UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x Quarterly Report under Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended March 31, 2016.

or

¨ Transition Report under Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from _______________ to ________________.

Commission File No. 0-24172

Southeastern Bank Financial Corporation

(Exact name of registrant as specified in its charter)

Georgia	58-2005097
(State of Incorporation)	(I.R.S. Employer Identification No.)

3530 Wheeler Road, Augusta, Georgia 30909

(Address of principal executive offices)

(706) 738-6990

(Issuer's telephone number, including area code)

Not Applicable

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

Indicate by check mark whether the issuer: (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the issuer 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 ¨	Non-accelerated filer ¨
	(do not check if a smaller reporting company)
Accelerated filer x	Smaller reporting company ¨

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

APPLICABLE ONLY TO CORPORATE ISSUERS

State the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:

6,746,897 shares of common stock, $3.00 par value per share, outstanding as of April 26, 2016.

SOUTHEASTERN BANK FINANCIAL CORPORATION
FORM 10-Q
INDEX
			Page
Part I
	Item 1.	Financial Statements (Unaudited)
		Consolidated Balance Sheets as of March 31, 2016 and December 31, 2015	3
		Consolidated Statements of Comprehensive Income for the Three Months ended March 31, 2016 and 2015	4
		Consolidated Statements of Cash Flows for the Three Months ended March 31, 2016 and 2015	6
		Notes to Consolidated Financial Statements	8
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	39
	Item 3.	Quantitative and Qualitative Disclosures about Market Risk	59
	Item 4.	Controls and Procedures	59
Part II  Other Information
	Item 1.	Legal Proceedings	60
	Item 1A.	Risk Factors	60
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	60
	Item 3.	Defaults Upon Senior Securities	61
	Item 4.	Mine Safety Disclosures	61
	Item 5.	Other Information	61
	Item 6.	Exhibits	61
Signature			62

1

PART I

FINANCIAL INFORMATION

2

SOUTHEASTERN BANK FINANCIAL CORPORATION

Consolidated Balance Sheets

(Dollars in thousands, except share data)

	March 31,
	2016		December 31,
	(Unaudited)		2015
Assets
Cash and due from banks	$	61,396	$	40,181
Interest-bearing deposits in other banks		29,321		2,736
Cash and cash equivalents		90,717		42,917
Available-for-sale securities		662,265		691,563
Loans held for sale, at fair value		18,588		18,647
Loans		1,029,936		1,009,149
Less allowance for loan losses		21,548		21,367
Loans, net		1,008,388		987,782
Premises and equipment, net		26,959		27,398
Accrued interest receivable		6,237		6,331
Bank-owned life insurance		43,496		43,167
Restricted equity securities		5,478		5,169
Other real estate owned		655		360
Deferred tax asset		11,094		13,958
Other assets		3,398		3,073
	$	1,877,275	$	1,840,365
Liabilities and Stockholders' Equity
Deposits
Noninterest-bearing	$	254,356	$	229,002
Interest-bearing:
NOW accounts		406,553		401,674
Savings		548,413		548,729
Money management accounts		16,154		16,330
Time deposits		342,977		333,345
		1,568,453		1,529,080
Securities sold under repurchase agreements		763		15,684
Advances from Federal Home Loan Bank		90,000		85,000
Accrued interest payable and other liabilities		19,866		20,688
Subordinated debentures		20,000		20,000
Total liabilities		1,699,082		1,670,452
Stockholders' equity:
Preferred stock, no par value; 10,000,000 shares authorized; 0 shares outstanding in 2016 and 2015, respectively		-		-
Common stock, $3.00 par value; 10,000,000 shares authorized; 6,746,328 and 6,745,818 shares issued in 2016 and 2015, respectively; 6,746,328 and 6,745,818 shares outstanding in 2016 and 2015, respectively		20,239		20,237
Additional paid-in capital		63,869		63,637
Retained earnings		90,867		87,250
Treasury stock, at cost; 0 shares in 2016 and 2015, respectively		-		-
Accumulated other comprehensive income (loss), net		3,218		(1,211	)
Total stockholders' equity		178,193		169,913
	$	1,877,275	$	1,840,365

See accompanying notes to unaudited consolidated financial statements.

3

SOUTHEASTERN BANK FINANCIAL CORPORATION

Consolidated Statements of Comprehensive Income

(Dollars in thousands, except share and per share data)

(Unaudited)

	Three Months Ended
	March 31,
	2016			2015
Interest income:
Loans, including fees	$	11,954		$	11,525
Investment securities		3,849			3,647
Interest-bearing deposits in other banks		37			17
Total interest income		15,840			15,189
Interest expense:
Deposits		1,375			1,460
Securities sold under repurchase agreements		10			3
Other borrowings		626			638
Total interest expense		2,011			2,101
Net interest income		13,829			13,088
Provision for loan losses		428			547
Net interest income after provision for loan losses		13,401			12,541
Noninterest income:
Service charges and fees on deposits		1,765			1,744
Gain on sales of loans		1,688			1,554
Investment securities gains, net		236			57
Retail investment income		538			526
Trust service fees		354			336
Earnings from cash surrender value ofbank-owned life insurance		329			278
Miscellaneous income		305			224
Total noninterest income		5,215			4,719
Noninterest expense:
Salaries and other personnel expense		6,772			6,587
Occupancy expenses		1,091			1,018
Other real estate losses (gains), net		-			(66	)
Other operating expenses		3,849			3,526
Total noninterest expense		11,712			11,065
Income before income taxes		6,904			6,195
Income tax expense		2,208			1,989
Net income	$	4,696		$	4,206
Other comprehensive income:
Unrealized loss on derivatives	$	(643	)	$	(366	)
Unrealized gain on securities available-for-sale		8,128			4,263
Reclassification adjustment for realized gainon securities, net of OTTI		(236	)		(57	)
Tax effect		(2,820	)		(1,494	)
Total other comprehensive income		4,429			2,346
Comprehensive income	$	9,125		$	6,552

4

SOUTHEASTERN BANK FINANCIAL CORPORATION

Consolidated Statements of Comprehensive Income

(Dollars in thousands, except share and per share data)

(Unaudited)

	Three Months Ended
	March 31,
	2016		2015
Basic net income per share	$	0.70	$	0.63
Diluted net income per share		0.70		0.63
Weighted average common shares outstanding		6,718,157		6,695,011
Weighted average number of common andcommon equivalent shares outstanding		6,731,088		6,707,037

See accompanying notes to unaudited consolidated financial statements.

5

SOUTHEASTERN BANK FINANCIAL CORPORATION

Consolidated Statements of Cash Flows

(Dollars in thousands)

(Unaudited)

	Three Months Ended
	March 31,
	2016			2015
Cash flows from operating activities:
Net income	$	4,696		$	4,206
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation		598			548
Deferred income tax expense (benefit)		44			(321	)
Provision for loan losses		428			547
Net investment securities gains		(236	)		(57	)
Net amortization of premiums on investment securities		1,085			908
Earnings from CSV of bank-owned life insurance		(329	)		(278	)
Stock-based compensation expense		117			117
Deferred gain on the sale of other real estate		-			(77	)
Gain on the sale of other real estate		-			(67	)
Provision for other real estate valuation allowance		-			1
Gain on sales of loans		(1,688	)		(1,554	)
Real estate loans originated for sale		(54,702	)		(48,268	)
Proceeds from sales of real estate loans		56,449			49,917
Decrease (increase) in accrued interest receivable		94			(413	)
Increase in other assets		(325	)		(859	)
Decrease in accrued interest payable and other liabilities		(1,465	)		(285	)
Net cash provided by operating activities		4,766			4,065
Cash flows from investing activities:
Proceeds from sales of available-for-sale securities		51,004			23,300
Proceeds from maturities and calls of available-for-sale securities		20,718			24,440
Purchase of available-for-sale securities		(35,381	)		(73,655	)
Proceeds from redemption of FHLB stock		-			160
Purchase of FHLB stock		(309	)		(38	)
Net increase in loans		(21,329	)		(4,526	)
Additions to premises and equipment		(159	)		(726	)
Proceeds from sale of other real estate		-			206
Net cash provided by (used in) investing activities		14,544			(30,839	)

6

SOUTHEASTERN BANK FINANCIAL CORPORATION

Consolidated Statements of Cash Flows

(Dollars in thousands)

(Unaudited)

	Three Months Ended
	March 31,
	2016			2015
Cash flows from financing activities:
Net increase in deposits		39,373			73,155
Net decrease in securities sold under repurchase agreements		(14,921	)		(9,963	)
Advances from Federal Home Loan Bank		5,000			-
Purchase of treasury stock		-			(11	)
Payment of cash dividends		(1,079	)		(1,011	)
Tax benefit from stock-based compensation		100			46
Proceeds from directors' stock purchase plan		17			12
Net cash provided by financing activities		28,490			62,228
Net increase in cash and cash equivalents		47,800			35,454
Cash and cash equivalents at beginning of period		42,917			35,995
Cash and cash equivalents at end of period	$	90,717		$	71,449
Supplemental disclosures of cash paid during the period for:
Interest	$	2,048		$	2,214
Income taxes		1,780			2,295
Supplemental information on noncash investing activities:
Loans transferred to other real estate owned	$	295		$	303
Loans provided for sales of other real estate owned		-			392
Due to broker		-			1,586

See accompanying notes to unaudited consolidated financial statements.

7

SOUTHEASTERN BANK FINANCIAL CORPORATION

Notes to Unaudited Consolidated Financial Statements

(Dollar amounts are expressed in thousands unless otherwise noted)

March 31, 2016

Note 1 – Summary of Significant Accounting Policies

(a) Nature of Operations and Principles of Consolidation

The accompanying consolidated financial statements include the accounts of Southeastern Bank Financial Corporation and its wholly-owned subsidiary, Georgia Bank & Trust Company of Augusta, Georgia, together referred to as “the Company.” Significant intercompany transactions and balances are eliminated in consolidation. Dollar amounts are rounded to thousands except share and per share data.

The Company provides financial services through its offices in Richmond and Columbia Counties, Georgia, and Aiken County, South Carolina. Its primary deposit products are checking, savings, and term certificate accounts, and its primary lending products are residential mortgage, commercial, and installment loans. Substantially all loans are secured by specific items of collateral including business assets, consumer assets, and commercial and residential real estate. Commercial loans are expected to be repaid from cash flow from operations of businesses. The Company has a significant concentration of commercial real estate loans. The ability of these customers to repay their loans is dependent on the real estate and general economic conditions in the area.

The financial statements for the three months ended March 31, 2016 and 2015 are unaudited and have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and footnotes included in the Company's annual report on Form 10-K for the year ended December 31, 2015.

In the opinion of management, all adjustments necessary to present fairly the financial position and the results of operations and cash flows for the interim periods have been made. All such adjustments are of a normal recurring nature. The results of operations for the three months ended March 31, 2016 are not necessarily indicative of the results of operations which the Company may achieve for the entire year.

Some items in the prior period financial statements were reclassified to conform to the current presentation.

8

(b) Recent Accounting Pronouncements

In May 2014, the FASB issued an update (ASU No. 2014-09, Revenue from Contracts with Customers) creating FASB Topic 606, Revenue from Contracts with Customers. The guidance in this update affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards (for example, insurance contracts or lease contracts). The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance provides steps to follow to achieve the core principle. An entity should disclose sufficient information to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. Qualitative and quantitative information is required about contracts with customers, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract. The amendments in this update are effective for interim and annual reporting periods beginning after December 15, 2017. We are currently evaluating the impact of adopting the new guidance on the consolidated financial statements.

In January 2016, the FASB issued an update (ASU No. 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities.) The guidance in this update affects any entity that holds financial assets or owes financial liabilities. It is intended to provide users of financial statements with more useful information on the recognition, measurement, presentation, and disclosure of financial instruments by requiring (1) equity investments (except those accounted for under the equity method) to be measured at fair value with changes in fair value recognized in net income (2) public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes (3) entities to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value (4) a separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes and eliminating (1) the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities and (2) the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet. The amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2017. The Company is currently evaluating the impact on the consolidated financial statements and related disclosures.

9

In February 2016, the FASB issued an update (ASU No. 2016-02, Leases) creating FASB Topic 842, Leases. The guidance is intended to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and requiring more disclosures related to leasing transactions. The amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2018. Early adoption is permitted. The Company is currently evaluating the impact on the consolidated financial statements and related disclosures.

