UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

Annual Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934
For The Fiscal Year Ended: December 31, 2016.

Transition Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934
For the Transition Period from ______ to ______

Commission file number 000-51907

Independence Bancshares, Inc.
(Exact name of registrant as specified in its charter)

South Carolina	20-1734180
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

500 E. Washington Street, Greenville	29601
(Address of principal executive offices)	(Zip Code)

864-672-1776
(Registrant’s telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x

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 ¨

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

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.

Large accelerated filer	¨		Accelerated filer	¨
Non-accelerated filer	¨	(Do not check if a smaller reporting company)	Smaller reporting company	x

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

As of June 30, 2016, the aggregate market value of the issued and outstanding common stock held by non-affiliates of the registrant, based upon an estimate the last sales price of the registrant’s common stock of $0.19 was approximately $3,895,524.

The number of shares outstanding of the issuer’s common stock, as of March 23, 2017 was 20,502,760.

DOCUMENTS INCORPORATED BY REFERENCE

None.

PART I

As used in this Annual Report on Form 10-K, “we,” “our” and “us” refer to Independence Bancshares, Inc. and its subsidiaries, collectively unless the context requires otherwise.

Cautionary Note Regarding Forward-Looking Statements

This Annual report on Form 10-K, including information included or incorporated by reference in this document, contains statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements may relate to our financial condition, results of operation, plans, objectives, or future performance. These statements are based on many assumptions and estimates and are not guarantees of future performance. Our actual results may differ materially from those anticipated in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors which are beyond our control. The words “may,” “would,” “could,” “should,” “will,” “expect,” “anticipate,” “predict,” “project,” “potential,” “believe,” “continue,” “assume,” “intend,” “plan,” and “estimate,” as well as similar expressions, are meant to identify such forward-looking statements. Potential risks and uncertainties that could cause our actual results to differ from those anticipated in our forward-looking statements include, but are not limited, to the following:

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strategies for growth and sources of new operating revenues, including the Bank’s expansion of its consumer lending program to target prime and super-prime borrowers in its current market areas as well as throughout South Carolina;

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suspension of business divisions or segments, including digital banking or consumer lending;

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operating revenues, expenses, effective tax rates, and other results of operations;

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current and future products and services and plans to develop and promote them;

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capital expenditures and our estimates regarding our capital expenditures;

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liquidity, working capital requirements and access to funding;

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cybersecurity risks, business disruptions or financial losses and changes in technology;

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our shareholder relations;

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defense of litigation brought by current and/or former officers, directors and/or shareholders;

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mergers and acquisition activity;

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use of proceeds from sales of our securities;

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our ability to comply with regulations;

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relations with federal and state regulators;

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listing our shares, including any listing on a national securities exchange;

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changes in economic conditions;

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credit losses;

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the rate of delinquencies and amount of loans charged-off;

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allowances for loan losses and loan loss provisions;

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the lack of loan growth in recent years;

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our ability to attract and retain key personnel;

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our ability to protect, use, develop, market and otherwise exploit our proprietary technology and intellectual property;

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our ability to retain our existing customers;

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increases in competitive pressure in the banking and financial services industries;

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adverse changes in asset quality and resulting credit risk related losses and expenses;

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changes in the interest rate environment, business conditions, inflation and changes in monetary and tax policies;

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changes in political, legislative or regulatory conditions;

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loss of consumer confidence and economic disruptions resulting from terrorist activities or other military actions;

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changes in deposit flows;

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changes in accounting policies and practices; and

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other risks and uncertainties detailed in our other filings with the SEC.

All forward-looking statements in this Annual Report on Form 10-K are based on information available to us as of the date of this Annual Report on Form 10-K. Although we believe that the expectations reflected in our forward-looking statements are reasonable, we cannot guarantee you that these expectations will be achieved. For additional information with respect to factors that could cause actual results to differ from the expectations stated in the forward-looking statements, see “Risk Factors” under Part I, Item 1A of this Annual Report on Form 10-K. We undertake no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

Item 1. Business.

General

Independence Bancshares, Inc. (the “Company”) is a South Carolina corporation organized to operate as a bank holding company pursuant to the Federal Bank Holding Company Act of 1956 and the South Carolina Banking and Branching Efficiency Act of 1996, and to own and control all of the capital stock of Independence National Bank (the “Bank”), a national association organized under the laws of the United States. Since opening for business on May 16, 2005, the Bank has operated as a traditional community bank in Greenville, South Carolina, fulfilling the financial needs of individuals and small businesses in its market. The Bank provides traditional checking and savings products insured by the Federal Deposit Insurance Corporation (the “FDIC”) and consumer, commercial and mortgage loans, as well as ATM and online banking, cash management and safe deposit boxes.

As previously reported, on September 25, 2015, the Company suspended development of its digital banking, payments and transaction services business and subsequently began evaluating strategic alternatives for the Company. A key goal of the Company’s digital banking business was to reduce costs for banking activities and operate more efficiently through utilizing mobile and online delivery channels. In furtherance of this goal and based in part upon the institutional knowledge acquired in the pursuit of the digital banking strategy, the Company plans to supplement its current lending strategy by expanding its consumer lending program with online offerings, targeting prime and super-prime borrowers in the Bank’s current market area as well as throughout South Carolina. The Company’s board of directors is focused on profitably growing the Bank and enhancing shareholder value through this targeted expansion of its consumer lending program which may include purchases of in-market consumer loans that meet our underwriting criteria.

Banking Services

Market

Our primary focus and target market is to fulfill the financial needs of individual consumers, small business owners, the legal and medical communities, insurance agencies, and clients owning and developing income producing properties primarily in the Greenville metropolitan area. In our consumer lending line of business, we focus on a broader market area that currently includes the entire state of South Carolina. We intend to use our “closeness” to the market via local ownership, quick response time, pricing discretion, person-to-person relationships and an experienced, well known senior management team in leveraging our market share in the greater

Greenville area while looking for ways to differentiate the Bank from our competition. Our new on-line consumer lending program is one of these ways we seek to differentiate the Bank from our competition.

Location and Service Area

Our primary market is Greenville County, which is located in the upstate region of South Carolina. The cities of Fountain Inn, Greenville, Greer, Mauldin, Simpsonville, and Travelers Rest make up Greenville County. The Greenville metropolitan area, positioned on the I-85 corridor, is home to one of the strongest manufacturing centers in the country, including approximately 250 international companies, such as the North American headquarters of BMW and Michelin, as well as Fluor Corporation, General Electric, and Lockheed Martin. Greenville County has a population of approximately 492,000, with a five-year projected annual growth rate of approximately 2.1%, according to the South Carolina Community Profiles published by the South Carolina Budget and Control Board’s Office of Research and Statistics. The area’s demographics have changed considerably over the past 10 years and currently over 42,000 businesses are operating within the county limits, according to the U.S. Census Bureau.

Our main office is located in Greenville, South Carolina, one block off a major artery, and provides excellent visibility for the Bank. We also have full-service branches on Wade Hampton Boulevard in Taylors, South Carolina and in Simpsonville, South Carolina. These branch offices have extended the market reach of our Bank and have increased our personal service delivery capabilities to all of our customers. We plan to continue to take advantage of existing contacts and relationships with individuals and companies in this area to more effectively market the banking services of the Bank.

With respect to our on-line consumer lending program, we believe that because the business has been structured to be overwhelmingly conducted on-line, we will be able to expand our lending area outside of the area served by our physical branch network.

Competition

The Greenville market is highly competitive, with all of the largest banks in the state, as well as super regional banks, represented in our market area. The competition among the various financial institutions is based upon a variety of factors, including interest rates offered on deposit accounts, interest rates charged on loans, credit and service charges, the quality of services rendered, the convenience of banking facilities and, in the case of loans to large commercial borrowers, relative lending limits. In addition to banks and savings associations, we compete with other financial institutions including securities firms, insurance companies, credit unions, leasing companies and finance companies. Size gives larger banks certain advantages in competing for business from large corporations. These advantages include higher lending limits and the ability to offer services in other areas of South Carolina. As a result, we do not generally attempt to compete for the banking relationships of large corporations, but concentrate our efforts on small- to medium-sized businesses and retail customers. We believe we have competed effectively in this market by offering quality and personal service.

With respect to our on-line consumer lending program, our greatest source of competition is non-bank lenders and we believe that we can effectively compete in this product through utilizing mobile and online delivery channels as well as advantages – such as state law preemption – afforded to us as a national bank.

Products and Services

The Bank is primarily engaged in the business of accepting demand and time deposits and providing consumer, commercial and mortgage loans to the general public. With respect to our on-line consumer lending business, we provide unsecured consumer loans up to $35,000 to individual borrowers. Deposits in the Bank are insured by the FDIC up to a maximum amount, which is currently set at $250,000 per depositor. Other services which the Bank offers include mobile banking, online banking, commercial cash management, remote deposit capture, safe deposit boxes, bank official checks, traveler’s checks, and wire transfer capabilities.

Lending Activities

General. We emphasize a range of lending services, including commercial, real estate, unsecured consumer loans and equity-line consumer loans to individuals and small- to medium-sized businesses and professional firms that are located in or conduct a substantial portion of their business in our market area. The larger, well-established banks in our service area make proportionately more loans to medium- to large-sized businesses than we do. Our small- to medium-sized borrowers may be less able to withstand competitive, economic, and financial conditions than larger borrowers. Our underwriting standards vary for each type of loan, as described below. We compete for these loans with competitors who are well established in our service area and have greater resources and lending limits.

Loan Approval. Certain credit risks are inherent in making loans. These include prepayment risks, risks resulting from uncertainties in the future value of collateral, risks resulting from changes in economic and industry conditions, and risks inherent in dealing with individual borrowers. We attempt to mitigate repayment risks by adhering to internal credit policies and procedures. These policies and procedures include officer and client lending limits, a multi-layered approval process for larger loans, documentation examination, and follow-up procedures for exceptions to credit policies. Our loan approval policies provide for various levels of officer lending authority. When the amount of aggregate loans to a single borrower exceeds an individual officer’s lending authority, the loan request will be considered by an executive officer with a higher lending limit, executive officers combining authority or the directors’ loan committee. We do not make any loans to any director or executive officer of the Bank unless the loan is approved by the full board of directors of the Bank and is on terms not more favorable than would be available to a person not affiliated with the Bank.

Credit Administration and Loan Review. We maintain a continuous loan review system. We also apply a credit grading system to each loan, and we use an independent consultant to review the loan files on a test basis to confirm our loan grading. Each loan officer is responsible for each loan he or she makes, regardless of whether other individuals or committees joined in the approval. This responsibility continues until the loan is repaid or until the loan is officially assigned to another officer.

Lending Limits. Our lending activities are subject to a variety of lending limits imposed by federal law. In general, the Bank is subject to a legal limit on loans to a single borrower equal to 15% of the Bank’s capital and unimpaired surplus. These limits will increase or decrease in response to increases or decreases in the Bank’s level of capital. We are able to sell participations in our larger loans to other financial institutions, which allows us to manage the risk involved in these loans and to meet the lending needs of our clients requiring extensions of credit in excess of these limits.

Consumer Loans. We have historically made a variety of loans to individuals for personal and household purposes, including secured and unsecured installment loans and revolving lines of credit but have this year increased our focus on this line of business by implementing an on-line unsecured consumer loan product to individual borrowers of up to $35,000 per loan. Consumer loans are underwritten based on the borrower’s income, current debt level, past credit history, and the availability and value of collateral, if a secured loan. Consumer rates are both fixed and variable, with terms negotiable. Our installment loans typically amortize over periods up to 60 months. We will offer consumer loans with a single maturity date when a specific source of repayment is available. We typically require monthly payments of interest and a portion of the principal on our revolving loan products. Consumer loans are generally considered to have a greater risk than first or second mortgages on real estate because they may be unsecured, or, if they are secured, the value of the collateral may be difficult to assess and more likely to decrease in value than real estate.

Real Estate Mortgage Loans. The principal component of our loan portfolio is loans secured by real estate mortgages. We obtain a security interest in real estate whenever possible, in addition to any other available collateral, in order to increase the likelihood of the ultimate repayment of the loan. At December 31, 2016, loans secured by mortgages on real estate — first mortgages of approximately $45.2 million and second mortgages of approximately $3.9 million — made up approximately 71% of our loan portfolio.

These loans generally fall into one of four categories: commercial real estate loans, construction and development loans (including land loans), residential real estate loans, or home equity loans. Most of our real estate loans are secured by residential or commercial property. Interest rates for all categories may be fixed or adjustable, and will more likely be fixed for shorter-term loans. We generally charge an origination fee for each loan. Other loan fees consist primarily of late charge fees or prepayment penalties. Real estate loans are subject to the same general risks as other loans and are particularly sensitive to fluctuations in the value of real estate. Fluctuations in the value of real estate, as well as other factors arising after a loan has been made, could negatively affect a borrower’s cash flow, credit-worthiness, and ability to repay the loan.

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Commercial Real Estate Loans. Commercial real estate loans generally have terms of five years or less, although payments may be structured on a longer amortization basis. We evaluate each borrower on an individual basis and attempt to determine their business risks and credit profile. We attempt to reduce credit risk in the commercial real estate portfolio by emphasizing loans on owner-occupied office and retail buildings where the loan-to-value ratio, established by independent appraisals, does not exceed 85% at origination. We generally require that debtor cash flow exceed 120% of monthly debt service obligations. We typically review all of the personal financial statements of the principal owners and require their personal guarantees. These reviews generally reveal secondary sources of payment and liquidity to support a loan request.

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Construction and Development Real Estate Loans (Including Land Loans). We offered adjustable and fixed rate residential and commercial construction loans in the past. We continue to offer construction and development loans on a limited basis to certain qualified borrowers. The terms of construction and development loans have generally been limited to eighteen months, although some payments have been structured on a longer amortization basis. Most loans mature and require payment in full upon the sale of the property. We believe that construction and development loans generally carry a higher degree of risk than long term financing of existing properties. Repayment depends on the ultimate completion of the project and usually on the sale of the property. Specific risks include:

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cost overruns;

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mismanaged construction;

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inferior or improper construction techniques;

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economic changes or downturns during construction;

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a downturn in the real estate market;

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rising interest rates which may prevent sale of the property; and

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failure to sell completed projects in a timely manner.

We attempt to reduce risk by obtaining personal guarantees where possible, and by keeping the loan-to-value ratio of the completed project below specified percentages. We previously reduced risk by selling participations in larger loans to other institutions when possible.

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Residential Real Estate Loans and Home Equity Loans. We generally do not originate traditional long term residential mortgages, but we do issue traditional second mortgage residential real estate loans and home equity lines of credit. Generally, we limit the loan-to-value ratio on our residential real estate loans to 80% at origination. We offer fixed and adjustable rate residential real estate loans with terms of up to 30 years. We typically offer these fixed rate loans through a third party rather than originating and retaining these loans ourselves. We typically originate and retain residential real estate loans only if they have adjustable rates. We also offer home equity lines of credit. Our underwriting criteria and the risks associated with home equity loans and lines of credit are generally the same as those for first mortgage loans. Home equity lines of credit typically have terms of fifteen years or less. We generally limit the extension of credit to 90% of the available equity of each property, although we may extend up to 100% of the available equity.

Commercial Business Loans. We make commercial loans across various lines of business. Commercial loans are generally considered to have greater risk than first or second mortgages on real estate because they may be unsecured, or if they are secured, the value of the security may be difficult to assess and more likely to decrease than real estate.

Equipment loans typically will be made for a term of five years or less at fixed or variable rates, with the loan fully amortized over the term and secured by the financed equipment. Generally, we limit the loan-to-value ratio on these loans to 80% or less at origination. Working capital loans typically have terms not exceeding one year and usually are secured by accounts receivable, inventory, or personal guarantees of the principals of the business. For loans secured by accounts receivable or inventory, principal will typically be repaid as the assets securing the loan are converted into cash, and in other cases principal will typically be due at maturity. Trade letters of credit, standby letters of credit, and foreign exchange will generally be handled through a correspondent bank as agent for the Bank.

Deposit Services

Our principal source of funds is core deposits. We offer a full range of deposit services, including checking accounts, commercial accounts, NOW accounts, savings accounts, and time deposits of various types, ranging from daily money market accounts to long-term certificates of deposit. We solicit these accounts from individuals, businesses, associations, organizations and governmental authorities. Deposit rates are reviewed regularly by senior management of the Bank and the asset/liability management committee (“ALCO”) of the Bank’s board of directors. We believe that the rates we offer are competitive with those offered by other financial institutions in our area.

Credit Cards

The Bank offers Visa branded credit cards for personal and business clients in coordination with a third party vendor known as ServisFirst Bank. Two types of credit cards are offered to consumers and businesses: Visa Platinum Card with no annual fee and Visa Platinum Card with cash back feature that is charged an annual fee. Clients enjoy the freedom of Visa acceptance worldwide with available 24/7 customer support as well as protection and security services.

Merchant Services

The Bank offers merchant transaction processing and equipment for clients in coordination with a third party vendor known as Merchants’ Choice Payment Solutions. Clients enjoy the capability, as well as the specialized equipment, to accept debit and credit card transactions to conduct business with speed, ease and security. Clients are able to accept payments from Visa, MasterCard, American Express and Discover. Equipment and services available include POS terminals, wireless units, web based processing, online debit and TeleCheck services.

Other Banking Services

We offer other community bank services including cashier’s checks, banking by mail, direct deposit, remote deposit capture, United States Savings Bonds, and travelers’ checks. We earn fees for most of these services, in addition to fees earned from debit and credit card transactions, sales of checks, and wire transfers. We are associated with the Plus and Star ATM networks, which are available to our clients throughout the country. We offer merchant banking and credit card services through a correspondent bank. We also offer online banking services, bill payment services, and cash management services.

Market Share

As of June 30, 2016, the most recent date for which FDIC deposit market share data is available, total deposits in the Greenville-Anderson-Mauldin, South Carolina MSA were over $15.4 billion, an increase of approximately 3.5% from $14.8 billion as of June 30, 2015. At June 30, 2016 and 2015, the Bank’s deposits represented 0.53% and 0.62% of this market, respectively.

Research and Development

All costs incurred to establish the technological feasibility of computer software to be sold, leased or otherwise marketed as research and development are expensed as incurred. Once technological feasibility has been established, the subsequent costs of producing, coding and testing the products should be capitalized. The expensing of computer software costs is discontinued when the product is available for general release for customers. The Company did not achieve technological feasibility in connection with the development its digital banking, payments and transaction services business and therefore expensed all computer software purchases and development expenses related to research and development. On September 25, 2015 the Company suspended the development of its digital banking business. During the year ended December 31, 2016 and 2015, we incurred product research and development expenses of approximately $250,000 and $2.2 million, respectively. The 2016 expenses related to remaining monthly contract costs which have since been completed.

Employees

As of March 23, 2017, we had 33 full-time employees and two part-time employees.

Business Segments

The Company reports its activities as four business segments - Community Banking, Transaction Services, Asset Management and Parent Only. In determining proper segment definition, the Company considers the materiality of a potential segment and components of the business about which financial information is available and regularly evaluated, relative to a resource allocation and performance assessment. Please refer to “Note 19 — Business Segments” for further information on the reporting for the four business segments.

Supervision and Regulation

Both the Company and the Bank are subject to extensive state and federal banking laws and regulations that impose specific requirements or restrictions on and provide for general regulatory oversight of virtually all aspects of our operations. These laws and regulations are generally intended to protect depositors, federal insurance deposit funds, and the banking system as a whole and not our shareholders. Changes in applicable laws or regulations may have a material effect on our business and prospects.

The following discussion is not intended to be a complete list of all the activities regulated by the banking laws or of the impact of such laws and regulations on our operations. It is intended only to briefly summarize some material provisions. The following summary is qualified by reference to the statutory and regulatory provisions discussed.

General Overview

Compliance with legal and regulatory requirements is a highly complex and integral part of our day-to-day operations. Our products and services are generally subject to federal, state and local laws and regulations, including:

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anti-money laundering laws;

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privacy and information safeguard laws;

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consumer protection laws; and

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bank regulations.

These laws are often evolving and sometimes ambiguous or inconsistent, and the extent to which they apply to us or our customers is at times unclear. Any failure to comply with applicable law — either by us or by our third-party vendors and service providers, over which we have limited legal and practical control — could result in restrictions on our ability to provide our products and services, as well as the imposition of civil fines and criminal penalties and the suspension or revocation of a license or registration required to sell our products and services. See “Risk Factors” under Part I, Item 1A for additional discussion regarding the potential effects of changes in laws and regulations to which we are subject and failure to comply with existing or future laws and regulations.

We continually monitor and enhance our compliance program to stay current with the most recent legal and regulatory changes. We also continue to implement policies and programs and to adapt our business practices and strategies to help us comply with current legal standards, as well as with new and changing legal requirements affecting particular services or the conduct of our business generally. These programs include dedicated compliance personnel and training and monitoring programs, as well as support and guidance to our third-party vendors and service providers on compliance programs.

Privacy and Information Safeguard Laws

In the ordinary course of our business, we collect certain types of data, which subjects us to certain privacy and information security laws in the United States, including, for example, the Gramm-Leach-Bliley Act of 1999, or the “GLBA,” and other laws or rules designed to regulate consumer information and mitigate identity theft. We are also subject to privacy laws of various states. These state and federal laws impose obligations with respect to the collection, processing, storage, disposal, use and disclosure of personal information, and require that financial institutions have in place policies regarding information privacy and security. In addition, under federal and certain state financial privacy laws, we must provide notice to consumers of our policies and practices for sharing nonpublic information with third parties, provide advance notice of any changes to our policies and, with limited exceptions, give consumers the right to prevent use of their nonpublic personal information and disclosure of it to unaffiliated third parties. Certain state laws may, in some circumstances, require us to notify affected individuals of security breaches of computer databases that contain their personal information. These laws may also require us to notify state law enforcement, regulators or consumer reporting agencies in the event of a data breach, as well as businesses and governmental agencies that own data. In order to comply with the privacy and information safeguard laws, we have confidentiality/information security standards and procedures in place for our business activities and with network acceptance members and our third-party vendors and service providers. Privacy and information security laws evolve regularly, requiring us to adjust our compliance program on an ongoing basis and presenting compliance challenges.

Consumer Protection Laws

We are subject to state and federal consumer protection laws, including laws prohibiting unfair and deceptive practices, regulating electronic fund transfers and protecting consumer nonpublic information. We believe that we have appropriate procedures in place for compliance with these consumer protection laws, but many issues regarding our service have not yet been addressed by the federal and state agencies charged with interpreting the applicable laws.

Although not expressly required to do so under the Electronic Fund Transfer Act and Regulation E of the Federal Reserve, we disclose, consistent with banking industry practice, the terms of our electronic fund transfer services to consumers prior to their use of the service, provide 21 days’ advance notice of material changes, establish specific error resolution procedures and timetables, and limit customer liability for transactions that are not authorized by the consumer.

Recent Legislative and Regulatory Developments

Although the financial crisis has now passed, two legislative and regulatory responses - the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) and the Basel III-based capital rules – continue to have an impact on our operations.

The Dodd-Frank Wall Street Reform and Consumer Protection Act. On July 21, 2010, President Obama signed into law the Dodd-Frank Act. The Dodd-Frank Act specifically impacts financial institutions in numerous ways, including:

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The creation of a Financial Stability Oversight Council responsible for monitoring and managing systemic risk;

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Granting additional authority to the Board of Governors of the Federal Reserve “(Federal Reserve”) to regulate certain types of nonbank financial companies;

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Granting new authority to the FDIC as liquidator and receiver;

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Changing the manner in which deposit insurance assessments are made;

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Requiring regulators to modify capital standards;

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Establishing the Consumer Financial Protection Bureau (the “CFPB”);

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Capping interchange fees that banks with assets of $10 billion or more charge merchants for debit card transactions;

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Imposing more stringent requirements on mortgage lenders; and

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Limiting banks’ proprietary trading activities.

There are many provisions in the Dodd-Frank Act mandating regulators to adopt new regulations and conduct studies upon which future regulation may be based. While some have been issued, many remain to be issued. Governmental intervention and new regulations could materially and adversely affect our business, financial condition and results of operations.

