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3. Loans

12 Months Ended

Dec. 31, 2016

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

(Dollars in thousands)
	December 31, 2016		December 31, 2015
Real estate loans:
Construction and land development	$	61,749		65,791
Single-family residential		240,700		220,690
Single-family residential -
Banco de la Gente stated income		40,189		43,733
Commercial		247,521		228,526
Multifamily and farmland		21,047		18,080
Total real estate loans		611,206		576,820

Loans not secured by real estate:
Commercial loans		87,596		91,010
Farm loans		-		3
Consumer loans		9,832		10,027
All other loans		15,177		11,231

Total loans		723,811		689,091

Less allowance for loan losses		7,550		9,589

Total net loans	$	716,261		679,502

The above table includes deferred costs, net of deferred fees, totaling $1.4 million and $488,000 at December 31, 2016 and 2015, respectively.

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 December 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 December 31, 2016, single-family residential loans comprised approximately 39% of the Bank's total loan portfolio, including 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 December 31, 2016, 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 December 31, 2016, commercial loans comprised approximately 12% 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 December 31, 2016 and 2015:

December 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	$	-		10		10		61,739		61,749		-
Single-family residential		4,890		80		4,970		235,730		240,700		-
Single-family residential -
Banco de la Gente stated income		5,250		249		5,499		34,690		40,189		-
Commercial		342		126		468		247,053		247,521		-
Multifamily and farmland		471		-		471		20,576		21,047		-
Total real estate loans		10,953		465		11,418		599,788		611,206		-

Loans not secured by real estate:
Commercial loans		273		-		273		87,323		87,596		-
Farm loans		-		-		-		-		-		-
Consumer loans		68		6		74		9,758		9,832		-
All other loans		3		-		3		15,174		15,177		-
Total loans	$	11,297		471		11,768		712,043		723,811		-

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 the Bank's non-accrual loans as of December 31, 2016 and 2015:

(Dollars in thousands)
	December 31, 2016		December 31, 2015
Real estate loans:
Construction and land development	$	22		146
Single-family residential		1,662		4,023
Single-family residential -
Banco de la Gente stated income		1,340		1,106
Commercial		669		2,992
Multifamily and farmland		78		-
Total real estate loans		3,771		8,267

Loans not secured by real estate:
Commercial loans		21		113
Consumer loans		33		52
Total	$	3,825		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. Impaired loans collectively evaluated for impairment totaled $5.9 million and $8.4 million at December 31, 2016 and 2015, respectively. Accruing impaired loans were $23.5 million and $25.0 million at December 31, 2016 and December 31, 2015, respectively. Interest income recognized on accruing impaired loans was $1.2 million and $1.3 million for the years ended December 31, 2016 and 2015, respectively. No interest income is recognized on non-accrual impaired loans subsequent to their classification as non-accrual.

The following tables present the Bank's impaired loans as of December 31, 2016, 2015 and 2014:

December 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		YTD Interest Income Recognized
Real estate loans:
Construction and land development	$	282		-		278		278		11		330		13
Single-family residential		5,354		703		4,323		5,026		47		7,247		164
Single-family residential -
Banco de la Gente stated income		18,611		-		18,074		18,074		1,182		17,673		861
Commercial		3,750		1,299		2,197		3,496		166		4,657		152
Multifamily and farmland		78		-		78		78		-		78		-
Total impaired real estate loans		28,075		2,002		24,950		26,952		1,406		29,985		1,190

Loans not secured by real estate:
Commercial loans		27		-		27		27		-		95		-
Consumer loans		211		-		202		202		3		222		8
Total impaired loans	$	28,313		2,002		25,179		27,181		1,409		30,302		1,198

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		YTD Interest Income Recognized
Real estate loans:
Construction and land development	$	643		216		226		442		12		705		18
Single-family residential		8,828		1,489		6,805		8,294		189		10,852		224
Single-family residential -
Banco de la Gente stated income		20,375		-		19,215		19,215		1,143		18,414		921
Commercial		4,556		-		4,893		4,893		179		5,497		89
Multifamily and farmland		96		-		83		83		-		93		6
Total impaired real estate loans		34,498		1,705		31,222		32,927		1,523		35,561		1,258

