UWHARRIE CAPITAL CORP - Quarter Report: 2019 March (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 March 31, 2019

☐	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)

Securities registered pursuant to Section 12(b) of the Act: None

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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit 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 an 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	☒	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: 7,097,227 shares of common stock outstanding as of April 26, 2019.

Table of Contents

		Page No.

Part I.	FINANCIAL INFORMATION

Item 1 -	Financial Statements (Unaudited)

	Consolidated Balance Sheets as of March 31, 2019 and December 31, 2018	3

	Consolidated Statements of Income for the Three Months Ended March 31, 2019 and 2018	4

	Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2019 and 2018	5

	Consolidated Statements of Changes in Shareholders’ Equity for the Three Months Ended March 31, 2019 and 2018	6

	Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2019 and 2018	7

	Notes to Consolidated Financial Statements	8

Item 2 -	Management’s Discussion and Analysis of Financial Condition and Results of Operations	26

Item 3 -	Quantitative and Qualitative Disclosures about Market Risk	31

Item 4 -	Controls and Procedures	31

Part II.	OTHER INFORMATION

Item 1 -	Legal Proceedings	31

Item 1A -	Risk Factors	32

Item 2 -	Unregistered Sales of Equity Securities and Use of Proceeds	32

Item 3 -	Defaults Upon Senior Securities	32

Item 4 -	Mine Safety Disclosures	32

Item 5 -	Other Information	32

Item 6 -	Exhibits	33

	Signatures	34

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Uwharrie Capital Corp and Subsidiaries

Consolidated Balance Sheets

Part I. Financial Information

Item 1.

Financial Statements.

	March 31, 2019 (Unaudited)			December 31, 2018*
	(dollars in thousands)
ASSETS
Cash and due from banks	$	8,518		$	4,473
Interest-earning deposits with banks		134,878			113,461
Securities available for sale, at fair value		90,737			91,299
Securities held to maturity, at amortized cost (fair value $10,677 and $10,750, respectively)		10,673			10,837
Loans held for sale		3,567			4,800
Loans:
Loans held for investment		367,962			369,970
Less allowance for loan losses		(2,233	)		(2,374	)
Net loans held for investment		365,729			367,596
Premises and equipment, net		16,467			14,800
Interest receivable		1,649			1,763
Restricted stock		1,144			1,094
Bank owned life insurance		8,699			8,671
Other real estate owned		781			1,047
Prepaid assets		980			558
Other assets		11,159			11,905
Total assets	$	654,981		$	632,304

LIABILITIES
Deposits:
Demand noninterest-bearing	$	145,279		$	129,714
Interest checking and money market accounts		277,609			324,391
Savings deposits		57,568			54,784
Time deposits, $250,000 and over		53,200			7,920
Other time deposits		52,856			50,092
Total deposits		586,512			566,901
Short-term borrowed funds		1,403			1,190
Long-term debt		9,974			9,974
Interest payable		41			16
Other liabilities		10,738			9,048
Total liabilities		608,668			587,129

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 7,097,227 and 7,126,541		8,871			8,908
Preferred stock, 10,000,000 shares authorized; none issued and outstanding		—			—
Additional paid-in capital		12,776			12,885
Undivided profits		14,971			14,421
Accumulated other comprehensive loss		(960	)		(1,694	)
Total Uwharrie Capital shareholders’ equity		35,658			34,520
Noncontrolling interest		10,655			10,655
Total shareholders’ equity		46,313			45,175
Total liabilities and shareholders’ equity	$	654,981		$	632,304

(*)	Derived from audited consolidated financial statements

See accompanying notes

-3-

Uwharrie Capital Corp and Subsidiaries

Consolidated Statements of Income (Unaudited)

	Three Months Ended March 31,
	2019			2018
	(in thousands, except share and per share data)
Interest Income
Loans, including fees	$	4,667		$	4,256
Investment securities
US Treasury		33			—
US Government agencies and corporations		348			387
State and political subdivisions non-taxable		106			113
State and political subdivisions taxable		9			11
Interest-earning deposits with banks and federal funds sold		793			277
Total interest income		5,956			5,044

Interest Expense
Interest checking and money market accounts		425			144
Savings deposits		27			12
Time deposits, $250,000 and over		65			16
Other time deposits		80			45
Short-term borrowed funds		6			3
Long-term debt		141			135
Total interest expense		744			355
Net interest income		5,212			4,689
Provision for (recovery of) loan losses		(113	)		78
Net interest income after provision (recovery of) for loan losses		5,325			4,611

Noninterest Income
Service charges on deposit accounts		327			283
Interchange and card transaction fees, net		194			142
Other service fees and commissions		756			638
Income from mortgage loan sales		492			662
Other income (loss)		(21	)		169
Total noninterest income		1,748			1,894

Noninterest Expense
Salaries and employee benefits		4,133			3,946
Net occupancy expense		405			364
Equipment expense		176			170
Data processing costs		222			250
Office supplies and printing		27			36
Foreclosed real estate expense		56			39
Professional fees and services		153			248
Marketing and donations		204			211
Electronic banking expense		99			101
Software amortization and maintenance		219			213
FDIC insurance		80			66
Other noninterest expense		426			569
Total noninterest expense		6,200			6,213
Income before income taxes		873			292
Income taxes		183			58
Net income	$	690		$	234

Consolidated net income	$	690		$	234
Less: net income attributable to noncontrolling interest		(140	)		(143	)
Net income attributable to Uwharrie Capital Corp and common shareholders		550			91
Net income per common share
Basic	$	0.08		$	0.01
Diluted	$	0.08		$	0.01
Weighted average shares outstanding
Basic		7,125,564			7,254,594
Diluted		7,125,564			7,254,594

See accompanying notes

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Uwharrie Capital Corp and Subsidiaries

Consolidated Statements of Comprehensive Income (Unaudited)

	Three Months Ended March 31,
	2019			2018
	(in thousands)

Net Income	$	690		$	234

Unrealized gain (loss) on available for sale securities		953			(1,099	)
Related tax effect		(219	)		250

Total other comprehensive income (loss)		734			(849	)

Comprehensive income (loss)		1,424			(615	)

Less: Comprehensive income attributable to noncontrolling interest		(140	)		(143	)

Comprehensive income (loss) attributable to Uwharrie Capital	$	1,284		$	(758	)

