Table of Contents














UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549


FORM 10-Q








Quarterly Report Pursuant to Section 13 or 15(d) of the


Securities Exchange Act of 1934


For the quarterly period ended June 30, 2014Commission File Number 0-13823








COMMUNITYONE BANCORP


(Exact name of Registrant as specified in its Charter)





North Carolina56-1456589(State of Incorporation)(I.R.S. Employer Identification No.)1017 E. Morehead StreetCharlotte, North Carolina28204(Address of principal executive offices)(Zip Code)





(336) 626-8300


(Registrant's telephone number, including area code)








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





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





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


Large accelerated fileroAccelerated filerxNon-accelerated fileroSmaller reporting Companyo(Do not check if a smaller reporting company)


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





As of July 31, 2014 (the most recent practicable date), the Registrant had outstanding approximately 21,738,699 shares of Common Stock.





---

Table of Contents


CommunityOne Bancorp and Subsidiaries


Report on Form 10-Q


June 30, 2014





TABLE OF CONTENTS


PART I.  FINANCIAL INFORMATIONItem 1Consolidated Financial Statements (Unaudited)Consolidated Balance Sheets as of June 30, 2014 and December 31, 20131Consolidated Statements of Operations for Three and Six Months Ended June 30, 2014 and 20132Consolidated Statements of Comprehensive Income (Loss) for Three and Six Months Ended June 30, 2014 and 20133Consolidated Statements of Shareholders' Equity for Six Months Ended June 30, 2014 and 20134Consolidated Statements of Cash Flows for Six Months Ended June 30, 2014 and 20135Item 2Management’s Discussion and Analysis of Financial Condition and Results of Operations36Item 3Quantitative and Qualitative Disclosures about Market Risk55Item 4Controls and Procedures56PART II.  OTHER INFORMATIONItem 1Legal Proceedings57Item 1ARisk Factors57Item 2Unregistered Sales of Equity Securities and Repurchases57Item 3Defaults Upon Senior Securities57Item 4Mine Safety Disclosures57Item 5Other Information57Item 6Exhibits57Signatures58








i


---

Table of Contents


PART I.    FINANCIAL INFORMATION


Item 1.    Financial Statements


CommunityOne Bancorp and Subsidiaries


Consolidated Balance Sheets (unaudited)


(in thousands, except share and per share data)June 30, 2014December 31, 2013*AssetsCash and due from banks$30,377$31,917Interest-bearing bank balances40,10035,513Investment securities:Available-for-sale, at estimated fair value (amortized cost of $409,715 in 2014 and $438,057 in 2013)399,110414,614Held-to-maturity, at amortized cost (estimated fair value of $142,288 in 2014                                     and $141,125 in 2013)147,055151,795Loans held for sale1,7651,836Loans held for investment1,269,8651,212,248Less: Allowance for loan losses(23,975)(26,785)Net loans held for investment1,245,8901,185,463Premises and equipment, net47,85550,889Other real estate owned and property acquired in settlement of loans21,87128,395Core deposit premiums and other intangibles6,2966,914Goodwill4,2054,205Bank-owned life insurance40,50439,940Other assets28,48533,551Total Assets$2,013,513$1,985,032LiabilitiesDeposits:Noninterest-bearing demand deposits$321,829$290,461Interest-bearing deposits:Demand, savings and money market deposits850,514875,970Time deposits of $100 or more241,844229,395Other time deposits349,578352,879Total deposits1,763,7651,748,705Retail repurchase agreements8,3336,917Federal Home Loan Bank advances73,25973,283Long-term notes payable5,3005,263Junior subordinated debentures56,70256,702Other liabilities13,45713,801Total Liabilities1,920,8161,904,671Shareholders' EquityPreferred stock, 10,000,000 shares authorizedSeries A, $10.00 par value; 51,500 shares issued and no shares outstanding in 2014 and 2013——Series B, no par value, authorized 250,000 shares, no shares issued and outstanding in 2014 and 2013——Common stock, no par value; authorized 2,500,000,000 shares, issued 21,738,699 shares in 2014 and 21,861,418 in 2013462,206461,636Accumulated deficit(359,601)(363,670)Accumulated other comprehensive loss(9,908)(17,605)Total Shareholders' Equity92,69780,361Total Liabilities and Shareholders' Equity$2,013,513$1,985,032


See accompanying notes to consolidated financial statements.


* Derived from audited consolidated financial statements


1


---

Table of Contents


CommunityOne Bancorp and Subsidiaries


Consolidated Statements of Operations (unaudited)


(in thousands, except share and per share data)Three Months Ended June 30,Six Months Ended June 30,2014201320142013Interest IncomeInterest and fees on loans$14,376$14,422$28,457$29,207Interest and dividends on investment securities:Taxable income3,7313,5187,4266,578Non-taxable income———14Other interest income156197307409Total interest income18,26318,13736,19036,208Interest ExpenseDeposits1,7412,0903,4434,337Retail repurchase agreements3469Federal Home Loan Bank advances514365983747Other borrowed funds287264561528Total interest expense2,5452,7234,9935,621Net Interest Income before Provision for Loan Losses15,71815,41431,19730,587Recovery of loan losses(1,685)(1,057)(2,369)(947)Net Interest Income after Provision for Loan Losses17,40316,47133,56631,534Noninterest IncomeService charges on deposit accounts1,6191,6813,1833,057Mortgage loan income2619214351,665Cardholder and merchant services income1,2091,1742,3222,243Trust and investment services399394757635Bank-owned life insurance278276530538Other service charges, commissions and fees332337684595Securities gains, net7203457202,723Other income75119205324Total noninterest income4,8935,2478,83611,780Noninterest ExpensePersonnel expense9,95610,80720,34921,486Net occupancy expense1,5121,6713,0653,502Furniture, equipment and data processing expense2,0472,0944,0504,462Professional fees4677601,1002,253Stationery, printing and supplies173187335373Advertising and marketing147179300844Other real estate owned expense9543,3321,2154,214Credit/debit card expense6044731,199898FDIC insurance5956641,2341,334Loan collection expense5511,4081,2082,979Merger-related expense—1,989—3,498Core deposit intangible amortization352352704704Other expense1,9107493,3152,457Total noninterest expense19,26824,66538,07449,004Income (loss) before income taxes3,028(2,947)4,328(5,690)Income tax expense2362362592,089Net income (loss)$2,792$(3,183)$4,069$(7,779)Weighted average number of shares outstanding - basic21,888,77221,729,32921,912,08421,713,808Weighted average number of shares outstanding - diluted21,899,99421,729,32921,925,79821,713,808Net income (loss) per share - basic and diluted$0.13$(0.15)$0.19$(0.36)


See accompanying notes to consolidated financial statements.


2


---

Table of Contents


CommunityOne Bancorp and Subsidiaries


Consolidated Statements of Comprehensive Income (Loss) (unaudited)


(dollars in thousands)Three Months Ended June 30,20142013Net income (loss)$2,792$(3,183)Other comprehensive income (loss):Unrealized holdings gains (losses) arising during the period on available-for-sale securities8,266(16,514)Tax effect(3,161)6,523Unrealized holdings gains (losses) arising during the period on available-for-sale securities, net of tax5,105(9,991)Reclassification adjustment for gain on available-for-sale securities included in net income(720)(345)Tax effect275136Reclassification adjustment for gain on available-for-sale securities included in net income, net of tax(445)(209)Unrealized gain (loss) on interest rate swaps(414)—Tax effect159—Unrealized gain (loss) on interest rate swaps, net of tax(255)—Change in defined benefit plans liability—(255)Tax effect—101Change in defined benefit plans liability, net of tax—(154)Other comprehensive income (loss), net of tax4,405(10,354)Comprehensive income (loss)$7,197$(13,537)





(dollars in thousands)Six Months Ended June 30,20142013Net income (loss)$4,069$(7,779)Other comprehensive income (loss):Unrealized holdings gains (losses) arising during the period on available-for-sale securities13,557(21,448)Tax effect(5,185)8,472Unrealized holdings gains (losses) arising during the period on available-for-sale securities, net of tax8,372(12,976)Reclassification adjustment for (gain) losses on available-for-sale securities included in net income(720)(2,723)Tax effect2751,076Reclassification adjustment for (gain) losses on available-for-sale securities included in net income, net of tax(445)(1,647)Unrealized gain (loss) on interest rate swaps(373)—Tax effect143—Unrealized gain (loss) on interest rate swaps, net of tax(230)—Change in defined benefit plans liability—(509)Tax effect—201Change in defined benefit plans liability, net of tax—(308)Other comprehensive income (loss), net of tax:7,697(14,931)Comprehensive income (loss)$11,766$(22,710)


See accompanying notes to consolidated financial statements.


3


---

Table of Contents


CommunityOne Bancorp and Subsidiaries


Consolidated Statements of Shareholders’ Equity (unaudited)


For Six Months Ended June 30, 2014 and 2013


Accumulated(dollars in thousands, except share and per share data)OtherPreferred StockCommon StockAccumulatedComprehensiveSharesAmountSharesAmountDeficitIncome (Loss)TotalBalance, December 31, 2012—$—21,698,115$460,955$(362,187)$(323)$98,445Comprehensive loss:Net loss————(7,779)—(7,779)Other comprehensive income, net of tax—————(14,931)(14,931)Stock options and restricted stock awards:Compensation expense recognized———297——297Issuance of restricted stock awards, net of cancellations——37,823————Shares issued as compensation to directors9351414Balance, June 30, 2013—$—21,736,873$461,266$(369,966)$(15,254)$76,046Balance, December 31, 2013—$—21,861,418$461,636$(363,670)$(17,605)$80,361Comprehensive income:Net income————4,069—4,069Other comprehensive income, net of tax—————7,6977,697Stock options and restricted stock awards:Compensation expense recognized———529——529Issuance of restricted stock awards, net of cancellations——(125,475)————Shares issued as compensation to directors——2,75641——41Balance, June 30, 2014—$—21,738,699$462,206$(359,601)$(9,908)$92,697





See accompanying notes to consolidated financial statements.


4


---

Table of Contents


CommunityOne Bancorp and Subsidiaries


Consolidated Statements of Cash Flows (unaudited)


(dollars in thousands)Six Months Ended June 30,20142013Operating ActivitiesNet income (loss)$4,069$(7,779)Adjustments to reconcile net income (loss) to cash (used in) provided by operating activities:Depreciation and amortization of premises and equipment1,9041,829Provision for (recovery of) loan losses(2,369)(947)Deferred income taxes2592,089Deferred loan fees and costs, net61(1,093)Premium amortization and discount accretion of investment securities, net1,1932,334Net gain on sale of investment securities(720)(2,723)Amortization of core deposit premiums704704Net accretion on acquired loans(5,285)(8,744)Stock compensation expense570311Increase in cash surrender value of bank-owned life insurance, net(564)(572)Loans held for sale:Origination of loans held for sale(27,879)(67,783)Net proceeds from sale of loans held for sale28,23171,958Net gain on sale of loans held for sale(281)(1,277)Mortgage servicing rights capitalized(310)(724)Mortgage servicing rights amortization225113Net gain on sale of premises and equipment(11)—Net loss on sales and write-downs of other real estate owned9342,764Changes in assets and liabilities:Decrease in accrued interest receivable and other assets1,7151,881Increase in accrued interest payable and other liabilities(307)1,729Net cash provided by (used in) operating activities2,139(5,930)Investing ActivitiesAvailable-for-sale securities:Proceeds from sales2,473174,492Proceeds from maturities, calls and principal repayments25,58541,895Purchases—(128,681)Held-to-maturity securities:Proceeds from maturities, calls and principal repayments4,550556Purchases—(155,394)Net increase in loans held for investment(52,404)(12,483)Proceeds from sales of other real estate owned5,22930,675Purchases of premises and equipment(1,002)(1,603)Proceeds from sales of premises and equipment2537Net cash used in investing activities(15,544)(50,506)Financing ActivitiesNet increase (decrease) in deposits15,060(95,116)Increase in retail repurchase agreements1,416434Decrease in Federal Home Loan Bank advances(24)(22)Net cash (used in) provided by financing activities16,452(94,704)Net Increase (Decrease) in Cash and Cash Equivalents3,047(151,140)Cash and Cash Equivalents at Beginning of Period67,430239,610Cash and Cash Equivalents at End of Period$70,477$88,470Supplemental disclosure of cash flow informationCash paid during the period for:Interest$4,485$5,525Noncash transactions:Foreclosed loans transferred to other real estate owned1,2516,793Loans to facilitate the sale of other real estate owned1,699488Unrealized securities gains/(losses), net of income taxes7,927(14,623)Transfer of fixed assets to other assets2,136—Employee benefit plan costs, net of income taxes—(308)Unrealized gain (loss) on interest rate swaps, net of income taxes(230)—


See accompanying notes to consolidated financial statements.


5


---

Table of Contents





CommunityOne Bancorp and Subsidiaries


Notes to Consolidated Financial Statements


(Unaudited)





1.   Basis of Presentation


Nature of Operations


CommunityOne Bancorp, or "COB" or the "Company" (which also refers to us and our subsidiaries on a consolidated basis), is a bank


holding company incorporated in 1984 under the laws of the State of North Carolina. Through our ownership of CommunityOne


Bank, N.A., or the "Bank," a national banking association headquartered in Asheboro, North Carolina, we offer a complete line of


consumer, wealth management, mortgage and business banking services, including loan, deposit, cash management, investment


management and trust services, to individual and business customers through operations located throughout central, southern and


western North Carolina.


In addition to the Bank, we own FNB United Statutory Trust I, FNB United Statutory Trust II, and Catawba Valley Capital Trust II, which were formed to facilitate the issuance of trust preferred securities. COB also owned Granite Mortgage, Inc., which ceased mortgage operations in 2009, filed for Chapter 11 bankruptcy on February 15, 2012 and was dissolved on May 5, 2014.


The Bank holds the stock of First National Investor Services, Inc., which holds deeds of trust for the Bank. The Bank had also owned Dover Mortgage, which had previously engaged in the business of originating, underwriting and closing mortgage loans for sale in the secondary market. Dover ceased operations in the first quarter of 2011, filed for Chapter 11 bankruptcy on February 15, 2012 and was dissolved on April 28, 2014.


On October 21, 2011, as part of the recapitalization of COB, COB acquired Bank of Granite Corporation and its subsidiary bank, Bank of Granite, through the merger of a wholly owned subsidiary of ours into Granite Corp. (the “Merger”).  Bank of Granite was merged into the Bank on June 8, 2013.


We earn revenue primarily from interest on loans and securities investments, mortgage banking income and fees charged for financial services provided to our customers.  Offsetting these revenues are the cost of deposits and other funding sources, provision for loan losses and write-downs in the value of, gains and losses on disposition of and holding costs associated with our OREO, and other operating costs such as:  salaries and employee benefits, occupancy, data processing expenses, merger-related expenses and tax expense.


General


In the accompanying consolidated financial statements, prepared without audit, all significant intercompany balances and transactions have been eliminated.  Descriptions of the organization and business of COB, accounting policies followed by COB and other relevant information are contained in our Annual Report on Form 10-K for the year ended December 31, 2013 (the "Form 10-K"), including the Notes to the consolidated financial statements filed as part of that report.  This quarterly report should be read in conjunction with the Form 10-K.


In the opinion of management, the accompanying consolidated financial statements contain the adjustments, all of which are normal recurring adjustments, necessary to present fairly the financial position of COB as of June 30, 2014 and December 31, 2013 , and the results of its operations for the three and six months, and cash flows for the six months ended June 30, 2014 and 2013 , respectively.


Use of Estimates


We have made a number of estimates and assumptions relating to the reporting of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period to prepare these consolidated financial statements in conformity with accounting principles generally accepted in the United States ("GAAP").  Actual results could differ from those estimates.  Material estimates subject to change in the near term include, among other items, the allowances for loan losses (“ALL”), estimated cash flows of purchased impaired loans, the carrying value of other real estate owned (“OREO”), the carrying value of intangible assets and the realization of deferred tax assets.


Reclassification


Certain reclassifications have been made to the prior period consolidated financial statements to place them on a comparable basis with the current period consolidated financial statements.  These reclassifications have no effect on net income or shareholders' equity as previously reported.


Recent Accounting Pronouncements


Troubled Debt Restructurings - In January 2014, the Financial Accounting Standards Board (“FASB”)  issued ASU No. 2014-04 Troubled Debt Restructurings by Creditors (Subtopic 310-40): "Reclassification of Residential Real Estate Collateralized Consumer


6


---

Table of Contents


Mortgage Loans upon Foreclosure" (“ASU No. 2014-04”). This pronouncement clarifies the criteria for concluding that an in substance repossession or foreclosure has occurred, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan.  The amendments also outline interim and annual disclosure requirements.  The amendments will be effective for the Company for interim and annual reporting periods beginning after December 15, 2014. Companies are allowed to use either a modified retrospective transition method or a prospective transition method when adopting this update.  Early adoption is permitted.  The Company does not expect these amendments to have a material effect on its financial statements.


FASB - From time to time, the FASB issues exposure drafts for 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 COB and monitors the status of changes to and proposed effective dates of exposure drafts. Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on our financial position, results of operations or cash flows.


2.   Goodwill and Other Intangible Assets


We accounted for the Merger as a business combination under the acquisition method of accounting.  As a result, we have recognized in our financial statements the identifiable net assets acquired and an amount of goodwill (representing the difference between the purchase price and the identifiable net assets).


Goodwill and other intangible assets deemed to have indefinite lives generated from purchased business combinations are not subject to amortization and are instead tested for impairment no less than annually.  Impairment exists when the carrying value of goodwill exceeds its implied fair value.  An impairment loss would be recognized in an amount equal to that excess and would be included in noninterest expense in the Consolidated Statements of Operations.  None of the goodwill recognized in the Merger is expected to be deductible for income tax purposes.


Our intangible assets with definite lives are core deposit premiums ("CDP") and mortgage servicing rights ("MSR"). CDPs are amortized over their useful lives to their estimated residual value and reviewed for impairment at least quarterly.  The amortization expense represents the estimated decline in the value of the underlying deposits. MSRs are amortized over the expected lives of the underlying mortgages including prepayment estimates.


3.   Investment Securities


Securities designated as available-for-sale are carried at fair value.  However, the unrealized difference between amortized cost and fair value of securities available-for-sale is excluded from net income unless there is an other than temporary impairment and is reported, net of deferred taxes, as a component of shareholders' equity as accumulated other comprehensive income (loss).  Securities designated as held-to-maturity are carried at amortized cost, as the Bank has the ability, and management has the positive intent, to hold these securities to maturity.  Premiums and discounts on securities are amortized and accreted according to the interest method.