In March 2016, the FASB issued an update (ASU No. 2016-08, Revenue from Contracts with Customers: Principal versus Agent Considerations.) The amendments in this update affect the guidance in ASU 2014-09, Revenue from Contracts with Customers. The amendments do not change the core principal of the guidance, but rather clarify the implementation guidance on principal versus agent considerations. The amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2017. The Company is currently evaluating the impact on the consolidated financial statements and related disclosures.

In March 2016, the FASB issued an update (ASU No. 2016-09, Stock Compensation: Improvements to Employee Share-Based Payment Accounting.) The guidance in this update affects any entity that issues share-based payment awards to its employees and is intended to simplify several aspects of the accounting for share-based payment awards including income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2016. Early adoption is permitted. The Company is currently evaluating the impact on the consolidated financial statements and related disclosures.

10

Note 2 – Investment Securities

All investment securities held at March 31, 2016 and December 31, 2015 are classified as available-for-sale.

The following tables summarize the amortized cost and fair value of the available-for-sale investment securities portfolio at March 31, 2016 and December 31, 2015 and the corresponding amounts of unrealized gains and losses therein.

	March 31, 2016
			Gross		Gross
	Amortized		unrealized		unrealized			Estimated
	cost		gains		losses			fair value
Available-for-sale	(Dollars in thousands)
Obligations of U.S.
Government agencies	$	122,090		391		(309	)		122,172
Obligations of states and political subdivisions		129,823		4,922		(76	)		134,669
Mortgage backed securities
U.S. GSE's* MBS - residential		120,111		1,634		(140	)		121,605
U.S. GSE's* MBS - commercial		17,392		189		(1	)		17,580
U.S. GSE's CMO		152,956		1,841		(340	)		154,457
Corporate bonds		111,971		823		(1,012	)		111,782
	$	654,343		9,800		(1,878	)		662,265

* Government sponsored entities

	December 31, 2015
			Gross		Gross
	Amortized		unrealized		unrealized			Estimated
	cost		gains		losses			fair value
Available-for-sale	(Dollars in thousands)
Obligations of U.S.
Government agencies	$	147,135		274		(1,433	)		145,976
Obligations of states and political subdivisions		136,499		3,827		(266	)		140,060
Mortgage backed securities
U.S. GSE's MBS - residential		121,646		752		(890	)		121,508
U.S. GSE's MBS - commercial		21,805		125		(261	)		21,669
U.S. GSE's CMO		146,782		437		(1,642	)		145,577
Corporate bonds		117,666		524		(1,417	)		116,773
	$	691,533		5,939		(5,909	)		691,563

As of March 31, 2016 and December 31, 2015, except for the U.S. Government agencies and government sponsored entities, there was no issuer who represented 10% or more of stockholders’ equity within the investment portfolio.

11

Proceeds from sales of securities available-for-sale and the associated gains (losses), excluding gains (losses) on called securities, for the three months ended March 31, 2016 and 2015 were as follows:

	Three Months Ended
	March 31,
	2016			2015
	(Dollars in thousands)
Proceeds from Sales	$	51,004		$	23,300
Gross Gains		463			108
Gross Losses		(227	)		(51	)

The amortized cost and fair value of the investment securities portfolio are shown below by contractual maturity. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties.

	March 31, 2016
	Amortized		Estimated
	cost		fair value
	(Dollars in thousands)
Available-for-sale:
One year or less	$	10,923		10,957
After one year through five years		99,163		100,453
After five years through ten years		158,440		159,600
After ten years		385,817		391,255
	$	654,343		662,265

The following tables summarize the investment securities with unrealized losses at March 31, 2016 and December 31, 2015, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position.

	March 31, 2016
	Less than 12 months				12 months or longer				Total
	Estimated		Unrealized		Estimated		Unrealized		Estimated		Unrealized
	fair value		loss		fair value		loss		fair value		loss
Temporarily impaired	(Dollars in thousands)
Obligations of U.S.
Government agencies	$	9,920		20		34,537		289		44,457		309
Obligations of states and political subdivisions		4,414		25		4,053		51		8,467		76
Mortgage backed securities
U.S. GSE's MBS - residential		8,066		39		8,144		101		16,210		140
U.S. GSE's MBS - commercial		5,325		1		—		—		5,325		1
U.S. GSE's CMO		21,401		204		8,135		136		29,536		340
Corporate bonds		18,780		88		20,887		924		39,667		1,012
	$	67,906		377		75,756		1,501		143,662		1,878

12

	December 31, 2015
	Less than 12 months				12 months or longer				Total
	Estimated		Unrealized		Estimated		Unrealized		Estimated		Unrealized
	fair value		loss		fair value		loss		fair value		loss
Temporarily impaired	(Dollars in thousands)
Obligations of U.S.
Government agencies	$	57,409		388		63,971		1,045		121,380		1,433
Obligations of states and political subdivisions		21,421		235		2,794		31		24,215		266
Mortgage backed securities
U.S. GSE's MBS - residential		71,185		607		11,105		283		82,290		890
U.S. GSE's MBS - commercial		9,428		261		—		—		9,428		261
U.S. GSE's CMO		102,082		1,463		6,584		179		108,666		1,642
Corporate bonds		69,459		705		17,683		712		87,142		1,417
	$	330,984		3,659		102,137		2,250		433,121		5,909

Other-Than-Temporary Impairment – March 31, 2016

Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. Investment securities classified as available-for-sale or held-to-maturity are generally evaluated for OTTI under the provisions of ASC 320-10, Investments – Debt and Equity Securities. In determining OTTI, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the entity has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.

When OTTI occurs, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis. If an entity intends to sell or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis, the OTTI shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income or loss, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment.

13

As of March 31, 2016, the Company’s security portfolio consisted of 424 securities, 80 of which were in an unrealized loss position. Of these securities with unrealized losses, 79.50% were related to the Company’s mortgage-backed and corporate securities as discussed below.

Mortgage-backed Securities

At March 31, 2016, all of the Company’s mortgage-backed securities were issued by U.S. government-sponsored entities and agencies, primarily the Federal National Mortgage Association (“Fannie Mae”), the Federal Home Loan Mortgage Corporation (“Freddie Mac”) and the Government National Mortgage Association (“Ginnie Mae”), institutions which the government has affirmed its commitment to support. Because the decline in fair value is attributable to changes in interest rates and illiquidity, and not credit quality, and because the Company does not have the intent to sell these mortgage-backed securities and it is not more likely than not that it will be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at March 31, 2016.

Corporate Securities

The Company holds forty-five corporate securities totaling $111,782, of which nineteen had an unrealized loss of $1,012 at March 31, 2016. Eighteen of the securities with an unrealized loss of $970 were issued by entities rated lower medium investment grade or higher. Because the decline in fair value is attributable primarily to changes in interest rates and not credit quality and because the Company does not have the intent to sell the securities and it is not more likely than not that it will be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at March 31, 2016.

Included in the Company’s corporate bonds is one trust preferred security with an amortized cost of $250, which had an unrealized loss of $42, resulting in a fair value of $208 at March 31, 2016. This security is not rated. Although the issuer is not in default, in January of 2011 the Company was notified that the issuer had elected to defer interest payments in accordance with the terms of the instrument. As of July of 2015, the issuer is no longer deferring interest and is current on all payments. Because the Company does not have the intent to sell this security and it is not more likely than not that it will be required to sell the security before its anticipated recovery, the Company does not consider this security to be other-than-temporarily impaired at March 31, 2016.

There were no credit losses recognized in earnings for the three month periods ended March 31, 2016 and 2015.

14

Note 3 – Loans

The following table summarizes loans at March 31, 2016 and December 31, 2015.

	March 31, 2016		December 31, 2015
	(Dollars in thousands)
Commercial, financial, and agricultural	$	217,653		210,712
Real estate:
Commercial		381,541		366,566
Residential		236,682		229,161
Acquisition, development and construction		174,994		184,292
Consumer installment		19,097		18,584
	$	1,029,967		1,009,315
Less allowance for loan losses		21,548		21,367
Less deferred loan origination fees (costs)		31		166
	$	1,008,388		987,782

The following tables present the activity in the allowance for loan losses by portfolio segment as of and for the three month periods ended March 31, 2016 and 2015.

	Three Months Ended March 31, 2016
	Commercial,
	Financial, and			CRE - Owner			CRE - Non Owner		Residential			ADC			ADC
	Agricultural			Occupied			Occupied		Real Estate			CSRA			Other			Consumer			Total
	(Dollars in thousands)
Allowance for loan losses:
Beginning balance	$	4,908			4,667			2,709		5,027			2,469			914			673			21,367
Charge-offs		(17	)		—			—		(96	)		(60	)		(100	)		(187	)		(460	)
Recoveries		9			1			100		1			2			—			100			213
Provision		98			(63	)		27		92			142			14			118			428
Ending balance	$	4,998			4,605			2,836		5,024			2,553			828			704			21,548

	Three Months Ended March 31, 2015
	Commercial,
	Financial, and			CRE - Owner		CRE - Non Owner		Residential			ADC			ADC
	Agricultural			Occupied		Occupied		Real Estate			CSRA			Other			Consumer			Total
	(Dollars in thousands)
Allowance for loan losses:
Beginning balance	$	5,407			4,805		3,817		6,591			1,943			2,320			623			25,506
Charge-offs		(617	)		—		—		(41	)		(5	)		—			(129	)		(792	)
Recoveries		30			1		—		11			—			29			59			130
Provision		475			567		21		(206	)		(307	)		(152	)		149			547
Ending balance	$	5,295			5,373		3,838		6,355			1,631			2,197			702			25,391

15

The following tables present the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of March 31, 2016 and December 31, 2015.

	March 31, 2016
	Commercial,
	Financial, and		CRE - Owner		CRE - Non Owner		Residential		ADC		ADC
	Agricultural		Occupied		Occupied		Real Estate		CSRA		Other		Consumer		Total
	(Dollars in thousands)
Allowance for loan losses:
Ending balance attributable to loans:
Individually evaluated for impairment	$	—		—		—		—		—		—		—		—
Collectively evaluated for impairment		4,998		4,605		2,836		5,024		2,553		828		704		21,548
	$	4,998		4,605		2,836		5,024		2,553		828		704		21,548
Loans:
Individually evaluated for impairment		775		3,723		5,736		2,281		1,022		—		—		13,537
Collectively evaluated for impairment		216,878		230,010		142,072		234,401		133,860		40,112		19,097		1,016,430
	$	217,653		233,733		147,808		236,682		134,882		40,112		19,097		1,029,967

	December 31, 2015
	Commercial,
	Financial, and		CRE - Owner		CRE - Non Owner		Residential		ADC		ADC
	Agricultural		Occupied		Occupied		Real Estate		CSRA		Other		Consumer		Total
	(Dollars in thousands)
Allowance for loan losses:
Ending balance attributable to loans:
Individually evaluated for impairment	$	—		—		—		—		—		—		—		—
Collectively evaluated for impairment		4,908		4,667		2,709		5,027		2,469		914		673		21,367
	$	4,908		4,667		2,709		5,027		2,469		914		673		21,367
Loans:
Individually evaluated for impairment		991		3,771		6,244		1,998		2,468		—		—		15,472
Collectively evaluated for impairment		209,721		225,592		130,959		227,163		138,649		43,175		18,584		993,843
	$	210,712		229,363		137,203		229,161		141,117		43,175		18,584		1,009,315

16

The following tables present loans individually evaluated for impairment by class of loans as of March 31, 2016 and December 31, 2015.

