UWHARRIE CAPITAL CORP - Quarter Report: 2018 June (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2018

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to .

COMMISSION FILE NUMBER 000-22062

UWHARRIE CAPITAL CORP

(Exact name of registrant as specified in its charter)

NORTH CAROLINA		56-1814206
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

132 NORTH FIRST STREET ALBEMARLE, NORTH CAROLINA		28001
(Address of Principal Executive Offices)		(Zip Code)

Registrant’s Telephone number, including area code: (704) 983-6181

N/A

(Former name, former address and former fiscal year, if changed since last report)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐

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

Large accelerated filer	☐	Accelerated filer	☐

Non-accelerated filer	☐ (Do not check if a smaller reporting company.)	Smaller reporting company	☒
Emerging growth company	☐

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date: 7,100,749 shares of common stock outstanding as of August 6, 2018.

Table of Contents

		Page No.

Part I.	FINANCIAL INFORMATION

Item 1 -	Financial Statements (Unaudited)

	Consolidated Balance Sheets as of June 30, 2018 and December 31, 2017	3

	Consolidated Statements of Income for the Three and Six Months Ended June 30, 2018 and 2017	4

	Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2018 and 2017	5

	Consolidated Statements of Changes in Shareholders’ Equity for the Six Months Ended June 30, 2018	6

	Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2018 and 2017	7

	Notes to Consolidated Financial Statements	8

Item 2 -	Management’s Discussion and Analysis of Financial Condition and Results of Operations	27

Item 3 -	Quantitative and Qualitative Disclosures About Market Risk	34

Item 4 -	Controls and Procedures	34

Part II.	OTHER INFORMATION

Item 1 -	Legal Proceedings	35

Item 1A -	Risk Factors	35

Item 2 -	Unregistered Sales of Equity Securities and Use of Proceeds	35

Item 3 -	Defaults Upon Senior Securities	35

Item 4 -	Mine Safety Disclosures	35

Item 5 -	Other Information	35

Item 6 -	Exhibits	36

	Signatures	37

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Uwharrie Capital Corp and Subsidiaries

Consolidated Balance Sheets

Part I. Financial Information

Item 1.

Financial Statements.

	June 30, 2018 (Unaudited)			December 31, 2017*
	(dollars in thousands)
ASSETS
Cash and due from banks	$	7,505		$	7,538
Interest-earning deposits with banks		91,520			62,865
Securities available for sale, at fair value		90,429			95,743
Securities held to maturity, at amortized cost (fair value $11,002 and $11,461, respectively)		11,118			11,458
Loans held for sale		5,292			4,414
Loans:
Loans held for investment		370,577			356,871
Less allowance for loan losses		(2,583	)		(2,458	)
Net loans held for investment		367,994			354,413
Premises and equipment, net		15,064			14,728
Interest receivable		1,714			1,709
Restricted stock		1,094			1,067
Bank owned life insurance		8,613			8,546
Other real estate owned		1,439			2,349
Prepaid assets		1,150			786
Other assets		11,303			10,742
Total assets	$	614,235		$	576,358

LIABILITIES
Deposits:
Demand noninterest-bearing	$	133,924		$	113,762
Interest checking and money market accounts		307,736			289,953
Savings deposits		49,804			45,698
Time deposits, $250,000 and over		7,633			7,933
Other time deposits		51,556			55,282
Total deposits		550,653			512,628
Short-term borrowed funds		1,522			1,752
Long-term debt		9,534			9,534
Interest payable		149			148
Other liabilities		8,452			7,756
Total liabilities		570,310			531,818

Off balance sheet items, commitments and contingencies (Note 9)

SHAREHOLDERS’ EQUITY
Common stock, $1.25 par value: 20,000,000 shares authorized; shares issued and outstanding 7,100,749 and 7,112,853		8,876			8,891
Preferred stock, 10,000,000 shares authorized; none issued and outstanding		—			—
Additional paid-in capital		12,762			12,824
Undivided profits		13,699			13,282
Accumulated other comprehensive income (loss)		(2,066	)		(1,107	)
Total Uwharrie Capital shareholders’ equity		33,271			33,890
Noncontrolling interest		10,654			10,650
Total shareholders’ equity		43,925			44,540
Total liabilities and shareholders’ equity	$	614,235		$	576,358

(*)	Derived from audited consolidated financial statements

See accompanying notes

-3-

Uwharrie Capital Corp and Subsidiaries

Consolidated Statements of Income (Unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
	2018			2017			2018			2017
	(in thousands, except share and per share data)
Interest Income
Loans, including fees	$	4,469		$	4,132		$	8,725		$	8,122
Investment securities
US Treasury		—			12			—			23
US Government agencies and corporations		364			378			751			753
State and political subdivisions		120			117			244			240
Interest-earning deposits with banks and federal funds sold		365			158			642			262
Total interest income		5,318			4,797			10,362			9,400

Interest Expense
Interest checking and money market accounts		192			98			336			182
Savings deposits		13			13			25			25
Time deposits, $250,000 and over		17			19			33			30
Other time deposits		47			45			92			92
Short-term borrowed funds		4			6			7			13
Long-term debt		138			137			273			272
Total interest expense		411			318			766			614
Net interest income		4,907			4,479			9,596			8,786
Provision for (recovery of) loan losses		38			(114	)		116			(173	)
Net interest income after provision (recovery of) for loan losses		4,869			4,593			9,480			8,959

Noninterest Income
Service charges on deposit accounts		290			286			573			575
Interchange and card transaction fees		144			201			286			337
Other service fees and commissions		652			592			1,290			1,388
Income from mortgage loan sales		869			878			1,531			1,749
Other income		216			66			385			352
Total noninterest income		2,171			2,023			4,065			4,401

Noninterest Expense
Salaries and employee benefits		4,121			3,642			8,067			7,340
Net occupancy expense		396			307			760			611
Equipment expense		165			148			335			300
Data processing costs		283			178			533			360
Office supplies and printing		39			37			75			62
Foreclosed real estate expense		33			176			72			264
Professional fees and services		214			171			462			347
Marketing and donations		209			228			420			486
Electronic banking expense		98			86			199			170
Software amortization and maintenance		234			190			447			371
FDIC insurance		65			46			131			91
Other noninterest expense		638			462			1,207			1,139
Total noninterest expense		6,495			5,671			12,708			11,541
Income before income taxes		545			945			837			1,819
Income taxes		78			313			136			570
Net income	$	467		$	632		$	701		$	1,249

Consolidated net income	$	467		$	632		$	701		$	1,249
Less: net income attributable to noncontrolling interest		(141	)		(148	)		(284	)		(294	)
Net income attributable to Uwharrie Capital Corp and common shareholders	$	326		$	484		$	417		$	955
Net income (loss) per common share
Basic	$	0.05		$	0.07		$	0.06		$	0.13
Diluted	$	0.05		$	0.07		$	0.06		$	0.13
Weighted average shares outstanding
Basic		7,107,245			7,141,240			7,109,782			7,163,493
Diluted		7,107,245			7,141,572			7,109,782			7,163,986

See accompanying notes

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Uwharrie Capital Corp and Subsidiaries

Consolidated Statements of Comprehensive Income (Unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
	2018			2017			2018			2017
	(in thousands)

Net Income	$	467		$	632		$	701		$	1,249

Unrealized gain (loss) on available for sale securities		(142	)		467			(1,241	)		844
Related tax effect		32			(159	)		282			(287	)

Total other comprehensive income (loss)		(110	)		308			(959	)		557

Comprehensive income (loss)		357			940			(258	)		1,806

Less: Comprehensive income (loss) attributable to noncontrolling interest		(141	)		(148	)		(284	)		(294	)

Comprehensive income (loss) attributable to Uwharrie Capital	$	216		$	792		$	(542	)	$	1,512

See accompanying notes

-5-

Uwharrie Capital Corp and Subsidiaries

Consolidated Statement of Changes in Shareholders’ Equity (Unaudited)

	Number of Common Shares Issued			Common Stock			Additional Paid-in Capital			Undivided Profits		Accumulated Other Comprehensive Income (Loss)			Non Controlling Interest			Total
	(dollars in thousands, except share data)

Balance, December 31, 2017		7,112,853		$	8,891		$	12,824		$	13,282	$	(1,107	)	$	10,650		$	44,540
Net Income		—			—			—			417		—			284			701
Repurchase of common stock		(25,482	)		(31	)		(111	)		—		—			—			(142	)
Stock options exercised		13,378			16			49			—		—			—			65
Other comprehensive Income		—			—			—			—		(959	)		—			(959	)
Record preferred stock dividend Series B (noncontrolling interest)		—			—			—			—		—			(206	)		(206	)
Record preferred stock dividend Series C (noncontrolling interest)		—			—			—			—		—			(74	)		(74	)
Balance, June 30, 2018		7,100,749		$	8,876		$	12,762		$	13,699	$	(2,066	)	$	10,654		$	43,925

See accompanying notes

-6-

Uwharrie Capital Corp and Subsidiaries

Consolidated Statements of Cash Flows (Unaudited)

	Six Months Ended June 30,
	2018			2017
	(dollars in thousands)
Cash flows from operating activities
Net income	$	701		$	1,249
Adjustments to reconcile net income to net cash
Provided (used) by operating activities:
Depreciation and amortization		515			426
Provision for (recovery of) loan losses		116			(173	)
Gain on sale of OREO		27			35
Net amortization of premium on investment securities AFS		364			453
Net amortization of premium on investment securities HTM		75			72
Net amortization of mortgage servicing rights		346			374
OREO write downs		—			78
Originations and purchases of mortgage loans for sale		(48,033	)		(47,656	)
Proceeds from sales of mortgage loans for sale		46,809			49,993
Cash surrender value of life insurance		(67	)		(60	)
Net change in:
Accrued interest receivable		(5	)		26
Prepaid assets		(364	)		(533	)
Miscellaneous other assets		(275	)		(1,196	)
Accrued interest payable		1			(2	)
Miscellaneous other liabilities		696			1,029
Net cash provided by operating activities		906			4,115


Cash flows from investing activities
Proceeds from maturities, calls & paydowns of investment securities held to maturity		265			138
Proceeds from maturities, calls & paydowns of investment securities available for sale		3,709			4,081
Purchase of life insurance investment		—			(1,525	)
Net change in restricted stock		(27	)		(15	)
Net increase in loans		(13,857	)		(11,581	)
Purchase of premises and equipment		(851	)		(304	)
Proceeds from sale of OREO		1,043			1,510
Net cash used by investing activities		(9,718	)		(7,696	)

Cash flows from financing activities
Net increase in deposit accounts		38,025			36,401
Net decrease in federal funds purchased
and securities sold under agreements to repurchase and other short-term borrowings		(230	)		(714	)
Repayment of other borrowings		—			(506	)
Common stock repurchased		(142	)		(367	)
Exercise of stock options		65			—
Dividends paid on preferred stock		(284	)		(294	)
Net cash provided by financing activities		37,434			34,520
Increase in cash and cash equivalents		28,622			30,939
Cash and cash equivalents, beginning of period		70,403			45,968
Cash and cash equivalents, end of period	$	99,025		$	76,907

Supplemental Disclosures of Cash Flow Information
Interest paid	$	765		$	616
Income taxes paid		335			433
Supplemental Schedule of Non-Cash Activities
Net change in fair value securities available for sale, net of tax	$	959		$	557
Loans transferred to foreclosed real estate		160			248
Mortgage servicing rights capitalized		169			329

See accompanying notes

-7-

UWHARRIE CAPITAL CORP AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

Note 1 – Basis of Presentation

The financial statements and accompanying notes are presented on a consolidated basis including Uwharrie Capital Corp (the “Company”) and its subsidiaries, Uwharrie Bank (the “Bank”), Uwharrie Investment Advisors, Inc., and Uwharrie Mortgage, Inc. The Bank consolidates its subsidiaries, the Strategic Alliance Corporation, BOS Agency, Inc. and Gateway Mortgage, Inc., each of which is wholly-owned by the Bank.