Basel Capital Standards. Regulatory capital rules released in July 2013 to implement capital standards referred to as Basel III and developed by an international body known as the Basel Committee on Banking Supervision, impose higher minimum capital requirements for bank holding companies and banks. The rules apply to all national and state banks and savings associations, regardless of size and bank holding companies and savings and loan holding companies with more than $1 billion in total consolidated assets. More stringent requirements are imposed on “advanced approaches” banking organizations— those organizations with $250 billion or more in total consolidated assets, $10 billion or more in total foreign exposures, or that have opted in to the Basel II capital regime. The requirements in the rule began to phase in on January 1, 2015 for the Bank. The requirements in the rule will be fully phased in by January 1, 2019.

The rule includes certain new and higher risk-based capital and leverage requirements than those currently in place. Specifically, the following minimum capital requirements apply to the Bank:

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a new common equity Tier 1 risk-based capital ratio of 4.5%;

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a Tier 1 risk-based capital ratio of 6% (increased from the former 4% requirement);

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a total risk-based capital ratio of 8% (unchanged from the former requirement); and

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a leverage ratio of 4% (also unchanged from the former requirement).

Under the rule, Tier 1 capital is redefined to include two components: Common Equity Tier 1 capital and additional Tier 1 capital. The new and highest form of capital, Common Equity Tier 1 capital, consists solely of common stock (plus related surplus), retained earnings, accumulated other comprehensive income, and limited amounts of minority interests that are in the form of common stock. Additional Tier 1 capital includes other perpetual instruments historically included in Tier 1 capital, such as noncumulative perpetual preferred stock Tier 1 capital generally consists of instruments that previously qualified as Tier 2 capital plus instruments that the rule has disqualified from Tier 1 capital treatment. Cumulative perpetual preferred stock, formerly includable in Tier 1 capital, is now included only in Tier 2 capital; except that the rule permits bank holding companies with less than $15 billion in total consolidated assets to continue to include trust preferred securities and cumulative perpetual preferred stock issued before May 19, 2010 in Tier 1 capital (but not in Common Equity Tier 1 capital), subject to certain restrictions. Accumulated other comprehensive income (AOCI) is

presumptively included in Common Equity Tier 1 capital and often would operate to reduce this category of capital. The rule provided a one-time opportunity at the end of the first quarter of 2015 for covered banking organizations to opt out of much of this treatment of AOCI. We made this opt-out election and, as a result, will retain the pre-existing treatment for AOCI.

In addition, in order to avoid restrictions on capital distributions or discretionary bonus payments to executives, a covered banking organization must maintain a “capital conservation buffer” on top of its minimum risk-based capital requirements. This buffer must consist solely of Tier 1 Common Equity, but the buffer applies to all three measurements (Common Equity Tier 1, Tier 1 capital and total capital). The capital conservation buffer will be phased in incrementally over time, becoming fully effective on January 1, 2019 and will consist of an additional amount of common equity equal to 2.5% of risk-weighted assets. As of January 1, 2016, we are required to hold a capital conservation buffer of 1.25%, increasing by 0.625% each successive year until 2019.

In general, the rules have had the effect of increasing capital requirements by increasing the risk weights on certain assets, including high volatility commercial real estate, certain loans past due 90 days or more or in nonaccrual status, mortgage servicing rights not includable in Common Equity Tier 1 capital, equity exposures, and claims on securities firms, that are used in the denominator of the three risk-based capital ratios.

Volcker Rule. Section 619 of the Dodd-Frank Act, known as the “Volcker Rule”, prohibits any bank, bank holding company, or affiliate (referred to collectively as “banking entities”) from engaging in two types of activities: “proprietary trading” and the ownership or sponsorship of private equity or hedge funds that are referred to as “covered funds”. Proprietary trading is, in general, trading in securities on a short-term basis for a banking entity’s own account. Funds subject to the ownership and sponsorship prohibition are those not required to register with the SEC because they have only accredited investors or no more than 100 investors. In December 2013, our primary federal regulators, the Federal Reserve and the FDIC, together with other federal banking agencies, the SEC, and the Commodity Futures Trading Commission, finalized a regulation to implement the Volcker Rule. At December 31, 2016, the Company has evaluated our securities portfolio and has determined that we do not hold any covered funds.

Independence Bancshares, Inc.

The Company owns 100% of the outstanding capital stock of the Bank, and therefore is considered to be a bank holding company under the federal Bank Holding Company Act of 1956 (the “BHCA”). As a result, the Company is primarily subject to the supervision, examination and reporting requirements of the Federal Reserve under the BHCA and its regulations promulgated thereunder. Moreover, as a bank holding company of a bank located in South Carolina, the Company is also are subject to the South Carolina Banking and Branching Efficiency Act.

Permitted Activities. Under the BHCA, a bank holding company is generally permitted to engage in or acquire direct or indirect control of more than 5% of the voting shares of any company engaged in the following activities:

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banking, managing or controlling banks;

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furnishing services to or performing services for our subsidiaries; and

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any activity that the Federal Reserve determines to be so closely related to banking as to be a proper incident to the business of banking.

As a bank holding company we also can elect to be treated as a “financial holding company,” which would allow us to engage in a broader array of activities. In summary, a financial holding company can engage in activities that are financial in nature or incidental or complimentary to financial activities, including insurance underwriting, sales and brokerage activities, providing financial and investment advisory services, underwriting services and limited merchant banking activities. We have not sought financial holding company status but may elect such status in the future as our business matures. If we were to elect financial holding company status, each insured depository institution we control would have to be well capitalized, well managed, and have at least a satisfactory rating under the Community Reinvestment Act, or “CRA” (discussed below).

The Federal Reserve has the authority to order a bank holding company or its subsidiaries to terminate any of these activities or to terminate its ownership or control of any subsidiary when it has reasonable cause to believe that the bank holding company’s continued ownership, activity or control constitutes a serious risk to the financial safety, soundness or stability of it or any of its bank subsidiaries.

Change in Control. Two statutes, the BHCA and the Change in Bank Control Act, together with regulations promulgated under them, require some form of regulatory review before any company may acquire “control” of a bank or a bank holding company. Under the BHCA, control is deemed to exist if a company acquires 25% or more of any class of voting securities of a bank holding company; controls the election of a majority of the members of the board of directors; or exercises a controlling influence over the

management or policies of a bank or bank holding company. In guidance issued in 2008, the Federal Reserve has stated that it would not expect control to exist if an investor acquires, in aggregate, less than 33% of the total equity of a bank or bank holding company (voting and nonvoting equity), provided such investor’s ownership does not include 15% or more of any class or voting securities. Prior Federal Reserve approval is necessary before an entity acquires sufficient control to become a bank holding company. Natural persons, certain non-business trusts, and other entities are not treated as companies (or bank holding companies), and their acquisitions are not subject to the review under the Bank Holding Company Act. State laws generally, including South Carolina law, require state approval before an acquirer may become the holding company of a state bank.

Under the Change in Bank Control Act, a person or company is required to file a notice with the Federal Reserve if it will, as a result of the transaction, own or control 10% or more of any class of voting securities or direct the management or policies of a bank or bank holding company and either if the bank or bank holding company has registered securities or if the acquirer would be the largest holder of that class of voting securities after the acquisition. For a change in control at the holding company level, both the Federal Reserve and the subsidiary bank’s primary federal regulator must approve the change in control; at the bank level, only the bank’s primary regulator is involved. Transactions subject to the BHCA are exempt from Change in Bank Control Act requirements. For state banks, state laws, including that of South Carolina, typically require approval by the state bank regulator as well.

Source of Strength. There are a number of obligations and restrictions imposed by law and regulatory policy on bank holding companies with regard to their depository institution subsidiaries that are designed to minimize potential loss to depositors and to the FDIC insurance funds in the event that the depository institution becomes in danger of defaulting under its obligations to repay deposits. Under a policy of the Federal Reserve, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit resources to support such institutions in circumstances where it might not do so absent such policy. Under the Federal Deposit Insurance Corporate Improvement Act of 1991, to avoid receivership of its insured depository institution subsidiary, a bank holding company is required to guarantee the compliance of any insured depository institution subsidiary that may become “undercapitalized” within the terms of any capital restoration plan filed by such subsidiary with its appropriate federal banking agency up to the lesser of (i) an amount equal to 5% of the institution’s total assets at the time the institution became undercapitalized, or (ii) the amount which is necessary (or would have been necessary) to bring the institution into compliance with all applicable capital standards as of the time the institution fails to comply with such capital restoration plan.

Under the BHCA, the Federal Reserve may require a bank holding company to terminate any activity or relinquish control of a non-bank subsidiary, other than a non-bank subsidiary of a bank, upon the Federal Reserve’s determination that such activity or control constitutes a serious risk to the financial soundness or stability of any depository institution subsidiary of a bank holding company. Further, federal bank regulatory authorities have additional discretion to require a bank holding company to divest itself of any bank or non-bank subsidiaries if the agency determines that divestiture may aid the depository institution’s financial condition.

In addition, the “cross guarantee” provisions of the FDIA require insured depository institutions under common control to reimburse the FDIC for any loss suffered or reasonably anticipated by the FDIC as a result of the default of a commonly controlled insured depository institution or for any assistance provided by the FDIC to a commonly controlled insured depository institution in danger of default. The FDIC’s claim for damages is superior to claims of shareholders of the insured depository institution or its holding company, but is subordinate to claims of depositors, secured creditors and holders of subordinated debt (other than affiliates) of the commonly controlled insured depository institutions.

The FDIA also provides that amounts received from the liquidation or other resolution of any insured depository institution by any receiver must be distributed (after payment of secured claims) to pay the deposit liabilities of the institution prior to payment of any other general or unsecured senior liability, subordinated liability, general creditor or shareholder. This provision would give depositors a preference over general and subordinated creditors and shareholders in the event a receiver is appointed to distribute the assets of the Bank.

Further, any loans by a bank holding company to a subsidiary bank are subordinate in right of payment to deposits and certain other indebtedness of the subsidiary bank. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank at a certain level would be assumed by the bankruptcy trustee and entitled to priority payment.

Capital Requirements. Although the Company is not subject to the same regulatory capital requirements that apply to the Bank, the Federal Reserve nevertheless may impose specific requirements on the Company or direct the Company to raise capital either to be held at the Company or to be contributed to the Bank. We may borrow money to make a capital contribution to the Bank, and these loans may be repaid from dividends paid from the Bank to the Company. We are also able to raise capital for contribution to the Bank by issuing securities without having to receive regulatory approval, subject to compliance with federal and state securities laws.

Dividends. Since the Company is a bank holding company, its ability to declare and pay dividends is dependent on certain federal and state regulatory considerations, including the guidelines of the Federal Reserve. The Federal Reserve has issued a policy statement

regarding the payment of dividends by bank holding companies. In general, the Federal Reserve’s policies provide that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the bank holding company appears consistent with the organization’s capital needs, asset quality, and overall financial condition. The Federal Reserve’s policies also require that a bank holding company serve as a source of financial strength to its subsidiary banks by standing ready to use available resources to provide adequate capital funds to those banks during periods of financial stress or adversity and by maintaining the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks where necessary. Further, under the prompt corrective action regulations, the ability of a bank holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized. These regulatory policies could affect the ability of the Company to pay dividends or otherwise engage in capital distributions.

In addition, since the Company is a legal entity separate and distinct from the Bank and does not conduct stand-alone operations, its ability to pay dividends depends on the ability of the Bank to pay dividends to it, which is also subject to regulatory restrictions as described below in “Independence National Bank — Dividends.”

South Carolina State Regulation. As a South Carolina bank holding company under the South Carolina Banking and Branching Efficiency Act, we are subject to limitations on sale or merger and to regulation by the South Carolina Board of Financial Institutions (the “SCBFI”). We are not required to obtain the approval of the SCBFI prior to acquiring the capital stock of a national bank, but we must notify them at least 15 days prior to doing so. We must obtain approval from the SCBFI prior to engaging in the acquisition of a South Carolina state chartered bank or another South Carolina bank holding company.

Independence National Bank

The Bank operates as a national banking association incorporated under the laws of the United States and subject to examination by the OCC. Deposits in the Bank are insured by the FDIC up to a maximum amount, which is currently $250,000 per depositor. The OCC and the FDIC regulate or monitor virtually all areas of the Bank’s operations, including:

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security devices and procedures;

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adequacy of capitalization and loss reserves;

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loans;

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investments;

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borrowings;

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deposits;

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mergers;

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issuances of securities;

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payment of dividends;

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interest rates payable on deposits;

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interest rates or fees chargeable on loans;

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establishment of branches;

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corporate reorganizations;

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maintenance of books and records; and

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adequacy of staff training to carry on safe lending and deposit gathering practices.

These agencies, and the federal and state laws applicable to the Bank’s operations, extensively regulate various aspects of our banking business, including among other things, permissible types and amounts of loans, investments and other activities, capital adequacy, branching, interest rates on loans and on deposits, the maintenance of reserves on demand deposit liabilities, and the safety and soundness of our banking practices.

Prompt Corrective Action. As an insured depository institution, the Bank is required to comply with the capital requirements under the FDIA and the OCC’s prompt corrective action regulations, which set forth five capital categories, each with specific regulatory consequences. Under these regulations, the categories are:

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Well Capitalized — The institution exceeds the required minimum level for each relevant capital measure. A well-capitalized institution (i) has a total risk-based capital ratio of 10% or greater, (ii) has a Tier 1 risk-based capital ratio of 8% or greater, (iii) has a common equity Tier 1 risk-based capital ratio of 6.5% or greater, (iv) has a leverage capital ratio of 5% or greater, and (v) is not subject to any order or written directive to meet and maintain a specific capital level for any capital measure. In addition, an institution is well capitalized only if it is not subject to any written agreement, order or capital directive, or prompt corrective action directive issued by the OCC to meet and maintain a specific capital level for any capital measure.

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Adequately Capitalized — The institution meets the required minimum level for each relevant capital measure. No capital distribution may be made that would result in the institution becoming undercapitalized. An adequately capitalized institution (i) has a total risk-based capital ratio of 8% or greater, (ii) has a Tier 1 risk-based capital ratio of 6% or greater, and (iii) has a common equity Tier 1 risk-based capital ratio of 4.5%, and (iv) has a leverage capital ratio of 4% or greater.

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Undercapitalized — The institution fails to meet the required minimum level for any relevant capital measure. An undercapitalized institution (i) has a total risk-based capital ratio of less than 8%, (ii) has a Tier 1 risk-based capital ratio of less than 6%, (iii) has a common equity Tier 1 risk-based capital ratio is less than 4.5% or greater, or (iv) has a leverage capital ratio of less than 4%.

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Significantly Undercapitalized — The institution is significantly below the required minimum level for any relevant capital measure. A significantly undercapitalized institution (i) has a total risk-based capital ratio of less than 6%, (ii) has a Tier 1 risk-based capital ratio of less than 4%, (iii) has a common equity Tier 1 risk-based capital ratio of less than 3% or greater, or (iv) has a leverage capital ratio of less than 3%.

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Critically Undercapitalized — The institution fails to meet a critical capital level set by the appropriate federal banking agency. A critically undercapitalized institution has a ratio of tangible equity to total assets that is equal to or less than 2%.

If the OCC determines, after notice and an opportunity for hearing, that the Bank is in an unsafe or unsound condition, the regulator is authorized to reclassify the Bank to the next lower capital category (other than critically undercapitalized) and require the submission of a plan to correct the unsafe or unsound condition.

If a bank is not well capitalized, it cannot accept brokered time deposits without prior regulatory approval, and if approval is granted, it cannot offer an effective yield in excess of 75 basis points on interest paid on deposits of comparable size and maturity in such institution’s normal market area for deposits accepted from within its normal market area or the national rate paid on deposits of comparable size and maturity for deposits accepted outside a bank’s normal market area.

If the Bank becomes less than adequately capitalized, it would become subject to increased regulatory oversight and would be increasingly restricted in the scope of its permissible activities. The Bank would be required to adopt a capital restoration plan acceptable to the OCC that is subject to a limited performance guarantee by the Company. Each company having control over an undercapitalized institution also must provide a limited guarantee that the institution will comply with its capital restoration plan. Except under limited circumstances consistent with an accepted capital restoration plan, an undercapitalized institution may not grow. An undercapitalized institution may not acquire another institution, establish additional branch offices or engage in any new line of business unless determined by the appropriate federal banking agency to be consistent with an accepted capital restoration plan, or unless the FDIC determines that the proposed action will further the purpose of prompt corrective action. If an undercapitalized institution fails to submit an acceptable capital restoration plan or fails in any material respect to implement a plan accepted by the agency, the appropriate federal banking agency may take any action authorized for a significantly undercapitalized institution. Significantly undercapitalized categorized depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become categorized as adequately capitalized, requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. A critically undercapitalized institution is subject to having a receiver or conservator appointed to manage its affairs and for loss of its charter to conduct banking activities.

An insured depository institution may not pay a management fee to a bank holding company controlling that institution or any other person having control of the institution if, after making the payment, the institution, would be undercapitalized. In addition, an institution cannot make a capital distribution, such as a dividend or other distribution that is in substance a distribution of capital to the owners of the institution if following such a distribution the institution would be undercapitalized. Thus, if payment of such a management fee or capital distribution would cause the Bank to become undercapitalized, it could not pay a management fee or dividend to the bank holding company.

Standards for Safety and Soundness. The FDIA also requires the federal banking regulatory agencies to prescribe, by regulation or guideline, operational and managerial standards for all insured depository institutions relating to: (i) internal controls, information systems and internal audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) interest rate risk exposure; and (v) asset growth. The agencies also must prescribe standards for asset quality, earnings, and stock valuation, as well as standards for compensation, fees and benefits. The federal banking agencies have adopted regulations and Interagency Guidelines Prescribing Standards for Safety and Soundness to implement these required standards. These guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. Under the regulations, if the OCC determines that the Bank fails to meet any standards prescribed by the guidelines, the agency may require the Bank to submit to the agency an acceptable plan to achieve compliance with the standard, as required by the OCC. The final regulations establish deadlines for the submission and review of such safety and soundness compliance plans.

Regulatory Examination. The OCC requires the Bank to prepare annual reports on the Bank’s financial condition and to conduct an annual audit of its financial affairs in compliance with its minimum standards and procedures. All insured institutions must undergo regular on-site examinations by their appropriate banking agency. The cost of examinations of insured depository institutions and any affiliates may be assessed by the appropriate federal banking agency against each institution or affiliate as it deems necessary or appropriate. Insured institutions are required to submit annual reports to the FDIC, their federal regulatory agency, and state supervisor when applicable. The FDIC has developed a method for insured depository institutions to provide supplemental disclosure of the estimated fair market value of assets and liabilities, to the extent feasible and practicable, in any balance sheet, financial statement, report of condition or any other report of any insured depository institution. The federal banking regulatory agencies prescribe, by regulation, standards for all insured depository institutions and depository institution holding companies relating, among other things, to the following:

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internal controls;

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information systems and audit systems;

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loan documentation;

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credit underwriting;

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interest rate risk exposure; and

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asset quality.

Insurance of Accounts and Regulation by the FDIC. The Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund of the FDIC. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC insured institutions. It also may prohibit any FDIC insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the insurance fund. The FDIC also has the authority to initiate enforcement actions against savings institutions, after giving the OCC an opportunity to take such action, and may terminate the deposit insurance if it determines that the institution has engaged in unsafe or unsound practices or is in an unsafe or unsound condition.

As an FDIC-insured bank, the Bank must pay deposit insurance assessments to the FDIC based on its average total assets minus its average tangible equity. The Bank’s assessment rates are currently based on its risk classification (i.e., the level of risk it poses to the FDIC’s deposit insurance fund). Institutions classified as higher risk pay assessments at higher rates than institutions that pose a lower risk. In addition, following the fourth consecutive quarter (and any applicable phase-in period) where an institution’s total consolidated assets equal or exceed $10 billion, the FDIC will use a performance score and a loss-severity score to calculate an initial assessment rate. In calculating these scores, the FDIC uses an institution’s capital level and regulatory supervisory ratings and certain financial measures to assess an institution’s ability to withstand asset-related stress and funding-related stress. The FDIC also has the ability to make discretionary adjustments to the total score based upon significant risk factors that are not adequately captured in the calculations. In addition to ordinary assessments described above, the FDIC has the ability to impose special assessments in certain instances.

The FDIC’s deposit insurance fund is currently underfunded, and the FDIC has raised assessment rates and imposed special assessments on certain institutions during recent years to raise funds. Under the Dodd-Frank Act, the minimum designated reserve ratio for the deposit insurance fund is 1.35% of the estimated total amount of insured deposits. In October 2010, the FDIC adopted a restoration plan to ensure that the fund reserve ratio reaches 1.35% by September 30, 2020, as required by the Dodd-Frank Act. At least semi-annually, the FDIC will update its loss and income projections for the fund and, if needed, will increase or decrease assessment rates, following notice-and-comment rulemaking if required.

In addition, FDIC insured institutions are required to pay a Financing Corporation assessment to fund the interest on bonds issued to resolve thrift failures in the 1980s. These assessments, which may be revised based upon the level of deposits, will continue until the bonds mature in the years 2017 through 2019. The amount assessed on individual institutions is in addition to the amount, if any, paid for deposit insurance according to the FDIC’s risk-related assessment rate schedules. Assessment rates may be adjusted quarterly to reflect changes in the assessment base.

The FDIC may terminate the deposit insurance of any insured depository institution, including the Bank, if it determines after a hearing that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the OCC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. Management of the Bank is not aware of any practice, condition or violation that might lead to termination of the Bank’s deposit insurance.

Transactions with Affiliates and Insiders. The Company is a legal entity separate and distinct from the Bank. Various legal limitations restrict the Bank from lending or otherwise supplying funds to the Company. The Company and the Bank are subject to Sections 23A and 23B of the Federal Reserve Act and Federal Reserve Regulation W.

Section 23A of the Federal Reserve Act places limits on the amount of loans or extensions of credit by a bank to any affiliate, including its holding company and on a bank’s investments in, or certain other transactions with, affiliates and on the amount of advances to third parties collateralized by the securities or obligations of any affiliates of the bank. The aggregate of all covered transactions is limited in amount, as to any one affiliate, to 10% of the Bank’s capital and surplus and, as to all affiliates combined, to 20% of the Bank’s capital and surplus. Furthermore, within the foregoing limitations as to amount, each covered transaction must meet specified collateral requirements. The Bank is forbidden to purchase low quality assets from an affiliate.

Section 23B of the Federal Reserve Act, among other things, prohibits an institution from engaging in certain transactions with certain affiliates unless the transactions are on terms substantially the same, or at least as favorable to such institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies. Regulation W generally excludes all non-bank and non-savings association subsidiaries of banks from treatment as affiliates, except to the extent that the Federal Reserve decides to treat these subsidiaries as affiliates. The regulation also limits the amount of loans that can be purchased by a bank from an affiliate to not more than 100% of the bank’s capital and surplus.

The affiliates of a bank include any holding company of the bank, any other company under common control with the bank (including any company controlled by the same shareholders who control the bank), any subsidiary of the bank that is itself a bank, any company in which the majority of the directors or trustees also constitute a majority of the directors or trustees of the bank or holding company of the bank, any company sponsored and advised on a contractual basis by the bank or an affiliate, and any mutual fund advised by a bank or any of the bank’s affiliates. Regulation W generally excludes all non-bank and non-savings association subsidiaries of banks from treatment as affiliates, except to the extent that the Federal Reserve decides to treat these subsidiaries as affiliates.

The Bank is also subject to certain restrictions on extensions of credit to executive officers, directors, certain principal shareholders, and their related interests. Such extensions of credit (i) must be made on substantially the same terms, including interest rates, and collateral, as those prevailing at the time for comparable transactions with third parties and (ii) must not involve more than the normal risk of repayment or present other unfavorable features.

Dividends. The Company’s principal source of cash flow, including cash flow to pay dividends to its shareholders, is dividends it receives from the Bank. Statutory and regulatory limitations apply to the Bank’s payment of dividends to the Company. As a general rule, the amount of a dividend may not exceed, without prior regulatory approval, the sum of net income in the calendar year to date and the retained net earnings of the immediately preceding two calendar years. A depository institution may not pay any dividend if payment would cause the institution to become undercapitalized or if it already is undercapitalized. The OCC may prevent the payment of a dividend if it determines that the payment would be an unsafe and unsound banking practice. The OCC also has advised that a national bank should generally pay dividends only out of current operating earnings.

