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3. Loans

3 Months Ended

Mar. 31, 2018

Major classifications of loans at March 31, 2018 and December 31, 2017 are summarized as follows:

(Dollars in thousands)
	March 31, 2018		December 31, 2017
Real estate loans:
Construction and land development	$	82,046		84,987
Single-family residential		244,061		246,703
Single-family residential -
Banco de la Gente stated income		36,540		37,249
Commercial		261,636		248,637
Multifamily and farmland		29,108		28,937
Total real estate loans		653,391		646,513

Loans not secured by real estate:
Commercial loans		89,304		89,022
Farm loans		1,095		1,204
Consumer loans		9,329		9,888
All other loans		12,705		13,137

Total loans		765,824		759,764

Less allowance for loan losses		6,373		6,366

Total net loans	$	759,451		753,398

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, 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 March 31, 2018, construction and land development loans comprised approximately 11% 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, 2018, single-family residential loans comprised approximately 37% of the Bank’s total loan portfolio, and include Banco’s single-family residential stated income loans, which were approximately 5% 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, 2018, 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 March 31, 2018, 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 of 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, 2018 and December 31, 2017:

March 31, 2018
(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	$	156		117		273		81,773		82,046		-
Single-family residential		2,775		96		2,871		241,190		244,061		-
Single-family residential -
Banco de la Gente stated income		4,196		54		4,250		32,290		36,540		-
Commercial		427		-		427		261,209		261,636		-
Multifamily and farmland		-		-		-		29,108		29,108		-
Total real estate loans		7,554		267		7,821		645,570		653,391		-

Loans not secured by real estate:
Commercial loans		59		97		156		89,148		89,304		-
Farm loans		-		-		-		1,095		1,095		-
Consumer loans		85		5		90		9,239		9,329		-
All other loans		-		-		-		12,705		12,705		-
Total loans	$	7,698		369		8,067		757,757		765,824		-

December 31, 2017
(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	$	277		-		277		84,710		84,987		-
Single-family residential		3,241		193		3,434		243,269		246,703		-
Single-family residential -
Banco de la Gente stated income		4,078		465		4,543		32,706		37,249		-
Commercial		588		-		588		248,049		248,637		-
Multifamily and farmland		-		12		12		28,925		28,937		-
Total real estate loans		8,184		670		8,854		637,659		646,513		-

Loans not secured by real estate:
Commercial loans		53		100		153		88,869		89,022		-
Farm loans		-		-		-		1,204		1,204		-
Consumer loans		113		5		118		9,770		9,888		-
All other loans		-		-		-		13,137		13,137		-
Total loans	$	8,350		775		9,125		750,639		759,764		-

The following table presents non-accrual loans as of March 31, 2018 and December 31, 2017:

(Dollars in thousands)
	March 31, 2018		December 31, 2017
Real estate loans:
Construction and land development	$	130		14
Single-family residential		1,535		1,634
Single-family residential -
Banco de la Gente stated income		1,508		1,543
Commercial		378		396
Multifamily and farmland		-		12
Total real estate loans		3,551		3,599

Loans not secured by real estate:
Commercial loans		97		100
Consumer loans		17		12
Total	$	3,665		3,711

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 $23.8 million, $24.6 million and $26.1 million at March 31, 2018, December 31, 2017 and March 31, 2017, respectively. Interest income recognized on accruing impaired loans was $352,000, $1.4 million, and $372,000 for the three months ended March 31, 2018, the year ended December 31, 2017 and the three months ended March 31, 2017, respectively. No interest income is recognized on non-accrual impaired loans subsequent to their classification as non-accrual.

The following table presents impaired loans as of March 31, 2018:

March 31, 2018
(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	$	397		-		265			265		9		333		6
Single-family residential		5,080		1,124		3,486			4,610		37		6,258		68
Single-family residential -
Banco de la Gente stated income		17,027		-		17,639			17,639		1,096		15,099		238
Commercial		2,420		477		2,873			3,350		13		2,294		37
Multifamily and farmland		-		-		78			78		-		6		-
Total impaired real estate loans		24,924		1,601		24,341			25,942		1,155		23,990		349

Loans not secured by real estate:
Commercial loans		260		97		(92	)		5		-		102		-
Consumer loans		154		-		192			192		2		152		2
Total impaired loans	$	25,338		1,698		24,441			26,139		1,157		24,244		351

The following table presents impaired loans as of and for the year ended December 31, 2017:

December 31, 2017
(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		-		277		277		6		253		17
Single-family residential		5,226		1,135		3,686		4,821		41		5,113		265
Single-family residential -
Banco de la Gente stated income		17,360		-		16,805		16,805		1,149		16,867		920
Commercial		2,761		807		1,661		2,468		1		3,411		148
Multifamily and farmland		78		-		12		12		-		28		-
Total impaired real estate loans		25,707		1,942		22,441		24,383		1,197		25,672		1,350

Loans not secured by real estate:
Commercial loans		264		100		4		104		-		149		3
Consumer loans		158		-		154		154		2		194		9
Total impaired loans	$	26,129		2,042		22,599		24,641		1,199		26,015		1,362