The information contained in the consolidated financial statements is unaudited. In the opinion of management, the consolidated financial statements have been prepared in conformity with generally accepted accounting principles in the United States of America (“GAAP”) and material adjustments necessary for a fair presentation of results of interim periods, all of which are of a normal recurring nature, have been made. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for an entire year. Management is not aware of economic events, outside influences or changes in concentrations of business that would require additional clarification or disclosure in the consolidated financial statements.

The organization and business of the Company, accounting policies followed by the Company and other information are contained in the notes to consolidated financial statements filed as part of the Company’s 2017 Annual Report on Form 10-K. This Quarterly Report should be read in conjunction with such Annual Report.

Use of Estimates

The preparation of financial statements, in conformity with GAAP, 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 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.

Note 2 – Comprehensive Income

The Company reports as comprehensive income all changes in shareholders’ equity during the year from sources other than shareholders. Other comprehensive income refers to all components (revenues, expenses, gains, and losses) of comprehensive income that are excluded from net income. The Company’s only component of other comprehensive income is unrealized gains and losses, net of income tax, on investment securities available for sale.

The following table presents the changes in accumulated other comprehensive income for the three and six months ended June 30, 2018 and 2017:

	Unrealized holding gains on available-for-sale securities (net)
	For the Three Months Ended June 30,						For the Six Months Ended June 30,
	2018			2017			2018			2017
	(dollars in thousands)

Beginning Balance	$	(1,956	)	$	(1,069	)	$	(1,107	)	$	(1,318	)

Other Comprehensive income (loss) before reclassifications, net of $32,000, $159,000, ($282,000), and $287,000 tax effect, respectively		(110	)		308			(959	)		557

Amounts reclassified from accumulated other comprehensive income		—			—			—			—

Net current-period other comprehensive income (loss)		(110	)		308			(959	)		557

Ending Balance	$	(2,066	)	$	(761	)	$	(2,066	)	$	(761	)

-8-

Note 3 – Noncontrolling Interest

In January 2013, the Company’s subsidiary banks issued a total of $7.9 million of Fixed Rate Noncumulative Perpetual Preferred Stock, Series B. The preferred stock qualified as Tier 1 capital at each bank and pays dividends at an annual rate of 5.30%. The preferred stock has no voting rights. This capital is presented as noncontrolling interest in the consolidated balance sheets. Dividends declared on this preferred stock are presented as earnings allocated to the noncontrolling interest in the consolidated statements of income. Effective September 1, 2013, the Fixed Rate Noncumulative Perpetual Preferred Stock, Series B was rolled into one issue under Uwharrie Bank in connection with the consolidation of the Company’s subsidiary banks and name change.

During 2013, the Company’s subsidiary bank, Uwharrie Bank, raised $2.8 million of Fixed Rate Noncumulative Perpetual Preferred Stock, Series C. The preferred stock qualifies as Tier 1 capital at the bank and pays dividends at an annual rate of 5.30%. The preferred stock has no voting rights.

Note 4 – Per Share Data

Basic and diluted net income per common share is computed based on the weighted average number of shares outstanding during each period after retroactively adjusting for stock dividends. Diluted net income per common share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the net income of the Company. The Company had no stock options outstanding at June 30, 2018 but there were 13,116 shares of common stock underlying outstanding stock options at December 31, 2017. All of these options were dilutive at December 31, 2017 because the strike price was lower than the market price.

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

The computation of basic and diluted earnings per share is summarized below:

	For the Three Months Ended June 30,				For the Six Months Ended June 30,
	2018		2017		2018		2017

Weighted average number of common shares outstanding		7,107,245		7,141,240		7,109,782		7,163,493

Effect of dilutive stock options		—		332		—		493

Weighted average number of common shares and dilutive potential common shares used in computing diluted net income per common share		7,107,245		7,141,572		7,109,782		7,163,986

Note 5 – Investment Securities

Carrying amounts and fair values of securities available for sale and held to maturity as of June 30, 2018 and December 31, 2017 are summarized below:

June 30, 2018	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
	(dollars in thousands)
Securities available for sale
U.S. Government agencies	$	55,113	$	41	$	1,548	$	53,606
GSE - Mortgage-backed securities and CMO’s		19,158		2		671		18,489
State and political subdivisions		13,806		15		492		13,329
Corporate bonds		5,036		18		49		5,005
Total securities available for sale	$	93,113	$	76	$	2,760	$	90,429

-9-

June 30, 2018	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
	(dollars in thousands)
Securities held to maturity
U.S. Government agencies	$	1,072	$	—	$	15	$	1,057
State and political subdivisions		6,901		2		78		6,825
Corporate bonds		3,145		—		25		3,120
Total securities held to maturity	$	11,118	$	2	$	118	$	11,002

December 31, 2017	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
	(dollars in thousands)
Securities available for sale
U.S. Government agencies	$	56,522	$	33	$	940	$	55,615
GSE - Mortgage-backed securities and CMO’s		21,253		12		374		20,891
State and political subdivisions		14,368		27		196		14,199
Corporate bonds		5,042		7		11		5,038
Total securities available for sale	$	97,185	$	79	$	1,521	$	95,743

December 31, 2017	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
	(dollars in thousands)
Securities held to maturity
U.S. Government agencies	$	1,348	$	—	$	9	$	1,339
State and political subdivisions		6,925		23		36		6,912
Corporate bonds		3,185		25		—		3,210
Total securities held to maturity	$	11,458	$	48	$	45	$	11,461

At June 30, 2018 and December 31, 2017, the Company owned Federal Reserve Bank stock (FRB) reported at cost of $509,000 and $508,000, respectively, and Federal Home Loan Bank stock (FHLB) of $585,000 and $559,000, respectively. The investments in FRB stock and FHLB stock are required investments related to the Company’s membership in, and borrowings with, these banks and classified as restricted stock on the consolidated balance sheet. These investments are carried at cost since there is no ready market and redemption has historically been made at par value. The Company estimated that the fair value approximated cost and that these investments were not impaired at June 30, 2018.

There were no sales of securities available for sale for the three and six-month periods ended June 30, 2018 and June 30, 2017.

At June 30, 2018 and December 31, 2017, securities available for sale with a carrying amount of $74.4 million and $75.5 million, respectively, were pledged as collateral on public deposits and for other purposes as required or permitted by law.

-10-

The following tables show the gross unrealized losses and fair value of investments, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at June 30, 2018 and December 31, 2017. These unrealized losses on investment securities are a result of temporary fluctuations in market prices due to a rise in interest rates, which will adjust if rates decline, and in a volatile market and are in no way a reflection of the credit quality of the investments. Management does not believe these fluctuations are a reflection of the quality of the investments. At June 30, 2018, the unrealized losses on available for sale securities less than twelve months related to five government agency bonds, five government sponsored enterprise (GSE) mortgage backed securities, one state and political bond, and one corporate bond. The Company had thirteen government agency bonds, twelve GSE mortgage backed securities, and seven state and political bonds at June 30, 2018 that had been in a loss position for more than twelve months. At June 30, 2018, the unrealized losses on held to maturity securities related to one government agency bond, eight state and political bonds, and two corporate bonds. The held to maturity securities consisted of one state and political bond that had been in an unrealized loss position for more than twelve months at June 30, 2018. At December 31, 2017, the unrealized losses on available for sale securities less than twelve months related to six government agency bonds, four GSE mortgage backed securities, one corporate bond, and one state and political subdivision bond. At December 31, 2017, the Company had fifteen government agency bonds, twelve GSE mortgage backed securities, and seven state and political subdivision bonds that had been in a loss position for more than twelve months. At December 31, 2017, the unrealized losses on held to maturity securities related to one government agency security and five state and political subdivision bonds.

	Less than 12 Months				12 Months or More				Total
June 30, 2018	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(dollars in thousands)
Securities available for sale temporary impairment
U.S. Government agencies	$	8,163	$	225	$	40,673	$	1,323	$	48,836	$	1,548
GSE-Mortgage-backed securities and CMO’s		5,353		128		12,497		543		17,850		671
State and political subdivisions		1,136		38		9,986		454		11,122		492
Corporate bonds		1,967		49		—		—		1,967		49
Total securities available for sale	$	16,619	$	440	$	63,156	$	2,320	$	79,775	$	2,760

	Less than 12 Months				12 Months or More				Total
June 30, 2018	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(dollars in thousands)
Held to maturity temporary impairment
U.S. Government agencies	$	1,057	$	15	$	—	$	—	$	1,057	$	15
State and political subdivisions		5,317		56		994		22		6,311		78
Corporate bonds		3,120		25		—		—		3,120		25
Total securities held to maturity	$	9,494	$	96	$	994	$	22	$	10,488	$	118

	Less than 12 Months				12 Months or More				Total
December 31, 2017	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(dollars in thousands)
Securities available for sale temporary impairment
U.S. Government agencies	$	9,028	$	112	$	43,352	$	828	$	52,380	$	940
GSE-Mortgage-backed securities and CMO’s		5,074		37		14,057		337		19,131		374
State and political subdivisions		1,182		1		10,317		195		11,499		196
Corporate bonds		2,008		11		—		—		2,008		11
Total securities available for sale	$	17,292	$	161	$	67,726	$	1,360	$	85,018	$	1,521

	Less than 12 Months				12 Months or More				Total
December 31, 2017	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(dollars in thousands)
Held to maturity temporary impairment
U.S. Government agencies	$	1,338	$	9	$	—	$	—	$	1,338	$	9
State and political subdivisions		4,269		36		—		—		4,269		36
Total securities held to maturity	$	5,607	$	45	$	—	$	—	$	5,607	$	45

Declines in the fair value of the investment portfolio are believed by management to be temporary in nature. When evaluating an investment for other-than-temporary impairment management considers, among other things, the length of time and the extent to

-11-

which the fair value has been in a loss position, the financial condition of the issuer and the intent and the ability of the Company to hold the investment until the loss position is recovered.

