................................................... 3 Consolidated Financial Statements Consolidated Balance Sheets ....................................................................................... 4 Consolidated Statements of Earnings ........................................................................... 5 Consolidated Statements of Comprehensive Income ................................................... 6 Consolidated Statements of Changes in Stockholders’ Equity ...................................... 7 Consolidated Statements of Cash Flows ...................................................................... 8 Notes to Consolidated Financial Statements .................................................................... 10 Board of Directors and Executive Management ............................................................... 32 General Corporate Information ......................................................................................... 33

May 1, 2018 Dear Shareholders: We are pleased to provide you with the 2017 annual report of Aquesta Financial Holdings, Inc. and its subsidiaries. Aquesta recently celebrated its 11th anniversary and we are proud of how well we have performed over the last decade. We are dedicated to our clients, shareholders, employees and our local communities. Aquesta is one of the top bank growth stories in the country with significant organic – not merger – loan and deposit growth. Our growth is generated by lending in our original focus area near Lake Norman as well as more recently expanding our presence in Charlotte and Wilmington. We are growing profits too. We are pleased to provide a fair return to shareholders that allows for investments for future growth and future profits. 2017 continued to be a year of exceptional growth for Aquesta. Both loan and deposit growth outpaced the local economic growth resulting in Aquesta capturing a larger market share. Aquesta’s growth and asset quality in 2017:

• Total assets increased $55.5 million or 15.7% • Total gross loans increased $54.5 million or 21.7% • Total core deposits increased $38.6 million or 18.8% • Total shareholder’s equity increased $2.5 million or 9.3% • Book value per share increased to $7.48 per share from $6.91 per share • Nonperforming assets to total assets of <0.01%

Aquesta had another year of very good earnings with pre-tax income of $3.5 million (an increase of 7.1%) resulting in income to shareholders of $0.48 per share. This is primarily due to loan and deposit growth along with excellent credit quality. During the year, we paid our 6th consecutive cash dividend as well as our 3rd stock split. We have grown to 7 full service branches in the Lake Norman, Charlotte and Wilmington areas of North Carolina. We also have loan production offices in Greenville and Charleston, South Carolina. And we are continuing to expand! We recently announced a new branch located at Rea Farms in south Charlotte. We anticipate this branch will open in early 2019. And, based on recent merger announcements, Aquesta is the second largest bank headquartered in the Charlotte area – but a bit behind Bank of America’s $2 trillion in assets. We believe that each new Aquesta customer is a potential future ambassador for our bank. As shareholders, you too can help with the success of Aquesta and your investment by using our services, providing us feedback and telling your friends and family about your positive experiences. Please do not hesitate to call us about your banking or insurance needs. We are here to help. Thank you for your support. BANK NEAR. GO FAR. Best regards, Jim Engel Craig Larsen President & Chief Executive Officer Chairman of the Board

INDEPENDENT AUDITOR’S REPORT

To the Board of Directors and Stockholders Aquesta Financial Holdings, Inc. Cornelius, North Carolina Report on the Consolidated Financial Statements

We have audited the accompanying consolidated financial statements of Aquesta Financial Holdings, Inc. and subsidiaries (the “Company”), which comprise the consolidated balance sheets as of December 31, 2017 and 2016, and the related consolidated statements of earnings, comprehensive income, changes in stockholders’ equity and cash flows for the years then ended, and the related notes to the consolidated financial statements (collectively, the financial statements). Management’s Responsibility for the Financial Statements

Management is responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error. Auditor’s Responsibility

Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Opinion

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Aquesta Financial Holdings, Inc. and subsidiaries as of December 31, 2017 and 2016, and the results of their operations and their cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America. Atlanta, Georgia May 1, 2018

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AQUESTA FINANCIAL HOLDINGS, INC. AND SUBSIDIARIES Consolidated Balance Sheets December 31, 2017 and 2016

2017 2016

Assets

Cash and due from banks $ 11,077,105 8,964,830 Interest-bearing deposits in banks and federal funds sold 1,651,000 976,000

Cash and cash equivalents 12,728,105 9,940,830 Investment securities held-to-maturity - 13,931,128 Investment securities available-for-sale 61,869,093 51,206,164 Other investments 3,158,200 2,439,600 Loans, net 302,495,878 248,157,565 Premises and equipment, net 13,443,645 12,368,077 Goodwill 895,456 686,533 Intangible assets, net 1,677,770 1,751,027 Other real estate owned - 1,539,230 Bank owned life insurance 6,068,678 5,926,306 Accrued interest receivable 1,181,192 1,055,583 Other assets 5,062,187 4,106,914

Total assets $ 408,580,204 353,108,957

Liabilities and Stockholders’ Equity

Liabilities: Deposits:

Non-interest bearing demand $ 95,130,853 77,978,013 NOW 17,078,041 19,140,199 Money market and savings 131,696,631 108,183,855 Time deposits 61,183,055 64,004,360

Total deposits 305,088,580 269,306,427

Federal Home Loan Bank advances 66,900,000 49,200,000 Other borrowed funds 4,271,893 3,806,495 Accrued interest payable 76,610 54,223 Other liabilities 2,513,002 3,538,821

Total liabilities 378,850,085 325,905,966

Commitments

Stockholders’ equity: Common stock, $.01 par value; 10,000,000 shares authorized;

3,972,760 and 3,936,377 shares issued and outstanding, respectively 39,727 39,365

Additional paid-in capital 25,822,159 25,496,799 Unearned compensation (259,065) (103,262) Retained earnings 6,523,537 4,616,386 Accumulated other comprehensive loss (2,396,239) (2,846,297)

Total stockholders’ equity 29,730,119 27,202,991

Total liabilities and stockholders’ equity $ 408,580,204 353,108,957 See accompanying notes to consolidated financial statements.

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AQUESTA FINANCIAL HOLDINGS, INC. AND SUBSIDIARIES Consolidated Statements of Earnings

For the Years Ended December 31, 2017 and 2016

2017 2016 Interest income:

Loans, including fees $ 13,438,177 11,002,002 Investment securities 1,683,062 1,987,388 Deposits in other banks 84,028 48,215

Total interest income 15,205,267 13,037,605

Interest expense: Money market, NOW and savings deposits 649,228 336,879 Time deposits 641,698 638,734 Federal Home Loan Bank advances 1,201,944 120,234 Other borrowed funds 71,336 928,014

Total interest expense 2,564,206 2,023,861

Net interest income 12,641,061 11,013,744

Provision for loan losses 170,000 260,000

Net interest income after provision for loan losses 12,471,061 10,753,744

Noninterest income: Service charges on deposit accounts 826,523 793,285 Insurance commissions 2,500,311 2,558,153 Gain on sale of securities, net 37,464 178,204 Other than temporary impairment (332,797) - SBA loan sale income 210,919 521,701 Mortgage broker fees 77,636 227,987 Gain on acquisition - 115,776 Other income 412,198 779,369

Total noninterest income 3,732,254 5,174,475

Noninterest expense: Salaries and employee benefits 7,965,504 7,725,398 Occupancy 1,254,324 1,346,504 Loss on sales and write-downs of other real estate owned 33,360 243,384 Advertising and promotion 156,845 182,355 Professional fees 589,398 512,773 Other operating 2,689,637 2,634,947

Total noninterest expense 12,689,068 12,645,361

Earnings before income taxes 3,514,247 3,282,858

Income tax expense 1,615,058 1,127,460

Net earnings $ 1,899,189 2,155,398

Earnings per share – Basic $ 0.48 0.58

Earnings per share – Diluted $ 0.45 0.55

Weighted Average shares outstanding - Basic 3,964,329 3,733,091

Weighted Average shares outstanding - Diluted 4,234,698 3,943,397 See accompanying notes to consolidated financial statements.

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AQUESTA FINANCIAL HOLDINGS, INC. AND SUBSIDIARIES Consolidated Statements of Comprehensive Income

For the Years Ended December 31, 2017 and 2016 2017 2016

Net earnings $ 1,899,189 2,155,398

Other comprehensive income: Unrealized holding gain/(loss) on investment securities available-for-

sale 462,948 (532,120) Tax effect (185,179) 212,848

Reclassification of gains recognized in net earnings (37,464) (178,204) Tax effect 14,986 71,282

Reclassification for other than temporary impairment losses on securities available-for-sale 332,797 - Tax effect (133,119) -

Unrealized holding gain on derivatives 305,646 329,236 Tax effect (122,258) (131,694)

Gains on calls recognized in other comprehensive income related to available-for-sale securities previously transferred to held-to-maturity 85,136 390,941

Amount amortized from other comprehensive income related to available-for-sale securities previously transferred to held-to-maturity (1,656) (71,196)

Amount transferred from held-to-maturity transferred to available-for-sale 132,844 -

Other comprehensive income 854,681 91,093

Comprehensive income $ 2,753,870 2,246,491 See accompanying notes to consolidated financial statements.

