(3)

Loans

Major classifications of loans at March 31, 2012 and December 31, 2011 are summarized as follows:

(Dollars in thousands)
	March 31, 2012		December 31, 2011
Real estate loans
Construction and land development	$	90,838	93,812
Single-family residential		260,037	267,051
Commercial		212,124	214,415
Multifamily and farmland		4,453	4,793
Total real estate loans		567,452	580,071

Commercial loans (not secured by real estate)		62,020	60,646
Consumer loans (not secured by real estate)		10,277	10,490
All other loans (not secured by real estate)		18,594	19,290

Total loans		658,343	670,497

Less allowance for loan losses		16,612	16,604

Total net loans	$	641,731	653,893

The Bank 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 March 31, 2012 and December 31, 2011:

March 31, 2012
(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	$	3,969	3,226	7,195	83,643	90,838	-
Single-family residential		14,413	4,138	18,551	241,486	260,037	1,023
Commercial		1,118	376	1,494	210,630	212,124	-
Multifamily and farmland		-	-	-	4,453	4,453	-
Total real estate loans		19,500	7,740	27,240	540,212	567,452	1,023

Commercial loans (not secured by real estate)		681	87	768	61,252	62,020	-
Consumer loans (not secured by real estate)		96	36	132	10,145	10,277	-
All other loans (not secured by real estate)		-	-	-	18,594	18,594	-
Total loans	$	20,277	7,863	28,140	630,203	658,343	1,023

December 31, 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	$	10,033	3,338	13,371	80,441	93,812	-
Single-family residential		16,536	6,189	22,725	244,326	267,051	2,709
Commercial		1,002	958	1,960	212,455	214,415	-
Multifamily and farmland		13	-	13	4,780	4,793	-
Total real estate loans		27,584	10,485	38,069	542,002	580,071	2,709

Commercial loans (not secured by real estate)		576	9	585	60,061	60,646	-
Consumer loans (not secured by real estate)		116	36	152	10,338	10,490	-
All other loans (not secured by real estate)		-	-	-	19,290	19,290	-
Total loans	$	28,276	10,530	38,806	631,691	670,497	2,709

The following table presents the Company's non-accrual loans as of March 31, 2012 and December 31, 2011:

(Dollars in thousands)
	March 31, 2012		December 31, 2011
Real estate loans
Construction and land development	$	16,204	13,257
Single-family residential		5,480	5,522
Commercial		1,758	2,451
Multifamily and farmland		-	-
Total real estate loans		23,442	21,230

Commercial loans (not secured by real estate)		473	403
Consumer loans (not secured by real estate)		66	152
Total	$	23,981	21,785

At each reporting period, the Bank determines which loans are impaired. Accordingly, the Bank'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 REAS, a subsidiary of the Bank. REAS is staffed by certified appraisers that also perform appraisals for other companies. 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. Impaired loans under $250,000 are not individually evaluated for impairment, with the exception of the Bank's troubled debt restructured ("TDR") loans in the residential mortgage loan portfolio, which are individually evaluated for impairment. Accruing impaired loans amounted to $32.2 million, $19.1 million and $30.6 million at March 31, 2012, March 31, 2011 and December 31, 2011, respectively. Interest income recognized on accruing impaired loans was $422,000, $301,000 and $1.7 million for the three months ended March 31, 2012, the three months ended March 31, 2011 and the year ended December 31, 2011, respectively. No interest income is recognized on non-accrual impaired loans subsequent to their classification as impaired.

The following tables present the Company's impaired loans as of March 31, 2012 and December 31, 2011:

March 31, 2012
(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	$	30,523	15,798	5,747	21,545	3,303	15,152
Single-family residential		29,793	649	28,502	29,151	1,506	27,253
Commercial		4,179	1,399	2,663	4,062	57	4,538
Multifamily and farmland		-	-	-	-	-	206
Total impaired real estate loans		64,495	17,846	36,912	54,758	4,866	47,149

Commercial loans (not secured by real estate)		1,173	408	736	1,144	25	1,135
Consumer loans (not secured by real estate)		73	28	41	69	1	110
Total impaired loans	$	65,741	18,282	37,689	55,971	4,892	48,394


December 31, 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	$	28,721	14,484	6,098	20,582	3,264	17,848
Single-family residential		26,382	969	24,719	25,688	1,427	25,102
Commercial		7,717	3,845	3,139	6,984	77	4,518
Multifamily and farmland		209	-	209	209	1	214
Total impaired real estate loans		63,029	19,298	34,165	53,463	4,769	47,682

Commercial loans (not secured by real estate)		1,111	-	1,083	1,083	26	1,485
Consumer loans (not secured by real estate)		157	-	152	152	2	140
Total impaired loans	$	64,297	19,298	35,400	54,698	4,797	49,307

Changes in the allowance for loan losses for the three months ended March 31, 2012 and the year ended December 31, 2011 were as follows:

Three months ended March 31, 2012
(Dollars in thousands)
		Real Estate Loans
		Construction and Land Development			Single- Family Residential		Commercial		Multifamily and Farmland	Commercial		Consumer and All Other		Unallocated	Total
Allowance for loan losses:
Beginning balance		$	7,182		5,357		1,731		13	1,029		255		1,037	16,604
	Charge-offs		(1,851	)	(278	)	(71	)	-	(239	)	(157	)	-	(2,596	)
	Recoveries		118		2		374		-	5		56		-	555
	Provision		1,431		200		(600	)	-	209		96		713	2,049
Ending balance		$	6,880		5,281		1,434		13	1,004		250		1,750	16,612