See accompanying notes

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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		—			—			—			91		—			143			234
Repurchase of common stock		(18,711	)		(23	)		(80	)		—		—			—			(103	)
Stock options exercised		13,378			16			49			—		—			—			65
Other comprehensive (loss)		—			—			—			—		(849	)		—			(849	)
Record preferred stock dividend Series B (noncontrolling interest)		—			—			—			—		—			(103	)		(103	)
Record preferred stock dividend Series C (noncontrolling interest)		—			—			—			—		—			(37	)		(37	)
Balance, March 31, 2018		7,107,520		$	8,884		$	12,793		$	13,373	$	(1,956	)	$	10,653		$	43,747

Balance, December 31, 2018		7,126,541		$	8,908		$	12,885		$	14,421	$	(1,694	)	$	10,655		$	45,175
Net Income		—			—			—			550		—			140			690
Repurchase of common stock		(29,314	)		(37	)		(109	)		—		—			—			(146	)
Other comprehensive income		—			—			—			—		734			—			734
Record preferred stock dividend Series B (noncontrolling interest)		—			—			—			—		—			(103	)		(103	)
Record preferred stock dividend Series C (noncontrolling interest)		—			—			—			—		—			(37	)		(37	)
Balance, March 31, 2019		7,097,227		$	8,871		$	12,776		$	14,971	$	(960	)	$	10,655		$	46,313

See accompanying notes

-6-

Uwharrie Capital Corp and Subsidiaries

Consolidated Statements of Cash Flows (Unaudited)

	Three Months Ended March 31,
	2019			2018
	(dollars in thousands)
Cash flows from operating activities
Net income	$	690		$	234
Adjustments to reconcile net income to net cash
Provided (used) by operating activities:
Depreciation and amortization		271			240
Provision for (recovery of) loan losses		(113	)		78
Loss on sale of OREO		37			9
Net amortization of premium on investment securities AFS		162			170
Net amortization of premium on investment securities HTM		36			40
Net amortization of mortgage servicing rights		172			167
Originations and purchases of mortgage loans for sale		(19,115	)		(18,608	)
Proceeds from sales of mortgage loans for sale		20,180			20,706
Accrued interest receivable		114			4
Prepaid Assets		(422	)		(447	)
Cash surrender value of life insurance		(28	)		(38	)
Miscellaneous other assets		523			(158	)
Accrued interest payable		25			(1	)
Miscellaneous other liabilities		1,690			619
Net cash provided by operating activities		4,222			3,015

Cash flows from investing activities
Proceeds from maturities, calls & paydowns of investment securities held to maturity		128			265
Proceeds from maturities, calls & paydowns of investment securities available for sale		1,353			1,560
Net change in restricted stock		(50	)		(27	)
Net decrease (increase) in loans		1,980			(8,272	)
Purchase of premises and equipment		(1,938	)		(446	)
Proceeds from sale of OREO		229			607
Net cash provided (used) by investing activities		1,702			(6,313	)

Cash flows from financing activities
Net increase in deposit accounts		19,611			25,278
Net increase in federal funds purchased
and securities sold under agreements to repurchase and other short-term borrowings		213			527
Common stock repurchased		(146	)		(103	)
Exercise of stock options		—			65
Dividends paid on preferred stock		(140	)		(143	)
Net cash provided by financing activities		19,538			25,624
Increase in cash and cash equivalents		25,462			22,326
Cash and cash equivalents, beginning of period		117,934			70,403
Cash and cash equivalents, end of period	$	143,396		$	92,729

Supplemental Disclosures of Cash Flow Information
Interest paid	$	719		$	296
Income taxes paid		—			—
Supplemental Schedule of Non-Cash Activities
Net change in fair value securities available for sale, net of tax	$	(734	)	$	849
Loans transferred to foreclosed real estate		—			—
Mortgage servicing rights capitalized		83			74

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. (“UIA”), 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 2018 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 accounting principles generally accepted in the United States of America (“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.

Accounting Changes, Reclassifications and Restatements

Certain items in prior financial statements have been reclassified to conform to the current presentation.

Accounting Standards Update (“ASU”) 2016-02 Leases, Topic 842 was adopted January 1, 2019 and comparative periods have not been re-stated. 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.

Uwharrie Capital Corp currently has two properties that are considered in-scope for application of ASU 2016-02. The Company recognized a $1.9 million operating lease right-of-use asset (“ROU”), which is included in premises and equipment on the balance sheet, and a corresponding $1.9 million operating lease liability, recorded in other liabilities on the balance sheet. See Note 9 – Leases for additional information.

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.

-8-

The following table presents the changes in accumulated other comprehensive income for the three months ended March 31, 2019 and 2018:

	Unrealized holding gains on available-for-sale securities (net)
	For the Three Months Ended March 31,
	2019			2018
	(dollars in thousands)

Beginning Balance	$	(1,694	)	$	(1,107	)

Other Comprehensive income (loss) before reclassifications, net of $219,000 and ($250,000) tax effect, respectively		734			(849	)

Amounts reclassified from accumulated other comprehensive income		—			—

Net current-period other comprehensive income (loss)		734			(849	)

Ending Balance	$	(960	)	$	(1,956	)

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 corresponding 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 March 31, 2019 or December 31, 2018.

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 March 31,
	2019		2018

Weighted average number of common shares outstanding		7,125,564		7,254,594

Effect of dilutive stock options		—		—

Weighted average number of common shares and dilutive potential common shares used in computing diluted net income per common share		7,125,564		7,254,594

-9-

Note 5 – Investment Securities

Carrying amounts and fair values of securities available for sale and held to maturity are summarized below:

March 31, 2019	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
	(dollars in thousands)
Securities available for sale
U.S. Treasury	$	4,952	$	21	$	—	$	4,973
U.S. Government agencies		52,260		35		765		51,530
GSE - Mortgage-backed securities and CMO’s		16,419		—		342		16,077
State and political subdivisions		13,326		6		127		13,205
Corporate bonds		5,027		5		80		4,952
Total securities available for sale	$	91,984	$	67	$	1,314	$	90,737

March 31, 2019	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
	(dollars in thousands)
Securities held to maturity
U.S. Government agencies	$	724	$	—	$	—	$	724
State and political subdivisions		6,864		23		18		6,869
Corporate bonds		3,085		2		3		3,084
Total securities held to maturity	$	10,673	$	25	$	21	$	10,677