Branching. Federal legislation permits out-of-state acquisitions by bank holding companies, interstate branching by banks, and interstate merging by banks. The Dodd-Frank Act removed previous state law restrictions on de novo interstate branching in states such as South Carolina. This change effectively permits out-of-state banks to open de novo branches in states where the laws of such state would permit a bank chartered by such state to open a de novo branch.

Community Reinvestment Act. The CRA requires that the OCC evaluate the record of the Bank in meeting the credit needs of its local community, including low and moderate income neighborhoods. These factors are also considered in evaluating mergers,

acquisitions, and applications to open a branch or facility. Failure to adequately meet these criteria could impose additional requirements and limitations on the Bank.

The GLBA made various changes to the CRA. Among other changes, CRA agreements with private parties must be disclosed and annual CRA reports must be made available to a bank’s primary federal regulator. A bank holding company will not be permitted to become a financial holding company and no new activities authorized under the GLBA may be commenced by a holding company or by a bank financial subsidiary if any of its bank subsidiaries received less than a satisfactory CRA rating in its latest CRA examination.

As of February 11, 2013, the date of the most recent examination, the Bank received a satisfactory CRA rating.

Consumer Protection Regulations. Activities of the Bank are subject to a variety of statutes and regulations designed to protect consumers. Interest and other charges collected or contracted for by the Bank are subject to state usury laws and federal laws concerning interest rates. The Bank’s loan operations are also subject to federal laws applicable to credit transactions, such as:

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the Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;

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the Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;

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the Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;

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the Fair Credit Reporting Act of 1978, as amended by the Fair and Accurate Credit Transactions Act, governing the use and provision of information to credit reporting agencies, certain identity theft protections, and certain credit and other disclosures;

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the Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; and

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the rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws.

The deposit operations of the Bank also are subject to:

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the Federal Deposit Insurance Act, which among other things, limits the amount of deposit insurance available per account to $250,000 and imposes other limits on deposit-taking;

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the Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;

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the Electronic Funds Transfer Act and Regulation E which governs automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services; and

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the Truth in Savings Act and Regulation DD, which requires depository institutions to provide disclosures so that consumers can make meaningful comparisons about depository institutions and accounts.

Anti-Money Laundering. Financial institutions must maintain anti-money laundering programs that include established internal policies, procedures, and controls; a designated compliance officer; an ongoing employee training program; and testing of the program by an independent audit function. The Company and the Bank are also prohibited from entering into specified financial transactions and account relationships and must meet enhanced standards for due diligence and “knowing your customer” in their dealings with foreign financial institutions and foreign customers. Financial institutions must take reasonable steps to conduct enhanced scrutiny of account relationships to guard against money laundering and to report any suspicious transactions, and recent laws provide law enforcement authorities with increased access to financial information maintained by banks. Anti-money laundering obligations have been substantially strengthened as a result of the USA PATRIOT Act, enacted in 2001 and renewed through 2019. Bank regulators routinely examine institutions for compliance with these obligations and are required to consider compliance in connection with the regulatory review of applications. The regulatory authorities have been active in imposing “cease and desist” orders and money penalty sanctions against institutions that have not complied with these requirements.

USA PATRIOT Act and Bank Secrecy Act. The USA PATRIOT Act amended, in part, the Bank Secrecy Act and provides for the facilitation of information sharing among governmental entities and financial institutions for the purpose of combating terrorism

and money laundering by enhancing anti-money laundering and financial transparency laws, as well as enhanced information collection tools and enforcement mechanics for the U.S. government, including: (i) requiring standards for verifying customer identification at account opening; (ii) rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering; (iii) reports by nonfinancial trades and businesses filed with the Treasury Department’s Financial Crimes Enforcement Network for transactions exceeding $10,000; and (iv) filing suspicious activities reports if a bank believes a customer may be violating U.S. laws and regulations and requires enhanced due diligence requirements for financial institutions that administer, maintain, or manage private bank accounts or correspondent accounts for non-U.S. persons. Bank regulators routinely examine institutions for compliance with these obligations and are required to consider compliance in connection with the regulatory review of applications.

Under the USA PATRIOT Act, the FBI can send to the banking regulatory agencies lists of the names of persons suspected of involvement in terrorist activities. The Bank can be requested to search its records for any relationships or transactions with persons on those lists. If the Bank finds any relationships or transactions, it must file a suspicious activity report and contact the FBI.

OFAC is responsible for helping to insure that United States entities do not engage in transactions with “enemies” of the United States, as defined by various Executive Orders and Acts of Congress. OFAC has sent, and will send, our banking regulatory agencies lists of names of persons and organizations suspected of aiding, harboring or engaging in terrorist acts. If the Bank finds a name on any transaction, account or wire transfer that is on an OFAC list, it must freeze such account, file a suspicious activity report and notify the FBI. The Bank has appointed an OFAC compliance officer to oversee the inspection of its accounts and the filing of any notifications. The Bank actively checks high-risk OFAC areas such as new accounts, wire transfers and customer files. The Bank performs these checks utilizing software, which is updated each time a modification is made to the lists provided by OFAC and other agencies of Specially Designated Nationals and Blocked Persons.

Privacy, Data Security and Credit Reporting. Financial institutions are required to disclose their policies for collecting and protecting confidential information. Customers generally may prevent financial institutions from sharing nonpublic personal financial information with nonaffiliated third parties except under narrow circumstances, such as the processing of transactions requested by the consumer. Additionally, financial institutions generally may not disclose consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing to consumers. It is the Bank’s policy not to disclose any personal information unless required by law. The OCC and the federal banking agencies have prescribed standards for maintaining the security and confidentiality of consumer information. The Bank is subject to such standards, as well as standards for notifying consumers in the event of a security breach.

Recent cyberattacks against banks and other institutions that resulted in unauthorized access to confidential customer information have prompted the Federal banking agencies to issue several warnings and extensive guidance on cyber security. The agencies are likely to devote more resources to this part of their safety and soundness examination than they have in the past.

In addition, pursuant to the Fair and Accurate Credit Transactions Act of 2003 (the “FACT Act”) and the implementing regulations of the federal banking agencies and the Federal Trade Commission, the Bank is required to have in place an “identity theft red flags” program to detect, prevent, and mitigate identity theft. The Bank has implemented an identity theft red flags program designed to meet the requirements of the FACT Act and the joint final rules. Additionally, the FACT Act amends the Fair Credit Reporting Act to generally prohibit a person from using information received from an affiliate to make a solicitation for marketing purposes to a consumer, unless the consumer is given notice and a reasonable opportunity and a reasonable and simple method to opt out of the making of such solicitations.

Federal Home Loan Bank System. The Bank is a member of the Federal Home Loan Bank (“FHLB”) of Atlanta, which is one of 12 regional FHLBs that administer home financing credit for depository institutions. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans or advances to members in accordance with policies and procedures established by the Board of Directors of the FHLB, which are subject to the oversight of the Federal Housing Financing Board. All advances from the FHLB, which are subject to the oversight of the Federal Housing Finance Board. All advances from the FHLB are required to be fully secured by sufficient collateral as determined by the FHLB.

Effect of Governmental Monetary Policies. Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the U.S. government and its agencies. The Federal Reserve’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the Federal Reserve have major effects upon the levels of bank loans, investments and deposits through its open market operations in U.S. government securities and through its regulation of the discount rate on borrowings of member banks and the reserve requirements against member bank deposits. It is not possible to predict the nature or impact of future changes in monetary and fiscal policies. On December 15, 2016, the Federal

Open Market Committee raised the federal funds target rate by 25 basis points, the second increase in as many years. An additional increase to the federal funds target rate of 25 basis points was made on March 16, 2017. Further increases may occur in 2017, but, if so, there is no announced timetable.

Incentive Compensation. The Dodd-Frank Act requires the federal bank regulators and the SEC to establish joint regulations or guidelines prohibiting incentive-based payment arrangements at specified regulated entities having at least $1 billion in total assets that encourage inappropriate risks by providing an executive officer, employee, director or principal stockholder with excessive compensation, fees, or benefits or that could lead to material financial loss to the entity. In addition, these regulators must establish regulations or guidelines requiring enhanced disclosure to regulators of incentive-based compensation arrangements. The agencies proposed such regulations in April 2011. However, the 2011 proposal was replaced with a new proposal in May 2016, which makes explicit that the involvement of risk management and control personnel includes not only compliance, risk management and internal audit, but also legal, human resources, accounting, financial reporting and finance roles responsible for identifying, measuring, monitoring or controlling risk-taking. A final rule had not been adopted as of December 31, 2016.

In June 2010, the Federal Reserve, the OCC and the FDIC issued a comprehensive final guidance on incentive compensation policies intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The guidance, which covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking organization’s incentive compensation agreements should (i) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors.

The Federal Reserve will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as the Company, that are not “large, complex banking organizations.” These reviews will be tailored to each organization based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation agreements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the organization’s supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a banking organization if its incentive compensation agreements, or related risk-management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.

Corporate Information

Our corporate headquarters is located at 500 East Washington Street, Greenville, South Carolina, 29601, and our telephone number is (864) 672-1776. Our Bank primary website is located at www.independencenb.com and our on-line consumer lending website is located at www.inb-loans.com. The information on these websites are not incorporated by reference into this report.

We file annual, quarterly and current reports, proxy statements and other information with the SEC. You may read and copy any reports, statements or other information that we file at the SEC’s public reference facilities at 100 F Street, N.E., Washington, DC 20549. Please call the SEC at (800) SEC-0330 for further information regarding the public reference facilities. The SEC maintains a website, http://www.sec.gov, which contains reports, proxy statements and information statements and other information regarding registrants that file electronically with the SEC, including us. Our SEC filings are also available to the public from commercial document retrieval services.

You may also request a copy of our filings at no cost by writing to us at Independence Bancshares, Inc., 500 East Washington Street, Greenville, South Carolina, 29601, Attention: Ms. Martha L. Long, Chief Financial Officer, or calling us at: (864) 672-1776.

Item 1A. Risk Factors.

The following risk factors and other information included in this Annual Report on Form 10-K should be carefully considered. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently now to us or that we currently deem immaterial may also impact our business operations. If any of the following risks occur, our business, financial condition, operating results, and cash flows could be materially adversely affected.

Risks Related to Our Business

If we do not generate positive earnings, there will be an adverse effect on our future results of operations.

For the years ended December 31, 2016 and 2015, we incurred net losses of $2.6 million and $4.8 million, respectively. For 2016, the $2.6 million loss was largely due to $1.1 million in professional fees, $407,000 in provisions for loan losses and $511,268 in expenses related to real estate owned. For 2015, the $4.8 million loss was largely due to $2.2 million in expenses for product research and development relating to our technology and infrastructure investments, $275,000 in license fees, and $457,173 in expenses related to real estate owned. Our failure to generate earnings could result in negative consequences, including that the regulatory authorities could implement enforcement actions against the Company and/or the Bank.

Working capital needs could adversely affect our results of operations and financial condition.

Our Bank’s primary funding sources are customer deposits and loan repayments. Deposit levels may be affected by a number of factors, including rates paid by competitors, general interest rate levels, returns available to customers on alternative investments and general economic conditions. Scheduled loan repayments are a relatively stable source of funds; however, they are subject to the ability of borrowers to repay the loans. The ability of borrowers to repay loans can be adversely affected by a number of factors outside of our control, including changes in economic conditions, adverse trends or events affecting business industry groups, reductions in real estate values or markets, business closings or lay-offs, inclement weather, natural disasters and international instability. Accordingly, we may be required from time to time to rely on secondary sources of working capital to meet withdrawal demands or otherwise fund operations. Those sources may include borrowings from the FHLB or Federal Reserve, federal funds lines of credit from correspondent banks and brokered deposits, to the extent allowable by regulatory authorities. While we believe that these sources are currently adequate, there can be no assurance they will be sufficient to meet future working capital demands, particularly if we were to experience atypical deposit withdrawal demands, increased loan demand or if regulatory decisions should limit available funding sources such as brokered deposits. We may be required to slow or discontinue loan growth (including through our new consumer lending program), capital expenditures or other investments or liquidate assets should those sources not be adequate.

We may need to raise additional capital and that capital may not be available on favorable terms, if at all.

Our management may adopt or deploy business strategies or plans, such as our new consumer lending program, the execution of which requires securing additional capital. Our ability to raise additional capital will depend on a number of factors outside of our control, including conditions in the capital markets. There is a risk we will not be able to raise the capital we need at all or upon favorable terms. If we cannot raise capital when needed, we would not be able to implement any such strategies or plans developed by management and we may be subject to increased regulatory supervision and restriction. Any restrictions imposed by regulators could have a material adverse effect on our financial condition and results of operations, whether directly or indirectly.

The Company may pursue additional financings to maintain adequate capital resources and/or execute on business strategies. Financings, if any, may include the issuance of debt or equity securities, which issuances could dilute the percentage ownership interests of our shareholders and dilute the per share book value of our stock. In addition, new investors could have rights, preferences, and privileges senior to our current shareholders.

The success of our growth strategy depends on our ability to identify and retain individuals with experience and relationships in the markets and lines of business in which we intend to expand.

To expand our franchise successfully, we must identify and retain experienced key management members with expertise and relationships in particular markets or lines of business. We expect that competition for qualified management in the markets in which we may expand will be intense and that there will be a limited number of qualified persons with knowledge of and experience in the banking industry in these markets or lines of business. Even if we identify individuals that we believe could assist us in establishing a presence in a new market or line of business, we may be unable to recruit these individuals away from more established financial institutions. In addition, the process of identifying and recruiting individuals with the combination of skills and attributes required to carry out our strategy requires both management and financial resources and is often lengthy. Our inability to identify, recruit, and retain talented personnel to manage new offices effectively would limit our growth and could materially adversely affect our business, financial condition, and results of operations.

A return of recessionary conditions could result in increases in our level of non-performing loans and/or reduce demand for our products and services, which could have an adverse effect on our results of operations.

Economic conditions have improved since the end of the economic recession; however, economic growth has been slow and uneven, unemployment remains relatively high, and concerns still exist over the federal deficit, government spending and economic risks. A return of recessionary conditions and/or negative developments in the domestic and international credit markets may significantly affect the markets in which we do business, the value of our loans and investments, and our ongoing operations, costs and profitability. Declines in real estate value and sales volumes and high unemployment levels may result in higher than expected loan delinquencies and a decline in demand for our products and services. These negative events may cause us to incur losses and may adversely affect our capital, liquidity and financial condition.

Furthermore, the Federal Reserve, in an attempt to help the overall economy, has among other things, kept interest rates low through its targeted federal funds rate and the purchase of U.S. Treasury and mortgage-backed securities. The Federal Reserve increased the target range for the federal funds rate by 25 basis points in December 2016 and indicated the potential for further gradual increases in the target rate depending on the economic outlook. As the federal funds rate increases, market interest rates will likely rise, which may negatively impact the housing markets and the U.S. economic recovery.

A continuation of the current low interest rate environment or subsequent movements in interest rates may have an adverse effect on our profitability.

Changes in the interest rate environment may materially affect our business. Changes in interest rates affect the following areas, among others, of our business:

•

the level of net interest income we earn;

	•	the volume of loans originated and prepayment of loans;

	•	the market value of our securities holdings; and

	•	gains from sales of loans and securities.

In recent years, it has been the policy of the Federal Reserve to maintain interest rates at historically low levels through its targeted federal funds rate and the purchase of mortgage-backed securities. As a result, yields on securities purchased, and market rates on the loans originated, have been at levels lower than were available prior to 2008. Consequently, the average yield on our interest-earning assets has decreased during the recent low interest rate environment. As a general matter, our interest-bearing liabilities reprice or mature more quickly than our interest-earning assets; however, our ability to lower interest expense has been limited at these interest rate levels, while the average yield on interest-earning assets has continued to decrease. If a low interest rate environment persists, net interest income may further decrease, which may have an adverse effect on our profitability.

Our net interest margin would narrow if the cost of funding increases without a correlative increase in the interest we earn from loans and investments. Because we rely extensively on deposits to fund operations, our cost of funding would increase if there is an increase in the interest rate we are required to pay customers to retain their deposits. In addition, if the interest rates we are required to pay in respect of other sources of funding, either in the interbank or capital markets, increases, our cost of funding would increase. If either of these risks occurs, our net interest margin would narrow without a correlative increase in the interest we earn from loans and investments. Our assets currently reprice faster than our liabilities, which would result in a benefit to net interest income as interest rates rise; however, the benefit from rising rates could be less than assumed as interest rates rise if increased competition for deposits causes the deposit expense to rise faster than assumed.

In addition, increases in interest rates may decrease customer demand for loans as the higher cost of obtaining credit may deter customers from new loans. Further, higher interest rates might also lead to an increased number of delinquent loans and defaults, which would impact the value of our loans.

We cannot control or predict with certainty changes in interest rates. Global, national, regional and local economic conditions, competitive pressures and the policies of regulatory authorities, including monetary policies of the Federal Reserve, affect interest income and interest expense. Although we have policies and procedures designed to manage the risks associated with changes in market interest rates, changes in interest rates still may have an adverse effect on profitability.

If our assumptions regarding borrower behavior are wrong or overall economic conditions are significantly different than we anticipate, then risk mitigation may be insufficient to protect against interest rate risk and net income would be adversely affected.

Competition with other financial institutions may have an adverse effect on our ability to retain and grow our client base, which could have a negative effect on our financial condition or results of operations.

The banking and financial services industry is very competitive and includes services offered from other banks, savings and loan associations, credit unions, mortgage companies, other lenders, and institutions offering uninsured investment alternatives. Legal and regulatory developments have made it easier for new and sometimes unregulated businesses to compete with us. The financial services industry has and is experiencing an ongoing trend towards consolidation in which fewer large national and regional banks and other financial institutions are replacing many smaller and more local banks. These larger banks and other financial institutions hold a large accumulation of assets and have significantly greater resources and a wider geographic presence or greater accessibility. In some instances, these larger entities operate without the traditional brick and mortar facilities that restrict geographic presence. Some competitors have more aggressive marketing campaigns and better brand recognition, and are able to offer more services, more favorable pricing or greater customer convenience than the Bank. In addition, competition has increased from new banks and other financial services providers that target our existing or potential customers. As consolidation continues among large banks, we expect other smaller institutions to try to compete in the markets we serve. This competition could reduce our net income by decreasing the number and size of the loans that the Bank originates and the interest rates the Bank charges on these loans. Additionally, these competitors may offer higher interest rates, which could decrease the deposits the Bank attracts or require it to increase rates to retain existing deposits or attract new deposits.

Increased deposit competition could adversely affect the Bank’s ability to generate the funds necessary for lending operations, which could increase the cost of funds.

The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies can merge as part of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. Technological developments have allowed competitors, including some non-depository institutions, to compete more effectively in local markets and have expanded the range of financial products, services and capital available to our target customers. If we are unable to implement, maintain and use such technologies effectively, we may not be able to offer products or achieve cost efficiencies necessary to compete in the industry. In addition, some of these competitors have fewer regulatory constraints and lower cost structures.

Clients could pursue alternatives to bank deposits, causing us to lose a relatively inexpensive source of funding.

Checking and savings account balances and other forms of client deposits could decrease if clients perceive alternative investments, such as the stock market, provide superior expected returns. When clients move money out of bank deposits in favor of alternative investments, we can lose a relatively inexpensive source of funds, increasing our funding costs.

We may be adversely affected by credit exposures to other financial institutions.

Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and routinely execute transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks, and other institutional clients. Many of these transactions expose us to credit risk in the event of a default by a counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by the Bank cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due to the Bank. Any such losses could have a material adverse effect on our financial condition and results of operations.

Negative public opinion could damage our reputation and adversely affect earnings.

Reputation risk, or the risk to our business, earnings and capital from negative public opinion, is inherent in our operations. Negative public opinion can result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance and acquisitions, and from actions taken by government regulators and community organizations in response to those activities. Negative public opinion can adversely affect our ability to keep and attract clients and employees and can expose us to litigation and regulatory action and adversely affect our results of operations. Although we take steps to minimize reputation risk in dealing with clients and communities, this risk will always be present given the nature of our business.

We are subject to a variety of operational risks, including reputational risk, legal risk and regulatory and compliance risk, and the risk of fraud or theft by employees or outsiders, which may adversely affect business and results of operations.

We are exposed to many types of operational risks, including reputational risk, legal, regulatory and compliance risk, the risk of fraud or theft by employees or outsiders, including unauthorized transactions by employees, or operational errors, such as clerical or

record-keeping errors or those resulting from faulty or disabled computer or telecommunications systems. Negative public opinion can result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance and acquisitions, and from actions taken by government regulators and community organizations in response to those activities. In addition, negative public opinion can adversely affect our ability to attract and keep customers and can expose it to litigation and regulatory action. Actual or alleged conduct by us can result in negative public opinion about our other business. Negative public opinion could also affect our credit ratings, which are important to its access to unsecured wholesale borrowings.

Our business involves storing and processing sensitive consumer and business customer data. If personal, nonpublic, confidential or proprietary information of customers in its possession were to be mishandled or misused, we could suffer significant regulatory consequences, reputational damage and financial loss. Such mishandling or misuse could include, for example, if such information were erroneously provided to parties who are not permitted to have the information, either by fault of our systems, employees or counterparties, or where such information is intercepted or otherwise inappropriately taken by third parties.

Because the financial services business involves a high volume of transactions, certain errors may be repeated or compounded before they are discovered and successfully rectified. Our necessary dependence upon automated systems to record and process transactions and its large transaction volume may further increase the risk that technical flaws or employee tampering or manipulation of those systems will result in losses that are difficult to detect. We also may be subject to disruptions of operating systems arising from events that are wholly or partially beyond our control, such as computer viruses, electrical or telecommunications outages, natural disasters, or other damage to property or physical assets which may give rise to disruption of service to customers and to financial loss or liability. We are further exposed to the risk that its external vendors may be unable to fulfill our contractual obligations, or will be subject to the same risk of fraud or operational errors by their respective employees as it is, and to the risk that our, or our vendors’, business continuity and data security systems prove to be inadequate. The occurrence of any of these risks could result in a diminished ability to operate our business, as well as potential liability to clients, reputational damage and regulatory intervention, which could adversely affect our business, financial condition or results of operations.

Our operational or security systems may experience an interruption or breach in security.

We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems, including as a result of cyber-attacks, could result in failures or disruptions in our customer relationship management, deposit, loan, and other systems and also the disclosure or misuse of confidential or proprietary information. While we have systems, policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our business, financial condition and results of operations.

Furthermore, information security risks for financial institutions have generally increased in recent years in part because of the proliferation of new technologies, the use of the Internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists, activists, and other external parties. Our technologies, systems, networks, and our customers’ devices may become the target of cyberattacks or information security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of our or our customers’ confidential, proprietary and other information, or otherwise disrupt our or our customers’ or other third parties’ business operations. As cyber threats continue to evolve, we may also be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate any information security vulnerabilities.

While we have not experienced any material losses relating to cyberattacks or other information security breaches to date, we may suffer such losses in the future and any information security breach could result in significant costs to us, which may include fines and penalties, potential liabilities from governmental or third party investigations, proceedings or litigation, legal, forensic and consulting fees and expenses, costs and diversion of management attention required for investigation and remediation actions, and the negative impact on our reputation and loss of confidence of our customers and others, any of which could have a material adverse impact on our business, financial condition and operating results.

Our controls and procedures may fail or be circumvented.

We regularly review and update our internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations and financial condition.

If our nonperforming assets increase, earnings will be adversely affected.

At December 31, 2016, our nonperforming assets (which consist of nonaccrual loans and other real estate owned) totaled $2.5 million, or 2.8% of total assets. At December 31, 2015, our nonperforming assets were $2.9 million, or 3.1% of total assets. Our nonperforming assets adversely affect our earnings in various ways:

•

We do not record interest income on any nonperforming assets.

•

We must provide for probable loan losses through a charge to the provision for loan losses.

•

Noninterest expense increases when we must write down the value of properties in our other real estate owned portfolio to reflect changing market values.