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AQUESTA FINANCIAL HOLDINGS, INC. AND SUBSIDIARIES Consolidated Statements of Changes in Stockholders’ Equity


Common Stock

Additional

Paid-in Capital

Unearned Compensation

Retained Earnings

Accumulated Other

Comprehensive Loss

Total

Shares Amount Balance December 31, 2015 3,651,517 $ 36,515 23,556,075 - 2,805,425 (2,937,390) 23,460,625 Dividends on common stock -

$.09 per share - - -

- (344,437) - (344,437) Issuance of common stock 251,642 2,518 1,713,425 - - - 1,715,943 Exercise of stock options 16,418 164 58,836 - - - 59,000 Restricted stock grant 16,800 168 116,732 (116,900) - - - Equity compensation expense - - 51,731 13,638 - - 65,369 Net earnings - - - - 2,155,398 - 2,155,398 Other comprehensive income - - - - - 91,093 91,093 Balance December 31, 2016 3,936,377 39,365 25,496,799 (103,262) 4,616,386 (2,846,297) 27,202,991 Dividends on common stock -

$.11 per share - - -

- (396,661) - (396,661) Exercise of stock options 4,469 44 (44) - - - - Restricted stock grant 31,914 318 217,057 (217,375) - - - Equity compensation expense - - 108,347 61,572 - - 169,919 Reclassification of stranded tax

from AOCI to retained earnings - - -

- 404,623 (404,623) - Net earnings - - - - 1,899,189 - 1,899,189 Other comprehensive income - - - - - 854,681 854,681 Balance December 31, 2017 3,972,760 $ 39,727 25,822,159 (259,065) 6,523,537 (2,396,239) 29,730,119

See accompanying notes to consolidated financial statements.

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AQUESTA FINANCIAL HOLDINGS, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows


2017 2016 Cash flows from operating activities:

Net earnings $ 1,899,189 2,155,398 Adjustments to reconcile net earnings to net cash provided by operating

activities:

Depreciation and amortization 1,109,225 887,315 Amortization of intangible assets 406,244 356,556 Provision for loan losses 170,000 260,000 Deferred income tax expense (benefit) 621,393 (73,056) Equity compensation expense 169,919 65,369 Gain on sale of securities (37,464) (178,204) Other than temporary impairment losses 332,797 - Loss on sales and write-downs of other real estate owned 33,360 243,384 Gain on acquisition - (115,776) Change in (net of effect of business combinations):

Accrued interest receivable (125,609) (85,886) Other assets (2,369,371) (261,455) Accrued interest payable 22,387 29,075 Other liabilities (720,174) 245,586

Net cash provided by operating activities 1,511,896 3,528,306

Cash flows from investing activities (net of effect of business combinations): Proceeds from maturities/calls/paydowns of investment securities

available-for-sale

6,211,566 9,593,292 Proceeds from maturities/calls/paydowns of investment securities held-to-

maturity

1,449,184 8,761,976 Proceeds from sales of investment securities available-for-sale 5,614,920 29,619,513 Proceeds from sales of investment securities held-to-maturity 529,235 824,000 Purchases of investment securities available-for-sale (10,157,076) (48,901,611) Purchases of investment securities held-to-maturity - - Change in loans, net (54,508,313) (56,815,818) Proceeds from the sale of other real estate owned 30,870 591,974 Purchases of premises and equipment (135,387) (2,205,751) Purchases of other investments (718,600) (493,700) Cash paid for acquisition (350,000) (274,989) Cash paid for non-compete agreements - (650,000)

Net cash used in investing activities (52,033,601) (59,951,114)

Cash flows from financing activities (net of effect of business combinations): Change in deposits, net 35,782,153 57,412,934 Dividends on common stock (396,661) (344,437) Sale of common stock - 1,834,840 Stock issuance costs - (118,897) Exercise of stock options - 59,000 Change in other borrowings 2,077,888 1,659,324 Net change in federal funds purchased (1,854,400) (11,710,500) Net change in Federal Home Loan Bank advances 17,700,000 9,000,000

Net cash provided by financing activities 53,308,980 57,792,264 Net change in cash and cash equivalents 2,787,275 1,369,456

Cash and cash equivalents at beginning of the year 9,940,830 8,571,374 Cash and cash equivalents at end of the year $ 12,728,105 9,940,830

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AQUESTA FINANCIAL HOLDINGS, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows, continued For the Years Ended December 31, 2017 and 2016

2017 2016 Supplemental information on cash payments:

Interest paid $ 2,541,819 1,994,786 Taxes paid $ 1,610,200 954,000

Supplemental information of non-cash transactions: Change in unrealized loss on derivatives, net of tax $ 183,388 201,125 Change in unrealized loss on available-for-sale investments, net of tax 477,477 110,032 Loans transferred to other real estate owned - 1,475,000 Other real estate transferred to premises and equipment 1,475,000 - Transfer of securities held-to-maturity to available-for-sale 12,244,218 - Cashless exercise of stock options $ 36,428 29,456

The following is a summary of the fair value of assets acquired and liabilities assumed in the business combination in 2017 and 2016: 2017 2016

Fair value of assets acquired $ 382,987 390,765 Fair value of liabilities assumed $ - - See accompanying notes to consolidated financial statements.

AQUESTA FINANCIAL HOLDINGS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements

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(1) Organization and Operations Aquesta Bank (the “Bank”) was incorporated on June 12, 2006 and began banking operations on August 1, 2006. The Bank is engaged in commercial banking in the Charlotte region of North Carolina, principally Mecklenburg County and has seven banking branches. The Bank operates 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. Aquesta Financial Holdings, Inc. (the “Company”) was incorporated on August 8, 2013 and acquired the Bank on April 1, 2014. In addition, the Bank offers property, casualty and health insurance products through Aquesta Insurance Services, Inc. (“Aquesta Insurance Services”). Aquesta Insurance Services has three insurance agency branches in North Carolina and one insurance branch in South Carolina. On March 31, 2016, Aquesta Insurance Services moved from a wholly-owned subsidiary of the Bank, to a wholly-owned subsidiary of the Company.

(2) Summary of Significant Accounting Policies

Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses, valuation of investment securities, and deferred taxes. Principles of Consolidation The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Cash and Cash Equivalents For the purpose of presentation in the statement of cash flows, cash and cash equivalents include amounts from cash, due from banks, interest-bearing deposits in banks and federal funds sold. Federal funds are generally sold for one-day periods and interest bearing deposits in banks are available on demand. A portion of cash on hand and on deposit with the Federal Reserve Bank was required to meet regulatory reserve requirements. At December 31, 2017 and 2016, the Bank’s regulatory reserve requirement was $2,535,000 and $2,118,000, respectively, with the Federal Reserve Bank. Investment Securities Available-for-sale securities are reported at fair value and consist of debt instruments that are not classified as trading securities nor as held-to-maturity securities. Trading securities are both debt and equity securities which an entity intends to sell in the short term for a profit. Trading securities are reported at fair value. Held-to-maturity securities are reported at amortized cost and consist of debt securities and are not available-for-sale or trading. Unrealized holding gains and losses, net of applicable deferred income tax, on available-for-sale securities are reported as a net amount in other comprehensive income. Gains and losses on the sale of available-for-sale securities are determined using the specific-identification method. Declines in the fair value of individual available-for-sale securities below their cost that are other than temporary would result in write-downs of the individual securities to their fair value. Such write-downs would be included in earnings as realized losses. Premiums and discounts are recognized in interest income using the interest method over the period to maturity. Other Investments Other investments include equity securities which have no readily determined fair value. These investments are carried at cost.

AQUESTA FINANCIAL HOLDINGS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, continued

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(2) Summary of Significant Accounting Policies, continued Loans Loans that management has the intent and ability to hold for the foreseeable future or until maturity are reported at their outstanding principal balance adjusted for any charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans. Loan origination fees are capitalized and recognized as an adjustment of the yield of the related loan. The accrual of interest on impaired loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed unless the collateral for the loan is sufficient to cover the accrued interest. Interest income is subsequently recognized only to the extent cash payments are received. Troubled Debt Restructurings The Company identifies loans for potential restructuring on a loan-by-loan basis using a variety of sources which may include, but are not limited to any one or a combination of the following: being approached or contacted by the borrower to modify loan terms; review of the borrower’s financial statements indicates the borrower may be experiencing financial difficulties; past due payment reports; loans extending past their stated maturity dates; and nonaccrual loan reports. Not all loan modifications constitute troubled debt restructurings (“TDRs”). Identifying whether a loan restructuring is a TDR is based upon individual facts and circumstances and requires the use of judgment on a loan-by-loan basis. The Company must first determine if the borrower is experiencing financial difficulty. A restructuring constitutes a TDR if for economic or legal reasons related to an individual borrower’s financial condition the Company grants a concession to the borrower that would not otherwise be considered. A restructuring that results in only a delay in payment that is insignificant is not a concession. Allowance for Loan Losses The provision for loan losses is based upon management’s estimate of the amount needed to maintain the allowance for loan losses at an adequate level. In making the evaluation of the adequacy of the allowance for loan losses, management gives consideration to current economic conditions, statutory examinations of the loan portfolio by regulatory agencies, delinquency information and management’s internal review of the loan portfolio. Loans are considered impaired when it is probable that all amounts due under the contractual terms of the loan will not be collected. The measurement of impaired loans is generally based on the present value of expected future cash flows discounted at the historical effective interest rate, or upon the fair value of the collateral if the loan is collateral dependent. If the recorded investment in the loan exceeds the measure of fair value, a valuation allowance is established as a component of the allowance for loan losses. While management uses the best information available to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the assumptions used in making the evaluations. In addition, regulatory examiners may require the Company to recognize changes to the allowance for loan losses based on their judgments about information available to them at the time of their examination. Premises and Equipment Land is stated at cost. Premises and equipment are stated at cost less accumulated depreciation. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets. Estimated useful lives are 40 years for buildings, 5 to 10 years for furniture, fixtures and equipment, and 5 years for computers and related equipment. Leasehold improvements are amortized over the terms of the respective leases or the estimated useful lives of the improvements, whichever is shorter. Repairs and maintenance costs are charged to operations as incurred and additions and improvements to premises and equipment are capitalized. Upon sale or retirement, the cost and related accumulated depreciation are removed from the accounts and any gains or losses are reflected in current operations.

