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3. Loans

12 Months Ended

Dec. 31, 2014

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

(Dollars in thousands)
	December 31, 2014		December 31, 2013
Real estate loans:
Construction and land development	$	57,617	63,742
Single-family residential		206,417	195,975
Single-family residential -
Banco de la Gente stated income		47,015	49,463
Commercial		228,558	209,287
Multifamily and farmland		12,400	11,801
Total real estate loans		552,007	530,268

Loans not secured by real estate:
Commercial loans		76,262	68,047
Farm loans		7	19
Consumer loans		10,060	9,593
All other loans		13,555	13,033

Total loans		651,891	620,960

Less allowance for loan losses		11,082	13,501

Total net loans	$	640,809	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, Wake and Durham 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 December 31, 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 December 31, 2014, single-family residential loans comprised approximately 39% of the Bank’s total loan portfolio, including Banco de la Gente single-family residential stated income loans which were approximately 7% 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 December 31, 2014, commercial real estate loans comprised approximately 35% 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 December 31, 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 December 31, 2014 and 2013:

December 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	$	294	3,540	3,834	53,783	57,617	-
Single-family residential		5,988	268	6,256	200,161	206,417	-
Single-family residential -
Banco de la Gente stated income		8,998	610	9,608	37,407	47,015	-
Commercial		3,205	366	3,571	224,987	228,558	-
Multifamily and farmland		85	-	85	12,315	12,400	-
Total real estate loans		18,570	4,784	23,354	528,653	552,007	-

Loans not secured by real estate:
Commercial loans		241	49	290	75,972	76,262	-
Farm loans		-	-	-	7	7	-
Consumer loans		184	-	184	9,876	10,060	-
All other loans		-	-	-	13,555	13,555	-
Total loans	$	18,995	4,833	23,828	628,063	651,891	-


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 Bank’s non-accrual loans as of December 31, 2014 and 2013:

(Dollars in thousands)
	December 31, 2014		December 31, 2013
Real estate loans:
Construction and land development	$	3,854	6,546
Single-family residential		2,370	2,980
Single-family residential -
Banco de la Gente stated income		1,545	1,990
Commercial		2,598	2,043
Multifamily and farmland		110	-
Total real estate loans		10,477	13,559

Loans not secured by real estate:
Commercial loans		176	250
Consumer loans		75	27
Total	$	10,728	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. Various factors, including the assumptions and techniques utilized by the appraiser, are considered by management in determining the impairment of a loan. 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 $25.6 million and $27.6 million at December 31, 2014 and December 31, 2013, respectively. Interest income recognized on accruing impaired loans was $1.3 million for the years ended December 31, 2014 and 2013. No interest income is recognized on non-accrual impaired loans subsequent to their classification as non-accrual.

The following tables present the Bank’s impaired loans as of December 31, 2014 and 2013:

December 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	$	5,481	3,639	555	4,194	31	5,248
Single-family residential		6,717	933	5,540	6,473	154	7,430
Single-family residential -
Banco de la Gente stated income		21,243	-	20,649	20,649	1,191	19,964
Commercial		4,752	1,485	2,866	4,351	272	4,399
Multifamily and farmland		111	-	110	110	1	154
Total impaired real estate loans		38,304	6,057	29,720	35,777	1,649	37,195

Loans not secured by real estate:
Commercial loans		218	-	201	201	4	641
Consumer loans		318	-	313	313	5	309
Total impaired loans	$	38,840	6,057	30,234	36,291	1,658	38,145

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

The fair value measurements for impaired loans and other real estate on a non-recurring basis at December 31, 2014 and 2013 are presented below. The fair value measurement process uses certified appraisals and other market-based information; however, in many cases, it also requires significant input based on management’s knowledge of and judgment about current market conditions, specific issues relating to the collateral, and other matters. As a result, all fair value measurements for impaired loans and other real estate are considered Level 3.

(Dollars in thousands)
	Fair Value Measurements December 31, 2014		Level 1 Valuation	Level 2 Valuation	Level 3 Valuation	Total Gains/(Losses) for the Year Ended December 31, 2014
Impaired loans	$	34,633	-	-	34,633	(1,444	)
Other real estate	$	2,016	-	-	2,016	(622	)

(Dollars in thousands)
	Fair Value Measurements December 31, 2013		Level 1 Valuation	Level 2 Valuation	Level 3 Valuation	Total Gains/(Losses) for the Year Ended December 31, 2013
Impaired loans	$	39,780	-	-	39,780	(3,207	)
Other real estate	$	1,679	-	-	1,679	(581	)

Changes in the allowance for loan losses for the year ended December 31, 2014 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
Allowance for loan losses:
Beginning balance	$	3,218		3,123		1,863		2,219		37		1,069		-	245		1,727		13,501
Charge-offs		(884	)	(309	)	(190	)	(290	)	-		(430	)	-	(534	)	-		(2,637	)
Recoveries		428		72		16		171		-		54		-	176		-		917
Provision		23		(320	)	(79	)	(198	)	(30	)	405		-	346		(846	)	(699	)
Ending balance	$	2,785		2,566		1,610		1,902		7		1,098		-	233		881		11,082