	March 31, 2016
	Unpaid				Allowance for		Average
	Principal		Recorded		Loan Losses		Recorded
	Balance		Investment (2)		Allocated		Investment
	(Dollars in thousands)
With no related allowance recorded: (1)
Commercial, financial, and agricultural:
Commerical	$	1,932		775		—		796
Financial		—		—		—		—
Agricultural		—		—		—		—
Equity lines		—		—		—		—
Other		—		—		—		—
Commercial real estate:
Owner occupied		4,766		3,723		—		3,745
Non Owner occupied		5,998		5,736		—		5,052
Residential real estate:
Secured by first liens		2,820		2,189		—		2,234
Secured by junior liens		145		92		—		93
Acquisition, development and construction:
Residential		—		—		—		—
Other		1,363		1,022		—		1,074
Consumer		—		—		—		—
		17,024		13,537		—		12,994
With an allowance recorded:		—		—		—		—
	$	17,024		13,537		—		12,994

(1) No specific allowance for credit losses is allocated to these loans since they are sufficiently collateralized or had sufficient cash flows

(2) Excludes accrued interest receivable and loan origination fees, net due to immateriality

17

	December 31, 2015
	Unpaid				Allowance for		Average
	Principal		Recorded		Loan Losses		Recorded
	Balance		Investment (2)		Allocated		Investment
	(Dollars in thousands)
With no related allowance recorded: (1)
Commercial, financial, and agricultural:
Commerical	$	1,948		810		—		1,222
Financial		—		—		—		—
Agricultural		251		181		—		193
Equity lines		—		—		—		—
Other		—		—		—		—
Commercial real estate:
Owner occupied		4,773		3,771		—		4,656
Non Owner occupied		7,659		6,244		—		7,201
Residential real estate:
Secured by first liens		2,587		1,904		—		2,026
Secured by junior liens		147		94		—		100
Acquisition, development and construction:
Residential		—		—		—		—
Other		3,440		2,468		—		2,645
Consumer		—		—		—		—
		20,805		15,472		—		18,043
With an allowance recorded:		—		—		—		—
	$	20,805		15,472		—		18,043

(1) No specific allowance for credit losses is allocated to these loans since they are sufficiently collateralized or had sufficient cash flows

(2) Excludes accrued interest receivable and loan origination fees, net due to immateriality

18

The following table presents interest income on impaired loans for the three months ended March 31, 2016 and 2015.

	Three Months Ended March 31, 2016				Three Months Ended March 31, 2015
	Interest		Cash Basis		Interest		Cash Basis
	Income		Interest Income		Income		Interest Income
	Recognized		Recognized		Recognized		Recognized
	(Dollars in thousands)				(Dollars in thousands)
Commercial, financial, and agricultural:
Commerical	$	—		—		—		—
Financial		—		—		—		—
Agricultural		—		—		—		—
Equity lines		—		—		—		—
Other		—		—		—		—
Commercial real estate:
Owner occupied		5		5		3		3
Non Owner occupied		60		60		104		104
Residential real estate:
Secured by first liens		14		14		20		20
Secured by junior liens		—		—		—		—
Acquisition, development and construction:
Residential		—		—		—		—
Other		9		9		7		7
Consumer		—		—		—		—
	$	88		88		134		134

Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans. The sum of nonaccrual loans and loans past due 90 days still on accrual will differ from the total impaired loan amount.

19

The following tables present the aging of the recorded investment in past due loans as of March 31, 2016 and December 31, 2015 by class of loans.

	March 31, 2016
	30 - 89 Days		90 Days or		Nonaccrual		Total		Loans Not
	Past Due		More Past Due		Loans		Past Due		Past Due		Total
	(Dollars in thousands)
Commercial, financial, andagricultural:
Commerical	$	1,058		—		775		1,833		134,739		136,572
Financial		—		—		—		—		4,351		4,351
Agricultural		28		—		—		28		10,343		10,371
Equity lines		35		—		88		123		40,836		40,959
Other		—		—		62		62		25,338		25,400
Commercial real estate:
Owner occupied		484		—		3,931		4,415		229,318		233,733
Non Owner occupied		430		127		2,302		2,859		144,949		147,808
Residential real estate:
Secured by first liens		2,540		—		3,394		5,934		225,779		231,713
Secured by junior liens		116		—		358		474		4,495		4,969
Acquisition, development and construction:
Residential		—		—		—		—		56,135		56,135
Other		52		—		835		887		117,972		118,859
Consumer		68		—		13		81		19,016		19,097
	$	4,811		127		11,758		16,696		1,013,271		1,029,967

	December 31, 2015
	30 - 89 Days		90 Days or		Nonaccrual		Total		Loans Not
	Past Due		More Past Due		Loans		Past Due		Past Due		Total
	(Dollars in thousands)
Commercial, financial, andagricultural:
Commerical	$	39		—		831		870		125,735		126,605
Financial		—		—		—		—		4,678		4,678
Agricultural		—		—		182		182		10,712		10,894
Equity lines		—		—		75		75		40,536		40,611
Other		—		—		63		63		27,861		27,924
Commercial real estate:
Owner occupied		1,158		—		3,988		5,146		224,217		229,363
Non Owner occupied		226		127		2,775		3,128		134,075		137,203
Residential real estate:
Secured by first liens		2,207		—		3,192		5,399		218,742		224,141
Secured by junior liens		—		—		368		368		4,652		5,020
Acquisition, development and construction:
Residential		—		—		—		—		54,266		54,266
Other		8		—		2,537		2,545		127,481		130,026
Consumer		19		—		33		52		18,532		18,584
	$	3,657		127		14,044		17,828		991,487		1,009,315

Troubled Debt Restructurings:

The Company has troubled debt restructurings (TDRs) with a balance of $10,167 and $8,636 included in impaired loans at March 31, 2016 and December 31, 2015, respectively. No specific reserves were allocated to customers whose loan terms had been modified in TDRs as of March 31, 2016 and December 31, 2015. The Company is not committed to lend additional amounts as of March 31, 2016 and December 31, 2015 to customers with outstanding loans that are classified as TDRs. The following tables present TDRs as of March 31, 2016 and December 31, 2015.

20

	March 31, 2016
	Number of		Recorded
	Loans		Investment
	(Dollars in thousands)
Troubled Debt Restructurings:
Commercial, financial, and agricultural:
Commerical		1	$	775
Financial		-		-
Agricultural		-		-
Equity lines		-		-
Other		-		-
Commercial real estate:
Owner occupied		2		3,723
Non Owner occupied		4		4,158
Residential real estate:
Secured by first liens		9		1,044
Secured by junior liens		1		92
Acquisition, development and construction:
Residential		-		-
Other		1		375
Consumer		-		-
		18	$	10,167

	December 31, 2015
	Number of		Recorded
	Loans		Investment
	(Dollars in thousands)
Troubled Debt Restructurings:
Commercial, financial, andagricultural:
Commerical		1	$	810
Financial		-		-
Agricultural		-		-
Equity lines		-		-
Other		-		-
Commercial real estate:
Owner occupied		1		273
Non Owner occupied		4		4,499
Residential real estate:
Secured by first liens		10		1,140
Secured by junior liens		1		94
Acquisition, development and construction:
Residential		-		-
Other		2		1,820
Consumer		-		-
		19	$	8,636

21

During the three months ended March 31, 2016, two loans were modified as TDRs. One modification involved a 2.25% reduction of the stated interest rate of the loan and an extension of the maturity date for 277 months while the other modification involved a 0.50% rate reduction.

No loans were modified as TDRs during the three months ended March 31, 2015.

The following table presents loans by class modified as TDRs that occurred during the three months ended March 31, 2016 and 2015.

	Three Months Ended March 31, 2016						Three Months Ended March 31, 2015
			Pre-Modification		Post-Modification				Pre-Modification		Post-Modification
	Number of		Outstanding		Outstanding		Number of		Outstanding		Outstanding
	Loans		Recorded Investment		Recorded Investment		Loans		Recorded Investment		Recorded Investment
	(Dollars in thousands)						(Dollars in thousands)
Troubled Debt Restructurings:
Commercial, financial, andagricultural:
Commerical		-	$	-	$	-		-	$	-	$	-
Financial		-		-		-		-		-		-
Agricultural		-		-		-		-		-		-
Equity lines		-		-		-		-		-		-
Other		-		-		-		-		-		-
Commercial real estate:
Owner occupied		1		4,508		3,452		-		-		-
Non Owner occupied		1		1,824		1,400		-		-		-
Residential real estate:
Secured by first liens		-		-		-		-		-		-
Secured by junior liens		-		-		-		-		-		-
Acquisition, development  and construction:
Residential		-		-		-		-		-		-
Other		-		-		-		-		-		-
Consumer		-		-		-		-		-		-
		2	$	6,332	$	4,852		-	$	-	$	-

There was no increase to the allowance for loan losses or resultant charge-offs on the TDRs described in the previous table during the three months ended March 31, 2016.

Charge-offs on such loans are factored into the rolling historical loss rate, which is used in the calculation of the allowance for loan losses.

A loan is considered to be in payment default once it is 90 days contractually past due under the modified terms. There were no TDRs with payment defaults during the three months ended March 31, 2016 and 2015.

The terms of certain other loans were modified during the three month periods ended March 31, 2016 and 2015 that did not meet the definition of a TDR. These loans have a total recorded investment as of March 31, 2016 and 2015 of $2,563 and $2,149, respectively, and had delays in payment ranging from 30 days to 3 months in 2016 and 2015. The modification of these loans involved either a modification of the terms of a loan to borrowers who were not experiencing financial difficulties or a delay in a payment that was considered to be insignificant.

22

In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. This evaluation is performed under the Company’s internal underwriting policy.

Credit Quality Indicators:

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company, through its originating account officer, places an initial credit risk rating on every loan. An annual review and analysis of loan relationships (irrespective of loan types included in the overall relationship) with total related exposure of $500 or greater is performed by the Credit Administration department in order to update risk ratings given current available information.

Through the review of delinquency reports, updated financial statements or other relevant information in the normal course of business, the lending officer and/or Credit Administration review personnel may determine that a loan relationship has weakened to the point that a criticized (Watch grade) or classified (Substandard & Doubtful grades) status is warranted. When a loan relationship with total related exposure of $200 or greater is adversely graded (Watch or above), the lending officer is then charged with preparing a Classified/Watch report which outlines the background of the credit problem, current repayment status of the loans, current collateral evaluation and a workout plan of action. This plan may include goals to improve the credit rating, assisting the borrower in moving the loans to another institution and/or collateral liquidation. All such Classified/Watch reports are reviewed on a quarterly basis by members of Executive Management at a regularly scheduled meeting in which each lending officer presents the workout plans for their criticized credit relationships.

The Company uses the following definitions for risk ratings.

Watch: Loans classified as watch have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.

Substandard: Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful: Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

23

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans. As of March 31, 2016 and December 31, 2015, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows.

	March 31, 2016
	Pass		Watch		Substandard		Doubtful
	(Dollars in thousands)
Commercial, financial, andagricultural:
Commerical	$	128,778		6,086		1,708		—
Financial		4,351		—		—		—
Agricultural		7,444		2,613		314		—
Equity lines		39,854		793		312		—
Other		25,014		324		62		—
Commercial real estate:
Owner occupied		212,516		14,602		6,615		—
Non Owner occupied		135,905		5,789		6,114		—
Residential real estate:
Secured by first liens		222,449		4,470		4,794		—
Secured by junior liens		4,425		124		420		—
Acquisition, development and construction:
Residential		56,135		—		—		—
Other		110,007		7,216		1,636		—
Consumer		18,693		366		38		—
	$	965,571		42,383		22,013		—

24

	December 31, 2015
	Pass		Watch		Substandard		Doubtful
	(Dollars in thousands)
Commercial, financial, andagricultural:
Commerical	$	120,385		4,469		1,751		—
Financial		4,678		—		—		—
Agricultural		7,758		2,641		495		—
Equity lines		39,576		691		344		—
Other		27,532		329		63		—
Commercial real estate:
Owner occupied		208,370		14,545		6,448		—
Non Owner occupied		124,945		5,632		6,626		—
Residential real estate:
Secured by first liens		213,167		6,370		4,604		—
Secured by junior liens		4,455		134		431		—
Acquisition, development and construction:
Residential		54,168		98		—		—
Other		119,330		7,354		3,342		—
Consumer		18,156		358		70		—
	$	942,520		42,621		24,174		—

Note 4 – Fair Value Measurements

Fair value is the exchange price that would be received to sell an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair values:

Level 1:	Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2:	Significant other observable inputs other than Level 1 prices, such as quoted market prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.
Level 3:	Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

In determining the appropriate levels, the Company used the following methods and significant assumptions to estimate the fair value of each type of financial instrument:

25

Investment Securities: The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on matrix pricing which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the securities relationship to other benchmark quoted securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other non-observable market indicators (Level 3). The fair values of Level 3 investment securities are determined by an independent third party. These valuations are then reviewed by the Company’s Controller and Chief Accounting Officer. Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. During times when trading is more liquid, broker quotes are used (if available) to validate the model. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations.

Interest Rate Swap Derivatives: The fair value of interest rate swap derivatives is determined based on discounted cash flow valuation models using observable market data as of the measurement date (Level 2 inputs). The fair value adjustment is included in other liabilities.

Mortgage Banking Derivatives: The fair value of mortgage banking derivatives is determined by individual third party sales contract prices for the specific loans held at each reporting period end (Level 2 inputs). The fair value adjustment is included in other assets.

Loans Held for Sale: Loans held for sale are carried at fair value, as determined by outstanding commitments, from third party investors (Level 2).