Any unrealized losses were largely due to increases in market interest rates over the yields available at the time of purchase. The fair value is expected to recover as the bonds approach their maturity date or market yields for such investments decline. Management does not believe any of the securities are impaired due to reasons of quality but that the losses are temporary in nature. At June 30, 2018, the Company does not intend to sell and is not likely to be required to sell the available for sale securities that were in a loss position prior to full recovery.

The aggregate amortized cost and fair value of the available for sale securities portfolio at June 30, 2018 by remaining contractual maturity are as follows:

	June 30, 2018
	Amortized Cost		Estimated Fair Value		Book Yield
	(dollars in thousands)
Securities available for sale

U.S. Government agencies
Due within twelve months		12,001		11,881		1.18	%
Due after one but within five years		30,667		29,587		1.59	%
Due after five but within ten years		7,910		7,616		1.98	%
Due after ten years		4,535		4,522		1.73	%
		55,113		53,606		1.68	%
Mortgage-backed securities
Due within twelve months		250		247		1.48	%
Due after one but within five years		1,622		1,613		2.24	%
Due after five but within ten years		6,233		6,021		2.00	%
Due after ten years		11,053		10,608		1.97	%
		19,158		18,489		2.00	%
State and political subdivisions
Due within twelve months		1,362		1,375		4.39	%
Due after one but within five years		1,082		1,059		3.57	%
Due after five but within ten years		1,702		1,641		3.08	%
Due after ten years		9,660		9,254		2.45	%
		13,806		13,329		2.80	%
Corporate Bonds
Due after one but within five years		5,036		5,005		1.86	%
		5,036		5,005		1.86	%
Total Securities available for sale
Due within twelve months		13,613		13,503		1.51	%
Due after one but within five years		38,407		37,264		1.71	%
Due after five but within ten years		15,845		15,278		2.07	%
Due after ten years		25,248		24,384		2.11	%
	$	93,113	$	90,429		1.85	%

-12-

	June 30, 2018
	Amortized Cost		Estimated Fair Value		Book Yield
	(dollars in thousands)
Held to maturity

U. S. Government agencies
Due after five but within ten years	$	1,072	$	1,057		2.49	%
		1,072		1,057		2.49	%
State and political subdivisions
Due after one but within five years		5,050		4,981		2.50	%
Due after five but within ten years		1,851		1,844		2.99	%
		6,901		6,825		2.63	%
Corporate Bonds
Due after one but within five years		3,145		3,120		2.76	%
		3,145		3,120		2.76	%
Total Securities held for maturity
Due after one but within five years		8,195		8,101		2.60	%
Due after five but within ten years		2,923		2,901		2.81	%
	$	11,118	$	11,002		2.66	%

Note 6 – Loans Held for Investment

The composition of net loans held for investment by class as of June 30, 2018 and December 31, 2017 are as follows:

	June 30, 2018			December 31, 2017
	(dollars in thousands)
Commercial
Commercial	$	55,837		$	54,912
Real estate - commercial		134,120			114,712
Other real estate construction loans		32,457			40,186
Noncommercial
Real estate 1-4 family construction		5,037			5,024
Real estate - residential		78,604			78,023
Home equity		50,188			50,506
Consumer loans		11,686			10,774
Other loans		2,879			2,838
		370,808			356,975
Less:
Allowance for loan losses		(2,583	)		(2,458	)
Deferred loan (fees) costs, net		(231	)		(104	)

Loans held for investment, net	$	367,994		$	354,413

-13-

Note 7 – Allowance for Loan Losses

The following table shows the change in the allowance for loss losses by loan segment for the three and six months ended June 30, 2018 and 2017, respectively:

Commercial	Three Months Ended June 30,						Six Months Ended June 30,
	2018			2017			2018			2017
	(dollars in thousands)

Balance, beginning of period	$	1,461		$	1,439		$	1,401		$	1,404
Provision (recovery) charged to operations		21			(107	)		66			(135	)
Charge-offs		(31	)		(16	)		(31	)		(16	)
Recoveries		9			7			24			70
Net (charge-offs) / Recoveries		(22	)		(9	)		(7	)		54
Balance at end of period	$	1,460		$	1,323		$	1,460		$	1,323

Non-Commercial	Three Months Ended June 30,						Six Months Ended June 30,
	2018			2017			2018			2017
	(dollars in thousands)

Balance, beginning of period	$	1,086		$	1,238		$	1,057		$	1,303
Provision (recovery) charged to operations		17			(7	)		50			(38	)
Charge-offs		(40	)		(26	)		(57	)		(84	)
Recoveries		60			23			73			47
Net (charge-offs) / Recoveries		20			(3	)		16			(37	)
Balance at end of period	$	1,123		$	1,228		$	1,123		$	1,228

Total	Three Months Ended June 30,						Six Months Ended June 30,
	2018			2017			2018			2017
	(dollars in thousands)

Balance, beginning of period	$	2,547		$	2,677		$	2,458		$	2,707
Provision (recovery) charged to operations		38			(114	)		116			(173	)
Charge-offs		(71	)		(42	)		(88	)		(100	)
Recoveries		69			30			97			117
Net (charge-offs) / Recoveries		(2	)		(12	)		9			17
Balance at end of period	$	2,583		$	2,551		$	2,583		$	2,551

The following table shows period-end loans and reserve balances by loan segment both individually and collectively evaluated for impairment at June 30, 2018 and December 31, 2017:

June 30, 2018
	Individually Evaluated				Collectively Evaluated				Total
	Reserve		Loans		Reserve		Loans		Reserve		Loans
	(dollars in thousands)

Commercial	$	45	$	1,635	$	1,415	$	220,779	$	1,460	$	222,414
Non-Commercial		124		3,540		999		144,623		1,123		148,163

Total	$	169	$	5,175	$	2,414	$	365,402	$	2,583	$	370,577

December 31, 2017
	Individually Evaluated				Collectively Evaluated				Total
	Reserve		Loans		Reserve		Loans		Reserve		Loans
	(dollars in thousands)

Commercial	$	22	$	1,788	$	1,379	$	208,022	$	1,401	$	209,810
Non-Commercial		172		3,781		885		143,280		1,057		147,061

Total	$	194	$	5,569	$	2,264	$	351,302	$	2,458	$	356,871

-14-

Past due loan information is used by management when assessing the adequacy of the allowance for loan losses. The following table summarizes the past due information of the loan portfolio by class as of June 30, 2018 and December 31, 2017:

June 30, 2018
	Loans 30-89 Days Past Due		Loans 90 Days or More Past due and Non - Accrual		Total Past Due Loans		Current Loans		Total Loans		Accruing Loans 90 or More Days Past Due
	(dollars in thousands)

Commercial	$	—	$	—	$	—	$	55,837	$	55,837	$	—
Real estate - commercial		93		288		381		133,739		134,120		—
Other real estate construction		—		49		49		32,408		32,457		—
Real estate 1-4 family construction		—		—		—		5,037		5,037		—
Real estate - residential		811		470		1,281		77,092		78,373		—
Home equity		—		152		152		50,036		50,188		—
Consumer loans		5		—		5		11,681		11,686		—
Other loans		—		—		—		2,879		2,879		—

Total	$	909	$	959	$	1,868	$	368,709	$	370,577	$	—

December 31, 2017
	Loans 30-89 Days Past Due		Loans 90 Days or More Past due and Non - Accrual		Total Past Due Loans		Current Loans		Total Loans		Accruing Loans 90 or More Days Past Due
	(dollars in thousands)

Commercial	$	—	$	34	$	34	$	54,878	$	54,912	$	—
Real estate - commercial		—		377	$	377		114,335		114,712		—
Other real estate construction		—		51	$	51		40,135		40,186		—
Real estate construction		—		—		—		5,024		5,024		—
Real estate - residential		579		540		1,119		76,800		77,919		—
Home equity		108		23		131		50,375		50,506		—
Consumer loan		83		—		83		10,691		10,774		—
Other loans		—		—		—		2,838		2,838		—

Total	$	770	$	1,025	$	1,795	$	355,076	$	356,871	$	—

Once a loan becomes 90 days past due, the loan is automatically transferred to a nonaccrual status. The exception to this policy is credit card loans that remain in accruing status 90 days or more until they are paid current or charged off.

The Company had $474,000 in foreclosed residential real estate and no residential real estate in process of foreclosure at June 30, 2018.

-15-

The composition of nonaccrual loans by class as of June 30, 2018 and December 31, 2017 is as follows:

	June 30, 2018		December 31, 2017
	(dollars in thousands)

Commercial	$	—	$	34
Real estate - commercial		288		377
Other real estate construction		49		51
Real estate 1 – 4 family construction		—		—
Real estate – residential		470		540
Home equity		152		23
Consumer loans		—		—
Other loans		—		—
	$	959	$	1,025

Management uses a risk-grading program to facilitate the evaluation of probable inherent loan losses and to measure the adequacy of the allowance for loan losses. In this program, risk grades are initially assigned by the loan officers and reviewed and monitored by the lenders and credit administration. The program has eight risk grades summarized in five categories as follows:

Pass: Loans that are pass grade credits include loans that are fundamentally sound and risk factors are reasonable and acceptable. They generally conform to policy with only minor exceptions and any major exceptions are clearly mitigated by other economic factors.

Watch: Loans that are watch credits include loans on management’s watch list where a risk concern may be anticipated in the near future.

Substandard: Loans that are considered substandard are loans that are inadequately protected by current sound net worth, paying capacity of the obligor or the value of the collateral pledged. All nonaccrual loans are graded as substandard.

Doubtful: Loans that are considered to be doubtful have all weaknesses inherent in loans classified substandard, plus the added characteristic that the weaknesses make the collection or liquidation in full on the basis of current existing facts, conditions and values highly questionable and improbable.

Loss: Loans that are considered to be a loss are considered to be uncollectible and of such little value that their continuance as bankable assets is not warranted.