December 31, 2018	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
	(dollars in thousands)
Securities available for sale
U.S. Treasury	$	4,944	$	11	$	—	$	4,955
U.S. Government agencies		52,935		47		1,066		51,916
GSE - Mortgage-backed securities and CMO’s		17,217		—		515		16,702
State and political subdivisions		13,373		5		423		12,955
Corporate bonds		5,030		6		265		4,771
Total securities available for sale	$	93,499	$	69	$	2,269	$	91,299

December 31, 2018	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
	(dollars in thousands)
Securities held to maturity
U.S. Government agencies	$	855	$	—	$	12	$	843
State and political subdivisions		6,877		6		61		6,822
Corporate bonds		3,105		—		20		3,085
Total securities held to maturity	$	10,837	$	6	$	93	$	10,750

At March 31, 2019 and December 31, 2018, the Company owned Federal Reserve Bank (FRB) stock reported at cost of $509,000 for both periods, and Federal Home Loan Bank (FHLB) stock of $635,000 and $585,000, 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 is 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 March 31, 2019.

There were no sales of securities available for sale for the three-month periods ended March 31, 2019 and March 31, 2018.

At March 31, 2019 and December 31, 2018, securities available for sale with a carrying amount of $70.6 million and $71.5 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 March 31, 2019 and December 31, 2018. 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 March 31, 2019, the unrealized losses on available for sale securities less than twelve months related to three government agency bonds, two government sponsored enterprise (GSE) mortgage backed securities, and one corporate bond. The Company had eighteen government agency bonds, sixteen GSE mortgage backed securities, six state and political subdivision bonds, and one corporate bond at March 31, 2019, that had been in a loss position for twelve months or more. At March 31, 2019, the unrealized losses on held to maturity securities related to one government agency bond, seven state and political bonds, and one corporate bond. At December 31, 2018, the unrealized losses on available for sale securities less than twelve months related to four government agency bonds, one GSE mortgage backed securities, and one corporate bond. At December 31, 2018, the Company had sixteen government agency bonds, sixteen GSE mortgage backed securities, eight state and political subdivision bonds, and one corporate bond that had been in a loss position for twelve months or more. At December 31, 2018, the unrealized losses for less than twelve months on held to maturity securities related to two corporate bonds and two state and political subdivision bonds. The unrealized losses for twelve months or more on the held to maturity portfolio for December 31, 2018 relate to one government agency and six state and political subdivision bonds.

	Less than 12 Months				12 Months or More				Total
March 31, 2019	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	$	1,298	$	18	$	48,553	$	747	$	49,851	$	765
GSE-Mortgage-backed securities and CMO’s		999		3		15,078		339		16,077		342
State and political subdivisions		—		—		8,769		127		8,769		127
Corporate bonds		2,147		64		1,995		16		4,142		80
Total securities available for sale	$	4,444	$	85	$	74,395	$	1,229	$	78,839	$	1,314

	Less than 12 Months				12 Months or More				Total
March 31, 2019	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(dollars in thousands)
Held to maturity temporary impairment
State and political subdivisions	$	—	$	—	$	5,635	$	18	$	5,635	$	18
Corporate bonds		—		—		1,531		3		1,531		3
Total securities held to maturity	$	—	$	—	$	7,166	$	21	$	7,166	$	21

	Less than 12 Months				12 Months or More				Total
December 31, 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	$	1,924	$	29	$	47,814	$	1,037	$	49,738	$	1,066
GSE-Mortgage-backed securities and CMO’s		526		6		15,602		509		16,128		515
State and political subdivisions		—		—		11,109		423		11,109		423
Corporate bonds		1,989		224		1,971		41		3,960		265
Total securities available for sale	$	4,439	$	259	$	76,496	$	2,010	$	80,935	$	2,269

	Less than 12 Months				12 Months or More				Total
December 31, 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	$	—	$	—	$	843	$	12	$	843	$	12
State and political subdivisions		755		6		5,157		55		5,912		61
Corporate bonds		3,085		20		—		—		3,085		20
Total securities held to maturity	$	3,840	$	26	$	6,000	$	67	$	9,840	$	93

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 March 31, 2019, 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 March 31, 2019 by remaining contractual maturity are as follows:

	March 31, 2019
	Amortized Cost		Estimated Fair Value		Book Yield
	(dollars in thousands)
Securities available for sale

U.S. Treasury
Due after one but within five years		4,952		4,973		2.66	%
		4,952		4,973		2.66	%
U.S. Government agencies
Due within twelve months		17,470		17,426		1.24	%
Due after one but within five years		25,091		24,612		1.63	%
Due after five but within ten years		6,255		6,053		1.82	%
Due after ten years		3,444		3,439		2.95	%
		52,260		51,530		1.61	%
Mortgage-backed securities
Due after one but within five years		1,410		1,405		2.65	%
Due after five but within ten years		7,432		7,302		2.04	%
Due after ten years		7,577		7,370		2.20	%
		16,419		16,077		2.16	%
State and political subdivisions
Due within twelve months		1,004		1,006		3.25	%
Due after one but within five years		1,078		1,069		3.23	%
Due after five but within ten years		1,680		1,671		3.13	%
Due after ten years		9,564		9,459		3.10	%
		13,326		13,205		3.12	%
Corporate Bonds
Due after one but within five years		5,027		4,952		3.05	%
		5,027		4,952		3.05	%
Total Securities available for sale
Due within twelve months		18,474		18,432		1.35	%
Due after one but within five years		37,558		37,011		2.04	%
Due after five but within ten years		15,367		15,026		2.07	%
Due after ten years		20,585		20,268		2.74	%
	$	91,984	$	90,737		2.06	%

-12-

	March 31, 2019
	Amortized Cost		Estimated Fair Value		Book Yield
	(dollars in thousands)
Held to maturity

U. S. Government agencies
Due after one but within five years	$	724	$	724		2.57	%
		724		724		2.57	%
State and political subdivisions
Due after one but within five years		5,536		5,532		2.21	%
Due after five but within ten years		1,328		1,337		2.21	%
		6,864		6,869		2.25	%
Corporate Bonds
Due within twelve months		1,533		1,554		2.73	%
Due after one but within five years		1,552		1,530		2.79	%
		3,085		3,084		2.76	%
Total Securities held for maturity
Due within twelve months		1,533		1,554		2.73	%
Due after one but within five years		7,812		7,786		2.36	%
Due after five but within ten years		1,328		1,337		2.42	%
	$	10,673	$	10,677		2.42	%