Our primary objective in managing the investment portfolio is to maintain a portfolio of high quality, highly liquid investments yielding competitive returns.  We are required under federal regulations to maintain adequate liquidity to ensure safe and sound operations.  We maintain investment balances based on a continuing assessment of cash flows, the level of loan production, current interest rate risk strategies and an assessment of the potential future direction of market interest rate changes.  Investment securities differ in terms of default, interest rate, liquidity and expected rate of return risks.


7


---

Table of Contents


The following table summarizes the amortized cost and estimated fair value of investment securities and presents the related gross unrealized gains and losses:


June 30, 2014(dollars in thousands)Amortized CostGross Unrealized GainsGross Unrealized LossesEstimated Fair ValueAvailable-for-Sale:Obligations of:U.S. government sponsored enterprises$2,040$24$—$2,064Residential mortgage-backed securities-GSE347,9161,27812,298336,896Residential mortgage-backed securities-Private18,4041,104—19,508Commercial mortgage-backed securities-GSE22,573—52222,051Commercial mortgage-backed securities-Private10,387—24110,146Corporate notes8,39550—8,445Total available-for-sale$409,715$2,456$13,061$399,110Held-to-Maturity:Residential mortgage-backed securities-GSE136,987—4,589132,398Commercial mortgage-backed securities-Private10,068—1789,890Total held-to-maturity$147,055$—$4,767$142,288Total investment securities$556,770$2,456$17,828$541,398December 31, 2013(dollars in thousands)Amortized CostGross Unrealized GainsGross Unrealized LossesEstimated Fair ValueAvailable-for-Sale:Obligations of:U.S. government sponsored enterprises$2,051$26$—$2,077Residential mortgage-backed securities-GSE364,51397424,340341,147Residential mortgage-backed securities-Private19,770982—20,752Commercial mortgage-backed securities-GSE22,767—1,32821,439Commercial mortgage-backed securities-Private10,408—8239,585Business Development Company investment1,7539842,737Corporate notes16,79582—16,877Total available-for-sale$438,057$3,048$26,491$414,614Held-to-Maturity:Residential mortgage-backed securities-GSE141,724—9,907131,817Commercial mortgage-backed securities-Private10,071—7639,308Total held-to-maturity$151,795$—$10,670$141,125Total investment securities$589,852$3,048$37,161$555,739


As a member of the Federal Home Loan Bank of Atlanta (“FHLB”), the Bank is required to own capital stock in the FHLB based generally upon the balances of total assets and FHLB advances.  FHLB capital stock is pledged to secure FHLB advances.  This investment is carried at cost since no ready market exists for FHLB stock and there is no quoted market value.  However, redemption of this stock has historically been at par value.  The Bank owned a total of $5.1 million of FHLB stock at June 30, 2014 and $5.9 million at December 31, 2013 .  Due to the redemption provisions of FHLB stock, we have estimated that fair value approximated cost and that this investment was not impaired at June 30, 2014 .  FHLB stock is included in other assets at its original cost basis.


As a member bank of the Federal Reserve Bank of Richmond (“FRBR”), the Bank also is required to own capital stock of the FRBR based upon a percentage of the Bank's common stock and surplus.  This investment is carried at cost since no ready market exists for FRBR stock and there is no quoted market value.  At June 30, 2014 and December 31, 2013 , the Bank owned a total of $4.4 million and $4.3 million of FRBR stock, respectively.  Due to the nature of this investment in an entity of the U.S. government, we have


8


---

Table of Contents


estimated that fair value approximated the cost and that this investment was not impaired at June 30, 2014 .  FRBR stock is included in other assets at its original cost basis.


At June 30, 2014 , $98.2 million of the investment securities portfolio was pledged to secure public deposits, $17.9 million was pledged to retail repurchase agreements and $75.7 million was pledged to others, leaving $354.3 million available as lendable collateral.


During the three months and six months ended June 30, 2014, the Bank sold securities with a book value of $2.5 million and recognized a gain of $0.7 million . During the three months and six months ended June 30, 2013, the Bank sold securities with a book value of $25.7 million and $171.8 million , respectively, and recognized gross gains of $0.3 million and $2.9 million, respectively, and gross losses of $0 and $0.2 million, respectively. The Bank sold securities in 2014 after an SBIC Fund investment converted to a publicly traded equity.  The Bank sold securities in 2013 in order to manage our interest rate sensitivity profile.


The following tables show our investments' estimated fair value and gross unrealized losses, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, at June 30, 2014 and December 31, 2013 .  The change in unrealized losses during the six months ending June 30, 2014 was attributed to changes in interest rates and not to changes in the credit quality of these securities. All unrealized losses on investment securities are considered by management to be temporary given the credit quality of these investment securities or the short duration of the unrealized loss, or both.


Less than 12 Months12 Months or MoreTotal(dollars in thousands)Estimated Fair ValueGross Unrealized LossesEstimated Fair ValueGross Unrealized LossesEstimated Fair ValueGross Unrealized LossesJune 30, 2014Available-for-Sale:Residential mortgage-backed securities-GSE$14$—$300,334$12,298$300,348$12,298Commercial mortgage-backed securities-GSE——22,05252222,052522Commercial mortgage-backed securities-Private——10,14624110,146241Total available-for-sale$14$—$332,532$13,061$332,546$13,061Held-to-Maturity:Residential mortgage-backed securities-GSE$—$—$132,398$4,589$132,398$4,589Commercial mortgage-backed securities-Private——9,8901789,890178Total held-to-maturity$—$—$142,288$4,767$142,288$4,767Total$14$—$474,820$17,828$474,834$17,828December 31, 2013Available-for-SaleResidential mortgage-backed securities-GSE$222,475$16,585$76,501$7,755$298,976$24,340Commercial mortgage-backed securities-GSE——21,4391,32821,4391,328Commercial mortgage-backed securities-Private9,585823——9,585823Total available-for-sale$232,060$17,408$97,940$9,083$330,000$26,491Held-to-Maturity:Residential mortgage-backed securities-GSE$131,817$9,907$—$—$131,817$9,907Commercial mortgage-backed securities-Private9,308763——9,308763Total held-to-maturity$141,125$10,670$—$—$141,125$10,670Total$373,185$28,078$97,940$9,083$471,125$37,161


At June 30, 2014 and December 31, 2013, there were thirty-eight and ten available-for-sale securities that were in an unrealized loss position for 12 months or more, respectively.


9


---

Table of Contents


COB analyzed its securities portfolio at June 30, 2014, and considered ratings, fair value, cash flows and other factors to determine if any of the securities were other than temporarily impaired. Since none of the unrealized losses relate to the marketability of the securities or the issuer’s ability to honor redemption obligations, and COB has determined that it is not more likely than not that COB will be required to sell the security before recovery of its amortized cost basis, none of the securities are deemed to be other than temporarily impaired.





The aggregate amortized cost and fair value of securities at June 30, 2014 , by remaining contractual maturity, are shown in the following table.  Actual expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations.


Available-for-SaleHeld-to-Maturity(dollars in thousands)Amortized CostEstimated Fair ValueAmortized CostEstimated Fair ValueDue in one year or less$8,395$8,445$—$—Due after one year through five years2,0402,064——Total10,43510,509——Mortgage-backed securities399,280388,601147,055142,288Total$409,715$399,110$147,055$142,288





10


---

Table of Contents


4.   Loans and Allowance for Loan Losses


General


Loans held for investment are stated at the principal amounts outstanding adjusted for purchase premiums/discounts, deferred net loan fees and costs, and unearned income.  We report our loan portfolio by segments and classes, which are disaggregations of portfolio segments.  Our portfolio segments are:  Commercial and agricultural, Real estate, and Consumer loans.  The Commercial and agricultural loan and Consumer loan portfolios are not further segregated into classes.  The classes within the Real estate portfolio segment include Real estate - construction and Real estate - mortgage, which is further broken into 1-4 family residential mortgage and Commercial real estate mortgage loans.


Loan fees and the incremental direct costs associated with originating a loan are deferred and subsequently recognized over the life of the loan as an adjustment to interest income.


In addition to originating loans, we also purchase loans.  At acquisition, purchased loans are designated as either purchased contractual loans ("PC loans") or purchased impaired loans ("PI loans"). PC loans are acquired loans where management believes it is probable that it will receive all principal as of the date of acquisition.  These loans are accounted for under the contractual cash flow method, under ASC 310-20.  Any discount or premium paid on PC loans is recorded in interest income using the effective yield method over the expected life of the loans.


PI loans are acquired loans whose purchase price has been discounted, in part, due to credit deterioration occurring subsequent to origination.  Accordingly, management believes it is probable that all contractual principal and interest on these acquired loans will not be received.  PI loans are placed in homogeneous risk-based pools where accounting for projected cash flows is performed, as allowed under ASC 310-30.  Once a pool is established the individual loans within each pool do not change.  As management obtains new information related to changes in expected principal loss and expected cash flows, by pool, we record either an increase in yield when new expected cash flows increase, an allowance for loan losses when new expected cash flows decline, or a decrease in yield when there is only a timing difference in expected cash flows.


Loans acquired in the Merger ("Granite Purchased Loans") included PI loans and PC loans. Loans designated as PC loans included performing revolving consumer and performing revolving commercial loans on acquisition date.


The following table presents an aging analysis of accruing and nonaccruing loans as of June 30, 2014 :


(dollars in thousands)Accruing30-59 days past due60-89 days past dueMore than 90 days past dueNonaccrualTotal past due and nonaccrualCurrent and accruingTotal LoansPC and Originated LoansCommercial and agricultural$—$—$—$400$400$76,908$77,308Real estate - construction136——2,7732,90958,67861,587Real estate - mortgage:1-4 family residential3841,007769,00710,474630,002640,476Commercial8413320619,19219,615273,039292,654Consumer797—3111755,79955,916Total$683$1,147$282$31,403$33,515$1,094,426$1,127,941PI loansCommercial and agricultural$69$11$2,250$—$2,330$6,694$9,024Real estate - construction——4,203—4,2036,23410,437Real estate - mortgage:1-4 family residential289582,921—3,26816,26019,528Commercial2625413,252—13,53288,315101,847Consumer6213—211,0671,088Total$390$325$22,639$—$23,354$118,570$141,924Total Loans$1,073$1,472$22,921$31,403$56,869$1,212,996$1,269,865





11


---

Table of Contents


The following table presents an aging analysis of accruing and nonaccruing loans as of December 31, 2013 :


(dollars in thousands)Accruing30-59 days past due60-89 days past dueMore than 90 days past dueNonaccrualTotal past due and nonaccrualCurrent and accruingTotal LoansPC and Originated LoansCommercial and agricultural$18$43$—$516$577$60,946$61,523Real estate - construction168634—4,6775,47948,71154,190Real estate - mortgage:1-4 family residential3,454522—11,58015,556593,698609,254Commercial1,76577—18,38020,222261,524281,746Consumer5617—128543,79843,883Total$5,461$1,293$—$35,165$41,919$1,008,677$1,050,596PI loansCommercial and agricultural$35$16$1,977$—$2,028$8,701$10,729Real estate - construction48—2,758—2,8067,0879,893Real estate - mortgage:1-4 family residential13592,907—3,05123,80226,853Commercial903—17,479—18,38294,796113,178Consumer6—12—18981999Total$1,127$25$25,133$—$26,285$135,367$161,652Total Loans$6,588$1,318$25,133$35,165$68,204$1,144,044$1,212,248


All PI loans are considered to be accruing for all periods presented, in accordance with ASC 310-30.





Risk Grades





The risk-grade categories presented in the following table, which are standard categories used by the bank regulators, are:





Pass - Loans categorized as Pass are higher quality loans that have adequate sources of repayment and little risk of collection.





Special Mention - A Special Mention loan has potential weaknesses that deserve management's close attention.  If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution's credit position at some future date.  Special Mention loans are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.





Substandard - A Substandard loan is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any.  Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt.  They are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected.  Loss potential, while existing in the aggregate amount of Substandard loans, does not have to exist in individual assets classified Substandard.





Doubtful - A loan classified as Doubtful has all the weaknesses inherent in one classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.  The possibility of loss is extremely high, but because of certain important and reasonable specific pending factors, which may work to the advantage of strengthening of the asset, its classification as an estimated loss is deferred until its more exact status may be determined.  Pending factors include proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens on additional collateral and refinancing plans.


Loans categorized as Special Mention or worse are considered Criticized.  Loans categorized as Substandard or Doubtful are considered Classified.  Purchased loans acquired in the Merger are recorded at estimated fair value on the date of acquisition without the carryover of related ALL.  The table below includes $33.9 million and $40.5 million in Granite Purchased Loans categorized as Substandard or Doubtful at June 30, 2014 and December 31, 2013 , respectively.


12


---

Table of Contents


The following table presents loans held for investment balances by risk grade as of June 30, 2014 :


(dollars in thousands)PassSpecial MentionSubstandardDoubtful(Ratings 1-5)(Rating 6)(Rating 7)(Rating 8)TotalCommercial and agricultural$81,579$1,361$3,392$—$86,332Real estate - construction61,1252,9307,969—72,024Real estate - mortgage:1-4 family residential633,3358,34718,322—660,004Commercial316,32628,45149,724—394,501Consumer56,614196330857,004Total$1,148,979$41,108$79,470$308$1,269,865


The following table presents loans held for investment balances by risk grade as of December 31, 2013 :


(dollars in thousands)PassSpecial MentionSubstandardDoubtful(Ratings 1-5)(Rating 6)(Rating 7)(Rating 8)TotalCommercial and agricultural$67,277$1,262$3,713$—$72,252Real estate - construction50,1383,9849,961—64,083Real estate - mortgage:1-4 family residential601,30410,88723,916—636,107Commercial307,66129,71157,552—394,924Consumer44,450404734544,882Total$1,070,830$45,884$95,189$345$1,212,248


Loans included in the preceding loan composition table are net of participations sold.  Loans are increased by net loan premiums and deferred loan discounts or fees of $3.5 million at June 30, 2014 .  Loans are increased by net deferred loan discounts or fees of $3.6 million at December 31, 2013 .


At June 30, 2014 and December 31, 2013, loans held for sale consisted of originated residential mortgage loans held for sale carried at the lower of cost or fair market value.


Loans serviced for others are not included in the consolidated balance sheet.  The unpaid principal balance of loans serviced for others amounted to $212.6 million at June 30, 2014 and $190.2 million at December 31, 2013 .


Loans Pledged


To borrow from the FHLB, members must pledge collateral to secure advances and letters of credit.  Acceptable collateral includes, among other types of collateral, a variety of residential, multifamily, home equity lines and second mortgages, and commercial loans.  Gross loans of $137.8 million and $23.7 million of investment securities, and gross loans of $169.5 million and $24.1 million of investment securities, were pledged to collateralize FHLB advances and letters of credit at June 30, 2014 and December 31, 2013 , respectively, of which there was $38.1 million and $31.8 million of credit availability for borrowing, respectively. At June 30, 2014 , $7.7 million of loans and $50.0 million of securities were pledged to collateralize potential borrowings from the Federal Reserve Discount Window, of which $53.4 million was available as borrowing capacity.  We could also access $288.9 million of additional borrowings from the FHLB under credit lines by pledging additional collateral.


Nonaccruing and Impaired Loans


Interest income on loans is calculated by using the interest method based on the daily outstanding balance.  The recognition of interest income is discontinued when, in management's opinion, the collection of all or a portion of interest becomes doubtful.  Loans are returned to accrual status when the factors indicating doubtful collectability cease to exist and the loan has performed in accordance with its terms for a demonstrated period of time.  The past due status of loans is based on the contractual payment terms.  Had nonaccruing loans been on accruing status, interest income would have been higher by $0.9 million and $0.8 million for the three months ended June 30, 2014 and June 30, 2013 , respectively. At June 30, 2014 and December 31, 2013 , COB had certain impaired loans of $31.7 million and $35.2 million , respectively, which were on nonaccruing interest status.


13


---

Table of Contents


All loan classes are considered past due when the contractual amounts due with respect to principal and interest are not received within 30 days of the contractual due date.  When we cannot reasonably expect full and timely repayment of a loan, the loan is placed on nonaccrual.


All loan classes on which principal or interest is in default for 90 days or more are put on nonaccrual status, unless there is sufficient documentation to conclude that the loan is well secured and in the process of collection.  A debt is "well-secured" if collateralized by liens on or pledges of real or personal property, including securities, which have a realizable value sufficient to discharge the debt in full, or by the guarantee of a financially responsible party.  A debt is "in process of collection" if collection is proceeding in due course either through legal action, including judgment enforcement procedures, or, in appropriate circumstances, through collection efforts not involving legal action that are reasonably expected to result in repayment of the debt or its restoration to a current status.


Loans that are less than 90 days delinquent may also be placed on nonaccrual if deterioration in the financial condition of the borrower has increased the probability of less than full repayment.


At the time a loan is placed on nonaccrual, all accrued, unpaid interest is charged off, unless it is documented that repayment of all principal and presently accrued but unpaid interest is probable.  Charge-offs of accrued and unpaid interest are charged against the current year's interest income and not against the current ALL.


For all loan classes, a nonaccrual loan may be returned to accrual status when we can reasonably expect continued timely payments until payment in full.  All prior arrearage does not have to be eliminated, nor do all previously charged off amounts need to have been recovered, but the loan can still be returned to accrual status if the following conditions are met:  (1) all principal and interest amounts contractually due (including arrearage) are reasonably assured of repayment within a reasonable period; and (2) there is a sustained period of repayment performance (generally a minimum of six months) by the borrower, in accordance with the contractual terms involving payments of cash or cash equivalents.


For all classes within all loan portfolios, cash receipts received on nonaccrual loans are applied entirely against principal until the loan or lease has been collected in full, after which time any additional cash receipts are recognized as interest income.


For all loan classes, as soon as any portion of a loan becomes uncollectible, the loan will be charged down or charged off as follows:


|  |                                                    
|- | ---------------------------------------------------
|• | If unsecured, the loan must be charged off in full.

|  |                                                                                                                                 
|- | --------------------------------------------------------------------------------------------------------------------------------
|• | If secured, the outstanding principal balance of the loan should be charged down to the net liquidation value of the collateral.