The tables below summarize risk grades of the loan portfolio by class at June 30, 2018 and December 31, 2017:

June 30, 2018
	Pass		Watch		Sub- standard		Doubtful		Total
	(dollars in thousands)

Commercial	$	53,939	$	1,886	$	12	$	—	$	55,837
Real estate - commercial		128,368		3,765		1,987		—		134,120
Other real estate construction		29,987		2,081		389		—		32,457
Real estate 1 - 4 family construction		5,037		—		—		—		5,037
Real estate - residential		70,806		6,499		1,068		—		78,373
Home equity		49,066		970		152		—		50,188
Consumer loans		11,601		84		1		—		11,686
Other loans		2,879		—		—		—		2,879

Total	$	351,683	$	15,285	$	3,609	$	—	$	370,577

-16-

December 31, 2017
	Pass		Watch		Sub- standard		Doubtful		Total
	(dollars in thousands)

Commercial	$	53,649	$	1,215	$	48	$	—	$	54,912
Real estate - commercial		109,224		3,321		2,167		—		114,712
Other real estate construction		38,082		1,713		391		—		40,186
Real estate 1 - 4 family construction		5,024		—		—		—		5,024
Real estate - residential		69,645		7,119		1,155		—		77,919
Home equity		49,743		740		23		—		50,506
Consumer loans		10,709		64		1		—		10,774
Other loans		2,838		—		—		—		2,838

Total	$	338,914	$	14,172	$	3,785	$	—	$	356,871

Loans that are in nonaccrual status or 90 days past due and still accruing are considered to be nonperforming. At both June 30, 2018 and December 31, 2017 there were no loans 90 days past due and still accruing. The following tables show the breakdown between performing and nonperforming loans by class at June 30, 2018 and December 31, 2017:

June 30, 2018
	Performing		Non- Performing		Total
	(dollars in thousands)

Commercial	$	55,837	$	—	$	55,837
Real estate - commercial		133,832		288		134,120
Other real estate construction		32,408		49		32,457
Real estate 1 – 4 family construction		5,037		—		5,037
Real estate – residential		77,903		470		78,373
Home equity		50,036		152		50,188
Consumer loans		11,686		—		11,686
Other loans		2,879		—		2,879

Total	$	369,618	$	959	$	370,577

December 31, 2017
	Performing		Non- Performing		Total
	(dollars in thousands)

Commercial	$	54,878	$	34	$	54,912
Real estate - commercial		114,335		377		114,712
Other real estate construction		40,135		51		40,186
Real estate 1 – 4 family construction		5,024		—		5,024
Real estate – residential		77,379		540		77,919
Home equity		50,483		23		50,506
Consumer loans		10,774		—		10,774
Other loans		2,838		—		2,838

Total	$	355,846	$	1,025	$	356,871

-17-

Loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement. If a loan is deemed impaired, a specific calculation is performed and a specific reserve is allocated, if necessary. The tables below summarize the loans deemed impaired and the amount of specific reserves allocated by class at June 30, 2018 and December 31, 2017.

June 30, 2018
	Unpaid Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Related Allowance
	(dollars in thousands)

Commercial	$	8	$	—	$	8	$	0
Real estate - commercial		1,529		—		1,529		41
Other real estate construction		636		101		49		4
Real estate 1 - 4 family construction		—		—		—		—
Real estate - residential		3,407		717		2,690		123
Home equity		97		78		19		1
Consumer loans		36		36		—		—
Other loans		—		—		—		—

Total	$	5,713	$	932	$	4,295	$	169

December 31, 2017
	Unpaid Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Related Allowance
	(dollars in thousands)

Commercial	$	44	$	10	$	34	$	10
Real estate - commercial		1,593		1,305		288		9
Other real estate construction		689		101		50		3
Real estate 1 - 4 family construction		—		—		—		—
Real estate - residential		3,701		1,319		2,382		171
Home equity		35		22		13		1
Consumer loans		45		45		—		—
Other loans		—		—		—		—

Total	$	6,107	$	2,802	$	2,767	$	194

	Three Months Ended June 30, 2018				Three Months Ended June 30, 2017
	Average Recorded Investment		Interest Income		Average Recorded Investment		Interest Income
	(dollars in thousands)

Commercial	$	25	$	—	$	20	$	—
Real estate - commercial		1,541		15		1,646		14
Other real estate construction		123		—		223		2
Real estate 1- 4 family construction		—		—		4		—
Real estate - residential		3,540		41		3,852		43
Home equity		66		2		94		1
Consumer loans		38		—		55		2
Other loans		—		—		—		—

Total	$	5,333	$	58	$	5,894	$	62

-18-

	Six Months Ended June 30, 2018				Six Months Ended June 30, 2017
	Average Recorded Investment		Interest Income		Average Recorded Investment		Interest Income
	(dollars in thousands)

Commercial	$	32	$	—	$	23	$	1
Real estate - commercial		1,566		30		1,655		29
Other real estate construction		132		2		246		3
Real estate 1- 4 family construction		—		—		5		—
Real estate - residential		3,598		82		3,899		84
Home equity		55		2		74		2
Consumer loans		41		1		57		2
Other loans		—		—		—		—

Total	$	5,424	$	117	$	5,959	$	121

Note 8 – Troubled Debt Restructures

A modification of a loan constitutes a troubled debt restructuring (“TDR”) when a borrower is experiencing financial difficulty and the modification involves providing a concession to the existing loan contract. The Company offers various types of concessions when modifying loans to troubled borrowers, however, forgiveness of principal is rarely granted. Concessions offered are term extensions, capitalizing accrued interest, reducing interest rates to below current market rates or a combination of any of these. Combinations from time to time may include allowing a customer to be placed on interest-only payments. The presentations below in the “other” category are TDRs with a combination of concessions. At the time of a TDR, additional collateral or a guarantor may be requested.

Loans modified as TDRs are typically already on nonaccrual status and in some cases, partial charge-offs may have already been taken against the outstanding loan balance. The Company classifies TDR loans as impaired loans and evaluates the need for an allowance for loan loss on a loan-by-loan basis. An allowance is based on either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price or the estimated fair value of the underlying collateral less any selling costs, if the loan is deemed to be collateral dependent.

At June 30, 2018, the Company had $4.4 million in TDRs outstanding, of which one was on a non-accruing basis.

For the three and six months ended June 30, 2018 and 2017, the following table presents a breakdown of the types of concessions made by loan class:

	For the three months ended June 30, 2018
	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
	(dollars in thousands)

Other:
Commercial		—	$	—	$	—
Real estate - commercial		—		—		—
Other real estate construction		—		—		—
Real estate 1 – 4 family construction		—		—		—
Real estate – residential		3		387		387
Home equity		—		—		—
Consumer loans		—		—		—
Other loans		—		—		—

Total		3	$	387	$	387

-19-

	For the three months ended June 30, 2017
	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
	(dollars in thousands)

Other:
Commercial		1	$	12	$	11
Real estate - commercial		1		166		165
Other real estate construction		—		—		—
Real estate 1 – 4 family construction		—		—		—
Real estate – residential		1		65		38
Home equity		—		—		—
Consumer loans		—		—		—
Other loans		—		—		—

Total		3	$	243	$	214

	For the six months ended June 30, 2018
	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
	(dollars in thousands)

Other:
Commercial		—	$	—	$	—
Real estate - commercial		—		—		—
Other real estate construction		—		—		—
Real estate 1 – 4 family construction		—		—		—
Real estate – residential		4		445		444
Home equity		—		—		—
Consumer loans		—		—		—
Other loans		—		—		—

Total		4	$	445	$	444

	For the six months ended June 30, 2017
	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
	(dollars in thousands)

Other:
Commercial		1	$	12	$	11
Real estate - commercial		1		166		165
Other real estate construction		—		—		—
Real estate 1 – 4 family construction		—		—		—
Real estate – residential		4		475		446
Home equity		—		—		—
Consumer loans		—		—		—
Other loans		—		—		—

Total		6	$	653	$	622

During the twelve months ended June 30, 2018, there was one TDR for which there was a payment default. During the twelve months ended June 30, 2017, there were three TDRs for which there was a payment default.

-20-

A default on a TDR is defined as being past due 90 days or being out of compliance with the modification agreement. As previously mentioned, the Company considers TDRs to be impaired loans and has $156,000 in the allowance for loan losses as of June 30, 2018, as a direct result of these TDRs. At June 30, 2017, there was $124,000 in the allowance for loan losses related to TDRs.

The following table presents the successes and failures of the types of loan modifications within the previous twelve months as of June 30, 2018 and 2017:

	Paid In Full				Paying as restructured				Converted to nonaccrual				Foreclosure/ Default
	Number of Loans		Recorded Investments		Number of Loans		Recorded Investments		Number of Loans		Recorded Investments		Number of Loans		Recorded Investments
	(dollars in thousands)
June 30, 2018

Below market
Interest rate		—	$	—		—	$	—		—	$	—		—	$	—
Extended payment Terms		—		—		—		—		—		—		—		—
Forgiveness of Principal/Other		5		109		8		687		—		—		1		17

Total		5	$	109		8	$	687		—	$	—		1	$	17

June 30, 2017

Below market
Interest rate		—	$	—		—	$	—		—	$	—		—	$	—
Extended payment Terms		—		—		—		—		—		—		—		—
Forgiveness of Principal/Other		8		779		8		832		—		—		3		19

Total		8	$	779		8	$	832		—	$	—		3	$	19

The Company has not committed to fund any additional disbursements for TDRs.

Note 9 - Commitments and Contingencies

The Company’s subsidiary bank is 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, lines of credit and standby letters of credit. These instruments involve elements of credit risk in excess of amounts recognized in the accompanying financial statements.

The bank’s risk of loss with unfunded loans and lines of credit or standby letters of credit is represented by the contractual amount of these instruments. The bank uses the same credit policies in making commitments under such instruments as it does for on-balance sheet instruments. The amount of collateral obtained, if any, is based on management’s credit evaluation of the borrower. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Credit card commitments are unsecured.

At June 30, 2018, outstanding financial instruments whose contract amounts represent credit risk were approximately:

	(dollars in thousands)
Commitments to extend credit	$	104,277
Credit card commitments		11,676
Standby letters of credit		935
Total commitments	$	116,888

Additionally, Uwharrie Bank has a five-year operating lease for commercial property. The term expires on September 30, 2021. The annual cost of the lease is $156,000 and includes a 2.625% annual escalator.

In first quarter 2018, Uwharrie Bank entered into a second lease for a branch. The lease has a ten-year term expiring in 2028 with two five-year renewal options. The annual cost of the lease is $189,000 and includes a 2.0% annual escalator.

-21-

Note 10 – Fair Value Disclosures

Accounting Standards Codification (ASC) 820 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. ASC 820 does not require any new fair value measurements but clarifies and standardizes some divergent practices that have emerged since prior guidance was issued. ASC 820 creates a three-level hierarchy under which individual fair value estimates are to be ranked based on the relative reliability of the inputs used in the valuation.