Note 6 – Loans Held for Investment

The composition of net loans held for investment by class as of March 31, 2019 and December 31, 2018 are as follows:

	March 31, 2019			December 31, 2018
	(dollars in thousands)
Commercial
Commercial	$	58,135		$	57,176
Real estate - commercial		131,032			130,634
Other real estate construction loans		28,438			31,141
Noncommercial
Real estate 1-4 family construction		6,625			7,805
Real estate - residential		78,940			76,564
Home equity		50,869			52,541
Consumer loans		12,089			12,159
Other loans		2,004			2,110
		368,132			370,130
Less:
Allowance for loan losses		(2,233	)		(2,374	)
Deferred loan (fees) costs, net		(170	)		(160	)

Loans held for investment, net	$	365,729		$	367,596

-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 months ended March 31, 2019 and 2018, respectively:

Commercial	Three Months Ended March 31,
	2019			2018
	(dollars in thousands)

Balance, beginning of period	$	1,334		$	1,401
Provision (recovery) charged to operations		(64	)		45
Charge-offs		(5	)		—
Recoveries		16			15
Net (charge-offs) / Recoveries		11			15
Balance at end of period	$	1,281		$	1,461

Non-Commercial	Three Months Ended March 31,
	2019			2018
	(dollars in thousands)

Balance, beginning of period	$	1,040		$	1,057
Provision (recovery) charged to operations		(49	)		33
Charge-offs		(53	)		(17	)
Recoveries		14			13
Net (charge-offs) / Recoveries		(39	)		(4	)
Balance at end of period	$	952		$	1,086

Total	Three Months Ended March 31,
	2019			2018
	(dollars in thousands)

Balance, beginning of period	$	2,374		$	2,458
Provision (recovery) charged to operations		(113	)		78
Charge-offs		(58	)		(17	)
Recoveries		30			28
Net (charge-offs) / Recoveries		(28	)		11
Balance at end of period	$	2,233		$	2,547

The following table shows period-end loans and reserve balances by loan segment both individually and collectively evaluated for impairment at March 31, 2019 and December 31, 2018:

March 31, 2019
	Individually Evaluated				Collectively Evaluated				Total
	Reserve		Loans		Reserve		Loans		Reserve		Loans
	(dollars in thousands)

Commercial	$	40	$	1,243	$	1,241	$	216,362	$	1,281	$	217,605
Non-Commercial		105		3,033		847		147,324		952		150,357

Total	$	145	$	4,276	$	2,088	$	363,686	$	2,233	$	367,962

December 31, 2018
	Individually Evaluated				Collectively Evaluated				Total
	Reserve		Loans		Reserve		Loans		Reserve		Loans
	(dollars in thousands)

Commercial	$	42	$	1,359	$	1,292	$	217,592	$	1,334	$	218,951
Non-Commercial		112		3,119		928		147,900		1,040		151,019

Total	$	154	$	4,478	$	2,220	$	365,492	$	2,374	$	369,970

-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:

March 31, 2019
	Loans 30-89 Days Past Due		Loans 90 Days or More Past due		Total Past Due Loans		Current Loans		Total Loans		Accruing Loans 90 or More Days Past Due
	(dollars in thousands)

Commercial	$	145	$	—	$	145	$	57,990	$	58,135	$	—
Real estate - commercial		12		176		188		130,844		131,032		—
Other real estate construction		—		46		46		28,392		28,438		—
Real estate 1-4 family construction		—		—		—		6,625		6,625		—
Real estate - residential		641		648		1,289		77,481		78,770		—
Home equity		153		79		232		50,637		50,869		—
Consumer loans		21		—		21		12,068		12,089		—
Other loans		—		—		—		2,004		2,004		—

Total	$	972	$	949	$	1,921	$	366,041	$	367,962	$	—

December 31, 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	$	54	$	—	$	54	$	57,122	$	57,176	$	—
Real estate - commercial		—		273	$	273		130,361		130,634		—
Other real estate construction		—		47	$	47		31,094		31,141		—
Real estate construction		—		—		—		7,805		7,805		—
Real estate - residential		890		606		1,496		74,908		76,404		—
Home equity		100		118		218		52,323		52,541		—
Consumer loan		86		—		86		12,073		12,159		—
Other loans		—		—		—		2,110		2,110		—

Total	$	1,130	$	1,044	$	2,174	$	367,796	$	369,970	$	—

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 $211,000 in foreclosed residential real estate and $161,000 of residential real estate in process of foreclosure at March 31, 2019. At December 31, 2018, the Company had $371,000 in foreclosed residential real estate and $161,000 of residential real estate in process of foreclosure.

The composition of nonaccrual loans by class as of March 31, 2019 and December 31, 2018 is as follows:

	March 31, 2019		December 31, 2018
	(dollars in thousands)

Commercial	$	—	$	—
Real estate - commercial		176		273
Other real estate construction		46		47
Real estate 1 – 4 family construction		—		—
Real estate – residential		648		606
Home equity		79		118
Consumer loans		—		—
Other loans		—		—
	$	949	$	1,044

-15-

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 March 31, 2019 and December 31, 2018:

March 31, 2019
	Pass		Watch		Sub- standard		Doubtful		Total
	(dollars in thousands)

Commercial	$	56,405	$	1,722	$	8	$	—	$	58,135
Real estate - commercial		128,032		1,594		1,406		—		131,032
Other real estate construction		26,041		2,039		358		—		28,438
Real estate 1 - 4 family construction		6,625		—		—		—		6,625
Real estate - residential		73,059		4,755		956		—		78,770
Home equity		50,404		386		79		—		50,869
Consumer loans		12,057		31		1		—		12,089
Other loans		2,004		—		—		—		2,004

Total	$	354,627	$	10,527	$	2,808	$	—	$	367,962

December 31, 2018
	Pass		Watch		Sub- standard		Doubtful		Total
	(dollars in thousands)

Commercial	$	55,883	$	1,284	$	9	$	—	$	57,176
Real estate - commercial		127,592		1,518		1,524		—		130,634
Other real estate construction		28,711		2,070		360		—		31,141
Real estate 1 - 4 family construction		7,805		—		—		—		7,805
Real estate - residential		69,900		5,470		1,034		—		76,404
Home equity		52,028		395		118		—		52,541
Consumer loans		12,085		73		1		—		12,159
Other loans		2,110		—		—		—		2,110