Impaired Loans: The fair value of collateral dependent impaired loans is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

Other Real Estate Owned: Assets acquired through or instead of loan foreclosure are initially recorded at fair value less estimated costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. The fair value of other real estate owned is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value. Real estate owned properties are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

26

Appraisals for both collateral dependent impaired loans and other real estate owned are performed by certified general appraisers, certified residential appraisers or state licensed appraisers whose qualifications and licenses are annually reviewed and verified by the Company. Once received, a member of the Real Estate Valuation Department reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value and determines if reasonable. Appraisals for collateral dependent impaired loans and other real estate owned are updated annually. On an annual basis the Company compares the actual selling costs of collateral that has been liquidated to the selling price to determine what additional adjustment should be made to the appraisal value. The most recent analysis performed indicated that an additional discount of 8% should be applied to properties with appraisals performed within 12 months.

Assets and Liabilities Measured on a Recurring Basis

The following tables present the balances of assets and liabilities measured at fair value on a recurring basis by level within the hierarchy as of March 31, 2016 and December 31, 2015.

	March 31,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	2016		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Assets:
Available-for-sale securities
Obligations of U.S.
Government agencies	$	122,172		-		122,172		-
Obligations of states and political subdivisions		134,669		-		134,669		-
Mortgage-backed securities
U.S. GSE's MBS - residential		121,605		-		121,605		-
U.S. GSE's MBS - commercial		17,580		-		17,580		-
U.S. GSE's CMO		154,457		-		154,457		-
Corporate bonds		111,782		-		111,782		-
Total available-for-sale securities	$	662,265		-		662,265		-
Loans held for sale		18,588		-		18,588		-
Mortgage banking derivatives		95		-		95		-
	$	680,948		-		680,948		-
Liabilities:
Interest rate swap derivatives		2,655		-		2,655		-
	$	2,655		-		2,655		-

27

	December 31,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	2015		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Assets:
Available-for-sale securities
Obligations of U.S.
Government agencies	$	145,976		-		145,976		-
Obligations of states and political subdivisions		140,060		-		140,060		-
Mortgage-backed securities
U.S. GSE's MBS - residential		121,508		-		121,508		-
U.S. GSE's MBS - commercial		21,669		-		21,669		-
U.S. GSE's CMO		145,577		-		145,577		-
Corporate bonds		116,773		-		116,773		-
Total available-for-sale securities	$	691,563		-		691,563		-
Loans held for sale		18,647		-		18,647		-
Mortgage banking derivatives		24		-		24		-
	$	710,234		-		710,234		-
Liabilities:
Interest rate swap derivatives		2,013		-		2,013		-
	$	2,013		-		2,013		-

The Company’s policy is to recognize transfers into or out of a level as of the end of the reporting period.

Transfers between Level 1 and Level 2:

No securities were transferred between Level 1 and Level 2 during the three months ended March 31, 2016 and 2015.

Transfers between Level 2 and Level 3:

No securities were transferred between Level 2 and Level 3 during the three months ended March 31, 2016. During the three months ended March 31, 2015, one corporate security was transferred out of Level 3 and into Level 2 based on observable market data for this security due to increased market activity for this security. This security with a market value of $138 as of March 31, 2015 was transferred on March 31, 2015.

During the three months ended March 31, 2016 and the year ended December 31, 2015, there were no assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3).

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The following table presents a reconciliation and income statement classification of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31, 2015.

Fair Value Measurements Using Significant Unobservable

Inputs (Level 3)

	Total			Corporate bonds
	(Dollars in thousands)
Beginning balance, January 1, 2015	$	112		$	112
Total gains or losses (realized/unrealized)
Included in earnings
Gain (loss) on sales		-			-
Other-than-temporary impairment		-			-
Included in other comprehensive income		26			26
Purchases, sales, issuances and settlements
Purchases		-			-
Sales, Calls		-			-
Issuances		-			-
Settlements		-			-
Principal repayments		-			-
Transfers into Level 3		-			-
Transfers out of Level 3		(138	)		(138	)
Ending balance, March 31, 2015	$	-		$	-

The Company uses an independent third party to value its U.S. government agencies, mortgage-backed securities, and corporate bonds. Their approach uses relevant information generated by transactions that have occurred in the market place that involve similar assets, as well as using cash flow information when necessary. These inputs are observable, either directly or indirectly in the market place for similar assets. The Company considers these valuations to be Level 2 pricing.

The fair value of the Company’s municipal securities is determined by another independent third party. Their approach uses relevant information generated by transactions that have occurred in the market place that involve similar assets. These inputs are observable, either directly or indirectly in the market place for similar assets. The Company considers these valuations to be Level 2 pricing.

For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows (Level 3 pricing) as determined by an independent third party. The significant unobservable inputs used in the valuation model include prepayment rates, constant default rates, loss severity and yields.

On a quarterly basis, the Company selects a random sample of investment security valuations, as determined by the independent third party, to validate pricing and level assignments.

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Assets and Liabilities Measured on a Non-Recurring Basis

Assets and liabilities measured at fair value on a non-recurring basis as of March 31, 2016 and December 31, 2015 are summarized below.

	March 31,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	2016		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Assets:
Impaired loans (1)	$	4,627		-		-		4,627
Other real estate owned		360		-		-		360
	$	4,987		-		-		4,987

(1) Includes loans directly charged down to fair value.

	December 31,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	2015		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Assets:
Impaired loans (1)	$	10,171		-		-		10,171
Other real estate owned		360		-		-		360
	$	10,531		-		-		10,531

(1) Includes loans directly charged down to fair value.

The following represents impairment charges recognized during the period:

Impaired loans, which are measured for impairment using the fair value of collateral for collateral dependent loans, had a recorded investment of $4,627, resulting in an additional provision for loan losses of $34 for the three months ended March 31, 2016.

As of December 31, 2015, impaired loans had a recorded investment of $10,171, resulting in an additional provision for loan losses of $3,342 for the year ending 2015.

Other real estate owned was $360 which consisted of the outstanding balance of $607, less a valuation allowance of $247. There were no write downs on this property for the three months ended March 31, 2016.

As of December 31, 2015, other real estate owned was $360 which consisted of the outstanding balance of $607, less a valuation allowance of $247. There were no write downs on this property during the year ended 2015.

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The following tables present quantitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at March 31, 2016 and December 31, 2015.

	Mar. 31,		Valuation	Unobservable	Range
	2016		Techniques	Inputs	(Weighted Avg)
	(Dollars in thousands)
Impaired loans	$	4,627	sales comparison	adjustment for differences between the comparable sales	0.00% - 70.99% (14.44%)
			income approach	capitalization rate	8.25% - 10.82% (9.70%)
Other real estate owned		360	sales comparison	adjustment for differences between the comparable sales	11.00% - 25.00% (18.00%)

	Dec. 31,		Valuation	Unobservable	Range
	2015		Techniques	Inputs	(Weighted Avg)
	(Dollars in thousands)
Impaired loans	$	10,171	sales comparison	adjustment for  differences between  the comparable sales	0.00% - 70.99% (15.71%)
			income approach	capitalization rate	8.25% - 10.82% (9.69%)
			income approach	discount rate	4.75%
			liquidation value
Other real estate owned		360	sales comparison	adjustment for  differences between  the comparable sales	11.00% - 25.00% (18.00%)

Fair Value Option:

The Company has elected the fair value option for loans held for sale. These loans are intended for sale and the Company believes that the fair value is the best indicator of the resolution of these loans. None of these loans are past due 90 days or more or on nonaccrual as of March 31, 2016 and December 31, 2015.

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As of March 31, 2016 and December 31, 2015, the aggregate fair value, unpaid principal balance (including accrued interest), and gain or loss was as follows:

	Mar. 31, 2016		Dec. 31, 2015
	(Dollars in thousands)
Aggregate fair value	$	18,588		18,647
Unpaid principal balance		18,134		18,345
Gain		456		303

Interest income on loans held for sale is recognized based on contractual rates and is reflected in loan interest income in the consolidated statements of comprehensive income. The following table details gains and losses from changes in fair value included in earnings for three months ended March 31, 2016 and 2015 for loans held for sale.

	Three Months Ended
	March 31,
	2016		2015
	(Dollars in thousands)
Change in fair value	$	153		9

Fair Value of Financial Instruments:

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

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

Fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.

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The assumptions used in the estimation of the fair value of the Company’s financial instruments are explained below. Where quoted market prices are not available, fair values are based on estimates using discounted cash flow and other valuation techniques. Discounted cash flows can be significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The following fair value estimates cannot be substantiated by comparison to independent markets and should not be considered representative of the liquidation value of the Company’s financial instruments, but rather a good-faith estimate of the fair value of financial instruments held by the Company. Certain financial instruments and all nonfinancial instruments are excluded from disclosure requirements.

The following methods and assumptions, not previously presented, were used by the Company in estimating the fair value of its financial instruments:

(a) Cash and Cash Equivalents

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

(b) Loans, net

The fair value of loans is calculated using discounted cash flows by loan type resulting in a Level 3 classification. The discount rate used to determine the present value of the loan portfolio is an estimated market rate that reflects the credit and interest rate risk inherent in the loan portfolio without considering widening credit spreads due to market illiquidity. The estimated maturity is based on the Company’s historical experience with repayments adjusted to estimate the effect of current market conditions. The carrying amount of related accrued interest receivable, due to its short term nature, approximates its fair value, is not significant and is not disclosed. The fair value of loans held for sale is estimated based upon binding contracts and quotes from third party investors resulting in a Level 2 classification. The allowance for loan losses is considered a reasonable discount for credit risk. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.

(c) Restricted Equity Securities

The fair value of Federal Home Loan Bank (“FHLB”) stock was not practicable to determine due to restrictions placed on its transferability.

(d) Deposits

Fair values for certificates of deposit have been determined using discounted cash flows. The discount rate used is based on estimated market rates for deposits of similar remaining maturities and are classified as Level 2. The carrying amounts of all other deposits, due to their short-term nature, approximate their fair values and are classified as Level 1. The carrying amount of related accrued interest payable, due to its short-term nature, approximates its fair value, is not significant and is not disclosed.

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(e) Securities Sold Under Repurchase Agreements

Fair value approximates the carrying value of such liabilities due to their short-term nature and is classified as Level 1.

(f) Advances from FHLB

The fair value of the FHLB advances is obtained from the FHLB and is calculated by discounting contractual cash flows using an estimated interest rate based on the current rates available to the Company for debt of similar remaining maturities and collateral terms resulting in a Level 2 classification.

(g) Subordinated debentures

The fair value for subordinated debentures is calculated using discounted cash flows based upon current market spreads to LIBOR for debt of similar remaining maturities and collateral terms resulting in a Level 3 classification.

(h) Commitments

The difference between the carrying values and fair values of commitments to extend credit are not significant and are not disclosed.

The carrying amounts and estimated fair values of the Company’s financial instruments at March 31, 2016 and December 31, 2015, not previously presented, are as follows:

	March 31, 2016
	Carrying		Fair Value Measurements
	amount		Total		Level 1		Level 2		Level 3
	(Dollars in thousands)
Financial assets:
Cash and cash equivalents	$	90,717		90,717		90,717		-		-
Loans, net		1,003,761		1,007,306		-		-		1,007,306
Restricted equity securities		5,478		N/A
Financial liabilities:
Deposits with stated maturities		342,977		344,145		-		344,145		-
Deposits without stated maturities		1,225,476		1,225,476		1,225,476		-		-
Securities sold under repurchase agreements		763		763		763		-		-
Advances from FHLB		90,000		91,959		-		91,959		-
Subordinated debentures		20,000		15,121		-		-		15,121

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	December 31, 2015
	Carrying		Fair Value Measurements
	amount		Total		Level 1		Level 2		Level 3
	(Dollars in thousands)
Financial assets:
Cash and cash equivalents	$	42,917		42,917		42,917		-		-
Loans, net		977,611		981,011		-		-		981,011
Restricted equity securities		5,169		N/A
Financial liabilities:
Deposits with stated maturities		333,345		334,920		-		334,920		-
Deposits without stated maturities		1,195,735		1,195,735		1,195,735		-		-
Securities sold under repurchase agreements		15,684		15,691		15,691		-		-
Advances from FHLB		85,000		86,854		-		86,854		-
Subordinated debentures		20,000		15,065		-		-		15,065

Note 5 – Stock-Based Compensation

The Company’s 2006 Long Term Incentive Plan provides for the issuance of restricted stock awards to officers and directors. Compensation expense is recognized over the vesting period of the awards based on the fair value of the stock at issue date.

