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3. Loans

9 Months Ended

Sep. 30, 2013

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

(Dollars in thousands)
	September 30, 2013		December 31, 2012
Real estate loans
Construction and land development	$	67,870	73,176
Single-family residential		191,338	195,003
Single-family residential -
Banco de la Gente stated income		50,035	52,019
Commercial		205,911	200,633
Multifamily and farmland		11,541	8,951
Total real estate loans		526,695	529,782

Loans not secured by real estate
Commercial loans		64,957	64,295
Farm loans		22	11
Consumer loans		9,754	10,148
All other loans		15,633	15,738
Total loans		617,061	619,974

Less allowance for loan losses		13,854	14,423

Net loans	$	603,207	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 the 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 September 30, 2013, construction and land development loans comprised approximately 11% 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 September 30, 2013, single-family residential loans comprised approximately 39% of the Bank’s total loan portfolio, and include Banco de la Gente single-family residential stated income loans which were 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 September 30, 2013, commercial real estate loans comprised approximately 33% 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 September 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 folloing tables present an age analysis of past due loans, by loan type, as of September 30, 2013 and December 31, 2012:

September 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	$	229	5,752	5,981	61,889	67,870	-
Single-family residential		4,242	1,773	6,015	185,323	191,338	-
Single-family residential -
Banco de la Gente stated income		4,388	2,764	7,152	42,883	50,035	1,987
Commercial		2,437	153	2,590	203,321	205,911	-
Multifamily and farmland		137	185	322	11,219	11,541	185
Total real estate loans		11,433	10,627	22,060	504,635	526,695	2,172

Loans not secured by real estate
Commercial loans		902	62	964	63,993	64,957	-
Farm loans		-	-	-	22	22	-
Consumer loans		180	25	205	9,549	9,754	1
All other loans		-	-	-	15,633	15,633	-
Total loans	$	12,515	10,714	23,229	593,832	617,061	2,173

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 September 30, 2013 and December 31, 2012:

(Dollars in thousands)
	September 30, 2013		December 31, 2012
Real estate loans
Construction and land development	$	6,993	9,253
Single-family residential		3,284	2,491
Single-family residential -
Banco de la Gente stated income		1,748	2,232
Commercial		1,969	3,263
Total real estate loans		13,994	17,239

Loans not secured by real estate
Commercial loans		112	344
Consumer loans		38	47
Total	$	14,144	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 $27.1 million, $30.6 million and $38.7 million at September 30, 2013, December 31, 2012 and September 30, 2012, respectively. Interest income recognized on accruing impaired loans was $916,000, $1.4 million and $1.5 million for the nine months ended September 30, 2013, the nine months ended September 30, 2012 and the year ended December 31, 2012, respectively. Interest income recognized on accruing impaired loans was $337,000 and $543,000 for the three months ended September 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 September 30, 2013 and December 31, 2012:

September 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 September 30, 2012	Three Months Ended September 30, 2013	Nine Months Ended September 30, 2012	Nine Months Ended September 30, 2013
Real estate loans
Construction and land development	$	10,399	6,705	923	7,628	61	12,318	7,902	13,806	8,954
Single-family residential		8,705	1,228	6,828	8,056	161	7,320	7,965	7,868	8,404
Single-family residential -
Banco de la Gente stated income		21,651	-	20,775	20,775	1,259	21,038	20,780	20,752	20,904
Commercial		4,063	3,100	556	3,656	8	6,317	3,753	5,565	4,297
Multifamily and farmland		185	-	185	185	3	200	185	201	188
Total impaired real estate loans		45,003	11,033	29,267	40,300	1,492	47,193	40,585	48,192	42,747

Loans not secured by real estate
Commercial loans		643	-	628	628	11	1,186	701	1,187	816
Consumer loans		317	272	43	315	1	23	316	38	185
Total impaired loans	$	45,963	11,305	29,938	41,243	1,504	48,402	41,602	49,417	43,748

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 nine months ended September 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
Nine months ended September 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		(732	)	(1,204	)	(252	)	(327	)	-	(483	)	-	(485	)	-	(3,483	)
Recoveries		374		75		101		50		-	39		-	111		-	750
Provision		99		864		67		240		8	140		-	379		367	2,164
Ending balance	$	4,140		2,966		1,914		2,012		36	784		-	250		1,752	13,854

Three months ended September 30, 2013
Allowance for loan losses:
Beginning balance	$	4,725		3,304		1,924		1,858		34	822		-	229		1,133	14,029
Charge-offs		(17	)	(569	)	(28	)	(51	)	-	(101	)	-	(204	)	-	(970	)
Recoveries		348		31		31		-		-	14		-	34		-	458
Provision		(916	)	200		(13	)	205		2	49		-	191		619	337
Ending balance	$	4,140		2,966		1,914		2,012		36	784		-	250		1,752	13,854

