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3. Loans

9 Months Ended

Sep. 30, 2015

Receivables [Abstract]

3. Loans

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

(Dollars in thousands)
		September 30, 2015				December 31, 2014
Real estate loans:
Construction and land development		$	61,748				57,617
Single-family residential			218,365				206,417
Single-family residential -
Banco de la Gente stated income			44,433				47,015
Commercial			234,003				228,558
Multifamily and farmland			14,003				12,400
Total real estate loans			572,552				552,007

Loans not secured by real estate:
Commercial loans			88,931				76,262
Farm loans			3				7
Consumer loans			10,047				10,060
All other loans			13,267				13,555

Total loans			684,800				651,891

Less allowance for loan losses			10,420				11,082

Total net loans		$	674,380				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 September 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 September 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 6% 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 September 30, 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 September 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 September 30, 2015 and December 31, 2014:

September 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		$	383				273				656				61,092				61,748				197
Single-family residential			1,779				1,463				3,242				215,123				218,365				-
Single-family residential -
Banco de la Gente stated income			1,588				246				1,834				42,599				44,433				-
Commercial			602				142				744				233,259				234,003				-
Multifamily and farmland			117				-				117				13,886				14,003				-
Total real estate loans			4,469				2,124				6,593				565,959				572,552				197

Loans not secured by real estate:
Commercial loans			323				29				352				88,579				88,931				29
Farm loans			-				-				-				3				3				-
Consumer loans			204				18				222				9,825				10,047				-
All other loans			-				-				-				13,267				13,267				-
Total loans		$	4,996				2,171				7,167				677,633				684,800				226


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 non-accrual loans as of September 30, 2015 and December 31, 2014:

(Dollars in thousands)
	September 30, 2015			December 31, 2014
Real estate loans:
Construction and land development	$	209		3,854
Single-family residential		3,335		2,370
Single-family residential -
Banco de la Gente stated income		1,955		1,545
Commercial		2,598		2,598
Multifamily and farmland		-		110
Total real estate loans		8,097		10,477

Loans not secured by real estate:
Commercial loans		102		176
Consumer loans		67		75
Total	$	8,266		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 $25.5 million, $25.6 million and $26.8 million at September 30, 2015, December 31, 2014 and September 30, 2014, respectively. Interest income recognized on accruing impaired loans was $968,000, $992,000 and $1.3 million for the nine months ended September 30, 2015, the nine months ended September 30, 2014 and the year ended December 31, 2014, respectively. Interest income recognized on accruing impaired loans was $286,000 and $311,000 for the three months ended September 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 impaired loans as of September 30, 2015 and December 31, 2014:

September 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		$	643				241				289				530				19				1,638
Single-family residential			8,828				1,496				7,287				8,783				201				9,483
Single-family residential -
Banco de la Gente stated income			20,375				-				19,572				19,572				1,155				19,114
Commercial			4,556				-				4,172				4,172				234				4,948
Multifamily and farmland			96				-				93				93				-				100
Total impaired real estate loans			34,498				1,737				31,413				33,150				1,609				35,283

Loans not secured by real estate:
Commercial loans			180				-				154				154				3				149
Consumer loans			286				-				280				280				5				298
Total impaired loans		$	34,964				1,737				31,847				33,584				1,617				35,730


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
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 nine months ended September 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
Nine months ended September 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		(198	)	(447	)	(59	)	(62	)	-		(16	)	-		(394	)	-		(1,176	)
Recoveries		43		30		22		15		-		96		-		115		-		321
Provision		119		676		(113	)	75		(2	)	(297	)	-		258		(523	)	193
Ending balance	$	2,749		2,825		1,460		1,930		5		881		-		212		358		10,420

Three months ended September 30, 2015
Allowance for loan losses:
Beginning balance	$	2,924		2,456		1,528		1,749		2		902		-		231		586		10,378
Charge-offs		(110	)	(48	)	-		-		-		(1	)	-		(156	)	-		(315	)
Recoveries		20		21		-		5		-		43		-		33		-		122
Provision		(85	)	396		(68	)	176		3		(63	)	-		104		(228	)	235
Ending balance	$	2,749		2,825		1,460		1,930		5		881		-		212		358		10,420

Allowance for loan losses September 30, 2015:
Ending balance: individually
evaluated for impairment	$	-		96		1,128		227		-		-		-		-		-		1,451
Ending balance: collectively
evaluated for impairment		2,749		2,729		332		1,703		5		881		-		212		358		8,969
Ending balance	$	2,749		2,825		1,460		1,930		5		881		-		212		358		10,420

Loans September 30, 2015:
Ending balance	$	61,748		218,365		44,433		234,003		14,003		88,931		3		23,314		-		684,800

