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3. Loans

6 Months Ended

Jun. 30, 2013

Major classifications of loans at June 30, 2013 and December 31, 2012 are summarized as follows:

(Dollars in thousands)
		June 30, 2013		December 31, 2012
Real estate loans
Construction and land development		$	70,112	73,176
Single-family residential			192,601	195,003
Single-family residential -
	Banco de la Gente stated income		50,454	52,019
Commercial			191,368	200,633
Multifamily and farmland			10,918	8,951
Total real estate loans			515,453	529,782

Loans not secured by real estate
Commercial loans			66,161	64,295
Farm loans			24	11
Consumer loans			9,903	10,148
All other loans			16,531	15,738
Total loans			608,072	619,974

Less allowance for loan losses			14,029	14,423

Net loans		$	594,043	605,551

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. Risk characteristics of the major components of the Bank’s loan portfolio are discussed below:

·

Construction and land development loans – The risk of loss is largely dependent on the initial estimate of whether the property’s value at completion equals or exceeds the cost of property construction and the availability of take-out financing. During the construction phase, a number of factors can result in delays or cost overruns. If the estimate is inaccurate or if actual construction costs exceed estimates, the value of the property securing our loan may be insufficient to ensure full repayment when completed through a permanent loan, sale of the property, or by seizure of collateral. As of June 30, 2013, construction and land development loans comprised approximately 12% of the Bank’s total loan portfolio.

·

Single-family residential loans – Declining home sales volumes, decreased real estate values and higher than normal levels of unemployment could contribute to losses on these loans. As of June 30, 2013, single-family residential loans comprised approximately 40% of the Bank’s total loan portfolio, including Banco de la Gente single-family residential stated income loans amounting to approximately 8% of the Bank’s total loan portfolio.

·

Commercial real estate loans – Repayment is dependent on income being generated in amounts sufficient to cover operating expenses and debt service. These loans also involve greater risk because they are generally not fully amortizing over a loan period, but rather have a balloon payment due at maturity. A borrower’s ability to make a balloon payment typically will depend on being able to either refinance the loan or timely sell the underlying property. As of June 30, 2013, commercial real estate loans comprised approximately 31% of the Bank’s total loan portfolio.

·

Commercial loans – Repayment is generally dependent upon the successful operation of the borrower’s business. In addition, the collateral securing the loans may depreciate over time, be difficult to appraise, be illiquid, or fluctuate in value based on the success of the business. As of June 30, 2013, commercial loans comprised approximately 11% of the Bank’s total loan portfolio.

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, 2013 and December 31, 2012:

June 30, 2013
(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		$	505	6,061	6,566	63,546	70,112	-
Single-family residential			3,148	3,083	6,231	186,370	192,601	1,376
Single-family residential -
	Banco de la Gente stated income		4,647	2,249	6,896	43,558	50,454	1,476
Commercial			494	-	494	190,874	191,368	-
Multifamily and farmland			186	-	186	10,732	10,918	-
Total real estate loans			8,980	11,393	20,373	495,080	515,453	2,852

Loans not secured by real estate
Commercial loans			332	162	494	65,667	66,161	-
Farm loans			-	-	-	24	24	-
Consumer loans			211	13	224	9,679	9,903	8
All other loans			-	-	-	16,531	16,531	-
Total loans		$	9,523	11,568	21,091	586,981	608,072	2,860

December 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		$	1,280	6,858	8,138	65,038	73,176	-
Single-family residential			4,316	1,548	5,864	189,139	195,003	-
Single-family residential -
	Banco de la Gente stated income		11,077	3,659	14,736	37,283	52,019	2,378
Commercial			1,720	1,170	2,890	197,743	200,633	-
Multifamily and farmland			7	-	7	8,944	8,951	-
Total real estate loans			18,400	13,235	31,635	498,147	529,782	2,378

Loans not secured by real estate
Commercial loans			888	66	954	63,341	64,295	23
Farm loans			-	-	-	11	11	-
Consumer loans			250	10	260	9,888	10,148	2
All other loans			-	-	-	15,738	15,738	-
Total loans		$	19,538	13,311	32,849	587,125	619,974	2,403

The following table presents the Company’s non-accrual loans as of June 30, 2013 and December 31, 2012:

(Dollars in thousands)
		June 30, 2013		December 31, 2012
Real estate loans
Construction and land development		$	7,692	9,253
Single-family residential			3,992	2,491
Single-family residential -
	Banco de la Gente stated income		2,138	2,232
Commercial			1,741	3,263
Total real estate loans			15,563	17,239