ASC 820 defines fair value as the price that would be received to sell an asset or transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities, the Company considers the principal or most advantageous market in which those assets or liabilities are sold and considers assumptions that market participants would use when pricing those assets or liabilities. Fair values determined using Level 1 inputs rely on active and observable markets to price identical assets or liabilities. In situations where identical assets and liabilities are not traded in active markets, fair values may be determined based on Level 2 inputs, which exist when observable data exists for similar assets and liabilities. Fair values for assets and liabilities for which identical or similar assets and liabilities are not actively traded in observable markets are based on Level 3 inputs, which are considered to be unobservable.

Among the Company’s assets and liabilities, investment securities available for sale are reported at their fair values on a recurring basis. Certain other assets are adjusted to their fair value on a nonrecurring basis, including other real estate owned, impaired loans, loans held for sale, which are carried at the lower of cost or market; loan servicing rights, where fair value is determined using similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions; and goodwill, which is periodically tested for impairment. Deposits, short-term borrowings and long-term obligations are not reported at fair value.

Prices for US Treasury securities are readily available in the active markets in which those securities are traded, and the resulting fair values are shown in the ‘Level 1 input’ column. Prices for government agency securities, mortgage-backed securities and for state, county and municipal securities are obtained for similar securities, and the resulting fair values are shown in the ‘Level 2 input’ column. Prices for all other non-marketable investments are determined based on various assumptions that are not observable. The fair values for these investment securities are shown in the ‘Level 3 input’ column. Non-marketable investment securities, which are carried at their purchase price, include those that may only be redeemed by the issuer. The changes in securities between Level 1 and Level 2 were related to the purchase and sale of several securities and not the transfer of securities.

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment by using one of several methods including collateral value, fair value of similar debt or discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the present value of the expected repayments or fair value of collateral exceed the recorded investments in such loans. The Company typically bases the fair value of the collateral on appraised values which the Company considers Level 3 valuations.

Foreclosed assets are adjusted to fair value upon transfer of the loans to other real estate owned. Real estate acquired in settlement of loans is recorded initially at the estimated fair value of the property less estimated selling costs at the date of foreclosure. The initial recorded value may be subsequently reduced by additional allowances, which are charged to earnings if the estimated fair value of the property less estimated selling costs declines below the initial recorded value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. The Company typically bases the fair value of the collateral on appraised values which the Company considers Level 3 valuations.

Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate, based on secondary market prices. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income. These loans are recorded in Level 2

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The following table provides fair value information for assets and liabilities measured at fair value on a recurring basis as of June 30, 2018 and December 31, 2017:

	June 30, 2018
	(dollars in thousands)
	Total		Level 1		Level 2		Level 3

Securities available for sale:
U.S. Government agencies	$	53,606	$	—	$	53,606	$	—
GSE - Mortgage-backed securities and CMO’s		18,489		—		18,489		—
State and political subdivisions		13,329		—		13,329		—
Corporate bonds		5,005		—		5,005		—

Total assets at fair value	$	90,429	$	—	$	90,429	$	—

Total liabilities at fair value	$	—	$	—	$	—	$	—

	December 31, 2017
	(dollars in thousands)
	Total		Level 1		Level 2		Level 3

Securities available for sale:
U.S. Government agencies	$	55,615	$	—	$	55,615	$	—
GSE - Mortgage-backed securities and CMO’s		20,891		—		20,891		—
State and political subdivisions		14,199		—		14,199		—
Corporate bonds		5,038		—		5,038		—

Total assets at fair value	$	95,743	$	—	$	95,743	$	—

Total liabilities at fair value	$	—	$	—	$	—	$	—

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. GAAP. These include assets that are measured at the lower of cost or market that were recognized at fair value less cost to sell at the end of the period. Assets measured at fair value on a nonrecurring basis are included in the table below as of June 30, 2018 and December 31, 2017:

	June 30, 2018
	(dollars in thousands)
	Total		Level 1		Level 2		Level 3

Impaired loans	$	4,175	$	—	$	—	$	4,175
Other real estate owned		1,278		—		—		1,278
Total assets at fair value	$	5,453	$	—	$	—	$	5,453

Total liabilities at fair value	$	—	$	—	$	—	$	—

	December 31, 2017
	(dollars in thousands)
	Total		Level 1		Level 2		Level 3

Impaired loans	$	2,624	$	—	$	—	$	2,624
Other real estate owned		1,785		—		—		1,785

Total assets at fair value	$	4,409	$	—	$	—	$	4,409
Total liabilities at fair value	$	—	$	—	$	—	$	—

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Quantitative Information about Level 3 Fair Value Measurements

June 30, 2018
	Valuation Technique	Unobservable Input	General Range
Nonrecurring measurements:

Impaired loans	Discounted appraisals	Collateral discounts and Estimated costs to sell	0 – 25%
	Discounted cash flows	Discount Rate	4%-8.75%

OREO	Discounted appraisals	Collateral discounts and Estimated costs to sell	0 – 10%

December 31, 2017
	Valuation Technique	Unobservable Input	General Range
Nonrecurring measurements:

Impaired loans	Discounted appraisals	Collateral discounts and Estimated costs to sell	0 – 25%
	Discounted cash flows	Discount rates	4%-8.75%

OREO	Discounted appraisals	Collateral discounts and Estimated costs to sell	0 – 10%

At June 30, 2018, impaired loans were being evaluated with discounted expected cash flows and discounted appraisals were being used on collateral dependent loans.

Note 11 – Fair Values of Financial Instruments and Interest Rate Risk

ASC 825, “Disclosures about Fair Value of Financial Instruments,” requires disclosure of the fair value of financial assets and financial liabilities, including those that are not measured and reported at fair value on a recurring basis or non-recurring basis.

The fair value estimates presented at June 30, 2018 and December 31, 2017 are based on relevant market information and information about the financial instruments. Fair value estimates are intended to represent the price an asset could be sold at or the price at which a liability could be settled. However, given there is no active market or observable market transactions for many of the Company’s financial instruments, the Company has made estimates of many of these fair values which are subjective in nature, involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimated values. The estimated fair values disclosed in the following table do not represent market values of all assets and liabilities of the Company and should not be interpreted to represent the underlying value of the Company. The valuations at June 30, 2018 are observed under the exit price notion as a result of adoption of ASU 2016-01. The following table reflects a comparison of carrying amounts and the estimated fair value of the financial instruments as of June 30, 2018 and December 31, 2017:

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June 30, 2018
	Carrying Value		Estimated Fair Value		Level 1		Level 2		Level 3
	(dollars in thousands)
FINANCIAL ASSETS
Cash and cash equivalents	$	99,025	$	98,985	$	96,535	$	2,450	$	—
Securities available for sale		90,429		90,429		—		90,429		—
Securities held to maturity		11,118		11,002		—		11,002		—
Loans held for investment, net		370,577		366,093		—		—		366,093
Loans held for sale		5,292		5,292		—		5,292		—
Restricted stock		1,094		1,094		1,094		—		—
Mortgage servicing rights		1,948		3,534		—		3,534		—
Accrued interest receivable		1,714		1,714		—		—		1,714

FINANCIAL LIABILITIES
Deposits	$	550,653	$	505,334	$	—	$	505,334	$	—
Short-term borrowings		1,522		1,522		—		1,522		—
Long-term borrowings		9,534		9,648		—		—		9,648
Accrued interest payable		149		149		—		—		149

December 31, 2017
	Carrying Value		Estimated Fair Value		Level 1		Level 2		Level 3
	(dollars in thousands)
FINANCIAL ASSETS
Cash and cash equivalents	$	70,403	$	70,379	$	67,913	$	2,466	$	—
Securities available for sale		95,743		95,743		—		95,743		—
Securities held to maturity		11,458		11,461		—		11,461		—
Loans held for investment, net		356,871		359,325		—		—		359,325
Loans held for sale		4,414		4,414		—		4,414		—
Restricted stock		1,067		1,067		1,067		—		—
Mortgage servicing rights		2,125		3,310		—		3,310
Accrued interest receivable		1,709		1,709		—		—		1,709

FINANCIAL LIABILITIES
Deposits		512,628		481,300		—		481,300		—
Short-term borrowings		1,752		1,752		—		1,752		—
Long-term borrowings		9,534		9,658		—		—		9,658
Accrued interest payable		148		148		—		—		148

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

•

Cash and cash equivalents – The carrying amount of cash and cash equivalents approximate their fair values due to the short period of time until their expected realization and are recorded in Level 1 with the exception of time deposits due from banks that are in Level 2.

•

Securities available for sale – Securities available for sale are carried at fair value based on quoted and observable market prices and are recorded in Levels 1 and 2. Also see discussion in Note 5.

•

Securities held to maturity – Securities held to maturity are carried at amortized cost and are recorded in Level 2.

•

Loans – The fair value of loans is estimated based on discounted expected cash flows using the current interest rates at which similar loans would be made, a future expected credit loss based on historical charge-offs, and a liquidity discount based on the overall risk grade of the load portfolio. These loans are carried in Level 3. Loans held for sale, which represent current mortgage production forward sales not yet delivered, are valued based on secondary market prices. The fair value of loans held for sale does not consider uncertainty in the market that would affect the valuation. Loans held for sale are recorded in Level 2.

•

Restricted stock – It is not practicable to determine fair value of restricted stock which is comprised of Federal Home Loan Bank and Federal Reserve Bank stock due to restrictions placed on its transferability and it is presented at its carrying value and is recorded in Level 1 due to the redemption provisions of the Federal Home Loan Bank and the Federal Reserve Bank.

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•

Mortgage servicing rights – The fair value disclosed for mortgage servicing rights is based on an independent market valuation and is recorded at Level 2.

•

Accrued interest receivable and payable – Both accrued interest receivable and payable are recorded in Level 3, as there are not active markets for these.

•

Deposits – The fair value of deposits is estimated based on discounted cash flow analyses using offered market rates and is recorded in Level 2. The fair value of deposits does not consider any customer related intangibles.

•

Borrowings – The fair value disclosed for short-term borrowings, which are composed of overnight borrowings and debt due within one year approximate the carrying value for such debt and is recorded in Level 2. The estimated fair value for long-term borrowings are estimated based on discounted cash flow analyses using offered market rates. Total borrowings are carried in Level 2. Long-term debt is fair valued based on discounted cash flow analyses and is recorded in Level 3.

At June 30, 2018, the subsidiary bank had outstanding standby letters of credit and commitments to extend credit. These off-balance sheet financial instruments are generally exercisable at the market rate prevailing at the date the underlying transaction will be completed; therefore, the fair value is the fee the bank is expected to receive. This amount is deemed immaterial by management. See Note 9.

