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3. Loans

6 Months Ended

Jun. 30, 2016

Receivables [Abstract]

3. Loans

Major classifications of loans at June 30, 2016 and December 31, 2015 are summarized as follows:

(Dollars in thousands)
		June 30, 2016				December 31, 2015
Real estate loans:
Construction and land development		$	60,075				65,791
Single-family residential			229,586				220,690
Single-family residential -
Banco de la Gente stated income			41,910				43,733
Commercial			232,035				228,526
Multifamily and farmland			18,688				18,080
Total real estate loans			582,294				576,820

Loans not secured by real estate:
Commercial loans			91,347				91,010
Farm loans			1				3
Consumer loans			9,776				10,027
All other loans			18,613				11,231

Total loans			702,031				689,091

Less allowance for loan losses			8,540				9,589

Total net loans		$	693,491				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 June 30, 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 June 30, 2016, single-family residential loans comprised approximately 39% 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 June 30, 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 June 30, 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 June 30, 2016 and December 31, 2015:

June 30,2016
(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		$	215				28				243				59,832				60,075				-
Single-family residential			1,934				465				2,399				227,187				229,586				-
Single-family residential -
Banco de la Gente stated income			1,582				173				1,755				40,155				41,910				-
Commercial			1,061				824				1,885				230,150				232,035				-
Multifamily and farmland			-				-				-				18,688				18,688				-
Total real estate loans			4,792				1,490				6,282				576,012				582,294				-

Loans not secured by real estate:
Commercial loans			63				21				84				91,263				91,347				-
Farm loans			-				-				-				1				1				-
Consumer loans			87				7				94				9,682				9,776				-
All other loans			-				-				-				18,613				18,613				-
Total loans		$	4,942				1,518				6,460				695,571				702,031				-

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 June 30, 2016 and December 31, 2015:

(Dollars in thousands)
		June 30, 2016				December 31, 2015
Real estate loans:
Construction and land development		$	36				146
Single-family residential			3,055				4,023
Single-family residential -
Banco de la Gente stated income			265				1,106
Commercial			2,445				2,992
Multifamily and farmland			-				-
Total real estate loans			5,801				8,267

Loans not secured by real estate:
Commercial loans			140				113
Consumer loans			44				52
Total		$	5,985				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 $23.7 million, $25.0 million and $26.2 million at June 30, 2016, December 31, 2015 and June 30, 2015, respectively. Interest income recognized on accruing impaired loans was $596,000, $662,000 and $1.3 million for the six months ended June 30, 2016, the six months ended June 30, 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 June 30, 2016 and December 31, 2015:

June 30, 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		$	341				-				295				295				14				405
Single-family residential			5,886				888				4,682				5,570				149				9,769
Single-family residential -
Banco de la Gente stated income			19,470				-				18,886				18,886				1,117				17,875
Commercial			4,641				1,746				2,582				4,328				182				5,978
Multifamily and farmland			78				-				78				78				-				79
Total impaired real estate loans			30,416				2,634				26,523				29,157				1,462				34,106

Loans not secured by real estate:
Commercial loans			192				-				160				160				2				139
Consumer loans			240				-				231				231				4				241
Total impaired loans		$	30,848				2,634				26,914				29,548				1,468				34,486

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 and six months ended June 30, 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
Six months ended June 30, 2016:
Allowance for loan losses:
Beginning balance		$	2,185				2,534				1,460				1,917				-				842				-				172				479				9,589
Charge-offs			-				(123	)			-				(106	)			-				(39	)			-				(240	)			-				(508	)
Recoveries			6				13				-				11				-				105				-				72				-				207
Provision			(609	)			(191	)			(106	)			(172	)			46				(105	)			-				230				159				(748	)
Ending balance		$	1,582				2,233				1,354				1,650				46				803				-				234				638				8,540

Three months ended June 30, 2016:
Allowance for loan losses:
Beginning balance		$	1,844				2,475				1,423				1,788				-				810				-				190				586				9,116
Charge-offs			-				(64	)			-				-				-				(10	)			-				(112	)			-				(186	)
Recoveries			3				5				-				6				-				99				-				28				-				141
Provision			(265	)			(183	)			(69	)			(144	)			46				(96	)			-				128				52				(531	)
Ending balance		$	1,582				2,233				1,354				1,650				46				803				-				234				638				8,540

Allowance for loan losses at June 30, 2016:
Ending balance: individually
evaluated for impairment		$	-				94				1,092				177				-				-				-				-				-				1,363
Ending balance: collectively
evaluated for impairment			1,582				2,139				262				1,473				46				803				-				234				638				7,177
Ending balance		$	1,582				2,233				1,354				1,650				46				803				-				234				638				8,540

Loans at June 30, 2016:
Ending balance		$	60,075				229,586				41,910				232,035				18,688				91,347				1				28,389				-				702,031

Ending balance: individually
evaluated for impairment		$	-				1,116				17,430				4,716				-				-				-				-				-				23,262
Ending balance: collectively
evaluated for impairment		$	60,075				228,470				24,480				227,319				18,688				91,347				1				28,389				-				678,769

(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 at 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 at 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

The provision for loan losses for the three months ended June 30, 2016 was a credit of $531,000, as compared to a credit of $214,000 for the three months ended June 30, 2015. The increase in the credit to 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 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 provision for loan losses for the six months ended June 30, 2016 was a credit of $748,000, as compared to a credit of $41,000 for the six months ended June 30, 2015. The increase in the credit to 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 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 June 30, 2016 and December 31, 2015:

June 30, 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		$	-				13,196				-				-				-				492				-				1,028				50				14,766
2- High Quality			7,507				93,770				-				39,397				2,942				27,341				-				3,327				2,799				177,083
3- Good Quality			32,970				86,587				17,597				158,036				11,873				57,190				1				4,677				13,982				382,913
4- Management Attention			12,456				27,771				16,258				27,113				1,221				5,870				-				647				1,782				93,118
5- Watch			6,911				3,436				2,828				3,708				2,652				252				-				41				-				19,828
6- Substandard			231				4,826				5,227				3,781				-				202				-				56				-				14,323
7- Doubtful			-				-				-				-				-				-				-				-				-				-
8- Loss			-				-				-				-				-				-				-				-				-				-
Total		$	60,075				229,586				41,910				232,035				18,688				91,347				1				9,776				18,613				702,031

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

Current year TDR modifications, past due TDR loans and non-accrual TDR loans totaled $4.7 million and $8.8 million at June 30, 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 June 30, 2016. There were $354,000 performing loans classified as TDR loans at December 31, 2015.

There were no TDR modifications during the six months ended June 30, 2016.

The following table presents an analysis of loan modifications during the six months ended June 30, 2015:

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 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 June 30, 2016 and 2015, which were within 12 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.