Ending balance: individually
evaluated for impairment	$	-		82		1,155		260		-		-		-	-		-		1,497
Ending balance: collectively
evaluated for impairment		2,785		2,484		455		1,642		7		1,098		-	233		881		9,585
Ending balance	$	2,785		2,566		1,610		1,902		7		1,098		-	233		881		11,082

Loans:
Ending balance	$	57,617		206,417		47,015		228,558		12,400		76,262		7	23,615		-		651,891

Ending balance: individually
evaluated for impairment	$	3,639		2,298		18,884		3,345		-		-		-	-		-		28,166
Ending balance: collectively
evaluated for impairment	$	53,978		204,119		28,131		225,213		12,400		76,262		7	23,615		-		623,725

Changes in the allowance for loan losses for the year ended December 31, 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
Allowance for loan losses:
Beginning balance	$	4,399		3,231		1,998		2,049		28	1,088		-	245		1,385	14,423
Charge-offs		(777	)	(1,724	)	(272	)	(445	)	-	(502	)	-	(652	)	-	(4,372	)
Recoveries		377		111		141		50		-	44		-	143		-	866
Provision		(781	)	1,505		(4	)	565		9	439		-	509		342	2,584
Ending balance	$	3,218		3,123		1,863		2,219		37	1,069		-	245		1,727	13,501


Ending balance: individually
evaluated for impairment	$	-		39		1,268		171		-	-		-	-		-	1,478
Ending balance: collectively
evaluated for impairment		3,218		3,084		595		2,048		37	1,069		-	245		1,727	12,023
Ending balance	$	3,218		3,123		1,863		2,219		37	1,069		-	245		1,727	13,501

Loans:
Ending balance	$	63,742		195,975		49,463		209,287		11,801	68,047		19	22,626		-	620,960

Ending balance: individually
evaluated for impairment	$	6,293		3,127		19,958		3,767		-	256		-	265		-	33,666
Ending balance: collectively
evaluated for impairment	$	57,449		192,848		29,505		205,520		11,801	67,791		19	22,361		-	587,294

Changes in the allowance for loan losses for the year ended December 31, 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
Allowance for loan losses:
Beginning balance	$	7,182		3,253		2,104		1,731		13	1,029		-	255		1,037	16,604
Charge-offs		(4,728	)	(886	)	(668	)	(937	)	-	(555	)	-	(557	)	-	(8,331	)
Recoveries		528		72		-		374		-	104		-	148		-	1,226
Provision		1,417		792		562		881		15	510		-	399		348	4,924
Ending balance	$	4,399		3,231		1,998		2,049		28	1,088		-	245		1,385	14,423

Allowance for loan losses:
Ending balance: individually
evaluated for impairment	$	24		84		1,254		-		-	-		-	-		-	1,362
Ending balance: collectively
evaluated for impairment		4,375		3,147		744		2,049		28	1,088		-	245		1,385	13,061
Ending balance	$	4,399		3,231		1,998		2,049		28	1,088		-	245		1,385	14,423

Loans:
Ending balance	$	73,176		195,003		52,019		200,633		8,951	64,295		11	25,886		-	619,974

Ending balance: individually
evaluated for impairment	$	11,961		3,885		20,024		4,569		-	346		-	-		-	40,785
Ending balance: collectively
evaluated for impairment	$	61,215		191,118		31,995		196,064		8,951	63,949		11	25,886		-	579,189

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 December 31, 2014 and 2013.

December 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	$	-	15,099	-	-	-	924	-	1,232	-	17,255
2- High Quality		6,741	74,367	-	39,888	241	18,730	-	3,576	1,860	145,403
3- Good Quality		24,641	74,453	21,022	142,141	8,376	44,649	7	4,549	8,055	327,893
4- Management Attention		13,013	30,954	12,721	36,433	1,001	11,312	-	566	3,640	109,640
5- Watch		9,294	5,749	5,799	6,153	2,672	383	-	46	-	30,096
6- Substandard		3,928	5,795	7,473	3,943	110	264	-	87	-	21,600
7- Doubtful		-	-	-	-	-	-	-	-	-	-
8- Loss		-	-	-	-	-	-	-	4	-	4
Total	$	57,617	206,417	47,015	228,558	12,400	76,262	7	10,060	13,555	651,891

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 $15.0 million and $21.9 million at December 31, 2014 and 2013, respectively. 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. There were $1.4 million and $355,000 in performing loans classified as TDR loans at December 31, 2014 and 2013, respectively.

The following tables present an analysis of loan modifications during the years ended December 31, 2014 and 2013:

Year ended December 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	$	291	266
Single-family residential	2		849	845
Single-family residential -
Banco de la Gente stated income	3		281	278
Total real estate TDR loans	6		1,421	1,389

Total TDR loans	6	$	1,421	1,389

Year ended December 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	2	$	841	824
Single-family residential -
Banco de la Gente stated income	7		796	788
Total real estate TDR loans	9		1,637	1,612

Total TDR loans	9	$	1,637	1,612

- 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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