Loans are considered uncollectible when:


|  |                                                                                                                                       
|- | --------------------------------------------------------------------------------------------------------------------------------------
|• | No regularly scheduled payment has been made within four months and the determination is made that any further payment is unlikely, or

|  |                                                                                                                                                                              
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | The loan is unsecured, the borrower has filed for bankruptcy protection and there is no other (guarantor, etc.) support from an entity outside of the bankruptcy proceedings.

Based on a variety of credit, collateral and documentation issues, loans with lesser degrees of delinquency or obvious loss may also be deemed uncollectible.


A loan is considered impaired, based on current information and events, if it is probable that we will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. If the loan has been modified to provide relief to the borrower, the loan is deemed to be impaired if all principal and interest will not be repaid according to the original contract.


When a loan has been determined to be impaired, the amount of the impairment is measured using the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, the observable market price of the loan, or the fair value of the collateral if the loan is collateral dependent.  When the present value of expected future cash flows is used, the effective interest rate is the original contractual interest rate of the loan adjusted for any premium or discount.  When the contractual interest rate is variable, the effective interest rate of the loan changes over time.  A specific reserve is established as a component of the ALL when a loan has been determined to be impaired.  Subsequent to the initial measurement of impairment, if there is a significant change to the impaired loan's expected future cash flows, or if actual cash flows are significantly different from the cash flows previously estimated, we recalculate the impairment and appropriately adjust the specific reserve.  Similarly, if we measure impairment based on the observable market price of an impaired loan or the fair value of the collateral of an impaired collateral-dependent loan, we will adjust the specific reserve if there is a significant change in either of those bases.


When a loan is impaired and principal and interest is in doubt when contractually due, interest income is not recognized.  Cash receipts received on nonaccruing impaired loans within any class are generally applied entirely against principal until the loan has


14


---

Table of Contents


been collected in full, after which time any additional cash receipts are recognized as interest income.  Cash receipts received on accruing impaired loans within any class are applied in the same manner as accruing loans that are not considered impaired.


The following table summarizes information relative to impaired loans for the dates indicated:


June 30, 2014December 31, 2013(dollars in thousands)Recorded InvestmentAssociated ReservesRecorded InvestmentAssociated ReservesImpaired loans, not individually reviewed for impairment$4,750$—$4,612$—Impaired loans, individually reviewed, with no impairment29,890—39,865—Impaired loans, individually reviewed, with impairment9,6938552,965927Total impaired loans, excluding purchased impaired *$44,333$855$47,442$927Purchased impaired loans with subsequent deterioration$141,9244,123$161,3075,560Purchased impaired loans with no subsequent deterioration$——$345—Total Reserves$4,978$6,487Average impaired loans calculated using a simple average$45,888$65,527
 * Included at June 30, 2014 and December 31, 2013 were $12.9 million and $12.1 million, respectively, in restructured and performing loans.


The following table presents loans held for investment on nonaccrual status by loan class for the dates indicated:


(dollars in thousands)June 30, 2014December 31, 2013Loans held for investment:Commercial and agricultural$400$516Real estate - construction2,7734,677Real estate - mortgage:1-4 family residential9,00711,580Commercial19,19218,380Consumer3112Total nonaccrual loans$31,403$35,165Loans more than 90 days delinquent, still on accrual282—Total nonperforming loans$31,685$35,165


There were no loans held for sale on nonaccrual status as of June 30, 2014 or December 31, 2013.





15


---

Table of Contents


The following table presents individually reviewed impaired loans and purchased impaired loans with subsequent credit deterioration, segregated by portfolio segment, and the corresponding reserve for impaired loan losses as of June 30, 2014 :


Unpaid(dollars in thousands)RecordedPrincipalRelatedInvestmentBalanceAllowanceWith no related allowance recorded:Commercial and agricultural$242$485$—Real estate - construction2,1792,736—Real estate - mortgage:1-4 family residential8,22010,940—Commercial19,24924,655—Consumer———Total$29,890$38,816$—With an allowance recorded:Commercial and agricultural$—$—$—Real estate - construction547643280Real estate - mortgage:1-4 family residential3,6984,020452Commercial5,4485,792123Consumer———Total$9,693$10,455$855Total individually evaluated impaired loansCommercial and agricultural$242$485$—Real estate - construction2,7263,379280Real estate - mortgage:1-4 family residential11,91814,960452Commercial24,69730,447123Consumer———Total$39,583$49,271$855PI loans with subsequent credit deterioration:Commercial and agricultural$9,024$7,823$581Real estate - construction10,43711,521729Real estate - mortgage:1-4 family residential19,52821,076411Commercial101,847109,2892,212Consumer1,088712190Total$141,924$150,421$4,123


16


---

Table of Contents


The following table presents individually reviewed impaired loans, and purchased impaired loans with subsequent credit deterioration, segregated by portfolio segment, and the corresponding reserve for impaired loan losses as of December 31, 2013 :


Unpaid(dollars in thousands)RecordedPrincipalRelatedInvestmentBalanceAllowanceWith no related allowance recorded:Commercial and agricultural$398$643$—Real estate - construction4,7348,893—Real estate - mortgage:1-4 family residential11,15414,431—Commercial23,57928,905—Consumer———Total$39,865$52,872$—With an allowance recorded:Commercial and agricultural$—$—$—Real estate - construction———Real estate - mortgage:1-4 family residential2,9653,032927Commercial———Consumer———Total$2,965$3,032$927Total individually evaluated impaired loansCommercial and agricultural$398$643$—Real estate - construction4,7348,893—Real estate - mortgage:1-4 family residential14,11917,463927Commercial23,57928,905—Consumer———Total$42,830$55,904$927PI loans with subsequent credit deterioration:Commercial and agricultural$10,729$10,344$382Real estate - construction9,79211,2161,015Real estate - mortgage:1-4 family residential26,62828,143724Commercial113,178121,8133,251Consumer980785188Total$161,307$172,301$5,560








17


---

Table of Contents


The following summary includes impaired loans individually reviewed.  Average recorded investment and interest income recognized on impaired loans, segregated by portfolio segment, is shown in the following tables as of June 30, 2014 and June 30, 2013 :


For Three Months EndedFor Three Months EndedJune 30, 2014June 30, 2013AverageInterestAverageInterest(dollars in thousands)RecordedIncomeRecordedIncomeInvestmentRecognizedInvestmentRecognizedWith no related allowance recorded:Commercial and agricultural$242$—$1,398$1Real estate - construction2,19179,513—Real estate - mortgage:1-4 family residential8,2632312,6629Commercial19,6863330,46625Consumer————Total$30,382$63$54,039$35With an allowance recorded:Commercial and agricultural$—$—$107$—Real estate - construction583—2193Real estate - mortgage:1-4 family residential3,706141,6621Commercial5,474333,912—Consumer——164—Total$9,763$47$6,064$4Total:Commercial and agricultural$242$—$1,505$1Real estate - construction2,77479,7323Real estate - mortgage:1-4 family residential11,9693714,32410Commercial25,1606634,37825Consumer——164—Total$40,145$110$60,103$39


18


---

Table of Contents


For Six Months EndedFor Six Months EndedJune 30, 2014June 30, 2013AverageInterestAverageInterest(dollars in thousands)RecordedIncomeRecordedIncomeInvestmentRecognizedInvestmentRecognizedWith no related allowance recorded:Commercial and agricultural$242$—$1,414$8Real estate - construction2,209189,705—Real estate - mortgage:1-4 family residential8,2505112,64333Commercial20,00413731,042144Consumer————Total$30,705$206$54,804$185With an allowance recorded:Commercial and agricultural$—$—$107$—Real estate - construction594—2206Real estate - mortgage:1-4 family residential3,722321,6824Commercial5,504913,933—Consumer——1671Total$9,820$123$6,109$11Total:Commercial and agricultural$242$—$1,521$8Real estate - construction2,803189,9256Real estate - mortgage:1-4 family residential11,9728314,32537Commercial25,50822834,975144Consumer——1671Total$40,525$329$60,913$196


Impaired loans also include loans for which we may elect to grant a concession, providing terms more favorable than those prevalent in the market (e.g., rate, amortization term), and formally restructure due to the weakening credit status of a borrower.  Restructuring is designed to facilitate a repayment plan that minimizes the potential losses that we otherwise may have to incur.  If these impaired loans are on nonaccruing status as of the date of restructuring, the loans are included in nonperforming loans.  Nonperforming restructured loans will remain as nonperforming until the borrower can demonstrate adherence to the restructured terms for a period of no less than six months and when it is otherwise determined that continued adherence is reasonably assured.  Some restructured loans continue as accruing loans after restructuring if the borrower is not past due at the time of restructuring, adequate collateral valuations support the restructured loans, and the cash flows of the underlying business appear adequate to support the restructured debt service.  Not included in nonperforming loans are loans that have been restructured that were performing as of the restructure date.  At June 30, 2014 , there was $17.8 million in restructured loans, of which $12.9 million were accruing and in a performing status.  At December 31, 2013 , there was $18.1 million in restructured loans, of which $12.1 million were accruing and in a performing status.





19


---

Table of Contents


Granite Purchased Loans


Granite Purchased Loans include PI loans and PC loans.  PC loans include performing revolving consumer and commercial loans.


PI loans are segregated into pools and recorded at estimated fair value on the date of acquisition without the carryover of the related ALL.  PI loans are accounted for under ASC 310-30 when the loans have evidence of credit deterioration since origination and it is probable at the date of acquisition we will not collect all contractually required principal and interest payments.  Evidence of credit quality deterioration as of the date of acquisition may include statistics such as past due status, nonaccrual status and risk grade.  PI loans generally meet our definition for nonaccrual status; however, even if the borrower is not currently making payments, we will classify loans as accruing if we can reasonably estimate the amount and timing of future cash flows.  All Granite Purchased PI loans are presented on an accruing basis. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the nonaccretable difference.


Periodically, we estimate the expected cash flows for each pool of the PI loans and evaluate whether the expected cash flows for each pool have changed from prior estimates.  Decreases to the expected cash flows will generally result in a provision for loan losses.  Subsequent increases in cash flows result in a reversal of the provision for loan losses to the extent of prior charges, or reclassification from nonaccretable difference to accretable yield with a positive impact on future interest income.  Excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized into interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows.


We have elected to account for the Granite Purchased PI loans under ASC 310-30 and the Granite Purchased PC loans under ASC 310-20.


At June 30, 2014 , and December 31, 2013, our financial statements reflected a PI loan ALL of $4.1 million and $5.6 million , respectively, and an ALL for PC loans of $0.3 million and $0.3 million , respectively.





The following table presents the balance of all Granite Purchased Loans:


At June 30, 2014(dollars in thousands)Purchased ImpairedPurchased ContractualTotal Purchased LoansUnpaidPrincipalBalanceCommercial and agricultural$9,024$3,727$12,751$11,627Real estate - construction10,437—10,43711,521Real estate - mortgage:1-4 family residential19,52824,23243,76046,072Commercial101,84711101,858109,300Consumer1,088—1,088712Total$141,924$27,970$169,894$179,232


At December 31, 2013(dollars in thousands)Purchased ImpairedPurchased ContractualTotalPurchased LoansUnpaidPrincipalBalanceCommercial and agricultural$10,729$5,948$16,677$16,452Real estate - construction9,893—9,89311,368Real estate - mortgage:1-4 family residential26,85322,12748,98051,359Commercial113,178373113,551122,197Consumer999—999798Total$161,652$28,448$190,100$202,174


20


---

Table of Contents


The tables below include only those Granite Purchased Loans accounted for under the expected cash flow method (PI loans) for the periods indicated.  These tables do not include PC loans, including Granite Purchased PC loans or purchased performing residential mortgage loans.


For Three Months EndedFor Three Months EndedJune 30, 2014June 30, 2013Purchased ImpairedPurchased Impaired(dollars in thousands)Carrying AmountFutureAccretionCarrying AmountFuture AccretionBalance, beginning of period$149,033$28,327$205,884$26,096Accretion2,415(2,415)4,191(4,191)Increase in future accretion—1,852—6,801Payments received(9,524)—(20,403)—Foreclosed and transferred to OREO——(513)—Subtotal before allowance141,92427,764189,15928,706Allowance for credit losses(4,123)—(4,066)—Net carrying amount, end of period$137,801$27,764$185,093$28,706
 For Six Months EndedFor Six Months EndedJune 30, 2014June 30, 2013Purchased ImpairedPurchased Impaired(dollars in thousands)Carrying AmountFutureAccretionCarrying AmountFuture AccretionBalance, beginning of period$161,652$29,987$228,392$30,299Accretion5,079(5,079)8,394(8,394)Increase in future accretion—2,856—6,801Reclassification of loans and adjustments(4,180)———Payments received(20,605)—(46,331)—Foreclosed and transferred to OREO(22)—(1,296)—Subtotal before allowance141,92427,764189,15928,706Allowance for credit losses(4,123)—(4,066)—Net carrying amount, end of period$137,801$27,764$185,093$28,706


Allowance for Loan Losses


COB's ALL, which is utilized to absorb actual losses in the loan portfolio, is maintained at a level consistent with management's best estimate of probable loan losses to be incurred as of the balance sheet date.  Management assesses COB's ALL quarterly.  This assessment includes a methodology that separates the total loan portfolio into homogeneous loan classifications for purposes of evaluating risk.  The required allowance is calculated by applying a risk adjusted reserve requirement to the dollar volume of loans within a homogenous group.  For purposes of the ALL, we have grouped our loans into pools according to the loan segmentation regime employed on schedule RC-C of the FFIEC's Consolidated Reports of Condition and Income.  Major loan portfolio subgroups include: risk graded commercial loans, mortgage loans, home equity loans, retail loans and retail credit lines.  Management also analyzes the loan portfolio on an ongoing basis to evaluate current risk levels, and risk grades are adjusted accordingly.  While management uses the best information available to make evaluations, future adjustments may be necessary, if economic or other conditions differ substantially from the assumptions used.


Historical loss rates are calculated by associating losses to the risk-graded pool to which they relate for each of the previous eight quarters. Then, using a look back period consisting of the twenty most recent quarters, loss factors are calculated for each risk-graded pool using a simple average. This represents a change in methodology which began in the third quarter of 2013. Previously, we used a look back period beginning in the third quarter of 2006 and a weighted average of losses. The impact of this change was immaterial to the allowance calculation in the period we adopted the methodology change.





21


---

Table of Contents


In addition to our ability to use our own historical loss data and migration between risk grades, we have a rigorous process for computing the qualitative factors that impact the ALL.  A committee, independent of the historical loss migration team, reviews risk factors that may impact the ALL.  Some factors are statistically quantifiable, such as concentration, growth, delinquency, and nonaccrual risk by loan type, while other factors are qualitative in nature, such as staff competency, competition within our markets and economic and regulatory changes impacting the loans held for investment.





We lend primarily in North Carolina.  As of June 30, 2014 , a majority of the principal amount of the loans held for investment in our portfolio was to businesses and individuals in North Carolina.  This geographic concentration subjects the loan portfolio to the general economic conditions within this area.  The risks created by this concentration have been considered by management in the determination of the adequacy of the ALL.  Management believes the ALL is adequate to cover estimated losses on loans at each balance sheet date.





During the three month period ended June 30, 2014 , we charged off $2.0 million in loans and realized $1.7 million in recoveries, for $0.4 million of net charge-offs.





The ALL, as a percentage of loans held for investment, was 1.89% at June 30, 2014 , compared to 2.11% at June 30, 2013 .  At December 31, 2013 , the ALL, as a percentage of loans held for investment, was 2.21% .





An analysis of the changes in the ALL is as follows:


For Three Months EndedFor Six Months Ended(dollars in thousands)June 30, 2014June 30, 2013June 30, 2014June 30, 2013Balance, beginning of period$26,039$29,641$26,785$29,314Recovery of losses charged to continuing operations(1,685)(1,057)(2,369)(947)Net recoveries (charge-offs):Charge-offs(2,033)(6,102)(4,010)(9,113)Recoveries1,6542,6033,5695,831Net charge-offs(379)(3,499)(441)(3,282)Balance, end of period$23,975$25,085$23,975$25,085Annualized net charge-offs during the period to average loans held for investment0.12%1.26%0.07%0.59%Annualized net charge-offs during the period to ALL6.34%55.79%3.71%26.17%Allowance for loan losses to loans held for investment1.89%2.11%1.89%2.11%


The following table presents ALL activity by portfolio segment for the three months ended June 30, 2014 :


Real Estate - Mortgage(dollars in thousands)Commercial and AgriculturalReal Estate - Construction1-4 Family ResidentialCommercialConsumerTotalALL:Beginning balance April 1, 2014$3,441$5,308$7,923$6,966$2,401$26,039Charge-offs(621)(91)(151)(730)(440)(2,033)Recoveries2623632635272391,654Provision (recovery of provision)426(802)(625)(1,097)413(1,685)Ending balance June 30, 2014$3,508$4,778$7,410$5,666$2,613$23,975





22


---

Table of Contents


The following table presents ALL activity by portfolio segment for the three months ended June 30, 2013 :


Real Estate - Mortgage(dollars in thousands)Commercial and AgriculturalReal Estate - Construction1-4 Family ResidentialCommercialConsumerTotalALL:Beginning balance April 1, 2013$3,373$5,594$8,803$9,291$2,580$29,641Charge-offs(875)(584)(2,537)(1,371)(735)(6,102)Recoveries6332714921,0751322,603Provision (recovery of provision)(939)371642(1,608)477(1,057)Ending balance June 30, 2013$2,192$5,652$7,400$7,387$2,454$25,085





The following table presents ALL activity by portfolio segment for the six months ended June 30, 2014:


Real Estate - Mortgage(dollars in thousands)Commercial and AgriculturalReal Estate - Construction1-4 Family ResidentialCommercialConsumerTotalALL:Beginning balance at January 1, 2014$2,931$5,233$8,869$7,195$2,557$26,785Charge-offs(1,010)(624)(635)(796)(945)(4,010)Recoveries6541,3274985934973,569Provision (recovery of provision)933(1,158)(1,322)(1,326)504(2,369)Ending balance at June 30, 2014$3,508$4,778$7,410$5,666$2,613$23,975





The following table presents ALL activity by portfolio segment for the six months ended June 30, 2013 :


Real Estate - Mortgage(dollars in thousands)Commercial and AgriculturalReal Estate - Construction1-4 Family ResidentialCommercialConsumerTotalALL:Beginning balance at January 1, 2013$3,238$4,987$8,701$9,627$2,761$29,314Charge-offs(1,194)(928)(3,169)(2,262)(1,560)(9,113)Recoveries9111,0676772,0071,1695,831Provision (recovery of provision)(763)5261,191(1,985)84(947)Ending balance at June 30, 2013$2,192$5,652$7,400$7,387$2,454$25,085