Loans not secured by real estate
Commercial loans			510	344
Consumer loans			34	47
Total		$	16,107	17,630

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 that is 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. An allowance for each impaired loan that is non-collateral dependent is calculated based on the present value of projected cash flows. If the recorded investment in the impaired loan exceeds the present value of projected cash flows, 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 were $26.2 million, $30.6 million and $35.0 million at June 30, 2013, December 31, 2012 and June 30, 2012, respectively. Interest income recognized on accruing impaired loans was $579,000, $873,000 and $1.5 million for the six months ended June 30, 2013, the six months ended June 30, 2012 and the year ended December 31, 2012, respectively. Interest income recognized on accruing impaired loans was $286,000 and $451,000 for the three months ended June 30, 2013 and 2012, respectively. No interest income is recognized on non-accrual impaired loans subsequent to their classification as non-accrual.

The following tables present the Company’s impaired loans as of June 30, 2013 and December 31, 2012:

June 30, 2013
(Dollars in thousands)
							Average Outstanding Impaired Loans
	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance	Recorded Investment With Allowance	Recorded Investment in Impaired Loans	Related Allowance	Three Months Ended June 30, 2012	Three Months Ended June 30, 2013	Six Months Ended June 30, 2012	Six Months Ended June 30, 2013
Real estate loans
Construction and land development	$	11,676	1,866	6,465	8,331	63	14,990	9,222	14,500	9,422
Single-family residential		9,152	270	8,176	8,446	444	7,515	8,926	6,930	8,662
Single-family residential -
Banco de la Gente stated income		21,679	-	20,785	20,785	1,259	21,327	20,921	20,752	20,947
Commercial		3,772	3,125	308	3,433	4	4,872	4,143	4,919	4,441
Multifamily and farmland		186	-	186	186	1	202	187	205	189
Total impaired real estate loans		46,465	5,261	35,920	41,181	1,771	48,906	43,399	47,306	43,661

Loans not secured by real estate
Commercial loans		827	-	773	773	14	1,222	848	1,175	878
Consumer loans		320	280	38	318	-	41	187	79	142
Total impaired loans	$	47,612	5,541	36,731	42,272	1,785	50,169	44,434	48,560	44,681

December 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		$	17,738	11,795	680	12,475	61	12,810
Single-family residential			9,099	766	7,799	8,565	177	7,590
Single-family residential -
	Banco de la Gente stated income		21,806	-	21,000	21,000	1,278	21,158
Commercial			5,830	4,569	467	5,036	6	5,433
Multifamily and farmland			193	-	193	193	1	200
Total impaired real estate loans			54,666	17,130	30,139	47,269	1,523	47,191

Loans not secured by real estate
Commercial loans			983	347	592	939	12	1,125
Consumer loans			68	-	66	66	1	41
Total impaired loans		$	55,717	17,477	30,797	48,274	1,536	48,357

Changes in the allowance for loan losses for the three and six months ended June 30, 2013 and 2012 were as follows:

(Dollars in thousands)
	Real Estate Loans
	Construction and Land Development			Single- Family Residential		Single- Family Residential - Banco de la Gente Stated Income		Commercial		Multifamily and Farmland	Commercial		Farm	Consumer and All Other		Unallocated		Total
Six months ended June 30, 2013
Allowance for loan losses:
Beginning balance	$	4,399		3,231		1,998		2,049		28	1,088		-	245		1,385		14,423
Charge-offs		(715	)	(636	)	(224	)	(275	)	-	(382	)	-	(281	)	-		(2,513	)
Recoveries		26		44		70		50		-	25		-	78		-		293
Provision		1,015		665		80		34		6	91		-	187		(252	)	1,826
Ending balance	$	4,725		3,304		1,924		1,858		34	822		-	229		1,133		14,029

Three months ended June 30, 2013
Allowance for loan losses:
Beginning balance	$	4,785		3,182		1,976		1,811		30	1,209		-	232		1,187		14,412
Charge-offs		(218	)	(272	)	(72	)	(275	)	-	(361	)	-	(134	)	-		(1,332	)
Recoveries		25		26		70		2		-	14		-	43		-		180
Provision		133		368		(50	)	320		4	(40	)	-	88		(54	)	769
Ending balance	$	4,725		3,304		1,924		1,858		34	822		-	229		1,133		14,029