Loans not secured by real estate:
Commercial loans		180		-		161		161		3		132		5
Consumer loans		286		-		260		260		4		283		11
Total impaired loans	$	34,964		1,705		31,643		33,348		1,530		35,976		1,274

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		YTD Interest Income Recognized
Real estate loans:
Construction and land development	$	5,481		3,639		555		4,194		31		5,248		20
Single-family residential		6,717		933		5,540		6,473		154		7,430		214
Single-family residential -
Banco de la Gente stated income		21,243		-		20,649		20,649		1,191		19,964		952
Commercial		4,752		1,485		2,866		4,351		272		4,399		76
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		1,262

Loans not secured by real estate:
Commercial loans		218		-		201		201		4		641		2
Farm loans (non RE)						-
Consumer loans		318		-		313		313		5		309		12
Total impaired loans	$	38,840		6,057		30,234		36,291		1,658		38,145		1,276

The fair value measurements for mortgage loans held for sale, impaired loans and other real estate on a non-recurring basis at December 31, 2016 and 2015 are presented below. The Company's valuation methodology is discussed in Note 15.

(Dollars in thousands)
	Fair Value Measurements December 31, 2016		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
Mortgage loans held for sale	$	5,709		-		-		5,709
Impaired loans	$	25,931		-		-		25,931
Other real estate	$	283		-		-		283

(Dollars in thousands)
	Fair Value Measurements December 31, 2015		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
Mortgage loans held for sale	$	4,149		-		-		4,149
Impaired loans	$	31,818		-		-		31,818
Other real estate	$	739		-		-		739

(Dollars in thousands)
	Fair Value December 31, 2016		Fair Value December 31, 2015		Valuation Technique	Significant Unobservable Inputs	General Range of Significant Unobservable Input Values
Mortgage loans held for sale	$	5,709		4,149	Rate lock commitment	N/A		N/A
Impaired loans	$	25,931		31,818	Appraised value and discounted cash flows	Discounts to reflect current market conditions and ultimate collectability		0 - 25%
Other real estate	$	283		739	Appraised value	Discounts to reflect current market conditions and estimated costs to sell		0 - 25%

Changes in the allowance for loan losses for the year ended December 31, 2016 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
Allowance for loan losses:
Beginning balance	$	2,185		2,534		1,460		1,917		-	842		-	172		479		9,589
Charge-offs		(7	)	(275	)	-		(318	)	-	(146	)	-	(492	)	-		(1,238	)
Recoveries		10		55		-		19		-	170		-	151		-		405
Provision		(1,036	)	(188	)	(83	)	(25	)	52	(191	)	-	373		(108	)	(1,206	)
Ending balance	$	1,152		2,126		1,377		1,593		52	675		-	204		371		7,550


Ending balance: individually
evaluated for impairment	$	-		-		1,160		159		-	-		-	-		-		1,319
Ending balance: collectively
evaluated for impairment		1,152		2,126		217		1,434		52	675		-	204		371		6,231
Ending balance	$	1,152		2,126		1,377		1,593		52	675		-	204		371		7,550

Loans:
Ending balance	$	61,749		240,700		40,189		247,521		21,047	87,596		-	25,009		-		723,811

Ending balance: individually
evaluated for impairment	$	-		935		16,718		3,648		-	-		-	-		-		21,301
Ending balance: collectively
evaluated for impairment	$	61,749		239,765		23,471		243,873		21,047	87,596		-	25,009		-		702,510

Changes in the allowance for loan losses for the year ended December 31, 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
Allowance for loan losses:
Beginning balance	$	2,785		2,566		1,610		1,902		7		1,098		-	233		881		11,082
Charge-offs		(198	)	(618	)	(117	)	(329	)	-		(37	)	-	(545	)	-		(1,844	)
Recoveries		45		34		22		21		-		101		-	145		-		368
Provision		(447	)	552		(55	)	323		(7	)	(320	)	-	339		(402	)	(17	)
Ending balance	$	2,185		2,534		1,460		1,917		-		842		-	172		479		9,589