On March 19, 2014, the Compensation Committee of the Company approved grants of 63,000 shares to certain of its directors and executive officers. The fair value of the stock was determined using the closing price on date of grant. The shares vest in equal one-third increments on each of February 1, 2015; February 1, 2016; and February 1, 2017. For the three months ended March 31, 2016 and 2015, the Company recognized $117 in compensation expense related to the restricted stock awards.

A summary of changes in the Company’s nonvested shares for the three month period ended March 31, 2016 is as follows:

				Weighted Avg
	Number of			Grant-Date
	Shares			Fair Value
Nonvested at January 1, 2016		42,000		$	21.60
Granted		-			-
Vested		(21,000	)		21.60
Forfeited		-			-
Nonvested at March 31, 2016		21,000		$	21.60

As of March 31, 2016, there was $389 of total unrecognized compensation cost related to nonvested shares granted under the Plan. This cost is being recognized over a period of ten months.

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The total fair value of shares vested during the three month period ended March 31, 2016 was $693 based on the market price as of the vesting date.

Note 6 – Interest Rate Swap Derivatives

The Company utilizes interest rate swap agreements as part of its asset liability management strategy to help manage its interest rate risk position.  The notional amount of the interest rate swaps does not represent amounts exchanged by the parties.  The amount exchanged is determined by reference to the notional amount and the other terms of the individual interest rate swap agreements.

During May 2011, the Company entered into two interest rate swaps with notional amounts totaling $10,000 which were designated as cash flow hedges of certain subordinated debentures and were determined to be fully effective during all periods presented.  As such, no amount of ineffectiveness has been included in net income.  Therefore, the aggregate fair value of the swaps is recorded in other liabilities with changes in fair value recorded in other comprehensive income.  The amount included in accumulated other comprehensive income would be reclassified to current earnings should the hedges no longer be considered effective. The Company expects the hedges to remain highly effective during the remaining terms of the swaps.

Summary information about the interest rate swaps designated as cash flow hedges as of March 31, 2016 and December 31, 2015 is as follows:

	March 31, 2016			December 31, 2015
	(Dollars in thousands)
Notional Amounts	$	10,000		$	10,000
Weighted average pay rates		5.35	%		5.35	%
Weighted average receive rates		2.03	%		1.91	%
Weigted average maturity		12.83 years			13.08 years
Unrealized losses	$	2,655		$	2,013

The swaps were forward starting and had effective dates of March 15, 2012 and June 15, 2012. Interest expense recorded on these swap transactions totaled $86 and $92 for the three months ended March 31, 2016 and 2015, respectively, and is reported as a component of interest expense in other borrowings.

If the fair value falls below specified levels, the Company is required to pledge collateral against these derivative contract liabilities. As of March 31, 2016, the Company had pledged $2,809 with the counterparty. Under certain circumstances, including a downgrade of its credit rating below specified levels, the counterparty is required to pledge collateral against these derivative contract liabilities. As of March 31, 2016, no collateral had been pledged by the counterparty.

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Note 7 – Other Comprehensive Income (Loss)

Other comprehensive income (loss) for the Company consists of changes in net unrealized gains and losses on investment securities available-for-sale and interest rate swap derivatives. The following tables present a summary of the accumulated other comprehensive income (loss) balances, net of tax, as of March 31, 2016 and 2015.

	Unrealized Gain (Loss) on Derivatives			Unrealized Gain (Loss) on Securities		Accumulated Other Comprehensive Income (Loss)
	(Dollars in thousands)
Balance, December 31, 2015	$	(1,229	)	$	18	$	(1,211	)
Current Year change		(393	)		4,822		4,429
Balance, March 31, 2016	$	(1,622	)	$	4,840	$	3,218

	Unrealized Gain (Loss) on Derivatives			Unrealized Gain (Loss) on Securities		Accumulated Other Comprehensive Income (Loss)
	(Dollars in thousands)
Balance, December 31, 2014	$	(1,197	)	$	1,268	$	71
Current Year change		(223	)		2,569		2,346
Balance, March 31, 2015	$	(1,420	)	$	3,837	$	2,417

The following table presents reclassifications out of accumulated other comprehensive income (loss).

	Three Months Ended March 31,
	2016			2015
Details about Accumulated Other Comprehensive Income (Loss) Components	Amount reclassified from Accumulated Other Comprehensive Income			Amount reclassified from Accumulated Other Comprehensive Income			Affected line item in the Statement where Net Income is presented
(Dollars in thousands)
Unrealized gains and losses on available-for-sale securities
	$	236		$	57		Investment securities gains (losses), net
		(75	)		(18	)	Tax expense
	$	161		$	39		Net of tax

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Note 8 – Dividends

On January 21, 2016, the Company declared a quarterly cash dividend of $0.16 per share on outstanding shares. The dividend was paid on February 19, 2016 to shareholders of record as of February 5, 2016.

On April 20, 2016, the Company declared a quarterly cash dividend of $0.16 per share on outstanding shares. The dividend is payable on May 20, 2016 to shareholders of record as of May 6, 2016.

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

(Dollar amounts, except per share amounts, are expressed in thousands unless otherwise noted)

Overview

Southeastern Bank Financial Corporation (the “Company”) is a Georgia corporation that is a bank holding company registered with the Board of Governors of the Federal Reserve System (the “Federal Reserve”) under the Bank Holding Company Act of 1956, as amended (the “BHCA”). Southeastern Bank Financial Corporation (OTCQB: SBFC) trades on OTCQB, the marketplace for companies that are current in their reporting with a U.S. regulator. Investors can find Real-Time quotes and market information for the Company on www.otcmarkets.com.

The Company’s wholly-owned subsidiary, Georgia Bank & Trust Company of Augusta (“GB&T”), primarily does business in the Augusta-Richmond County, GA-SC metropolitan area. GB&T was organized by a group of local citizens and commenced business on August 28, 1989, with one branch location. Today, it is Augusta’s largest community banking company, operating nine full service branches in Augusta, Martinez, and Evans, Georgia. GB&T also operates three full service branches in North Augusta and Aiken, South Carolina under the name “Southern Bank & Trust, a division of Georgia Bank & Trust Company of Augusta.” Mortgage origination offices are located in Augusta and Savannah, Georgia and in Aiken, South Carolina. The Company’s Operations Center is located in Martinez, Georgia.

The Company’s primary market includes Richmond and Columbia Counties in Georgia and Aiken County in South Carolina, all part of the Augusta-Richmond County, GA-SC metropolitan statistical area (MSA). The Augusta market area has a diversified economy based principally on government, public utilities, health care, manufacturing, construction, and wholesale and retail trade. Augusta is one of the leading medical centers in the Southeast.

The Company’s services include the origination of residential and commercial real estate loans, construction and development loans, and commercial and consumer loans. The Company also offers a variety of deposit programs, including noninterest-bearing demand, interest checking, money management, savings, and time deposits. In its primary market area, the Augusta-Richmond County, GA-SC metropolitan area, the Company had 19.45% of all deposits and was the second largest depository institution and the largest locally based institution at June 30, 2015, as cited from the Federal Deposit Insurance Corporation’s (“FDIC”) website. Securities sold under repurchase agreements are also offered. Additional services include wealth management, trust, retail investment, and mortgage. As a matter of practice, most mortgage loans are sold in the secondary market; however, some mortgage loans are placed in the portfolio based on asset/liability management strategies. The Company continues to concentrate on increasing its market share through various new deposit and loan products and other financial services and by focusing on its customer relationship management philosophy. The Company is committed to building life-long relationships with its customers, employees, shareholders, and the communities it serves.

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The Company’s primary source of income is from its lending activities, followed by interest income from its investment activities, service charges and fees on deposits and gain on sales of mortgage loans in the secondary market. Interest income on loans including loans held for sale increased $429 or 3.72% for the first three months of 2016 as compared to the first three months of 2015 and was due to higher average balances of loans offset somewhat by lower yields. Interest income on investment securities increased $202 or 5.54% due to both increased volume and rate. Gain on sales of loans increased $134 or 8.62% due primarily to increased mortgage originations and refinancing activity during the first three months of the year.

Table 1 - Selected Financial Data

	March 31,			December 31,			March 31,
	2016			2015			2015
	(Dollars in thousands)
Assets		1,877,275		$	1,840,365		$	1,803,344
Investment securities		662,265			691,563			675,321
Loans		1,029,936			1,009,149			970,307
Deposits		1,568,453			1,529,080			1,537,019
Annualized return on average total assets		1.03	%		1.08	%		0.97	%
Annualized return on average equity		10.82	%		11.87	%		10.82	%

Annualized return on average total assets was 1.03% for the three months ended March 31, 2016, an increase from 0.97% for the same period last year and annualized return on average equity was 10.82% for the three months ended March 31, 2016 and March 31, 2015. Net income for the three months ended March 31, 2016 was $4,696 compared to $4,206 for the same period in 2015.

Table 2 highlights significant changes in the balance sheet at March 31, 2016 as compared to December 31, 2015. Total assets increased $36,910 and reflect increases in cash and equivalents of $47,800 and loans of $20,787. Partially offsetting these increases were investment securities which decreased $29,298. Total liabilities increased $28,630 and reflect increases in deposits of $39,373 and advances from FHLB of $5,000 offset by a $14,921 decrease in securities sold under repurchase agreements. Stockholders’ equity increased $8,280 and was due primarily to an increase in accumulated other comprehensive income, net of $4,429 and an increase in retained earnings of $3,617.

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Table 2 - Selected Balance Sheet Data

	March 31,		December 31,		Variance
	2016		2015		Amount			%
	(Dollars in thousands)
Cash, due from banks and interest-bearing deposits	$	90,717	$	42,917	$	47,800			111.38	%
Investment securities		662,265		691,563		(29,298	)		(4.24	)%
Loans		1,029,936		1,009,149		20,787			2.06	%
Other real estate owned		655		360		295			81.94	%
Deferred tax asset		11,094		13,958		(2,864	)		(20.52	)%
Assets		1,877,275		1,840,365		36,910			2.01	%
Deposits		1,568,453		1,529,080		39,373			2.57	%
Securities sold under repurchase agreements		763		15,684		(14,921	)		(95.14	)%
Advances from Federal Home Loan Bank		90,000		85,000		5,000			5.88	%
Liabilities		1,699,082		1,670,452		28,630			1.71	%
Stockholders' equity		178,193		169,913		8,280			4.87	%

The Company meets its liquidity needs by managing cash and due from banks, federal funds purchased and sold, maturity of investment securities, principal repayments from mortgage-backed securities, and draws on lines of credit. Additionally, liquidity can be managed through structuring deposit and loan maturities. The Company funds loan and investment growth with core deposits, securities sold under repurchase agreements, FHLB advances and other wholesale funding including brokered certificates of deposit. During inflationary periods, interest rates generally increase and operating expenses generally rise. When interest rates rise, variable rate loans and investments produce higher earnings; however, deposit and other borrowings interest expense also rise. The Company monitors its interest rate risk as it applies to net interest income in various simulations up and down 400 basis points (4.00%) and as it applies to economic value of equity in a shock up and down 400 basis points scenario. The Company monitors operating expenses through responsibility center budgeting.

Forward-Looking Statements

Southeastern Bank Financial Corporation may, from time to time, make written or oral forward-looking statements, including statements contained in the Company’s filings with the Securities and Exchange Commission (the “Commission”) and its reports to shareholders. Statements made in such documents, other than those concerning historical information, should be considered forward-looking and subject to various risks and uncertainties. Such forward-looking statements are made based upon management’s belief as well as assumptions made by, and information currently available to, management pursuant to “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. The Company’s actual results may differ materially from the results anticipated in forward-looking statements due to a variety of factors, including unanticipated changes in the Company’s local economies, the national economy, governmental monetary and fiscal policies, deposit levels, loan demand, loan collateral values and securities portfolio values; difficulties in interest rate risk management; the effects of competition in the banking business; difficulties in expanding the Company’s business into new markets; changes in governmental regulation relating to the banking industry, including but not limited to the Dodd-Frank Wall Street Reform and Consumer Protection Act and the Basel III international capital accord; failure of assumptions underlying the establishment of reserves for loan losses, including the value of collateral underlying delinquent loans; and other factors. The Company cautions that such factors are not exclusive. The Company does not undertake to update any forward-looking statement that may be made from time to time by, or on behalf of, the Company.