•

There are legal fees associated with the resolution of problem assets, as well as carrying costs, such as taxes, insurance, and maintenance fees related to other real estate owned.

•

The resolution of nonperforming assets requires the active involvement of management, which can distract them from more profitable activity.

If additional borrowers become delinquent and do not pay their loans and we are unable to successfully manage our nonperforming assets, our losses and troubled assets could increase significantly, which could have a material adverse effect on our results of operations.

We have previously sustained losses from a decline in credit quality and may see further losses.

Our ability to generate earnings is significantly affected by the ability to properly originate, underwrite and service loans. We have previously sustained losses primarily because borrowers, guarantors or related parties have failed to perform in accordance with the terms of their loans and we failed to detect or respond to deterioration in asset quality in a timely manner. We could sustain additional losses for these reasons. Further problems with credit quality or asset quality could cause interest income and net interest margin to further decrease, which could adversely affect our business, financial condition and results of operations. We have identified credit deficiencies with respect to certain loans in our loan portfolio which were primarily related to the downturn in the real estate industry. As a result of the decline of the residential housing market between 2007 and 2012, property values for this type of collateral declined substantially. In response to this determination, we increased our loan loss reserve throughout 2010 and 2011 to address the risks inherent within our loan portfolio. Since that time, we consistently applied our methodology in calculating the reserve, and because charge offs dropped and market conditions stabilized, our reserve has declined from its peak. At December 31, 2016, our loan loss reserve was $1.3 million, or 2.21% of gross loans. Although credit quality has generally improved, future deterioration in the South Carolina real estate market as a whole or individual deterioration in the financial condition of our borrowers may cause management to adjust its opinion of the level of credit quality in our loan portfolio. Such a determination may lead to an increase in our provisions for loan losses, which could also adversely affect our business, financial condition, and results of operations.

A significant portion of our loan portfolio is secured by real estate, and events that negatively impact the real estate market hurt our business.

As of December 31, 2016, approximately 71% of our loans had real estate as a primary or secondary component of collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. A weakening of the real estate market in our primary market area could result in an increase in the number of borrowers who default on their loans and a reduction in the value of the collateral securing their loans, which in turn could adversely affect our profitability and asset quality. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and capital could be adversely affected. Acts of nature, including hurricanes, tornados, earthquakes, fires and floods, which may cause uninsured damage and other loss of value to real estate that secures these loans, may also negatively impact our financial condition.

We are subject to certain risks related to originating and selling mortgages. We may be required to repurchase mortgage loans or indemnify mortgage loan purchasers as a result of breaches of representations and warranties, or borrower fraud, and this could harm our liquidity, results of operations and financial condition.

We originate and often sell mortgage loans. When we sell mortgage loans, we are required to make customary representations and warranties to the purchaser about the mortgage loans and the manner in which they were originated. Our whole loan sale agreements require us to repurchase or substitute mortgage loans in the event that we breach certain of these representations or warranties. In addition, we may be required to repurchase mortgage loans as a result of borrower fraud or in the event of early payment default of the borrower on a mortgage loan. Therefore, if a purchaser enforces its remedies against us, we may not be able to recover our losses from third parties. We have received repurchase and indemnity demands from purchasers. These have resulted in an increase in the amount of losses for repurchases. While we have taken steps to enhance its underwriting policies and procedures, these steps will not reduce risk associated with loans sold in the past. If repurchase and indemnity demands increase materially, then our results of operations may be adversely affected.

Our decisions regarding the allowance for loan losses and credit risk may materially and adversely affect our business.

Making loans and other extensions of credit is an essential element of our business. Although we seek to mitigate risks inherent in lending by adhering to specific underwriting practices, our loans and other extensions of credit may not be repaid. The risk of nonpayment is affected by a number of factors, including:

•

the duration of the credit;

•

credit risks of a particular customer;

•

changes in economic and industry conditions; and

•

in the case of a collateralized loan, risks resulting from uncertainties about the future value of the collateral.

We attempt to maintain an appropriate allowance for loan losses to provide for potential losses in our loan portfolio. We periodically determine the amount of the allowance based on consideration of several factors, including, but not limited to:

•

an ongoing review of the quality, mix, and size of our overall loan portfolio;

•

historical loan loss experience;

•

evaluation of economic conditions;

•

regular reviews of loan delinquencies and loan portfolio quality;

•

ongoing review of financial information provided by borrowers; and

•

the amount and quality of collateral, including guarantees, securing the loans.

The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses. In addition, regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance for loan losses, we will need additional provisions to increase the allowance for loan losses. Any increases in the allowance for loan losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on our financial condition and results of operations.

While we generally underwrite the loans in our portfolio in accordance with our own internal underwriting guidelines and regulatory supervisory guidelines, in certain circumstances we have made loans which exceed either our internal underwriting guidelines, supervisory guidelines, or both. We are permitted to hold loans that exceed supervisory guidelines up to 100% of our regulatory capital. We have made loans that exceed our internal guidelines to a limited number of customers who have significant liquid assets, net worth, and amounts on deposit with the Bank. As of December 31, 2016, approximately $1.8 million of our loans, or a loan balance equal to 18.5% of the Bank’s regulatory capital, had loan-to-value ratios that exceeded regulatory supervisory guidelines. In addition, supervisory limits on commercial loan-to-value exceptions are generally set at 30% of the Bank’s capital. At December 31, 2016, $691,746 of our commercial loans, or a loan balance equal to 7.0% of the Bank’s regulatory capital, exceeded the supervisory loan-to-value ratio. The number of loans in our portfolio with loan-to-value ratios in excess of supervisory guidelines, our internal guidelines, or both could increase the risk of delinquencies and defaults in our portfolio.

An economic downturn, in particular an economic downturn in South Carolina, could reduce our customer base, level of deposits, and demand for financial products such as loans.

Our success significantly depends upon the growth in population, income levels, deposits, and housing starts in our markets. Although negative developments that began in the latter half of 2007 have shown signs of improvement in recent years both nationally and in our primary markets of South Carolina, if the communities in which we operate do not grow or if economic conditions locally or nationally are unfavorable, our business may not succeed. An economic downturn or prolonged recession would likely result in further deterioration of the quality of our loan portfolio and reduce our level of deposits, which in turn would hurt our business. Interest received on loans represented approximately 92% of our interest income for the year ended December 31, 2016. If we experience an economic downturn or a prolonged economic recession occurs in the economy as a whole, borrowers will be less likely to repay their loans as scheduled. Moreover, in many cases the value of the real estate or other collateral that secures our loans was adversely affected by the recent economic downturn, and a more severe economic downtown or a prolonged economic recession could further negatively affect such values. Unlike many larger institutions, we are not able to spread the risks of unfavorable local economic conditions across a large number of diversified economies. An economic downturn could, therefore, result in losses that materially and adversely affect our business.

Our small- to medium-sized business target markets may have fewer financial resources to weather financial stress.

We target the banking and financial services needs of small- and medium-sized businesses. These businesses generally have fewer financial resources in terms of capital borrowing capacity than larger entities. If general economic conditions negatively impact these businesses in the markets in which we operate, our business, financial condition, and results of operation may be adversely affected.

Lack of seasoning of loans may increase the risk of credit defaults in the future.

Due to the periodic addition of new loans in our loan portfolio, there is a relatively short credit history on some of our loans. In general, loans do not begin to show signs of credit deterioration or default until they have been outstanding for some period of time, a process we refer to as “seasoning.” As a result, a portfolio of older loans will usually behave more predictably than a newer portfolio. Because our loan portfolio includes new loans, the current level of delinquencies and defaults may not be representative of the level that will prevail when the portfolio becomes more seasoned, which may be higher than current levels. If delinquencies and defaults increase, we may be required to increase our provision for loan losses, which would adversely affect our results of operations and financial condition.

Consumers may decide not to use banks to complete their financial transactions.

Technology and other changes are allowing parties to complete financial transactions through alternative methods that historically have involved banks. For example, consumers can now maintain funds that would have historically been held as bank deposits in brokerage accounts, mutual funds or general-purpose reloadable prepaid cards. Consumers can also complete transactions such as paying bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost of deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.

Failure to keep pace with technological change could adversely affect our business.

The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business and, in turn, our financial condition and results of operations.

We depend on third-party providers, and the inability of these providers to deliver, or their refusal to deliver, necessary technological and customer services support for our systems in a timely manner at prices, quality levels, and volumes acceptable to us could have material adverse effects on our financial condition and operating results.

Our existing digital banking services, including mobile banking, online banking, and remote deposit capture use third-party providers for technological and customer service support. We also outsource check processing, check imaging, electronic bill

payment, statement rendering, internal audit and other services to third-party vendors. While we believe that such providers will be able to continue to supply us with these essential services, they may be unable to do so in the short term or at prices or costs that are favorable to us, or at all. In addition, our agreements with each service provider are generally cancelable without cause by either party upon specified notice periods. If one of our third-party service providers terminates its agreement with us and we are unable to replace it with another service provider, our operations may be interrupted. In particular, while we believe that we will be able to secure alternate providers for most of this essential technological and customer services support in a relatively short time frame, qualifying alternate providers or developing our own replacement technology services may be time consuming, costly, and may force us to change our services offered. If an interruption were to continue for a significant period of time, our earnings could decrease, we could experience losses, and we could lose customers. In addition, we are obligated to exercise comprehensive risk management and oversight of third-party providers involving critical activities, including through the adoption of risk management processes commensurate with the level of risk and complexity of our third-party providers. If in the future we expand our digital banking and payment and transaction services, our dependence on third-party providers will likely increase, and more robust compliance policies and procedures to monitor third party providers will need to be implemented.

If our security is breached, our business could be disrupted, our operating results could be harmed, and customers could be deterred from using our products and services.

Our business relies on the secure electronic transmission, storage, and hosting of sensitive information, including financial information and other sensitive information relating to our customers. As a result, we face the risk of a deliberate or unintentional incident involving unauthorized access to our computer systems that could result in misappropriation or loss of assets or sensitive information, data corruption, or other disruption of business operations. To our knowledge, the Company has not experienced a data breach. In light of this risk, we have devoted significant resources to protecting and maintaining the confidentiality of our information, including implementing security and privacy programs and controls, training our workforce, and implementing new technology. We have no guarantee that these programs and controls will be adequate to prevent all possible security threats. We believe that any compromise of our electronic systems, including the unauthorized access, use, or disclosure of sensitive information or a significant disruption of our computing assets and networks, would adversely affect our reputation and our ability to fulfill contractual obligations, and would require us to devote significant financial and other resources to mitigate such problems, and could increase our future cyber security costs. Moreover, unauthorized access, use or disclosure of such sensitive information could result in significant contractual, supervisory or other liability, or exposure of our trade secrets or other confidential or proprietary information. In addition, any real or perceived compromise of our security or disclosure of sensitive information may result in lost revenues by deterring customers from using or purchasing our products and services in the future or prompting them to use competing service providers.

Risks Related to the Legal and Regulatory Environment

We are subject to extensive regulation that could limit or restrict our activities, have an adverse impact on our operations, and impose financial requirements or limitations on the conduct of our business.

We operate in a highly regulated industry and are subject to examination, supervision, and comprehensive regulation by various regulatory agencies. We are subject to Federal Reserve regulation. The Bank is subject to extensive regulation, supervision, and examination by our primary federal regulators, the OCC and the FDIC, the regulating authority that insures customer deposits. Also, as a member of the FHLB, the Bank must comply with applicable regulations of the Federal Housing Finance Board and the FHLB. Regulation by these agencies is intended primarily for the protection of the Bank’s depositors and the Deposit Insurance Fund and not for the benefit of our shareholders. The Bank’s activities are also regulated under consumer protection laws applicable to its lending, deposit, and other activities. A sufficient claim against the Bank under these laws could have a material adverse effect on our results of operations.

Further, changes in laws, regulations and regulatory practices affecting the financial services industry could subject us to additional costs, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could also result in heightened regulatory scrutiny and in sanctions by regulatory agencies (such as a memorandum of understanding, a written supervisory agreement or a cease and desist order), civil money penalties and/or reputation damage. Any of these consequences could restrict our ability to expand our business or could require us to raise additional capital or sell assets on terms that are not advantageous to us or our shareholders and could have a material adverse effect on our business, financial condition and results of operations. While we have policies and procedures designed to prevent any such violations, such violations may occur despite our best efforts.

Failure to comply with government regulation and supervision could result in sanctions by regulatory agencies, civil money penalties, and damage to our reputation.

Our operations are subject to extensive regulation by federal, state, and local governmental authorities. Given the current disruption in the financial markets, we expect that the government will continue to pass new regulations and laws that will impact us. Compliance with such regulations may increase our costs and limit our ability to pursue business opportunities. Failure to comply with laws, regulations, and policies could result in sanctions by regulatory agencies, civil money penalties, and damage to our reputation. While we have policies and procedures in place that are designed to prevent violations of these laws, regulations, and policies, there can be no assurance that such violations will not occur.

The final Basel III capital rules generally require insured depository institutions and their holding companies to hold more capital, which could adversely affect our financial condition and operations.

In July 2013, the federal bank regulatory agencies issued a final rule that will revise their risk based capital requirements and the method for calculating risk weighted assets to make them consistent with agreements that were reached by Basel III and certain provisions of the Dodd Frank Act. This rule substantially amended the regulatory risk based capital rules applicable to us. The requirements in the rule began to phase in on January 1, 2015 for the Bank. The requirements in the rule will be fully phased in by January 1, 2019.

The rule includes certain new and higher risk-based capital and leverage requirements than those currently in place. Specifically, the following minimum capital requirements apply to us:

•

a new common equity Tier 1 risk-based capital ratio of 4.5%;

•

a Tier 1 risk-based capital ratio of 6% (increased from the former 4% requirement);

•

a total risk-based capital ratio of 8% (unchanged from the former requirement); and

•

a leverage ratio of 4% (also unchanged from the former requirement).

Under the rule, Tier 1 capital is redefined to include two components: common equity Tier 1 capital and additional Tier 1 capital. The new and highest form of capital, common equity Tier 1 capital, consists solely of common stock (plus related surplus), retained earnings, accumulated other comprehensive income, and limited amounts of minority interests that are in the form of common stock. Additional Tier 1 capital includes other perpetual instruments historically included in Tier 1 capital, such as noncumulative perpetual preferred stock. Tier 2 capital consists of instruments that currently qualify in Tier 2 capital plus instruments that the rule has disqualified from Tier 1 capital treatment. Cumulative perpetual preferred stock, formerly includable in Tier 1 capital, is now included only in Tier 2 capital. Accumulated other comprehensive income (AOCI) is presumptively included in common equity Tier 1 capital and often would operate to reduce this category of capital. The rule provided a one-time opportunity at the end of the first quarter of 2015 for covered banking organizations to opt out of much of this treatment of AOCI. We made this opt-out election and, as a result, will retain the pre-existing treatment for AOCI.

In addition, in order to avoid restrictions on capital distributions or discretionary bonus payments to executives, a covered banking organization must maintain a “capital conservation buffer” on top of its minimum risk-based capital requirements. This buffer must consist solely of Tier 1 common equity, but the buffer applies to all three measurements (common equity Tier 1, Tier 1 capital and total capital). The capital conservation buffer will be phased in incrementally over time, becoming fully effective on January 1, 2019, and will consist of an additional amount of common equity equal to 2.5% of risk-weighted assets. As of January 1, 2017, we are required to hold a capital conservation buffer of 1.25%, increasing by 0.625% each successive year until 2019.

In addition, in the current economic and regulatory environment, bank regulators may impose capital requirements that are more stringent than those required by applicable existing regulations. The application of more stringent capital requirements for us could, among other things, result in lower returns on equity, require the raising of additional capital, and result in regulatory actions if we are unable to comply with such requirements. Implementation of changes to asset risk weightings for risk based capital calculations, items included or deducted in calculating regulatory capital or additional capital conservation buffers, could result in

management modifying our business strategy and could limit our ability to make distributions, including paying dividends or buying back our shares.

Higher FDIC deposit insurance premiums and assessments could adversely affect our financial condition.

The Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund of the FDIC and are subject to deposit insurance assessments to maintain deposit insurance. As an FDIC-insured institution, the Bank is required to pay quarterly deposit insurance premium assessments to the FDIC. Although the Bank cannot predict what the insurance assessment rates will be in the future, deterioration in the Bank’s risk-based capital ratios or adjustments to the base assessment rates could have a material adverse effect on our business, financial condition, results of operations, and cash flows.

We face a risk of noncompliance and enforcement action with the Bank Secrecy Act and other anti-money laundering statutes and regulation, which risk increases as we expand our business model.

The Bank Secrecy Act, the USA PATRIOT Act, and other laws and regulations require financial institutions, among other duties, to institute and maintain effective anti-money laundering programs and file suspicious activity and currency transaction reports as appropriate. The Financial Crimes Enforcement Network, established by the U.S. Treasury to administer the Bank Secrecy Act, is authorized to impose significant civil money penalties for violations of those requirements and has recently engaged in coordinated enforcement efforts with the individual federal banking regulators, as well as the U.S. Department of Justice, Drug Enforcement Administration and Internal Revenue Service. There is also increased scrutiny of compliance with the rules enforced by the OFAC. Federal and state bank regulators also have begun to focus on compliance with Bank Secrecy Act and anti-money laundering regulations. If our policies, procedures and systems are deemed deficient, we would be subject to liability, including fines and regulatory actions such as restrictions on our ability to pay dividends and the necessity to potentially obtain regulatory approvals to further expand our new consumer lending program, which would negatively impact our business, financial condition and results of operations. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for us.

Federal, state and local consumer lending laws may restrict our ability to originate certain mortgage loans or increase our risk of liability with respect to such loans and could increase our cost of doing business.

Federal, state and local laws have been adopted that are intended to eliminate certain lending practices considered “predatory.” These laws prohibit practices such as steering borrowers away from more affordable products, selling unnecessary insurance to borrowers, repeatedly refinancing loans and making loans without a reasonable expectation that the borrowers will be able to repay the loans irrespective of the value of the underlying property. Loans with certain terms and conditions and that otherwise meet the definition of a “qualified mortgage” may be protected from liability to a borrower for failing to make the necessary determinations. In either case, we may find it necessary to tighten our mortgage loan underwriting standards in response to the CFPB rules, which may constrain our ability to make loans consistent with our business strategies. It is our policy not to make predatory loans and to determine borrowers’ ability to repay, but the law and related rules create the potential for increased liability with respect to our lending and loan investment activities. They increase our cost of doing business and, ultimately, may prevent us from making certain loans and cause us to reduce the average percentage rate or the points and fees on loans that we do make.

We are subject to federal and state fair lending laws, and failure to comply with these laws could lead to material penalties.

Federal and state fair lending laws and regulations, such as the Equal Credit Opportunity Act and the Fair Housing Act, impose nondiscriminatory lending requirements on financial institutions. The Department of Justice, CFPB and other federal and state agencies are responsible for enforcing these laws and regulations. Private parties may also have the ability to challenge an institution’s performance under fair lending laws in private class action litigation. A successful challenge to our performance under the fair lending laws and regulations could adversely affect the Bank’s rating under the CRA and result in a wide variety of sanctions, including the required payment of damages and civil money penalties, injunctive relief, imposition of restrictions on merger and acquisition activity and restrictions on expansion activity, which could negatively impact our reputation, business, financial condition and results of operations.

The Federal Reserve may require us to commit capital resources to support the Bank.

The Federal Reserve requires a bank holding company to act as a source of financial and managerial strength to a subsidiary bank and to commit resources to support such subsidiary bank. Under the “source of strength” doctrine, the Federal Reserve may require a bank holding company to make capital injections into a troubled subsidiary bank and may charge the bank holding company with engaging in unsafe and unsound practices for failure to commit resources to such a subsidiary bank. In addition, the Dodd-Frank Act directs the federal bank regulators to require that all companies that directly or indirectly control an insured depository institution

serve as a source of strength for the institution. Under these requirements, in the future, we could be required to provide financial assistance to the Bank if the Bank experiences financial distress.

A capital injection may be required at times when we do not have the resources to provide it, and therefore we may be required to borrow the funds. In the event of a bank holding company’s bankruptcy, the bankruptcy trustee will assume any commitment by the holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank. Moreover, bankruptcy law provides that claims based on any such commitment will be entitled to a priority of payment over the claims of the holding company’s general unsecured creditors, including the holders of its note obligations. Thus, any borrowing that must be done by the holding company in order to make the required capital injection becomes more difficult and expensive and will adversely affect the holding company’s cash flows, financial condition, results of operations and prospects.

Our business is subject to laws and regulations regarding privacy, data protection, and other matters. Many of these could result in claims, changes to our business practices, increased cost of operations, or otherwise harm our business.

We are subject to a variety of laws and regulations in the United States that involve matters central to our business, including user privacy, electronic contracts and other communications, consumer protection, taxation, and online payment services. These U.S. federal and state laws and regulations, which can be enforced by private parties or government entities, are constantly evolving and can be subject to significant change. In addition, the application and interpretation of these laws and regulations are often uncertain, particularly in the new and rapidly evolving industry in which we operate. These existing and proposed laws and regulations can be costly to comply with and can delay or impede the development of new products, and a failure to comply with such laws and regulations could result in negative publicity, increase our operating costs, require significant management time and attention, and subject us to inquiries or investigations, claims or other remedies, including fines or demands that we modify or cease existing business practices.

Changes in accounting standards could materially affect our financial statements.

Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. From time to time, the Financial Accounting Standards Board (the “FASB”), the SEC and our bank regulators change the financial accounting and reporting standards, or the interpretation thereof, and guidance that govern the preparation and disclosure of external financial statements. For example, in 2012, the FASB issued a proposed standard on accounting for credit losses. The standard would replace multiple existing impairment models, including replacing an “incurred loss” model for loans with an “expected loss” model. The FASB has indicated a tentative effective date of January 1, 2019, and final guidance is expected to be issued in the second quarter of 2016. These changes are beyond our control, can be hard to predict and could materially impact how we report and disclose our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retrospectively, or apply an existing standard differently, also retrospectively, which under some circumstances could potentially result in a need to revise or restate prior period financial statements.

Risks Related to our Common Stock

We are a holding company and depend on the Bank for dividends, distributions, and other payments.

Substantially all of our activities are conducted through the Bank, and consequently, as the parent company of the Bank, we receive substantially all of our revenue as dividends from the Bank. We are currently prohibited from paying dividends without the prior approval Federal Reserve Bank of Richmond. There can be no assurance such approvals would be granted or with regard to how long these restrictions will remain in place. In the future, any declaration and payment of cash dividends will be subject to the board’s evaluation of our operating results, financial condition, future growth plans, general business and economic conditions, and tax and other relevant considerations. The payment of cash dividends by us in the future will also be subject to certain other legal and regulatory limitations (including the requirement that our capital be maintained at certain minimum levels) and ongoing review by our banking regulators.

There is no liquid market for our shares.

There is currently no established trading market for our common stock. As a result, any investor in shares of our common stock may find it difficult or impossible to resell such shares.

If securities or industry analysts publish inaccurate or unfavorable research about our business, our stock price could decline.

The trading market for the common stock will depend in part on the research and reports that securities or industry analysts publish about us or our business. If one or more of the analysts who cover us downgrades the common stock or publishes inaccurate or unfavorable research about our business, the common stock price would likely decline.

Our securities are not FDIC insured.

Our securities, including the outstanding shares of common stock, are not savings or deposit accounts or other obligations of ours and are not insured by the Deposit Insurance Fund, the FDIC, or any other governmental agency, and therefore are subject to investment risk, including the possible loss of the entire investment.

Item 1B. Unresolved Staff Comments.

Not Applicable.

Item 2. Properties.

Our principal executive offices consist of 6,500 square feet of leased space in downtown Greenville, South Carolina. The Bank has two branch offices located in Taylors, South Carolina, and Simpsonville, South Carolina. We lease our Greenville and Taylors offices in South Carolina and believe these premises will be adequate for present and anticipated needs and that we have adequate insurance to cover our owned and leased premises. For each property that we lease, we believe that upon expiration of the lease we will be able to extend the lease on satisfactory terms or relocate to another acceptable location.

Item 3. Legal Proceedings.

In the ordinary course of operations, we may be a party to various legal proceedings from time to time. We do not believe that there is any pending or threatened proceeding against us, which, if determined adversely, would have a material effect on our business, results of operations, or financial condition.

