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3. Loans

6 Months Ended

Jun. 30, 2014

(3)

Loans

Major classifications of loans at June 30, 2014 and December 31, 2013 are summarized as follows:

(Dollars in thousands)
	June 30, 2014		December 31, 2013
Real estate loans
Construction and land development	$	59,843	63,742
Single-family residential		196,192	195,975
Single-family residential -
Banco de la Gente stated income		48,165	49,463
Commercial		214,378	209,287
Multifamily and farmland		11,821	11,801
Total real estate loans		530,399	530,268

Loans not secured by real estate
Commercial loans		78,056	68,047
Farm loans		93	19
Consumer loans		10,143	9,593
All other loans		14,645	13,033

Total loans		633,336	620,960

Less allowance for loan losses		12,675	13,501

Total net loans	$	620,661	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 June 30, 2014, construction and land development loans comprised approximately 9% 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, 2014, 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 June 30, 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 June 30, 2014, commercial loans comprised approximately 12% 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, 2014 and December 31, 2013:

June 30, 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	$	830	4,862	5,692	54,151	59,843	-
Single-family residential		1,453	667	2,120	194,072	196,192	392
Single-family residential -
Banco de la Gente stated income		1,874	719	2,593	45,572	48,165	-
Commercial		1,652	289	1,941	212,437	214,378	-
Multifamily and farmland		169	-	169	11,652	11,821	-
Total real estate loans		5,978	6,537	12,515	517,884	530,399	392

Loans not secured by real estate
Commercial loans		1,001	49	1,050	77,006	78,056	-
Farm loans		-	-	-	93	93	-
Consumer loans		129	-	129	10,014	10,143	-
All other loans		-	-	-	14,645	14,645	-
Total loans	$	7,108	6,586	13,694	619,642	633,336	392


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 June 30, 2014 and December 31, 2013:

(Dollars in thousands)
	June 30, 2014		December 31, 2013
Real estate loans
Construction and land development	$	5,216	6,546
Single-family residential		1,563	2,980
Single-family residential -
Banco de la Gente stated income		1,780	1,990
Commercial		1,804	2,043
Total real estate loans		10,363	13,559

Loans not secured by real estate
Commercial loans		511	250
Consumer loans		47	27
Total	$	10,921	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 $27.7 million, $27.6 million and $26.2 million at June 30, 2014, December 31, 2013 and June 30, 2013, respectively. Interest income recognized on accruing impaired loans was $681,000, $579,000 and $1.3 million for the six months ended June 30, 2014, the six months ended June 30, 2013 and the year ended December 31, 2013, respectively. Interest income recognized on accruing impaired loans was $325,000 and $286,000 for the three months ended June 30, 2014 and 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 June 30, 2014 and December 31, 2013:

June 30, 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	$	6,963	3,784	2,355	6,139	56	6,502
Single-family residential		5,972	947	4,827	5,774	132	7,507
Single-family residential -
Banco de la Gente stated income		21,758	-	21,129	21,129	1,217	20,303
Commercial		4,665	2,251	2,145	4,396	256	4,463
Multifamily and farmland		169	-	169	169	1	172
Total impaired real estate loans		39,527	6,982	30,625	37,607	1,662	38,947

Loans not secured by real estate
Commercial loans		849	-	755	755	16	895
Consumer loans		303	249	51	300	1	305
Total impaired loans	$	40,679	7,231	31,431	38,662	1,679	40,147

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 and six months ended June 30, 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
Six months ended June 30, 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	)	(194	)	(140	)	(131	)	-		(193	)	-	(254	)	-		(1,172	)
Recoveries		282		60		17		161		-		26		-	82		-		628
Provision		147		(141	)	(32	)	(410	)	(30	)	179		-	180		(175	)	(282	)
Ending balance	$	3,387		2,848		1,708		1,839		7		1,081		-	253		1,552		12,675