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Critical Accounting Estimates

The accounting and financial reporting policies of the Company and its subsidiary conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. Of these policies, management has identified the allowance for loan losses, determining the fair values of financial instruments including other real estate owned, interest rate swap derivatives, investment securities, and other-than-temporary impairment as critical accounting estimates that requires difficult, subjective judgment and are important to the presentation of the financial condition and results of operations of the Company.

Allowance for Loan Losses

The allowance for loan losses is established through a provision for loan losses charged to expense, which affects the Company’s earnings directly. Loans are charged against the allowance for loan losses when management believes that the collectability of the principal is unlikely. Subsequent recoveries are added to the allowance. The allowance is an amount that reflects management’s estimate of the level of probable incurred losses in the portfolio. Factors considered by management in determining the adequacy of the allowance include, but are not limited to: (1) detailed reviews of individual loans; (2) historical and current trends in loan charge-offs for the various portfolio segments evaluated; (3) the level of the allowance in relation to total loans and to historical loss levels; (4) levels and trends in non-performing and past due loans; (5) collateral values of properties securing loans; and (6) management’s assessment of economic conditions. The Company’s Board of Directors reviews the recommendations of management regarding the appropriate level for the allowance for loan losses based upon these factors.

The provision for loan losses is the charge to operating earnings necessary to maintain an adequate allowance for loan losses. The Company has developed policies and procedures for evaluating the overall quality of its loan portfolio and the timely identification of problem credits. Management continues to review these policies and procedures and makes further improvements as needed. The adequacy of the Company’s allowance for loan losses and the effectiveness of the Company’s internal policies and procedures are also reviewed periodically by the Company’s regulators and the Company’s internal loan review personnel. The Company’s regulators may advise the Company to recognize additions to the allowance based upon their judgments about information available to them at the time of their examination. Such regulatory guidance is considered, and the Company may recognize additions to the allowance as a result.

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The Company continues to refine the methodology on which the level of the allowance for loan losses is based by comparing historical loss ratios utilized to actual experience and by classifying loans for analysis based on similar risk characteristics. Cash receipts for accruing loans are applied to principal and interest under the contractual terms of the loan agreement; however, cash receipts on impaired and nonaccrual loans for which the accrual of interest has been discontinued are applied to principal and interest income depending upon the overall risk of principal loss to the Company.

Fair Value of Financial Instruments

A significant portion of the Company’s assets are financial instruments carried at fair value. This includes securities available-for-sale, loans held for sale, certain impaired loans, mortgage banking derivatives and other real estate owned. At March 31, 2016 and December 31, 2015 the percentage of total assets measured at fair value was 36.54% and 39.16%, respectively. The majority of assets carried at fair value are based on either quoted market prices or market prices for similar instruments. At March 31, 2016, 0.73% of assets measured at fair value were based on significant unobservable inputs. This consisted primarily of impaired loans and other real estate owned and represents approximately 0.27% of the Company’s total assets. See Note 4 “Fair Value Measurements” in the “Notes to Consolidated Financial Statements” herein for additional disclosures regarding the fair value of financial instruments.

Other Real Estate Owned

Assets acquired through or instead of loan foreclosure are initially recorded at fair value less estimated costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Operating costs after acquisition are expensed. Costs related to the development and improvement of real estate owned are capitalized.

Interest Rate Swap Derivatives

The fair value of interest rate swap derivatives is determined based on discounted cash flow valuation models using observable market data as of the measurement date. The fair value adjustment is included in other liabilities. See Note 1 “Summary of Significant Accounting Policies” in the “Notes to Consolidated Financial Statements” herein for additional disclosures regarding the fair value of financial instruments.

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Investment Securities

The fair values for available-for-sale securities are generally based upon quoted market prices or observable market prices for similar instruments. These values take into account recent market activity as well as other market observable data such as interest rate, spread and prepayment information. When market observable data is not available, which generally occurs due to the lack of liquidity for certain securities, the valuation of the security is subjective and may involve substantial judgment. The Company conducts periodic reviews to identify and evaluate each available-for-sale security that has an unrealized loss for other-than-temporary impairment. An unrealized loss exists when the fair value of an individual security is less than its amortized cost basis. The primary factors the Company considers in determining whether an impairment is other-than-temporary are the financial condition and near-term prospects of the issuer, including any specific events which may influence the operations of the issuer and whether the Company intends to sell the security or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis. As of March 31, 2016, the Company had no securities valued using unobservable inputs (Level 3).

Results of Operations

Net income for the first three months of 2016 was $4,696, an increase of $490 or 11.65% compared with net income of $4,206 for the first three months of 2015. Increases in net interest income, investment securities gains, gain on sales of loans, and reduced provision for loan losses were partially offset by increased operating expenses.

Total other comprehensive income for the first three months of 2016 was $4,429 compared to $2,346 in the first three months of 2015. The change was due primarily to an increase in the unrealized gain on securities available-for-sale of $3,865 during the three months ended March 31, 2016 as compared to the same period last year which was caused by a decrease in market interest rates and therefore an increase in the market value of the portfolio.

Noninterest income increased $496 or 10.51% for the three months ended March 31, 2016 as compared to the three months ended March 31, 2015 and resulted primarily from increases in investment securities gains, net of $179 and gain on sales of loans of $134.

Noninterest expense totaled $11,712 for the three months ended March 31, 2016, an increase of $647, or 5.85% compared to the same period ended March 31, 2015. The change was primarily due to an increase in salaries and other personnel expense of $185 due to salary increases and benefit accruals.

Net Interest Income

The primary source of earnings for the Company is net interest income, which is the difference between income on interest-earning assets, such as loans and investment securities, and interest expense incurred on interest-bearing sources of funds, such as deposits and borrowings. The following table shows the average balances of interest-earning assets and interest-bearing liabilities, annualized average yields earned and rates paid on those respective balances, and the actual interest income and interest expense for the periods indicated. Average balances are calculated based on daily balances, yields on non-taxable investments are not reported on a tax equivalent basis and average balances for loans include nonaccrual loans even though interest was not earned.

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Table 3 - Average Balances, Income and Expenses, Yields and Rates

	Three Months Ended March 31, 2016							Three Months Ended March 31, 2015
	Average Amount		Annualized Average Yield or Rate			Amount Paid or Earned		Average Amount		Annualized Average Yield or Rate			Amount Paid or Earned
	(Dollars in thousands)
Interest-earning assets:
Loans		1,016,873		4.60	%		11,786		967,594		4.73	%		11,402
Loans held for sale		20,559		3.28	%		168		15,481		3.22	%		123
Investment securities
Taxable		540,048		2.24	%		3,026		541,684		2.19	%		2,964
Tax-exempt		111,619		2.95	%		823		92,421		2.96	%		683
Interest-bearing deposits in other banks		15,409		0.96	%		37		12,316		0.56	%		17
Total interest-earning assets	$	1,704,508		3.70	%	$	15,840	$	1,629,496		3.74	%	$	15,189
Interest-bearing liabilities:
Deposits	$	1,294,348		0.43	%	$	1,375	$	1,292,351		0.46	%	$	1,460
Securities sold under repurchase agreements		5,457		0.73	%		10		3,078		0.39	%		3
Other borrowings		107,987		2.33	%		626		84,000		3.08	%		638
Total interest-bearing liabilities	$	1,407,792		0.57	%	$	2,011	$	1,379,429		0.62	%	$	2,101
Net interest margin/income:				3.23	%	$	13,829				3.22	%	$	13,088

Net interest income increased $741 (5.66%) during the three month period ended March 31, 2016 as compared to the same period in 2015 and resulted from higher levels of interest earning assets and lower rates paid on deposits and other borrowings.

Loan interest income increased $384 (3.37%) in the three month period as compared to the same period in the prior year. The change resulted primarily from a $49,279 increase in average loans and a decrease in yields from 4.73% to 4.60%. Interest on loans held for sale increased $45 and resulted primarily from a $5,078 increase in average loans and an increase in yields from 3.22% to 3.28%.

Interest income on taxable investment securities increased $62 or 2.09% and interest income on tax-exempt investment securities increased $140 or 20.50%. The increases were due primarily to volume for tax-exempt securities and rate for taxable securities. Average taxable investment balances decreased $1,636 or 0.30% and average tax-exempt balances increased $19,198 or 20.77%. The average yield on the taxable investment portfolio increased from 2.19% in the first quarter of 2015 to 2.24% in the first quarter of 2016 and the average yield on the tax-exempt investment portfolio declined from 2.96% in the first quarter of 2015 to 2.95% in the first quarter of 2016.

Total interest income increased $651 (4.29%) and average yields on interest-earning assets decreased from 3.74% in 2015 to 3.70% in 2016.

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Deposit interest expense decreased $85 (5.82%) in the three month period as compared to the same period in the prior year, primarily as a result of lower rates paid on deposits offset in part by an increase in average deposits of $1,997. Due to these reductions and the low interest rate environment, the annualized average rate of interest bearing liabilities decreased from 0.62% in the first quarter of 2015 to 0.57% in the first quarter of 2016.

The Company’s net interest margin for the three months ended March 31, 2016 increased one basis point to 3.23% compared to 3.22% for the three months ended March 31, 2015. The increase in the net interest margin was due primarily to reduced liability costs.

Changes in net interest income from period to period result from increases or decreases in the volume of interest-earning assets and interest-bearing liabilities, increases or decreases in the average rates earned and paid on such assets and liabilities, the ability to manage the earning asset portfolio, and the availability of particular sources of funds, such as noninterest-bearing deposits.

The following table presents the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have impacted the Company’s interest income and interest expense during the period indicated. Information is provided in each category with respect to changes attributable to change in volume (change in volume multiplied by prior rate), changes attributable to change in rate (change in rate multiplied by prior volume), and changes in rate/volume (change in rate multiplied by change in volume).

Table 4 - Rate/Volume Analysis

	Three Months Ended March 31, 2016
	compared to Three Months ended March 31, 2015
	Increase (Decrease) due to
	Volume			Rate			Combined			Total
	(Dollars in thousands)
Interest-earning assets:
Loans		581			(187	)		(10	)		384
Loans held for sale		40			4			1			45
Investment securities
Taxable		(9	)		71			-			62
Tax-exempt		142			(2	)		-			140
Interest-bearing deposits in other banks		4			13			3			20
Total interest-earning assets		758			(101	)		(6	)		651
Interest-bearing liabilities:
Deposits		2			(87	)		-			(85	)
Securities sold under repurchase agreements		2			3			2			7
Other borrowings		182			(151	)		(43	)		(12	)
Total interest-bearing liabilities		186			(235	)		(41	)		(90	)
Net change in net interest income										$	741

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Provision for Loan Losses

The provision for loan losses is the charge to operating earnings necessary to maintain the allowance for loan losses at a level which, in management’s estimate, is adequate to cover the estimated amount of probable incurred losses in the loan portfolio. A provision for loan losses totaling $428 was recognized for the three months ended March 31, 2016 compared to provision for loan losses of $547 for the three months ended March 31, 2015. See “Allowance for Loan Losses” for further analysis of the provision for loan losses.

Noninterest Income

Table 5 - Noninterest Income

	Three Months Ended
	March 31,				Variance
	2016		2015		Amount		%
(Dollars in thousands)
Service charges and fees on deposits	$	1,765	$	1,744	$	21		1.20	%
Gain on sales of loans		1,688		1,554		134		8.62	%
Investment securities gains, net		236		57		179		314.04	%
Retail investment income		538		526		12		2.28	%
Trust service fees		354		336		18		5.36	%
Earnings from cash surrender value of bank-owned life insurance		329		278		51		18.35	%
Miscellaneous income		305		224		81		36.16	%
Total noninterest income	$	5,215	$	4,719	$	496		10.51	%

Noninterest income increased $496 (10.51%) during the three month period ended March 31, 2016 as compared to the same period in 2015. The change was mostly due to an increase in investment securities gains, net of $179 (314.04%) and gain on sales of loans of $134 (8.62%).

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Noninterest Expense

Table 6 - Noninterest Expense

	Three Months Ended
	March 31,					Variance
	2016		2015			Amount			%
	(Dollars in thousands)
Salaries and other personnel expense	$	6,772	$	6,587		$	185			2.81	%
Occupancy expenses		1,091		1,018			73			7.17	%
Marketing & business development		627		497			130			26.16	%
Processing expense		939		827			112			13.54	%
Legal and professional fees		465		412			53			12.86	%
Data processing expense		440		389			51			13.11	%
FDIC insurance		231		241			(10	)		(4.15	)%
Communications expense		288		263			25			9.51	%
Gain on sale of other real estate, net		-		(67	)		67			(100.00	)%
Provision for other real estate losses		-		1			(1	)		(100.00	)%
Loan costs (excluding OREO)		212		274			(62	)		(22.63	)%
Other operating expenses		647		623			24			3.85	%
Total noninterest expense	$	11,712	$	11,065		$	647			5.85	%

Noninterest expense increased $647 (5.85%) during the three month period ended March 31, 2016 as compared to the same period in 2015. The increase was mainly due to salaries and other personnel expense which increased $185 (2.81%) due to salary increases and increased retirement, incentive and other benefit plan costs and higher commission expense. In addition, marketing & business development expense increased $130 (26.16%) due to increased sponsorships and processing expense increased $112 (13.54%) due increased investment in technology.