Note 12 – Recent Accounting Pronouncements

In February 2016, the FASB issued ASU 2016-02, “Leases, Topic 842 (“ASU 2016-02”)”. This ASU increases the transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The key difference between existing standards and this ASU is the requirement for lessees to recognize on their balance sheet all lease contracts with lease terms greater than 12 months, including operating leases. Both a right-of-use asset, representing the right to use the leased asset, and a lease liability, representing the contractual obligation, are required to be recognized on the balance sheet of the lessee at lease commencement. Further, this ASU requires lessees to classify leases as either operating or finance leases, which are substantially similar to the current operating and capital leases classifications. The distinction between these two classifications under the new standard does not relate to balance sheet treatment but relates to treatment in the statements of income and cash flows. Lessor guidance remains largely unchanged with the exception of how a lessor determines the appropriate lease classification for each lease to better align the lessor guidance with revised lessee classification guidance. The amendments in this ASU are effective for public business entities for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. We are currently evaluating the impact of the new standard, which we we will adopt during the first quarter of 2019. We currently have two properties that we operate under a lease, both of which would be recorded on the Consolidated Balance Sheet upon adoption.

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”. ASU 2016-13 requires an entity to utilize a new impairment model known as the current expected credit loss (“CECL”) model to estimate its lifetime “expected credit loss” and record an allowance that, when deducted from the amortized cost basis of the financial asset, presents the net amount expected to be collected on the financial asset. The CECL model is expected to result in earlier recognition of credit losses. ASU 2016-13 also requires new disclosures for financial assets measured at amortized cost, loans and available-for-sale debt securities. The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted. Entities will apply the standard’s provisions as a cumulative effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted. We are currently exploring vendor-based options for outsourcing our current model as well as extending our current model to comply with CECL. We continue to assess the potential financial impact to the Company’s financial position.

From time to time, the FASB issues exposure drafts of proposed statements of financial accounting standards. Such exposure drafts are subject to comment from the public, to revisions by the FASB and to final issuance by the FASB as statements of financial accounting standards. Management considers the effect of the proposed statements on the consolidated financial statements of the Company and monitors the status of changes to and proposed effective dates of exposure drafts.

Reclassification

Certain amounts in the 2017 financial statements have been reclassified to conform to the 2018 presentation. These reclassifications do not have a material impact on net income or shareholders’ equity.

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

This Quarterly Report on Form 10-Q may contain certain forward-looking statements consisting of estimates with respect to the financial condition, results of operations and business of the Company that are subject to various factors which could cause actual results to differ materially from these estimates. These factors include, but are not limited to: general economic conditions; changes in interest rates, deposit flows, loan demand, real estate values, and competition; changes in accounting principles, policies, or guidelines; changes in legislation or regulation; and other economic, competitive, governmental, regulatory, and technological factors affecting the Company’s operations, pricing, products and services. Any use of “we” or “our” in the following discussion refers to the Company on a consolidated basis.

Comparison of Financial Condition at June 30, 2018 and December 31, 2017.

During the six months ended June 30, 2018, the Company’s total assets increased $37.9 million, from $576.4 million to $614.2 million.

Cash and cash equivalents increased $28.6 million during the six months ended June 30, 2018. Cash and due from banks decreased $33,000, while interest-earning deposits with banks increased $28.7 million. The increase is directly related to the increase in both noninterest-bearing and interest-bearing customer deposits.

Investment securities consist of securities available for sale and securities held to maturity. Investment securities decreased $5.7 million to $101.5 million for the six-month period ended June 30, 2018 due to contractual principal pay downs. At June 30, 2018, the Company had net unrealized losses on securities available for sale of $2.1 million.

Loans held for investment increased $13.7 million to $370.6 million for the six-month period ended June 30, 2018, or 7.7% annualized growth. The Company experienced the majority of growth in the commercial real estate loan segment, which grew $19.4 million, or 16.9%, during the six-month period ended June 30, 2018. The largest decline was in the other real estate construction segment of $7.7 million or 19.2%. The majority of the decrease in this segment was due to completed construction on commercial real estate, which attributed to the growth in the commercial real estate segment. Loans held for sale increased 19.9%, or $878,000, as production for the mortgage division increased during the month of June. The allowance for loan losses was $2.58 million at June 30, 2018, which represented 0.70% of the total loan portfolio compared to $2.46 million or 0.69% at December 31, 2017.

Other changes in our consolidated assets are primarily related to other real estate owned, prepaid assets, fixed assets, and other assets. Other real estate owned decreased $910,000. During the six months ended June 30, 2018, the Company sold seven pieces of property totaling $1.1 million, which generated a loss of $27,000. Two new properties moved into other real estate owned totaling $160,000. Prepaid assets have increased $364,000 from December 31, 2017 to June 30, 2018 as invoices are paid in the first half of the year and amortized over the remaining year per contract terms. Premises and equipment increased $336,000 in the first six months as capitalized leasehold improvements were added for our new Charlotte branch. Other assets increased $561,000 due to the annual funding of executive supplemental employee retirement accounts.

Customer deposits, our primary funding source, experienced a $38.0 million increase during the six-month period ended June 30, 2018, increasing from $512.6 million to $550.7 million or 14.8% annualized growth. Demand noninterest-bearing checking increased $20.2 million, interest checking and money market accounts increased $17.8 million, and savings deposits increased $4.1 million. These increases were offset by declines in time deposits of $4.0 million.

Total short-term borrowings decreased $230,000 for the period.

Other liabilities increased from $7.8 million at December 31, 2017 to $8.5 million at June 30, 2018, an increase of $696,000 related to an increase in the annual funding of executive supplemental employee retirement accounts.

At June 30, 2018, total shareholders’ equity was $43.9 million, a decrease of $615,000 from December 31, 2017. Net income for the six-month period was $701,000. Unrealized losses on investment securities, net of tax, increased by $959,000. The Company repurchased 25,482 shares of common stock for a total value of $142,000, though we issued 13,378 shares for a value of $65,000 upon the excercising of the final remaining outstanding stock options. The Company paid $284,000 in dividends attributed to noncontrolling interest.

Comparison of Results of Operations for the Three Months Ended June 30, 2018 and 2017.

Net Income and Net Income Available to Common Shareholders

Uwharrie Capital Corp reported net income of $467,000 for the three months ended June 30, 2018, as compared to $632,000 for the three months ended June 30, 2017, a decrease of $165,000. Net income available to common shareholders was $326,000 or $0.05 per

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common share at June 30, 2018, compared to $484,000 or $0.07 per common share at June 30, 2017. Net income available to common shareholders is net income less dividends on the aforementioned noncontrolling interest.

Net Interest Income

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

Net interest income for the three months ended June 30, 2018 was $4.9 million compared to $4.5 million for the three months ended June 30, 2017, an increase of $428,000. During the second quarter of 2018, the average yield on our interest–earning assets increased twelve basis points to 3.83%, which was offset partly by the increase in the average rate we paid for our interest-bearing liabilities, which increased seven basis points to 0.39%. The aforementioned changes resulted in a higher interest rate spread of 3.44% as of June 30, 2018 compared to 3.40% as of June 30, 2017. Our net interest margin was 3.54% and 3.46% for the comparable periods in 2018 and 2017, respectively.

The following table presents average balance sheets and a net interest income analysis for the three months ended June 30, 2018 and 2017:

Average Balance Sheet and Net Interest Income Analysis

For the Three Months Ended June 30,

(dollars in thousands)
	Average Balance				Income/Expenses				Rate/Yield
	2018		2017		2018		2017		2018			2017
Interest-earning assets:
Taxable securities	$	85,170	$	98,064	$	374	$	402		1.76	%		1.64	%
Nontaxable securities (1)		17,495		16,960		110		105		3.20	%		4.01	%
Short-term investments		88,255		63,993		365		158		1.66	%		0.99	%
Taxable loans		360,202		340,158		4,403		4,063		4.90	%		4.79	%
Non-taxable loans (1)		10,581		10,887		66		69		3.17	%		4.12	%
Total interest-earning assets		561,703		530,062		5,318		4,797		3.83	%		3.71	%

Interest-bearing liabilities:
Interest-bearing deposits		408,331		391,079		269		175		0.26	%		0.18	%
Short-term borrowed funds		1,848		2,484		4		6		0.87	%		0.97	%
Long-term debt		9,538		9,531		138		137		5.80	%		5.85	%
Total interest-bearing liabilities		419,717		403,094		411		318		0.39	%		0.32	%

Net interest spread	$	141,986	$	126,968	$	4,907	$	4,479		3.44	%		3.40	%

Net interest margin (1) (% of earning assets)										3.54	%		3.46	%

(1)	Yields related to securities and loans exempt from income taxes are stated on a fully tax-equivalent basis, assuming a 21% tax rate in 2018 and a 34% tax rate in 2017.

Provision and Allowance for Loan Losses

The provision for loan losses was $38,000 for the three months ending June 30, 2018 compared to a recovery of $114,000 for the same period in 2017. There were net loan charge offs of $2,000 for the three months ended June 30, 2018, as compared with net loan charge offs of $12,000 during the same period of 2017. Refer to the Asset Quality discussion on page 32 for further information.

Noninterest Income

The Company generates most of its revenue from net interest income; however, diversification of our revenue sources is important as well. Total noninterest income increased $148,000 for the three-month period ending June 30, 2018 as compared to the same period in

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2017. The primary factor contributing to the overall increase was an increase in income from supplemental employee retirement plans of $115,000 and the additional gain on sale of SBA loans of $44,000, both of which are part of other income.

Interchange fees, or “swipe” fees, are charges that merchants pay to us and other card-issuing banks for processing electronic payment transactions. Interchange and card transaction fees consist of income from check card usage, point of sale income from PIN-based debit card transactions, ATM service fees, and credit card usage. Beginning in 2018, in connection with the adoption of Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers (Topic 606),” interchange and card transaction fees are reported net of related network costs. Previously, such network costs were reported as a component of other non-interest expense. Interchange and card transaction fees for the three months ended June 30, 2018 and 2017 reported on a net basis totaled $144,000 and $201,000, respectively. A comparison of gross interchange and card transaction fees and interchange and card transaction fees net of associated network costs for the reported periods is presented in the table below:

	Three Months Ended June 30,
	2018		2017
	(in thousands)

Income from debit card transactions	$	350	$	323
Income from credit card transactions		75		78
Gross interchange and transaction fee income		425		401
Network costs - debit card		179		143
Network costs - credit card		102		57
Total	$	144	$	201

Noninterest Expense

Noninterest expense for the quarter ended June 30, 2018 was $6.5 million compared to $5.7 million for the same period of 2017. Salaries and employee benefits, the largest component of noninterest expense, increased $479,000 for the quarter ending June 30, 2018. The majority of this increase is attributable to the increase in personnel associated with staffing the Company’s new Charlotte, NC branch, which opened in first quarter 2018, as well as increased personnel in other fee income producing business lines, SBA lending and Mortgage. Net occupancy expense increased $89,000 from $307,000 at June 30, 2017 to $396,000 at June 30, 2018. The increase is attributed to increased rent associated with the new branch location. Data processing expense increased $105,000 year-over-year for the second quarter of 2018 due to the on-going core conversion project scheduled for completion in August of 2018. The Company has incurred both conversion and de-conversion costs associated with this project. In addition, professional fees and services has increased $43,000 from June 30, 2017 to June 30, 2018 due to consulting, training, and travel associated with the core conversion training.