Item 4. Mine Safety Disclosures.

Not Applicable.

PART II

Market Information, Holders, and Dividends

No established public trading market exists for our common stock, and there can be no assurance that a public trading market for our common stock will develop. Our common stock is quoted on the OTC Bulletin Board under the symbol “IEBS,” and we have a sponsoring broker-dealer to match buy and sell orders for our common stock. Although we are quoted on the OTC Bulletin Board, the trading markets on the OTC Bulletin Board lack the depth, liquidity, and orderliness necessary to maintain a liquid market, and trading and quotations of our common stock have been limited and sporadic. The OTC Bulletin Board prices are quotations, which reflect inter-dealer prices, without retail mark-up, mark-down or commissions and may not represent actual transactions.

The following table sets forth for the period indicated the high and low bid prices for our common stock reported by the OTC Bulletin Board for the periods indicated:

2016	High	Low
Fourth Quarter	0.18	0.12
Third Quarter	0.21	0.13
Second Quarter	0.21	0.11
First Quarter	0.38	0.18

2015
Fourth Quarter	0.43	0.23
Third Quarter	0.59	0.43
Second Quarter	0.56	0.42
First Quarter	0.60	0.42

As of March 23, 2017, there were 20,502,760 shares of common stock outstanding held by approximately 580 shareholders of record, and 8,425 shares of series A preferred convertible stock outstanding held by 11 shareholders.

We have not declared or paid any cash dividends on our common stock since our inception. For the foreseeable future, we do not intend to declare cash dividends. We intend to retain earnings to grow our business and strengthen our capital base. Our ability to pay dividends depends on the ability of the Bank to pay dividends to the Company. As a national bank, the Bank may only pay dividends out of its net profits, after deducting expenses, including losses and bad debts. In addition, the Bank is prohibited from declaring a dividend on its shares of common stock until its surplus equals its stated capital, unless there has been transferred to surplus no less than one-tenth of the Bank’s net profits of the preceding two consecutive half-year periods (in the case of an annual dividend). The approval of the OCC will be required if the total of all dividends declared in any calendar year by the Bank exceeds the Bank’s net profits to date for that year combined with its retained net profits for the preceding two years less any required transfers to surplus. The OCC also has the authority under federal law to enjoin a national bank from engaging in what in its opinion constitutes an unsafe or unsound practice in conducting its business, including the payment of a dividend under certain circumstances.

Equity-Based Compensation Plan Information

For information regarding equity-based compensation awards outstanding and available for future grants at December 31, 2016, see Part III, Item 12 “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” included in this Annual Report on Form 10-K.

Item 6. Selected Financial Data.

Not applicable.

Item 7. Management’s Discussion and Analysis or Plan of Operation.

Overview

We derive the majority of our income from interest we receive on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, on which we pay interest. Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income earned on our interest-earning assets, such as loans and investments, and the expense cost of our interest-bearing liabilities, such as deposits. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities.

The Company has reported losses from operations during 2016 and 2015, primarily due to expenses incurred in 2016 as a result of professional fees relating to the expansion of the Bank’s consumer lending program, credit write-downs, and losses on other real estate owned sold and due to expenses incurred in 2015 related to the costs associated with the transaction services segment, credit write-downs, and losses on other real estate owned sold. Due to regulatory restrictions, the Bank may not be a source of cash or capital for affiliates, including the Company, and may not be relied on as a source of financing. The foregoing discussion is a summary only and is qualified by reference to the report of the Company’s independent registered public accounting firm, Elliott Davis Decosimo, LLC, on page F-2 and the disclosure in other sections of this Form 10-K, including this section, the Risk Factors and our financial statements.

The Consolidated Company

At December 31, 2016, we had total assets of $90.5 million, a decrease of $7.0 million, or 7.2%, from total assets of $97.5 million at December 31, 2015. This decrease in assets was primarily driven by a decrease in investment securities of $8.2 million, a decrease in net loans of $7.3 million, and a decrease in cash and due from banks and federal funds sold of $3.1 million, partially offset by an increase in interest-bearing deposits in other institutions of $9.0 million and an increase in bank-owned life insurance of $2.5 million. Total assets at December 31, 2016 consisted of cash and due from banks of $4.6 million, interest bearing deposits in other institutions of $10.5 million, federal funds sold of $6.1 million, investment securities available for sale of $2.5 million, bank-owned life insurance of $2.5 million, non-marketable equity securities of $380,050, property, equipment and software of $2.0 million, other real estate owned and repossessed assets of $2.2 million, loans net of allowances for loan losses of $59.1 million, and accrued interest receivable and other assets of $358,277. Total liabilities at December 31, 2016 were $80.5 million compared to $84.8 million at December 31, 2015, a decrease of $4.3 million, or 5.1%. At December 31, 2016, liabilities consisted of deposits of $79.7 million, securities sold under agreements to repurchase of $113,598, and accrued interest payable and accounts payable and accrued expenses of $683,446. Shareholders’ equity at December 31, 2016 was $9.9 million, compared to $12.6 million at December 31, 2015, a decrease of $2.7 million or 21.4%. This decrease was primarily due to the recognition of a net loss of $2.6 million and a decrease in the unrealized gain on investment securities of $121,902.

Our net loss for the year ended December 31, 2016 was $2.6 million, or $0.13 per share, a decrease in loss of $2.2 million, or 46.7%, compared to a net loss of $4.8 million for the year ended December 31, 2015, or $0.23 per share. The Company’s decrease in net loss for the year was primarily driven by a decrease in noninterest expenses due to the suspension of further development of its digital banking business in September 2015. As a result, product research and development decreased $2.0 million. In addition, compensation and benefits expenses decreased $392,994, despite expenses incurred as a result of the filling of open positions during the year. Each of these components is discussed in greater detail below.

The Company

The Company’s cash balances, independent of the Bank, were $1.8 million and its real estate held for sale was zero at December 31, 2016 compared to cash balances of approximately $2.9 million and real estate held for sale of $631,320 at December 31, 2015. The Company’s accrued and other liabilities, independent of the Bank, were $304,346 at December 31, 2016 compared to $905,824 at December 31, 2015. The decrease in liquid assets of approximately $1.1 million and the decrease in payables of $601,478 is due primarily to a decrease in expenses incurred related to the transaction services segment as the Company suspended further development of its digital banking, payments and transaction services business in September 2015. The existing liabilities for the Company are related to deferred director fees and accrued audit and professional fees. See “Note 22 — Parent Company Financial Information” for additional information related to the transaction services segment.

The Bank

At December 31, 2016, we had total assets at the Bank of $90.4 million compared to $96.6 million at December 31, 2015. Total assets at December 31, 2016 consisted of cash and due from banks of $4.6 million, federal funds sold of $6.1 million, investment securities available for sale of $2.5 million, nonmarketable equity securities of $380,050, property, equipment, and software of $2.0 million, other real estate owned and repossessed assets of $2.23 million, net loans of $59.1 million, interest-bearing deposits in other

institutions of $10.5 million, bank-owned life insurance of $2.5 million and accrued interest receivable and other assets of $731,838. At December 31, 2016, we had total liabilities at the Bank of approximately $82.0 million compared to approximately $86.8 million at December 31, 2015. The largest components of total liabilities at the Bank are deposits which were $81.6 million, respectively. We have included a number of tables to assist in our description of our results of operations. For example, the “Average Balances” table shows the average balance during 2016 and 2015 of each category of our assets and liabilities, as well as the yield we earned or the rate we paid with respect to each category. A review of this table shows that our loans typically provide higher interest yields than do other types of interest-earning assets, which is why we have channeled a substantial percentage of our earning assets into our loan portfolio. We also track the sensitivity of our various categories of assets and liabilities to changes in interest rates, and we have included a table to help explain this. Finally, we have included a number of tables that provide detail about our investment securities, our loans, and our deposits and other borrowings.

There are risks inherent in all loans, so we maintain an allowance for loan losses to absorb probable losses on existing loans that may become uncollectible. We establish and maintain this allowance by charging a provision for loan losses against our operating earnings. In the following section we have included a detailed discussion of this process.

In addition to earning interest on our loans and investments, we earn income through fees and other expenses we charge to our customers. We describe the various components of this non-interest income, as well as our non-interest expenses, in the following discussion.

Throughout our discussion we have identified significant factors that we believe have affected our financial position and operating results during the periods included in the accompanying financial statements. We encourage you to read this discussion and analysis in conjunction with our financial statements and the other statistical information included in this report.

Critical Accounting Policies

We have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States and with general practices within the banking industry in the preparation of our financial statements. Our significant accounting policies are described in Note 1 to our audited consolidated financial statements as of December 31, 2016.

Certain accounting policies involve significant judgments and assumptions by us that have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgment and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Because of the nature of the judgments and assumptions we make, actual results could differ from these judgments and estimates that could have a material impact on the carrying values of our assets and liabilities and our results of operations.

Provision and Allowance for Loan Losses

We believe the allowance for loan losses is the critical accounting policy that requires the most significant judgments and estimates used in preparation of our consolidated financial statements. Some of the more critical judgments supporting the amount of our allowance for loan losses include judgments about the credit worthiness of borrowers, the estimated value of the underlying collateral, the assumptions about cash flow, determination of loss factors for estimating credit losses, the impact of current events and conditions, and other factors impacting the level of probable inherent losses. Under different conditions or using different assumptions, the actual amount of credit losses incurred by us may be different from management’s estimates provided in our consolidated financial statements. Refer to the portion of this discussion that addresses our allowance for loan losses for a more complete discussion of our processes and methodology for determining our allowance for loan losses.

Other Real Estate Owned and Repossessed Assets

Real estate and other property acquired in settlement of loans is recorded at the lower of cost or fair value less estimated selling costs, establishing a new cost basis when acquired. Fair value of such property is reviewed regularly and write-downs are recorded when it is determined that the carrying value of the property exceeds the fair value less estimated costs to sell. Recoveries of value are recorded only to the extent of previous write-downs on the property in accordance with FASB ASC Topic 360 “Property, Plant, and Equipment”. Write-downs or recoveries of value resulting from the periodic reevaluation of such properties, costs related to holding such properties, and gains and losses on the sale of foreclosed properties are charged against income. Costs relating to the development and improvement of such properties are capitalized.

Income Taxes

We use assumptions and estimates in determining income taxes payable or refundable for the current year, deferred income tax liabilities and assets for events recognized differently in our consolidated financial statements and income tax returns, and income tax benefit or expense. Determining these amounts requires analysis of certain transactions and interpretation of tax laws and regulations. Management exercises judgment in evaluating the amount and timing of recognition of resulting tax liabilities and assets. These judgments and estimates are reevaluated on a continual basis as regulatory and business factors change. Valuation allowances are established to reduce deferred tax assets if it is determined to be “more likely than not” that all or some portion of the potential deferred tax asset will not be realized. No assurance can be given that either the tax returns submitted by us or the income tax reported on the financial statements will not be adjusted by either adverse rulings by the United States Tax Court, changes in the tax code, or assessments made by the Internal Revenue Service. We are subject to potential adverse adjustments, including, but not limited to, an increase in the statutory federal or state income tax rates, the permanent non-deductibility of amounts currently considered deductible either now or in future periods, and the dependency on the generation of future taxable income, including capital gains, in order to ultimately realize deferred income tax assets.

Research and Development

All costs incurred to establish the technological feasibility of computer software to be sold, leased or otherwise marketed as research and development are expensed as incurred. Once technological feasibility has been established, the subsequent costs of producing, coding and testing the products should be capitalized. The expensing of computer software costs is discontinued when the product is available for general release for customers. The Company did not achieve technological feasibility in connection with the development of its digital banking business and therefore expensed all computer software purchases and development expenses related to research and development. As previously noted, on September 25, 2015, the Company suspended the development of its digital banking business.

Results of Operations

Net Interest Income

Net interest income is the Company’s primary source of revenue. Net interest income is the difference between interest earned on assets and interest paid on deposits and borrowings used to support such assets. Net interest income is determined by the rates earned on the Company’s interest-earning assets and the rates paid on its interest-bearing liabilities and the relative amounts of interest-earning assets and interest-bearing liabilities. Net interest income was $3.2 million for the year ended December 31, 2016, a slight decrease of $1,787, or 0.1%, over net interest income of $3.2 million in 2015. Total interest income decreased by $2,935, or 0.1%, during the year, primarily due to a decrease in interest income on investment securities. Total interest expense decreased by $4,722, or 1.4%, during the year due to decreases in interest expense on deposits and borrowings.

Our consolidated net interest margin for the year ended December 31, 2016 was 3.89%, a 27 basis point increase over the net interest margin for the year ended December 31, 2015 of 3.62%. The net interest margin is calculated as net interest income divided by year-to-date average earning assets. Earning assets averaged $83.2 million in 2016, a decrease of $6.4 million, or 7.2%, from $89.6 million in 2015. This decrease in earning assets is due to the $4.4 million decrease in average investment securities available for sale and a decrease in average net loans of $2.6 million, partially offset by an increase in federal funds sold between years of $542,044. Our yield on earning assets increased during the year, moving from 3.99% for the year ended December 31, 2015 to 4.28% for the year ended December 31, 2016. This increase is largely attributable to an increase in yield on loans and investment securities. These increases were accompanied by an increase in the cost of interest-bearing liabilities, which moved from 0.44% for the year ended December 31, 2015 to 0.48% for the year ended December 31, 2016. The increase in this area was a result of several factors, including the repricing of deposits, specifically money market accounts and retail time deposits, which increased to a rate of 0.25% and 0.86%, respectively, for the year ended December 31, 2016 from 0.24% and 0.77%, respectively, for the year ended December 31, 2015. In pricing deposits, we considered our liquidity needs, the direction and levels of interest rates and local market conditions. At times, higher rates are paid initially to attract deposits. Borrowings averaged $135,708 for the year ended December 31, 2016 compared to $553,599 for the year ended December 31, 2015, primarily as a result of the repayment of the note payable. Our net interest spread was 3.81% for 2016 compared to 3.54% in 2015. The net interest spread is the difference between the yield we earn on our interest-earning assets and the rate we pay on our interest-bearing liabilities.

The following table sets forth information related to our average balance sheet, average yields on assets, and average costs of liabilities. We derived these yields by dividing income or expense by the average balance of the corresponding assets or liabilities. We derived average balances from the daily balances throughout the periods indicated. The net amount of capitalized loan fees is amortized into interest income on loans.

	For the Year Ended December 31,
	2016							2015
	Average Balance		Income/ Expense		Yield/ Rate			Average Balance		Income/ Expense		Yield/ Rate
Interest-earning assets:
Federal funds sold and other	$	10,013,935	$	73,030		0.76	%	$	9,471,891	$	49,953		0.56	%
Investment securities		9,173,821		219,507		2.31	%		13,575,466		323,979		2.31	%
Loans (1)		64,014,530		3,272,291		5.11	%		66,593,873		3,193,831		4.81	%
Total interest-earning assets		83,202,286		3,564,828		4.28	%		89,641,230		3,567,763		3.99	%
Non-interest-earning assets		10,500,151							9,541,314
Total assets	$	93,702,437						$	99,182,544
Interest-bearing liabilities:
NOW accounts	$	9,101,906	$	10,935		0.12	%	$	8,129,603	$	9,840		0.12	%
Savings & money market		32,082,911		80,458		0.25	%		35,400,117		83,492		0.24	%
Time deposits (excluding brokered time deposits)		27,380,014		234,727		0.86	%		29,021,956		222,152		0.77	%
Total interest-bearing deposits		68,564,831		326,120		0.48	%		72,551,676		315,484		0.44	%
Borrowings		135,708		220		0.16	%		553,599		15,578		2.82	%
Total interest-bearing liabilities		68,700,539		326,340		0.48	%		73,105,275		331,062		0.45	%
Non-interest-bearing liabilities:
Non-interest-bearing deposits		12,419,304							11,742,521
Other non-interest-bearing liabilities		776,104							1,836,190
Shareholders’ equity		11,806,490							12,498,558
Total liabilities and shareholders’ equity	$	93,702,437						$	99,182,544
Net interest spread						3.81	%						3.54	%
Net interest income/margin			$	3,238,488		3.89	%			$	3,236,701		3.62	%

(1)

Nonaccrual loans are included in average balances for yield computations.

	For the Year Ended December 31,
	2014
	Average Balance		Income/ Expense		Yield/ Rate
Interest-earning assets:
Federal funds sold and other	$	5,125,344	$	34,505		0.68	%
Investment securities		19,225,587		495,403		2.58	%
Loans (1)		66,635,561		3,388,060		5.10	%
Total interest-earning assets		90,986,482		3,917,968		4.32	%
Non-interest-earning assets		10,041,726
Total assets	$	101,028,208
Interest-bearing liabilities:
NOW accounts	$	7,112,555	$	9,689		0.14	%
Savings & money market		38,844,285		92,213		0.24	%
Time deposits (excluding brokered time deposits)		28,085,586		184,351		0.66	%
Brokered time deposits		388,688		6,034		1.56	%
Total interest-bearing deposits		74,431,114		292,287		0.39	%
Borrowings		2,596,893		19,737		0.76	%
Total interest-bearing liabilities		77,028,007		312,024		0.41	%
Non-interest-bearing liabilities:
Non-interest-bearing deposits		10,646,556
Other non-interest-bearing liabilities		924,433
Shareholders’ equity		12,429,212
Total liabilities and shareholders’ equity	$	101,028,208
Net interest spread						3.91	%
Net interest income/margin			$	3,605,944		3.97	%

(1)

Nonaccrual loans are included in average balances for yield computations.

Rate/Volume Analysis

Net interest income can be analyzed in terms of the impact of changing interest rates and changing volume. The following tables set forth the effect which the varying levels of interest-earning assets and interest-bearing liabilities and the applicable rates have had on changes in net interest income for the periods presented.

	2016 Compared to 2015
	Total Change			Change in Volume			Change in Rate
Interest-earning assets:
Federal funds sold and other	$	22,992		$	3,185		$	19,807
Investment securities		(100,952	)		(101,797	)		846
Loans (1)		69,711			(127,018	)		196,728
Total interest income		(8,249	)		(225,630	)		217,381
Interest-bearing liabilities:
Interest-bearing deposits		9,772			(20,047	)		29,818
Borrowings		(15,401	)		(6,849	)		(8,552	)
Total interest expense		(5,629	)		(26,895	)		21,267
Net Interest Income	$	(2,621	)	$	(198,733	)	$	196,113

	2015 Compared to 2014
	Total Change			Change in Volume			Change in Rate
Interest-earning assets:
Federal funds sold and other	$	18,332		$	25,142		$	(6,810	)
Investment securities		(182,755	)		(134,712	)		(48,043	)
Loans (1)		(194,760	)		(2,124	)		(192,636	)
Total interest income		(359,183	)		(111,694	)		(247,489	)
Interest-bearing liabilities:
Interest-bearing deposits		23,261			(3,538	)		26,798
Borrowings		(4,170	)		(25,062	)		20,891
Total interest expense		22,091			(28,600	)		47,689
Net Interest Income	$	(359,183	)	$	(83,094	)	$	(297,178	)

(1)

Nonaccrual loans are included in average balances for yield computations.

Provision for Loan Losses

We have established an allowance for loan losses through a provision for loan losses charged to expense to our consolidated statement of operations. We review our loan portfolio at least quarterly to evaluate our outstanding loans and to measure both the performance of the portfolio and the adequacy of the allowance for loan losses. Please see the discussion below under “Provision and Allowance for Loan Losses” for a description of the factors we consider in determining the amount of the provision we expense each period to maintain this allowance.

The provision, reversal of provision and allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

We recorded a provision for loan losses of $407,000 for the year ended December 31, 2016, an increase of $257,000, or 171% from a provision for loan losses of $150,000 for the year ended December 31, 2015. The increase in provision for loan losses is primarily due to the recognition of specific reserves during 2016 on six impaired loans. The allowance as a percentage of gross loans increased to 2.21% at December 31, 2016 from 1.68% at December 31, 2015. Specific reserves were approximately $611,000 on impaired loans of $2.2 million as of December 31, 2016 compared to specific reserves of approximately $375,000 on impaired loans of $2.4 million as of December 31, 2015. As of December 31, 2016, the general reserve allocation was 1.22% of gross loans not impaired compared to 1.17% as of December 31, 2015. The provision for loan losses is discussed further below under “Provision and Allowance for Loan Losses.”

Non-interest Income

Non-interest income for the year ended December 31, 2016 was $840,100, an increase of 26.0% from non-interest income of $666,907 for the year ended December 31, 2015. Our largest components of non-interest income in 2016 were from residential loan origination fees, which were $231,495 for 2016, or approximately 27.6% of total non-interest income, and from the recognition of gains on sales of investments of $296,723, or approximately 35.3% of total non-interest income. Residential loan origination fees increased by $6,832, or 3.0%, during the year due to the changes in mortgage loan underwriting and compensation regulations as well as increased customer demand. The remaining increase is primarily due to the recognition of income related to the collection of SBA loan fees of $119,306. For the year ended December 31, 2016, service fees on deposit accounts totaled $95,431, an increase of $14,272, or 17.6%, from 2015 due primarily to an increase in NSF/return check fees. Other income includes ATM surcharges, wire fees, and commissions on insurance referrals. Other income was $97,145 for 2016, an increase of $51,310, or 111.9%, compared to $45,835 for the year ended December 31, 2015 due primarily to an increase related to commissions received and income recognized for bank-owned life insurance.

The Company recognized a gain on sale of investment securities available for sale of approximately $297,000 during 2016. The Company recognized a loss on sale of investment securities available for sale of approximately $88,000 during 2015.

Non-interest Expenses

The following table sets forth information related to our non-interest expenses for the years ended December 31, 2016 and 2015.

	2016		2015
Compensation and benefits	$	2,557,959	$	2,950,953
Real estate owned activity		512,407		457,173
Occupancy and equipment		639,167		678,404
Insurance		216,295		233,168
Data processing and related costs		471,976		343,107
Professional fees		1,050,062		1,320,505
Product research and development		249,594		2,209,978
Other		562,146		353,759
Total non-interest expenses	$	6,259,606	$	8,547,047

Non-interest expenses decreased by approximately $2.3 million, or 26.8%, for the year ended December 31, 2016. This decrease was primarily due to decreases in product research and development expenses, professional fees, and compensation and benefits expenses, partially offset by increases in data processing costs and other expenses. Product research and development expenses decreased $2.0 million due to the suspension of further development of the transaction services segment in September 2015. Product research and development expenses consisted primarily of outside service fees to developers, software licenses, compensation expense, consulting fees and research and development expense. Compensation and benefits decreased $392,994 due to the reduction in staffing related to the suspension of the product development segment as well as by a decrease of $293,703 in expense incurred related to stock option expense. Professional fees decreased $270,443 due to a decrease in consulting fees. These decreases were offset by a $128,869 increase in data processing costs and an increase of $208,387 in other expenses related to marketing and costs related to our consumer lending program.

Income Tax Expense

No income tax benefit or expense was recognized for the year ended December 31, 2016. In 2015, we recognized approximately $5,100 in state income taxes due with the Bank’s state tax return.

Accounting literature states that a deferred tax asset should be reduced by a valuation allowance if, based on the weight of all available evidence, it is more likely than not (a likelihood of more than 50%) that some portion or the entire deferred tax asset will not be realized. The determination of whether a deferred tax asset is realizable is based on weighing all available evidence, including both positive and negative evidence. In making such judgments, significant weight is given to evidence that can be objectively verified. We will continue to analyze our deferred tax assets and related valuation allowance on a quarterly basis, taking into account performance compared to forecasted earnings as well as current economic or internal information.

Balance Sheet Review

Investments

The purpose of the investment portfolio is to provide liquidity and stable returns through the purchase of high quality investment securities. At December 31, 2016, our investment portfolio of $2.5 million represented approximately 2.8% of total assets. The portfolio decreased from $10.7 million at December 31, 2015, or 11.0% of total assets. Decreases in investment balances during 2016 were due to normal investment maturities and repayments as well as due to the October 2016 sale of the mortgage-backed and municipal security portfolios. At December 31, 2016, we held one US Treasury note as an investment security available for sale. At December 31, 2015, we held government-sponsored mortgage-backed securities, non-taxable and taxable municipal bonds as investment securities available for sale. The amortized costs and the fair value of our investments at December 31, 2016, 2015 and 2014 are shown in the following table.