23


---

Table of Contents


The following table details the recorded investment in loans related to each segment in the allowance for loan losses by portfolio segment and disaggregated on the basis of impairment evaluation methodology at June 30, 2014 :


Real Estate - Mortgage(dollars in thousands)Commercial and AgriculturalReal Estate - Construction1-4 Family ResidentialCommercialConsumerTotalALL:Individually evaluated for impairment$—$280$452$123$—$855Collectively evaluated for impairment2,9273,7696,5473,3312,42318,997PI loans evaluated for credit impairment5817294112,2121904,123Total ALL$3,508$4,778$7,410$5,666$2,613$23,975Loans held for investmentIndividually evaluated for impairment$242$2,726$11,929$24,698$—$39,595Collectively evaluated for impairment77,06658,861628,547267,95655,9161,088,346PI loans with subsequent credit deterioration9,02410,43719,528101,8471,088141,924Total loans$86,332$72,024$660,004$394,501$57,004$1,269,865


The following table details the recorded investment in loans related to each segment in the allowance for loan losses by portfolio segment and disaggregated on the basis of impairment evaluation methodology at December 31, 2013 :


Real Estate - Mortgage(dollars in thousands)Commercial and AgriculturalReal Estate - Construction1-4 Family ResidentialCommercialConsumerTotalALL:Individually evaluated for impairment$—$—$927$—$—$927Collectively evaluated for impairment2,5494,2187,2183,9442,36920,298PI loans evaluated for credit impairment3821,0157243,2511885,560PI loans with no credit deterioration——————Total ALL$2,931$5,233$8,869$7,195$2,557$26,785Loans held for investmentIndividually evaluated for impairment$398$4,734$14,119$23,579$—$42,830Collectively evaluated for impairment61,12549,456595,135258,16743,8831,007,766PI loans with subsequent credit deterioration10,7299,79226,628113,178980161,307PI loans with no credit deterioration—101225—19345Total loans$72,252$64,083$636,107$394,924$44,882$1,212,248


24


---

Table of Contents


Troubled Debt Restructuring


The following tables present a breakdown of troubled debt restructurings that were restructured during the three months and six months ended June 30, 2014 and June 30, 2013, respectively, segregated by portfolio segment:


For Three Months Ended June 30, 2014For Three Months Ended June 30, 2013Pre-ModificationPost-ModificationPre-ModificationPost-ModificationOutstandingOutstandingOutstandingOutstanding(dollars in thousands)NumberRecordedRecordedNumberRecordedRecordedof LoansInvestmentInvestmentof LoansInvestmentInvestmentCommercial and agricultural—$—$——$—$—Real estate - construction———1114114Real estate - mortgage:1-4 family residential117214915894Commercial———1460421Consumer——————Total1$17$216$1,489$1,429


For Six Months Ended June 30, 2014For Six Months Ended June 30, 2013Pre-ModificationPost-ModificationPre-ModificationPost-ModificationOutstandingOutstandingOutstandingOutstanding(dollars in thousands)NumberRecordedRecordedNumberRecordedRecordedof LoansInvestmentInvestmentof LoansInvestmentInvestmentCommercial and agricultural—$—$——$—$—Real estate - construction———1114114Real estate - mortgage:1-4 family residential775282882,6922,667Commercial———21,6111,228Consumer——————Total7$752$82811$4,417$4,009


During the six months ended June 30, 2014, we modified seven loans that were considered to be troubled debt restructurings.  We extended the terms for two of these loans and both extended the terms and modified the interest rate for the five remaining loans. During the six months ended June 30, 2013, we modified eleven loans that were considered to be troubled debt restructurings.  We extended the terms for two of these loans, modified the interest rate for one of these loans, and modified the remaining eight loans in both ways.


There were no loans restructured in the twelve months prior to June 30, 2014 that went into default during the six months ended June 30, 2014 . There were also no loans restructured in the twelve months prior to June 30, 2013 that went into default during the six months ended June 30, 2013 .


In the determination of the ALL, management considers troubled debt restructurings and any subsequent defaults in these restructurings as impaired loans.  The amount of the impairment is measured using the present value of expected future cash flows discounted at the loan's effective interest rate, the observable market price of the loan, or the fair value of the collateral if the loan is collateral dependent.


Unfunded Commitments


The reserve for unfunded commitments, which is included in other liabilities, is calculated by estimating the amount of additional


funding on the commitment and multiplying that amount by the historical loss rate (including Q&E factors). The following


describes our method for determining the estimated additional funding by commitment type:





|  |                                                                                 
|- | --------------------------------------------------------------------------------
|• | Straight Lines of Credit - Unfunded balance of line of credit (100% utilization)

|  |                                                                                                  
|- | -------------------------------------------------------------------------------------------------
|• | Revolving Lines of Credit - Average Utilization (for the last 12 months) less Current Utilization

|  |                                  
|- | ---------------------------------
|• | Letters of Credit -10%utilization

The reserve for unfunded commitments was $0.8 million as of June 30, 2014 and $0.5 million at December 31, 2013 .


25


---

Table of Contents


5.   Other Real Estate Owned and Property Acquired in Settlement of Loans


OREO consists of real estate acquired through foreclosure or deed in lieu thereof.  The property is classified as held for sale.  The property is initially carried at fair value based on recent appraisals, less estimated costs to sell.  Declines in the fair value of properties included in other real estate below carrying value are recognized by a charge to income.


Total OREO and property acquired in settlement of loans decreased $6.5 million during the first six months of 2014 from $28.4 million at December 31, 2013 , to $21.9 million at June 30, 2014 . This represents 41% of total nonperforming assets.  At December 31, 2013 , OREO and property acquired in settlement of loans represented 45% of total nonperforming assets.


The following table summarizes OREO and property acquired in settlement of loans at the periods indicated:


(dollars in thousands)June 30, 2014December 31, 2013Real estate acquired in settlement of loans$21,742$28,353Property acquired in settlement of loans12942Total property acquired in settlement of loans$21,871$28,395


The following tables summarize the changes in real estate acquired in settlement of loans at the periods indicated:


For Three Months Ended(dollars in thousands)June 30, 2014June 30, 2013Real estate acquired in settlement of loans, beginning of period$24,573$46,307Plus:  New real estate acquired in settlement of loans9832,824Less:  Sales of real estate acquired in settlement of loans(3,154)(10,422)Less:  Write-downs and net gain (loss) on sales charged to expense(660)(3,047)Real estate acquired in settlement of loans, end of period$21,742$35,662


For Six Months Ended(dollars in thousands)June 30, 2014June 30, 2013Real estate acquired in settlement of loans, beginning of period$28,353$62,796Plus:  New real estate acquired in settlement of loans1,2516,793Less:  Sales of real estate acquired in settlement of loans(6,928)(30,661)Less:  Write-downs and net loss on sales charged to expense(934)(3,266)Real estate acquired in settlement of loans, end of period$21,742$35,662


At June 30, 2014 , 18 assets with a net carrying amount of $4.3 million were under contract for sale.  Estimated losses on these sales have been recognized in the Consolidated Statements of Operations in the first six months of 2014 .


6.   Earnings Per Share


Basic net earnings (loss) per share, or basic earnings (loss) per share (“EPS”), is computed by dividing net loss to common shareholders by the weighted average number of common shares outstanding for the period.


Diluted EPS reflects the potential dilution that could occur if COB's potential common stock, which consists of dilutive stock options and a common stock warrant, were issued.  As required for entities with complex capital structures, a dual presentation of basic and diluted EPS is included on the face of the income statement, and a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation is provided in this note.


26


---

Table of Contents


(dollars in thousands, except per share data)For Three Months EndedFor Six Months EndedJune 30, 2014June 30, 2013June 30, 2014June 30, 2013Net income (loss)$2,792$(3,183)$4,069$(7,779)Weighted average number of shares outstanding - basic21,888,77221,729,32921,912,08421,713,808Weighted average number of shares outstanding - diluted21,899,99421,729,32921,925,79821,713,808Net income (loss) per share - basic and diluted$0.13$(0.15)$0.19$(0.36)


During the three and six months ended June 30, 2014, the price of the Company's common stock (as quoted on the Nasdaq Capital Market) was above the exercise price of 50,688 vested stock options, but below the price of the common stock warrant. As a result, the warrant was considered antidilutive and thus is not included in the diluted share calculation.  During the three and six months ended June 30, 2013 the price of the Company's common stock was below the exercise price of all vested stock options and the common stock warrant. In addition, as a result of the net loss for the three and six months ended June 30, 2013, all stock options and the common stock warrant were considered antidilutive and thus are not included in this calculation.  As a result, the options and warrants were considered antidilutive and thus are not included in the diluted share calculation.  For the three and six months ended June 30, 2014, there were 22,072 antidilutive shares. For the three months and six months ended June 30, 2013, there were 66,627 and 44,771 antidilutive shares, respectively. Of the antidilutive shares, the number of shares relating to stock options were 44,555 for the three months ended June 30, 2013 and 22,699 for the six months ended June 30, 2013, while the number relating to the warrant was 22,072 for all periods presented.


7.   Derivatives and Financial Instruments


A derivative is a financial instrument that derives its cash flows, and therefore its value, by reference to an underlying instrument, index or referenced interest rate.  These instruments include interest rate swaps, caps, floors, collars, options or other financial instruments designed to hedge exposures to interest rate risk or for speculative purposes.


Accounting guidance requires an entity to recognize all derivatives as either assets or liabilities in the balance sheet, and measure those instruments at fair value.  Changes in the fair value of those derivatives are reported in current earnings or other comprehensive income depending on the purpose for which the derivative is held and whether the derivative qualifies for hedge accounting.


In connection with its asset / liability management objectives, the Company during the first quarter of 2014 entered into two interest rate swaps on $40 million of FHLB advances, each swap having a $20 million notional amount, that convert the floating rate cash flow exposure on the FHLB a dvances to a fixed rate cash flow. As structured, the receive-variable, pay-fixed swaps were evaluated as being cash flow hedges that have remained highly effective since inception through the quarter ending June 30, 2014. The differences in cash flows in each period between the fixed rate interest payments that the Company makes and the variable rate interest payments received is currently reported in earnings. These interest rate swaps mature on June 15, 2020.


Mortgage banking derivatives used in the ordinary course of business consist of mandatory forward sales contracts or forward contracts and rate lock loan commitments.  The fair value of our derivative instruments is primarily measured by obtaining pricing from broker-dealers recognized to be market participants.


We have established guidelines in originating, selling loans to Fannie Mae, and retaining or selling the loan servicing rights.  The commitments to borrowers to originate residential mortgage loans and the forward sales commitments to investors are freestanding derivative instruments. As such, they do not qualify for hedge accounting treatment, and the fair value adjustments for these instruments is recorded through the Consolidated Statements of Operations in mortgage loan income. The fair market value of mortgage banking derivatives is recorded in the consolidated balance sheet in Other Assets.


27


---

Table of Contents


Gain (Loss) Recognized(dollars in thousands)For Three Months EndedFor Six Months EndedJune 30, 2014June 30, 2013June 30, 2014June 30, 2013Derivatives designated as hedging instruments:Interest rate swap contracts - FHLB advances$—$—$—$—Derivatives not designated as hedging instruments:Mortgage loan rate lock commitments$1$(19)$3$(11)Mortgage loan forward sales18(15)18(93)Total$19$(34)$21$(104)





8.   Fair Values of Assets and Liabilities


We use fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures.  Securities available-for-sale, derivative assets and liabilities, performing mortgage loans held for sale, and mortgage servicing rights are recorded at fair value on a recurring basis.  Additionally, from time-to-time, we may be required to record at fair value other assets and liabilities on a nonrecurring basis, such as loans held for investment, impaired loans and certain other assets and liabilities.  These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets or liabilities.


Fair Value Hierarchy


We group assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.  These levels are:


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


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


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


The following is a description of valuation methodologies used for assets and liabilities recorded at fair value:


Investments Securities Available-for-Sale


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


Liquidity is a significant factor in the determination of the fair values of available-for-sale debt securities.  Market price quotes may not be readily available for some positions, or positions within a market sector where trading activity has slowed significantly or ceased.  Some of these instruments are valued using a discounted cash flow model, which estimates the fair value of the securities using internal credit risk, interest rate and prepayment risk models that incorporate management's best estimate of current key assumptions such as default rates, loss severity and prepayment rates.  Principal and interest cash flows are discounted using an observable discount rate for similar instruments with adjustments that management believes a market participant would consider in determining fair value for the specific security.  Underlying assets are valued using external pricing services, where available, or matrix pricing based on the vintages and ratings. Situations of illiquidity generally are triggered by the market's perception of credit uncertainty regarding a single company or a specific market sector.  In these instances, fair value is determined based on limited available market information and other factors, principally from reviewing the issuer's financial statements and changes in credit ratings made by one or more ratings agencies.


28


---

Table of Contents


Loans Held for Sale


Loans held for sale are carried at the lower of cost or fair value less estimated costs to sell. Once sold, the loans are beyond the reach of COB in all respects and the purchasing investor has all rights of ownership, including the ability to pledge or exchange the loans. Most of the loans sold are without recourse. Gains or losses on loan sales are recognized at the time of sale, are determined by the difference between net sales proceeds and the carrying value of the loan sold, and are included in Consolidated Statements of Operations. Since loans held for sale are carried at the lower of cost or fair value, the fair value of loans held for sale is based on contractual agreements with independent third party buyers. As such, we classify loans held for sale subjected to nonrecurring fair value adjustments as Level 2. Based on the nature of the portfolio, lack of market volatility and the short duration for which the loans are held, fair value generally exceeds cost.


Loans Held for Investment


We do not record loans held for investment at fair value on a recurring basis.  However, from time to time, a loan is considered impaired and the related impairment is charged against the allowance or a specific allowance 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 impaired, management determines the fair value of the loan to quantify impairment, should such exist.  The fair value of impaired loans is estimated using one of several methods, including collateral net liquidation value, market value of similar debt, enterprise value, and discounted cash flows.  Those impaired loans not requiring a specific allowance represent loans for which the fair value of the expected repayments or collateral meet or exceed the recorded investments in such loans.  At June 30, 2014 and December 31, 2013 , substantially all of the total impaired loans were evaluated based on the fair value of the collateral.  Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy.  We record impaired loans as nonrecurring Level 3.


Other Real Estate Owned


OREO is adjusted to fair value upon transfer of the loans to OREO.  Subsequently, OREO is carried at the lower of carrying value or fair value less estimated costs to sell.  Fair value is based upon independent market prices, appraised values of the collateral or management's estimation of the value of the collateral.  Given the lack of observable market prices for identical properties, we record OREO as nonrecurring Level 3.


Interest Rate Locks and Forward Loan Sale Commitments


We enter into interest rate lock commitments and commitments to sell mortgages.  The fair value of interest rate lock commitments is based on servicing rate premium, origination income net of origination costs, fall out rates and changes in loan pricing between the commitment date and the balance sheet date. The fair value of forward loan sale commitments is based on pricing in a secondary market.  We record interest rate lock commitments as recurring level 2.


Interest Rate Swaps


We enter into interest rate swaps to hedge the variability of interest cash flow payments on certain FHLB advances.  These cash flow hedges are recorded through other comprehensive income at fair value.  Any ineffectiveness of the hedge is included in current period earnings.  The fair value of our interest rate swaps is based on a third party valuation because there is not a readily available quoted price in the market.  We record interest rate swap commitments as recurring level 2.





Mortgage Servicing Rights


The fair value of mortgage serving rights (MSR) is dependent upon a number of assumptions including the fee per loan, the cost to service, the expected loan prepayment rate, and the discount rate.  In determining the fair value of the existing MSR management reviews the key assumptions, analyzes pricing in the market for comparable MSR, and uses a third party provider to independently calculate the fair value of its MSR. We record mortgage servicing rights as recurring Level 3.





29


---

Table of Contents


Assets and Liabilities Recorded at Fair Value on a Recurring Basis


Assets and liabilities carried at fair value on a recurring basis at June 30, 2014 are summarized in the following table:


(dollars in thousands)TotalLevel 1Level 2Level 3Assets:Available-for-sale debt securities:U.S. government sponsored agencies$2,064$—$2,064$—Residential mortgage-backed securities-GSE336,896—336,896—Residential mortgage-backed securities-Private19,508—19,508—Commercial mortgage-backed securities-GSE22,05122,051Commercial mortgage-backed securities-Private10,146—10,146—Corporate notes8,445—8,445—Total available-for-sale debt securities399,110—399,110—Mortgage servicing rights1,637——1,637Interest rate swaps(373)—(373)—Interest rate locks and forward loan sales commitments44—44—Total assets at fair value$400,418$—$398,781$1,637


Assets and liabilities carried at fair value on a recurring basis at December 31, 2013 are summarized in the following table:


(dollars in thousands)TotalLevel 1Level 2Level 3Assets:Available-for-sale debt securities:U.S. government sponsored agencies$2,077$—$2,077$—Residential mortgage-backed securities-GSE341,147—341,147—Residential mortgage-backed securities-Private20,752—20,752—Commercial mortgage-backed securities-GSE21,439—21,439—Commercial mortgage-backed securities-Private9,585—9,585—Business Development Company investment2,7372,737——Corporate notes16,877—16,877—Total available-for-sale debt securities414,6142,737411,877—Mortgage servicing rights1,552——1,552Interest rate locks and forward loan sales commitments39—39—Total assets at fair value$416,205$2,737$411,916$1,552


30


---

Table of Contents


The following tables present a reconciliation of all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the periods indicated:


Fair Value Measurements Using SignificantUnobservable Inputs (Level 3)Mortgage Servicing Rights(dollars in thousands)Three Months Ended June 30,20142013Balance, beginning of period$1,587$1,028Total gains or losses (realized/unrealized):Included in earnings, gross166376Less amortization(116)(67)Balance, end of period$1,637$1,337
 Fair Value Measurements Using SignificantUnobservable Inputs (Level 3)Mortgage Servicing Rights(dollars in thousands)Six Months Ended June 30,20142013Beginning balance at January 1,$1,552$726Total gains or losses (realized/unrealized):Included in earnings, gross310724Less amortization(225)(113)Balance, end of period$1,637$1,337


Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis


We may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles.  These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period.  This is due to further deterioration in the value of the assets. There were no loans held for sale that had a fair value below cost in any periods reported.