These increases have been offset by decline in foreclosed real estate expenses. Foreclosed real estate has declined from $176,000 at June 30, 2017 to $33,000 at June 30, 2018. As the Company’s other real estate holdings decline, the expenses associated with holding the property also declines. The table below reflects the composition of other noninterest expense.

	Three Months Ended June 30,
	2018		2017
	(dollars in thousands)
Postage	$	55	$	49
Telephone and data lines		45		41
Loan costs		104		90
Shareholder relations expense		36		30
Dues and subscriptions		66		54
Other		332		198
Total	$	638	$	462

Income Tax Expense

The Company had income tax expense of $78,000 for the three months ended June 30, 2018 at an effective tax rate of 14.31% compared to income tax expense of $313,000 with an effective tax rate of 33.12% in the comparable 2017 period. Income taxes computed at the statutory rate are affected primarily by the eligible amount of interest earned on state and municipal securities, tax-free municipal loans and income earned on bank owned life insurance. In 2018, the effective tax rate decreased significantly due to the enactment of the Tax Cuts and Jobs Act of 2017, which lowered the overall federal corporate income tax rate from 35% to 21% effective January 1, 2018.

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Comparison of Results of Operations for the Six Months Ended June 30, 2018 and 2017.

Net Income and Net Income Available to Common Shareholders

Uwharrie Capital Corp reported net income of $701,000 for the six months ended June 30, 2018, as compared to $1.2 million for the six months ended June 30, 2017, a decrease of $548,000. Net income available to common shareholders was $417,000 or $0.06 per common share at June 30, 2018, compared to $955,000 or $0.13 per common share at June 30, 2017. Net income available to common shareholders is net income less dividends on the aforementioned noncontrolling interest.

Net Interest Income

Net interest income for the six months ended June 30, 2018 was $9.6 million compared to $8.8 million for the six months ended June 30, 2017, an increase of $810,000. During the first six months of 2018, the average yield on our interest–earning assets increased ten basis points to 3.84%, which was offset by an increase in the average rate we paid for our interest-bearing liabilities, which increased six basis points to 0.37%. The aforementioned changes resulted in a higher interest rate spread of 3.47% as of June 30, 2018 compared to 3.42% as of June 30, 2017. Our net interest margin was 3.56% and 3.50% for the comparable periods in 2018 and 2017, respectively.

The following table presents average balance sheets and a net interest income analysis for the six months ended June 30, 2018 and 2017:

Average Balance Sheet and Net Interest Income Analysis

For the Six Months Ended June 30,

(dollars in thousands)
	Average Balance				Income/Expenses				Rate/Yield
	2018		2017		2018		2017		2018			2017
Interest-earning assets:
Taxable securities	$	86,438	$	98,726	$	771	$	799		1.80	%		1.63	%
Nontaxable securities (1)		17,726		17,277		224		217		3.23	%		4.08	%
Short-term investments		78,067		55,107		642		262		1.66	%		0.96	%
Taxable loans		356,566		337,036		8,592		7,989		4.86	%		4.78	%
Non-taxable loans (1)		10,717		10,584		133		133		3.17	%		4.08	%
Total interest-earning assets		549,514		518,730		10,362		9,400		3.84	%		3.74	%

Interest-bearing liabilities:
Interest-bearing deposits		403,354		383,734		486		329		0.24	%		0.17	%
Short-term borrowed funds		1,912		2,627		7		13		0.74	%		1.00	%
Long-term debt		9,536		9,533		273		272		5.77	%		5.75	%
Total interest-bearing liabilities		414,802		395,894		766		614		0.37	%		0.31	%

Net interest spread	$	134,712	$	122,836	$	9,596	$	8,786		3.47	%		3.42	%

Net interest margin (1) (% of earning assets)										3.56	%		3.50	%

(1)	Yields related to securities and loans exempt from income taxes are stated on a fully tax-equivalent basis, assuming a 21% tax rate in 2018 and a 34% tax rate in 2017.

Provision and Allowance for Loan Losses

The provision for loan losses was $116,000 for the six months ending June 30, 2018 compared to a recovery of $173,000 for the same period in 2017. There were net loan recoveries of $9,000 for the six months ended June 30, 2018, as compared with net loan recoveries of $17,000 during the same period of 2017. Refer to the Asset Quality discussion on page 32 for further information.

Noninterest Income

The Company generates most of its revenue from net interest income; however, diversification of our revenue sources is important as well. Total noninterest income decreased $336,000 for the six-month period ending June 30, 2018 as compared to the same period in 2017. The primary factor contributing to the overall decrease versus the comparable period was a decrease in revenue from mortgage loan sales of $218,000. Rising interest rates, as well as a shortage in the housing supply, has reduced the number of applications for new home purchases.

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Furthermore, during the 2017 comparative period, the Strategic Alliance Corporation, the broker-dealer subsidiary of Uwharrie Bank, acting as the selling agent, completed a private placement offering of slightly over $4 million, which resulted in $203,000 of other service fees and commissions.

Interchange fees, or “swipe” fees, are charges that merchants pay to us and other card-issuing banks for processing electronic payment transactions. Interchange and card transaction fees consist of income from check card usage, point of sale income from PIN-based debit card transactions, ATM service fees, and credit card usage. Beginning in 2018, in connection with the adoption of Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers (Topic 606),” interchange and card transaction fees are reported net of related network costs. Previously, such network costs were reported as a component of other non-interest expense. Interchange and card transaction fees for the six months ended June 30, 2018 and 2017 reported on a net basis totaled $286,000 and $337,000, respectively. A comparison of gross interchange and card transaction fees and interchange and card transaction fees net of associated network costs for the reported periods is presented in the table below:

	Six Months Ended June 30,
	2018		2017
	(in thousands)

Income from debit card transactions	$	647	$	631
Income from credit card transactions		157		153
Gross interchange and transaction fee income		804		784
Network costs - debit card		332		308
Network costs - credit card		186		139
Total	$	286	$	337

Noninterest Expense

Noninterest expense for the six months ending June 30, 2018 was $12.7 million compared to $11.5 million for the same period of 2017. Salaries and employee benefits, the largest component of noninterest expense, increased $727,000 for the period ending June 30, 2018. The majority of this increase is attributable to the increase in personnel associated with staffing the Company’s new Charlotte, NC branch, which opened in first quarter 2018, as well as increased personnel in other fee income producing business lines, SBA lending and Mortgage. Net occupancy expense increased $149,000 from $611,000 at June 30, 2017 to $760,000 at June 30, 2018. The increase is attributed to increased rent associated with the new branch location. Data processing expense increased $173,000 year-over-year for the year-to-date period of 2018 due to the on-going core conversion project scheduled for completion in August of 2018. The Company has incurred both conversion and de-conversion costs associated with this project. In addition, professional fees and services has increased $115,000 from June 30, 2017 to June 30, 2018 due to consulting, training, and travel associated with the core conversion training.

These increases have been offset by decline in foreclosed real estate expenses. Foreclosed real estate has declined from $264,000 at June 30, 2017 to $72,000 at June 30, 2018. As the Company’s other real estate holdings decline, the expenses associated with holding the property also declines. The table below reflects the composition of other noninterest expense.

	Six Months Ended June 30,
	2018		2017
	(in thousands)

Postage	$	104	$	97
Telephone and data lines		90		81
Loan costs		179		172
Shareholder relations expense		74		63
Dues and subscriptions		133		108
Other		627		618
Total	$	1,207	$	1,139

Income Tax Expense

The Company had income tax expense of $136,000 for the six months ended June 30, 2018 at an effective tax rate of 16.25% compared to income tax expense of $570,000 with an effective tax rate of 31.34% in the comparable 2017 period. Income taxes computed at the statutory rate are affected primarily by the eligible amount of interest earned on state and municipal securities, tax-free municipal loans and income earned on bank owned life insurance. In 2018, the effective tax rate decreased significantly due to the enactment of the Tax Cuts and Jobs Act of 2017, which lowered the overall federal corporate income tax rate from 35% to 21% effective January 1, 2018.

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Asset Quality

The Company’s allowance for loan losses is established through charges to earnings in the form of a provision for loan losses. The allowance is increased by provisions charged to operations and decreased by recoveries of amounts previously charged off and is reduced by recovery of provisions and loans charged off. Management continuously evaluates the adequacy of the allowance for loan losses. In evaluating the adequacy of the allowance, management considers the following: the growth, composition and industry diversification of the portfolio; historical loan loss experience; current delinquency levels; adverse situations that may affect a borrower’s ability to repay; estimated value of any underlying collateral; prevailing economic conditions and other relevant factors. The Company’s credit administration function, through a review process, periodically validates the accuracy of the initial risk grade assessment. In addition, as a given loan’s credit quality improves or deteriorates, the credit administration department has the responsibility to change the borrower’s risk grade accordingly. For loans determined to be impaired, the allowance is based on either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price or the estimated fair value of the underlying collateral less the selling costs. This evaluation is inherently subjective, as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans, which may be susceptible to significant change. In addition, regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses and may require additions for estimated losses based upon judgments different from those of management.

Management uses a risk-grading program designed to evaluate the credit risk in the loan portfolio. In this program, risk grades are initially assigned by loan officers then reviewed and monitored by credit administration. This process includes the maintenance of an internally classified loan list that is designed to help management assess the overall quality of the loan portfolio and the adequacy of the allowance for loan losses. In establishing the appropriate classification for specific assets, management considers, among other factors, the estimated value of the underlying collateral, the borrower’s ability to repay, the borrower’s payment history and the current delinquent status. Because of this process, certain loans are deemed to be impaired and evaluated as an impaired loan.

The allowance for loan losses represents management’s best estimate of an appropriate amount to provide for probable credit risk inherent in the loan portfolio in the normal course of business. While management believes that it uses the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary and results of operations could be adversely affected if circumstances differ from the assumptions used in making the determinations. Furthermore, while management believes it has established the allowance for loan losses in conformity with generally accepted accounting principles, there can be no assurance that banking regulators, in reviewing the Company’s portfolio, will not require an adjustment to the allowance for loan losses. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that increases will not be necessary, should the quality of any loans deteriorate because of the factors discussed herein. Any material increase in the allowance for loan losses may adversely affect the Company’s financial condition and results of operations.

