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3. Loans

3 Months Ended

Mar. 31, 2016

Receivables [Abstract]

3. Loans

Major classifications of loans at March 31, 2016 and December 31, 2015 are summarized as follows:

(Dollars in thousands)
		March 31, 2016				December 31, 2015
Real estate loans:
Construction and land development		$	63,973				65,791
Single-family residential			223,104				220,690
Single-family residential -
Banco de la Gente stated income			42,951				43,733
Commercial			228,166				228,526
Multifamily and farmland			18,122				18,080
Total real estate loans			576,316				576,820

Loans not secured by real estate:
Commercial loans			91,784				91,010
Farm loans			2				3
Consumer loans			9,705				10,027
All other loans			15,226				11,231

Total loans			693,033				689,091

Less allowance for loan losses			9,116				9,589

Total net loans		$	683,917				679,502

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, Durham and Forsyth 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, 2016, 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, 2016, single-family residential loans comprised approximately 38% of the Bank's total loan portfolio, and include Banco's 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 March 31, 2016, commercial real estate loans comprised approximately 33% 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, 2016, 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, 2016 and December 31, 2015:

March 31, 2016
(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		$	76				17				93				63,880				63,973				-
Single-family residential			2,964				1,101				4,065				219,039				223,104				-
Single-family residential -
Banco de la Gente stated income			6,416				315				6,731				36,220				42,951				127
Commercial			860				1,824				2,684				225,482				228,166				-
Multifamily and farmland			-				-				-				18,122				18,122				-
Total real estate loans			10,316				3,257				13,573				562,743				576,316				127

Loans not secured by real estate:
Commercial loans			74				23				97				91,687				91,784				-
Farm loans			-				-				-				2				2				-
Consumer loans			83				7				90				9,615				9,705				-
All other loans			16				-				16				15,210				15,226				-
Total loans		$	10,489				3,287				13,776				679,257				693,033				127

December 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		$	330				17				347				65,444				65,791				-
Single-family residential			2,822				1,385				4,207				216,483				220,690				-
Single-family residential -
Banco de la Gente stated income			7,021				114				7,135				36,598				43,733				-
Commercial			2,619				157				2,776				225,750				228,526				-
Multifamily and farmland			-				-				-				18,080				18,080				-
Total real estate loans			12,792				1,673				14,465				562,355				576,820				-

Loans not secured by real estate:
Commercial loans			185				40				225				90,785				91,010				17
Farm loans			-				-				-				3				3				-
Consumer loans			136				8				144				9,883				10,027				-
All other loans			-				-				-				11,231				11,231				-
Total loans		$	13,113				1,721				14,834				674,257				689,091				17

The following table presents non-accrual loans as of March 31, 2016 and December 31, 2015:

(Dollars in thousands)
		March 31, 2016				December 31, 2015
Real estate loans:
Construction and land development		$	149				146
Single-family residential			3,540				4,023
Single-family residential -
Banco de la Gente stated income			1,007				1,106
Commercial			3,431				2,992
Multifamily and farmland			-				-
Total real estate loans			8,127				8,267

Loans not secured by real estate:
Commercial loans			102				113
Consumer loans			39				52
Total		$	8,268				8,432

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 $24.8 million, $25.0 million and $25.9 million at March 31, 2016, December 31, 2015 and March 31, 2015, respectively. Interest income recognized on accruing impaired loans was $314,000, $335,000 and $1.3 million for the three months ended March 31, 2016, the three months ended March 31, 2015 and the year ended December 31, 2015, 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 March 31, 2016 and December 31, 2015:

March 31, 2016
(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		$	497				-				433				433				22				459
Single-family residential			8,097				1,479				6,206				7,685				179				11,287
Single-family residential -
Banco de la Gente stated income			19,621				-				19,061				19,061				1,304				17,951
Commercial			5,984				4,720				604				5,324				4				6,739
Multifamily and farmland			78				-				78				78				-				80
Total impaired real estate loans			34,277				6,199				26,382				32,581				1,509				36,516

Loans not secured by real estate:
Commercial loans			179				-				148				148				2				129
Consumer loans			245				-				238				238				4				245
Total impaired loans		$	34,701				6,199				26,768				32,967				1,515				36,890

December 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		$	643				216				226				442				12				705
Single-family residential			8,828				1,489				6,805				8,294				189				10,852
Single-family residential -
Banco de la Gente stated income			20,375				-				19,215				19,215				1,143				18,414
Commercial			4,556				-				4,893				4,893				179				5,497
Multifamily and farmland			96				-				83				83				-				93
Total impaired real estate loans			34,498				1,705				31,222				32,927				1,523				35,561