Assets measured at fair value on a nonrecurring basis are included in the following table at June 30, 2014 :


(dollars in thousands)TotalLevel 1Level 2Level 3Impaired loans, net$8,837$—$—$8,837Other real estate owned17,956——17,956Total assets at fair value from continuing operations$26,793$—$—$26,793


Assets measured at fair value on a nonrecurring basis are included in the following table at December 31, 2013 :


(dollars in thousands)TotalLevel 1Level 2Level 3Impaired loans, net$2,038$—$—$2,038Other real estate owned18,263——18,263Total assets at fair value from continuing operations$20,301$—$—$20,301


31


---

Table of Contents


Quantitative Information about Level 3 Fair Value Measurements


(dollars in thousands)Fair Value at June 30, 2014Valuation TechniquesUnobservableInputRangeImpaired loans, net$8,837Discounted appraisalsCollateral discounts1.00% - 30.00%Other real estate owned17,956Discounted appraisalsCollateral discounts1.00% - 30.00%Mortgage servicing rights1,637Discounted cash flowsPrepayment rate10.00% - 25.00%Mortgage servicing rightsDiscount rate6.00% - 10.00%





(dollars in thousands)Fair Value atDecember 31, 2013Valuation TechniquesUnobservableInputRangeImpaired loans, net$2,038Discounted appraisalsCollateral discounts1.00%-30.00%Other real estate owned18,263Discounted appraisalsCollateral discounts1.00%-30.00%Mortgage servicing rights1,552Discounted cash flowsPrepayment rate10.00% - 25.00%Mortgage servicing rightsDiscount rate6.00% - 10.00%


Level 3 Valuation Methodologies. Following is a description of the unobservable inputs used for Level 3 fair value measurements.


Disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value is required.  Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument.  These estimates do not reflect any premium or discount that could result from offering for sale at one time our entire holdings of a particular financial instrument.


Because no market exists for a portion of our financial instruments, fair value estimates are based on judgments regarding future expected losses, current economic conditions, risk characteristics of various financial instruments, and other factors.  These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision.  Changes in assumptions could significantly affect the estimates.


Fair Value of Financial Instruments


The following methods and assumptions were used to estimate the fair value for each class of COB's financial instruments.


Cash and cash equivalents.  Fair value equals the carrying value of such assets due to their nature and is classified as Level 1.


Investment securities. The fair value of investment securities is based on quoted market prices, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. The fair value of equity investments in the restricted stock of the FRBR and FHLB approximates the carrying value. The fair value of investment securities is classified as Level 1 if a quoted market price is available, or Level 2 if a quoted market price is not available.


Loans held for sale.  Substantially all residential mortgage loans held for sale are pre-sold and their carrying value approximates fair value.  We classified the fair value of loans held for sale as Level 2.


Loans held for investment. The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. We classified the fair value of loans as Level 3.


Accrued interest receivable and payable . The carrying amounts of accrued interest payable and receivable approximate fair value and are classified as Level 2 if the related asset or liability is classified as Level 2, or Level 3 if the related asset or liability is classified as Level 3.


Deposits. The fair value of noninterest-bearing and interest-bearing demand deposits and savings are the amounts payable on demand because these products have no stated maturity.  The fair value of time deposits is estimated using the rates currently offered for deposits of similar remaining maturities and are classified as Level 2.


Borrowed funds . The carrying value of retail repurchase agreements is considered to be a reasonable estimate of fair value.  The fair value of FHLB advances and other borrowed funds is estimated using the rates currently offered for advances of similar remaining


32


---

Table of Contents


maturities and is classified as Level 2. For the long-term note payable, the current market rate for similar debt is substantially equal to the rate on this note, so its fair value approximates its carrying value.


Junior subordinated debentures. Included in junior subordinated debentures are variable rate trust preferred securities issued by COB.  Fair values for the trust preferred securities were estimated by developing cash flow estimates for each of these debt instruments based on scheduled principal and interest payments and current interest rates.  Once the cash flows were determined, a rate for comparable subordinated debt was used to discount the cash flows to the present value. We classified the fair value of junior subordinated debentures as Level 3.


Financial instruments with off-balance sheet risk . The fair value of financial instruments with off-balance sheet risk is considered to approximate carrying value, since the large majority of these future financing commitments would result in loans that have variable rates and/or relatively short terms to maturity.  For other commitments, generally of a short-term nature, the carrying value is considered to be a reasonable estimate of fair value.


Interest rate swaps . The fair value of interest rate swaps are measured based on cash flow models discounted to the valuation date and are classified as Level 2.


Interest rate locks and forward loan sale commitments . The fair value of interest rate locks and forward loan sale commitments are measured by comparing the underlying terms of the contract with current pricing obtained from broker dealer pricing and are classified as Level 2.








33


---

Table of Contents


The estimated fair values of financial instruments are as follows at the periods indicated:


At June 30, 2014(dollars in thousands)Carrying ValueEstimated Fair ValueLevel 1Level 2Level 3Financial Assets:Cash and cash equivalents$70,477$70,477$70,477$—$—Investment securities:  Available-for-sale399,110399,110—399,110—Investment securities:  Held-to-maturity147,055142,288—142,288—Loans held for sale1,7651,765—1,765—Loans held for investment, net1,245,8901,232,404——1,232,404Accrued interest receivable6,2356,235—1,4434,792Interest rate swaps(373)(373)—(373)—Interest rate locks and forward loan sale commitments4444—44—Financial Liabilities:Deposits1,763,7651,764,631—1,764,631—Retail repurchase agreements8,3338,333—8,333—Federal Home Loan Bank advances73,25976,266—76,266—Long-term notes payable5,3005,300——5,300Junior subordinated debentures56,70222,410——22,410Accrued interest payable3,1323,132—3742,758


At December 31, 2013(dollars in thousands)Carrying ValueEstimated Fair ValueLevel 1Level 2Level 3Financial Assets:Cash and cash equivalents$67,430$67,430$67,430$—$—Investment securities:  Available-for-sale414,614414,6142,737411,877—Investment securities:  Held-to-maturity151,795141,125141,125—Loans held for sale1,8361,836—1,836—Loans held for investment, net1,185,4631,129,826——1,129,826Accrued interest receivable6,2836,283—1,5834,700Interest rate locks and forward loan sale commitments3939—39—Financial Liabilities:Deposits1,748,7051,748,685—1,748,685—Retail repurchase agreements6,9176,917—6,917—Federal Home Loan Bank advances73,28375,663—75,663—Long-term notes payable5,2635,263——5,263Junior subordinated debentures56,70222,316——22,316Accrued interest payable2,6242,624—3892,235


There were no transfers between valuation levels for any assets during the three months ended June 30, 2014 . If different valuation techniques are deemed necessary, we would consider those transfers to occur at the end of the period when the assets are valued.


34


---

Table of Contents


9.   Accumulated Other Comprehensive Income





The following tables present the changes in our accumulated other comprehensive income (loss), net of tax, by component for the periods indicated:





(Dollars in thousands)Unrealized Gains (Losses) on Available-For-Sale SecuritiesInterest Rate SwapsDefined Benefit Plan ItemsTotalBeginning balance January 1, 2014$(14,476)$—$(3,129)$(17,605)Other comprehensive income before reclassifications8,372(230)—8,142Amounts reclassified from accumulated other comprehensive income(445)——(445)Net current period other comprehensive income7,927(230)—7,697Ending balance June 30, 2014$(6,549)$(230)$(3,129)$(9,908)





(Dollars in thousands)Unrealized Gains (Losses) on Available-For-Sale SecuritiesDefined Benefit Plan ItemsTotalBeginning balance January 1, 2013$3,650$(3,973)$(323)Other comprehensive loss before reclassifications(12,976)—(12,976)Amounts reclassified from accumulated other comprehensive income(1,647)(308)(1,955)Net current period other comprehensive loss(14,623)(308)(14,931)Ending balance June 30, 2013$(10,973)$(4,281)$(15,254)





The following table presents the reclassifications out of our accumulated other comprehensive income (loss) for the three months and six months ended , June 30 , 2014 and 2013:





(Dollars in thousands)Amount Reclassified from AOCIThree Months Ended June 30, 2014Three Months Ended June 30, 2013Six Months Ended June 30, 2014Six Months Ended June 30, 2013Line Item in the Consolidated Statement of OperationsAvailable-for-sale securities:Net realized gains on sale of securities$(720)$(345)$(720)$(2,723)Securities gains, netIncome tax (benefit) expense2751362751,076Income tax expenseTotal, net of tax(445)(209)(445)(1,647)Defined benefit plan items:Net actuarial gains—(255)—(509)Personnel expenseIncome tax (benefit) expense—101—201Income tax expenseTotal, net of tax—(154)—(308)Total reclassifications for the period$(445)$(363)$(445)$(1,955)




















35


---

Table of Contents


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


The following presents management's discussion and analysis of the financial condition and results of operations of COB.  Certain reclassifications have been made to prior periods to place them on a basis comparable with the current period presentation.  This discussion should be read in conjunction with the financial statements and related notes included elsewhere in this quarterly Report on Form 10-Q.  Results of operations for the periods included in this review are not necessarily indicative of results to be obtained during any future period.


Important Note Regarding Forward-Looking Statements


This quarterly Report on Form 10-Q contains statements that we believe are forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995.  These statements generally relate to our financial condition, results of operations, plans, objectives, future performance or business.  They usually can be identified by the use of forward-looking terminology, such as “believes,” “expects,” or “are expected to,” “plans,” “projects,” “goals,” “estimates,” “may,” “should,” “could,” “would,” “intends to,” “outlook” or “anticipates,” or variations of these and similar words, or by discussions of strategies that involve risks and uncertainties.  You should not place undue reliance on these statements, as they are subject to risks and uncertainties, including but not limited to, those described in this quarterly Report on Form 10-Q.  When considering these forward-looking statements, you should keep in mind these risks and uncertainties, as well as any cautionary statements we may make.  Moreover, you should treat these statements as speaking only as of the date they are made and based only on information actually known to us at the time.  We undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise.


Forward-looking statements contained in this quarterly Report on Form 10-Q are based on current expectations, estimates and projections about our business, management's beliefs and assumptions made by management.  These statements are not guarantees of our future performance and involve certain risks, uncertainties and assumptions (called Future Factors), which are difficult to predict.  Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in the forward-looking statements.  Future factors include, without limitation:


|  |                                                                                                          
|- | ---------------------------------------------------------------------------------------------------------
|• | financial resources in the amount, at the times and on the terms required to support our future business;

|  |                                                                                                                                           
|- | ------------------------------------------------------------------------------------------------------------------------------------------
|• | adverse changes in financial performance or condition of our borrowers, which could affect repayment of such borrowers' outstanding loans;

|  |                                                                                                                                                   
|- | --------------------------------------------------------------------------------------------------------------------------------------------------
|• | changes in interest rates, spreads on earning assets and interest-bearing liabilities, the shape of the yield curve and interest rate sensitivity;

|  |                                          
|- | -----------------------------------------
|• | a prolonged period of low interest rates;

|  |                                                                         
|- | ------------------------------------------------------------------------
|• | credit losses and material changes in the quality of our loan portfolio;

|  |                                       
|- | --------------------------------------
|• | new declines in the value of our OREO;

|  |                                                                           
|- | --------------------------------------------------------------------------
|• | increased competitive pressures in the banking industry or in our markets;

|  |                                                                                                                                                              
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | less favorable general economic conditions, either nationally or regionally, resulting in, among other things, a reduced demand for credit or other services;

|  |                                                                                                                      
|- | ---------------------------------------------------------------------------------------------------------------------
|• | a slowdown in the housing markets, or an increase in interest rates, either of which may reduce demand for mortgages;

|  |                                                                  
|- | -----------------------------------------------------------------
|• | repurchase risk in connection with our mortgage line of business;

|  |                             
|- | ----------------------------
|• | reducing costs and expenses;

|  |                                                                                                                                
|- | -------------------------------------------------------------------------------------------------------------------------------
|• | our ability to raise capital in amounts, on terms and at times that will support our business needs and meet our Business Plan;

|  |                                                                 
|- | ----------------------------------------------------------------
|• | increasing price and product/service competition by competitors;

|  |                                             
|- | --------------------------------------------
|• | rapid technological development and changes;

|  |                                                                       
|- | ----------------------------------------------------------------------
|• | the inaccuracy of assumptions underlying the establishment of our ALL;

|  |                                                     
|- | ----------------------------------------------------
|• | loss of one or more members of executive management;

|  |                                                                                                                                                     
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------
|• | disruptions in or manipulations of our operating systems or the systems of our vendors due to, among other things, cybersecurity risks or otherwise;

|  |                                                                                                                                                                        
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | changes in trade, monetary and fiscal policies and laws, including interest rate policies of the Federal Reserve Board and Federal, State and local taxing authorities;

|  |                                                                                                                                                                                                                                                              
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | the outcome of legislation and regulation affecting the financial services industry, including COB, including the effects resulting from the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act and the Basel III capital rules;

|  |                                                
|- | -----------------------------------------------
|• | changes in accounting principles and standards;

|  |                                                                                                                                    
|- | -----------------------------------------------------------------------------------------------------------------------------------
|• | the effect of any mergers, acquisitions or other transactions to which we or our subsidiaries may from time to time be a party; and

|  |                                                             
|- | ------------------------------------------------------------
|• | our success at managing the risks involved in the foregoing.




All forward-looking statements speak only as of the date on which such statements are made, and COB undertakes no obligation to update any statement, to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events.


36


---

Table of Contents


Financial highlights are presented in the accompanying table.


Selected Financial Data


(dollars in thousands, except per share data)As of and for Three Months EndedAs of and for Six Months EndedJune 30, 2014June 30, 2013June 30, 2014June 30, 2013Income Statement DataNet interest income$15,718$15,414$31,197$30,587Provision for (recovery of) loan losses(1,685)(1,057)(2,369)(947)Noninterest income4,8935,2478,83611,780Noninterest expense19,26824,66538,07449,004Income (loss) before income taxes3,028(2,947)4,328(5,690)Net income (loss)2,792(3,183)4,069(7,779)Period End BalancesAssets$2,013,513$2,036,313$2,013,513$2,036,313Loans held for sale1,7654,0761,7654,076Loans held for investment (1)1,269,8651,189,4131,269,8651,189,413Allowance for loan losses23,97525,08523,97525,085Goodwill and other intangible assets10,50111,60810,50111,608Deposits1,763,7651,811,4851,763,7651,811,485Borrowings143,594124,117143,594124,117Shareholders' equity92,69776,04692,69776,046Average BalancesAssets$1,997,909$2,061,891$1,988,524$2,084,737Loans held for sale1,6644,8611,4824,739Loans held for investment (1)1,237,1831,109,9801,222,8791,126,265Allowance for loan losses26,54429,32326,74229,545Goodwill and other intangible assets10,63611,46510,79411,504Deposits1,755,1271,826,2971,747,2841,845,523Borrowings141,390123,156141,815123,526Shareholders' equity88,14088,04785,97092,283Per Common Share DataNet income (loss) - basic and diluted$0.13$(0.15)$0.19$(0.36)Book value (2)4.263.504.263.50Tangible book value (2)3.782.963.782.96Performance RatiosReturn on average assets0.61%(0.62)%0.41%(0.75)%Return on average tangible assets (2)0.61(0.62)0.41(0.76)Return on average equity12.71(14.50)9.54(17.00)Return on average tangible equity (2)14.45(16.67)10.91(19.42)Net interest margin (tax equivalent)3.403.273.423.23Core noninterest expense as a percentage of average assets (2)3.473.543.533.59Asset Quality RatiosAllowance for loan losses to period end loans held for investment (1)1.89%2.11%1.89%2.11%


37


---

Table of Contents


Nonperforming loans to period end allowance for loan losses (3)132%235%132%235%Net annualized charge-offs (recoveries) to average loans held for investment (1)0.121.260.070.59Nonperforming assets to period end total assets (3)2.74.72.74.7Capital and Liquidity RatiosAverage equity to average assets4.41%4.27%4.32%4.43%Leverage capital6.355.376.355.37Tier 1 risk-based capital9.708.719.708.71Total risk-based capital12.6612.0212.6612.02Period end loans to period end deposits72667266





(1) Loans held for investment, net of unearned income, before allowance for loan losses.


(2) Refer to the "Non-GAAP Measures" section in Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.


(3) Nonperforming loans and nonperforming assets include loans past due 90 days or more that are still accruing interest.





38


---



Overview


CommunityOne Bancorp, or "COB" or the "Company" (which also refers to us and our subsidiaries on a consolidated basis), is a bank


holding company incorporated in 1984 under the laws of the State of North Carolina. Through our ownership of CommunityOne


Bank, N.A., or the "Bank," a national banking association headquartered in Asheboro, North Carolina, we offer a complete line of


consumer, wealth management, mortgage and business banking services, including loan, deposit, cash management, investment


management and trust services, to individual and business customers through operations located throughout central, southern and


western North Carolina.





In addition to the Bank, we own FNB United Statutory Trust I, FNB United Statutory Trust II, and Catawba Valley Capital Trust II,


which were formed to facilitate the issuance of trust preferred securities. COB also owned Granite Mortgage, Inc., which ceased


mortgage operations in 2009, filed for Chapter 11 bankruptcy on February 15, 2012 and was dissolved on May 5, 2014.





The Bank holds the stock of First National Investor Services, Inc., which holds deeds of trust for the Bank. The Bank had also owned


Dover Mortgage, which had previously engaged in the business of originating, underwriting and closing mortgage loans for sale in the


secondary market. Dover ceased operations in the first quarter of 2011, filed for Chapter 11 bankruptcy on February 15, 2012 and was dissolved on April 28, 2014.


On October 21, 2011, as part of the recapitalization of COB, COB acquired Bank of Granite Corporation and its subsidiary bank, Bank of Granite, through the merger of a wholly owned subsidiary of ours into Granite Corp. (the “Merger”).  Bank of Granite was merged into the Bank on June 8, 2013.


We earn revenue primarily from interest on loans and securities investments, mortgage banking income and fees charged for financial services provided to our customers.  Offsetting these revenues are the cost of deposits and other funding sources, provision for loan losses and write-downs in the value of, gains and losses on disposition of, and holding costs associated with our OREO, and other operating costs such as:  salaries and employee benefits, occupancy, data processing expenses, merger-related expenses and tax expense.