Total	$	356,114	$	10,810	$	3,046	$	—	$	369,970

-16-

Loans that are in nonaccrual status or 90 days past due and still accruing are considered to be nonperforming. At both March 31, 2019 and December 31, 2018 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 March 31, 2019 and December 31, 2018:

March 31, 2019
	Performing		Non- Performing		Total
	(dollars in thousands)

Commercial	$	58,135	$	—	$	58,135
Real estate - commercial		130,856		176		131,032
Other real estate construction		28,392		46		28,438
Real estate 1 – 4 family construction		6,625		—		6,625
Real estate – residential		78,122		648		78,770
Home equity		50,790		79		50,869
Consumer loans		12,089		—		12,089
Other loans		2,004		—		2,004

Total	$	367,013	$	949	$	367,962

December 31, 2018
	Performing		Non- Performing		Total
	(dollars in thousands)

Commercial	$	57,176	$	—	$	57,176
Real estate - commercial		130,361		273		130,634
Other real estate construction		31,094		47		31,141
Real estate 1 – 4 family construction		7,805		—		7,805
Real estate – residential		75,798		606		76,404
Home equity		52,423		118		52,541
Consumer loans		12,159		—		12,159
Other loans		2,110		—		2,110

Total	$	368,926	$	1,044	$	369,970

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 March 31, 2019 and December 31, 2018.

March 31, 2019
	Unpaid Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Related Allowance
	(dollars in thousands)

Commercial	$	7	$	—	$	7	$	—
Real estate - commercial		1,144		—		1,144		37
Other real estate construction		630		46		46		3
Real estate 1 - 4 family construction		—		—		—		—
Real estate - residential		2,926		759		2,167		103
Home equity		79		51		28		1
Consumer loans		28		—		28		1
Other loans		—		—		—		—

Total	$	4,814	$	856	$	3,420	$	145

-17-

December 31, 2018
	Unpaid Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Related Allowance
	(dollars in thousands)

Commercial	$	7	$	—	$	7	$	—
Real estate - commercial		1,258		93		1,165		38
Other real estate construction		632		47		47		4
Real estate 1 - 4 family construction		—		—		—		—
Real estate - residential		3,005		901		2,104		110
Home equity		83		51		32		1
Consumer loans		31		—		31		1
Other loans		—		—		—		—

Total	$	5,016	$	1,092	$	3,386	$	154

	Three Months Ended March 31, 2019				Three Months Ended March 31, 2018
	Average Recorded Investment		Interest Income		Average Recorded Investment		Interest Income
	(dollars in thousands)

Commercial	$	7		—	$	43		—
Real estate - commercial		1,201		19		1,573		15
Other real estate construction		92		1		149		2
Real estate 1- 4 family construction		—		—		—		—
Real estate - residential		2,966		39		3,687		41
Home equity		81		1		34		—
Consumer loans		30		1		43		1
Other loans		—		—		—		—

Total	$	4,377	$	61	$	5,529	$	59

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 March 31, 2019, the Company had $3.4 million in TDRs outstanding, of which one with a balance of $29,000 was on a non-accruing basis.

-18-

For the three months ended March 31, 2019 and 2018, the following table presents a breakdown of the types of concessions made by loan class:

	For the three months ended March 31, 2019
	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
	(dollars in thousands)

Other:
Commercial		—	$	—	$	—
Real estate - commercial		1		1,629		806
Other real estate construction		—		—		—
Real estate 1 – 4 family construction		—		—		—
Real estate – residential		—		—		—
Home equity		—		—		—
Consumer loans		—		—		—
Other loans		—		—		—

Total		1	$	1,629	$	806

	For the three months ended March 31, 2018
	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
	(dollars in thousands)

Other:
Commercial		—	$	—	$	—
Real estate - commercial		1		12		11
Other real estate construction		—		—		—
Real estate 1 – 4 family construction		—		—		—
Real estate – residential		4		357		355
Home equity		—		—		—
Consumer loans		1		9		3
Other loans		—		—		—

Total		6	$	378	$	369

During the twelve months ended March 31, 2019, there was one TDR for which there was a payment default. During the twelve months ended March 31, 2018, there were two TDRs for which there was a payment default.

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 $136,000 in the allowance for loan losses as of March 31, 2019, as a direct result of these TDRs. At March 31, 2018, there was $141,000 in the allowance for loan losses related to TDRs.

-19-

The following table presents the status of the types of loan modifications within the previous twelve months as of March 31, 2019 and 2018:

	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)
March 31, 2019

Below market
Interest rate		—	$	—		—	$	—		—	$	—		—	$	—
Extended payment Terms		—		—		—		—		—		—		—		—
Forgiveness of Principal/Other		7		1,018		6		1,992		—		—		1		242

Total		7	$	1,018		6	$	1,992		—	$	—		1	$	242

March 31, 2018

Below market
Interest rate		—	$	—		—	$	—		—	$	—		—	$	—
Extended payment Terms		—		—		—		—		—		—		—		—
Forgiveness of Principal/Other		6		216		6		369		—		—		1		12

Total		6	$	216		6	$	369		—	$	—		1	$	12

The Company has not committed to fund any additional disbursements for TDRs as of March 31, 2019.

Note 9 - Leases

Operating leases in which we are the lessee are recorded as operating lease ROU assets and operating lease liabilities, included in premises and equipment and other liabilities, respectively, on our consolidated balance sheet. We do not currently have any significant finance leases in which we are the lessee.

Operating lease ROU assets represent our right to use an underlying asset during the lease term and operating lease liabilities represent our obligation to make lease payments arising from the lease. ROU assets and operating lease liabilities are recognized at lease commencement based on the present value of the remaining lease payments using a discount rate that represents our incremental collateralized borrowing rate at the lease commencement date. ROU assets are further adjusted for the lease incentives. Operating lease expense, which is comprised of amortization of the ROU asset and the implicit interest accreted on the operating lease liability, is recognized on a straight-line basis over the lease term, and is recorded in the net occupancy expense in the consolidated statement of income.

Our leases relate to an office space and a bank branch with remaining terms of two to nine years. Certain lease arrangements contain extension options which range from five to ten years at the then fair market rental rates. As these extension options are not generally considered reasonably certain of exercise, they are not included in the lease term. As of March 31, 2019, operating lease ROU assets and liabilities were both $1.9 million. Lease costs associated with all leases is $111,000 for the three months ended, March 31, 2019.