Income Taxes

The Company recognized income tax expense of $2,208 for the three months ended March 31, 2016 as compared to an income tax expense of $1,989 for the same period in 2015. The effective income tax rate for the three months ended March 31, 2016 was 31.98% compared to 32.11% for the three months ended March 31, 2015. The primary reason for the decrease in the effective tax rate as compared to the same period in 2015 is due to higher levels of tax exempt interest income and an increase in state tax credits utilized.

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Loans

The following table presents the composition of the Company’s loan portfolio as of March 31, 2016 and December 31, 2015.

Table 7 - Loan Portfolio Composition

	March 31, 2016						December 31, 2015
	Amount			%			Amount			%
	(Dollars in thousands)
Commercial, financial and agricultural	$	217,653			21.13	%	$	210,712			20.88	%
Real estate
Commercial		381,541			37.05	%		366,566			36.32	%
Residential		236,682			22.98	%		229,161			22.71	%
Acquisition, development and construction		174,994			16.99	%		184,292			18.26	%
Total real estate		793,217			77.02	%		780,019			77.29	%
Consumer
Direct		18,363			1.78	%		17,947			1.78	%
Revolving		734			0.07	%		637			0.06	%
Total consumer		19,097			1.85	%		18,584			1.84	%
Deferred loan origination fees		(31	)		(0.00	)%		(166	)		(0.01	)%
Total	$	1,029,936			100.00	%	$	1,009,149			100.00	%

At March 31, 2016, 77.02% of the loan portfolio is comprised of real estate loans. Commercial, financial and agricultural loans comprise 21.13%, and consumer loans comprise 1.85% of the portfolio.

Commercial real estate (“CRE”) comprises 37.05% of the loan portfolio and consists of both non-owner occupied and owner occupied properties, where the operations of the commercial entity provide the necessary cash flow to service the debt. For this portion of the real estate loan portfolio, repayment is generally not dependent upon the sale of the real estate held as collateral. Acquisition, development and construction (“ADC”) loans comprise 16.99% of the loan portfolio. The Company carefully monitors the loans in this category since the repayment of these loans is generally dependent upon the sale of the real estate in the normal course of business and can be impacted by national and local economic conditions. The residential category, 22.98% of the portfolio, represents those loans that the Company chooses to maintain in its portfolio rather than selling into the secondary market for marketing and competitive reasons and commercial loans secured by residential real estate.

The Company has no large loan concentrations to individual borrowers. Unsecured loans at March 31, 2016 totaled $33,818.

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Interest reserves are established for certain ADC loans and certain CRE loans with major renovations based on the feasibility of the project, the timeframe for completion, the creditworthiness of the borrower and guarantors, and collateral. An interest reserve allows the borrower’s interest cost to be capitalized and added to the loan balance. As a matter of practice GB&T does not generally establish loan funded interest reserves on ADC or CRE loans; however, the Company’s loan portfolio includes five loans with interest reserves at March 31, 2016. The following table details the loans and accompanying interest reserves as of March 31, 2016.

	March 31, 2016
			Reserves
	Balance		Approved		Advanced		Remaining
	(Dollars in thousands)
Loan 1	$	5,987		62		62		-
Loan 2		3,554		100		19		81
Loan 3		1,079		35		8		27
Loan 4		7,042		108		108		-
Loan 5		962		35		4		31

These ADC and CRE loans have not been renewed or restructured and, as of March 31, 2016, are not on nonaccrual.

Underwriting for ADC and CRE loans with interest reserves follows the same process as those loans without reserves. In order for GB&T to establish a loan-funded interest reserve, the borrower must have the ability to repay without the use of a reserve and a history of developing and stabilizing similar properties. All ADC and CRE loans, including those with interest reserves, are carefully monitored through periodic construction site inspections by bank employees or third party inspectors to ensure projects are moving along as planned. Management assesses the appropriateness of the use of interest reserves during the entire term of the loan as well as the adequacy of the reserve. Collateral inspections are completed before approval of advances.

Loan Review and Classification Process

The Company maintains a loan review and classification process which involves multiple officers of the Company and is designed to assess the general quality of credit underwriting and to promote early identification of potential problem loans. All loan officers are charged with the responsibility of risk rating all loans in their portfolios and updating the ratings, positively or negatively, on an ongoing basis as conditions warrant. Risk ratings are selected from an 8-point scale with ratings as follows: ratings 1- 4 Satisfactory (pass), rating 5 Watch (potential weakness), rating 6 Substandard (well-defined weakness), rating 7 Doubtful and rating 8 Loss.

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When a loan officer originates a new loan, he or she documents the credit file with an offering sheet summary, supplemental underwriting analyses, relevant financial information and if applicable, collateral evaluations. All of this information is used in the determination of the initial loan risk rating. Then, the Company’s Credit Administration department undertakes an independent credit review of that relationship in order to validate the lending officer’s rating. Lending relationships with total related exposure of $500 or greater are also placed into a tracking database and reviewed by Credit Administration personnel on an annual basis in conjunction with the receipt of updated borrower and guarantor financial information. The individual loan reviews analyze such items as: loan type; nature, type and estimated value of collateral; borrower and/or guarantor estimated financial strength; most recently available financial information; related loans and total borrower exposure; and current/anticipated performance of the loan. The results of such reviews are presented to Executive Management.

Through the review of delinquency reports, updated financial statements or other relevant information in the normal course of business, the lending officer and/or Credit Administration review personnel may determine that a loan relationship has weakened to the point that a criticized (loan grade 5) or classified (loan grade 6 through 8) status is warranted. When a loan relationship with total related exposure of $200 or greater is adversely graded (5 or above), the lending officer is then charged with preparing a Classified/Watch report which outlines the background of the credit problem, current repayment status of the loans, current collateral evaluation and a workout plan of action. This plan may include goals to improve the credit rating, assisting the borrower in moving the loans to another institution and/or collateral liquidation. All such Classified/Watch reports are reviewed on a quarterly basis by members of Executive Management at a regularly scheduled meeting in which each lending officer presents the workout plans for their criticized credit relationships.

Depending upon the individual facts, circumstances and the result of the Classified/Watch review process, Executive Management may categorize the loan relationship as impaired. Once that determination has occurred, Executive Management in conjunction with Credit Administration personnel, will complete an evaluation of the collateral (for collateral-dependent loans) based upon appraisals on file adjusting for current market conditions and other local factors that may affect collateral value. This subjective evaluation may produce an initial specific allowance for placement in the Company’s Allowance for Loan Losses calculation. As soon as practical, updated appraisals on the collateral backing that impaired loan relationship are ordered. When the updated appraisals are received, Executive Management with assistance from Credit Administration department personnel reviews the appraisal, and updates the specific allowance analysis for each loan relationship accordingly. The Director’s Loan Committee reviews on a quarterly basis the Classified/Watch reports including changes in credit grades of 5 or higher as well as all impaired loans, the related allowances and other real estate owned (“OREO”).

In general, once the specific allowance has been finalized, Executive Management will authorize a charge-off prior to the following calendar quarter-end in which that reserve calculation is finalized.

The review process also provides for the upgrade of loans that show improvement since the last review.

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Nonperforming Assets

Non-performing assets include nonaccrual loans, restructured loans, and other real estate owned. Table 8 shows the current and prior period amounts of non-performing assets. Non-performing assets were $15,738 at March 31, 2016, compared to $17,766 at December 31, 2015 and $19,961 at March 31, 2015. The change from March 2015 to March 2016 was due primarily to a $3,011 decrease in restructured loans and a net decrease of $912 in nonaccrual loans.

At March 31, 2016 and December 31, 2015 there were $127 of loans past due 90 days or more and still accruing interest. There were no loans past due 90 days or more and still accruing interest at March 31, 2015.

Troubled debt restructurings (TDRs) are troubled loans in which the original terms have been modified in favor of the borrower and either principal or interest has been forgiven due to deterioration in the borrower’s financial condition. There was $10,167 in TDRs at March 31, 2016, of which $6,842 were on nonaccrual status. TDRs totaled $8,636 at December 31, 2015, of which $5,274 were on nonaccrual status, and $9,550 at March 31, 2015, of which $3,214 were on nonaccrual status.

Table 8 - Non-Performing Assets

	March 31, 2016			December 31, 2015			March 31, 2015
	(Dollars in thousands)
Nonaccrual loans:
Commercial, financial and agricultural	$	925		$	1,151		$	1,854
Real Estate:
Commercial		6,233			6,763			1,806
Residential		3,752			3,560			3,294
Acquisition, development and construction		835			2,537			5,604
Consumer		13			33			112
Total Nonaccrual loans		11,758			14,044			12,670
Restructured loans (1)		3,325			3,362			6,336
Other real estate owned		655			360			955
Total Non-performing assets	$	15,738		$	17,766		$	19,961
Loans past due 90 days or more and still accruing interest	$	127		$	127		$	-
Non-performing assets to total assets		0.84	%		0.97	%		1.11	%
Non-performing assets to period end loans and OREO		1.53	%		1.76	%		2.06	%
Allowance for loan loss to period end nonaccrual loans		183.26	%		152.14	%		200.40	%

(1) Restructured loans on nonaccrual status at period end are included under nonaccrual loans in the table.

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The ratio of non-performing assets to total loans and other real estate was 1.53% at March 31, 2016 compared to 1.76% at December 31, 2015 and 2.06% at March 31, 2015. The ratio of allowance for loan losses to total nonaccrual loans was 183.26% at March 31, 2016 compared to 152.14% at December 31, 2015 and 200.40% at March 31, 2015. The resolution of non-performing assets continues to be a priority of management.

Nonaccrual loans decreased $912 (7.20%) from March 31, 2015 due primarily to a decline in nonaccrual ADC loans, which decreased $4,769. Partially offsetting this decrease was an increase in nonaccrual CRE loans of $4,427.

The decrease in nonaccrual ADC loans since March 31, 2015 was due primarily to the repayment of a $4,544 participation loan made to finance a retail center that was sold in the second quarter of 2015. The increase in nonaccrual CRE was due to one troubled loan and one impaired loan that moved to nonaccrual status during the last half of the 2015.

The following table provides further information regarding the Company’s most significant nonaccrual loans.

Table 9 - Nonaccrual Loans

Nonaccrual

Appraisal

Appraised

Balance

Originated

Date

Trigger

Collateral

Allowance

Method

Date

Value

(Dollars in thousands)

Commercial real estate

$

1,400

01/06/11

09/18/15

financial condition

motel

-

collateral value

09/15

$

2,050

Commercial real estate

3,452

01/17/12

12/21/15

financial condition

land & gym

-

income approach

12/11

8,000

$

4,852

Other, net

6,906

Nonaccrual loans at March 31, 2016

$

11,758

The following table presents a roll forward of other real estate owned for the three month periods ended March 31, 2016 and 2015, respectively.

Table 10 - Other Real Estate Owned
	2016		2015
	(Dollars in thousands)
Beginning balance, January 1	$	360	$	1,107
Additions		295		303
Increase in valuation allowance		-		(1	)
Sales		-		(598	)
Deferred gain on sale of OREO		-		77
Gain on sale of OREO		-		67
Ending balance, March 31	$	655	$	955

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The following table provides details of other real estate owned as of March 31, 2016, December 31, 2015 and March 31, 2015, respectively.

	March 31, 2016			December 31, 2015			March 31, 2015
	(Dollars in thousands)
Other Real Estate:
Real Estate
Commercial	$	-		$	-		$	378
Residential		265			-			74
Acquisition, development and construction		637			607			822
		902			607			1,274
Valuation allowance		(247	)		(247	)		(319	)
	$	655		$	360		$	955

The change in other real estate owned is due to the continuing process of resolving problem loans. In the first three months of 2016, additions to other real estate owned totaled $295 compared to $303 for the same period in 2015. There were no sales of other real estate for the three months ended March 31, 2016 compared to $598 for the three months ended March 31, 2015.

