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3. Loans

9 Months Ended

Sep. 30, 2019

Major classifications of loans at September 30, 2019 and December 31, 2018 are summarized as follows:

(Dollars in thousands)

	September 30, 2019		December 31, 2018
Real estate loans:
Construction and land development	$	95,622		94,178
Single-family residential		269,304		252,983
Single-family residential -
Banco de la Gente non-traditional		31,673		34,261
Commercial		281,607		270,055
Multifamily and farmland		47,266		33,163
Total real estate loans		725,472		684,640

Loans not secured by real estate:
Commercial loans		99,382		97,465
Farm loans		1,101		926
Consumer loans		8,473		9,165
All other loans		11,171		11,827

Total loans		845,599		804,023

Less allowance for loan losses		6,578		6,445

Total net loans	$	839,021		797,578

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 September 30, 2019, 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 September 30, 2019, single-family residential loans comprised approximately 36% of the Bank’s total loan portfolio, and include Banco’s non-traditional single-family residential loans, which were approximately 4% 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, 2019, 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 September 30, 2019, 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 September 30, 2019 and December 31, 2018:

September 30, 2019

(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	$	123		-		123		95,499		95,622		-
Single-family residential		1,854		189		2,043		267,261		269,304		-
Single-family residential - Banco de la Gente non-traditional		1,568		50		1,618		30,055		31,673		-
Commercial		98		178		276		281,331		281,607		-
Multifamily and farmland		-		-		-		47,266		47,266		-
Total real estate loans		3,643		417		4,060		721,412		725,472		-

Loans not secured by real estate:
Commercial loans		412		-		412		98,970		99,382		-
Farm loans		-		-		-		1,101		1,101		-
Consumer loans		115		4		119		8,354		8,473		-
All other loans		-		-		-		11,171		11,171		-
Total loans	$	4,170		421		4,591		841,008		845,599		-

December 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	$	3		-		3		94,175		94,178		-
Single-family residential		4,162		570		4,732		248,251		252,983		-
Single-family residential - Banco de la Gente non-traditional		4,627		580		5,207		29,054		34,261		-
Commercial		228		-		228		269,827		270,055		-
Multifamily and farmland		-		-		-		33,163		33,163		-
Total real estate loans		9,020		1,150		10,170		674,470		684,640		-

Loans not secured by real estate:
Commercial loans		445		90		535		96,930		97,465		-
Farm loans		-		-		-		926		926		-
Consumer loans		99		4		103		9,062		9,165		-
All other loans		-		-		-		11,827		11,827		-
Total loans	$	9,564		1,244		10,808		793,215		804,023		-

The following table presents non-accrual loans as of September 30, 2019 and December 31, 2018:

(Dollars in thousands)

	September 30, 2019		December 31, 2018
Real estate loans:
Construction and land development	$	-		1
Single-family residential		1,293		1,530
Single-family residential - Banco de la Gente non-traditional		1,559		1,440
Commercial		260		244
Multifamily and farmland		-		-
Total real estate loans		3,112		3,215

Loans not secured by real estate:
Commercial loans		131		89
Consumer loans		15		10
Total	$	3,258		3,314

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 $21.4 million, $22.8 million and $23.6 million at September 30, 2019, December 31, 2018 and September 30, 2018, respectively. Interest income recognized on accruing impaired loans was $1.0 million, $1.3 million, and $1.0 million for the nine months ended September 30, 2019, the year ended December 31, 2018 and the nine months ended September 30, 2018, 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 September 30, 2019:

September 30, 2019

(Dollars in thousands)

	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Recorded Investment in Impaired Loans		Related Allowance
Real estate loans:
Construction and land development	$	187		-		187		187		5
Single-family residential		4,900		409		4,010		4,419		31
Single-family residential - Banco de la Gente stated income		15,392		-		14,634		14,634		966
Commercial		1,896		-		1,888		1,888		12
Multifamily and farmland		-		-		-		-		-
Total impaired real estate loans		22,375		409		20,719		21,128		1,014

Loans not secured by real estate:
Commercial loans		578		100		88		188		1
Consumer loans		92		-		88		88		1
Total impaired loans	$	23,045		509		20,895		21,404		1,016

The following table presents the average impaired loan balance and the interest income recognized by loan class for the three and nine months ended September 30, 2019 and 2018.