Other Real Estate Owned Real estate acquired through, or in lieu of, loan foreclosure is initially recorded at fair value of the property less estimated costs to sell at the date of foreclosure. After foreclosure, management periodically performs valuations of the property and the real estate is carried at the lower of cost or fair value minus estimated cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in other noninterest expense.


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(2) Summary of Significant Accounting Policies, continued Income Taxes The Company does not anticipate any increase or decrease in unrecognized tax benefits during the next twelve months that would result in a material change to its financial position. The Company’s income tax returns for years ended after December 31, 2013 remain open for examination. The Company includes interest and penalties in the consolidated financial statements as a component of income tax expense. No interest or penalties are included in the Company’s income tax expense for the years ended December 31, 2017 and 2016. The Company has determined that it has no uncertain income tax positions as of December 31, 2017. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes. Deferred tax assets are also recognized for operating loss carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which the temporary differences are expected to be recovered or settled. Deferred tax assets are reduced by a valuation allowance if it is more likely than not that the tax benefits will not be realized. Derivative Instruments and Hedging Activities The Company’s interest rate risk management strategy incorporates the use of derivative instruments to minimize fluctuations in net earnings that are caused by interest rate volatility. The Company’s goal is to manage interest rate sensitivity by modifying the repricing or maturity characteristics of certain balance sheet assets and liabilities so that net interest income is not, on a material basis, adversely affected by movements in interest rates. The Company views this strategy as a prudent management of interest rate risk, such that net earnings is not exposed to undue risk presented by changes in interest rates. In carrying out this part of its interest rate risk management strategy, the Company uses interest rate derivative contracts. The primary type of derivative contract used by the Company to manage interest rate risk is interest rate swaps. Interest rate swaps generally involve the exchange of fixed and variable rate interest payments between two parties, based on a common notional principal amount and maturity date. The Company also utilizes interest rate caps which limit the Company’s interest expense exposure to a maximum rate on a notional principal amount. The Company classifies its derivative financial instruments as either (1) a hedge of an exposure to changes in the fair value of a recorded asset or liability (“fair value hedge”), (2) a hedge of an exposure to changes in the cash flows of a recognized asset, liability or forecasted transaction (“cash flow hedge”), or (3) derivatives not designated as accounting hedges. Changes in the fair value of derivatives not designated as hedges are recognized in current period earnings. Derivatives are reflected as gross assets and liabilities on the consolidated balance sheet. The Company uses the long-haul method to assess hedge effectiveness. The Company documents, both at inception and over the life of the hedge, at least quarterly, its analysis of actual and expected hedge effectiveness. This analysis includes techniques such as regression analysis and hypothetical derivatives to demonstrate that the hedge has been, and is expected to be, highly effective in offsetting corresponding changes in the fair value or the cash flows of the hedged item. For a qualifying fair value hedge, changes in the value of derivatives that have been highly effective as hedges are recognized in current period earnings along with the corresponding changes in the fair value of the designated hedged item attributable to the risk being hedged. For a qualifying cash flow hedge, the portion of changes in the fair value of the derivatives that have been highly effective are recognized in other comprehensive income until the related cash flows from the hedged item are recognized in earnings.

For fair value hedges and cash flow hedges, ineffectiveness is recognized in the same income statement line as interest accruals on the hedged item to the extent that changes in the value of the derivative instruments do not perfectly offset changes in the value of the hedged items. If the hedge ceases to be highly effective, the Company discontinues hedge accounting and recognizes the changes in fair value in current period earnings. If a derivative that qualifies as a fair value or cash flow hedge is terminated or the designation removed, the realized or then unrealized gain or loss is recognized into income over the life of the hedged item (fair value hedge) or over the time when the hedged item was forecasted to impact earnings (cash flow hedge).


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(2) Summary of Significant Accounting Policies, continued Derivative Instruments and Hedging Activities, continued Immediate recognition in earnings is required upon sale or extinguishment of the hedged item (fair value hedge) or if it is probable that the hedged cash flows will not occur (cash flow hedge). By using derivative instruments, the Company is exposed to credit and market risk. If the counterparty fails to perform, credit risk is represented by the fair value gain in a derivative. When the fair value of a derivative contract is positive, this situation generally indicates that the counterparty is obligated to pay the Company, and, therefore, creates a repayment risk for the Company. When the fair value of a derivative contract is negative, the Company is obligated to pay the counterparty and, therefore, has no repayment risk. The Company minimizes the credit risk in derivative instruments by entering into transactions with high-quality counterparties that are reviewed periodically by the Company. Acquisition Activities The Company accounts for business combinations under the acquisition method of accounting. Assets acquired and liabilities assumed are measured and recorded at fair value at the date of acquisition, including identifiable intangible assets. If the fair value of net assets purchased exceeds the fair value of consideration paid, a bargain purchase gain is recognized at the date of acquisition. Conversely, if the consideration paid exceeds the fair value of the net assets acquired, goodwill is recognized at the acquisition date. Fair values are subject to refinement for a period not to exceed one year after the closing date of an acquisition as information relative to closing date fair values becomes available. The determination of the fair value of loans acquired takes into account credit quality deterioration and probability of loss; therefore, the related allowance for loan losses is not carried forward. All identifiable intangible assets that are acquired in a business combination are recognized at fair value on the acquisition date. Identifiable intangible assets are recognized separately if they arise from contractual or other legal rights or if they are separable (i.e., capable of being sold, transferred, licensed, rented, or exchanged separately from the entity). Deposit liabilities and the related depositor relationship intangible assets may be exchanged in observable exchange transactions. As a result, the depositor relationship intangible asset is considered identifiable, because the separability criterion has been met. Goodwill and Intangible Assets Goodwill is deemed to have an indefinite useful life. Identifiable intangible assets include a core deposit premium, noncompete agreements and customer lists, which are being amortized on a straight-line basis over the estimated useful lives of the asset. The core deposit premium is being amortized over 10 years. The noncompete agreements and customer lists are being amortized over 2 to 15 years. Goodwill and intangible assets are reviewed annually for possible impairment, and if the assets are deemed impaired, an expense would be charged in the then current period. Per Share Results Basic earnings per share represents earnings available to common stockholders divided by the weighted-average number of common shares outstanding during the year. For the years ended December 31, 2017 and 2016, 270,369 and 210,306 options and warrants, respectively, were dilutive and were included in the calculation of the diluted earnings per share.

Stock Compensation Plans Accounting standards require recognition of the cost of employee services received in exchange for an award of equity instruments in the consolidated financial statements over the period the employee is required to perform the services in exchange for the award (presumptively the vesting period). These standards also require measurement of the cost of employee services received in exchange for an award based on the grant-date fair value of the award. 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 earnings.


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(2) Summary of Significant Accounting Policies, continued Comprehensive Income, continued The Company's only components of other comprehensive income are unrealized gains and losses on investment securities available-for-sale, unrealized gains and losses on investments held-to-maturity prior to reclassification from available-for-sale and unrealized gains and losses on derivatives, net of related income tax effects.

(3) Business Combinations On September 1, 2017, Aquesta Insurance Services acquired assets and a book of business from an insurance agency in Murrells Inlet, South Carolina. The total assets acquired were approximately $383,000, consisting of a book of business identified as an intangible asset to be amortized on a straight line basis over 15 years. No liabilities were assumed. Total purchase price at the date of acquisition was approximately $550,000. Approximately, $350,000 was paid upon closing the transaction and approximately $200,000 will be paid in equal installments annually over the next 3 years. As additional consideration for the acquired assets, approximately $42,000 is estimated to be paid out related the performance of the book of business, resulting in goodwill of approximately $208,000. On January 15, 2016, Aquesta Insurance Services acquired a book of business from an insurance agency in Wilmington, North Carolina. The total assets acquired were approximately $391,000, consisting of a book of business identified as an intangible asset to be amortized on a straight line basis over 15 years. No liabilities were assumed. Total consideration paid was approximately $275,000, resulting in a bargain purchase gain of approximately $116,000. In addition to the acquisition, Aquesta Insurance Services entered into non-compete agreements totaling $650,000 with certain individuals for a period of three years. Approximately, $298,000 was paid upon closing the transaction and approximately $352,000 was paid on May 1, 2016. The cost of the non-compete agreements will be amortized ratably over the 3 year period on a straight line basis.