Allowance for loan losses June 30, 2013:
Ending balance: individually
evaluated for impairment	$	6		343		1,234		-		-	-		-	-		-		1,583
Ending balance: collectively
evaluated for impairment		4,719		2,961		690		1,858		34	822		-	229		1,133		12,446
Ending balance	$	4,725		3,304		1,924		1,858		34	822		-	229		1,133		14,029

Loans June 30, 2013:
Ending balance	$	70,112		192,601		50,454		191,368		10,918	66,161		24	26,434		-		608,072

Ending balance: individually
evaluated for impairment	$	7,626		3,480		19,912		3,125		-	-		-	279		-		34,422
Ending balance: collectively
evaluated for impairment	$	62,486		189,121		30,542		188,243		10,918	66,161		24	26,155		-		573,650

(Dollars in thousands)
	Real Estate Loans
	Construction and Land Development			Single-Family Residential		Single- Family Residential - Banco de la Gente Stated Income		Commercial		Multifamily and Farmland	Commercial		Consumer and All Other		Unallocated		Total
Six months ended June 30, 2012
Allowance for loan losses:
Beginning balance	$	7,182		3,253		2,104		1,731		13	1,029		255		1,037		16,604
Charge-offs		(2,381	)	(490	)	(371	)	(523	)	-	(343	)	(268	)	-		(4,376	)
Recoveries		218		69		-		374		-	11		88		-		760
Provision		2,626		70		491		(66	)	-	(68	)	116		483		3,652
Ending balance	$	7,645		2,902		2,224		1,516		13	629		191		1,520		16,640

Three months ended June 30, 2012
Allowance for loan losses:
Beginning balance	$	6,880		3,101		2,180		1,434		13	1,004		250		1,750		16,612
Charge-offs		(530	)	(385	)	(198	)	(452	)	-	(104	)	(111	)	-		(1,780	)
Recoveries		100		67		-		-		-	6		32		-		205
Provision		1,195		119		242		534		-	(277	)	20		(230	)	1,603
Ending balance	$	7,645		2,902		2,224		1,516		13	629		191		1,520		16,640

Allowance for loan losses June 30, 2012:
Ending balance: individually
evaluated for impairment	$	1,101		78		1,286		-		-	-		-		-		2,465
Ending balance: collectively
evaluated for impairment		6,544		2,824		938		1,516		13	629		191		1,520		14,175
Ending balance	$	7,645		2,902		2,224		1,516		13	629		191		1,520		16,640

Loans June 30, 2012:
Ending balance	$	86,498		202,528		52,811		207,245		5,285	59,416		29,032		-		642,815

Ending balance: individually
evaluated for impairment	$	19,789		3,132		20,320		4,961		-	362		-		-		48,564
Ending balance: collectively
evaluated for impairment	$	66,709		199,396		32,491		202,284		5,285	59,054		29,032		-		594,251

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 8. These risk grades are evaluated on an ongoing basis. The Low Substandard risk grade was removed from the Company’s internal risk grading matrix during the first quarter of 2013. No loans were classified Low Substandard at December 31, 2012. A description of the general characteristics of the eight 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 higher risk and servicing needs but still are acceptable. Evidence of marginal performance or deteriorating trends is observed. 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 has been some recent past due history on repayment and there are potential weaknesses that may, if not corrected, weaken the asset or inadequately protect the Company’s position at some future date.

·

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 – 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 8 – 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 grades as of June 30, 2013 and December 31, 2012:

June 30, 2013
(Dollars in thousands)
	Real Estate Loans
	Construction and Land Development		Single-Family Residential	Single- Family Residential - Banco de la Gente Stated Income	Commercial	Multifamily and Farmland	Commercial	Farm	Consumer	All Other	Total

1- Excellent Quality	$	10	22,480	-	-	-	366	-	1,170	-	24,026
2- High Quality		5,410	56,324	-	27,309	245	8,318	-	3,768	2,216	103,590
3- Good Quality		27,715	66,297	23,549	110,755	6,745	44,279	24	4,149	14,311	297,824
4- Management Attention		15,821	32,514	10,461	42,868	1,182	11,916	-	436	4	115,202
5- Watch		8,934	7,551	3,671	6,139	2,560	721	-	50	-	29,626
6- Substandard		12,222	7,435	12,773	4,297	186	469	-	324	-	37,706
7- Doubtful		-	-	-	-	-	92	-	6	-	98
8- Loss		-	-	-	-	-	-	-	-	-	-
Total	$	70,112	192,601	50,454	191,368	10,918	66,161	24	9,903	16,531	608,072