Changes in the allowance for loan losses for the three months ended March 31, 2018 and 2017 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, 2018
Allowance for loan losses:
Beginning balance	$	804			1,812			1,280			1,193		72			574		-		155			476		6,366
Charge-offs		-			-			-			-		(5	)		-		-		(101	)		-		(106	)
Recoveries		1			5			-			4		1			8		-		63			-		82
Provision		(154	)		(177	)		(15	)		101		5			124		-		19			128		31
Ending balance	$	651			1,640			1,265			1,298		73			706		-		136			604		6,373

Allowance for loan losses March 31, 2018
Ending balance: individually
evaluated for impairment	$	-			-			1,079			12		-			-		-		-			-		1,091
Ending balance: collectively
evaluated for impairment		651			1,640			186			1,286		73			706		-		136			604		5,282
Ending balance	$	651			1,640			1,265			1,298		73			706		-		136			604		6,373

Loans March 31, 2017:
Ending balance	$	82,046			244,061			36,540			261,636		29,108			89,304		1,095		22,034			-		765,824

Ending balance: individually
evaluated for impairment	$	96			1,832			15,190			1,915		-			97		-		-			-		19,130
Ending balance: collectively
evaluated for impairment	$	81,950			242,229			21,350			259,721		29,108			89,207		1,095		22,034			-		746,694

(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, 2017
Allowance for loan losses:
Beginning balance	$	1,152			2,126			1,377			1,593		52		675			-		204			371		7,550
Charge-offs		-			(20	)		-			-		-		(2	)		-		(109	)		-		(131	)
Recoveries		8			7			-			7		-		8			-		50			-		80
Provision		(191	)		(110	)		(49	)		55		21		(53	)		-		33			58		(236	)
Ending balance	$	969			2,003			1,328			1,655		73		628			-		178			429		7,263

Allowance for loan losses March 31, 2017
Ending balance: individually
evaluated for impairment	$	-			-			1,120			62		-		-			-		-			-		1,182
Ending balance: collectively
evaluated for impairment		969			2,003			208			1,593		73		628			-		178			429		6,081
Ending balance	$	969			2,003			1,328			1,655		73		628			-		178			429		7,263

Loans March 31, 2017:
Ending balance	$	65,438			239,322			39,230			247,940		29,078		90,923			897		23,033			-		735,861

Ending balance: individually
evaluated for impairment	$	-			1,630			16,303			2,736		-		-			-		-			-		20,669
Ending balance: collectively
evaluated for impairment	$	65,438			237,692			22,927			245,204		29,078		90,923			897		23,033			-		715,192

The provision for loan losses for the three months ended March 31, 2018 was an expense of $31,000, as compared to a credit of $236,000 for the three months ended March 31, 2017. The increase in the provision for loan losses is primarily attributable to a $30.0 million increase in loans from March 31, 2017 to March 31, 2018.

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:

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. Certificates of deposit 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, 2018 and December 31, 2017:

March 31, 2018
(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	$	273		7,298		-		-		-		542		-		525		-		8,638
2- High Quality		20,125		119,589		-		35,003		518		19,667		-		3,427		2,320		200,649
3- Good Quality		51,400		90,160		14,788		205,753		25,635		64,485		933		4,717		9,594		467,465
4- Management Attention		4,495		19,595		14,925		17,177		1,825		4,199		162		609		791		63,778
5- Watch		5,476		4,346		3,136		3,282		1,130		292		-		21		-		17,683
6- Substandard		277		3,073		3,691		421		-		119		-		30		-		7,611
7- Doubtful		-		-		-		-		-		-		-		-		-		-
8- Loss		-		-		-		-		-		-		-		-		-		-
Total	$	82,046		244,061		36,540		261,636		29,108		89,304		1,095		9,329		12,705		765,824

December 31, 2017
(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	$	152		8,590		-		-		-		446		-		791		-		9,979
2- High Quality		20,593		120,331		-		34,360		561		17,559		-		3,475		2,410		199,289
3- Good Quality		53,586		89,120		14,955		196,439		25,306		65,626		1,085		5,012		9,925		461,054
4- Management Attention		4,313		20,648		15,113		13,727		1,912		5,051		119		562		802		62,247
5- Watch		6,060		4,796		3,357		3,671		1,146		223		-		23		-		19,276
6- Substandard		283		3,218		3,824		440		12		117		-		25		-		7,919
7- Doubtful		-		-		-		-		-		-		-		-		-		-
8- Loss		-		-		-		-		-		-		-		-		-		-
Total	$	84,987		246,703		37,249		248,637		28,937		89,022		1,204		9,888		13,137		759,764

Current year TDR modifications, past due TDR loans and non-accrual TDR loans totaled $4.4 million and $4.5 million at March 31, 2018 and December 31, 2017, 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, 2018. There was $21,000 in performing loans classified as TDR loans at December 31, 2017.

There were no new TDR modifications during the three months ended March 31, 2018 and 2017.

There were no loans modified as TDR that defaulted during the three months ended March 31, 2018 and 2017, 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.

- 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.

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