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3. Loans

3 Months Ended

Mar. 31, 2014

Loans

Major classifications of loans at March 31, 2014 and December 31, 2013 are summarized as follows:

(Dollars in thousands)
	March 31, 2014		December 31, 2013
Real estate loans
Construction and land development	$	61,162	63,742
Single-family residential		196,447	195,975
Single-family residential -
Banco de la Gente stated income		48,926	49,463
Commercial		211,882	209,287
Multifamily and farmland		11,566	11,801
Total real estate loans		529,983	530,268

Loans not secured by real estate
Commercial loans		65,456	68,047
Farm loans		16	19
Consumer loans		9,440	9,593
All other loans		13,145	13,033

Total loans		618,040	620,960

Less allowance for loan losses		12,978	13,501

Total net loans	$	605,062	607,459

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 March 31, 2014, construction and land development loans comprised approximately 10% 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 March 31, 2014, single-family residential loans comprised approximately 40% 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 March 31, 2014, commercial real estate loans comprised approximately 34% 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 March 31, 2014, 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 March 31, 2014 and December 31, 2013:

March 31, 2014
(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	$	735	4,986	5,721	55,441	61,162	-
Single-family residential		4,358	988	5,346	191,101	196,447	10
Single-family residential -
Banco de la Gente stated income		8,004	763	8,767	40,159	48,926	-
Commercial		767	941	1,708	210,174	211,882	-
Multifamily and farmland		132	-	132	11,434	11,566	-
Total real estate loans		13,996	7,678	21,674	508,309	529,983	10

Loans not secured by real estate
Commercial loans		448	78	526	64,930	65,456	49
Farm loans		-	-	-	16	16	-
Consumer loans		120	1	121	9,319	9,440	1
All other loans		-	-	-	13,145	13,145	-
Total loans	$	14,564	7,757	22,321	595,719	618,040	60


December 31, 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	$	3,416	5,426	8,842	54,900	63,742	-
Single-family residential		4,518	1,555	6,073	189,902	195,975	-
Single-family residential -
Banco de la Gente stated income		9,833	1,952	11,785	37,678	49,463	881
Commercial		1,643	486	2,129	207,158	209,287	-
Multifamily and farmland		177	-	177	11,624	11,801	-
Total real estate loans		19,587	9,419	29,006	501,262	530,268	881

Loans not secured by real estate
Commercial loans		424	29	453	67,594	68,047	-
Farm loans		-	-	-	19	19	-
Consumer loans		181	3	184	9,409	9,593	1
All other loans		-	-	-	13,033	13,033	-
Total loans	$	20,192	9,451	29,643	591,317	620,960	882

The following table presents the Company’s non-accrual loans as of March 31, 2014 and December 31, 2013:

(Dollars in thousands)
	March 31, 2014		December 31, 2013
Real estate loans
Construction and land development	$	5,279	6,546
Single-family residential		2,537	2,980
Single-family residential -
Banco de la Gente stated income		1,708	1,990
Commercial		1,770	2,043
Total real estate loans		11,294	13,559

Loans not secured by real estate
Commercial loans		224	250
Consumer loans		50	27
Total	$	11,568	13,836

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 $28.8 million, $27.6 million and $26.8 million at March 31, 2014, December 31, 2013 and March 31, 2013, respectively. Interest income recognized on accruing impaired loans was $356,000, $293,000 and $1.3 million for the three months ended March 31, 2014, the three months ended March 31, 2013 and the year ended December 31, 2013, 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 March 31, 2014 and December 31, 2013:

March 31, 2014
(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	$	7,107	5,465	741	6,206	45	6,683
Single-family residential		7,438	1,835	5,009	6,844	129	8,041
Single-family residential -
Banco de la Gente stated income		21,955	-	21,380	21,380	1,229	20,223
Commercial		4,983	2,854	1,605	4,459	187	4,497
Multifamily and farmland		171	-	171	171	1	174
Total impaired real estate loans		41,654	10,154	28,906	39,060	1,591	39,618

Loans not secured by real estate
Commercial loans		971	253	696	949	7	965
Consumer loans		317	257	58	315	1	307
Total impaired loans	$	42,942	10,664	29,660	40,324	1,599	40,890

December 31, 2013
(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	$	9,861	6,293	868	7,161	53	8,289
Single-family residential		7,853	1,428	5,633	7,061	123	7,859
Single-family residential -
Banco de la Gente stated income		22,034	-	21,242	21,242	1,300	21,242
Commercial		5,079	3,045	1,489	4,534	182	4,171
Multifamily and farmland		177	-	177	177	1	184
Total impaired real estate loans		45,004	10,766	29,409	40,175	1,659	41,745

Loans not secured by real estate
Commercial loans		999	257	724	981	15	826
Consumer loans		302	264	35	299	1	247
Total impaired loans	$	46,305	11,287	30,168	41,455	1,675	42,818

Changes in the allowance for loan losses for the three months ended March 31, 2014 and 2013 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
Three months ended March 31, 2014
Allowance for loan losses:
Beginning balance	$	3,218		3,123		1,863		2,219		37		1,069		-	245		1,727		13,501
Charge-offs		(260	)	(22	)	(32	)	(111	)	-		(12	)	-	(138	)	-		(575	)
Recoveries		279		9		12		60		-		5		-	36		-		401
Provision		(104	)	22		(76	)	28		(1	)	(117	)	-	87		(188	)	(349	)
Ending balance	$	3,133		3,132		1,767		2,196		36		945		-	230		1,539		12,978

