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3. Loans

6 Months Ended

Jun. 30, 2015

Receivables [Abstract]

3. Loans

Major classifications of loans at June 30, 2015 and December 31, 2014 are summarized as follows:

(Dollars in thousands)
		June 30, 2015				December 31, 2014
Real estate loans:
Construction and land development		$	60,066				57,617
Single-family residential			208,653				206,417
Single-family residential -
Banco de la Gente stated income			45,252				47,015
Commercial			231,684				228,558
Multifamily and farmland			12,402				12,400
Total real estate loans			558,057				552,007

Loans not secured by real estate:
Commercial loans			85,124				76,262
Farm loans			4				7
Consumer loans			10,069				10,060
All other loans			13,513				13,555

Total loans			666,767				651,891

Less allowance for loan losses			10,378				11,082

Total net loans		$	656,389				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 June 30, 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 June 30, 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 June 30, 2015, 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 June 30, 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 June 30, 2015 and December 31, 2014:

June 30, 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		$	313				227				540				59,526				60,066				-
Single-family residential			1,869				641				2,510				206,143				208,653				100
Single-family residential -
Banco de la Gente stated income			999				205				1,204				44,048				45,252				-
Commercial			36				326				362				231,322				231,684				-
Multifamily and farmland			-				-				-				12,402				12,402				-
Total real estate loans			3,217				1,399				4,616				553,441				558,057				100

Loans not secured by real estate:
Commercial loans			69				5				74				85,050				85,124				-
Farm loans			-				-				-				4				4				-
Consumer loans			150				9				159				9,910				10,069				-
All other loans			-				-				-				13,513				13,513				-
Total loans		$	3,436				1,413				4,849				661,918				666,767				100

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 June 30, 2015 and December 31, 2014:

(Dollars in thousands)
		June 30, 2015				December 31, 2014
Real estate loans:
Construction and land development		$	546				3,854
Single-family residential			3,171				2,370
Single-family residential -
Banco de la Gente stated income			1,062				1,545
Commercial			2,641				2,598
Multifamily and farmland			-				110
Total real estate loans			7,420				10,477

Loans not secured by real estate:
Commercial loans			109				176
Consumer loans			67				75
Total		$	7,596				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 $26.2 million, $25.6 million and $27.7 million at June 30, 2015, December 31, 2014 and June 30, 2014, respectively. Interest income recognized on accruing impaired loans was $662,000, $681,000 and $1.3 million for the six months ended June 30, 2015, the six months ended June 30, 2014 and the year ended December 31, 2014, respectively. Interest income recognized on accruing impaired loans was $327,000 and $325,000 for the three months ended June 30, 2015 and 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 June 30, 2015 and December 31, 2014:

June 30, 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		$	1,083				241				627				868				44				1,992
Single-family residential			8,396				1,606				6,442				8,048				176				8,535
Single-family residential -
Banco de la Gente stated income			20,375				-				19,798				19,798				1,167				19,421
Commercial			4,797				1,753				2,626				4,379				243				4,404
Multifamily and farmland			101				-				98				98				-				103
Total impaired real estate loans			34,752				3,600				29,591				33,191				1,630				34,455

Loans not secured by real estate:
Commercial loans			159				-				133				133				2				156
Consumer loans			296				-				288				288				5				304
Total impaired loans		$	35,207				3,600				30,012				33,612				1,637				34,915




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
Farm loans (non RE)											-
Consumer loans			318				-				313				313				5				309
All other loans (not secured by real estate)			-				-				-				-				-				-
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 and six months ended June 30, 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
Six months ended June 30, 2015
Allowance for loan losses:
Beginning balance		$	2,785				2,566				1,610				1,902				7				1,098				-				233				881				11,082
Charge-offs			(73	)			(400	)			(59	)			(62	)			-				(15	)			-				(253	)			-				(862	)
Recoveries			23				10				22				10				-				53				-				81				-				199
Provision			189				280				(45	)			(101	)			(5	)			(234	)			-				170				(295	)			(41	)
Ending balance		$	2,924				2,456				1,528				1,749				2				902				-				231				586				10,378