(Dollars in thousands)

	Three months ended								Nine months ended
	September 30, 2019				September 30, 2018				September 30, 2019				September 30, 2018
	Average Balance		Interest Income Recognized		Average Balance		Interest Income Recognized		Average Balance		Interest Income Recognized		Average Balance		Interest Income Recognized
Real estate loans:
Construction and land development	$	188		3		320		2		232		9		326		14
Single-family residential		4,360		70		6,441		73		4,724		188		6,350		207
Single-family residential - Banco de la Gente stated income		14,805		241		14,602		236		14,916		732		14,851		703
Commercial		1,808		26		2,320		17		1,823		71		2,307		144
Multifamily and farmland		-		-		-		-		-		-		3		-
Total impaired real estate loans		21,161		340		23,683		328		21,695		1,000		23,837		1,021

Loans not secured by real estate:
Commercial loans		153		16		96		-		127		20		99		-
Farm loans (non RE)		-		-		-		-		-		-		-		-
Consumer loans		94		1		144		3		102		5		147		7
Total impaired loans	$	21,408		357		23,923		331		21,924		1,025		24,803		1,028

The following table presents impaired loans as of and for the year ended December 31, 2018:

December 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	$	281		-		279		279		5		327		19
Single-family residential		5,059		422		4,188		4,610		32		6,271		261
Single-family residential -
Banco de la Gente non-traditional		16,424		-		15,776		15,776		1,042		14,619		944
Commercial		1,995		-		1,925		1,925		17		2,171		111
Total impaired real estate loans		23,759		422		22,168		22,590		1,096		23,388		1,335

Loans not secured by real estate:
Commercial loans		251		89		1		90		-		96		-
Consumer loans		116		-		113		113		2		137		7
Total impaired loans	$	24,126		511		22,282		22,793		1,098		23,621		1,342

Changes in the allowance for loan losses for the three and nine months ended September 30, 2019 and 2018 were as follows:

(Dollars in thousands)

	Real Estate Loans
	Construction and Land Development			Single-Family Residential			Single-Family Residential - Banco de la Gente Non-traditional			Commercial			Multifamily and Farmland		Commercial			Farm		Consumer and All Other			Unallocated		Total
Nine months ended September 30, 2019:
Allowance for loan losses:
Beginning balance	$	813			1,325			1,177			1,278			83		626			-		161			982		6,445
Charge-offs		(21	)		(42	)		-			-			-		(389	)		-		(459	)		-		(911	)
Recoveries		44			59			-			27			-		80			-		157			-		367
Provision		(141	)		22			(87	)		(26	)		35		333			-		303			238		677
Ending balance	$	695			1,364			1,090			1,279			118		650			-		162			1,220		6,578

Three months ended September 30, 2019:
Allowance for loan losses:
Beginning balance	$	763			1,312			1,116			1,334			110		548			-		161			1,197		6,541
Charge-offs		-			(19	)		-			-			-		(388	)		-		(144	)		-		(551	)
Recoveries		41			6			-			4			-		66			-		49			-		166
Provision		(109	)		65			(26	)		(59	)		8		424			-		96			23		422
Ending balance	$	695			1,364			1,090			1,279			118		650			-		162			1,220		6,578

Allowance for loan losses at September 30, 2019:
Ending balance: individually
evaluated for impairment	$	-			2			948			10			-		-			-		-			-		960
Ending balance: collectively
evaluated for impairment		695			1,362			142			1,269			118		650			-		162			1,220		5,618
Ending balance	$	695			1,364			1,090			1,279			118		650			-		162			1,220		6,578

Loans at September 30, 2019:
Ending balance	$	95,622			269,304			31,673			281,607			47,266		99,382			1,101		19,644			-		845,599

Ending balance: individually
evaluated for impairment	$	11			1,719			13,196			1,628			-		100			-		-			-		16,654
Ending balance: collectively
evaluated for impairment	$	95,611			267,585			18,477			279,979			47,266		99,282			1,101		19,644			-		828,945

(Dollars in thousands)

	Real Estate Loans
	Construction and Land Development			Single-Family Residential			Single-Family Residential - Banco de la Gente Non-traditional			Commercial			Multifamily and Farmland			Commercial			Farm		Consumer and All Other			Unallocated		Total
Nine months ended September 30, 2018:
Allowance for loan losses:
Beginning balance	$	804			1,812			1,280			1,193			72			574			-		155			476		6,366
Charge-offs		(53	)		(115	)		-			(271	)		(5	)		(4	)		-		(318	)		-		(766	)
Recoveries		4			55			-			101			1			23			-		139			-		323
Provision		(63	)		(293	)		(75	)		438			10			12			-		182			161		372
Ending balance	$	692			1,459			1,205			1,461			78			605			-		158			637		6,295

Three months ended September 30, 2018:
Allowance for loan losses:
Beginning balance	$	668			1,638			1,233			1,420			72			587			-		150			509		6,277
Charge-offs		(53	)		(73	)		-			-			-			(1	)		-		(132	)		-		(259	)
Recoveries		1			28			-			94			-			7			-		37			-		167
Provision		76			(134	)		(28	)		(53	)		6			12			-		103			128		110
Ending balance	$	692			1,459			1,205			1,461			78			605			-		158			637		6,295