Allowance for Loan Losses

The allowance for loan losses represents an allocation for the estimated amount of probable incurred losses in the loan portfolio. The adequacy of the allowance for loan losses is evaluated periodically based on a review of all significant loans, with particular emphasis on impaired, non-accruing, past due, and other loans that management believes require special attention. The determination of the allowance for loan losses is considered a critical accounting estimate of the Company. See “Critical Accounting Estimates.”

While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may advise additions to the allowance based on their judgments about information available to them at the time of their examination. Such regulatory guidance is considered, and the Company may recognize additions to the allowance as a result.

Additions to the allowance for loan losses are made periodically to maintain the allowance at an appropriate level based upon management’s analysis of risk in the loan portfolio. Loans determined to be uncollectible are charged to the allowance for loan losses and subsequent recoveries are added to the allowance. A provision for losses in the amount of $428 was charged to expense for the three months ended March 31, 2016 compared to provision of $547 for the three months ended March 31, 2015.

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At March 31, 2016 the ratio of allowance for loan losses to period end loans was 2.09% compared to 2.12% at December 31, 2015 and 2.62% at March 31, 2015. The decline in overall level of allowance as a percentage of the portfolio is due in part to the decline in the average historical net loss rate and the level of recoveries during the quarter. (see Note 1 — ALLL Methodology in the Notes to Consolidated Financial Statements).

For the three months ended March 31, 2016 charge-offs net of recoveries totaled $247 on all loans. This included charge-offs net of recoveries of $158 for ADC loans, $8 for commercial, financial and agricultural loans, $95 for residential real estate loans s. These were partially offset by recoveries net of charge-offs of $101 for CRE loans and $19 for consumer loans. The provisions for loan losses allocated to individual portfolio segments are affected by the calculation of average historical net loss rate factors and by the internal and external qualitative factors within each category.

Management considers the current allowance for loan losses appropriate based upon its analysis of risk in the portfolio using the methods previously discussed. Management’s judgment is based upon a number of assumptions about events which are believed to be reasonable, but which may or may not prove correct. While it is the Company’s policy to charge off in the current period the loans in which a loss is considered probable, there are additional risks of losses which cannot be quantified precisely or attributed to a particular loan or class of loans. Because management evaluates such factors as changes in the nature and volume of the loan portfolio, historical loss rates, overall portfolio quality, review of specific problem loans, and current economic conditions and trends that may affect a borrower’s ability to repay, management's judgment as to the adequacy of the allowance is necessarily approximate and imprecise. Thus, there can be no assurance that charge-offs in future periods will not exceed the allowance for loan losses or that additional increases in the allowance will not be required.

Liquidity and Capital Resources

The Company has maintained adequate liquidity to meet operating and loan funding requirements. The loan to deposit ratio at March 31, 2016 was 65.67% compared to 66.00% at December 31, 2015 and 63.13% at March 31, 2015. Deposits at March 31, 2016 and December 31, 2015 include $170,724 and $159,180 of brokered certificates of deposit, respectively. GB&T has also utilized borrowings from the FHLB. GB&T maintains a line of credit with the FHLB approximating 10% of its total assets. FHLB advances are collateralized by eligible first mortgage loans and CRE loans. FHLB advances totaled $90,000 at March 31, 2016. GB&T maintains repurchase lines of credit with SunTrust Robinson Humphrey, Atlanta, Georgia, for advances up to $30,000, of which none was outstanding at March 31, 2016 and a $10,000 repurchase line of credit with CenterState Bank, Orlando, Florida, of which none was outstanding at March 31, 2016. GB&T has a federal funds purchased accommodation with SunTrust Bank, Atlanta, Georgia for advances up to $10,000, of which none was outstanding at March 31, 2016 and a federal funds purchased accommodation with CenterState Bank, Orlando, Florida, for advances up to $10,000, of which none was outstanding at March 31, 2016. The Company also maintains a borrowing facility at the Federal Reserve Bank, under the Borrower-In-Custody Program, of which none was outstanding at March 31, 2016. Additionally, liquidity needs can be supplemented by the structuring of the maturities of investment securities and the pricing and maturities on loans and deposits offered to customers. The Company also uses retail securities sold under repurchase agreements to fund operations. Retail securities sold under repurchase agreements were $763 at March 31, 2016.

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Stockholders’ equity to total assets was 9.49% at March 31, 2016 compared to 9.23% at December 31, 2015 and 8.93% at March 31, 2015. The capital of the Company exceeded all required regulatory guidelines at March 31, 2016. The Company’s common equity Tier 1, Tier 1 risk-based, total risk-based and Tier 1 leverage capital ratios were 13.69%, 15.26%, 16.51%, and 10.65%, respectively, at March 31, 2016.

The following table reflects the current regulatory capital levels in more detail, including comparisons to the regulatory minimums.

Table 11 - Regulatory Capital Requirements

March 31, 2016

											To be well capitalized
						For capital adequacy					under prompt corrective
	Actual					purposes (1)					action provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
	(Dollars in thousands)
Southeastern Bank Financial Corporation
Risk-based capital:
Common equity tier 1 capital	$	174,835		13.69	%	$	65,448		5.125	%		N/A		N/A
Tier 1 capital		194,835		15.26	%		84,604		6.625	%		N/A		N/A
Total capital		210,866		16.51	%		110,144		8.625	%		N/A		N/A
Tier 1 leverage ratio		194,835		10.65	%		73,211		4.00	%		N/A		N/A
Georgia Bank & Trust Company:
Risk-based capital:
Common equity tier 1 capital	$	182,155		14.30	%	$	65,290		5.125	%	$	82,807		6.50	%
Tier 1 capital		182,155		14.30	%		84,400		6.625	%		101,917		8.00	%
Total capital		198,149		15.55	%		109,879		8.625	%		127,396		10.00	%
Tier 1 leverage ratio		182,155		9.97	%		82,179		4.50	%		91,311		5.00	%

(1) Risk-based capital includes a capital conservation buffer of 0.625%.

Georgia Bank & Trust Company is regulated by the Department of Banking and Finance of the State of Georgia (DBF). The DBF requires that state banks in Georgia generally maintain a minimum ratio of Tier 1 capital to total assets of four and one-half percent (4.50%).

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On July 2, 2013, the Federal Reserve and the FDIC approved rules that implement the “Basel III” regulatory capital reforms, as well as certain changes required by the Dodd-Frank Act. The rules include a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets, which is in addition to the Tier 1, common equity Tier 1 and total risk-based capital requirements. The capital conservation buffer is being phased in over four years beginning on January 1, 2016, with a maximum buffer of 0.625% of risk-weighted assets for 2016, 1.25% for 2017, 1.875% for 2018, and 2.5% for 2019 and thereafter. Failure to maintain the required capital conservation buffer will result in limitations on capital distributions and on discretionary bonuses to executive officers. Based on the Company’s current capital composition and levels, management does not presently anticipate that the rules present a material risk to the Company’s financial condition or results of operations.

Except as set forth above, management is not aware of any other events or uncertainties that are reasonably likely to have a material effect on the Company’s liquidity, capital resources or operations.

Commitments and Contractual Obligations

The Company is party to lines of credit with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. Lines of credit are unfunded commitments to extend credit. These instruments involve, in varying degrees, exposure to credit and interest rate risk in excess of the amounts recognized in the financial statements. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for unfunded commitments to extend credit and letters of credit is represented by the contractual amount of those instruments. The Company evaluates ADC loans for the percentage completed before extending additional credit. The Company follows the same credit policies in making commitments and contractual obligations as it does for on-balance sheet instruments.

Unfunded commitments to extend credit where contractual amounts represent potential credit risk totaled $220,921 at March 31, 2016. This includes standby letters of credit of $4,905 at March 31, 2016. These commitments are primarily at variable interest rates.

The Company’s commitments are funded through internal funding sources of scheduled repayments of loans and sales and maturities of investment securities available-for-sale or external funding sources through acceptance of deposits from customers or borrowings from other financial institutions.

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The following table is a summary of the Company’s commitments to extend credit, commitments under contractual leases as well as the Company’s contractual obligations, consisting of deposits, FHLB advances, which are subject to early termination options, borrowed funds and benefit plans by contractual maturity date.

Table 12 - Commitments and Contractual Obligations
	Less than 1 Year		1 - 3 Years		3 - 5 Years		More than 5 Years
	(Dollars in thousands)
Lines of credit (1)	$	216,016		-		-		-
Standby letters of credit (1)		4,905		-		-		-
Lease agreements		301		306		70		-
Deposits		1,455,648		95,103		17,702		-
Securities sold under repurchase agreements		763		-		-		-
Salary continuation agreements		264		1,335		1,674		34,171
FHLB advances		15,000		69,000		6,000		-
Subordinated debentures		-		-		-		20,000
Total commitments and contractual obligations	$	1,692,897	$	165,744	$	25,446	$	54,171

(1) Presented at contractual amounts; however, since many of these are expected to expire unused or partially used, the total amounts do not necessarily reflect future cash requirements

Although management regularly monitors the balance of outstanding commitments to fund loans to ensure funding availability should the need arise, management believes that the risk of all customers fully drawing on all these lines of credit at the same time is remote.

Effects of Inflation and Changing Prices

Inflation generally increases the cost of funds and operating overhead, and to the extent loans and other assets bear variable rates, the yields on such assets. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on the performance of a financial institution than the effects of general levels of inflation. Although interest rates do not necessarily move in the same direction and to the same extent as the prices of goods and services, increases in inflation generally have resulted in increased interest rates. In addition, inflation can increase a financial institution's cost of goods and services purchased, the cost of salaries and benefits, occupancy expense and similar items. Inflation and related increases in interest rates generally decrease the market value of investments and loans held and may adversely affect liquidity, earnings, and stockholders' equity. Mortgage originations and refinances tend to slow as interest rates increase, and can reduce the Company's earnings from such activities and the income from the sale of residential mortgage loans in the secondary market.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

As of March 31, 2016, there were no substantial changes in the interest rate sensitivity analysis or the sensitivity of market value of portfolio equity for various changes in interest rates calculated as of December 31, 2015. A detailed discussion of market risk is provided in the Company’s 2015 Annual Report on Form 10-K.

Item 4. Controls and Procedures

As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer (principal executive officer) and its Executive Vice President and Chief Financial Officer (principal financial officer), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, such officers concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiary) that is required to be included in the Company’s periodic filings with the Securities and Exchange Commission. There have been no changes in the Company’s internal controls or, to the Company’s knowledge, in other factors during the quarter covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

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Part II

OTHER INFORMATION

Item 1. Legal Proceedings

There are no material pending legal proceedings to which the Company or any of its subsidiaries is a party or of which any of their property is subject.

Item 1A. Risk Factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, which could materially affect its business, financial condition or future results. There are no material changes from the factors previously disclosed in the Company’s Annual Report on Form 10-K. The risks described in the Annual Report on Form 10-K are not the only risks facing the Company. Additional risks and uncertainties not currently known to management or that management currently deems to be immaterial also may materially adversely affect the Company’s business, financial condition and/or operating results.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Securities

The following table sets forth information regarding the Company’s purchases of its common stock on a monthly basis during the first quarter of 2016.

Period	Total Number of Shares Purchased (1)	Average Price Paid Per Share (1)	Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (1)	Maximum Number (or Appropriate Dollar Value) of Shares Yet To Be Purchased Under the Plans or Programs (1)
January 1 through January 31, 2016	-	-	-	299,454
February 1 through February 29, 2016	-	-	-	299,454
March 1 through March 31, 2016	-	-	-	299,454
Total	-	-	-	299,454

(1) On October 15, 2014, the Company’s Board of Directors announced the commencement of a stock repurchase program (the “2014 Program”), pursuant to which it will, from time to time, repurchase up to 300,000 shares of its outstanding common stock in the open market or in private transactions. The 2014 Program does not have a stated expiration date.

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Item 3. Defaults Upon Senior Securities

Not applicable

Item 4. Mine Safety Disclosures

Not applicable

Item 5. Other Information

None

Item 6. Exhibits

31.1	Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101	Interactive Data Files providing financial information from the Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2016 in XBRL (eXtensible Business Reporting Language).

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SOUTHEASTERN BANK FINANCIAL CORPORATION

Form 10-Q Signatures

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

	SOUTHEASTERN BANK FINANCIAL CORPORATION
Date: April 29, 2016		By:	/s/ Darrell R. Rains
		Darrell R. Rains
		Executive Vice President, Chief
		Financial Officer (Duly Authorized
		Officer of Registrant and Principal
		Financial Officer)

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