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3. Loans

3 Months Ended

Mar. 31, 2015

Major classifications of loans at March 31, 2015 and December 31, 2014 are summarized as follows:

(Dollars in thousands)
	March 31, 2015		December 31, 2014
Real estate loans:
Construction and land development	$	57,247	57,617
Single-family residential		207,113	206,417
Single-family residential -
Banco de la Gente stated income		46,272	47,015
Commercial		227,471	228,558
Multifamily and farmland		12,331	12,400
Total real estate loans		550,434	552,007

Loans not secured by real estate:
Commercial loans		87,055	76,262
Farm loans		5	7
Consumer loans		9,857	10,060
All other loans		13,126	13,555

Total loans		660,477	651,891

Less allowance for loan losses		10,843	11,082

Total net loans	$	649,634	640,809

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 March 31, 2015, 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 March 31, 2015, single-family residential loans comprised approximately 38% of the Bank’s total loan portfolio, and include 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 March 31, 2015, 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, 2015, commercial loans comprised approximately 13% 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, 2015 and December 31, 2014:

March 31, 2015
(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	$	62	257	319	56,928	57,247	-
Single-family residential		4,313	1,286	5,599	201,514	207,113	-
Single-family residential -
Banco de la Gente stated income		5,727	442	6,169	40,103	46,272	-
Commercial		1,875	381	2,256	225,215	227,471	-
Multifamily and farmland		-	-	-	12,331	12,331	-
Total real estate loans		11,977	2,366	14,343	536,091	550,434	-

Loans not secured by real estate:
Commercial loans		162	-	162	86,893	87,055	-
Farm loans		-	-	-	5	5	-
Consumer loans		97	9	106	9,751	9,857	-
All other loans		-	-	-	13,126	13,126	-
Total loans	$	12,236	2,375	14,611	645,866	660,477	-


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	-

The following table presents the Company’s non-accrual loans as of March 31, 2015 and December 31, 2014:

(Dollars in thousands)
	March 31, 2015		December 31, 2014
Real estate loans:
Construction and land development	$	565	3,854
Single-family residential		3,891	2,370
Single-family residential -
Banco de la Gente stated income		1,432	1,545
Commercial		2,755	2,598
Multifamily and farmland		99	110
Total real estate loans		8,742	10,477

Loans not secured by real estate:
Commercial loans		111	176
Consumer loans		81	75
Total	$	8,934	10,728

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 not 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 $25.9 million, $25.6 million and $28.8 million at March 31, 2015, December 31, 2014 and March 31, 2014, respectively. Interest income recognized on accruing impaired loans was $335,000, $356,000 and $1.3 million for the three months ended March 31, 2015, the three months ended March 31, 2014 and the year ended December 31, 2014, 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, 2015 and December 31, 2014:

March 31, 2015
(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	$	1,174	266	647	913	35	2,554
Single-family residential		9,169	2,092	6,496	8,588	170	8,246
Single-family residential -
Banco de la Gente stated income		20,886	-	20,310	20,310	1,179	19,764
Commercial		4,824	1,794	2,701	4,495	256	4,423
Multifamily and farmland		102	-	100	100	1	105
Total impaired real estate loans		36,155	4,152	30,254	34,406	1,641	35,092

Loans not secured by real estate:
Commercial loans		152	-	136	136	3	168
Consumer loans		317	-	310	310	4	312
Total impaired loans	$	36,624	4,152	30,700	34,852	1,648	35,572

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

Changes in the allowance for loan losses for the three months ended March 31, 2015 and 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
Three months ended March 31, 2015
Allowance for loan losses:
Beginning balance		$	2,785			2,566			1,610			1,902			7			1,098		-		233			881			11,082
Charge-offs			(88	)		(291	)		(42	)		(2	)		-			-		-		(107	)		-			(530	)
Recoveries			5			6			22			5			-			36		-		44			-			118
Provision			56			318			(4	)		(119	)		(1	)		47		-		38			(162	)		173
Ending balance		$	2,758			2,599			1,586			1,786			6			1,181		-		208			719			10,843

Allowance for loan losses March 31, 2015:
Ending balance: individually
evaluated for impairment		$	-			82			1,145			245			-			-		-		-			-			1,472
Ending balance: collectively
evaluated for impairment			2,758			2,517			441			1,541			6			1,181		-		208			719			9,371
Ending balance		$	2,758			2,599			1,586			1,786			6			1,181		-		208			719			10,843

Loans March 31, 2015:
Ending balance		$	57,247			207,113			46,272			227,471			12,331			87,055		5		22,983			-			660,477

Ending balance: individually
evaluated for impairment		$	266			3,448			18,655			3,633			-			-		-		-			-			26,002
Ending balance: collectively
evaluated for impairment		$	56,981			203,665			27,617			223,838			12,331			87,055		5		22,983			-			634,475

(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, 2015 was an expense of $173,000, as compared to a credit of $349,000 for the three months ended March 31, 2014. The increase in the provision for loan losses is primarily attributable to a $42.5 million increase in loans from March 31, 2014 to March 31, 2015 and a $238,000 increase in net charge-offs during the three months ended March 31, 2015, as compared to the same period one year ago.

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 as 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, 2015 and December 31, 2014:

March 31, 2015
(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	$	-	13,705	-	-	-	1,026	-	1,245	-	15,976
2- High Quality		7,768	76,955	-	38,374	231	26,199	-	3,465	1,798	154,790
3- Good Quality		26,737	74,746	20,561	140,510	8,978	47,317	5	4,494	10,392	333,740
4- Management Attention		12,918	29,884	12,714	38,734	369	11,995	-	514	936	108,064
5- Watch		9,176	4,619	5,677	5,706	2,653	379	-	47	-	28,257
6- Substandard		648	7,204	7,320	4,147	100	139	-	92	-	19,650
7- Doubtful		-	-	-	-	-	-	-	-	-	-
8- Loss		-	-	-	-	-	-	-		-	-
Total	$	57,247	207,113	46,272	227,471	12,331	87,055	5	9,857	13,126	660,477



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

Total TDR loans amounted to $5.5 million and $15.0 million at March 31, 2015 and December 31, 2014, 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 $146,000 and $1.4 million in performing loans classified as TDR loans at March 31, 2015 and December 31, 2014, respectively.

The following tables present an analysis of loan modifications during the three months ended March 31, 2015 and 2014:

Three months ended March 31, 2015
(Dollars in thousands)
	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Real estate loans
Single-family residential	1	$	146	146
Total real estate TDR loans	1		146	146

Total TDR loans	1	$	146	146

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

- 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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