Ending balance: individually
evaluated for impairment		$	967		1,356		-		-	-		-		-	2,323
Ending balance: collectively
evaluated for impairment			5,913		3,925		1,434		13	1,004		250		1,750	14,289
Ending balance		$	6,880		5,281		1,434		13	1,004		250		1,750	16,612

Loans:
Ending balance		$	90,838		260,037		212,124		4,453	62,020		28,871		-	658,343

Ending balance: individually
evaluated for impairment		$	21,045		23,963		3,357		-	408		28		-	48,801
Ending balance: collectively
evaluated for impairment		$	69,793		236,074		208,767		4,453	61,612		28,843		-	609,542

Year ended December 31, 2011
(Dollars in thousands)
		Real Estate Loans
		Construction and Land Development			Single- Family Residential		Commercial		Multifamily and Farmland		Commercial		Consumer and All Other		Unallocated	Total
Allowance for loan losses:
Beginning balance		$	5,774		6,097		1,409		17		1,174		430		592	15,493
	Charge-offs		(7,164	)	(2,925	)	(1,271	)	-		(314	)	(586	)	-	(12,260	)
	Recoveries		241		201		24		-		121		152		-	739
	Provision		8,331		1,984		1,569		(4	)	48		259		445	12,632
Ending balance		$	7,182		5,357		1,731		13		1,029		255		1,037	16,604

Ending balance: individually
evaluated for impairment		$	1,250		1,289		-		-		-		-		-	2,539
Ending balance: collectively
evaluated for impairment			5,932		4,068		1,731		13		1,029		255		1,037	14,065
Ending balance		$	7,182		5,357		1,731		13		1,029		255		1,037	16,604

Loans:
Ending balance		$	93,812		267,051		214,415		4,793		60,646		29,780		-	670,497

Ending balance: individually
evaluated for impairment		$	20,280		20,661		3,845		-		-		-		-	44,786
Ending balance: collectively
evaluated for impairment		$	73,532		246,390		210,570		4,793		60,646		29,780		-	625,711

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. These risk grades are evaluated on an ongoing basis. 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 as 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 as 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 March 31, 2012 and December 31, 2011.

March 31, 2012
(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	$	195	26,054	-	-	797	1,290	-	28,336
2- High Quality		4,829	61,918	24,270	46	9,766	4,169	2,683	107,681
3- Good Quality		27,569	93,117	129,046	3,114	36,218	4,140	15,905	309,109
4- Management Attention		26,675	48,119	46,445	363	13,621	372	6	135,601
5- Watch		14,503	11,550	2,981	726	614	98	-	30,472
6- Substandard		17,067	19,279	9,382	204	1,004	208	-	47,144
7- Low Substandard		-	-	-	-	-	-	-	-
8- Doubtful		-	-	-	-	-	-	-	-
9- Loss		-	-	-	-	-	-	-	-
Total	$	90,838	260,037	212,124	4,453	62,020	10,277	18,594	658,343

December 31, 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	$	197	25,474	-	-	715	1,344	-	27,730
2- High Quality		5,183	64,817	25,506	50	8,801	4,070	2,774	111,201
3- Good Quality		27,675	100,388	136,137	3,448	36,585	4,259	16,509	325,001
4- Management Attention		28,138	50,253	40,312	358	12,882	429	7	132,379
5- Watch		15,923	11,767	2,795	728	622	89	-	31,924
6- Substandard		16,696	14,352	9,665	209	1,041	154	-	42,117
7- Low Substandard		-	-	-	-	-	-	-	-
8- Doubtful		-	-	-	-	-	-	-	-
9- Loss		-	-	-	-	-	145	-	145
Total	$	93,812	267,051	214,415	4,793	60,646	10,490	19,290	670,497

At March 31, 2012, TDR loans amounted to $25.6 million, including $617,000 in performing TDR loans. Effective March 31, 2012, performing TDR balances reflect current year TDR loans only, in accordance with GAAP. Previously reported TDR amounts reflect cumulative TDR loans from prior periods in addition to current year TDR loans. At December 31, 2011, TDR loans amounted to $44.1 million, including $15.1 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.

The following table presents an analysis of TDR loans by loan type as of March 31, 2012 and December 31, 2011.

March 31, 2012
(Dollars in thousands)
	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Real Estate Loans
Construction and land development	25	$	18,652	11,825
Single-family residential	117		12,969	11,549
Commercial	9		3,649	1,759
Total real estate TDR loans	151		35,270	25,133

Commercial loans (not secured by real estate)	9		601	391
Consumer loans (not secured by real estate)	6		151	55
Total TDR loans	166	$	36,022	25,579

December 31, 2011
(Dollars in thousands)
	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Real Estate Loans
Construction and land development	29	$	19,762	12,840
Single-family residential	241		25,541	24,846
Commercial	15		7,200	5,013
Multifamily and Farmland	1		322	209
Total real estate TDR loans	286		52,825	42,908

Commercial loans (not secured by real estate)	21		1,711	1,083
Consumer loans (not secured by real estate)	8		124	142
Total TDR loans	315	$	54,660	44,133