Three months ended June 30, 2015
Allowance for loan losses:
Beginning balance		$	2,758				2,599				1,586				1,786				6				1,181				-				208				719				10,843
Charge-offs			-				(109	)			(17	)			(59	)			-				(15	)			-				(132	)			-				(332	)
Recoveries			18				4				-				5				-				17				-				37				-				81
Provision			148				(38	)			(41	)			17				(4	)			(281	)			-				118				(133	)			(214	)
Ending balance		$	2,924				2,456				1,528				1,749				2				902				-				231				586				10,378

Allowance for loan losses June 30, 2015:
Ending balance: individually
evaluated for impairment		$	-				92				1,135				235				-				-				-				-				-				1,462
Ending balance: collectively
evaluated for impairment			2,924				2,364				393				1,514				2				902				-				231				586				8,916
Ending balance		$	2,924				2,456				1,528				1,749				2				902				-				231				586				10,378

Loans June 30, 2015:
Ending balance		$	60,066				208,653				45,252				231,684				12,402				85,124				4				23,582				-				666,767

Ending balance: individually
evaluated for impairment		$	241				2,998				18,346				3,575				-				-				-				-				-				25,160
Ending balance: collectively
evaluated for impairment		$	59,825				205,655				26,906				228,109				12,402				85,124				4				23,582				-				641,607

(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

The provision for loan losses for the three months ended June 30, 2015 was a credit of $214,000, as compared to an expense of $67,000 for the three months ended June 30, 2014. The decrease in the provision for loan losses is primarily attributable to a $3.3 million reduction in non-accrual loans from June 30, 2014 to June 30, 2015 and a $119,000 reduction in net charge-offs during the three months ended June 30, 2015, as compared to the same period one year ago.

The provision for loan losses for the six months ended June 30, 2015 was a credit of $41,000, as compared to a credit of $282,000 for the six months ended June 30, 2014. The credit to the provision for loan losses for the six months ended June 30, 2015 was less than the credit to the provision for loan losses for the six months ended June 30, 2014 primarily due to a $33.5 million increase in loans from June 30, 2014 to June 30, 2015 and a $119,000 increase in net charge-offs during the six months ended June 30, 2015, as compared to the same period one year ago. The credit to provision for loan losses in the three and six months ended June 30, 2015 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, 2015 to $10.4 million from $11.1 million at December 31, 2014 were the continuing positive trends in indicators of potential losses on loans, primarily non-accrual loans and the declining trend 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 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 June 30, 2015 and December 31, 2014:

June 30, 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		$	-				14,306				-				-				-				984				-				1,222				-				16,512
2- High Quality			9,578				80,824				-				41,564				218				26,392				-				3,698				1,741				164,015
3- Good Quality			28,682				71,510				20,081				142,618				9,096				44,283				4				4,499				9,997				330,770
4- Management Attention			12,361				30,906				12,510				37,876				358				12,839				-				540				1,775				109,165
5- Watch			8,817				4,674				5,746				5,604				2,730				473				-				42				-				28,086
6- Substandard			628				6,433				6,915				4,022				-				153				-				68				-				18,219
7- Doubtful			-				-				-				-				-				-				-				-				-				-
8- Loss			-				-				-				-				-				-				-				-				-				-
Total		$	60,066				208,653				45,252				231,684				12,402				85,124				4				10,069				13,513				666,767

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

TDR loans modified in 2015, past due TDR loans and non-accrual TDR loans totaled $5.6 million and $15.0 million at June 30, 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 $144,000 and $1.4 million in performing loans classified as TDR loans at June 30, 2015 and December 31, 2014, respectively.

The following tables present an analysis of loan modifications during the six months ended June 30, 2015 and 2014:

Six months ended June 30, 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		144
Total real estate TDR loans	1			146		144

Total TDR loans	1		$	146		144

During the six months ended June 30, 2015, one loan was modified that was considered to be a troubled debt restructuring. The interest rate was modified on this loan.

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
Commercial	-			-		-
Multifamily and farmland	-			-		-
Total real estate TDR loans	8			1,544		1,544
Total TDR loans	8		$	1,544		1,544

During the six months ended June 30, 2015, eight loans were modified that were considered to be troubled debt restructurings. The interest rate was modified on these loans.