(3)

Loans

Major classifications of loans at June 30, 2011 and December 31, 2010 are summarized as follows:

(Dollars in thousands)

	June 30, 2011		December 31, 2010

Real Estate Loans
Construction and land development	$	108,353	124,048
Single-family residential		276,452	287,307
Commercial		210,186	213,487
Multifamily and farmland		5,179	6,456
Total real estate loans		600,170	631,298

Commercial loans (not secured by real estate)		56,575	60,994
Consumer loans (not secured by real estate)		10,557	11,500
All other loans (not secured by real estate)		25,511	22,368

Total loans		692,813	726,160

Less allowance for loan losses		15,984	15,493

Total net loans	$	676,829	710,667

The Company grants loans and extensions of credit primarily within the Catawba Valley region of North Carolina, which encompasses Catawba, Alexander, Iredell and Lincoln counties and also in Mecklenburg, Union and Wake counties of North Carolina. Although the Bank has a diversified loan portfolio, a substantial portion of the loan portfolio is collateralized by improved and unimproved real estate, the value of which is dependent upon the real estate market.

Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when, in management's opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

The following tables present an age analysis of past due loans, by loan type, as of June 30, 2011 and December 31, 2010:

June 30, 2011
(Dollars in thousands)
	Loans 30-89 Days Past Due		Loans 90 or More Days Past Due	Total Past Due Loans	Total Current Loans	Total Loans	Accruing Loans 90 or More Days Past Due
Real Estate Loans
Construction and land development	$	1,031	2,882	3,913	104,441	108,353	-
Single-family residential		7,766	5,064	12,830	263,621	276,452	1,124
Commercial		1,340	1,191	2,531	207,655	210,186	-
Multifamily and farmland		-	-	-	5,179	5,179	-
Total real estate loans		10,137	9,137	19,274	580,896	600,170	1,124

Commercial loans (not secured by real estate)		340	92	432	56,143	56,575	-
Consumer loans (not secured by real estate)		20	31	51	10,506	10,557	-
All other loans (not secured by real estate)		-	-	-	25,511	25,511	-
Total loans	$	10,497	9,260	19,757	673,056	692,813	1,124

December 31, 2010
(Dollars in thousands)
	Loans 30-89 Days Past Due		Loans 90 or More Days Past Due	Total Past Due Loans	Total Current Loans	Total Loans	Accruing Loans 90 or More Days Past Due
Real Estate Loans
Construction and land development	$	2,306	8,870	11,176	112,872	124,048	197
Single-family residential		19,377	5,936	25,313	261,994	287,307	-
Commercial		382	1,482	1,864	211,623	213,487	-
Multifamily and Farmland		-	-	-	6,456	6,456	-
Total real estate loans		22,065	16,288	38,353	592,945	631,298	197

Commercial loans (not secured by real estate)		1,098	720	1,818	59,176	60,994	13
Consumer loans (not secured by real estate)		98	13	111	11,389	11,500	-
All other loans (not secured by real estate)		-	-	-	22,368	22,368	-
Total loans	$	23,261	17,021	40,282	685,878	726,160	210

The following table presents the Company's non-accrual loans as of June 30, 2011 and December 31, 2010:

(Dollars in thousands)
	June 30, 2011		December 31, 2010
Real Estate Loans
Construction and land development	$	19,256	22,916
Single-family residential		7,035	10,837
Commercial		3,922	5,351
Multifamily and Farmland		-	-
Total real estate loans		30,213	39,104

Commercial loans (not secured by real estate)		637	816
Consumer loans (not secured by real estate)		147	142
All other loans (not secured by real estate)		-	-
Total	$	30,997	40,062

At each reporting period, the Company determines which loans are impaired. Accordingly, the Company's impaired loans are reported at their estimated fair value on a non-recurring basis. An allowance for each impaired loan, which is generally collateral-dependent, is calculated based on the fair value of its collateral. The fair value of the collateral is based on appraisals performed by third-party valuation specialists. Factors including the assumptions and techniques utilized by the appraiser are considered by management. If the recorded investment in the impaired loan exceeds the measure of fair value of the collateral, a valuation allowance is recorded as a component of the allowance for loan losses. No interest income is recognized on impaired loans subsequent to their classification as impaired.