(4) Investment Securities

The amortized cost and estimated fair value of securities available-for-sale, with gross unrealized gains and losses, at December 31, 2017 and 2016 are as follows:

Amortized

Cost

Gross Unrealized

Gains

Gross Unrealized

Losses

Estimated Fair

Value December 31, 2017:

U.S. government agency securities $ 12,371,872 - 295,047 12,076,825 Mortgage-backed securities 45,971,685 27,286 914,559 45,084,412 Corporate shares 3,843,447 12,500 452,866 3,403,081 Foreign debt securities 1,005,146 - 21,751 983,395 Municipal bonds 328,393 - 7,013 321,380

Total $ 63,520,543 39,786 1,691,236 61,869,093

December 31, 2016: Amortized

Cost

Gross Unrealized

Gains

Gross Unrealized

Losses

Estimated Fair

Value

U.S. government agency securities $ 13,017,298 - 374,684 12,642,614 Mortgage-backed securities 32,691,600 5,271 882,606 31,814,265 Preferred shares 500,000 10,400 - 510,400 Corporate shares 3,736,914 - 1,017,141 2,719,773 Foreign debt securities 1,377,262 - 81,644 1,295,618 Municipal bonds 2,292,820 666 69,992 2,223,494

Total $ 53,615,894 16,337 2,426,067 51,206,164


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(4) Investment Securities, continued During 2017, amortized cost of approximately $12,200,000 of held-to-maturity securities were transferred to available-for-sale. The securities were transferred to available-for-sale classification with the intention of selling the corporate bonds. As of December, 31 2017, there were no securities classified as held-to-maturity. The amortized cost and estimated fair value of securities held-to-maturity, with gross unrealized gains and losses, at December 31, 2016 are as follows:

Recognized

in AOCI* Not Recognized

in AOCI

December 31, 2016:

Amortized

Cost

Gross Unrealized

Gains

Gross Unrealized

Losses Amortized

Cost

Gross Unrealized

Gains

Gross Unrealized

Losses

Estimated Fair

Value

Mortgage-backed securities $ 9,536,979 - 97,056 9,439,923 68,474 151,511 9,356,886

Preferred shares 516,856 - 28,966 487,890 - 21,290 466,600 Corporate bonds 3,150,125 - 82,156 3,067,969 29,757 38,957 3,058,769 Foreign debt

securities 935,346 - - 935,346 - 16,323 919,023

Total $ 14,139,306 - 208,178 13,931,128 98,231 228,081 13,801,278

*The gross unrealized losses recognized in accumulated other comprehensive income (AOCI) on held-to-maturity (HTM) securities resulted from a previous transfer of available-for-sale securities.

The amortized cost and estimated fair value of investment securities at December 31, 2017, by contractual maturity are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without prepayment penalties.

Amortized

Cost

Estimated Fair

Value

Due in one year or less $ - - Due after one year through five years 1,566,021 1,103,125 Due after five years through ten years 7,556,481 7,134,312 After ten years 8,426,356 8,547,244 Mortgage-backed securities 45,971,685 45,084,412

$ 63,520,543 61,869,093 The composition of the investment securities with an unrealized loss position at December 31, 2017 and 2016 is shown below.

2017 2016

Available-for-Sale Estimated

Fair Value Unrealized

Losses Estimated


Losses Unrealized loss for less than 12 months:

U.S. government agency securities $ - - 12,642,614 374,684 Mortgage-backed securities 14,568,581 180,744 31,615,943 882,606 Corporate bonds 492,500 3,133 - - Foreign debt securities 983,395 21,751 - - Municipal bonds 321,380 7,013 1,954,502 69,992

Less than 12 months 16,365,856 212,641 46,213,059 1,327,282 Unrealized loss for greater than 12 months:

U.S. government agency securities 12,076,826 295,047 - - Mortgage-backed securities 28,168,168 733,815 - - Corporate bonds 2,341,829 449,733 2,719,773 1,017,141 Foreign debt securities - - 1,295,618 81,644 Municipal bonds - - - -

Total more than 12 months 42,586,823 1,478,595 4,015,391 1,098,785 Total $ 58,952,679 1,691,236 50,228,450 2,426,067


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(4) Investment Securities, continued 2016

Held-to-Maturity Estimated


Losses Unrealized loss for less than 12 months:

U.S. Government agency securities $ - - Mortgage-backed securities 5,746,671 151,511 Preferred shares 466,600 21,290 Corporate bonds 951,603 38,957 Foreign debt securities - -

Less than 12 months 7,164,874 211,758 Unrealized loss for greater than 12

months: U.S. Government agency securities - - Mortgage-backed securities - - Preferred shares - - Corporate bonds - - Foreign debt securities 919,023 16,323

Total more than 12 months 919,023 16,323 Total $ 8,083,897 228,081

Management continuously evaluates unrealized losses in its investment securities portfolio. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Bank to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. The declines in fair value noted above were largely attributable to the increases in interest rates and not attributable to credit quality. Since the Bank has the ability and intent to hold these investments until a market price recovery or maturity, these investments were not considered other-than-temporarily impaired. Proceeds from the sales of investment securities totaled $6,144,155 and $30,443,513 in 2017 and 2016, respectively. The Company realized gross gains of $85,327 and $646,130 in 2017 and 2016, respectively. The Company realized gross losses of $47,863 and $467,926 in 2017 and 2016, respectively. As of December 31, 2017, the investment security portfolio had 51 securities that were in an unrealized loss position. During 2017, the Bank determined the value of a corporate bond to be other-than-temporarily impaired. The determination was a result of the financial condition and performance of the corporation. As a result, the Company recorded a $332,797 non-cash other-than-temporary impairment on this security. Securities with a fair value of approximately $20,602,000 and $22,314,000 were pledged to secure pubic deposits at December 31, 2017 and 2016, respectively.


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(5) Loans Major classifications of loans at December 31, 2017 and 2016, are summarized as follows: 2017 2016

Amount % of Total

Loans Amount % of Total

Loans Real estate loans:

1 - 4 Family residential $ 16,549,057 5.4% $ 17,283,511 6.9% Multi-family and commercial 202,043,749 66.1% 157,564,841 62.7% Construction 14,427,866 4.7% 12,317,305 4.9% Home equity lines of credit 31,688,340 10.4% 26,873,341 10.7%

Total real estate loans 264,709,012 86.6% 214,038,998 85.2%

Other loans: Commercial and industrial 40,742,970 13.2% 37,106,026 14.6% Loans to individuals 324,966 0.1% 102,569 0.1% Overdrafts 15,899 0.1% 58,763 0.1%

Total other loans 41,083,835 13.4% 37,267,358 14.8%

Total loans 305,792,847 100.0% 251,306,356 100.0%

Less: Allowance for loan losses 2,817,248 2,649,942 Less: Unamortized deferred fees 479,721 498,849

Total loans, net $ 302,495,878 $ 248,157,565 Following is a summary of the changes in the allowance for loan losses by portfolio class for the years ended December 31, 2017 and 2016:

December 31, 2017:

Allowance for loan losses:

1 – 4 Family

Residential

Multi-family and

Commercial Construction

Home Equity

Lines of Credit

Commercial and

Industrial Loans to

Individuals Overdrafts

Unallocated Total

Balance at beginning of the period

$ 99,120 1,808,850 63,363 291,589 255,939 629 - 130,452 2,649,942 Provision for loan losses (26,304) 211,019 (13,008) (9,563) 18,700 14,518 12,336 (37,698) 170,000 Charge-offs - - - - (47,434) - (12,336) - (59,770) Recoveries - 56,271 - - - 805 - - 57,076

Ending balance $ 72,816 2,076,140 50,355 282,026 227,205 15,952 - 92,754 2,817,248

Ending balance individually evaluated for impairment

$ - - - - 5,094 - - - 5,094 Ending balance

collectively evaluated for impairment 72,816 2,076,140 50,355 282,026 222,111 15,952 - 92,754 2,812,154

$ 72,816 2,076,140 50,355 282,026 227,205 15,952 - 92,754 2,817,248

Loans:

Individually evaluated for impairment

$ - 2,119 - - 338,728 - - - 340,847 Collectively evaluated

for impairment 16,549,057 202,041,630 14,427,866 31,688,340 40,404,242 324,966 15,899 - 305,452,000

$ 16,549,057 202,043,749 14,427,866 31,688,340 40,742,970 324,966 15,899 - 305,792,847


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(5) Loans, continued December 31, 2016:

Allowance for loan losses:

1 – 4 Family

Residential

Multi-family and

Commercial Construction

Home Equity

Lines of Credit

Commercial and

Industrial Loans to

Individuals Overdrafts

Unallocated Total

Balance at beginning of the period

$ 115,260 1,569,612 67,242 384,336 191,688 2,828 - 230,204 2,561,170 Provision for loan losses (21,847) 198,560 220,282 (92,747) 57,703 (2,199) - (99,752) 260,000 Charge-offs - - (255,411) - - - - - (255,411) Recoveries 5,707 40,678 31,250 - 6,548 - - - 84,183

Ending balance $ 99,120 1,808,850 63,363 291,589 255,939 629 - 130,452 2,649,942

Ending balance individually evaluated for impairment

$ 14,985 - 9,067 - 75,542 - - - 99,594 Ending balance

collectively evaluated for impairment 84,135 1,808,850 54,296 291,589 180,397 629 - 130,452 2,550,348

$ 99,120 1,808,850 63,363 291,589 255,939 629 - 130,452 2,649,942

Loans:

Individually evaluated for impairment

$ 786,486 - 217,405 122,029 261,887 - - - 1,387,807 Collectively evaluated for

impairment 16,497,025 157,564,841 12,099,900 26,751,312 36,844,139 102,569 58,763 - 249,918,549