Ending balance: individually
evaluated for impairment	$	-		96		1,115		171		-		-		-	-		-		1,382
Ending balance: collectively
evaluated for impairment		2,185		2,438		345		1,746		-		842		-	172		479		8,207
Ending balance	$	2,185		2,534		1,460		1,917		-		842		-	172		479		9,589

Loans:
Ending balance	$	65,791		220,690		43,733		228,526		18,080		91,010		3	21,258		-		689,091

Ending balance: individually
evaluated for impairment	$	216		2,636		17,850		4,212		-		-		-	-		-		24,914
Ending balance: collectively
evaluated for impairment	$	65,575		218,054		25,883		224,314		18,080		91,010		3	21,258		-		664,177

Changes in the allowance for loan losses for the year ended December 31, 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
Allowance for loan losses:
Beginning balance	$	3,218		3,123		1,863		2,219		37		1,069		-	245		1,727		13,501
Charge-offs		(884	)	(309	)	(190	)	(290	)	-		(430	)	-	(534	)	-		(2,637	)
Recoveries		428		72		16		171		-		54		-	176		-		917
Provision		23		(320	)	(79	)	(198	)	(30	)	405		-	346		(846	)	(699	)
Ending balance	$	2,785		2,566		1,610		1,902		7		1,098		-	233		881		11,082


Ending balance: individually
evaluated for impairment	$	-		82		1,155		260		-		-		-	-		-		1,497
Ending balance: collectively
evaluated for impairment		2,785		2,484		455		1,642		7		1,098		-	233		881		9,585
Ending balance	$	2,785		2,566		1,610		1,902		7		1,098		-	233		881		11,082

Loans:
Ending balance	$	57,617		206,417		47,015		228,558		12,400		76,262		7	23,615		-		651,891

Ending balance: individually
evaluated for impairment	$	3,639		2,298		18,884		3,345		-		-		-	-		-		28,166
Ending balance: collectively
evaluated for impairment	$	53,978		204,119		28,131		225,213		12,400		76,262		7	23,615		-		623,725

The Bank 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 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 December 31, 2016 and 2015.

December 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	$	-	14,996	-	-	-	541	-	959	-	16,496
2- High Quality		9,784	109,809	-	39,769	2,884	26,006	-	3,335	2,507	194,094
3- Good Quality		33,633	82,147	16,703	176,109	14,529	55,155	-	4,842	10,921	394,039
4- Management Attention		10,892	25,219	15,580	24,753	2,355	5,586	-	619	1,749	86,753
5- Watch		7,229	4,682	3,943	4,906	1,201	246	-	31	-	22,238
6- Substandard		211	3,847	3,963	1,984	78	62	-	42	-	10,187
7- Doubtful		-	-	-	-	-	-	-	-	-	-
8- Loss		-	-	-	-	-	-	-	4	-	4
Total	$	61,749	240,700	40,189	247,521	21,047	87,596	-	9,832	15,177	723,811

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 $5.9 million and $8.8 million at December 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 $81,000 and $354,000 in performing loans classified as TDR loans at December 31, 2016 and December 31, 2015, respectively.

The following table presents an analysis of loan modifications during the year ended December 31, 2016:

Year ended December 31, 2016
(Dollars in thousands)
	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Real estate loans:
Single-family residential		3	$	124		121
Total TDR loans		3	$	124		121

During the year ended December 31, 2016, three loans were modified that were considered to be new TDR loans. The interest rate was modified on these TDR loans.

The following table presents an analysis of loan modifications during the year ended December 31, 2015:

Year ended December 31, 2015
(Dollars in thousands)
	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Real estate loans:
Construction and land development		1	$	216		216
Single-family residential		3		288		271
Total TDR loans		4	$	504		487

During the year ended December 31, 2015, four loans were modified that were considered to be new TDR loans. The interest rate was modified on these TDR loans.

There were no TDR loans with a payment default occurring within 12 months of the restructure date, and the payment default occurring during the years ended December 31, 2016 and 2015. TDR loans are deemed to be in default if they become past due by 90 days or more.

- 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.

+ References + Details