Loans not secured by real estate:
Commercial loans			180				-				161				161				3				132
Consumer loans			286				-				260				260				4				283
Total impaired loans		$	34,964				1,705				31,643				33,348				1,530				35,976

Changes in the allowance for loan losses for the three months ended March 31, 2016 and 2015 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, 2016
Allowance for loan losses:
Beginning balance		$	2,185		2,534		1,460		1,917		-		842		-		172		479		9,589
Charge-offs			-		(59	)	-		(106	)	-		(29	)	-		(128	)	-		(322	)
Recoveries			3		8		-		5		-		6		-		43		-		65
Provision			(344	)	(8	)	(37	)	(28	)	-		(9	)	-		103		107		(216	)
Ending balance		$	1,844		2,475		1,423		1,788		-		810		-		190		586		9,116

Allowance for loan losses March 31, 2016:
Ending balance: individually
evaluated for impairment		$	-		95		1,107		170		-		-		-		-		-		1,372
Ending balance: collectively
evaluated for impairment			1,844		2,380		316		1,618		-		810		-		190		586		7,744
Ending balance		$	1,844		2,475		1,423		1,788		-		810		-		190		586		9,116

Loans March 31, 2016:
Ending balance		$	63,973		223,104		42,951		228,166		18,122		91,784		2		24,931		-		693,033

Ending balance: individually
evaluated for impairment		$	-		2,612		17,711		4,890		-		-		-		-		-		25,213
Ending balance: collectively
evaluated for impairment		$	63,973		220,492		25,240		223,276		18,122		91,784		2		24,931		-		667,820

(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

The provision for loan losses for the three months ended March 31, 2016 was a credit of $216,000, as compared to an expense of $173,000 for the three months ended March 31, 2015. The decrease in the provision for loan losses is primarily attributable to a reduction in the required level of the allowance for loan losses resulting from lower historical loss rates used to calculate the FASB Accounting Standards Codification ("ASC") 450-20 reserve as the elevated level of loan losses incurred in 2011 and 2012 are no longer included in the historical loss calculations.

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, 2016 and December 31, 2015:

March 31, 2016
(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	$	-		11,461		-		-		-		655		-		1,128		50		13,294
2- High Quality		9,033		88,332		-		39,327		2,971		28,890		-		3,431		2,836		174,820
3- Good Quality		35,088		85,158		18,719		151,666		11,232		56,311		2		4,495		10,546		373,217
4- Management Attention		12,766		28,689		16,057		28,887		1,251		5,506		-		564		1,794		95,514
5- Watch		6,792		3,520		2,849		3,506		2,668		254		-		32		-		19,621
6- Substandard		294		5,944		5,326		4,780		-		168		-		54		-		16,566
7- Doubtful		-		-		-		-		-		-		-		1		-		1
8- Loss		-		-		-		-		-		-		-		-		-		-
Total	$	63,973		223,104		42,951		228,166		18,122		91,784		2		9,705		15,226		693,033

December 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	$	-		15,189		-		-		-		700		-		1,091		-		16,980
2- High Quality		10,144		86,061		-		38,647		2,998		24,955		-		3,647		1,665		168,117
3- Good Quality		35,535		78,843		19,223		148,805		12,058		58,936		3		4,571		7,828		365,802
4- Management Attention		12,544		30,259		15,029		31,824		335		5,905		-		620		1,738		98,254
5- Watch		7,265		4,322		3,308		4,561		2,689		332		-		43		-		22,520
6- Substandard		303		6,016		6,173		4,689		-		182		-		55		-		17,418
7- Doubtful		-		-		-		-		-		-		-		-		-		-
8- Loss		-		-		-		-		-		-		-		-		-		-
Total	$	65,791		220,690		43,733		228,526		18,080		91,010		3		10,027		11,231		689,091

TDR loans modified in 2016, past due TDR loans and non-accrual TDR loans totaled $7.8 million and $8.8 million at March 31, 2016 and December 31, 2015, 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 no performing loans classified as TDR loans at March 31, 2016. There were $354,000 performing loans classified as TDR loans at December 31, 2015.

There were no TDR modifications during the three months ended March 31, 2016.

The following table presents an analysis of loan modifications during the three months ended March 31, 2015:

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

During the three months ended March 31, 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 three months ended March 31, 2016 and 2015, 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.