December 31, 2012
(Dollars in thousands)
	Real Estate Loans
	Construction and Land Development		Single-Family Residential	Single- Family Residential - Banco de la Gente Stated Income	Commercial	Multifamily and Farmland	Commercial	Farm	Consumer	All Other	Total

1- Excellent Quality	$	11	24,662	-	-	-	672	-	1,239	-	26,584
2- High Quality		4,947	56,829	-	27,511	32	9,260	-	4,122	2,317	105,018
3- Good Quality		24,952	62,018	24,724	114,001	4,975	40,814	11	4,186	13,416	289,097
4- Management Attention		18,891	35,727	11,366	47,603	3,039	11,844	-	392	5	128,867
5- Watch		9,580	9,504	3,597	6,911	712	976	-	134	-	31,414
6- Substandard		14,795	6,263	12,332	4,607	193	729	-	70	-	38,989
7- Low Substandard		-	-	-	-	-	-	-	-	-	-
8- Doubtful		-	-	-	-	-	-	-	-	-	-
9- Loss		-	-	-	-	-	-	-	5	-	5
Total	$	73,176	195,003	52,019	200,633	8,951	64,295	11	10,148	15,738	619,974

At June 30, 2013, TDR loans amounted to $19.9 million, including $391,000 in performing TDR loans. Performing TDR balances reflect current year TDR loans only, in accordance with GAAP. At December 31, 2012, TDR loans were $23.9 million, including $2.0 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 June 30, 2013:

June 30, 2013
(Dollars in thousands)
	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Real estate loans
Construction and land development	16	$	10,498	7,597
Single-family residential	31		1,878	2,833
Single-family residential -
Banco de la Gente stated income	72		8,248	6,947
Commercial	5		2,015	1,741
Multifamily and farmland	1		322	186
Total real estate TDR loans	125		22,961	19,304

Loans not secured by real estate
Commercial loans	10		854	590
Consumer loans	1		2	-
Total TDR loans	136	$	23,817	19,894

The following tables present an analysis of loan modifications during the three and six months ended June 30, 2013:

Three months ended June 30, 2013
(Dollars in thousands)
	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Real estate loans
Construction and land development	1	$	724	712
Single-family residential	2	$	78	78
Single-family residential -
Banco de la Gente stated income	1	$	140	138
Total real estate TDR loans	4		942	928

Total TDR loans	4	$	942	928

Six months ended June 30, 2013
(Dollars in thousands)
	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Real estate loans
Construction and land development	2	$	841	829
Single-family residential	2	$	78	78
Single-family residential -
Banco de la Gente stated income	4	$	472	469
Total real estate TDR loans	8		1,391	1,376

Total TDR loans	8	$	1,391	1,376

The following table presents an analysis of loan modifications during the three and six months ended June 30, 2012:

Three months ended June 30, 2012
(Dollars in thousands)
	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Real estate loans
Single-family residential	1	$	125	125
Single-family residential -
Banco de la Gente stated income	8	$	855	848
Total real estate TDR loans	9		980	973

Loans not secured by real estate
Commercial loans	1		14	14
Total TDR loans	10	$	994	987

Six months ended June 30, 2012
(Dollars in thousands)
	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Real estate loans
Single-family residential	1	$	125	125
Single-family residential -
Banco de la Gente stated income	15	$	1,587	1,578
Total real estate TDR loans	16		1,712	1,703

Loans not secured by real estate
Commercial loans	1		14	14
Total TDR loans	17	$	1,726	1,717

The following table presents an analysis of TDR loans by loan type as of December 31, 2012:

December 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	11	$	10,465	6,633
Single-family residential	33		3,014	4,084
Single-family residential -
Banco de la Gente stated income	122		13,459	12,170
Commercial	4		1,457	682
Multifamily and farmland	-		-	-
Total real estate TDR loans	170		28,395	23,569

Loans not secured by real estate
Commercial loans	9		511	368
Consumer loans	1		2	-
Total TDR loans	180	$	28,908	23,937

- Definition

The entire disclosure for claims held for amounts due a entity, excluding financing receivables. Examples include, but are not limited to, trade accounts receivables, notes receivables, loans receivables. Includes disclosure for allowance for credit losses.

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