$ 17,283,511 157,564,841 12,317,305 26,873,341 37,106,026 102,569 58,763 - 251,306,356

The Bank individually assesses all nonaccrual loans and TDRs for potential impairment. A loan is considered impaired when, based on current events and circumstances it is probable that all amounts due, according to the contractual terms of the loan will not be collected. Impaired loans are measured based on the present value of expected future cash flows, discounted at the loan’s effective interest rate, at the loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent. Interest payments received on impaired loans are applied as a reduction of the outstanding principal balance. Impaired loans as of December 31, 2017 and 2016, segregated by class of loans, were as follows:

December 31, 2017:

Unpaid Principal

Balance (1)

Recorded

Investment(2)

Related

Allowance

Average Recorded Investment

Interest Income

Recognized Impaired loans without related

allowance:

Real estate loans:

Multi-family and construction $ 2,119 2,119 - 394,303 18,686 Other loans:

Commercial and industrial 230,406 181,402 - 382,768 22,244

232,525 183,521 - 777,071 40,930 Impaired loans with related allowance:

Other loans: Commercial and industrial 157,326 157,326 5,094 187,366 8,782

157,326 157,326 5,094 187,366 8,782 Total:

Real estate loans: Multi-family and construction 2,119 2,119 - 394,303 18,686

Other loans: Commercial and industrial 387,732 338,728 5,094 570,134 31,026

$ 389,851 340,847 5,094 964,437 49,712


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(5) Loans, continued

December 31, 2016:

Unpaid Principal

Balance (1)

Recorded

Investment(2)

Related

Allowance

Average Recorded Investment

Interest Income

Recognized Impaired loans without related

allowance:

Real estate loans:

HELOC $ 122,029 122,029 - 122,634 1,498 Other loans:

Commercial and industrial 186,345 186,345 - 232,700 16,105

308,374 308,374 - 355,334 17,603 Impaired loans with related allowance:

Real estate loans: 1 – 4 family residential 786,486 786,486 14,985 797,376 42,661 Construction 217,405 217,405 9,067 247,417 10,206

Other loans: Commercial & Industrial 75,542 75,542 75,542 90,175 5,286

1,079,433 1,079,433 99,594 1,134,968 58,153 Total: Real estate loans:

HELOC 122,029 122,029 - 122,634 1,498 1 – 4 family residential 786,486 786,486 14,985 797,376 42,661 Construction 217,405 217,405 9,067 247,417 10,206 Other loans: Commercial and industrial 261,887 261,887 75,542 322,875 21,391

$ 1,387,807 1,387,807 99,594 1,490,302 75,756

(1) Unpaid principal balance represents the contractual obligation due from the customer. (2) Recorded investment represents the unpaid principal balance less charge-offs and payments applied; it is shown before any

related allowance for loan losses.

At December 31, 2017 and 2016, the Bank had impaired loans classified as TDRs of approximately $341,000 and $1.3 million, respectively. During 2017, there was one new TDR added with a pre- and post-modification balance of $376,766 and $27,886, respectively. The Bank received approximately $301,000 for the government guaranteed portion of the loan and charged off approximately $49,000 in conjunction with the modification. There was one new TDR added during 2016 with a pre- and post-modification balance of $75,542. The Bank allocated $5,094 and $99,594 of the allowance for loan losses to customers whose loan terms have been modified in troubled debt restructurings as of December 31, 2017 and 2016, respectively. The Bank has no commitments to lend additional amounts to customers with outstanding loans that are classified as TDRs. There were no loans modified in a TDR during 2017 or 2016 for which there was subsequent payment default. Default is defined as 90 days or more past due or nonaccrual. The Bank categorizes loans into different risk categories based on relevant information about a borrower’s ability to service their debt. This is determined by various factors such as current financial information, historical payment experience, credit documentation and economic trends along with other factors. These categories are utilized to develop the associated allowance for loan losses using historical losses adjusted for current economic conditions and are defined as follows:

• Pass – loans which are well protected by the current net worth and paying capacity of the obligor (or guarantors, if any) or by the fair value, less cost to acquire and sell, of any underlying collateral.

• Special Mention – loans that are still adequately protected by the borrower’s capital adequacy and payment capability but have potential weakness that may, if not reversed or corrected, weaken the credit or inadequately protect the Bank’s position at some future date. If left unchecked or uncorrected, these potential weaknesses may result in deteriorated prospects of repayment and require management’s close attention. These loans are not adversely classified.

• Substandard Accruing – loans that exhibit a well-defined weakness which presently jeopardizes debt repayment, even though the loan is currently performing. These loans are characterized by the distinct possibility that the Bank may sustain a loss in the future if these weaknesses are not corrected.


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(5) Loans, continued Nonaccrual – includes loans where management has determined that full payment of principal and interest per the contract terms is in doubt. The loans categorized by different risk categories based on relevant information about a borrower’s ability to service their debt at December 31, 2017 and 2016 are as follows:

December 31, 2017:

Pass Special Mention

Substandard Accruing Nonaccrual Total

Real estate loans: 1 - 4 Family residential $ 16,549,057 - - - 16,549,057 Multi-family and commercial 198,629,716 3,411,914 2,119 - 202,043,749 Construction 14,155,760 272,106 - - 14,427,866 Home equity lines of credit 31,688,340 - - - 31,688,340

Total real estate loans 261,022,873 3,684,020 2,119 - 264,709,012

Other loans: Commercial and industrial 31,976,994 135,703 8,602,387 27,886 40,742,970 Loans to individuals 314,966 10,000 - - 324,966 Overdrafts 15,899 - - - 15,899

Total other loans 32,307,859 145,703 8,602,387 27,886 41,083,835

Total $ 293,330,732 3,829,723 8,604,506 27,886 305,792,847

December 31, 2016:

Real estate loans: 1 - 4 Family residential $ 16,497,023 786,488 - - 17,283,511 Multi-family and commercial 151,149,956 2,346,560 4,068,325 - 157,564,841 Construction 12,049,865 217,405 50,035 - 12,317,305 Home equity lines of credit 23,614,091 20,000 3,117,221 122,029 26,873,341

Total real estate loans 203,310,935 3,370,453 7,235,581 122,029 214,038,998

Other loans: Commercial and industrial 35,779,114 383,632 943,280 - 37,106,026 Loans to individuals 102,569 - - - 102,569 Overdrafts 58,763 - - - 58,763

Total other loans 35,940,446 383,632 943,280 - 37,267,358

Total $ 239,251,381 3,754,085 8,178,861 122,029 251,306,356 At December 31, 2017, there was one loan with a recorded investment of $27,886 that was past due greater than 90 days and there were no accruing loans past due greater than 90 days. All loans as of 2016 were current and there were no accruing loans past due greater than 30 days.

Periodically, the Bank may engage in loan transactions with the Company and the Bank’s directors and executive officers. Such loans are made in the ordinary course of business and on substantially the same terms and collateral as those for comparable transactions prevailing at the time and do not involve more than the normal risk of collectability or present other unfavorable features. The following is a summary of activity for related party loans for 2017:

Prior year balance $ 7,609,766 Advances 3,425,376 Repayments (3,815,405)

$ 7,219,737


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(6) Premises and Equipment Following is a summary of premises and equipment at December 31, 2017 and 2016:

2017 2016

Land $ 3,200,540 2,767,540 Buildings 11,120,318 10,079,273 Furniture and fixtures 3,715,748 3,633,916 Leasehold improvements 92,480 90,985 Construction-in-progress 138,093 35,078

18,267,179 16,606,792 Accumulated depreciation 4,823,534 4,238,715

Total $ 13,443,645 12,368,077 Depreciation totaling approximately $585,000 and $654,000 for the years ended December 31, 2017 and 2016, respectively, is included in occupancy expense. Amortization of software of approximately $23,000 and $61,000 for the years ended December 31, 2017 and 2016, respectively, is included in other operating expense. The Company leases out the third floor of its headquarters building to a third party. The lease began March 1, 2009 and expired on January 31, 2018. This lease was renewed on January 19, 2018, beginning February 1, 2018 and expiring on January 31, 2021. The Company also leases out the second floor of its Wilmington branch location. The lease began on March 24, 2016 and expired on March 31, 2018. A new lease commenced on February 22, 2018, beginning on March 1, 2018 and expiring on March 31, 2021. The Company received $159,592 and $134,028 in rental income during 2017 and 2016, respectively, and this amount is recorded in other noninterest income. The Company anticipates using this space for the Company’s future growth.