Progress on 2014 goals


The second quarter was our fourth consecutive profitable quarter and we made solid progress during the quarter and the first six months in achieving the four goals we established for 2014:


|   |           
|-- | ----------
|1. | Grow loans

|   |                   
|-- | ------------------
|2. | Grow core deposits

|   |                                                                         
|-- | ------------------------------------------------------------------------
|3. | Invest in people and products while maintaining sound expense discipline

|   |                                    
|-- | -----------------------------------
|4. | Resolve our remaining credit issues

Our highest priority goal is to grow loans, and during the second quarter, we experienced very strong loan growth, with loans growing by $49.9 million, or 4%, during the quarter for a 16% annualized growth rate.  Organic growth, which excludes the impact of purchased residential loan pools, totaled $34.8 million for a 14% annualized growth rate, and the pass rated portfolio grew $63.1 million for a 23% annualized rate.  We experienced loan growth in all segments of our business during the second quarter, especially in our commercial banking segment, and we expect additional growth from recent staff additions in the Greensboro market and new loan production offices announced in Raleigh in June and in Winston-Salem in July.  Our loan growth and the increase in our loans to deposit ratio to 72% are both ahead of plan.


On the deposit front, deposits have increased $15.1 million since year end for a 2% annualized growth rate.  During the quarter, however, deposits were down $4.2 million as core deposits fell 2.1% on seasonal declines in interest-bearing DDA accounts and declines in money market balances, partially offset by a $6.3 million increase in noninterest-bearing deposits.  Our investments in enhanced treasury management product capabilities and online and mobile banking infrastructure are on schedule with plan and should support reaching our 3% deposit growth goal for the full year.


39


---



We continued our expense reduction efforts during the quarter, even as we made investments in key areas to support our strategic initiatives.  Noninterest expense fell $5.4 million, or 22%, from the comparable quarter in 2013, as a result of reduced OREO levels and associated expenses, as well as expense synergies from the Bank of Granite merger.  Core noninterest expense was $0.4 million, or 2%, lower than the first quarter as a result of reduced personnel expenses and professional fee declines.  Year over year, core noninterest expense has declined 6%.  We also continued to be disciplined in managing our personnel, and average full time equivalent employees (FTE) were 558, down from 576 last quarter and 630 in the second quarter of 2013, reductions of 3% and 11%, respectively.  Overall, core NIE to average assets declined to 3.47% during the quarter and is better than our goal for 2014.  We expect this trend to continue as we have renegotiated one of our most significant vendor contracts during the quarter and anticipate related savings starting in the second half of 2014 and accelerating in 2015 and 2016.  Also starting in the third quarter, improvements in our capital, earnings and asset quality should drive a decline in the annual costs of our FDIC insurance and other regulatory expenses of greater than $1.0 million on a full year run rate basis.





Our fourth key goal is to resolve our remaining credit issues. We are currently ahead of schedule with low credit costs incurred to date.  Nonperforming assets were reduced 9% in the quarter, to 2.7% of total assets, versus a year-end goal of 2.3%.  We reduced classified assets by $22.3 million year-to date versus a full year reduction goal of $40.0 million, and the Bank classified asset ratio continues to drop, down from 67% to 56% at quarter end, well on track to reach our goal of 45% by year end.  Importantly we made this progress with very little credit cost, with only 12 basis points in annualized net charge-offs during the quarter and other real estate owned write-downs and valuation allowances of $1.1 million.





Results of Operations


Net Interest Income


Our principal source of revenue is net interest income.  Net interest income is the difference between interest income earned on interest-earning assets, primarily loans and investment securities, and interest expense paid on interest-bearing deposits and other interest-bearing liabilities. The net interest margin measures how effectively we manage the mix of interest-earning assets and interest-bearing liabilities and the difference between the interest income earned on interest-earning assets and the interest expense paid for funds to support those assets.  Fluctuations within net interest income are driven by changes in the mix of interest-earning assets and interest-bearing liabilities, changes in the interest rates earned on interest-earning assets and interest rates paid on interest-bearing liabilities, the rate of growth of the interest-earning assets and interest-bearing liabilities base, the ratio of interest-earning assets to interest-bearing liabilities, and the management of interest rate sensitivity. An analysis of these changes is presented in the Average Balances and Net Interest Income Analysis - Second Quarter for the three month periods ended June 30, 2014 and 2013, and in the Average Balances and Net Interest Income Analysis - Six Months for the six month periods ended June 30, 2014 and 2013.


Net interest margin (taxable equivalent) improved 13 basis points from 3.27% in the second quarter of 2013 to 3.40% in the second quarter of 2014.  Net interest income on a taxable equivalent basis was $15.7 million for the three month period ended June 30, 2014, an increase of 2%, or $0.2 million, from $15.5 million for the same period in 2013. The increase in interest income is a result of an increase in interest income on investment securities resulting from higher yields, as well as a decrease on interest paid on time deposits as both the rate and volume of such deposits have decreased. The yield on investment securities was improved as a result of declining prepayment expectations in the mortgage-backed security portfolio from rising interest rates.


The yield on average earning assets increased by 10 basis points during the second quarter of 2014 to 3.95% from 3.85% in the second quarter of 2013.  The cost of interest-bearing liabilities was unchanged from the second quarter of 2013 to the second quarter of 2014 at 0.65%. The cost of interest-bearing deposits declined 6 basis points, or 11%, from 0.54% for the second quarter of 2013 to 0.48% for the second quarter of 2014 as the percentage of CDs in our deposit portfolio declined from 35.8% to 33.5% at June 30, 2013 and 2014, respectively.


The following table summarizes the average balance sheets and net interest income/margin analysis for the three months ended June 30, 2014 and 2013 .  The interest yield earned on interest-earning assets and interest rate paid on interest-bearing liabilities shown in the table are derived by dividing interest income and expense by the average balances of interest-earning assets or interest-bearing liabilities, respectively.


40


---

Table of Contents


Average Balances and Net Interest Income Analysis - Second Quarter


Three Months Ended June 30,20142013AverageAverage(dollars in thousands)AverageIncome /Yield /AverageIncome /Yield /Balance (3)ExpenseRateBalance (3)ExpenseRateInterest-earning assets:Loans (1)(2)$1,238,847$14,3974.66%$1,114,841$14,4705.21%Taxable investment securities550,0323,7312.72577,4633,5182.44Other earning assets66,2131560.95202,8331970.39Total earning assets1,855,09218,2843.951,895,13718,1853.85Noninterest-earning assets:Cash and due from banks26,38832,420Goodwill and other intangible assets10,63611,465Other assets, net105,793122,869Total assets$1,997,909$2,061,891Interest-bearing liabilities:Interest-bearing demand deposits$335,971$2610.31%$352,953$2750.31%Savings deposits85,485220.1080,604200.10Money market deposits437,9212610.24447,8872480.22Time deposits581,0091,1970.83670,5331,5470.93Total interest-bearing deposits1,440,3861,7410.481,551,9772,0900.54Retail repurchase agreements6,13430.208,14140.20Federal Home Loan Bank advances73,2665142.8158,3133652.51Other borrowed funds61,9902871.8656,7022641.87Total interest-bearing liabilities1,581,7762,5450.651,675,1332,7230.65Noninterest-bearing liabilities and shareholders' equity:Noninterest-bearing demand deposits314,741274,320Other liabilities13,25224,391Shareholders' equity88,14088,047Total liabilities and shareholders' equity$1,997,909$2,061,891Net interest income and net yield on earning assets (4)$15,7393.40%$15,4623.27%Interest rate spread (5)3.30%3.20%


(1) The fully tax equivalent basis is computed using a federal tax rate of 35%.


(2) Average loan balances include nonaccruing loans and loans held for sale.


(3) Average balances include market adjustments to fair value for securities and loans held for sale.


(4) Net yield on earning assets is computed by dividing net interest income by average earning assets.


(5) Earning asset yield minus interest-bearing liabilities rate.





41


---

Table of Contents


Net interest income on a taxable equivalent basis was $31.2 million for the six month period ended June 30, 2014, an increase of $0.6 million, or 2%, from $30.7 million for the same period in 2013. The increase in interest income is a result of the rotation of the earning asset base into loans and securities from lower yielding cash balances, offset by lower loan yields and a smaller earning asset base, as well as a decrease in interest-bearing liability levels, an improvement in the level of low cost core deposits and a decrease in the rates paid on those liabilities.


Net interest margin (taxable equivalent) improved 19 basis points from 3.23% in the first six months of 2013 to 3.42% in the first six months of 2014. As described above, the increase was attributable primarily to the rotation of earning assets from cash and securities and into loans, and management's strategy to shift the mix of deposits away from higher cost time deposits. The yield on average earning assets increased by 13 basis points during the first half of 2014 to 3.96% from 3.83% in the comparable portion of 2013. The increase in average yield was the result of deploying cash invested at low short-term rates into higher-yielding and longer term securities, partially offset by a decline in loan yields. The cost of interest-bearing liabilities declined during the first six months of 2014 by 2 basis points to 0.64% compared to 0.66% in the same period of 2013, primarily as a result of the deposit mix shift. The cost of interest-bearing deposits declined 7 basis points, or 13%, from 0.55% for the first half of 2012 to 0.48% for the comparable period of 2013.


The following table summarizes the average balance sheets and net interest income/margin analysis for the six months ended June 30, 2014 and 2013. The interest yield earned on interest-earning assets and interest rate paid on interest-bearing liabilities shown in the table are derived by dividing interest income and expense by the average balances of interest-earning assets or interest-bearing liabilities, respectively.





42


---

Table of Contents


Average Balances and Net Interest Income Analysis - Six Months


Six Months Ended June 30,20142013AverageAverage(dollars in thousands)AverageIncome /Yield /AverageIncome /Yield /Balance (3)ExpenseRateBalance (3)ExpenseRateInterest-earning assets:Loans (1)(2)$1,224,361$28,5024.69%$1,131,004$29,3035.22%Taxable investment securities555,2657,4262.70571,3786,5922.33Tax-exempt investment securities (1)——————Other earning assets63,3983070.98210,5554090.39Total earning assets1,843,02436,2353.961,912,93736,3043.83Noninterest-earning assets:Cash and due from banks26,84832,175Goodwill and other intangible assets10,79411,504Other assets, net107,858128,121Total assets$1,988,524$2,084,737Interest-bearing liabilities:Interest-bearing demand deposits$336,663$5110.31%$354,759$5310.30%Savings deposits83,816430.1078,723390.10Money market deposits443,2745270.24452,5144930.22Time deposits577,9462,3620.82695,0763,2740.95Total interest-bearing deposits1,441,6993,4430.481,581,0724,3370.55Retail repurchase agreements6,56260.188,50690.21Federal Home Loan Bank advances73,2729832.7158,3187472.58Other borrowed funds61,9815611.8356,7025281.88Total interest-bearing liabilities1,583,5144,9930.641,704,5985,6210.66Noninterest-bearing liabilities and shareholders' equity:Noninterest-bearing demand deposits305,585264,451Other liabilities13,45523,405Shareholders' equity85,97092,283Total liabilities and shareholders' equity$1,988,524$2,084,737Net interest income and net yield on earning assets (4)$31,2423.42%$30,6833.23%Interest rate spread (5)3.32%3.17%


(1) The fully tax equivalent basis is computed using a federal tax rate of 35%.


(2) Average loan balances include nonaccruing loans and loans held for sale.


(3) Average balances include market adjustments to fair value for securities and loans held for sale.


(4) Net yield on earning assets is computed by dividing net interest income by average earning assets.


(5) Earning asset yield minus interest-bearing liabilities rate.





Interest accretion in excess of contractual interest received on Granite Purchased Impaired Loans was $0.7 million in the second quarter compared to $1.7 million in the second quarter of 2013. For the first six months of 2014, interest accretion in excess of


43


---

Table of Contents


contractual interest received on Granite Purchased Impaired Loans was $1.6 million as compared to $2.4 million in the comparable period of 2013.


Provision for Loan Losses


The provision for loan loss provides a level of allowance considered appropriate to absorb management's estimate of losses inherent in the loan portfolio.  The amount of this charge is affected by several considerations, including management's evaluation of various risk factors in determining the adequacy of the allowance (see additional discussion under “ Asset Quality ”), actual loan loss experience and changes in the composition of the loan portfolio.


During the three and six month periods ended June 30, 2014, the recovery of loan losses was $(1.7) million and $(2.4) million, respectively, compared to $(1.1) million and $(0.9) million in the same periods of 2013, as a result of the impact of declining loss rates net of recoveries in recent periods and an increase in forecasted cash flows for Granite PI loans that resulted in the reversal of previously recorded impairment on pools of loans within this portfolio. During the six month periods ended June 30, 2014 and 2013, net charge-offs totaled $0.4 million and $3.3 million, respectively, or 0.07% and 0.59% of annualized average loans, respectively.


Noninterest Income


Noninterest income includes mortgage banking income, fees and service charges on deposit accounts, fees from cardholder and merchant services, fees and commissions related to trust and investment services, gains and losses on the sales of securities, and all other types of noninterest revenue.


For the three months ended June 30, 2014 , noninterest income was $4.9 million compared to $ 5.2 million for the same period in 2013 , a decrease of $0.3 million, or 7%, primarily the result of a $0.7 million decrease in mortgage loan sales income as origination volumes declined 30%, partially offset by a $0.4 million increase in gains on sales of securities. Core noninterest income, which excludes securities gains and losses, was $4.2 million, a decrease of $0.7 million from the second quarter of 2013 for the reasons just noted.  See "Non-GAAP Measures" for further discussion.


For the six months ended June 30, 2014, noninterest income was $8.8 million compared to $11.8 million for the same period in 2013, a decrease of $3.0 million, or 25%, primarily the result of a $2.0 million decrease in net gains on sales of investment securities in the first six months of 2014, compared to the same period in 2013, as well as a $1.2 million decrease in mortgage loan sales income, as a result of higher mortgage interest rates, lower origination volume and lower sales of loans. Core noninterest income was $8.1 million, compared to $9.1 million in the first six months of 2013 as a result of the decline in mortgage loan income just noted, offset by increases in service charges on deposit accounts and cardholder and merchant services income.


Three Months EndedSix Months Ended(dollars in thousands)June 30, 2014June 30, 2013June 30, 2014June 30, 2013Noninterest IncomeService charges on deposit accounts$1,619$1,681$3,183$3,057Mortgage loan income2619214351,665Cardholder and merchant services income1,2091,1742,3222,243Trust and investment services399394757635Bank-owned life insurance278276530538Other service charges, commissions and fees332337684595Securities gains, net7203457202,723Other income75119205324Total noninterest income4,8935,2478,83611,780Less:Securities gains, net7203457202,723Core noninterest income(1)$4,173$4,902$8,116$9,057


(1) See "Non-GAAP Measures"


Noninterest Expense


Noninterest expense components are included in the next table and include salary and employee benefits, occupancy and equipment, and other expenses associated with our operations, in addition to credit related expenses related to OREO and loan collections, and one-time merger-related expenses incurred to acquire and integrate Granite.





44


---

Table of Contents


Noninterest expenses were $19.3 million in the second quarter of 2014 compared to $24.7 million in the same period of 2013, a decrease of $5.4 million, or 22%. The decrease in noninterest expense was primarily attributable to a $3.2 million decrease in total OREO and loan collection expense, as a result of our substantial reduction in nonperforming loans and OREO assets from the prior year and stabilizing real estate prices during 2013 and 2014. Our 2013 expenses include $2.0 million of merger-related costs in preparation for the merger of Bank of Granite into the Bank in June 2013. The second quarter of 2014 also includes nonrecurring expenses of $0.4 million related to the sale by the US Treasury of its common stock investment in the Company.


For the six months ended June 30, 2014, noninterest expenses declined $10.9 million, or 22%, from the same period of 2013, to $38.1 million. OREO expense declined $3.0 million from the first half of 2013, as a result of the decline in the OREO portfolio and stabilizing real estate prices during 2013 and 2014 described above. Loan collection expenses fell $1.8 million, and merger-related expense were $3.5 million in 2013, compared to zero in the first half of 2014. Personnel expenses declined $1.1 million from the first six months of 2013 as a result of branch closures and on-going staffing efficiency efforts.


As a result of the level of problem assets, actions taken to dispose of those assets, actions taken to restructure the balance sheet, and the expenses to acquire and integrate Bank of Granite, there are a significant number of non-core items within our noninterest expense.  Excluding the items that we identify as non-core, other real estate expenses, loan collection expenses, merger-related expense, branch closure and restructuring expenses, mortgage and litigation accruals, U.S. Treasury expenses and rebranding expenses, the core noninterest expense ("Core NIE"), was $17.3 million in the second quarter of 2014.  See " Non-GAAP Measures " for further discussion. This Core NIE was $0.9 million lower than Core NIE of $18.2 million in the same quarter in 2013.  For the six months ended June 30, 2014, Core NIE was $2.4 million lower than the same period of 2013.


Full-time equivalent employees averaged 558 employees for the second quarter of 2014 versus 630 employees for the second quarter of 2013 , a reduction of 11%.


Three Months EndedSix Months Ended(dollars in thousands)June 30, 2014June 30, 2013June 30, 2014June 30, 2013Noninterest ExpensePersonnel expense$9,956$10,807$20,349$21,486Net occupancy expense1,5121,6713,0653,502Furniture, equipment and data processing expense2,0472,0944,0504,462Professional fees4677601,1002,253Stationery, printing and supplies173187335373Advertising and marketing147179300844Other real estate owned expense9543,3321,2154,214Credit/debit card expense6044731,199898FDIC insurance5956641,2341,334Loan collection expense5511,4081,2082,979Merger-related expense—1,989—3,498Core deposit intangible amortization352352704704Other expense1,9107493,3152,457Total noninterest expense19,26824,66538,07449,004Less:Other real estate owned expense9543,3321,2154,214Merger-related expense—1,989—3,498Loan collection expense5511,4081,2082,979Rebranding expenses—58—610U.S. Treasury expenses409—409—Mortgage and litigation accrual7(370)(68)(370)Branch closure and restructuring expense715190602Core noninterest expense(1)$17,340$18,233$35,120$37,471


(1) See "Non-GAAP Measures"


45


---

Table of Contents


Provision for Income Taxes


Income tax expense totaled $0.2 million for the second quarter of 2014 and $0.2 million for the second quarter of 2013. For the first six months of 2014, income tax expense totaled $0.3 million, compared to $2.1 million for the first six months of 2013. Our provision for income taxes, as a percentage of income (loss) before income taxes, was 7.8% and (8.0)% for the three months ended June 30, 2014 and June 30, 2013 , respectively, and 6.0% and (36.7)% for the six months ended June 30, 2014 and June 30, 2013, respectively. Income tax expense in the first six months of 2014 and 2013 is primarily the result of the reduction of deferred tax liabilities as a result of sales of investment securities during the period which had unrealized gains (and associated deferred tax liabilities) prior to sale. Because we maintain a valuation allowance for net deferred tax assets equal to the gross deferred tax asset net of any deferred tax liabilities, reductions in deferred tax liabilities from the sale of the securities during the period resulted in an increase in the required valuation reserve and a corresponding increase in income tax expense.