The table below summarizes other information related to our operating leases:

	Three Months Ended March 31,
	2019
	(in thousands except percent and period data)

Cash paid for amounts included in the measurement of lease liabilities
Operating cash flows from operating leases	$	84
Right-of-use assets obtained in exchange for new operating lease liabilities		1,940
Weighted-average remaining lease term - operating leases, in years		7.7
Weighted-average discount rate - operating leases		2.9	%

The table below summarizes the maturity of remaining lease liabilities:

-20-


	March 31, 2019
	(in thousands except percent and period data)

2019	$	255
2020		348
2021		313
2022		189
2023		193
2024 and thereafter		871
Total lease payments		2,169
Less: Interest		(248	)
Present value of lease liabilities		1,921

Note 10 - 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 March 31, 2019, outstanding financial instruments whose contract amounts represent credit risk were approximately:

	(dollars in thousands)
Commitments to extend credit	$	123,240
Credit card commitments		10,806
Standby letters of credit		853
Total commitments	$	134,899

Note 11 – 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.

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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

The following table provides fair value information for assets and liabilities measured at fair value on a recurring basis as of March 31, 2019 and December 31, 2018:

	March 31, 2019
	(dollars in thousands)
	Total		Level 1		Level 2		Level 3

Securities available for sale:
U.S. Treasury	$	4,973	$	4,973	$	—	$	—
U.S. Government agencies		51,530	$	—	$	51,530	$	—
GSE - Mortgage-backed securities and CMO’s		16,077		—		16,077		—
State and political subdivisions		13,205		—		13,205		—
Corporate bonds		4,952		—		4,952		—

Total assets at fair value	$	90,737	$	4,973	$	85,764	$	—

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

	December 31, 2018
	(dollars in thousands)
	Total		Level 1		Level 2		Level 3

Securities available for sale:
U.S. Treasury	$	4,955	$	4,955	$	—	$	—
U.S. Government agencies		51,916		—		51,916		—
GSE - Mortgage-backed securities and CMO’s		16,702		—		16,702		—
State and political subdivisions		12,955		—		12,955		—
Corporate bonds		4,771		—		4,771		—

Total assets at fair value	$	91,299	$	4,955	$	86,344	$	—

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

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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 March 31, 2019 and December 31, 2018:

	March 31, 2019
	(dollars in thousands)
	Total		Level 1		Level 2		Level 3

Impaired loans	$	3,321	$	—	$	—	$	3,321
Other real estate owned		685		—		—		685
Total assets at fair value	$	4,006	$	—	$	—	$	4,006

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

	December 31, 2018
	(dollars in thousands)
	Total		Level 1		Level 2		Level 3

Impaired loans	$	3,279	$	—	$	—	$	3,279
Other real estate owned		951		—		—		951

Total assets at fair value	$	4,230	$	—	$	—	$	4,230
Total liabilities at fair value	$	—	$	—	$	—	$	—

Quantitative Information about Level 3 Fair Value Measurements

March 31, 2019
	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, 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 rates	4%-8.75%

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

At March 31, 2019, impaired loans were being evaluated with discounted expected cash flows and discounted appraisals were being used on collateral dependent loans.

Note 12 – 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 March 31, 2019 and December 31, 2018 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,

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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 March 31, 2019 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 March 31, 2019 and December 31, 2018:

March 31, 2019
	Carrying Value		Estimated Fair Value		Level 1		Level 2		Level 3
	(dollars in thousands)
FINANCIAL ASSETS
Cash and cash equivalents	$	143,396	$	143,396	$	141,172	$	2,224	$	—
Securities available for sale		90,737		90,737		4,973		85,764		—
Securities held to maturity		10,673		10,677		—		10,677		—
Loans held for investment, net		367,962		366,858		—		—		366,858
Loans held for sale		3,567		3,567		—		3,567		—
Restricted stock		1,144		1,144		1,144		—		—
Loan servicing rights		1,783		3,338		—		3,338		—
Accrued interest receivable		1,649		1,649		—		—		1,649

FINANCIAL LIABILITIES
Deposits	$	586,512	$	548,447	$	—	$	548,447	$	—
Short-term borrowings		1,403		1,403		—		1,403		—
Long-term borrowings		9,974		9,984		—		—		9,984
Accrued interest payable		41		41		—		—		41

December 31, 2018
	Carrying Value		Estimated Fair Value		Level 1		Level 2		Level 3
	(dollars in thousands)
FINANCIAL ASSETS
Cash and cash equivalents	$	117,934	$	117,901	$	115,693	$	2,208	$	—
Securities available for sale		91,299		91,299		4,955		86,344		—
Securities held to maturity		10,837		10,750		—		10,750		—
Loans held for investment, net		367,596		364,636		—		—		364,636
Loans held for sale		4,800		4,800		—		4,800		—
Restricted stock		1,094		1,094		1,094		—		—
Mortgage servicing rights		1,850		3,455		—		3,455
Accrued interest receivable		1,763		1,763		—		—		1,763

FINANCIAL LIABILITIES
Deposits		566,901		521,508		—		521,508		—
Short-term borrowings		1,190		1,190		—		1,190		—
Long-term debt		9,974		10,086		—		—		10,086
Accrued interest payable		16		16		—		—		16

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 loan 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

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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.

•

Loan servicing rights – The fair value disclosed for loan 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 March 31, 2019, 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 13 – Recent Accounting Pronouncements

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 have entered into a contract to outsource our current model with a CECL-ready vendor. We are currently evaluating various methods of determining credit losses within the software. We expect to run the CECL model parallel to our current model by the end of the second quarter in 2019. The impact of the adoption is dependent on the loan portfolio composition and credit quality at adoption date, as well as economic conditions and forecasts at that time.

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 2018 financial statements have been reclassified to conform to the 2019 presentation. These reclassifications do not have a material impact on net income or shareholders’ equity. Please refer to the disclosure in Note 1 on page 8 for further specific reclassification information.

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

Caution Regarding Forward-Looking Statements

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 March 31, 2019 and December 31, 2018.

During the three months ended March 31, 2019, the Company’s total assets increased $22.7 million, from $632.3 million to $655 million.

Cash and cash equivalents increased $25.5 million during the three months ended March 31, 2019. Cash and due from banks increased $4.0 million, while interest-earning deposits with banks increased $21.4 million. The increase is directly related to the increase in noninterest-bearing deposits.