(7) Goodwill and Intangible Assets

The Company recorded goodwill and intangible assets arising from the acquisition of Aquesta Insurance Services. The Company recorded a core deposit intangible from the purchase of a bank branch in 2015. The 2017 book of business acquisition described in footnote 3 added an additional customer list intangible asset. The Company evaluates intangible assets and goodwill for possible impairment on an annual basis. There was no impairment on intangible assets and goodwill identified in the years ending December 31, 2017 and 2016. The changes in the carrying amount of other identifiable intangibles for the years ended December 31, 2017 and 2016 were as follows:

Customer List

Intangibles

Non-Compete

Intangibles

Core Deposit

Intangible

Totals

Net carrying amount at December 31, 2015 $ 748,963 266,410 51,445 1,066,818

Current year additions 393,398 650,000 - 1,043,398 Current year amortization expense (101,688) (251,053) (6,448) (359,189)

Net carrying amount at December 31, 2016 1,040,673 665,357 44,997 1,751,027

Current year additions 332,987 - - 332,987 Current year amortization expense (113,544) (287,165) (5,535) (406,244)

Net carrying amount at December 31, 2017 $ 1,260,116 378,192 39,462 1,677,770


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(7) Goodwill and Intangible Assets, continued Following is a summary of accumulated amortization:

Customer List

Intangibles

Non-Compete

Intangibles

Core Deposit

Intangibles

Totals

Accumulated amortization at December 31, 2016 $ 550,218 689,626 9,202 1,249,046

Current year amortization expense 113,544 287,165 5,535 406,244

Accumulated amortization at December 31, 2017 $ 663,762 976,791 14,737 1,655,290

Estimated annual amortization expense for the years ending December 31 is as follows:

2018 $ 420,950 2019 224,812 2020 133,785 2021 133,785 2022 133,785 Thereafter 630,653

$ 1,677,770 (8) Deposits

The aggregate amount of time deposits in denominations of $250,000 or more at December 31, 2017 and 2016, was approximately $5,203,000 and $5,636,000, respectively. At December 31, 2017, contractual maturities of time deposits are summarized as follows:

2018 $ 48,288,232 2019 9,845,827 2020 1,643,815 2021 1,405,181

$ 61,183,055

At December 31, 2017 and 2016, deposits from directors, executive officers and their related interests aggregated approximately $4,412,000 and $3,060,000, respectively. These deposits were taken in the normal course of business at market interest rates.

(9) Borrowings

The Bank has established a credit line with the Federal Home Loan Bank (FHLB). The credit line is secured by a portion of the Bank’s loan portfolio that qualifies under FHLB guidelines as eligible collateral. Total availability, based on approximately $147,972,000 of collateral pledged at December 31, 2017 was approximately $104,010,000, of which $66,900,000 was advanced. Total availability, based on approximately $119,015,000 of collateral pledged at December 31, 2016 was approximately $86,184,000, of which $49,200,000 was advanced. The FHLB borrowings have variable and fixed rate terms with a weighted average interest rate of .61% at December 31, 2017. Interest expense on FHLB advances was $1,201,944 and $928,014 in 2017 and 2016, respectively.

The Company had available lines of credit totaling $29,500,000 and $26,700,000 from correspondent banks excluding the Federal Home Loan Bank and the Federal Reserve Discount Window at December 31, 2017 and 2016, respectively. As of December 31, 2017 and 2016, the Company had outstanding borrowings of approximately $3,968,000 and $3,696,000, respectively, with the Company’s correspondent banks.


- 23 -

(9) Borrowings, continued The Company has a secured a line of credit through the Federal Reserve Discount Window Borrower-In-Custody Program. The Company’s available line was $3,847,035 and $7,007,610 as of December 31, 2017 and 2016, respectively. If the line is drawn, the Company will pledge commercial loans as collateral for this line of credit. The interest rate is based on the federal funds rate plus 0.25%. There were no outstanding balances under this line of credit as of December 31, 2017 and 2016.

Other borrowed funds consisted of overnight borrowings, current and estimated future debt obligations assumed from the purchase of Aquesta Insurance Services. Other borrowed funds at December 31, 2017 and 2016 consisted of the following:

Maturity Dates

Interest Basis

Weighted Average

Interest Rate 2017 2016 Holding company

borrowings 2018 Variable

4.75% 3,900,000 1,750,000 Estimate of future

insurance debt 2018 - 2020 Fixed

1.00% 303,460 110,790 Other borrowed funds Overnight Fixed 0.01% 68,433 1,945,705

$ 4,271,893 3,806,495 Required annual principal payments on borrowed funds for years subsequent to December 31, 2017 are as follows:

FHLB

Advances Other

Borrowings Total 2018 $ 48,900,000 4,259,583 53,159,583 2019 5,000,000 12,310 5,012,310 2020 4,000,000 - 4,000,000 2021 8,000,000 - 8,000,000 2022 1,000,000 - 1,000,000 Thereafter - - -

Total $ 66,900,000 4,271,893 71,171,893

(10) Income Taxes On December 22, 2017, the Tax Cuts and Job Act ("Tax Reform") was signed into law and impacts individuals, pass through entities and corporations. The Company is impacted by the corporation changes. The corporate tax rate remains unchanged for the year ended December 31, 2017, with the new corporate tax rate falling from a maximum 35% rate to 21% beginning in 2018. Current income tax expense is based on a tax rate of 34%; however, GAAP requires the deferred tax components to be recorded at the rate in which the differences are expected to reverse which impacts tax expense for the year ended December 31, 2017. Based on the new corporate tax rate of 21% for 2018 and forward, the deferred tax assets and liabilities were revalued at the new rate and the adjustment was recorded directly to earnings in the current year, including any impact associated with the deferred tax component of unrealized gains or losses on available-for-sale securities. In February 2018, the FASB issued ASU 2018-02, “Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.” The amendment grants the option of reporting tax effects of the recently enacted Tax Cuts and Jobs Act that were temporarily stranded in accumulated other comprehensive income as a reclassification from AOCI to retained earnings. The bank elected to reflect the reclassification for reporting as of December 31, 2017 and for the year then ended in accordance with the update.


- 24 -

(10) Income Taxes, continued The Company recorded a reclassification entry of approximately $405,000 between accumulated other comprehensive income and retained earnings in order to correct the stranded amount associated with the true up of the net deferred asset on available-for-sale securities. The reclassification entry is disclosed within the consolidated Statements of Changes in Stockholders' Equity. The components of income tax expense (benefit) for the years ended December 31, 2017 and 2016 are as follows:

2017 2016 Current $ 589,042 1,200,516 Deferred 621,393 (73,056) Rate reduction adjustment 404,623 -

Total income tax expense $ 1,615,058 1,127,460 The difference between income tax expense and the amount computed by applying the statutory federal income tax rate to earnings before taxes for the years ended December 31, 2017 and 2016 is as follows:

2017 2016 Pretax income at statutory rate $ 1,194,844 1,116,171 State income tax expense, net 21,256 36,570 Other (5,665) (25,281) Rate reduction adjustment 404,623 -

$ 1,615,058 1,127,460

The following summarizes the components of the net deferred tax asset, which is included as a component of other assets at December 31, 2017 and 2016:

2017 2016 Deferred income tax assets:

Unrealized loss on securities $ 383,353 1,696,407 Unrealized loss on derivatives 328,611 201,125 Allowance for loan losses 405,385 562,956 Net operating loss carryforward 14,733 13,621 Pre-opening costs and expenses 52,490 58,321 Other real estate owned - 126,949 Stock-based compensation 169,399 251,076 Deferred compensation 98,842 99,403 Intangibles 176,685 230,057 Other 49,831 2,118

Total deferred income tax assets 1,679,329 3,242,033

Deferred income tax liabilities: Premises and equipment 618,323 283,981 Goodwill 105,641 141,243 SBA servicing asset 98,371 129,353 Other 13,969 28,506

Total deferred income tax liabilities 836,304 583,083

Net deferred income tax assets $ 843,025 2,658,950

The Company has a state net operating loss carryforward of approximately $949,000, which begins to expire in 2029 if not previously utilized.


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(11) Regulatory Matters The Bank, as a North Carolina banking corporation, may pay cash dividends only out of undivided profits as determined pursuant to North Carolina General Statutes. However, regulatory authorities may limit payment of dividends by any bank when it is determined that such limitation is in the public interest and is necessary to ensure financial soundness of the Bank. The Bank is subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. In July 2013, the Federal bank regulatory agencies issued a final rule that revises their risk-based capital requirements and the method for calculating components of capital and of computing risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. The final rule applies to all depository institutions, top-tier bank holding companies with total consolidated assets of $500 million or more and top-tier savings and loan holding companies. The rule establishes a new common equity Tier 1 minimum capital requirement, increases the minimum capital ratios and assigns a higher risk weight to certain assets based on the risk associated with these assets. The final rule includes transition periods that generally implement the new regulations over a five year period. These changes were phased in beginning in January 2015. Management continues to evaluate this final rule and its potential impact on the Bank. Preliminary assessments indicate that the Bank will continue to exceed all regulatory capital requirements under the phased in requirements of the new rule.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of total common equity Tier 1, of total and Tier I capital to risk-weighted assets and of Tier I capital to average assets. Management believes, as of December 31, 2017 and 2016, the Bank meets all capital adequacy requirements to which it is subject. As of December 31, 2017 and 2016, the most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum common equity Tier 1 risk-based, total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth below. There are no conditions or events since that notification that management believes have changed the institution’s category. The Bank’s actual capital amounts and ratios as of December 31, 2017 and 2016 are also presented below.