Allowance for loan losses September 30, 2013:
Ending balance: individually
evaluated for impairment	$	1		60		1,233		-		-	-		-	-		-	1,294
Ending balance: collectively
evaluated for impairment		4,139		2,906		681		2,012		36	784		-	250		1,752	12,560
Ending balance	$	4,140		2,966		1,914		2,012		36	784		-	250		1,752	13,854

Loans September 30, 2013:
Ending balance	$	67,870		191,338		50,035		205,911		11,541	64,957		22	25,387		-	617,061

Ending balance: individually
evaluated for impairment	$	6,790		3,079		19,803		3,100		-	-		-	272		-	33,044
Ending balance: collectively
evaluated for impairment	$	61,080		188,259		30,232		202,811		11,541	64,957		22	25,115		-	584,017

(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
Nine months ended September 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		(3,045	)	(666	)	(483	)	(547	)	-	(498	)	-	(403	)	-	(5,642	)
Recoveries		522		71		-		374		-	95		-	115		-	1,177
Provision		1,733		367		450		(21	)	-	(18	)	-	222		1,679	4,412
Ending balance	$	6,392		3,025		2,071		1,537		13	608		-	189		2,716	16,551

Three months ended September 30, 2012
Allowance for loan losses:
Beginning balance	$	7,645		2,902		2,224		1,516		13	629		-	191		1,520	16,640
Charge-offs		(663	)	(176	)	(112	)	(24	)	-	(156	)	-	(135	)	-	(1,266	)
Recoveries		304		2		-		-		-	84		-	26		-	416
Provision		(894	)	297		(41	)	45		-	51		-	107		1,196	761
Ending balance	$	6,392		3,025		2,071		1,537		13	608		-	189		2,716	16,551

Allowance for loan losses September 30, 2012:
Ending balance: individually
evaluated for impairment	$	1,527		376		1,261		114		-	-		-	-		-	3,278
Ending balance: collectively
evaluated for impairment		4,865		2,649		810		1,423		13	608		-	189		2,716	13,273
Ending balance	$	6,392		3,025		2,071		1,537		13	608		-	189		2,716	16,551

Loans September 30, 2012:
Ending balance	$	80,733		197,043		52,124		203,603		4,964	60,358		12	26,945		-	625,782

Ending balance: individually
evaluated for impairment	$	19,734		3,716		20,054		6,798		-	346		-	-		-	50,648
Ending balance: collectively
evaluated for impairment	$	60,999		193,327		32,070		196,805		4,964	60,012		12	26,945		-	575,134

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 September 30, 2013 and December 31, 2012:

September 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	$	8	18,693	-	-	-	361	-	1,171	-	20,233
2- High Quality		5,868	57,682	-	37,940	286	6,755	-	3,725	2,147	114,403
3- Good Quality		26,814	69,013	23,193	119,080	8,019	44,285	22	4,041	11,125	305,592
4- Management Attention		14,666	32,766	9,528	39,925	506	12,408	-	431	2,361	112,591
5- Watch		9,629	7,652	7,384	4,564	2,545	401	-	32	-	32,207
6- Substandard		10,885	5,532	9,930	4,402	185	747	-	351	-	32,032
7- Doubtful		-	-	-	-	-	-	-	-	-	-
8- Loss		-	-	-	-	-	-	-	3	-	3
Total	$	67,870	191,338	50,035	205,911	11,541	64,957	22	9,754	15,633	617,061

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 September 30, 2013, TDR loans amounted to $17.1 million, including $251,000 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 September 30, 2013:

September 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	14	$	10,098	6,750
Single-family residential	22		1,367	1,978
Single-family residential -
Banco de la Gente stated income	68		7,630	6,263
Commercial	6		2,236	1,816
Multifamily and farmland	1		322	185
Total real estate TDR loans	111		21,653	16,992

Loans not secured by real estate
Commercial loans	8		242	120
Consumer loans	1		2	-
Total TDR loans	120	$	21,897	17,112

The Bank did not enter into any new TDR loan modifications during the three months ended September 30, 2013. The following table presents an analysis of loan modifications during the nine months ended September 30, 2013:

Nine months ended September 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	825
Single-family residential -
Banco de la Gente stated income	4	$	471	466
Total real estate TDR loans	6		1,312	1,291

Total TDR loans	6	$	1,312	1,291

The following tables present an analysis of loan modifications during the three and nine months ended September 30, 2012:

Three months ended September 30, 2012
(Dollars in thousands)
	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Real estate loans
Single-family residential	2	$	177	176
Single-family residential -
Banco de la Gente stated income	3	$	276	275
Total real estate TDR loans	5		453	451

Total TDR loans	5	$	453	451

Nine months ended September 30, 2012
(Dollars in thousands)
	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Real estate loans
Single-family residential	3	$	302	301
Single-family residential -
Banco de la Gente stated income	18	$	1,862	1,847
Total real estate TDR loans	21		2,164	2,148

Loans not secured by real estate
Commercial loans	1		14	14
Total TDR loans	22	$	2,178	2,162

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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