46


---

Table of Contents


Balance Sheet Review


Total assets at June 30, 2014 were $2.01 billion , an increase of $28.5 million , or 1% , compared to total assets of $1.99 billion at December 31, 2013 .


Cash and interest-bearing balances were $70.5 million at June 30, 2014 , an increase of $3.0 million , or 5% , compared to $67.4 million at December 31, 2013 , primarily as a result of increases in the deposit portfolio and repayments and maturities of investment portfolio securities.


Total investment securities decreased $20.2 million during the first six months of 2014 , from $566.4 million at December 31, 2013 to $546.2 million at June 30, 2014 , a decrease of 4%.  The portfolio is comprised of U.S. federal agency securities and federal agency MBSs (GSE), private residential MBSs, commercial MBSs (GSE), private commercial MBSs, and corporate debt securities. During the first quarter of 2013, we began to purchase investment securities to be held-to-maturity.  At June 30, 2014 there were $147.1 million of investment securities so designated.


Gross loans held for investment increased $57.6 million , or 5% , during the first six months of 2014 , from $1,212.2 million at December 31, 2013 to $1,269.9 million at June 30, 2014 . The increase was primarily the result of loan originations net of reductions in problem loans, as well as the purchase of a $19.6 million residential mortgage loan pool. Loans held for investment grew in all lines of business during the first half of the year.


Other real estate owned ("OREO") and property acquired in settlement of loans decreased $6.5 million during the first six months of 2014 , from $28.4 million at December 31, 2013 to $21.9 million at June 30, 2014 , as a result of $6.9 million of OREO sales and $0.9 million of write-downs and losses, partially offset by the addition of $1.3 million of OREO properties. At June 30, 2014 , 18 assets with a net carrying amount of $4.3 million were under contract for sale.  Estimated losses, if any, with these sales have been recognized in the Consolidated Statements of Operations in the first six months of 2014 . Actual gains, if any, will be recorded at the time of sale.


Total deposits were $1.76 billion at June 30, 2014 , an increase of $15.1 million , or 1% from $1.75 billion at December 31, 2013 .  Noninterest-bearing deposits increased $31.4 million , or 11% , from $290.5 million at December 31, 2013 to $321.8 million at June 30, 2014 , as these deposits rebounded from seasonal lows at year end 2013. The total cost of interest-bearing deposits declined by 7 basis points from 0.55% in the first six months of 2013 to 0.48 % in the first six months of 2014 . The cost of all deposits, including noninterest-bearing deposits, fell to 0.40% for the first six months of 2014, a decline of 7 basis points from 0.47% for the first six months of 2013.


Shareholders' equity at June 30, 2014 was $92.7 million as compared to $80.4 million at December 31, 2013 .  The book value per share was $4.26 at June 30, 2014 and average equity to average assets was 4.32% for the six months ended June 30, 2014 as compared to a book value per share of $3.68 and average equity to average assets of 4.18% for the year ended December 31, 2013 .  The change in shareholders' equity reflects net income to common shareholders for the six months ended June 30, 2014 of $4.1 million as well as $7.7 million other comprehensive income, net of tax, including unrealized gain on available-for-sale securities described below.  We did not declare common dividends during the six months ended June 30, 2014, and will not pay any dividends until such time as we either receive or are not required to receive regulatory approval for the payment of dividends.  We do not expect to pay dividends to shareholders for the foreseeable future.


During the first six months of 2014, the Company issued 142,462 shares of restricted stock awards to employees.  With the US Treasury sale of its shares in May 2014 and in compliance with the U.S. Treasury’s TARP regulations, the Company cancelled 267,937 shares of restricted stock awards granted to certain senior executives.  As a result of these transactions total shares outstanding for the six months ended  June 30, 2014 declined by 125,475.





Investment Securities


We evaluate all securities on a quarterly basis, and more frequently as economic conditions warrant, to determine if an other than temporary impairment (“OTTI ” ) exists.  In evaluating the possible impairment of securities, consideration is given to the length of time and the extent to which the fair value has been less than book value, the financial conditions and near-term prospects of the issuer, and the ability and intent of COB to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.  In analyzing an issuer's financial condition, we may consider whether the securities are issued by the federal government or its agencies or government sponsored agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer's financial condition.  If management determines that an investment experienced an OTTI, the loss is recognized in the income statement as a realized loss.  Any recoveries related to the value of these securities are recorded as an unrealized gain (as other comprehensive income (loss) in shareholders' equity) and not recognized in income until the security is ultimately sold.  As of June 30, 2014 , there were no securities considered by COB to have OTTI.


During the first six months of 2014, changes in the overall level of interest rates resulted in net unrealized gains of $8.4 million in our available-for-sale portfolio. As a result, an unrealized gain of $13.6 million in the first six months of 2014, net of deferred taxes of $5.2 million, has been recorded in Other Comprehensive Income. We do not expect to sell these securities and realize these losses.


47


---

Table of Contents


Asset Quality


Management considers asset quality to be of primary importance.  A formal loan review function, independent of loan origination, is used to identify and monitor problem loans.  This function reports directly to the Risk Management Committee of the Board of Directors, and is independent of loan origination.


Acquired Loans


Loans acquired in the Merger ("Granite Purchased Loans") include purchased impaired loans ("PI loans") and purchased contractual loans ("PC loans"). At June 30, 2014 there were $169.9 million of Granite Purchased Loans, of which $28.0 million were PC loans, and $ 141.9 million were PI loans with subsequent credit deterioration.


PI loans are segregated into pools and recorded at estimated fair value on the date of acquisition without the carryover of the related ALL.  PI loans are accounted for under ASC 310-30 when the loans have evidence of credit deterioration since origination and it is probable at the date of acquisition we will not collect all contractually required principal and interest payments.  Evidence of credit quality deterioration as of the date of acquisition may include statistics such as past due status, nonaccrual status and risk grade.  PI loans generally meet our definition for nonaccrual status, however, even if the borrower is not currently making payments, we will classify loans as accruing if we can reasonably estimate the amount and timing of future cash flows.  The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the nonaccretable difference.


Periodically, we estimate the expected cash flows for each pool of the PI loans and evaluate whether the expected cash flows for each pool have changed from prior estimates.  Decreases to the expected cash flows will generally result in a provision for loan losses.  Subsequent increases in cash flows result in a reversal of the provision for loan losses to the extent of prior charges, or reclassification from nonaccretable difference to accretable yield with a positive impact on future interest income.  Excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized into interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows.


We have elected to treat the Granite portfolio under ASC 310-30, with the exception of performing revolving consumer and commercial loans, which are being accounted for under ASC 310-20.


At June 30, 2014 , an ALL of $4.1 million was required for the PI loans, and these loans are presented on an accruing basis.


Commercial Real Estate Secured Loans


Commercial real estate secured lending (including commercial, construction and land development) is a significant portion of our commercial loan portfolio.  These categories constitute $466.5 million, or approximately 37%, of our total loans held for investment portfolio at June 30, 2014, down from 38% at December 31, 2013.  These categories are generally affected by changes in economic conditions, fluctuations in interest rates, the availability of loans to potential purchasers, changes in tax and other laws and acts of nature.


Nonperforming Assets


Nonperforming assets are comprised of nonaccrual loans, accruing loans past due 90 days or more, property acquired in settlement of loans and OREO.  Nonperforming loans are loans placed in nonaccrual status when, in management's opinion, the collection of all or a portion of interest becomes doubtful.  Loans are returned to accrual status when the factors indicating doubtful collectability cease to exist and the loan has performed in accordance with its terms for a demonstrated period of time.  OREO represents real estate acquired through foreclosure or deed in lieu of foreclosure and it, and other property acquired in settlement of loans, is generally carried at fair value, less estimated costs to sell.


The level of nonperforming loans continued to decline, from $35.2 million or 2.90% of loans held for investment at December 31, 2013 , to $31.7 million, or 2.50% of loans held for investment at June 30, 2014 .  OREO and property acquired in settlement of loans were $21.9 million at June 30, 2014 , compared to $28.4 million at December 31, 2013 , a decline of $6.5 million .  During the first six months of 2014 , we recorded net write-downs (net of gains on sales) of OREO of $0.9 million as compared to $3.3 million during the first six months of 2013 . We have experienced stabilizing real estate prices during 2013 and 2014, and OREO sales in excess of additions to the portfolio.  Total nonperforming assets declined 16% from $63.6 million at December 31, 2013 to $53.6 million at June 30, 2014, and represented 2.7% of total assets, an improvement from 3.2% at December 31, 2013.


Allowance for Loan Losses


In determining the ALL and any resulting provision to be charged against earnings, particular emphasis is placed on the results of the loan review process.  Consideration is also given to a review of individual loans, historical loan loss experience, the value and adequacy of collateral, as well as the economic conditions in our market area.  For loans determined to be impaired, the allowance is based on discounted cash flows using the loan's initial effective interest rate or the fair value of the collateral for certain collateral dependent loans.  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 that may be susceptible to significant change.  In addition, as an integral part of


48


---

Table of Contents


its examination process, the OCC periodically reviews the Bank's ALL and may require the Bank to recognize changes to the allowance based on its judgments about information available to it at the time of its examinations.  Loans are charged off when, in the opinion of management, they are deemed to be uncollectible.  Recognized losses are charged against the allowance, and subsequent recoveries are added to the allowance.


Estimated credit losses should meet the criteria for accrual of a loss contingency, i.e., a provision to the ALL, set forth in GAAP.  Our methodology for determining the ALL is based on GAAP, the Interagency Policy Statement on the Allowance for Loan and Lease Losses and other regulatory and accounting pronouncements.  The ALL is determined by the sum of three separate components:  (i) the impaired loan component, which addresses specific reserves for impaired loans; (ii) the general reserve component, which addresses reserves for pools of homogeneous loans; and (iii) an unallocated reserve component (if any) based on management's judgment and experience.  The loan pools and impaired loans are mutually exclusive; any loan that is impaired should be excluded from its homogenous pool for purposes of that pool's reserve calculation, regardless of the level of impairment.  We have established a de minimis threshold for loan exposures that, if found to be impaired, will have impairment determined by applying the same general reserve rate as nonimpaired loans within the same pool.


The ALL of $26.8 million at December 31, 2013 decreased by 10% to $24.0 million at June 30, 2014 . The ALL, as a percentage of loans held for investment, amounted to 1.89% at June 30, 2014 compared to 2.21% at December 31, 2013 . Net charge-offs were $0.4 million in the first six months of 2014 compared to net charge-offs of $3.3 million in the first six months of 2013 .  Annualized net charge-offs in the first six months of 2014 were 0.07% of average loans, compared to annualized net charge-offs of 0.59% in the same period of 2013 .


Actual past due loans and loan charge-offs have declined and management continues to diligently work to improve asset quality.  Management believes the ALL of $24.0 million at June 30, 2014 is adequate to cover probable losses inherent in the loan portfolio; however, assessing the adequacy of the allowance is a process that requires considerable judgment.  Management's judgments are based on numerous assumptions about current events that it believes to be reasonable, but which may or may not be valid.  Thus, there can be no assurance that loan losses in future periods will not exceed the current allowance or that future increases in the allowance will not be required.  No assurance can be given that management's ongoing evaluation of the loan portfolio in light of changing economic conditions and other relevant circumstances will not require significant future additions to the allowance, thus adversely affecting the operating results of COB.  Additional information on the ALL is presented in Note 4 to the consolidated financial statements.


Historical loss rates are calculated by associating losses to the risk-graded pool to which they relate for each of the previous eight quarters. Then, using a look back period consisting of the twenty most recent quarters, loss factors are calculated for each risk-graded pool using a simple average. This represents a change in methodology which began in the third quarter of 2013. Previously, we used a look back period beginning in the third quarter of 2006 and a weighted average of losses. The impact of this change was immaterial to the financial statements of the Company during the quarter it was implemented.





In addition to the Bank's ability to use its own historical loss data and migration between risk grades, it has a rigorous process for computing the qualitative factors that impact the ALL.  A committee, independent of the historical loss migration team, reviews risk factors that may impact the ALL.  Some factors are statistically quantifiable, such as concentration, growth, delinquency, and nonaccrual risk by loan type, while other factors are qualitative in nature, such as staff competency, competition within our markets, economic and regulatory changes impacting the loans held for investment.





49


---

Table of Contents


The following table presents COB's investment in loans considered to be impaired and related information on those impaired loans as of June 30, 2014 and December 31, 2013 :


June 30, 2014December 31, 2013(dollars in thousands)BalanceAssociated ReservesBalanceAssociated ReservesImpaired loans, not individually reviewed for impairment$4,750$—$4,612$—Impaired loans, individually reviewed, with no impairment29,890—39,865—Impaired loans, individually reviewed, with impairment9,6938552,965927Total impaired loans *$44,333$855$47,442$927Purchased impaired loans with subsequent deterioration141,9244,123161,3075,560Purchased impaired loans with no subsequent deterioration——345—Total Reserves4,9786,487Average impaired loans calculated using a simple average$45,888$65,527* Included at June 30, 2014 and December 31, 2013 were $12.9 million and $12.1 million, respectively, in restructured and performing loans.


Liquidity Management


Liquidity management refers to the ability to meet day-to-day cash flow requirements based primarily on activity in loan and deposit accounts of COB's customers.  Liquidity is immediately available from four major sources: (a) cash on hand and on deposit at other banks; (b) the outstanding balance of federal funds sold; (c) the market value of unpledged investment securities, and (d) availability under lines of credit. At June 30, 2014, the total amount of these four items was $514.4 million, or 26% of total assets, a decrease of $10.7 million from $525.1 million, or 26% of total assets, at December 31, 2013. COB could also access $288.9 million of additional borrowings under credit lines by pledging additional collateral.


Consistent with the general approach to liquidity, loans and other assets of COB are funded primarily by local core deposits.  To date, a stable retail deposit base and a modest amount of brokered deposits have been adequate to meet our loan obligations, while maintaining the desired level of immediate liquidity.  Additionally, an investment securities portfolio is available for both immediate and secondary liquidity purposes.


At June 30, 2014 , $98.2 million of the investment securities portfolio was pledged to secure public deposits, $17.9 million was pledged to retail repurchase agreements and $75.7 million was pledged to others, leaving $354.3 million available as lendable collateral.


Commencing the first quarter of 2012, we resumed deferring the payment of cash dividends on the Company's outstanding junior subordinated debentures.





Asset/Liability Management and Interest Rate Sensitivity


One of the primary objectives of asset/liability management is to maximize the net interest margin while minimizing the earnings risk associated with changes in interest rates.  One method used to manage interest rate sensitivity is to measure, over various time periods, the interest rate sensitivity positions, or gaps.  This method, however, addresses only the magnitude of timing differences and does not address earnings or market value.  Therefore, management uses an earnings simulation model to prepare, on a regular basis, earnings projections based on a range of interest rate scenarios to more accurately measure interest rate risk.


COB's balance sheet continued to be asset-sensitive at June 30, 2014 .  During 2014, $40 million in interest rate swaps to fix the interest rate on FHLB advances offset the impact of fixed rate lending, maintaining the asset sensitivity profile. During 2013, increases in long-term interest rates that extended the duration of our fixed-rate mortgage-backed investment securities portfolio, purchases of $134 million of fixed-rate residential mortgage pools and the conversion of $50 million of fixed rate FHLB advances to floating rate reduced our overall level of asset sensitivity. An asset-sensitive position means that net interest income will generally move in the same direction as interest rates.  For instance, if interest rates increase, net interest income can be expected to increase, and if interest rates decrease, net interest income can be expected to decrease.  COB's asset sensitivity is primarily derived from cash and due from banks position, variable rate commercial loans that adjust as interest rates changes and the long duration of its indeterminate term deposits.  These variable rate loans are primarily funded by deposits that are not expected to reprice as quickly as the loans.  Management believes COB's risk to changes in interest rates to be moderate.





50


---

Table of Contents


Capital Adequacy and Resources


Under guidelines established by the Federal Reserve Board and the OCC, capital adequacy is currently measured for regulatory purposes by certain risk-based capital ratios, supplemented by a leverage capital ratio.  The guidelines define an institution's total qualifying capital as having two components:  Tier 1 capital, which must be at least 50% of total qualifying capital and is mainly comprised of common equity, retained earnings and qualifying preferred stock, less certain intangibles; and Tier 2 capital, which may include the ALL up to a maximum of 1.25% of risk weighted assets, qualifying subordinated debt, qualifying preferred stock and hybrid capital instruments.  The requirements also define the weights assigned to assets and off-balance sheet items to determine the risk weighted asset components of the risk-based capital rules.


Under the requirements, the minimum capital standards that must be met by any bank holding company or bank include a Tier 1 capital ratio of at least 4%, a total risk-based capital ratio of at least 8% and a leverage capital ratio of at least 4% (except for those institutions with the highest regulatory ratings and not experiencing significant growth or expansion).  The leverage capital ratio, which serves as a minimum capital standard, considers Tier 1 capital only and is expressed as a percentage of average total assets for the most recent quarter, after reduction of those assets for goodwill and other disallowed intangible assets at the measurement date.  Risks such as concentration of credit risks and the risk arising from non-traditional activities, as well as the institution's exposure to a decline in the economic value of its capital due to changes in interest rates, and an institutions ability to manage those risks are important factors that are to be taken into account by the federal banking agencies in assessing an institution's overall capital adequacy.