Three months ended June 30, 2014
Allowance for loan losses:
Beginning balance	$	3,133		3,132		1,767		2,196		36		945		-	230		1,539		12,978
Charge-offs		-		(171	)	(108	)	(20	)	-		(181	)	-	(117	)	-		(597	)
Recoveries		3		52		5		101		-		21		-	45		-		227
Provision		251		(165	)	44		(438	)	(29	)	296		-	95		13		67
Ending balance	$	3,387		2,848		1,708		1,839		7		1,081		-	253		1,552		12,675

Allowance for loan losses June 30, 2014:
Ending balance: individually
evaluated for impairment	$	-		67		1,175		-		-		242		-	-		-		1,484
Ending balance: collectively
evaluated for impairment		3,387		2,781		533		1,839		7		839		-	253		1,552		11,191
Ending balance	$	3,387		2,848		1,708		1,839		7		1,081		-	253		1,552		12,675

Loans June 30, 2014:
Ending balance	$	59,843		196,192		48,165		214,378		11,821		78,056		93	24,788		-		633,336

Ending balance: individually
evaluated for impairment	$	5,297		2,325		19,287		-		-		3,307		-	250		-		30,466
Ending balance: collectively
evaluated for impairment	$	54,546		193,867		28,878		214,378		11,821		74,749		93	24,538		-		602,870

(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		43		70		50		-	25		-	78		-		292
Provision		1,015		666		80		34		6	91		-	187		(252	)	1,827
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	)	(274	)	(72	)	(275	)	-	(361	)	-	(134	)	-		(1,334	)
Recoveries		25		24		70		2		-	14		-	43		-		178
Provision		133		372		(50	)	320		4	(40	)	-	88		(54	)	773
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

The provision for loan losses for the three months ended June 30, 2014 was $67,000, as compared to $773,000 for the same period one year ago. The decrease in the provision for loan losses is primarily attributable to a $5.2 million reduction in non-accrual loans from June 30, 2013 to June 30, 2014 and a reduction in net charge-offs of $786,000 during the three months ended June 30, 2014, as compared to the same period one year ago.

The provision for loan losses for the six months ended June 30, 2014 was a credit of $282,000, as compared to an expense of $1.8 million for the same period one year ago. The decrease in the provision for loan losses is primarily attributable to a $1.7 million decrease in net charge-offs during the six months ended June 30, 2014 compared to the same period one year ago and a $5.2 million reduction in non-accrual loans from June 30, 2013 to June 30, 2014. The credit to provision for loan losses in the six months ended June 30, 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 June 30, 2014 to $12.7 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.

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 June 30, 2014 and December 31, 2013:

June 30, 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	$	-	15,376	-	-	-	720	-	1,386	-	17,482
2- High Quality		8,224	66,361	-	37,883	682	11,404	-	3,659	1,972	130,185
3- Good Quality		23,249	71,086	21,528	129,951	6,621	51,697	93	4,424	10,439	319,088
4- Management Attention		12,949	32,416	8,293	35,900	1,643	12,452	-	575	2,234	106,462
5- Watch		7,355	5,914	7,040	6,661	2,706	944	-	20	-	30,640
6- Substandard		8,066	5,039	11,304	3,983	169	770	-	77	-	29,408
7- Doubtful		-	-	-	-	-	-	-	-	-	-
8- Loss		-	-	-	-	-	69	-	2	-	71
Total	$	59,843	196,192	48,165	214,378	11,821	78,056	93	10,143	14,645	633,336


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 $11.7 million and $21.9 million at June 30, 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 $1.5 million and $335,000 in performing loans classified as TDR loans at June 30, 2014 and December 31, 2013, respectively.

The Bank did not enter into any new TDR loan modifications during the three months ended June 30, 2014. The following table presents an analysis of loan modifications during the six months ended June 30, 2014:

Six months ended June 30, 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		734	734
Single-family residential -
Banco de la Gente stated income	6		494	494
Total real estate TDR loans	8		1,544	1,544

Total TDR loans	8	$	1,544	1,544

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

- 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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