Actual

For Capital Adequacy Purposes

To Be Well Capitalized Under Prompt Corrective Action Provisions

Amount Ratio Amount Ratio Amount Ratio December 31, 2017: (Dollars in Thousands)

Common Equity Tier 1 (to Risk-Weighted Assets) $ 33,296 10.29% $ 14,561 4.50% $ 21,032 6.50% Total Capital (to Risk-Weighted Assets) $ 36,113 11.16% $ 25,886 8.00% $ 32,358 10.00% Tier I Capital (to Risk-Weighted Assets) $ 33,296 10.29% $ 19,415 6.00% $ 25,886 8.00% Tier I Capital (to Average Assets) $ 33,296 8.48% $ 15,704 4.00% $ 19,630 5.00%

December 31, 2016:

Common Equity Tier 1 (to Risk-Weighted Assets) $ 28,740 10.68% $ 12,112 4.50% $ 17,495 6.50% Total Capital (to Risk-Weighted Assets) $ 31,390 11.66% $ 21,533 8.00% $ 26,916 10.00% Tier I Capital (to Risk-Weighted Assets) $ 28,740 10.68% $ 16,149 6.00% $ 21,533 8.00% Tier I Capital (to Average Assets) $ 28,740 8.25% $ 13,938 4.00% $ 17,423 5.00%


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(12) Leases The Company leases buildings for several of its branches. The Davidson branch, located in Davidson, North Carolina is in the Davidson Commons shopping center and is leased until October 31, 2024. The Northcross branch is located in the Northcross Shopping Center in Huntersville, North Carolina. The building for Northcross is owned by the Company; however, the land is leased until April 30, 2034. The South Park branch is located across from SouthPark Mall in Charlotte, North Carolina. The building is leased until March 31, 2028. However, the landlord has the option to terminate the lease on September 30, 2021 due to the potential development plans in the business park. The Company believes the landlord will not exercise its option to terminate the lease at this time. The Company has two leased office facilities for its four insurance agencies located in North Carolina and South Carolina. The Hempstead, North Carolina office lease expired in February 2018, and a new lease was entered into in Surf City, North Carolina that commenced on March 1, 2018 and expires on March 1, 2020. The Murrells Inlet, South Carolina office lease was entered into on September 1, 2017 and expires on August 31, 2020. Minimum future rental payments under the Company’s office facility leases are as follows:

2018 $ 336,433 2019 326,041 2020 302,775 2021 294,410 2022 300,144 Thereafter 1,977,387 $ 3,537,190

Rental expense amounting to $200,077 and $265,587 during the years ended December 31, 2017 and 2016, respectively, is included in occupancy expense in the accompanying consolidated statements of earnings.

(13) 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, inventory, stocks, bonds, and certificates of deposit. In management’s opinion, these commitments represent no more than normal lending risk to the Company and will be funded from normal sources of liquidity. A summary of the contract amount of the Company’s exposure to off-balance sheet risk as of December 31, 2017 and 2016 is as follows:

2017 2016 Financial instruments whose contract amounts represent credit risk:

Commitments to extend credit $ 49,174,635 19,316,399 Undisbursed lines of credit 23,877,731 10,745,758 Standby letters of credit 238,065 217,270


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(13) Off-Balance Sheet Risk, continued Cash Flow Hedges of Interest Rate Risk The Company’s objectives in using interest rate derivatives are to add stability to net interest income and to manage its exposure to interest rate movements. To accomplish this objective, the Company primarily uses interest rate swaps and caps as part of its interest rate risk management strategy. As of December 31, 2017, the Company has $33.9 million in notional amount designated as a cash flow hedge on variable rate borrowings. The Company’s management has determined the hedges to be effective cash flow hedges. These interest rate swaps were purchased to add protection to the Company against a potential rise in interest rates by converting variable rate liabilities into fixed rate instruments. These interest rate swaps are based on the three-month LIBOR rate and were in a loss position at December 31, 2017 and December 31, 2016 totaling approximately $1.5 million and $2.1 million, respectively. At December, 31, 2017, the Company also has an interest rate cap with a notational amount of $4.0 million designated as a cash flow hedge on variable rate money market deposit accounts. The Company’s management has determined the hedges to be effective cash flow hedges. This interest rate cap was purchased to add protection to the Company against the potential rise in interest rates. The interest rate cap is based on the one-month LIBOR rate and was in a gain position at December 31, 2017 and 2016 totaling $19 and $1,100, respectively. The derivative fair values are included in other assets and other liabilities on the Company’s consolidated balance sheets.

(14) Fair Value Measurements and Disclosures The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities. Securities available-for-sale, as well as derivative financial instruments, are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as impaired loans and other real estate owned. These nonrecurring fair value adjustments typically involve the application of the lower of cost or market accounting or write-downs of individual assets. Fair Value Hierarchy The Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

Level 1 – Valuation is based upon quoted prices for identical instruments traded in active markets.

Level 2 – Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

Level 3 – Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

Following is a description of valuation methodologies used for assets and liabilities which are recorded at fair value. Investments Securities Available-for-Sale Fair values for investment securities available-for-sale are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. For these items, a fair value hierarchy of Level 2 or Level 3 has been assigned.


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(14) Fair Value Measurements and Disclosures, continued 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 a specific allocation is established within the allowance for loan losses. 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 impairment using one of three methods, including collateral value, market value of similar debt, 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 in which an allowance is established based on one of the three impairment methods require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is utilized 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. Other Real Estate Owned Other real estate properties are adjusted to fair value less estimated selling costs upon transfer of the loans to other real estate owned. Subsequently, other real estate properties are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral of management’s estimation of the value of the collateral. When the fair value is based on an observable market price, the Company records the other real estate as nonrecurring Level 2. When the fair value is based on an appraised value, or when an appraised value is not available, the Company records the other real estate asset as nonrecurring Level 3. Derivative Financial Instruments For derivative financial instruments, fair value is estimated at the amount the Company would receive or pay to terminate the contracts at the reporting date, taking into account the current unrealized gain or loss on the open contracts. Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of December 31, 2016, the Company had assessed the significance of the effect of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, the Company has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.

Assets and liabilities measured at fair value on a recurring basis at December 31, 2017 and 2016 were as follows:

Assets and Liabilities Recorded at Fair Value on a Recurring Basis The table below presents the recorded amount of assets (liabilities) measured at fair value on a recurring basis as of December 31, 2017 and 2016.

December 31, 2017: Level 1 Level 2 Level 3 Total U.S. government agency

securities $ - 12,076,825 - 12,076,825 Mortgage-backed securities - 45,084,412 - 45,084,412 Corporate bonds - 3,403,081 - 3,403,081 Foreign debt securities - 983,395 - 983,395 Municipal bonds - 321,380 - 321,380 $ - 61,869,093 - 61,869,093 Fair value of derivatives:

Derivative assets $ - 56,357 - 56,357 Derivative liabilities - (1,516,299) - (1,516,299)

$ - (1,459,942) - (1,459,942)


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(14) Fair Value Measurements and Disclosures, continued

December 31, 2016: Level 1 Level 2 Level 3 Total U.S. government agency

securities $ - 12,642,614 - 12,642,614 Mortgage-backed securities - 31,814,265 - 31,814,265 Preferred shares - 510,400 - 510,400 Corporate bonds - 2,719,773 - 2,719,773 Municipal bonds - 1,295,618 - 1,295,618 Foreign debt securities - 2,223,494 - 2,223,494 $ - 51,206,164 - 51,206,164 Fair value of derivatives:

Derivative assets $ - 1,072 - 1,072 Derivative liabilities - (2,068,238) - (2,068,238)

$ - (2,067,166) - (2,067,166)

Assets Recorded at Fair Value on a Nonrecurring Basis The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. Assets measured at fair value on a nonrecurring basis are included in the table below as of December 31, 2017 and 2016.

December 31, 2017: Level 1 Level 2 Level 3 Total

Impaired loans, net - - 152,232 152,232 Total assets at fair value $ - - 152,232 152,232

December 31, 2016:

Other real estate owned $ - - 1,539,230 1,539,230 Impaired loans, net - - 979,839 979,839 Total assets at fair value $ - - 2,519,069 2,519,069

(15) Employee and Director Benefit Plans

401(k) Plan The Company has a 401(k) Plan in which full-time employees are eligible to participate. The Company makes matching contributions of up to 4 percent of an employee’s compensation contributed to the Plan. Matching contributions vest to the employee immediately. For the years ended December 31, 2017 and 2016, expense attributable to the Plan amounted to $188,129 and $162,182, respectively. Employment Contracts The Company has entered into employment agreements with three of its executive officers to ensure a stable and competent management base. The agreements provide for terms of six months to three years, with automatic extensions. The agreements provide for benefits as spelled out in the contracts and cannot be terminated by the Board of Directors, except for cause, without prejudicing the officers’ rights to receive certain vested rights, including compensation. In the event of a change in control of the Company and in certain other events, as defined in the agreements, the Company or any successor to the Company will be bound to the terms of the contracts. Postretirement Benefit Plan The Company has one supplemental executive retirement plan whereby benefits are payable at retirement over a fifteen year period. The estimated liability is being accrued over the expected remaining years of employment. Expenses incurred for benefits relating to the postretirement benefit plan were $146,671 and $134,823 for the years 2017 and 2016, respectively. The accrued liability recorded on the balance sheet related to the plan was $422,944 and $276,273 at December 31, 2017 and 2016, respectively.