At June 30, 2018, the levels of our impaired loans, which includes all loans in nonaccrual status, TDRs and other loans deemed by management to be impaired, were $5.2 million compared to $5.6 million at December 31, 2017, a net decrease of $400,000. Total nonaccrual loans, which are a component of impaired loans, decreased from $1.0 million at December 31, 2017 to $959,000 at June 30, 2018. During the first six months of 2018, three additional loans of $133,000 were added to impaired loans. The increase was offset by pay-off of four impaired relationships totaling $167,000, foreclosure of two loans totaling $160,000 as well as net pay downs of $206,000.

The allowance, expressed as a percentage of gross loans held for investment, increased one basis point from 0.69% at December 31, 2017 to 0.70% at June 30, 2018. The collectively evaluated reserve allowance as a percentage of collectively evaluated loans was 0.64% at December 31, 2017 and 0.66% at June 30, 2018. The increase is attributable to a slight increase in economic uncertainty, or market risk. The individually evaluated allowance as a percentage of individually evaluated loans decreased from 3.49% to 3.27% for the same periods due to an increase of individually evaluated loans that are sufficiently collateralized with expected returns of principal cash flow as contracted, therefore requiring no additional allowance. The portion of the Company’s allowance for loan loss model related to general reserves captures the mean loss of individual loans within the loan portfolio and adds additional loss based on economic uncertainty and volatility. Specifically, the Company calculates probable losses on loans by computing a probability of loss and multiplying that by a loss given default derived from historical experience, thus deriving the estimated loss scenario by FDIC call report codes. Together, these expected components, as well as a reserve determined by management for qualitative factors based on economic conditions and portfolio concentrations, form the basis of the allowance model. The loans that are impaired and included in the specific reserve are excluded from these calculations.

The Company assesses the probability of losses inherent in the loan portfolio using probability of default data acquired from a third-party vendor representing a one-year loss horizon for each obligor. The Company updates the data inputs into the model; specifically, the loss given default and the probability of defaults obtained from the vendor annually during the second quarter. The Company updates the credit scores, which is one of the components used within the allowance model, semi-annually during the first and third quarters. The probability of default associated with each credit score is the major driver in the allowance for loan losses.

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The ratio of nonperforming loans, which consist of nonaccrual loans and loans past due 90 days and still accruing, to total loans decreased from 0.29% at December 31, 2017, to 0.26% at June 30, 2018.

Management believes the current level of the allowance for loan losses is appropriate in light of the risk inherent in the loan portfolio.

Other real estate owned decreased $910,000 during 2018. The Company sold seven pieces of foreclosed property totaling $1.1 million realizing a loss of $27,000. The Company had no write-downs for the period ending June 30, 2018. There were two loans foreclosed on during the second quarter totaling $160,000.

Troubled debt restructured loans at June 30, 2018 totaled $4.4 million compared to $4.6 million at December 31, 2017 and are included in impaired loans. At June 30, 2018, there was one troubled debt restructured loan in nonaccrual status.

The following table shows the comparison of nonperforming assets at June 30, 2018 to December 31, 2017:

Nonperforming Assets

(dollars in thousands)

	June 30, 2018			December 31, 2017
Nonperforming assets:
Loans past due 90 days or more	$	—		$	—
Nonaccrual loans		959			1,025
Other real estate owned		1,439			2,349
Total nonperforming assets	$	2,398		$	3,374

Allowance for loans losses	$	2,583		$	2,458
Nonperforming loans to total loans		0.26	%		0.29	%
Allowance for loan losses to total loans		0.70	%		0.69	%
Nonperforming assets to total assets		0.39	%		0.59	%
Allowance for loan losses to nonperforming loans		269.34	%		239.80	%

Liquidity and Capital Resources

The objective of the Company’s liquidity management policy is to ensure the availability of sufficient cash flows to meet all financial commitments and to capitalize on any opportunities for expansion. Liquidity management addresses the ability to meet deposit withdrawals on demand or at contractual maturity, to repay borrowings as they mature and to fund new loans and investments as opportunities arise.

The Company’s primary sources of internally generated funds are principal and interest payments on loans, cash flows generated from operations and cash flow generated by investments. Growth in deposits is typically the primary source of funds for loan growth. The Company and its subsidiary bank have multiple funding sources, in addition to deposits, that can be used to increase liquidity and provide additional financial flexibility. These sources are the subsidiary bank’s established federal funds lines with correspondent banks totaling $28 million at June 30, 2018, with available credit of $28 million; established borrowing relationships with the Federal Home Loan Bank, with available credit of $39.6 million; access to borrowings from the Federal Reserve Bank discount window, with available credit of $25.1 million and the issuance of commercial paper. The Company has also secured long-term debt from other sources. Total debt from these sources totaled $9.5 million at June 30, 2018, compared to $9.5 million at December 31, 2017.

Banks and bank holding companies, as regulated institutions, must meet required levels of capital. The Federal Reserve, the primary federal regulator of the Company and its subsidiary bank, has adopted minimum capital regulations or guidelines that categorize components and the level of risk associated with various types of assets.

The Company continues to maintain capital ratios that support its asset growth. Bank regulatory agencies approved regulatory capital guidelines (“Basel III”) aimed at strengthening existing capital requirements for banking organizations. Under the final Basel III rules, minimum requirements increased for both the quantity and quality of capital held by the Company. The rules require a common equity Tier 1 capital to risk-weighted assets minimum ratio of 4.50%, a minimum ratio of Tier 1 capital to risk-weighted assets of 6.00%, a minimum ratio of total capital to risk-weighted assets of 8.00%, and a minimum Tier 1 leverage ratio of 4.00%. A capital conservation buffer, comprised of common equity Tier 1 capital, was also established above the regulatory minimum capital requirements. This capital conservation buffer began to be phased in on January 1, 2016 at 0.625% of risk-weighted assets and increases each subsequent year by an additional 0.625% until reaching its final level of 2.50% on January 1, 2019. Strict eligibility criteria for regulatory capital

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instruments were also implemented under the final rules. The final rules also revise the definition and calculation of Tier 1 capital, total capital, and risk-weighted assets.

The phase-in period for the final rules became effective for the Company and its subsidiary bank on January 1, 2015, with full compliance of all the final rules’ requirements phased in over a multi-year schedule, to be fully phased-in by January 1, 2019. As of June 30, 2018, the Company and its subsidiary bank continue to exceed minimum capital standards and remain well-capitalized under applicable capital guidelines.

As previously discussed, the Company’s subsidiary bank has a net total of $10.6 million in outstanding Fixed Rate Noncumulative Perpetual Preferred Stock. The preferred stock qualifies as Tier 1 capital at the bank and will pay dividends at an annual rate of 5.30%. The net total of $10.6 million is presented as noncontrolling interest at the Company level and qualifies as Tier 1 capital at the Company. At June 30, 2018, the Company had $9.5 million in subordinated debt outstanding that qualifies as Tier 2 capital. The Company has made all interest and dividend payments in a timely manner.

Off-Balance Sheet Arrangements

Off-balance sheet arrangements include transactions, agreements or other contractual arrangements to which an unconsolidated entity of the Company is a party and pursuant to which the Company has obligations, including an obligation to provide guarantees on behalf of an unconsolidated entity, or retains an interest in assets transferred to an unconsolidated entity. We have no off-balance sheet arrangements of this kind.

Derivative financial instruments include futures contracts, forward contracts, interest rate swaps, options contracts, and other financial instruments with similar characteristics. We have not engaged in significant derivative activities through June 30, 2018 and have no current plans to do so.

Contractual Obligations

The timing and amount of our contractual obligations has not changed materially since December 31, 2017, detail of which is presented on page 78 of our 2017 Annual Report to Shareholders filed as Exhibit 13 with our 2017 Annual Report on Form 10-K.

Item 3.

Quantitative and Qualitative Disclosures About Market Risk.

Disclosure under this item is not required for smaller reporting companies.

Item 4.Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

At the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s principal executive officer and principal financial officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Securities Exchange Act (“Exchange Act”) Rule 13a-15.

Based upon that evaluation, the principal executive officer and principal financial officer concluded that in their opinion, the Company’s disclosure controls and procedures were effective (1) to provide reasonable assurance that information required to be disclosed by the Company in the reports filed or submitted by it under the Exchange Act was recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) to provide reasonable assurance that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate to allow for timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

Management of the Company has evaluated, with the participation of the Company’s principal executive officer and principal financial officer, changes in the Company’s internal control over financial reporting (as defined in Rule 13a -15(f) and 15d - 15(f) of the Exchange Act) during the second quarter of 2018. In connection with such evaluation, the Company has determined that there were no changes in the Company’s internal control over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. The Company reviews its disclosure controls and procedures, which may include its internal control over financial reporting, on an ongoing basis, and may from time to time make changes aimed at enhancing their effectiveness and to ensuring that the Company’s systems evolve with its business.

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Part II. OTHER INFORMATION

Item 1.

Legal Proceedings.

Neither the Company nor its subsidiaries, nor any of their properties are subject to any material legal proceedings. From time to time, the Company’s subsidiary bank is engaged in ordinary routine litigation incidental to its business.

Item 1A.

Risk Factors.

Disclosure under this item is not required for smaller reporting companies.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

The following table sets forth information with respect to shares of common stock repurchased by the Company during the three months ended June 30, 2018.

	(a) Total Number of Shares Purchased		(b) Average Price Paid per Share		(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Program (1)		(d) Maximum Dollar Value of Shares that May Yet Be Purchased Under the Plans
April 1, 2018 Through April 30, 2018		—	$	—		—	$	—
May 1, 2018 Through May 31, 2018		—	$	—		—	$	—
June 1, 2018 Through June 30, 2018		6,771	$	5.77		—	$	—
Total		6,771	$	5.77		—	$	—

(1)

Trades of the Company’s stock occur in the Over-the-Counter Bulletin Board market from time to time. The Company also has in place a Stock Repurchase Plan that provides liquidity to its shareholders in the event a willing buyer is not available to purchase shares that are offered for sale. The Company is under no obligation to purchase shares offered; however, it will accommodate such offers as its Stock Repurchase Plan allows.

Item 3.

Defaults Upon Senior Securities

None

Item 4.

Mine Safety Disclosures

Not applicable

Item 5.

Other Information

None.

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Item 6.Exhibits

The following exhibits are being filed herewith:

Exhibit Number		Description of Exhibit



31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith)

31.2		Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith)

32		Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished herewith)

101		Interactive data files providing financial information from the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2018, in XBRL (eXtensible Business Reporting Language) (filed herewith)

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Signatures

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

		UWHARRIE CAPITAL CORP
		(Registrant)

Date:	August 7, 2018	By:	/s/ Roger L. Dick
		Roger L. Dick
		President and Chief Executive Officer

Date:	August 7, 2018	By:	/s/ R. David Beaver, III
		R. David Beaver, III
		Principal Financial Officer

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