Allowance for loan losses at September 30, 2018:
Ending balance: individually
evaluated for impairment	$	5			2			1,036			12			-			-			-		-			-		1,055
Ending balance: collectively
evaluated for impairment		687			1,457			169			1,449			78			605			-		158			637		5,240
Ending balance	$	692			1,459			1,205			1,461			78			605			-		158			637		6,295

Loans at September 30, 2018:
Ending balance	$	76,987			249,812			34,742			275,629			31,102			97,085			994		20,373			-		786,724

Ending balance: individually
evaluated for impairment	$	98			2,171			14,557			1,879			-			94			-		-			-		18,799
Ending balance: collectively
evaluated for impairment	$	76,889			247,641			20,185			273,750			31,102			96,991			994		20,373			-		767,925

The provision for loan losses for the three months ended September 30, 2019 was $422,000, compared to $110,000 for the three months ended September 30, 2018. The increase in the provision for loan losses is primarily attributable to a $58.9 million increase in loans from September 30, 2018 to September 30, 2019 and a $293,000 increase in net charge-offs during the third quarter of 2019 compared to the same period one year ago.

The provision for loan losses for the nine months ended September 30, 2019 was $677,000, compared to $372,000 for the nine months ended September 30, 2018. The increase in the provision for loan losses is primarily attributable to a $58.9 million increase in loans from September 30, 2018 to September 30, 2019 and a $101,000 increase in net charge-offs during the nine months ended September 30, 2019 compared to the same period one year ago.

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. 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 September 30, 2019 and December 31, 2018:

September 30, 2019

(Dollars in thousands)

	Real Estate Loans
	Construction and Land Development		Single-Family Residential		Single-Family Residential - Banco de la Gente non-traditional		Commercial		Multifamily and Farmland		Commercial		Farm		Consumer		All Other		Total

1- Excellent Quality	$	-		9,078		-		-		-		632		-		700		-		10,410
2- High Quality		29,679		132,304		-		22,363		291		22,014		-		2,756		1,999		211,406
3- Good Quality		57,270		103,843		12,494		219,509		41,730		69,335		980		4,534		8,441		518,136
4- Management Attention		5,582		17,828		14,213		36,583		4,694		7,033		121		450		731		87,235
5- Watch		3,025		3,261		2,147		2,892		551		231		-		8		-		12,115
6- Substandard		66		2,990		2,819		260		-		137		-		25		-		6,297
7- Doubtful		-		-		-		-		-		-		-		-		-		-
8- Loss		-		-		-		-		-		-		-		-		-		-
Total	$	95,622		269,304		31,673		281,607		47,266		99,382		1,101		8,473		11,171		845,599

December 31, 2018

(Dollars in thousands)

	Real Estate Loans
	Construction and Land Development		Single-Family Residential		Single-Family Residential - Banco de la Gente non-traditional		Commercial		Multifamily and Farmland		Commercial		Farm		Consumer		All Other		Total

1- Excellent Quality	$	504		5,795		-		-		-		605		-		673		-		7,577
2- High Quality		24,594		128,588		-		25,321		395		20,520		-		3,229		2,145		204,792
3- Good Quality		59,549		92,435		13,776		211,541		27,774		69,651		785		4,699		8,932		489,142
4- Management Attention		5,707		19,200		15,012		30,333		3,906		6,325		141		529		750		81,903
5- Watch		3,669		3,761		2,408		2,616		1,088		264		-		18		-		13,824
6- Substandard		155		3,204		3,065		244		-		100		-		17		-		6,785
7- Doubtful		-		-		-		-		-		-		-		-		-		-
8- Loss		-		-		-		-		-		-		-		-		-		-
Total	$	94,178		252,983		34,261		270,055		33,163		97,465		926		9,165		11,827		804,023

Current year TDR modifications, past due TDR loans and non-accrual TDR loans totaled $2.2 million and $4.7 million at September 30, 2019 and December 31, 2018, 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 was zero and $92,000 in performing loans classified as TDR loans at September 30, 2019 and December 31, 2018, respectively.

There were no new TDR modifications during the three and nine months ended September 30, 2019.

The following table presents an analysis of TDR loan modifications during the three months ended September 30, 2018.

Three months ended September 30, 2018

(Dollars in thousands)

	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Real estate loans
Single-family residential		1	$	61		61
Total real estate TDR loans		1		61		61

Total TDR loans		1	$	61		61

During the three months ended September 30, 2018, one loan was modified that was considered to be a new TDR loan. The interest rate was modified on this TDR loan.

The following table presents an analysis of TDR loan modifications during the nine months ended September 30, 2018.

Nine months ended September 30, 2018

(Dollars in thousands)

	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Real estate loans
Single-family residential		2	$	94		94
Total real estate TDR loans		2		94		94

Total TDR loans		2	$	94		94

During the nine months ended September 30, 2018, two loans were modified that were considered to be new TDR loans. The interest rates were modified on these TDR loans.

There were no loans modified as TDR that defaulted during the three and nine months ended September 30, 2019 and 2018, 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.