Investment securities consist of securities available for sale and securities held to maturity. Investment securities decreased $726,000 to $101.4 million for the three-month period ended March 31, 2019 due to contracted principal pay downs. At March 31, 2019, the Company had net unrealized losses on securities available for sale of $1.2 million compared to $2.2 million as December 31, 2018.

Loans held for investment decreased from $370 million to $368 million, a decrease of $2 million for the quarter. The Company experienced growth in the commercial real estate, commercial, and residential real estate loan segments during the first three months of 2019. The residential real estate segment has the largest increase in the portfolio of 3.1% or $2.4 million. The largest decline is in the real estate construction segment, not 1-4 family, of $2.7 million or 8.68%. Loans held for sale decreased 25.69%, or $1.2 million as many of the loans produced near year-end were not sold on the secondary market until first quarter 2019. The allowance for loan losses was $2.2 million at March 31, 2019, which represented 0.61% of the total loan portfolio compared to $2.4 million or 0.64% of the total loan portfolio at December 31, 2018.

Other changes in our consolidated assets are primarily related to premises and equipment, other real estate owned, prepaid assets, and other assets. Premises and equipment increased $1.7 million from $14.8 million at December 31, 2018 to $16.5 million at March 31, 2019 due to the adoption of ASU 2016-02, Leases. A $1.9 million right-of-use asset was booked to record the applicable lease agreements held by the Company. Other real estate owned decreased $266,000. During the three months ended March 31, 2019, the Company sold three pieces of property totaling $272,000. The Company recorded $37,000 of losses associated with the sold property. Prepaid assets have increased $422,000 from December 31, 2018 to March 31, 2019 as many prepaid invoices are paid in first quarter and amortized over the remaining year per contract terms. Other assets decreased $746,000 primarily due to the reduction in deferred tax on securities as the unrealized loss position declines.

Customer deposits, our primary funding source, experienced a $19.6 million increase during the three-month period ended March 31, 2019, increasing from $566.9 million to $586.5 million or 3.5% growth. Demand noninterest-bearing checking increased $15.6 million and savings deposits increased $2.7 million. Interest checking and money market accounts decreased by $46.8 million, which is related to the increase in time deposits greater than $250,000 of $45.3 million as one account switched product offerings.

Total short-term borrowings increased $213,000 for the period.

Other liabilities increased from $9.0 million at December 31, 2018 to $10.7 million at March 31, 2019, an increase of $1.7 million, of which $1.9 million is related to the adoption of ASU 2016-02 regarding the recognition of a lease liability to reflect the contractual lease obligations of the Company.

At March 31, 2019, total shareholders’ equity was $46.3 million, an increase of $1.1 million from December 31, 2018. Net income for the three-month period was $690,000. Unrealized losses on investment securities, net of tax, improved by $734,000. The Company repurchased 29,314 shares of common stock for a total value of $146,000 during the first quarter of 2019. The Company paid $140,000 in dividends attributed to noncontrolling interest during the first quarter of 2019.

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Comparison of Results of Operations for the Three Months Ended March 31, 2019 and 2018.

Net Income and Net Income Available to Common Shareholders

Uwharrie Capital Corp reported net income of $690,000 for the three months ended March 31, 2019, as compared to $234,000 for the three months ended March 31, 2018, an increase of $456,000. Net income available to common shareholders was $550,000 or $0.08 per common share at March 31, 2019, compared to $91,000 or $0.01 per common share at March 31, 2018. 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 March 31, 2019 was $5.2 million compared to $4.7 million for the three months ended March 31, 2018, an increase of $912,000. During the first quarter of 2019, the average yield on our interest-earning assets increased 20 basis points to 4.04%, as the average rate we paid for our interest-bearing liabilities increased thirty-two basis points to 0.67%. The aforementioned changes resulted in a lower interest rate spread of 3.37% as of March 31, 2019 compared to 3.49% as of March 31, 2018. Our net interest margin was 3.54% and 3.58% for the comparable periods in 2019 and 2018, respectively.

The following table presents average balance sheet and a net interest income analysis for the three months ended March 31, 2019 and 2018:

Average Balance Sheet and Net Interest Income Analysis

For the Three Months Ended March 31,

(dollars in thousands)
	Average Balance				Income/Expenses				Rate/Yield
	2019		2018		2019		2018		2019			2018
Interest-earning assets:
Taxable securities	$	84,488	$	87,725	$	390	$	398		1.87	%		1.84	%
Nontaxable securities (1)		17,150		17,960		106		113		3.09	%		3.23	%
Short-term investments		128,730		67,815		793		277		2.50	%		1.66	%
Taxable loans		363,103		352,893		4,610		4,189		5.15	%		4.81	%
Non-taxable loans (1)		9,116		10,852		57		67		3.13	%		3.17	%
Total interest-earning assets		602,587		537,245		5,956		5,044		4.04	%		3.84	%

Interest-bearing liabilities:
Interest-bearing deposits		440,208		398,666		597		217		0.55	%		0.22	%
Short-term borrowed funds		1,445		1,976		6		3		1.68	%		0.62	%
Long-term debt		9,974		9,534		141		135		5.73	%		5.74	%
Total interest-bearing liabilities		451,627		410,176		744		355		0.67	%		0.35	%

Net interest spread	$	150,960	$	127,069	$	5,212	$	4,689		3.37	%		3.49	%

Net interest margin (1) (% of earning assets)										3.54	%		3.58	%

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

Provision and Allowance for Loan Losses

The recovery for loan losses was $113,000 for the three months ending March 31, 2019 compared to a provision of $78,000 for the same period in 2018. There were net loan chargeoffs of $28,000 for the three months ended March 31, 2019, as compared with net loan recoveries of $11,000 during the same period of 2018. Refer to the Asset Quality discussion on page 29 for further information.

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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 $146,000 for the three-month period ending March 31, 2019 as compared to the same period in 2018. The primary factor contributing to the overall decrease was a decrease in income from mortgage loan sales of $170,000, decreasing from $662,000 for the quarter ended March 31, 2018 to $492,000 for the same period in 2019. Reduced margins to maintain production with competitors has impacted revenue from our mortgage division. Additionally, valuation adjustments for the supplemental employee retirement plans resulted in a decrease of other income by $177,000 from March 31, 2018 to March 31, 2019.