Allowance for loan losses March 31, 2014:
Ending balance: individually
evaluated for impairment	$	-		68		1,187		174		-		-		-	-		-		1,429
Ending balance: collectively
evaluated for impairment		3,133		3,064		580		2,022		36		945		-	230		1,539		11,549
Ending balance	$	3,133		3,132		1,767		2,196		36		945		-	230		1,539		12,978

Loans March 31, 2014:
Ending balance	$	61,162		196,447		48,926		211,882		11,566		65,456		16	22,585		-		618,040

Ending balance: individually
evaluated for impairment	$	5,464		3,220		19,625		3,577		-		253		-	257		-		32,396
Ending balance: collectively
evaluated for impairment	$	55,698		193,227		29,301		208,305		11,566		65,203		16	22,328		-		585,644

The provision for loan losses for the three months ended March 31, 2014 was a credit of $349,000, as compared to an expense of $1.1 million for the same period one year ago. The credit to provision in the first quarter of 2014 resulted from, and was considered appropriate as part of, management’s assessment and estimate of the risks in the total loan portfolio and determination of the total allowance for loan losses. The primary factors contributing to the decrease in the allowance for loan losses at March 31, 2014 to $13.0 million from $13.5 million at December 31, 2013 were the continuing positive trends in indicators of potential losses on loans, primarily non-accrual loans and the reduction in net charge-offs since 2010.

(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
Three months ended March 31, 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		(497	)	(364	)	(152	)	-		-	(21	)	-	(147	)	-		(1,181	)
Recoveries		1		18		-		48		-	11		-	35		-		113
Provision		882		297		130		(286	)	2	131		-	99		(198	)	1,057
Ending balance	$	4,785		3,182		1,976		1,811		30	1,209		-	232		1,187		14,412

Allowance for loan losses March 31, 2013:
Ending balance: individually
evaluated for impairment	$	102		110		1,245		-		-	247		-	-		-		1,704
Ending balance: collectively
evaluated for impairment		4,683		3,072		731		1,811		30	962		-	232		1,187		12,708
Ending balance	$	4,785		3,182		1,976		1,811		30	1,209		-	232		1,187		14,412

Loans March 31, 2013:
Ending balance	$	72,389		194,557		51,410		192,355		9,401	65,058		27	24,768		-		609,965

Ending balance: individually
evaluated for impairment	$	9,594		4,616		20,102		3,971		-	347		-	-		-		38,630
Ending balance: collectively
evaluated for impairment	$	62,795		189,941		31,308		188,384		9,401	64,711		27	24,768		-		571,335

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. 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 March 31, 2014 and December 31, 2013:

March 31, 2014
(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	$	-	14,330	-	-	-	403	-	1,374	-	16,107
2- High Quality		8,513	63,063	-	33,394	698	8,302	-	3,436	2,026	119,432
3- Good Quality		23,551	72,892	21,827	125,258	6,378	38,225	16	3,945	8,848	300,940
4- Management Attention		13,359	33,715	8,104	38,895	1,594	16,837	-	310	2,271	115,085
5- Watch		7,402	6,530	7,454	10,376	2,725	864	-	30	-	35,381
6- Substandard		8,337	5,917	11,541	3,959	171	796	-	341	-	31,062
7- Doubtful		-	-	-	-	-	29	-	-	-	29
8- Loss		-	-	-	-	-	-	-	4	-	4
Total	$	61,162	196,447	48,926	211,882	11,566	65,456	16	9,440	13,145	618,040



December 31, 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	$	7	15,036	-	-	-	365	-	1,270	-	16,678
2- High Quality		7,852	60,882	-	33,340	715	8,442	-	3,519	2,139	116,889
3- Good Quality		22,899	73,118	22,255	123,604	7,882	44,353	19	4,061	8,565	306,756
4- Management Attention		14,464	34,090	8,369	42,914	286	13,704	-	358	2,329	116,514
5- Watch		8,163	6,806	8,113	5,190	2,741	320	-	50	-	31,383
6- Substandard		10,357	6,043	10,726	4,239	177	863	-	330	-	32,735
7- Doubtful		-	-	-	-	-	-	-	-	-	-
8- Loss		-	-	-	-	-	-	-	5	-	5
Total	$	63,742	195,975	49,463	209,287	11,801	68,047	19	9,593	13,033	620,960

Total TDR loans amounted to $15.4 million and $21.9 million at March 31, 2014 and December 31, 2013, respectively. The terms of these loans have been renegotiated to provide a concession to original terms, including a reduction in principal or interest as a result of the deteriorating financial position of the borrower. There were $1.6 million and $335,000 in performing loans classified as TDR loans at March 31, 2014 and December 31, 2013, respectively.

The following table presents an analysis of loan modifications during the three months ended March 31, 2014:

Three months ended March 31, 2014
(Dollars in thousands)
	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Real estate loans
Construction and land development	1	$	316	316
Single-family residential	1		737	737
Single-family residential -
Banco de la Gente stated income	6		497	497
Total real estate TDR loans	8		1,550	1,550

Total TDR loans	8	$	1,550	1,550

The following table presents an analysis of loan modifications during the three months ended March 31, 2013:

Three months ended March 31, 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	$	117	117
Single-family residential -
Banco de la Gente stated income	3		332	331
Total real estate TDR loans	4		449	448
Total TDR loans	4	$	449	448

- 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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