Ending balance: individually
evaluated for impairment	$	241		2,944		18,193		3,525		-		-		-		-		-		24,903
Ending balance: collectively
evaluated for impairment	$	61,507		215,421		26,240		230,478		14,003		88,931		3		23,314		-		659,897

(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
Nine months ended September 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		(772	)	(223	)	(148	)	(181	)	-		(197	)	-		(399	)	-		(1,920	)
Recoveries		389		64		17		165		-		42		-		112		-		789
Provision		239		(230	)	(60	)	(435	)	(29	)	240		-		282		(34	)	(27	)
Ending balance	$	3,074		2,734		1,672		1,768		8		1,154		-		240		1,693		12,343

Three months ended September 30, 2014
Allowance for loan losses:
Beginning balance	$	3,387		2,848		1,708		1,839		7		1,081		-		253		1,552		12,675
Charge-offs		(513	)	(30	)	(7	)	(51	)	-		(4	)	-		(144	)	-		(749	)
Recoveries		107		2		-		4		-		15		-		33		-		161
Provision		93		(86	)	(29	)	(24	)	1		62		-		98		141		256
Ending balance	$	3,074		2,734		1,672		1,768		8		1,154		-		240		1,693		12,343

Allowance for loan losses at September 30, 2014:
Ending balance: individually
evaluated for impairment	$	-		67		1,164		182		-		-		-		-		-		1,413
Ending balance: collectively
evaluated for impairment		3,074		2,667		508		1,586		8		1,154		-		240		1,693		10,930
Ending balance	$	3,074		2,734		1,672		1,768		8		1,154		-		240		1,693		12,343

Loans at September 30, 2014:
Ending balance	$	56,959		202,797		47,665		227,183		10,887		78,139		10		26,910		-		650,550

Ending balance: individually
evaluated for impairment	$	3,808		2,312		19,083		3,563		-		-		-		-		-		28,766
Ending balance: collectively
evaluated for impairment	$	53,151		200,485		28,582		223,620		10,887		78,139		10		26,910		-		621,784

The provision for loan losses for the three months ended September 30, 2015 was $235,000, as compared to $256,000 for the three months ended September 30, 2014. The decrease in the provision for loan losses is primarily attributable to a $2.4 million reduction in non-accrual loans from September 30, 2014 to September 30, 2015 and a $395,000 reduction in net charge-offs during the three months ended September 30, 2015, as compared to the same period one year ago.

The provision for loan losses for the nine months ended September 30, 2015 was an expense of $193,000, as compared to a credit of $27,000 for the nine months ended September 30, 2014. The increase in the provision for loan losses is primarily attributable to a $34.2 million increase in loans from September 30, 2014 to September 30, 2015.

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 September 30, 2015 and December 31, 2014:

September 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		$	-				13,031				-				-				-				645				-				1,224				-				14,900
2- High Quality			8,448				84,774				-				41,529				174				26,079				-				3,608				1,723				166,335
3- Good Quality			32,941				79,052				19,547				149,064				10,766				56,106				3				4,490				9,783				361,752
4- Management Attention			11,751				29,762				15,353				34,261				347				5,577				-				594				1,761				99,406
5- Watch			8,240				5,499				3,474				5,180				2,716				349				-				65				-				25,523
6- Substandard			368				6,247				6,059				3,969				-				175				-				62				-				16,880
7- Doubtful			-				-				-				-				-				-				-				-				-				-
8- Loss			-				-				-				-				-				-				-				4				-				4
Total		$	61,748				218,365				44,433				234,003				14,003				88,931				3				10,047				13,267				684,800



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 $5.9 million and $15.0 million at September 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 $142,000 and $1.4 million in performing loans classified as TDR loans at September 30, 2015 and December 31, 2014, respectively.

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

Nine months ended September 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		142
Total real estate TDR loans	1			146		142

Total TDR loans	1		$	146		142

During the nine months ended September 30, 2015, one loan was modified that was considered to be a new TDR loan. The interest rate was modified on this TDR loan.

There were no loans modified as TDR that defaulted during the nine or three months ended September 30, 2015 and 2014, which were within twelve months of their modification date. Generally, a TDR loan is considered to be in default once it becomes 90 days or more past due following a modification.

Nine months ended September 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		$	291		291
Single-family residential	2			849		849
Single-family residential -
Banco de la Gente stated income	7			594		594
Commercial	-			-		-
Multifamily and farmland	-			-		-
Total real estate TDR loans	10			1,734		1,734
Total TDR loans	10		$	1,734		1,734

During the nine months ended September 30, 2014, ten loans were modified that were considered to be new TDR loans. The interest rate was modified on these TDR loans.