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. 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 March 31,
	2019		2018
	(in thousands)

Income from debit card transactions	$	342	$	297
Income from credit card transactions		107		82
Gross interchange and transaction fee income		449		379
Network costs - debit card		160		153
Network costs - credit card		95		84
Total	$	194	$	142

Noninterest Expense

Noninterest expense for the quarter ended March 31, 2019 remained flat at $6.20 million compared to $6.21 million for the same period of 2018. Salaries and benefits, the largest component of noninterest expense, increased $187,000 to account for wage and benefit cost increases.

This increase is offset by declines in both professional fees and services and other noninterest expense. Professional fees decreased $95,000 from March 31, 2018 to March 31, 2019 due to consulting and training expense recognized in 2018 relating to the 2018 core data processing system conversion. The table below reflects the composition of other noninterest expense.

	Three Months Ended March 31,
	2019		2018
	(in thousands)

Postage	$	64	$	49
Telephone and data lines		46		45
Loan costs		89		75
Shareholder relations expense		39		38
Dues and subscriptions		61		67
Other		127		295
Total	$	426	$	569

Income Tax Expense

The Company had income tax expense of $183,000 for the three months ended March 31, 2019 at an effective tax rate of 20.96% compared to income tax expense of $58,000 with an effective tax rate of 19.86% in the comparable 2018 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 2019, the effective tax rate increased due to less impact from tax-free instruments.

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

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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 March 31, 2019, the levels of our impaired loans, which includes all loans in nonaccrual status, TDRs and other loans deemed by management to be impaired, were $4.3 million compared to $4.5 million at December 31, 2018, a net decrease of $202,000. Total nonaccrual loans, which are a component of impaired loans, decreased from $1.0 million at December 31, 2018 to $949,000 at March 31, 2019. During the first three months of 2019, one additional loan of $54,000 was added to impaired loans. That was offset by the pay-off of three impaired relationships totaling $187,000 as well as net pay downs of $69,000.

The allowance, expressed as a percentage of gross loans held for investment, decreased three basis points from 0.64% at December 31, 2018 to 0.61% at March 31, 2019. The collectively evaluated reserve allowance as a percentage of collectively evaluated loans was 0.61% at December 31, 2018 and 0.57% at March 31, 2019. The decrease is attributable to a continued improvement in the credit quality of the current portfolio as charge offs remain low and classified assets continue to improve. The individually evaluated allowance as a percentage of individually evaluated loans decreased from 3.43% to 3.38% for the same periods due to a reduction in impaired loans and required reserves associated with the impaired loans as loan values decrease. 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 for qualitative factors based on management’s discretion of 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. During the first quarter, the average effective credit score of the portfolio, excluding loans in default, rose from 766 to 768. The probability of default associated with each credit score is the major driver in the allowance for loan losses.

The ratio of nonperforming loans, which consist of nonaccrual loans and loans past due 90 days and still accruing, to total loans decreased from 0.28% at December 31, 2018, to 0.26% at March 31, 2019.

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

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Other real estate owned decreased $266,000 during the first quarter of 2019. The Company sold three pieces of foreclosed property totaling $272,000 realizing a loss of $37,000. The Company had no write-downs for the period ending March 31, 2019. There were no loans foreclosed on during the first quarter.

Troubled debt restructured loans at March 31, 2019 totaled $3.6 million compared to $3.4 million at December 31, 2018 and are included in impaired loans. At March 31, 2019, there was one troubled debt restructured loan in nonaccrual status.

The following table shows the comparison of nonperforming assets at March 31, 2019 to December 31, 2018:

Nonperforming Assets

(dollars in thousands)

	March 31, 2019			December 31, 2018
Nonperforming assets:
Loans past due 90 days or more	$	—		$	—
Nonaccrual loans		949			1,044
Other real estate owned		781			1,047
Total nonperforming assets	$	1,730		$	2,091

Allowance for loans losses	$	2,233		$	2,374
Nonperforming loans to total loans		0.26	%		0.28	%
Allowance for loan losses to total loans		0.61	%		0.65	%
Nonperforming assets to total assets		0.26	%		0.33	%
Allowance for loan losses to nonperforming loans		235.35	%		227.38	%

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 aggregating $28 million at March 31, 2019, with available credit of $28 million; established borrowing relationships with the Federal Home Loan Bank, with available credit of $29.8 million; access to borrowings from the Federal Reserve Bank discount window, with available credit of $31.6 million and the issuance of commercial paper. The Company has also secured long-term debt from other sources. Total debt from these sources include $9.5 million of junior subordinated debt and notes payable of $440,000 at both March 31, 2019 and December 31, 2018.

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. The federal bank regulatory agencies have implemented regulatory capital rules known as “Basel III.” The Basel III 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%. There is also a capital conservation buffer that requires banks to hold common equity Tier 1 capital in excess of minimum risk-based capital ratios by at least 2.5% to avoid limits on capital distributions and certain discretionary bonus payments to executive officers and similar employees.

The Basel III rules began to phase in for the Company and its subsidiary bank on January 1, 2015, with full compliance of all the rules’ requirements effective on January 1, 2019. Pursuant to the Federal Reserve’s Small Bank Holding Company Policy Statement, the Company is exempt from the requirement to maintain consolidated regulatory capital ratios; instead, regulatory capital ratios only apply at the subsidiary bank level. As of March 31, 2019, the Bank continues to exceed minimum capital standards and remain well-capitalized under the applicable rules.

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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 pays 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 March 31, 2019, 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 March 31, 2019 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, 2018, detail of which is presented on page 77 of our 2018 Annual Report to Shareholders filed as Exhibit 13 with our 2018 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 controls over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) of the Exchange Act) during the first quarter of 2019. 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.

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.

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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 March 31, 2019.

	(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
January 1, 2019 Through January 31, 2019		—	$	—		—	$	—
February 1, 2019 Through February 28, 2019		—	$	—		—	$	—
March 1, 2019 Through March 31, 2019		29,314	$	4.99		—	$	—
Total		29,314	$	4.99		—	$	—

(1)

Trades of the Company’s stock are quoted on the OTC Pink 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 (filed herewith)

101		Interactive data files providing financial information from the Registrant’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2019, 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:	May 7, 2019	By:	/s/ Roger L. Dick
		Roger L. Dick
		President and Chief Executive Officer

Date:	May 7, 2019	By:	/s/ R. David Beaver, III
		R. David Beaver, III
		Principal Financial Officer

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