	2016				2015				2014
	Amortized Cost		Fair Value		Amortized Cost		Fair Value		Amortized Cost		Fair Value
Available for Sale
US Treasury Note	$	2,507,861	$	2,499,805	$	—	$	—	$	—	$	—
Government-sponsored mortgage-backed		—		—		4,290,680		4,312,449		7,597,334		7,601,517
Collateralized mortgage-backed		—		—		—		—		2,040,478		1,982,960
Municipals, tax-exempt		—		—		4,916,379		5,039,447		4,658,532		4,696,996
Municipals, taxable		—		—		1,308,298		1,335,955		1,317,433		1,334,053
Total	$	2,507,861	$	2,499,805	$	10,515,357	$	10,687,851	$	15,613,777	$	15,615,526

Contractual maturities and yields on our investment securities available for sale at December 31, 2016 are shown in the following table. Expected maturities may differ from contractual maturities as issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

	One year or less					After one year through five years					After five years through ten years					After ten years					Total
	Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield
Available for Sale
US Treasury Note		—		—		$	2,499,805		1.08	%		—		—			—		—		$	2,499,805		1.08	%
Total	$	—		—	%	$	2,499,805		1.08	%	$	—		—	%	$	—		—	%	$	2,499,805		1.08	%

At December 31, 2016 and 2015, we also held non-marketable equity securities, which consisted of Federal Reserve Bank stock of $293,050 and $303,500, respectively, and FHLB stock of $87,000 and $89,000, respectively. These investments are carried at cost, which approximates fair market value.

Loans

Since loans typically provide higher interest yields than other types of interest-earning assets, a significant percentage of our earning assets are invested in our loan portfolio. Average loans for the year ended December 31, 2016 were $64.0 million, a decrease of $2.6 million, or 3.9%, compared to average loans of $66.6 million for the year ended December 31, 2015. Before allowance for loan losses, gross loans outstanding at December 31, 2016 were $60.5 million, or 66.9% of total assets, compared to $67.5 million, or 69.3% of total assets at December 31, 2015.

The principal component of our loan portfolio is loans secured by real estate mortgages. Most of our real estate loans are secured by residential or commercial property. We do not generally originate traditional long term residential mortgages for the Bank’s portfolio, but we do issue traditional second mortgage residential real estate loans and home equity lines of credit. We obtain a security interest in real estate whenever possible, in addition to any other available collateral. This collateral is taken to increase the likelihood of the ultimate repayment of the loan. Generally, we limit the loan-to-value ratio on loans we make to 80%. The total amount of second lien mortgage collateral and home equity loans as of December 31, 2016, 2015, 2014, 2013 and 2012 were approximately $4.3 million, $5.8 million, $8.3 million, $7.3 million, and $8.6 million, respectively.

The largest component of our loan portfolio at year-end was commercial real estate loans, which represented 36.4% of the portfolio. We attempt to maintain a relatively diversified loan portfolio to help reduce the risk inherent in concentration of certain types of collateral. Refer to Item 1, “Lending Activities”, for a detailed discussion regarding the risks inherent in each loan category noted above. Due to the short time our portfolio has existed, the current mix may not be indicative of the ongoing portfolio mix.

As previously disclosed, although traditionally we have maintained only a small percentage of the Bank’s loan portfolio in consumer loans, we plan to supplement our current lending strategy by expanding our consumer lending program with on-line offerings, targeting prime and super-prime borrowers in the Bank’s current market area as well as throughout South Carolina. We are focused on profitably growing the Bank and enhancing shareholder value through this targeted expansion of our consumer lending program, which may include purchases of in-market consumer loans that meet the Bank’s underwriting criteria.

The following tables summarize the composition of our loan portfolio as of December 31, 2016, 2015, 2014, 2013 and 2012.

	2016						2015
	Amount			% of Total			Amount			% of Total
Real Estate:
Commercial	$	22,033,590			36.4	%	$	25,559,943			37.8	%
Construction and development		7,913,783			13.1			7,286,459			10.8
Single and multifamily residential		13,314,130			22.0			16,434,722			24.3
Total real estate loans		43,261,503			71.5			49,281,124			72.9
Commercial business		15,954,106			26.4			17,027,054			25.2
Consumer — other		1,434,449			2.4			1,369,224			2.1
Deferred origination fees, net		(167,062	)		(0.3	)		(135,647	)		(0.2	)
Gross loans, net of deferred fees		60,482,996			100.0	%		67,541,755			100.0	%
Less allowance for loan losses		(1,338,149	)					(1,139,509	)
Total loans, net	$	59,144,847					$	66,402,246


	2014						2013
	Amount			% of Total			Amount			% of Total
Real Estate:
Commercial	$	25,246,396			36.6	%	$	21,795,047			34.2	%
Construction and development		8,425,453			12.2			10,053,100			15.8
Single and multifamily residential		18,073,429			26.2			18,757,484			29.5
Total real estate loans		51,745,278			75.0			50,605,631			79.5
Commercial business		16,059,082			23.2			12,170,698			19.1
Consumer — other		1,372,906			2.0			999,941			1.6
Deferred origination fees, net		(149,823	)		(0.2	)		(106,134	)		(0.2	)
Gross loans, net of deferred fees		69,027,443			100.0	%		63,670,136			100.0	%
Less allowance for loan losses		(1,032,776	)					(1,301,886	)
Total loans, net	$	67,994,667					$	62,368,250


	2012
	Amount			% of Total
Real Estate:
Commercial	$	24,845,155			35.3	%
Construction and development		12,299,452			17.5
Single and multifamily residential		21,294,926			30.2
Total real estate		58,439,533			83.0
Commercial business		10,915,768			15.5
Consumer — other		1,128,544			1.6
Deferred origination fees, net		(102,099	)		(0.1	)
Gross loans		70,381,746			100.0	%
Less allowance for loan losses		(1,858,416	)
Total loans, net	$	68,523,330

Maturities and Sensitivity of Loans to Changes in Interest Rates

The information in the following table is based on the contractual maturities of individual loans, including loans which may be subject to renewal at their contractual maturity. Renewal of such loans is subject to review and credit approval, as well as modification of terms upon maturity. Actual repayments of loans may differ from the maturities reflected below because borrowers have the right to prepay obligations with or without prepayment penalties.

The following table summarizes the loan maturity distribution by type and related interest rate characteristics at December 31, 2016.

	One year or less		After one but within five years		After five years		Total
Real Estate:
Commercial	$	3,144,814	$	16,958,206	$	1,930,570	$	22,033,590
Construction and development		2,987,321		4,829,172		97,290		7,913,783
Single and multifamily residential		1,445,328		6,710,484		5,158,318		13,314,130
Total real estate		7,577,463		28,497,862		7,186,178		43,261,503
Commercial business		6,203,428		8,736,000		1,014,678		15,954,106
Consumer — other		540,500		821,639		72,310		1,434,449
Gross loans	$	14,321,391	$	38,055,501	$	8,273,166	$	60,650,058
Deferred origination fees, net								(167,062	)
Gross loans, net of deferred fees							$	60,482,996
Loans maturing — after one year with
Fixed interest rates							$	16,767,328
Floating interest rates							$	29,561,339

Loan Performance and Asset Quality

Generally, a loan will be placed on nonaccrual status when it becomes 90 days past due as to principal or interest (unless the loan is well-collateralized and in the process of collection), or when management believes, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of the loan is doubtful. When a loan is placed in nonaccrual status, interest accruals are discontinued and income earned but not collected is reversed. Cash receipts on nonaccrual loans are not recorded as interest income, but are used to reduce principal. Loans are removed from nonaccrual status when they become current as to both principal and interest and when concern no longer exists as to the collectability of principal or interest based on current available information or as evidenced by sufficient payment history, which generally is six months. Foregone interest income related to nonaccrual loans equaled $60,633 and $129,066 for the years ended December 31, 2016 and 2015, respectively. No interest income was recognized on nonaccrual loans during 2016 and 2015. At both December 31, 2016 and 2015, there were no accruing loans which were contractually past due 90 days or more as to principal or interest payments.

The following tables summarize delinquencies and nonaccruals, by portfolio class, as of December 31, 2016, 2015, 2014, 2013, and 2012.

	Single and multifamily residential real estate		Construction and development		Commercial real estate — other		Commercial business		Consumer		Total
December 31, 2016
30–59 days past due	$	442,295	$	—	$	—	$	617,052	$	—	$	1,059,347
60–89 days past due		—		—		—		409,675		—		409,675
Nonaccrual		108,951		—		195,500		—		—		304,451
Total past due and nonaccrual		551,246		—		195,500		1,026,727		—		1,773,473
Total debt restructurings		—		—		—		—		—		—
Current		12,762,884		7,913,783		21,838,090		14,927,379		1,434,449		58,876,585
Total loans	$	13,314,130	$	7,913,783	$	22,033,590	$	15,954,106	$	1,434,449	$	60,650,058

	Single and multifamily residential real estate		Construction and development		Commercial real estate — other		Commercial business		Consumer		Total
December 31, 2015
30–59 days past due	$	75,890	$	—	$	—	$	—	$	—	$	75,890
60–89 days past due		63,702		250,378		—		—		—		314,080
Nonaccrual		168,879		40,500		1,390,013		65,798		—		1,665,190
Total past due and nonaccrual		308,471		290,878		1,390,013		65,798		—		2,055,160
Total debt restructurings		—		—		—		—		—		—
Current		16,126,251		6,995,581		24,169,930		16,961,256		1,369,224		65,622,242
Total loans	$	16,434,722	$	7,286,459	$	25,559,943	$	17,027,054	$	1,369,224	$	67,677,402


	Single and multifamily residential real estate		Construction and development		Commercial real estate — other		Commercial business		Consumer		Total
December 31, 2014
30–59 days past due	$	188,033	$	39,561	$	—	$	23,938	$	—	$	251,532
60–89 days past due		—		—		—		9,129		—		9,129
Nonaccrual		—		—		534,057		—		—		534,057
Total past due and nonaccrual		188,033		39,561		534,057		33,067		—		794,718
Total debt restructurings		—		—		—		—		—		—
Current		17,885,396		8,385,892		24,712,339		16,026,015		1,372,906		68,382,548
Total loans	$	18,073,429	$	8,425,453	$	25,246,396	$	16,059,082	$	1,372,906	$	69,177,266


	Single and multifamily residential real estate		Construction and development		Commercial real estate — other		Commercial business		Consumer		Total
December 31, 2013
30–59 days past due	$	—	$	42,542	$	524,430	$	—	$	—	$	566,972
60–89 days past due		—		—		—		—		—		—
Nonaccrual		—		1,008,253		347,615		—		—		1,402,715
Total past due and nonaccrual		46,847		1,050,795		872,045		—		—		1,969,687
Total debt restructurings		46,847		—		—		—		—		—
Current		—		9,002,305		20,923,002		12,170,698		999,941		61,806,583
Total loans	$	18,757,484	$	10,053,100	$	21,795,047	$	12,170,698	$	999,941	$	63,776,270


	Single and multifamily residential real estate		Construction and development		Commercial real estate — other		Commercial business		Consumer		Total
December 31, 2012
30–59 days past due	$	46,178	$	—	$	—	$	—	$	9,316	$	55,494
60–89 days past due		—		—		—		—		1,541		1,541
Nonaccrual		719,260		3,710,587		331,000		—		—		4,760,847
Total past due and nonaccrual		765,438		3,710,587		331,000		—		10,857		4,817,882
Total debt restructurings		1,175,843		—		1,314,205		—		—		2,490,048
Current		19,353,645		8,588,865		23,199,950		10,915,768		1,117,687		63,175,915
Total loans	$	21,294,926	$	12,299,452	$	24,845,155	$	10,915,768	$	1,128,544	$	70,483,845

Total delinquent and nonaccrual loans decreased from $2,055,160 at December 31, 2015 to $1,773,473 at December 31, 2016, a decrease of $281,687 or 13.7%. This decrease was a result of the movement of three nonaccrual loans transferring to other real estate owned, which decreased by $1.4 million from 2015 to 2016, partially offset by an increase in loans past due 30-59 days of $983,457 and an increase in loans past due 60-89 days of $95,595 as discussed below. Nonaccrual decreases were seen in single and multifamily residential, construction and development, commercial real estate and residential lot real estate loans due to successful

foreclosure of the properties collateralizing these loans and their transfer to other real estate owned. At December 31, 2016, nonaccrual loans represented 0.5% of gross loans. Loans past due 30-89 days are considered potential problem loans and amounted to $1,469,022 and $389,970 at December 31, 2016 and 2015, respectively. The increase in 30-89 delinquent loans is due to seven loans moving into the 30-59 days delinquent category and two loans moving into the 60-89 days delinquent category.

Another method used to monitor the loan portfolio is credit grading. As part of the loan review process, loans are given individual credit grades, representing the risk we believe is associated with the loan balance. Credit grades are assigned based on factors that impact the collectability of the loan, the strength of the borrower, the type of collateral, and loan performance. Commercial loans are individually graded at origination and credit grades are reviewed on a regular basis in accordance with our loan policy. Consumer loans are assigned a “pass” credit rating unless something within the loan warrants a specific classification grade. The following tables summarize management’s internal credit risk grades, by portfolio class, as of December 31, 2016 and 2015.

	Single and multifamily residential real estate		Construction and development		Commercial real estate — other		Commercial business		Consumer		Total
December 31, 2016
Pass Loans (Consumer)	$	8,246,567	$	1,462,925	$	—	$	—	$	1,434,449	$	11,143,941
Grade 1 — Prime		—		—		—		—		—		—
Grade 2 — Good		—		—		—		—		—		—
Grade 3 — Acceptable		1,919,685		1,108,334		11,057,550		7,676,592		—		21,762,161
Grade 4 — Acceptable w/Care		2,877,013		5,273,411		9,232,019		7,307,961		—		24,690,404
Grade 5 — Special Mention		—		69,113		766,388		—		—		835,501
Grade 6 — Substandard		270,865		—		977,633		969,553		—		2,218,051
Grade 7 — Doubtful		—		—		—		—		—		—
Total loans	$	13,314,130	$	7,913,783	$	22,033,590	$	15,954,106	$	1,434,449	$	60,650,058


	Single and multifamily residential real estate		Construction and development		Commercial real estate — other		Commercial business		Consumer		Total
December 31, 2015
Pass Loans (Consumer)	$	8,340,816	$	1,350,332	$	—	$	—	$	1,369,224	$	11,060,372
Grade 1 — Prime		—		—		—		—		—		—
Grade 2 — Good		—		—		—		—		—		—
Grade 3 — Acceptable		4,479,116		809,004		8,121,125		7,667,706		—		21,076,951
Grade 4 — Acceptable w/Care		3,382,209		4,759,864		14,724,468		8,199,385		—		31,065,926
Grade 5 — Special Mention		63,702		76,381		611,189		846,106		—		1,597,378
Grade 6 — Substandard		168,879		290,878		2,103,161		313,857		—		2,876,775
Grade 7 — Doubtful		—		—		—		—		—		—
Total loans	$	16,434,722	$	7,286,459	$	25,559,943	$	17,027,054	$	1,369,224	$	67,677,402

Loans graded one through four are considered “pass” credits. Consumer loans are assigned a “pass” credit rating unless something within the loan warrants a specific classification grade. At December 31, 2016, approximately 95% of the loan portfolio had a credit grade of “pass” compared to 93% at December 31, 2015. For loans to qualify for this grade, they must be performing relatively close to expectations, with no significant departures from the intended source and timing of repayment.

Loans with a credit grade of five are not considered classified; however they are categorized as a special mention or watch list credit, and are considered potential problem loans. This classification is utilized by us when we have an initial concern about the financial health of a borrower. These loans are designated as such in order to be monitored more closely than other credits in our portfolio. We then gather current financial information about the borrower and evaluate our current risk in the credit. We will then either reclassify the loan as “substandard” or back to its original risk rating after a review of the information. There are times when we

may leave the loan on the watch list, if, in management’s opinion, there are risks that cannot be fully evaluated without the passage of time, and we determine to review the loan on a more regular basis. Loans on the watch list are not considered problem loans until they are determined by management to be classified as substandard. As of December 31, 2016, we had loans totaling $835,501 on the watch list compared to $1.6 million as of December 31, 2015. This decrease was primarily related to two loans from 2015 being deemed as acceptable and one loan being repaid in full, partially offset by two loans being deemed special mention during 2016.

Loans graded six or greater are considered classified credits. At December 31, 2016 and 2015, classified loans totaled $2.2 million and $2.9 million, respectively, with the vast majority of these loans being collateralized by real estate. The decrease was primarily related to three loans moving to other real estate owned and three loans being repaid in full during 2016. Classified credits are evaluated for impairment on a quarterly basis.

A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or interest when due, according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Impairment is measured on a loan-by-loan basis by calculating either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. The resulting shortfall is charged to provision for loan losses and is classified as a specific reserve. When an impaired loan is ultimately charged-off, the charge-off is taken against the specific reserve.

At December 31, 2016, impaired loans totaled $2.2 million, all of which were valued on a nonrecurring basis at the lower of cost or market value of the underlying collateral. Market values were obtained using independent appraisals, updated in accordance with our reappraisal policy, or other market data such as recent offers to the borrower. During 2016, the average recorded investment in impaired loans was $2.1 million compared to $2.4 million during 2015. As of December 31, 2016 and December 31, 2015, we had loans totaling approximately $835,501 and $498,437, respectively that were classified in accordance with our loan rating policies but were not considered impaired. On March 7, 2017, one impaired loan was transferred to other real estate owned for $165,000, net of a specific reserve of $35,000. The specific reserve was included in the December 31, 2016 allowance amounts. The following tables summarize information relative to impaired loans, by portfolio class, at December 31, 2016 and 2015.

	Unpaid principal balance		Recorded investment		Related allowance		Average impaired investment		Interest income
December 31, 2016
With no related allowance recorded:
Single and multifamily residential real estate	$	99,794	$	99,794	$	—	$	179,235	$	3,261
Construction and development		—		—		—		109,660		6,130
Commercial real estate — other		782,133		782,133		—		718,589		46,778
Commercial		231,448		231,448		—		96,283		4,744
Consumer		—		—		—		—		—
With related allowance recorded:
Single and multifamily residential real estate		171,071		171,071		93,471		201,000		3,251
Construction and development		—		—		—		98,139		—
Commercial real estate — other		195,500		195,500		30,500		524,283		—
Commercial		738,105		738,105		487,490		191,329		46,315
Consumer		—		—		—		—		—
Total:
Single and multifamily residential real estate		270,865		270,865		93,471		380,235		6,512
Construction and development		—		—		—		207,799		6,130
Commercial real estate — other		977,633		977,633		30,500		1,242,872		46,778
Commercial		969,553		969,553		487,490		287,612		51,059
Consumer		—		—		—		—		—
	$	2,218,051	$	2,218,051	$	611,461	$	2,118,518	$	110,479

	Unpaid principal balance		Recorded investment		Related allowance		Average impaired investment		Interest income
December 31, 2015
With no related allowance recorded:
Single and multifamily residential real estate	$	—	$	—	$	—	$	411,430	$	21,667
Construction and development		—		—		—		177,047		—
Commercial real estate — other		905,968		905,968		—		415,488		29,423
Commercial		—		—		—		62,015		—
Consumer		—		—		—		—		—
With related allowance recorded:
Single and multifamily residential real estate		236,938		236,938		163,138		270,668		—
Construction and development		40,500		40,500		10,500		239,206		727
Commercial real estate — other		1,197,193		1,197,193		201,793		805,654		46,761
Commercial		—		—		—		18,139		2,119
Consumer		—		—		—		—		—
Total:
Single and multifamily residential real estate		236,938		236,938		163,138		682,098		21,667
Construction and development		40,500		40,500		10,500		416,253		727
Commercial real estate — other		2,103,161		2,103,161		201,793		1,221,142		76,184
Commercial		—		—		—		80,154		2,119
Consumer		—		—		—		—		—
	$	2,380,599	$	2,380,599	$	375,431	$	2,399,647	$	100,697

Troubled debt restructurings (“TDRs”) are loans which have been restructured from their original contractual terms and include concessions that would not otherwise have been granted outside of the financial difficulty of the borrower. Concessions can relate to the contractual interest rate, maturity date, or payment structure of the note. As part of our workout plan for individual loan relationships, we may restructure loan terms to assist borrowers facing challenges in the current economic environment. The purpose of a TDR is to facilitate ultimate repayment of the loan.

At December 31, 2016, the principal balance of TDRs was zero as the one loan previously constituting our sole TDR during the year had been repaid in full at maturity in August 2016. At December 31, 2015, the principal balance of TDRs was zero as the one loan previously constituting our sole TDR had been transferred to other real estate owned. No TDRs went into default during the year ended December 31, 2015 and 2016. A TDR can be removed from “troubled” status once there is sufficient history of demonstrating the borrower can service the credit under market terms. We currently consider sufficient history to be approximately six months.

There were no loans modified as TDRs within the previous 12- month period for which there was a payment default during the years ended December 31, 2015 and 2016.

Provision and Allowance for Loan Losses

We have established an allowance for loan losses through a provision for loan losses charged to expense on our consolidated statements of operations. At December 31, 2016, the allowance for loan losses was $1.3 million, or 2.20% of gross loans, compared to $1.1 million at December 31, 2015, or 1.68% of gross loans. This increase in the allowance for loan losses is due to the recognition of provision for loan losses, partially offset by charge-offs taken against specific reserves, as well as payoffs in our commercial real estate portfolio, which carries a higher historical loss ratio and, consequently, a higher reserve factor within our allowance model.

prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The allowance for loan losses represents an amount which we believe will be adequate to absorb probable losses on existing loans that may become uncollectible. We strive to follow a comprehensive, well-documented, and consistently applied analysis of our loan portfolio in determining an appropriate level for the allowance for loan losses. Our judgment as to the adequacy of the allowance for loan losses is based on a number of assumptions about future events, which we believe to be reasonable, but which may or may not prove to be accurate. Our determination of the allowance for loan losses is based on what we believe are all significant factors that impact the collectability of loans, including consideration of factors such as the balance of impaired loans, the quality, mix, and size of our overall loan portfolio, economic conditions that may affect the borrower’s ability to repay, the amount and quality of collateral securing the loans, our historical loan loss experience, and a review of specific problem loans. We also consider subjective issues such as changes in lending policies and procedures, changes in the local/national economy, changes in volume or type of credits, changes in volume/severity of problem loans, quality of loan review and board of directors’ oversight, concentrations of credit, and peer group comparisons.

Our allowance for loan losses consists of both specific and general reserve components. The specific reserve component relates to loans that are impaired loans as defined in FASB ASC Topic 310, “Receivables”. Loans determined to be impaired are excluded from the general reserve calculation described below and evaluated individually for impairment. Impaired loans totaled $2.2 million at December 31, 2016, with an associated specific reserve of approximately $611,000. See above discussion under “Loan Performance and Asset Quality” for additional information related to impaired loans.

The general reserve component covers non-impaired loans and is calculated by applying historical loss factors to each sector of the loan portfolio and adjusting for qualitative environmental factors. The total general reserve is based upon the individual loan categories and their historical loss factors over an eight quarter moving average, adjusted for other risk factors as well. Therefore, the general allocation will move among the categories depending on if some loss factors increased while others decreased. Qualitative adjustments are used to adjust the historical average for changes to loss indicators within the economy, our market, and specifically our portfolio. The general reserve component is then combined with the specific reserve to determine the total allowance for loan losses.

The following tables summarize activity related to our allowance for loan losses for the years ended December 31, 2016, 2015, 2014, 2013, and 2012 by portfolio segment.