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(15) Employee and Director Benefit Plans, continued Stock Option Plans In October 2006, the Company’s stockholders approved a Non-statutory Stock Option Plan ("the Director Plan") and an Incentive Stock Option Plan ("Employee Plan"). The maximum numbers of shares available for grant under the Director Plan and the Employee Plan are 364,606 each. Exercise prices for both plans are established at market value on the grant date. Under the plans, unissued options expired in August 2016. Options granted become exercisable in accordance with the vesting schedule specified by the Board of Directors in the Plan agreements. A portion of the options granted under the Director Plan vest immediately and the balance vests over a three-year period with none vesting at the time of grant. The options granted under the Employee Plan vest over a five-year period with none vesting at the time of grant. All unexercised options expire 10 years after the date of grant. Option related compensation costs recorded during the years ended December 31, 2017 and 2016 totaled $61,572 and $51,731, respectively. At December 31, 2017, there was approximately $133,000 of total unrecognized compensation cost related to outstanding stock options. This cost is expected to be recognized over a weighted average period of approximately two years. A summary of the changes in the Company’s option plans for the years ended December 31, 2017 and 2016 is as follows:

Outstanding Options

Shares

Available for Future

Grants Number

Outstanding

Weighted Average Exercise

Price

Weighted Average

Remaining Contractual

Term Balance at December 31, 2015 118,264 610,950 $ 6.02 7.47 years

Options granted* (81,523) 123,289 $ 6.93 9.65 years Options exercised - (16,354) $ 4.92 - Options forfeited 14,923 (14,923) $ 5.75 8.02 years Expiration of unissued options (51,664) - - -

Balance at December 31, 2016 - 702,962 $ 6.19 7.61 years Options exercised - (12,082) $ 5.90 - Options forfeited - (18,112)

Balance at December 31, 2017 - 672,768

Exercisable at December 31, 2017 217,878

*Includes 41,766 of options granted from former board members options

Options granted under the Director Plan in 2016 had a weighted average fair value of $1.43; determined as of the date of grant using the Black-Scholes option pricing model, assuming no dividends; expected volatility of 14.45%; risk-free interest rate of 1.19%: and expected lives of 6 years. Options granted under the Employee Plan in 2016 had a weighted average fair value of $1.96; determined as of the date of grant using the Black-Scholes option pricing model, assuming no dividends; expected volatility between 18.26% and 19.39%; risk-free interest rate of 1.19% and 1.23%; and expected lives of 7 years. Warrants Organizers who personally guaranteed a portion of the Company’s organizational line of credit were granted warrants to purchase shares of the Company’s common stock. As part of the stock option and warrant exchange program, the Company's issued warrants are now exercisable for a period of ten years at an exercise price of $4.92 per share and were granted on a pro rata basis, based upon the dollar amount of a personal guarantee assumed by each organizer during the Company’s organization. All organizers currently serve as directors of the Company. These warrants vested immediately. There were no new warrants granted or exercised in 2017 or 2016. As of December 31, 2017 and 2016 there were 172,800 warrants outstanding. The warrants have a 10 year term from the date of grant and expire in 2023.


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(15) Employee and Director Benefit Plans, continued Restricted Stock Plan In 2015, the Company’s stockholders approved a Restricted Stock Plan. The Company has reserved 144,000 shares of its authorized but unissued common stock to be issued under the Plan. During 2016, the Company approved the grant of 16,800 shares of restricted stock under this plan. These shares of restricted stock had a five-year term, with the all shares vesting ratably over five years of continued employment. At grant date, the stock was valued $6.96 per share. The compensation cost for restricted stock is amortized to expense over the vesting period. Total restricted stock compensation expense for 2016 was $13,638. During 2017, the Company approved the grant of 31,800 shares of restricted stock under this plan. These shares of restricted stock had a five-year term, with all shares vesting ratably over five years of continued employment. At grant dates, the weighted average stock valued was $7.78 per share. The compensation cost for stock is amortized to expense over the vesting period. Total restricted stock compensation expense for 2017 was $61,572.

(16) Stockholders’ Equity

Stock Dividend On January 16, 2018, the Company declared a 20 percent stock dividend in the form of a stock split for all shareholders on record as of February 3, 2018. All share and per share amounts were restated to the earliest period presented in the consolidated financial statements. The Company issued 665,598 additional shares on February 23, 2018.

Common Stock During 2016, the Company issued 209,702 shares of common stock in a private placement offering. Total net proceeds from the offering were $1,715,943.

(17) Subsequent Events Management has evaluated all subsequent events through May 1, 2018, the date the consolidated financial statements were available to be issued.

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Aquesta Financial Holdings, Inc. and Subsidiaries Board of Directors and Executive Management

Aquesta Financial Holdings, Inc. Board of Directors

James Borders, Jr. Paul Dougovito AC Control Company, Inc., President Banking Consultant

Jim Engel Ginger GriffinAquesta Bank, President and CEO Ginger Griffin Marketing and Design, Principal

Charles Knox, Jr. Craig Larsen (Chairman)The Knox Group REVITA Anti-Aging Center

Commercial Real Estate Broker and Developer Owner/CEO

Alison J. SmithSmith Capital Inc., President

Aquesta Bank Board of Directors

Paul Dougovito Jonathon Dressler Banking Consultant Dressler’s Restaurant, Owner

Jim Engel J. David Goodrum Aquesta Bank, President and CEO JD Goodrum Company Inc.,

President and General Manager

Carol Houle Paul JaszewskiCognizant Technology Solutions Anesthesiologist

The Knox Group,

VP - Global Head of Digital Engineering Consulting

David PickensPSI Control Solutions, IncCEO and Majority Owner

Southeast Anesthesiology Consultants as CMC

Charles Knox, Jr. (Chairman) Craig LarsenREVITA Anti-Aging Center

Commercial Real Estate Broker and Developer Owner/CEO

Executive Aquesta Bank OfficersJim Engel Tim Beck

President and Chief Executive Officer Chief Credit Officer

Kristin Couch Carrie HewittChief Financial Officer Chief Operating Officer

Trey WeirChief Banking Officer

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Aquesta Financial Holdings, Inc. and Subsidiaries General Corporate Information

Office Location

19510 Jetton Road Cornelius, North Carolina 28031

Phone: (704) 439-4343 Fax: (704) 439-4344

Website: www.aquestabank.com

Regulatory and Securities Counsel Wyrick Robbins Yates & Ponton L.L.P.

4101 Lake Boone Trail, Suite 300 Raleigh, North Carolina 27607

Stock Transfer Agent Independent Auditors Continental Stock Transfer & Trust Company. Porter Keadle Moore, LLC 17 Battery Place 235 Peachtree Street, NE New York, New York 10004 Suite 1800 Atlanta, Georgia 30303

Annual Shareholders Meeting The Annual Meeting of the shareholders of Aquesta Financial Holdings, Inc. will be held at Aquesta Bank Headquarters Building on June 19, 2018 at 5:00 pm in Cornelius, North Carolina.

Common Stock and Related Matters

The Bank’s outstanding common stock shares were held by approximately 390 holders of record (excluding shares held in street name) as of December 31, 2017. As of December 31, 2017, the Bank had 3,972,760 shares of common stock outstanding. On January 16, 2018, the Company declared a 20 percent stock dividend in the form of a stock split for all shareholders on record as of February 3, 2018. A cash dividend was paid out on December 22, 2017 and 2016.

Market for Common Stock

On April 1, 2014, Aquesta Bank successfully completed its reorganization into a bank holding company, Aquesta Financial Holdings, Inc. (AQFH) (the "Company"). There is public trading market for the Company’s common stock under symbol AQFH. Shareholders received a letter along with a letter of transmittal that needs to be returned to the transfer agent in order to exchange shares. For more information, please contact investor relations by telephone or mail at the Bank’s corporate headquarters. This Annual Report serves as the annual financial disclosure statement furnished pursuant to the Federal Deposit Insurance Corporation’s rules and regulations. This statement has not been reviewed or confirmed for accuracy or relevance by the Federal Deposit Insurance Corporation.

http://www.aquestabank.com/

Cornelius Office19510 Jetton Rd.

Cornelius, NC 28031

704.892.6411

Wilmington Office901 Military Cutoff Rd.

Wilmington, NC 28405

910.794.6100

Charleston Loan Production Office4000 Faber Place Dr.

Suite 300

North Charleston, SC 29405

843.242.1555

www.aquesta.com

Main Office 19510 Jetton Road

Cornelius, NC 28031

704.439.4343

Brawley Rd Branch1078 Brawley School Rd.


704.439.1450

Williamson Rd Branch 837 Williamson Rd.


704.439.1440

Davidson Branch 568 Jetton St.

Davidson, NC 28036

704.439.4350

Huntersville Branch 9906 Knockando Ln.

Huntersville, NC 28078

704.439.1430

Southpark Branch 4519 Sharon Road

Charlotte, NC 28211

704.804.7930

Wilmington Branch 901 Military Cutoff Rd Wilmington, NC 28405

910.782.3830

Surf City Office214B N. Topsail Dr.

Surf City, NC 28445

910.794.6100

Murrells Inlet Office870 B Inlet Sq Dr.

PO Box 2295

Murrells Inlet, SC 29576

843.651.7111

Greenville Loan Production Office27 Cleveland St. Suite 103

Greenville, SC 29601

864.979.7117

Stock Symbol: AQFH

2017 Annual ReportProviding vision for the future

Documents

2017 Annual Report - Aquesta Bank...Murrells Inlet Office 870 B Inlet Sq Dr. PO Box 2295 Murrells Inlet, SC 29576 843.651.7111 Greenville Loan Production Office 27 Cleveland St. Suite