The following tables present the Company's impaired loans as of June 30, 2011 and December 31, 2010:

June 30, 2011
(Dollars in thousands)
	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance	Recorded Investment With Allowance	Recorded Investment in Impaired Loans	Related Allowance	Average Outstanding Impaired Loans
Real Estate Loans
Construction and land development	$	28,266	19,256	-	19,256	-	21,086
Single-family residential		8,507	6,927	108	7,035	1,257	8,936
Commercial		4,686	2,667	1,255	3,922	98	4,636
Multifamily and farmland		-	-	-	-	-	-
Total impaired real estate loans		41,459	28,850	1,363	30,213	1,355	34,658

Commercial loans (not secured by real estate)		686	313	324	637	113	727
Consumer loans (not secured by real estate)		162	147	-	147	-	144
All other loans (not secured by real estate)		-	-	-	-	-	-
Total impaired loans	$	42,307	29,310	1,687	30,997	1,468	35,529

December 31, 2010
(Dollars in thousands)
	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance	Recorded Investment With Allowance	Recorded Investment in Impaired Loans	Related Allowance	Average Outstanding Impaired Loans
Real Estate Loans
Construction and land development	$	31,346	20,787	2,130	22,916	1,055	18,767
Single-family residential		12,376	9,847	990	10,837	168	12,573
Commercial		6,018	4,991	359	5,351	148	4,769
Multifamily and Farmland		-	-	-	-	-	27
Total impaired real estate loans		49,740	35,625	3,479	39,104	1,371	36,136

Commercial loans (not secured by real estate)		1,243	811	5	816	5	1,479
Consumer loans (not secured by real estate)		152	142	-	142	-	79
Total impaired loans	$	51,135	36,578	3,484	40,062	1,376	37,694

Changes in the allowance for loan losses for the six months ended June 30, 2011 were as follows:

(Dollars in thousands)

	Real Estate Loans
	Construction and Land Development			Single- family Residential		Commercial		Multifamily and Farmland		Commercial		Consumer		Unallocated	Total
Allowance for loan losses:
Beginning balance	$	5,774		6,097		1,409		17		1,174		430		592	15,493
Charge-offs		(3,329	)	(1,698	)	(894	)	-		(118	)	(272	)	-	(6,311	)
Recoveries		234		65		23		-		77		85		-	484
Provision		2,915		1,696		1,081		(3	)	(31	)	11		649	6,318
Ending balance	$	5,594		6,160		1,619		14		1,102		254		1,241	15,984

Ending balance: Individually
evaluated for impairment	$	-		1,257		98		-		113		-		-	1,468
Ending balance: Collectively
evaluated for impairment		5,594		4,903		1,521		14		989		254		1,241	14,516
Ending balance	$	5,594		6,160		1,619		14		1,102		254		1,241	15,984

The Company utilizes an internal risk grading matrix to assign a risk grade to each of its loans. Loans are graded on a scale of 1 to 9. A description of the general characteristics of the nine risk grades is as follows:

·	Risk Grade 1 – Excellent Quality: Loans are well above average quality and a minimal amount of credit risk exists. CD or cash secured loans or properly margined actively traded stock or bond secured loans would fall in this grade.

·	Risk Grade 2 – High Quality: Loans are of good quality with risk levels well within the Company's range of acceptability. The organization or individual is established with a history of successful performance though somewhat susceptible to economic changes.

·	Risk Grade 3 – Good Quality: Loans of average quality with risk levels within the Company's range of acceptability but higher than normal. This may be a new organization or an existing organization in a transitional phase (e.g. expansion, acquisition, market change).

Risk Grade 4 – Management Attention: These loans have very high risk and servicing needs but still are acceptable. Evidence of marginal performance or deteriorating trends are evident. These are not problem credits presently, but may be in the future if the borrower is unable to change its present course.

Risk Grade 5 – Watch: These loans are currently performing satisfactorily, but there are potential weaknesses that may, if not corrected, weaken the asset or inadequately protect the Company's position at some future date. This frequently results from deviating from prudent lending practices, for instance over-advancing on collateral.

Risk Grade 6 – Substandard: A substandard loan is inadequately protected by the current sound net worth and paying capacity of the obligor or the collateral pledged (if there is any). There is a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. There is a distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

Risk Grade 7 – Low Substandard: These loans have the general characteristics of a Grade 6 Substandard loan, with heightened potential concerns. The exact amount of loss is not yet known because neither the liquidation value of the collateral nor the borrower's predicted repayment ability is known with confidence.

Risk Grade 8 – Doubtful: Loans classified Doubtful have all the weaknesses inherent in loans classified Substandard, plus 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. Doubtful is a temporary grade where a loss is expected but is presently not quantified with any degree of accuracy. Once the loss position is determined, the amount is charged off.

Risk Grade 9 – Loss: Loans classified Loss are considered uncollectable and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this worthless loan even though partial recovery may be realized in the future. Loss is a temporary grade until the appropriate authority is obtained to charge the loan off.