	Single and multifamily residential real estate			Construction and development			Commercial real estate — other			Commercial business		Consumer			Total
December 31, 2016
Allowance for loan losses:
Balance, beginning of year	$	265,797		$	184,130		$	439,830		$	244,679	$	5,073		$	1,139,509
Provision (reversal of provision) for loan losses		(30,000	)		(100,000	)		100,000			440,000		(3,000	)		407,000
Loan charge-offs		—			(10,500	)		(209,045	)		—		(640	)		(220,185	)
Loan recoveries		—			—			—			—		11,825			11,825
Net loans charged-off		—			(10,500	)		(209,045	)		—		11,185			(208,360	)
Balance, end of year	$	235,797		$	73,630		$	330,785		$	684,679	$	13,258		$	1,338,149
Individually reviewed for impairment	$	93,471		$	—		$	30,500		$	487,490	$	—		$	611,461
Collectively reviewed for impairment		142,326			73,630			300,285			197,189		13,258			726,688
Total allowance for loan losses	$	235,797		$	73,630		$	330,785		$	684,679	$	13,258		$	1,338,149
Gross loans, end of period:
Individually reviewed for impairment	$	171,071		$	—		$	195,500		$	738,105	$	—		$	1,104,676
Collectively reviewed for impairment		13,143,059			7,913,783			21,838,090			15,216,001		1,434,449			59,545,382
Total gross loans	$	13,314,130		$	7,913,783		$	22,033,590		$	15,954,106	$	1,434,449		$	60,650,058

	Single and multifamily residential real estate		Construction and development			Commercial real estate — other			Commercial business		Consumer			Total
December 31, 2015
Allowance for loan losses:
Balance, beginning of year	$	160,797	$	234,130		$	363,097		$	184,679	$	90,073		$	1,032,776
Provision (reversal of provision) for loan losses		105,000		(50,000	)		120,000			60,000		(85,000	)		150,000
Loan charge-offs		—		—			(43,267	)		—		—			(43,267	)
Loan recoveries		—		—			—			—		—			—
Net loans charged-off		—		—			(43,267	)		—		—			(43,267	)
Balance, end of year	$	265,797	$	184,130		$	439,830		$	244,679	$	5,073		$	1,139,509
Individually reviewed for impairment	$	163,138	$	10,500		$	201,793		$	—	$	—		$	375,431
Collectively reviewed for impairment		102,659		173,630			238,037			244,679		5,073			764,078
Total allowance for loan losses	$	265,797	$	184,130		$	439,830		$	244,679	$	5,073		$	1,139,509
Gross loans, end of period:
Individually reviewed for impairment	$	236,938	$	40,500		$	2,103,161		$	—	$	—		$	2,380,599
Collectively reviewed for impairment		16,197,784		7,245,959			23,456,782			17,027,054		1,369,224			65,296,803
Total gross loans	$	16,434,722	$	7,286,459		$	25,559,943		$	17,027,054	$	1,369,224		$	67,677,402


	Single and multifamily residential real estate			Construction and development			Commercial real estate — other			Commercial business			Consumer		Total
December 31, 2014
Allowance for loan losses:
Balance, beginning of year	$	237,230		$	485,010		$	360,564		$	129,009		$	90,073	$	1,301,886
Provision for loan losses		(150,000	)		(295,265	)		100,106			315,159			—		(30,000	)
Loan charge-offs		—			(118,577	)		(101,000	)		(297,889	)		—		(517,466	)
Loan recoveries		73,567			162,962			3,427			38,400			—		278,356
Net loans charged-off		73,567			44,385			(97,573	)		(259,489	)		—		(239,110	)
Balance, end of year	$	160,797		$	234,130		$	363,097		$	184,679		$	90,073	$	1,032,776
Individually reviewed for impairment	$	—		$	—		$	88,712		$	—		$	—	$	88,712
Collectively reviewed for impairment		160,797			234,130			274,385			184,679			90,073		944,064
Total allowance for loan losses	$	160,797		$	234,130		$	363,097		$	184,679		$	90,073	$	1,032,776
Gross loans, end of period:
Individually reviewed for impairment	$	725,090		$	—		$	1,290,503		$	—		$	—	$	2,015,593
Collectively reviewed for impairment		17,348,339			8,425,453			23,955,893			16,059,082			1,372,906		67,161,673
Total gross loans	$	18,073,429		$	8,425,453		$	25,246,396		$	16,059,082		$	1,372,906	$	69,177,266

	Single and multifamily residential real estate			Construction and development			Commercial real estate — other			Commercial business		Consumer			Total
December 31, 2013
Allowance for loan losses:
Balance, beginning of year	$	611,576		$	1,073,110		$	63,747		$	36,683	$	73,300		$	1,858,416
Provision for loan losses		(115,000	)		(586,040	)		703,817			85,827		16,820			105,424
Loan charge-offs		(259,346	)		(97,060	)		(407,000	)		—		(148	)		(763,554	)
Loan recoveries		—			95,000			—			6,499		101			101,600
Net loans charged-off		(259,346	)		(2,060	)		(407,000	)		6,499		(47	)		(661,954	)
Balance, end of year	$	237,230		$	485,010		$	360,564		$	129,009	$	90,073		$	1,301,886
Individually reviewed for impairment	$	7,425		$	101,000		$	83,614		$	—	$	—		$	192,039
Collectively reviewed for impairment		229,805			384,010			276,950			129,009		90,073			1,109,847
Total allowance for loan losses	$	237,230		$	485,010		$	360,564		$	129,009	$	90,073		$	1,301,886
Gross loans, end of period:
Individually reviewed for impairment	$	138,691		$	1,008,253		$	347,969		$	—	$	—		$	1,494,913
Collectively reviewed for impairment		18,618,793			9,044,847			21,447,078			12,170,698		999,941			62,281,357
Total gross loans	$	18,757,484		$	10,053,100		$	21,795,047		$	12,170,698	$	999,941		$	63,776,270


	Single and multifamily residential real estate			Construction and development			Commercial real estate — other			Commercial business			Consumer			Total
December 31, 2012
Allowance for loan losses:
Balance, beginning of year	$	576,669		$	688,847		$	347,061		$	412,808		$	85,138		$	2,110,523
Provision for loan losses		88,351			402,724			(233,315	)		(361,806	)		82,046			(22,000	)
Loan charge-offs		(55,330	)		(18,461	)		(49,999	)		(15,443	)		(93,884	)		(233,117	)
Loan recoveries		1,886			—			—			1,124			—			3,010
Net loans charged-off		(53,444	)		(18,461	)		(49,999	)		(14,320	)		(93,884	)		(230,108	)
Balance, end of year	$	611,576		$	1,073,110		$	63,747		$	36,683		$	73,300		$	1,858,416
Individually reviewed for impairment	$	159,979		$	248,417		$	34,000		$	—		$	—		$	442,396
Collectively reviewed for impairment		451,597			824,693			29,747			36,683			73,300			1,416,020
Total allowance for loan losses	$	611,576		$	1,073,110		$	63,747		$	36,683		$	73,300		$	1,858,416
Gross loans, end of period:
Individually reviewed for impairment	$	2,034,986		$	4,814,002		$	1,645,205		$	—		$	—		$	8,494,193
Collectively reviewed for impairment		19,259,940			7,485,450			23,199,950			10,915,768			1,128,544			61,989,652
Total gross loans	$	21,294,926		$	12,299,452		$	24,845,155		$	10,915,768		$	1,128,544		$	70,483,845

Net loan charge-offs increased during 2016 from $43,267 for the year ended December 31, 2015 to $208,360 for the year ended December 31, 2016, an increase of $165,093. Charge-offs in 2016 of approximately $220,000 were partial charge-offs taken on certain collateral-dependent loans within our commercial real estate and construction segments. Charge-offs in 2015 of approximately $43,000 were full charge-offs taken on one loan within our commercial real estate segment. Partial charge-offs were based on recent appraisals and evaluations on commercial real estate loans in the process of foreclosure. Loans with partial charge-offs are typically considered impaired loans and remain on nonaccrual status. In addition, when collateral is obtained in satisfaction of a loan, a charge-off is taken through the allowance at the time of repossession to move the collateral to other real estate owned at fair value less costs to sell.

The allowance as a percentage of gross loans increased from 1.68% at December 31, 2015 to 2.21% at December 31, 2016. The increase in the reserve percentage is due to an increase in allowance for loan losses of $198,640. The increase in allowance is attributed to the recognition of a provision for loan losses of $407,000, net of recoveries and charge-offs taken against specific reserves of $208,360. The general reserve as a percentage of non-impaired loans has increased from 1.17% at December 31, 2015 to 1.22% at December 31, 2016.

Portions of the allowance for loan losses may be allocated for specific loans or portfolio segments. However, the entire allowance for loan losses is available for any loan that, in management’s judgment, should be charge-off. While management utilizes the best judgment and information available to it, the ultimate adequacy of the allowance for loan losses depends on a variety of factors beyond our control, including the performance of our loan portfolio, the economy, changes in interest rates, and the view of the regulatory authorities toward loan classifications. If delinquencies and defaults increase, we may be required to increase our provision for loan losses, which would adversely affect our results of operations and financial condition. There can be no assurance that charge-offs of loans in future periods will not exceed the allowance for loan losses as estimated at any point in time or that provisions for loan losses will not be significant to a particular accounting period.

Other Real Estate Owned and Repossessed Assets

As of December 31, 2016, we had $2.2 million in other real estate owned. This compares to $1.9 million in other real estate owned as of December 31, 2015. During 2016, collateral was obtained from three loan relationships that went through the foreclosure process. We also completed the sale of three repossessed properties.

During 2016, other real estate owned for the Company decreased due to the sale of real estate owned that were purchased from the Bank for proceeds of approximately $613,000, which resulted in a loss of approximately $18,000 to the Company. Real estate owned for the Bank increased due to three pieces of real estate being moved to other real estate owned for $1.3 million, partially offset by the sale of one piece of real estate held by the Bank for proceeds of approximately $24,000, which resulted in a loss of approximately $6,000. In addition, the Bank recognized writedowns on real estate owned of approximately $284,000 during 2016. On March 7, 2017, one impaired loan was transferred to other real estate owned for $165,000, net of a specific reserve of $35,000. The specific reserve was included in the December 31, 2016 allowance amounts. The following table summarizes changes in the consolidated balance of other real estate owned and repossessed assets during the periods noted:

	2016			2015
Balance at beginning of year	$	1,910,220		$	2,557,457
Repossessed property acquired in settlement of loans		1,257,289			300,000
Proceeds from sales of repossessed property		(637,072	)		(582,295	)
Gain (loss) on sale and write-downs of repossessed property, net		(307,770	)		(364,942	)
Balance at end of year	$	2,222,667		$	1,910,220

The following table summarizes the composition of other real estate owned and repossessed assets as of the dates noted:

	December 31,
	2016		2015
Residential land lots	$	—	$	31,320
Single and multifamily residential real estate		—		—
Commercial office space		1,412,667		1,008,900
Commercial land		810,000		870,000
Equipment		—		—
Total	$	2,222,667	$	1,910,220

The remaining assets are being actively marketed with the primary objective of liquidating the collateral at a level which most accurately approximates fair value and allows recovery of as much of the unpaid principal loan balance as possible upon the sale of the asset within a reasonable period of time. Based on currently available valuation information, the carrying value of these assets is believed to be representative of their fair value less estimated costs to sell, although there can be no assurance that the ultimate

proceeds from the sale of these assets will be equal to or greater than their carrying values, particularly in the current real estate environment and the downward, though stabilizing, trends in third party appraised values.

Deposits and Other Interest-Bearing Liabilities

Our primary source of funds for loans and investments is our deposits and short-term repurchase agreements. Average total deposits for the years ended December 31, 2016 and 2015 were $83.1 million and $85.0 million, respectively. The following table shows the balance outstanding and the weighted-average rates paid on deposits held by us as of December 31, 2016, 2015, and 2014.

	2016					2015					2014
	Amount		Rate			Amount		Rate			Amount		Rate
Non-interest bearing demand deposits	$	13,723,902		—	%	$	13,010,209		—	%	$	11,016,882		—	%
Interest bearing demand deposits		8,959,818		0.11			8,894,408		0.12			7,335,360		0.12
Money market accounts		29,620,179		0.28			33,164,973		0.25			35,077,304		0.24
Savings accounts		1,054,314		0.05			1,034,438		0.05			767,668		0.05
Time deposits less than $100,000		5,565,797		0.76			5,756,202		0.71			6,695,936		0.62
Time deposits of $100,000 or more		20,783,638		0.92			21,707,095		0.84			21,981,513		0.76
Brokered time deposits less than $100,000		—		—			—		—			—		—
Total	$	79,707,648		0.45	%	$	83,567,325		0.38	%	$	82,874,663		0.36	%

Core deposits, which exclude time deposits of $100,000 or more, provide a relatively stable funding source for our loan portfolio and other earning assets. Core deposits decreased $4.9 million, or 4.7%, from $61.9 million at December 31, 2015 to $58.9 million at December 31, 2016. Total retail, or customer, deposits decreased $1.1 million during 2016, or 4.1%. Our loan-to-deposit ratio was 74.2% and 78.1% at December 31, 2016 and 2015, respectively.

All of our time deposits are certificates of deposits. The maturity distribution of our time deposits of $100,000 or more, excluding brokered deposits, at December 31, 2016 is as follows:

Three months or less	$	4,694,072
Over three through six months		3,153,453
Over six through twelve months		7,249,907
Over twelve months		11,252,003
Total	$	26,349,435

Time deposits that meet or exceed the FDIC insurance limit at $250,000 amounted to $8,913,592 and $7,578,706 as of December 31, 2016 and 2015, respectively.

Short-Term Borrowings

At December 31, 2016, 2015, and 2014, the Bank had sold $113,598, $113,080, and $153,603, respectively, of securities under agreements to repurchase with brokers with a weighted rate of 0.12%, 0.10%, and 0.15%, respectively that mature in less than 90 days. These agreements were secured with approximately $50,000, $107,000, and $130,000 of investment securities, respectively. The securities, under agreements to repurchase, averaged $135,708 during 2016, with $279,628 being the maximum amount outstanding at any month-end. The average rate paid in 2016 was 0.10%. The securities, under agreements to repurchase, averaged $98,636 during 2015, with $354,739 being the maximum amount outstanding at any month-end. The average rate paid in 2015 was 0.10%. The securities, under agreements to repurchase, averaged $110,307 during 2014, with $221,467 being the maximum amount outstanding at any month-end. The average rate paid in 2014 was 0.10%.

At December 31, 2016, the Bank had an unused unsecured line of credit to purchase federal funds of $2.0 million. The line of credit is available on a one to fourteen day basis for general corporate purposes of the Bank. The lender has reserved the right to withdraw the line at its option. At December 31, 2016, the Bank had pledged $15.5 million in loans to the FRB’s Borrower-in-Custody of Collateral program. Our available credit under this line was approximately $11.4 million as of December 31, 2016.

Federal Home Loan Bank Advances

From time to time, the Bank utilizes FHLB advances as a source of funding. However, at December, 31, 2016 and 2015, the Bank had no advances from the FHLB. In February 2017, an advance of $4,000,000 was obtained from the FHLB with a weighted average rate of 0.89% and a maturity date of November 2017.

Capital Resources

Total shareholders’ equity was $9.9 million at December 31, 2016, a decrease of $2.7 million, or 21.4%, from $12.6 million at December 31, 2015. Shareholders’ equity decreased during 2016 primarily due to the recognition of a net loss of $2.6 million and a decrease in the unrealized gain on investment securities of $121,902. For 2016, the $2.6 million net loss was primarily the result of $1.1 million in professional fees, $407,000 in provisions for loan losses and $512,407 in expenses related to real estate owned. Our shareholders’ equity is also affected by fluctuations in our other comprehensive income (loss). The highest month end reported unrealized loss in other comprehensive income during calendar 2016 was $288,014 in August 2016 as compared to the highest month end unrealized gain in December 2015 of $113,846.

Our Bank and Company are subject to various regulatory capital requirements administered by the federal banking agencies. Under the capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. Our capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors, and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements.

The Basel III capital rules, which were released in July 2013, implement new capital standards and apply to all national and state banks and savings associations regardless of size and bank holding companies and savings and loan holding companies with more than $1 billion in total consolidated assets. The requirements of the rules began to phase in on January 1, 2015 for the Bank, and the requirements of the rules will be fully phased in by January 1, 2019. Under the rules, the following minimum capital requirements apply to the Bank:

•

a new common equity Tier 1 risk-based capital ratio of 4.5%,

•

a Tier 1 risk-based capital ratio of 6% (increased from the former 4% requirement),

•

a total risk-based capital ratio of 8% (unchanged from the former requirement), and

•

a leverage ratio of 4% (also unchanged from the former requirement).

In addition, in order to avoid restrictions on capital distributions or discretionary bonus payments to executives, a covered banking organization must maintain a “capital conservation buffer” on top of its minimum risk-based capital requirements. This buffer must consist solely of Tier 1 common equity, but the buffer applies to all three measurements (common equity Tier 1, Tier 1 capital and total capital). The capital conservation buffer will be phased in incrementally over time, becoming fully effective on January 1, 2019, and will consist of an additional amount of common equity equal to 2.5% of risk-weighted assets. As of January 1, 2017, the Bank is required to hold a capital conservation buffer of 1.25%, increasing by 0.625% each successive year until 2019.

Under the regulations adopted by the federal regulatory authorities, the Bank will be categorized as:

•

Well capitalized if the institution (i) has total risk-based capital ratio of 10% or greater, (ii) has a Tier 1 risk-based capital ratio of 8% or greater, (iii) has a common equity Tier 1 risk-based capital ratio of 6.5% or greater, (iv) has a leverage capital ratio of 5% or greater, and (v) is not subject to any order or written directive to meet and maintain a specific capital level for any capital measure.

•

Adequately capitalized if the institution (i) has a total risk-based capital ratio of 8% or greater, (ii) has a Tier 1 risk-based capital ratio of 6% or greater, (iii) has a common equity Tier 1 risk-based capital ratio of 4.5% or greater, and (iv) has a leverage capital ratio of 4% or greater.

•

Undercapitalized if the institution (i) has a total risk-based capital ratio of less than 8%, (ii) has a Tier 1 risk-based capital ratio of less than 6%, (iii) has a common equity Tier 1 risk-based capital ratio of less than 4.5% or greater, or (iv) has a leverage capital ratio of less than 4%.

•

Significantly undercapitalized if the institution (i) has a total risk-based capital ratio of less than 6%, (ii) has a Tier 1 risk-based capital ratio of less than 4%, (iii) has a common equity Tier 1 risk-based capital ratio of less than 3% or greater, or (iv) has a leverage capital ratio of less than 3%.

•

Critically undercapitalized if the institution has a ratio of tangible equity to total assets that is equal to or less than 2%.

In addition, the Bank may be downgraded to, or deemed to be in, a capital category that is lower than indicated by its capital ratios if it is determined to be in an unsafe or unsound condition or if it receives an unsatisfactory examination rating with respect to certain matters. The Bank’s capital category is determined solely for the purpose of applying prompt corrective action regulations, and the capital category may not constitute an accurate representation of the Bank’s overall financial condition or prospects for other purposes.

See additional discussion above under “Business — Supervision and Regulation.”

The following table sets forth the Bank’s and the Company’s various capital ratios at December 31, 2016, 2015, and 2014.

	Bank									Holding Company
	2016			2015			2014			2016			2015			2014
Total risk-based capital		13.4	%		14.1	%		15.3	%		15.7	%		12.8	%		14.0	%
Tier 1 risk-based capital		12.1	%		12.8	%		14.0	%		14.4	%		16.7	%		12.7	%
Leverage capital		9.0	%		10.0	%		10.6	%		10.1	%		13.0	%		9.7	%
Common equity to Tier 1 capital		12.1	%		12.8	%		n/a			14.4	%		16.7	%		n/a

Since December 31, 2016, no conditions or events have occurred, of which we are aware, that have resulted in a material change in the Company’s or the Bank’s capital category. As of December 31, 2016, there were no commitments outstanding, and there were no new commitments as of March 23, 2017. Under Regulation W, the Bank may not be a source of cash or capital for the Company. As disclosed in “Note 22 — Parent Company Financial Information,” the Company’s cash balances were $1.8 million and it had no real estate held for sale at December 31, 2016.

Return on Equity and Assets

The following table shows the return on average assets (net income (loss) divided by average total assets), return on average equity (net income (loss) divided by average equity), and equity to assets ratio (average equity divided by average total assets) for the years ended December 31, 2016, 2015 and 2014. Since our inception, we have not paid cash dividends.

	2016			2015			2014
Return on average assets		(2.79	)%		(4.94	)%		(6.25	)%
Return on average equity		(27.36	)%		(38.47	)%		(6.24	)%
Equity to assets ratio		10.18	%		12.85	%		12.29	%

Effect of Inflation and Changing Prices

The effect of relative purchasing power over time due to inflation has not been taken into account in our consolidated financial statements. Rather, our financial statements have been prepared on a historical cost basis in accordance with GAAP.

Unlike most industrial companies, our assets and liabilities are primarily monetary in nature. Therefore, the effect of changes in interest rates will have a more significant impact on our performance than will the effect of changing prices and inflation in general. In addition, interest rates may generally increase as the rate of inflation increases, although not necessarily in the same magnitude.

Off-Balance Sheet Risk

Commitments to extend credit are agreements to lend to a client as long as the client has not violated any material condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. At December 31, 2016, unfunded commitments to extend credit were $8.6 million, of which approximately $7.9 million is at fixed rates and $677,000 is at variable rates. A significant portion of the unfunded commitments related to commercial lines of credit. Based on historical experience, we anticipate that a significant portion of these lines of credit will not be funded. We evaluate each client’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on our credit evaluation of the borrower. The type of collateral varies but may include accounts receivable, inventory, property, plant and equipment, and commercial and residential real estate.

We are not involved in off-balance sheet contractual relationships, unconsolidated related entities that have off-balance sheet arrangements, or other transactions that could result in liquidity needs or other commitments that significantly impact earnings.

Market Risk

Market risk is the risk of loss from adverse changes in market prices and rates, which principally arises from interest rate risk inherent in our lending, investing, deposit gathering, and borrowing activities. Other types of market risks, such as foreign currency exchange rate risk and commodity price risk, do not generally arise in the normal course of our business.

We actively monitor and manage our interest rate risk exposure principally by measuring our interest sensitivity “gap,” which is the positive or negative dollar difference between assets and liabilities that are subject to interest rate repricing within a given period of time. Interest rate sensitivity can be managed by repricing assets or liabilities, selling securities available for sale, replacing an asset or liability at maturity, or adjusting the interest rate during the life of an asset or liability. Managing the amount of assets and liabilities repricing in this same time interval helps to hedge the risk and minimize the impact on net interest income of rising or falling interest rates. We generally would benefit from increasing market rates of interest when we have an asset-sensitive gap position and generally would benefit from decreasing market rates of interest when we are liability-sensitive.

Approximately 67.7% of our loans were variable rate loans at December 31, 2016, an increase from 64.6% at December 31, 2015. As of December 31, 2016, our ratio of cumulative gap to total earning assets after 12 months but within five years was 18.84% because in a rate change scenario, $17.5 million more liabilities would reprice in a 12 month period than assets. However, our gap analysis is not a precise indicator of our interest sensitivity position. The analysis presents only a static view of the timing of maturities and repricing opportunities, without taking into consideration that changes in interest rates do not affect all assets and liabilities equally. For example, rates paid on a substantial portion of core deposits may change contractually within a relatively short time frame, but those rates are viewed by us as significantly less interest-sensitive than market-based rates such as those paid on noncore deposits. Net interest income may be affected by other significant factors in a given interest rate environment, including changes in the volume and mix of interest-earning assets and interest-bearing liabilities.

Interest rate risk is the Company’s primary market risk exposure. As part of interest rate risk management, the Company may enter into swap agreements to provide protection from rising rates and the impact on the current gap. There were no swap agreements at December 31, 2016. Currently, the Company’s exposure to market risk is reviewed on a regular basis by management, and at the Bank level, the ALCO.

Liquidity and Interest Rate Sensitivity

Liquidity represents the ability of a company to convert assets into cash or cash equivalents without significant loss, and the ability to raise additional funds by increasing liabilities. Liquidity management involves monitoring our sources and uses of funds in order to meet our day-to-day cash flow requirements while maximizing profits. Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control. For example, the timing of maturities of our investment portfolio is fairly predictable and subject to a high degree of control at the time investment decisions are made. However, net deposit inflows and outflows are far less predictable and are not subject to the same degree of control.