The prompt corrective action provisions of federal law require the federal bank agencies to take prompt corrective action to resolve problems of insured depository institutions such as the Bank.  The extent of these powers depends upon whether the institution is designated as well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized or critically undercapitalized, as defined by the law.  The minimum capital requirements to be characterized as “well-capitalized” and “adequately capitalized,” as defined by the applicable provisions of federal law, and COB and the Bank's capital ratios as of June 30, 2014 were as follows:


Minimum Regulatory RequirementCommunityOne BancorpCommunityOneBankAdequatelyCapitalizedWell-CapitalizedLeverage capital ratio6.35%7.86%4.00%5.00%Tier 1 risk-based capital ratio9.70%12.02%4.00%6.00%Total risk-based capital ratio12.66%13.28%8.00%10.00%





On June 10, 2013, the OCC terminated the Bank Consent Order; however, the Bank has continuing obligations to, among other things, adhere to its Business Plan, including maintaining the capital ratios in the Plan, and will continue to have restrictions on its ability to pay dividends. With the lifting of the Consent Order, the Bank is considered “well-capitalized” under the applicable provisions of the Federal Deposit Insurance Act. On November 5, 2013, the FRBR terminated its Written Agreement with the Company which had been entered into on October 21, 2010.  With the termination of the Written Agreement, the Company and the Bank are no longer subject to any formal supervisory orders.  However, the Company continues to have restrictions on its ability to declare or pay dividends, distribute interest, principal or other amounts on its trust preferred securities, incurring, increasing or guaranteeing any debt, or repurchasing or redeeming any shares of stock.


The federal banking agencies have issued revised capital rules that will change the leverage and risk-based capital requirements (including the prompt corrective action framework), which will become effective for community banks as of January 1, 2015.  Under these final rules, the definition of the regulatory capital components and minimum capital requirements will materially change.  Among the most important of these changes is that a new common equity Tier 1 risk-based capital ratio of 4.5% has been added, and the overall Tier 1 risk-based capital ratio has been raised to 6%.  Certain deductions from common equity will be expanded and others, including mortgage servicing assets and deferred tax assets subject to temporary timing differences, will be subject to threshold deductions.  In addition, the agencies are requiring a capital conservation buffer of up to 2.5% above each of the capital ratio requirements (common equity tier 1, tier 1, and total risk-based capital) which must be met for a bank to be able to pay dividends, engage in share buybacks or make discretionary bonus payments to executive management without restriction. This capital conservation buffer will be phased in over a four year period starting on January 1, 2016. The rulemakings also change the risk-weighting of certain assets, including “high volatility” commercial real estate, past due assets, structured securities and equity holdings. We believe that these changes, when implemented, will not have a material effect on COB or the Bank.


Application of Critical Accounting Policies


Our accounting policies are in accordance with GAAP and with general practice within the banking industry and are fundamental to understanding management's discussion and analysis of results of operations and financial condition.  Our significant accounting


51


---

Table of Contents


policies are discussed in detail in Note 1 of the consolidated financial statements contained in the Annual Report on Form 10-K for the year ended December 31, 2013 , as amended ("Form 10-K"), and are described below.


Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, valuation of OREO, carrying value of investment securities, estimated cash flows for purchased impaired loans and treatment of deferred tax assets.


Allowance for Loan Losses


The ALL, which is utilized to absorb actual losses in the loan portfolio, is maintained at a level consistent with management's best estimate of probable loan losses incurred as of the balance sheet date.  Our ALL is assessed quarterly by management.  This assessment includes a methodology that separates the total loan portfolio into homogeneous loan classifications for purposes of evaluating risk.  The required allowance is calculated by applying a risk adjusted reserve requirement to the dollar volume of loans within a homogenous group.  We have grouped our loans into pools according to the loan segmentation regime employed on schedule RC-C of the FFIEC's Consolidated Report of Condition and Income.  Management analyzes the loan portfolio on an ongoing basis to evaluate current risk levels, and risk grades are adjusted accordingly.  While management uses the best information available to make evaluations, future adjustments may be necessary, if economic or other conditions differ substantially from the assumptions used.  See additional discussion under "Asset Quality" .


During the third quarter of 2013, we changed a component of the calculation of our allowance for loan losses.  We began using a look back period consisting of the twenty most recent quarters to calculate loss factors for each risk-graded pool.  Previously, we used a look back period beginning in the third quarter of 2006.


Valuation of Other Real Estate Owned


Other real estate owned represents properties acquired through foreclosure or deed in lieu thereof.  The property is classified as held for sale and is carried at fair value based on recent appraisals, less estimated costs to sell.  Declines in the fair value of properties included in other real estate below carrying value are recognized by a charge to income. An increase in fair value is not recognized until the property is sold.


Carrying Value of Securities


Securities designated as available-for-sale are carried at fair value.  However, the unrealized difference between amortized cost and fair value of securities available-for-sale is excluded from net income unless there is an other than temporary impairment and is reported, net of deferred taxes, as a component of shareholders' equity as accumulated other comprehensive income (loss).  Securities held-to-maturity are carried at amortized cost, as the Bank has the ability, and management has the positive intent, to hold these securities to maturity.  Premiums and discounts on securities are amortized and accreted according to the interest method.


Purchased Loans Accounting


Purchased impaired ("PI") loans are recorded at fair value at acquisition date.  Therefore, amounts deemed uncollectible at acquisition date become part of the fair value determination and are excluded from the allowance for loan and lease losses.  Following acquisition, we periodically reforecast expected cash flows for PI loans.  Subsequent decreases in the amount expected to be collected result in a provision for loan losses with a corresponding increase in the allowance for loan losses.  Subsequent increases in the amount expected to be collected result in a reversal of any previously recorded provision for loan losses and related allowance for loan losses, if any, or prospective adjustment to the accretable yield if no provision for loan losses had been recorded.


Treatment of Deferred Tax Assets


Management's determination of the realization of deferred tax assets is based upon its judgment of various future events and uncertainties, including the timing and amount of future income earned and the implementation of various tax plans to maximize realization of the deferred tax assets.  In evaluating the positive and negative evidence to support the realization of the asset under current guidance, there is insufficient positive evidence to support a conclusion that it is more likely than not this asset will be realized in the foreseeable future.  Examinations of the income tax returns or changes in tax law may impact our tax liabilities and resulting provisions for income taxes.


A valuation allowance is recognized for a deferred tax asset if, based on the weight of available evidence, it is more-likely-than-not that some portion or the entire deferred tax asset will not be realized.  The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. In making such judgments, significant weight is given to evidence that can be objectively verified.  As a result of historical credit losses, COB is in a three-year cumulative pre-tax loss position as of June 30, 2014 .  A cumulative loss position is considered significant negative evidence in assessing the realizability of a deferred tax asset, which is difficult to overcome.  Our estimate of realizable deferred tax assets was based on the scheduled reversal of deferred tax liabilities and estimated unrealized losses in the available-for-sale investment portfolio.  In total, we have a net deferred tax asset of $150.4 million which is offset by a valuation allowance of $145.2 million. We did not consider future taxable income in determining the realizability of the deferred tax assets.  We expect our income tax expense (benefit) will be negligible except for tax expense or benefit related to the change in the deferred tax liability related to available-for-sale


52


---

Table of Contents


securities until profitability is considered sustainable.  At that time, a portion of the valuation allowance would be reversed.  Reversal of the valuation allowance requires a great deal of judgment and will be based on the circumstances that exist as of that future date.  If future events differ significantly from our current forecasts, we may need to increase this valuation allowance.


The Merger was considered a change in control for Granite Corp. under Internal Revenue Code Section 382 and the Regulations, thereunder.  Accordingly, we are required to evaluate potential limitation or deferral of its ability to carryforward pre-acquisition net operating losses and to determine the amount of net unrealized built-in losses (“NUBIL”), which may be subject to similar limitation or deferral.  Under the Internal Revenue Code and Regulations, NUBIL realized within 5 years of the change in control are subject to potential limitation, which for us is October 20, 2016.  Through that date, we will continue to analyze our ability to utilize such losses to offset anticipated future taxable income, however, this estimate will not be known until the five-year recognition period expires.  Losses limited under these provisions are generally limited to a carryforward period of 20 years, subject to the annual limitation and expire if not used by the end of that period.  The Company believes the remaining DTA of $2.9 million related to NOL carryforwards from the Merger will be realized on a go forward basis.


The State of North Carolina passed legislation to reduce the income tax rates from 6.9% to 6.0% in 2014 and to 5.0% in 2015.  The DTA has been reduced to account for the reduction in income tax rates to 5.0%.  The net reduction in DTA is offset by a corresponding reduction in the valuation allowance.


Summary


Management believes the accounting estimates related to the ALL, the valuation of OREO, the carrying value of securities, purchased loan accounting, and the valuation allowance for deferred tax assets are “critical accounting estimates” because:  (1) the estimates are highly susceptible to change from period to period as they require management to make assumptions concerning the changes in the types and volumes of the portfolios and anticipated economic conditions, and (2) the impact of recognizing an impairment or loan loss could have a material effect on the COB's assets reported on the balance sheet as well as its net earnings.


Non-GAAP Measures


This quarterly Report on Form 10-Q contains financial information determined by methods other than in accordance with GAAP.  We use these non-GAAP measures in our analysis of COB's performance.  Some of these non-GAAP measures exclude goodwill, core deposit premiums and other intangibles from the calculations of return on average assets and return on average equity.  We believe presentations of financial measures excluding the impact of goodwill, core deposit premiums and other intangible assets provide useful supplemental information that is essential to a proper understanding of the operating results of our core businesses.  In addition, certain designated net interest income amounts are presented on a taxable equivalent basis.  We believe that the presentation of net interest income on a taxable equivalent basis aids in the comparability of net interest income arising from taxable and tax-exempt sources.  We believe that other non-GAAP measures that exclude credit and non recurring income and expenses provide useful supplemental information that enhances the understanding of our core operating results.


These disclosures should not be viewed as a substitute for results determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies.


The non-GAAP financial measures used in this Report are “tangible equity,” “tangible assets”, “tangible book value”, "core earnings", "core and non-core noninterest expense" and "core and non-core noninterest income."  Our management, financial services companies, bank stock analysts, and bank regulators use these non-GAAP measures in their analysis of our performance.





|  |                                                                                                                                                              
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | “Average tangible shareholders’ equity” is defined as average shareholders’ equity reduced by average recorded goodwill, and average other intangible assets.

|  |                                                                                                                                       
|- | --------------------------------------------------------------------------------------------------------------------------------------
|• | “Average tangible assets” is defined as average total assets reduced by average recorded goodwill and average other intangible assets.

|  |                                                                                                                            
|- | ---------------------------------------------------------------------------------------------------------------------------
|• | “Tangible shareholders’ equity” is defined as shareholders’ equity reduced by recorded goodwill and other intangible assets

|  |                                                                                                       
|- | ------------------------------------------------------------------------------------------------------
|• | “Tangible assets” is defined as total assets reduced by recorded goodwill and other intangible assets.

|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | “Tangible book value” is defined as total equity reduced by recorded goodwill, other intangible assets and preferred stock divided by total common shares outstanding. This measure discloses changes from period-to-period in book value per share exclusive of changes in intangible assets and preferred stock. Goodwill, an intangible asset that is recorded in a purchase business combination, has the effect of increasing total book value while not increasing the tangible assets of a company. Companies utilizing purchase accounting in a business combination, as required by GAAP, must record goodwill related to such transactions.

|  |                                                                                                                                                                                                                                                                                                                                                                                                                      
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | “Non-core Noninterest Expense ” is defined as OREO expenses, loan collection expenses, nonrecurring items such as merger-related expense, mortgage servicing rights impairment, prepayment penalty on borrowings, goodwill impairment and loss on loans held for sale. This measure identifies items which are elevated during periods of elevated problem asset activity and items which are nonrecurring in nature.

53


---



|  |                                                                                                                                                                                                                                                                                     
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | "Core Noninterest Expense (NIE)" is defined as total noninterest expense reduced by Non-core Noninterest expense. This measure reduces noninterest expense by items which are elevated during periods of elevated problem asset activity and items which are nonrecurring in nature.

|  |                                                                                                                                                                                                                   
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | "Non-core Noninterest Income" is defined as gains and losses on securities and any other nonrecurring noninterest income items. This measure identifies noninterest income items which are nonrecurring in nature.

|  |                                                                                                                                                                                                  
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | “Core Noninterest Income (NII)” is defined as total noninterest income reduced by Non-core Noninterest Income. This measure reduces noninterest income by items which are nonrecurring in nature.

|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|• | "Core Earnings" is defined as income (loss) from continuing operations, before income taxes, increased by Non-core Noninterest Expense, decreased by Non-core Noninterest Income, and increased by provision for loan losses or decreased by recovery of loan losses. This measure identifies the Company's pre-tax earnings excluding items which are elevated during periods of elevated problem asset activity and items which are nonrecurring in nature.




The following tables provide a more detailed analysis of these non-GAAP measures:


(dollars in thousands, except per share data)As of and for the six months ended June 30, 2014As of and for the year ended December 31, 2013As of and for the six months ended June 30, 2013Total average shareholders' equity$88,047$85,576$92,283Less:Average goodwill(4,205)(4,205)(4,205)Average core deposit and other intangibles(6,589)(7,207)(7,299)Average tangible shareholders' equity (non-GAAP)$77,253$74,164$80,779Total average assets$1,988,524$2,047,146$2,084,737Less:Average goodwill(4,205)(4,205)(4,205)Average core deposit and other intangibles(6,589)(7,207)(7,299)Average tangible assets (non-GAAP)$1,977,730$2,035,734$2,073,233Total shareholders' equity$92,697$80,361$76,046Less:Goodwill(4,205)(4,205)(4,205)Core deposit and other intangibles(6,296)(6,914)(7,403)Tangible shareholders' equity (non-GAAP)$82,196$69,242$64,438Total assets$2,013,513$1,985,032$2,036,313Less:Goodwill(4,205)(4,205)(4,205)Core deposit and other intangibles(6,296)(6,914)(7,403)Tangible assets (non-GAAP)$2,003,012$1,973,913$2,024,705Book value per common share$4.26$3.70$3.50Effect of intangible assets(0.48)(0.51)(0.54)Tangible book value per common share (non-GAAP)$3.78$3.19$2.96








54


---



(dollars in thousands)Three Months EndedSix Months EndedJune 30, 2014June 30, 2013June 30, 2014June 30, 2013Total noninterest expense$19,268$24,665$38,074$49,004Less:Other real estate owned expense9543,3321,2154,214Loan collection expense5511,4081,2082,979Merger-related expense—1,989—3,498Rebranding expenses—58—610U.S. Treasury expenses409—409—Mortgage and litigation accrual7(370)(68)(370)Branch closure and restructuring expense715190602Total non-core noninterest expense (non-GAAP)1,9286,4322,95411,533Core noninterest expense (non-GAAP)$17,340$18,233$35,120$37,471Total noninterest income$4,893$5,247$8,836$11,780Less:Securities gains (losses), net7203457202,723Total non-core noninterest income (non-GAAP)7203457202,723Core noninterest income (non-GAAP)$4,173$4,902$8,116$9,057Income loss from continuing operations, before income taxes$3,028$(2,947)$4,328$(5,690)Non-core noninterest expense (non-GAAP)1,9286,4322,95411,533Less: Non-core noninterest income (non-GAAP)(720)(345)(720)(2,723)Recovery of loan losses(1,685)(1,057)(2,369)(947)Core earnings (non-GAAP)$2,551$2,083$4,193$2,173








Item 3.  Quantitative and Qualitative Disclosures About Market Risk


Management considers interest rate risk our most significant market risk.  Interest rate risk is the exposure to adverse changes in net interest income due to changes in interest rates.  Consistency of our net interest income is largely dependent upon the effective management of interest rate risk.


COB's Asset/Liability Management Committee (“ALCO”), which includes senior management representatives and reports to the Board of Directors, monitors and manages interest rate risk. See "Asset/Liability Management and Interest Rate Sensitivity" in Item 2 of this Form 10-Q for further discussion.


The objective of asset/liability management is the maximization of net interest income within our risk guidelines.  This objective is accomplished through management of our balance sheet composition, maturities, liquidity, and interest rate risk exposures arising from changing economic conditions, interest rates and customer preferences.


To identify and manage its interest rate risk, we employ an earnings simulation model to analyze net interest income sensitivity to changing interest rates.  The model is based on contractual cash flows and repricing characteristics and incorporates market-based assumptions regarding the effect of changing interest rates on the prepayment rates of certain assets and liabilities.  The model also includes management projections for activity levels in each of the product lines offered by the Bank.  Assumptions are inherently uncertain and the measurement of net interest income or the impact of rate fluctuations on net interest income cannot be precisely predicted.  Actual results may differ from simulated results due to timing, magnitude, and frequency of interest changes as well as changes in market conditions and management strategies.





55


---



Item 4.  Controls and Procedures


Evaluation of Disclosure Controls and Procedures


An evaluation of our disclosure controls and procedures (as defined in Sections 13(a)-15(e) and 15(d)-15(e) of the Securities Exchange Act of 1934), was carried out under the supervision and with the participation of COB 's Chief Executive Officer and Chief Financial Officer and several other members of senior management as of June 30, 2014 , the last day of the period covered by this Quarterly Report.  COB 's Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of June 30, 2014 in ensuring that the information required to be disclosed in the reports we file or submit under the Securities Exchange Act of 1934 is (i) accumulated and communicated to management (including COB 's Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized, and reported within the time periods specified in the SEC's rules and forms.


Internal Control Changes


We assess the adequacy of our internal control over financial reporting quarterly and enhance our internal controls in response to internal control assessments and internal and external audit and regulatory recommendations. No control enhancements during the quarter ended June 30, 2014 have materially affected, or are reasonably likely to materially affect, COB’s internal control over financial reporting.








56


---

Table of Contents


PART II.  OTHER INFORMATION


Item 1.  Legal Proceedings


In the ordinary course of operations, COB is party to various legal proceedings.  COB is not involved in, nor has it terminated during the six months ended June 30, 2014 , any pending legal proceedings other than routine, nonmaterial proceedings occurring in the ordinary course of business.


Item 1A.     Risk Factors


There have been no material changes to the risk factors that we have previously disclosed in Item 1A - “Risk Factors” in our Form 10-K.


Item 2.  Unregistered Sales of Equity Securities and Repurchases


Not Applicable


Item 3.  Defaults Upon Senior Securities


Not Applicable


Item 4.  Mine Safety Disclosures


Not Applicable


Item 5.  Other Information


None


Item 6.  Exhibits


Exhibits to this report are listed in the Index to Exhibits section of this report.


57


---

Table of Contents


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.








CommunityOne Bancorp


( Registrant )








Date: August 8, 2014 By: / s /  DAVID L. NIELSEN


David L. Nielsen


Executive Vice President and Chief


Financial Officer


(Principal Financial and Accounting Officer)





58


---

Table of Contents


INDEX TO EXHIBITS





Exhibit No.Description of Exhibit31.1Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.101Financial Statements submitted in XBRL format











59