The following tables present the credit risk profile of each loan type based on internally assigned risk grade as of June 30, 2011 and December 31, 2010.

June 30, 2011
(Dollars in thousands)
	Real Estate Loans
	Construction and land development		Single- family residential	Commercial	Multifamily and Farmland	Commercial	Consumer	All other	Total

1- Excellent Quality	$	17	24,408	37	-	656	1,008	-	26,126
2- High Quality	$	5,746	67,036	24,680	233	8,917	4,067	5,057	115,736
3- Good Quality	$	28,518	110,855	129,385	3,630	36,834	4,862	20,446	334,530
4- Management Attention	$	48,829	53,511	45,005	371	8,484	458	8	156,666
5- Watch	$	3,515	7,639	1,863	730	455	11	-	14,213
6- Substandard	$	21,728	13,003	9,216	215	1,229	151	-	45,542
7- Low Substandard	$	-	-	-	-	-	-	-	-
8- Doubtful	$	-	-	-	-	-	-	-	-
9- Loss	$	-	-	-	-	-	-	-	-
Total	$	108,353	276,452	210,186	5,179	56,575	10,557	25,511	692,813

December 31, 2010
(Dollars in thousands)
	Real Estate Loans
	Construction and land development		Single- family residential	Commercial	Multifamily and Farmland	Commercial	Consumer	All other	Total

1- Excellent Quality	$	19	27,698	102	-	630	1,006	-	29,455
2- High Quality	$	5,789	70,990	21,591	2,856	9,673	4,491	5,145	120,535
3- Good Quality	$	33,991	109,800	129,530	2,256	39,248	5,360	17,223	337,408
4- Management Attention	$	46,283	55,001	43,731	1,121	8,143	454		154,733
5- Watch	$	8,076	7,959	5,569	-	1,590	38		23,232
6- Substandard	$	29,502	15,022	12,605	223	1,678	145		59,175
7- Low Substandard	$	-	756	359	-	-	-		1,115
8- Doubtful	$	388	81	-	-	17	-		486
9- Loss	$	-	-	-	-	15	6	-	21
Total	$	124,048	287,307	213,487	6,456	60,994	11,500	22,368	726,160

The following tables present weighted average risk grades and balances of the total loan portfolio, along with balances of classified loans, by loan type as of June 30, 2011 and December 31, 2010. Classified loans include loans in risk grades 6, 7, 8 and 9.

June 30, 2011
(Dollars in thousands)
	Weighted Average Risk Grade of Loans Outstanding	Loans Outstanding		Classified Loans
Real Estate Loans
Construction and land development	4.06	$	108,353	21,728
Single-family residential	2.97		276,452	13,003
Commercial	3.25		210,186	9,216
Multifamily and farmland	3.43		5,179	215
Total real estate loans			600,170	44,161

Commercial loans (not secured by real estate)	3.05		56,575	1,229
Consumer loans (not secured by real estate)	2.47		10,557	151
All other loans (not secured by real estate)	2.80		25,511	-
Total loans		$	692,813	45,542	(1)

(1) Includes $36.2 million of TDR loans

December 31, 2010
(Dollars in thousands)
	Weighted Average Risk Grade of Loans Outstanding	Loans Outstanding		Classified Loans
Real Estate Loans
Construction and land development	4.19	$	124,048	29,890
Single-family residential	2.97		287,307	15,859
Commercial	3.33		213,487	12,964
Multifamily and Farmland	2.83		6,456	223
Total real estate loans			631,298	58,936

Commercial loans (not secured by real estate)	3.09		60,994	1,710
Consumer loans (not secured by real estate)	2.48		11,500	151
All other loans (not secured by real estate)	2.77		22,368	-
Total loans		$	726,160	60,797	(1)

(1) Includes $39.2 million of TDR loans

At June 30, 2011, troubled debt restructured (“TDR”) loans amounted to $51.2 million, including $16.5 million in performing TDR loans. The terms of these loans have been renegotiated to provide a reduction in principal or interest as a result of the deteriorating financial position of the borrower. At December 31, 2010, TDR loans amounted to $56.7 million, including $10.0 million in performing TDR loans.

The following table presents an analysis of TDR loans by loan type as of June 30, 2011.

(Dollars in thousands)
	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Real Estate Loans
Construction and land development	38	$	25,644	19,480
Single-family residential	239		27,249	25,236
Commercial	15		8,086	4,336
Multifamily and farmland	1		322	215
Total real estate TDR loans	293		61,301	49,267

Commercial loans (not secured by real estate)	24		5,856	1,763
Consumer loans (not secured by real estate)	10		160	148
Total TDR loans	327	$	67,317	51,178