The Consolidated Company

At December 31, 2016, our liquid assets, consisting of cash and due from banks and federal funds sold, amounted to $10.8 million, or 11.9% of total assets, a decrease from our cash liquidity ratio of 14.2% as of December 31, 2015. During 2016, the decrease in liquidity is due primarily to the decrease in cash and due from bank and fed funds sold.

The Company

The Company’s cash balances, independent of the Bank, were $1.8 million and its real estate held for sale was zero at December 31, 2016 compared to cash balances of approximately $2.9 million and real estate held for sale of $631,320 at December 31, 2015. The Company’s accrued and other liabilities, independent of the Bank, were $304,346 at December 31, 2016 compared to $905,824 at December 31, 2015. The decrease in liquid assets of approximately $1.1 million was primarily due to the repayment of accrued liabilities, approximately $250,000 in expenses incurred related to the transaction services segment, approximately $147,000 in other real estate owned expenses incurred related to the asset management segment and approximately $913,000 in professional fees and data processing expenses incurred at the Company. The decrease in payables of $601,478 was due primarily to the repayment of accrued liabilities related to the transaction services segment during 2016. See “Note 22 — Parent Company Financial Information” for additional information related to the transaction services segment.

Asset/liability management is the process by which we monitor and control the mix and maturities of our assets and liabilities. The essential purposes of asset/liability management are to ensure adequate liquidity and to maintain an appropriate balance between interest sensitive assets and liabilities in order to minimize potentially adverse impacts on earnings from changes in market interest rates. Our ALCO monitors and considers methods of managing exposure to interest rate risk. We have both an internal ALCO consisting of senior management that meets at various times during each month and a board ALCO that meets monthly. The ALCOs are responsible for maintaining the level of interest rate sensitivity of our interest sensitive assets and liabilities within board-approved limits.

The Bank

Our ability to maintain and expand our deposit base and borrowing capabilities serves as our primary source of liquidity. We plan to meet our future cash needs through the liquidation of temporary investments and the generation of deposits within our market. In addition, we will receive cash upon the maturity and sale of loans and the maturity of investment securities. Our investment securities available for sale at December 31, 2016 amounted to $2.5 million, or 2.8% of total assets. Investment securities traditionally provide a secondary source of liquidity since they can be converted into cash in a timely manner. At December 31, 2016, $2.4 million of our investment portfolio was pledged against outstanding debt. Therefore, the related debt would need to be repaid prior to the securities being sold and converted to cash.

We are a member of the FHLB, from which applications for borrowings can be made for leverage purposes. The FHLB requires that securities, qualifying mortgage loans, and stock of the FHLB owned by the Bank be pledged to secure any advances from the FHLB. At December 31, 2016, we had collateral that would support approximately $12.3 million in additional borrowings. Like all banks, we are subject to the FHLB’s credit risk rating policy which assigns member institutions a rating which is reviewed quarterly. The rating system utilizes key factors such as loan quality, capital, liquidity, profitability, etc. Our ability to access our available borrowing capacity from the FHLB in the future is subject to our rating and any subsequent changes based on our financial performance as compared to factors considered by the FHLB in their assignment of our credit risk rating each quarter.

At December 31, 2016, the Bank had an unused line of credit to purchase federal funds of $2.0 million. The line of credit is available on a one to fourteen day basis for general corporate purposes of the Bank. The lender has reserved the right to withdraw the line at its option. At December 31, 2016, the Bank had pledged $15.5 million in loans to the FRB’s Borrower-in-Custody of Collateral program. Our available credit under this line was approximately $11.4 million as of December 31, 2016.

The following table sets forth information regarding our rate sensitivity, as of December 31, 2016, at each of the time intervals. The information in the table may not be indicative of our rate sensitivity position at other points in time. In addition, the maturity distribution indicated in the table may differ from the contractual maturities of the earning assets and interest-bearing liabilities

presented due to consideration of prepayment speeds under various interest rate change scenarios in the application of the interest rate sensitivity methods described above.

	Within three months			After three but within twelve months			After one but within five years			After five years			Total
Interest-earning assets:
Federal funds sold and other	$	6,143,000		$	—		$	—		$	—		$	6,143,000
Investment securities		—			—			2,499,805			—			2,499,805
Interest-bearing deposits in other institutions		1,750,000			4,250,000			4,500,000			—			10,500,000
Loans		2,116,714			12,204,679			13,531,086			32,797,579			60,650,058
Total interest-earning assets	$	10,009,714		$	16,454,679		$	20,530,891		$	32,797,579		$	79,792,863
Interest-bearing liabilities:
Money market and NOW	$	38,579,997		$	—		$	—		$	—		$	38,579,997
Regular savings		1,054,314			—			—			—			1,054,314
Time deposits		4,694,072			10,403,360			9,686,221			1,565,781			26,349,434
Repurchase agreements		113,598			—			—			—			113,598
Total interest-bearing liabilities	$	44,441,981		$	10,403,360		$	9,686,221		$	1,565,781		$	66,097,343
Period gap	$	(34,432,267	)	$	6,051,319		$	10,844,670		$	31,231,798
Cumulative gap		(34,432,267	)		(28,380,948	)		(17,536,278	)		13,695,520
Ratio of cumulative gap to total earning assets		(36.99	)%		(30.49	)%		(18.84	)%		14.71	%

Accounting, Reporting, and Regulatory Matters

The following is a summary of recent authoritative pronouncements that may affect our accounting, reporting, and disclosure of financial information:

In May 2014, the FASB issued guidance to change the recognition of revenue from contracts with customers. The core principle of the new guidance is that an entity should recognize revenue to reflect the transfer of goods and services to customers in an amount equal to the consideration the entity receives or expects to receive. In August 2015, the FASB deferred the effective date of ASU 2014-09, Revenue from Contracts with Customers. This topic was amended again in March 2016 to clarify the implementation guidance on principal versus agent considerations and address how an entity should assess whether it is the principal or the agent in contracts that include three or more parties. The amendments will be effective for the Company for annual periods beginning after December 15, 2018, and interim periods within annual reporting periods beginning after December 15, 2019. The Company does not expect these amendments to have a material effect on its financial statements.

In January 2016, the FASB amended the Financial Instruments topic of the Accounting Standards Codification to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The amendments will be effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. The Company will apply the guidance by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amendments related to equity securities without readily determinable fair values will be applied prospectively to equity investments that exist as of the date of adoption of the amendments. The Company does not expect these amendments to have a material effect on its financial statements.

In February 2016, the FASB amended the Leases topic of the Accounting Standards Codification to revise certain aspects of recognition, measurement, presentation, and disclosure of leasing transactions. The amendments will be effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. The Company is currently evaluating the effect that implementation of the new standard will have on its financial position, results of operations, and cash flows.

In March 2016, the FASB issued guidance to simplify several aspects of the accounting for share-based payment award transactions including the income tax consequences, the classification of awards as either equity or liabilities, and the classification on the statement of cash flows. Additionally, the guidance simplifies two areas specific to entities other than public business entities allowing them apply a practical expedient to estimate the expected term for all awards with performance or service conditions that have certain characteristics and also allowing them to make a one-time election to switch from measuring all liability-classified

awards at fair value to measuring them at intrinsic value. The amendments will be effective for the Company for annual periods beginning after December 15, 2016 and interim periods within those annual periods. The Company does not expect these amendments to have a material effect on its financial statements.

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

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

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

Not applicable.

Item 8. Financial Statements and Supplementary Data.

INDEX TO FINANCIAL STATEMENTS

FOR THE YEARS ENDED DECEMBER 31, 2016 and 2015

	Page(s)
Report of Independent Registered Public Accounting Firm	F-2

Consolidated Financial Statements:

Consolidated Balance Sheets	F-3

Consolidated Statements of Operations and Comprehensive Income (Loss)	F-4

Consolidated Statements of Changes in Shareholders’ Equity	F-5

Consolidated Statements of Cash Flows	F-6

Notes to Consolidated Financial Statements	F-7

F-1

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders

Independence Bancshares, Inc.

Greenville, South Carolina

We have audited the accompanying consolidated balance sheets of Independence Bancshares, Inc. and its subsidiary (the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of operations and comprehensive income (loss), changes in shareholders’ equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2016 and 2015, and the results of its operations and cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.

/s/ Elliott Davis Decosimo, LLC

Greenville, South Carolina

March 23, 2017

F-2

INDEPENDENCE BANCSHARES, INC.
CONSOLIDATED BALANCE SHEETS

	December 31,
	2016			2015
Assets
Cash and due from banks	$	4,631,727		$	5,453,795
Federal funds sold		6,143,000			8,446,000
Cash and cash equivalents		10,774,727			13,899,795
Interest-bearing deposits in other institutions		10,500,000			1,500,000
Investment securities available for sale		2,499,805			10,687,851
Non-marketable equity securities		380,050			392,500
Loans, net of an allowance for loan losses of $1,338,149 and $1,139,509, respectively		59,144,847			66,402,246
Accrued interest receivable		170,342			232,215
Property, equipment, and software, net		2,025,774			2,198,796
Other real estate owned and repossessed assets		2,222,667			1,910,220
Bank-owned life insurance		2,542,910			—
Other assets		187,935			243,683
Total assets	$	90,449,057		$	97,467,306
Liabilities
Deposits:
Non-interest bearing	$	13,723,903		$	13,010,209
Interest bearing		65,983,745			70,557,116
Total deposits		79,707,648			83,567,325
Securities sold under agreements to repurchase		113,598			113,080
Accrued interest payable		8,802			7,909
Accounts payable and accrued expenses		674,644			1,134,833
Total liabilities		80,504,692			84,823,147
Commitments and contingencies — notes 13 and 14
Shareholders’ equity
Preferred stock, par value $.01 per share; 10,000,000 shares authorized; 8,425 Series A shares issued and outstanding		84			84
Common stock, par value $.01 per share; 300,000,000 shares authorized; 20,502,760 shares issued and outstanding		205,028			205,028
Additional paid-in capital		43,053,599			43,043,473
Accumulated other comprehensive income		(8,056	)		113,846
Accumulated deficit		(33,306,290	)		(30,718,272	)
Total shareholders’ equity		9,944,365			12,644,159
Total liabilities and shareholders’ equity	$	90,449,057		$	97,467,306

See notes to consolidated financial statements that are an integral part of these consolidated statements.

F-3

INDEPENDENCE BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)

	Year Ended December 31,
	2016			2015
Interest income
Loans	$	3,272,291		$	3,193,831
Investment securities		219,507			323,979
Federal funds sold and other		73,030			49,953
Total interest income		3,564,828			3,567,763
Interest expense
Deposits		326,120			315,484
Borrowings		220			15,578
Total interest expense		326,340			331,062
Net interest income		3,238,488			3,236,701
Provision for loan losses		407,000			150,000
Net interest income after provision for loan losses		2,831,488			3,086,701
Non-interest income
Service fees on deposit accounts		95,431			81,159
Residential loan origination fees		231,495			224,663
Forgiveness of debt		—			403,245
SBA loan fees		119,306			—
Gain (loss) on sale of investments		296,723			(87,995	)
Other income		97,739			45,835
Total non-interest income		840,694			666,907
Non-interest expenses
Compensation and benefits		2,557,959			2,950,953
Real estate owned activity		512,407			457,173
Occupancy and equipment		639,167			678,404
Insurance		216,295			233,168
Data processing and related costs		471,976			343,107
Professional fees		1,050,062			1,320,505
Product research and development expense		249,594			2,209,978
Other		562,740			353,759
Total non-interest expenses		6,260,000			8,547,047
Loss before income tax expense		(2,588,018	)		(4,793,439	)
Income tax expense		—			5,080
Net loss	$	(2,588,018	)	$	(4,798,519	)
Other comprehensive income (loss), net of tax
Unrealized (loss) gain on investment securities available for sale, net of tax		174,821			24,697
Reclassification adjustment included in net income, net of tax		(296,723	)		87,995
Other comprehensive (loss) income		(121,902	)		112,692
Total comprehensive loss	$	(2,709,920	)	$	(4,685,827	)
Loss per common share — basic and diluted	$	(0.13	)	$	(0.23	)
Weighted average common shares outstanding — basic and diluted		20,502,760			20,502,760

See notes to consolidated financial statements that are an integral part of these consolidated statements.

F-4

INDEPENDENCE BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2016 AND 2015

											Accumulated other
	Preferred stock				Common stock				Additional		comprehensive			Accumulated
	Shares		Amount		Shares		Amount		paid-in capital		income (loss)			deficit			Total
December 31, 2014		—	$	—		20,502,760	$	205,028	$	35,124,151	$	1,154		$	(25,919,753	)	$	9,410,580
Compensation expense related to stock options granted		—		—		—		—		303,829		—			—			303,829
Issuance of preferred stock – net of expenses		8,425		84		—		—		7,615,493		—			—			7,615,577

Net loss		—		—		—		—		—		—			(4,798,519	)		(4,798,519	)

Other comprehensive income		—		—		—		—		—		112,692			—			112,692

December 31, 2015		8,425	$	84		20,502,760	$	205,028	$	43,043,473	$	113,846		$	(30,718,272	)	$	12,644,159

Compensation expense related to stock options granted		—		—		—		—		10,126		—			—			10,126

Net loss		—		—		—		—		—		—			(2,588,018	)		(2,588,018	)

Other comprehensive loss		—		—		—		—		—		(121,902	)		—			(121,902	)

December 31, 2016		8,425	$	84		20,502,760	$	205,028	$	43,053,599	$	(8,056	)	$	(33,306,290	)	$	9,944,365

See notes to consolidated financial statements that are an integral part of these consolidated statements.

F-5

INDEPENDENCE BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS

	Year Ended December 31,
	2016			2015
Operating activities
Net loss	$	(2,588,018	)	$	(4,798,519	)
Adjustments to reconcile net loss to cash used in operating activities:
Provision for loan losses		407,000			150,000
Depreciation		206,623			215,471
Amortization of investment securities discounts/premiums, net		134,622			110,134
Stock option expense related to stock options granted		10,126			303,829
(Gain) loss on sale of investment securities		(296,723	)		87,995
Increase in value of bank owned life insurance		(42,910	)		—
Loss on disposal of property, equipment and software		566			—
Net changes in fair value and losses on sale of other real estate owned and repossessed assets		307,770			364,942
Forgiveness of debt		—			(403,245	)
Decrease in other assets, net		117,621			170,697
Decrease in other liabilities, net		(400,648	)		(1,185,202	)
Net cash used in operating activities		(2,143,971	)		(4,983,898	)
Investing activities
Net decrease in loans		5,593,110			1,142,421
Purchases of investment securities available for sale		(7,437,287	)		(336,864	)
Maturities and sales of investment securities available for sale		14,955,233			4,070,789
Repayments of investment securities available for sale		651,651			1,166,366
Net activity in interest bearing deposits in other institutions		(9,000,000	)		(1,500,000	)
Redemption of non-marketable equity securities, net		12,450			217,150
Purchase of bank owned life insurance		(2,500,000	)		—
Purchase of property, equipment, and software		(34,167	)		(30,260	)
Proceeds from sale of other real estate owned and repossessed assets		637,072			582,295
Net cash provided by investing activities		2,878,062			5,311,897
Financing activities
(Decrease) increase in deposits, net		(3,859,677	)		692,662
Repayments on borrowings		—			(5,000,000	)
Increase (decrease) in securities sold under agreements to repurchase		518			(40,523	)
Repayments on note payable		—			(600,000	)
Issuance of preferred stock, net		—			7,615,577
Net cash provided by (used in) financing activities		(3,859,159	)		2,667,716
Net increase (decrease) in cash and cash equivalents		(3,125,068	)		2,995,715
Cash and cash equivalents at beginning of the year		13,899,795			10,904,080
Cash and cash equivalents at end of the year	$	10,774,727		$	13,899,795
Supplemental information
Cash paid for
Interest	$	325,447		$	331,379
Schedule of non-cash transactions
Unrealized gain on securities available for sale, net of tax	$	174,821		$	24,697
Loans transferred to other real estate owned and repossessed assets	$	1,257,289		$	300,000

See notes to consolidated financial statements that are an integral part of these consolidated statements.

F-6

INDEPENDENCE BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ACTIVITIES

Independence Bancshares, Inc. (the “Company”) is a South Carolina corporation organized to operate as a bank holding company pursuant to the Federal Bank Holding Company Act of 1956 and the South Carolina Banking and Branching Efficiency Act of 1996, and to own and control all of the capital stock of Independence National Bank (the “Bank”), a national association organized under the laws of the United States. Since opening for business on May 16, 2005, the Bank has operated as a traditional community bank in Greenville, South Carolina, fulfilling the financial needs of individuals and small businesses in its market. The Bank provides traditional checking and savings products insured by the Federal Deposit Insurance Corporation (the “FDIC”) and consumer, commercial and mortgage loans, as well as ATM and online banking, cash management and safe deposit boxes.

As previously reported, on September 25, 2015, the Company suspended development of its digital banking, payments and transaction services business and has subsequently been evaluating strategic alternatives for the Company. A key goal of the Company’s digital banking business was to reduce costs for banking activities and operate more efficiently through utilizing mobile and on-line delivery channels. In furtherance of this goal and based in part upon the institutional knowledge acquired in the pursuit of the digital banking strategy, the Company plans to supplement its current lending strategy by expanding its consumer lending program with on-line offerings, targeting prime and super-prime borrowers in the Bank’s current market area as well as throughout South Carolina. The Company’s board of directors is focused on profitably growing the Bank and enhancing shareholder value through this targeted expansion of its consumer lending program, which may include purchases of in-market consumer loans that meet the Bank’s underwriting criteria.

The following is a description of the significant accounting and reporting policies that the Company follows in preparing and presenting consolidated financial statements.

Basis of Presentation

The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, Independence National Bank. In consolidation, all significant intercompany transactions have been eliminated. The accounting and reporting policies conform to accounting principles generally accepted in the United States and to general practices in the banking industry.

Subsequent Events

Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements. Non-recognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date. Management performed an evaluation to determine whether or not there have been any subsequent events since the balance sheet date.

Reclassifications

Certain amounts have been reclassified to state all periods on a comparable basis. Reclassifications had no effect on previously reported shareholders’ equity or net loss.

Estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amount of income and expenses during the reporting periods. Actual results could differ from those estimates.

Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses, including valuation allowances for impaired loans, the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans, and calculation of the provision for income taxes and deferred income tax assets and related valuation allowances. In connection with the determination of the allowance for loan losses and the valuation of foreclosed real estate,

F-7

management obtains independent appraisals for significant properties and takes into account other current market information. Management must also make estimates in determining the useful lives and methods for depreciating premises and equipment.

While management uses available information to recognize losses on loans and foreclosed real estate, future additions to the allowance for loan losses and changes to valuation of foreclosed real estate may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses and valuation of foreclosed real estate. Such agencies may require the Company to recognize additions to the allowance for loan losses or additional write-downs on foreclosed real estate based on their judgments about information available to them at the time of their examination. Because of these factors, it is reasonably possible that the allowance for loan losses and valuation of foreclosed real estate may change materially in the near term.

Risks and Uncertainties

In the normal course of its business, the Company encounters two significant types of risks: economic and regulatory. There are three main components of economic risk: interest rate risk, credit risk and market risk. The Company is subject to interest rate risk to the degree that its interest bearing liabilities mature or reprice at different speeds, or on different bases, than its interest-earning assets. Credit risk is the risk of default within the Company’s loan portfolio that results from borrowers’ inability or unwillingness to make contractually required payments. Market risk reflects changes in the value of collateral underlying loans receivable and the valuation of real estate held by the Company.

The Company is subject to the regulations of various governmental agencies. These regulations can change significantly from period to period. The Company also undergoes periodic examinations by the regulatory agencies, which may subject it to changes with respect to valuation of assets, amount of required loss allowance and operating restrictions resulting from the regulators’ judgments based on information available to them at the time of their examinations. The Bank makes loans to individuals and businesses in and around “Upstate” South Carolina for various personal and commercial purposes. The Bank has a diversified loan portfolio. Borrowers’ ability to repay their loans is not dependent upon any specific economic sector.

Cash and Cash Equivalents

For purposes of reporting cash flows, cash and cash equivalents includes cash, amounts due from banks and federal funds sold. Generally, federal funds are sold for one-day periods. Due to the short term nature of cash and cash equivalents, the carrying amount of these instruments is deemed to be a reasonable estimate of fair value.

At December 31, 2016 and 2015, the Company had restricted cash totaling $2,000 with the Federal Home Loan Bank (“FHLB”) of Atlanta. The Company places its deposits and correspondent accounts with and sells its federal funds to high quality institutions. Management believes credit risk associated with correspondent accounts is not significant.

Investment Securities

Investment securities are accounted for in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 320, “Investments — Debt and Equity Securities.” Management classifies securities at the time of purchase into one of three categories as follows: (1) Securities Held to Maturity: securities which the Company has the positive intent and ability to hold to maturity, which are reported at amortized cost; (2) Trading Securities: securities that are bought and held principally for the purpose of selling them in the near future, which are reported at fair value with unrealized gains and losses included in earnings; and (3) Securities Available for Sale: securities that may be sold under certain conditions, which are reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders’ equity as accumulated other comprehensive income. The amortization of premiums and accretion of discounts on investment securities are recorded as adjustments to interest income. Gains or losses on sales of investment securities are based on the net proceeds and the adjusted carrying amount of the securities sold, using the specific identification method. Losses on securities, reflecting a decline in value or impairment judged by the Company to be other-than-temporary, are charged to earnings in the consolidated statements of operations.

Non-Marketable Equity Securities

The Bank, as a member of the Federal Reserve Bank (“FRB”) and the FHLB, is required to own capital stock in these organizations. The amount of FRB stock owned is based on the Bank’s capital levels and totaled $293,050 and $303,500 at December 31, 2016 and 2015, respectively. The amount of FHLB stock owned is determined based on the Bank’s balances of residential mortgages and advances from the FHLB and totaled $87,000 and $89,000 at December 31, 2016 and 2015, respectively. No ready

F-8

market exists for these stocks, and they have no quoted market value. However, redemption of these stocks has historically been at par value. Accordingly, the carrying amounts are deemed to be a reasonable estimate of fair value.

Loans Receivable

Loans are stated at their unpaid principal balance net of any charge-offs. Interest income is computed using the simple interest method and is recorded in the period earned. Fees earned and direct costs incurred on loans are amortized using the effective interest method over the life of the loan.

When serious doubt exists as to the collectability of a loan or when a loan becomes contractually 90 days past due as to principal or interest, interest income is generally discontinued unless the estimated net realizable value of collateral exceeds the principal balance and accrued interest. When interest accruals are discontinued, income earned but not collected is reversed. Cash receipts on nonaccrual loans are not recorded as interest income, but are used to reduce principal. Generally, loans are returned to accrual status when the loan is brought current and ultimate collectability of principal and interest is no longer in doubt.

Allowance for Loan Losses

An allowance for loan losses is maintained at a level deemed appropriate by management to adequately provide for known and inherent losses in the loan portfolio. The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. In cases where management deems the amount of the reserve for loan losses to be less than previously determined, an adjustment to lower or reverse the provision will be recorded. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, as well as any reversal of provision, if any, are credited to the allowance.

The allowance for loan losses or any reversal of provision is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The allowance consists of both a specific and a general component. The specific component relates to loans that are impaired loans as defined in FASB ASC Topic 310, “Receivables”. For such loans, an allowance is established when either the discounted cash flows or collateral value (less estimated selling costs) or observable market price of the impaired loan is lower than the carrying value of that loan. The general reserve component covers non-impaired loans and is calculated by applying historical loss factors to each sector of the loan portfolio and adjusting for qualitative environmental factors. Qualitative adjustments are used to adjust the historical average for changes to loss indicators within the economy, our market, and specifically our portfolio. The general reserve component is then combined with the specific reserve to determine the total allowance for loan losses.

The Company identifies impaired loans through its internal loan review process. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Loans on the Company’s problem loan watch list are considered potentially impaired loans. Generally, once loans are considered impaired and in the process of the foreclosure process, they are moved to nonaccrual status and recognition of interest income is discontinued. Impairment is measured on a loan-by-loan basis based on the determination of the most probable source of repayment which is usually liquidation of the underlying collateral, but may also include discounted future cash flows, or in rare cases, the market value of the loan itself.

Independence Bancshares, Inc. 10-K