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3. Loans

12 Months Ended

Dec. 31, 2019

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

(Dollars in thousands)

	December 31, 2019		December 31, 2018
Real estate loans:
Construction and land development	$	92,596		94,178
Single-family residential		269,475		252,983
Single-family residential -
Banco de la Gente non-traditional		30,793		34,261
Commercial		291,255		270,055
Multifamily and farmland		48,090		33,163
Total real estate loans		732,209		684,640

Loans not secured by real estate:
Commercial loans		100,263		97,465
Farm loans		1,033		926
Consumer loans		8,432		9,165
All other loans		7,937		11,827

Total loans		849,874		804,023

Less allowance for loan losses		6,680		6,445

Total net loans	$	843,194		797,578

The above table includes deferred costs, net of deferred fees, totaling $1.5 million and $1.6 million at December 31, 2019 and 2018, 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, 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 December 31, 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 December 31, 2019, single-family residential loans comprised approximately 35% of the Bank’s total loan portfolio, including Banco single-family residential non-traditional 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 December 31, 2019, 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, 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 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, 2019 and 2018:

December 31, 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	$	803		—		803		91,793		92,596		—
Single-family residential		3,000		126		3,126		266,349		269,475		—
Single-family residential -
Banco de la Gente non-traditional		4,834		413		5,247		25,546		30,793		—
Commercial		504		176		680		290,575		291,255		—
Multifamily and farmland		—		—		—		48,090		48,090		—
Total real estate loans		9,141		715		9,856		722,353		732,209		—

Loans not secured by real estate:
Commercial loans		432		—		432		99,831		100,263		—
Farm loans		—		—		—		1,033		1,033		—
Consumer loans		170		22		192		8,240		8,432		—
All other loans		—		—		—		7,937		7,937		—
Total loans	$	9,743		737		10,480		839,394		849,874		—

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 the Bank’s non-accrual loans as of December 31, 2019 and 2018:

(Dollars in thousands)

	December 31, 2019		December 31, 2018
Real estate loans:
Construction and land development	$	—		1
Single-family residential		1,378		1,530
Single-family residential -
Banco de la Gente non-traditional		1,764		1,440
Commercial		256		244
Total real estate loans		3,398		3,215

Loans not secured by real estate:
Commercial loans		122		89
Consumer loans		33		10
Total	$	3,553		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. Impaired loans collectively evaluated for impairment totaled $5.3 million and $4.8 million at December 31, 2019 and 2018, respectively. Accruing impaired loans were $21.3 million and $22.8 million at December 31, 2019 and December 31, 2018, respectively. Interest income recognized on accruing impaired loans was $1.3 million for the years ended December 31, 2019 and 2018. 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, 2019, 2018 and 2017:

December 31, 2019

(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	$	183		—		183		183		7		231		12
Single-family residential		5,152		403		4,243		4,646		36		4,678		269
Single-family residential -
Banco de la Gente non-traditional		15,165		—		14,371		14,371		944		14,925		956
Commercial		1,879		—		1,871		1,871		7		1,822		91
Total impaired real estate loans		22,379		403		20,668		21,071		994		21,656		1,328

Loans not secured by real estate:
Commercial loans		180		92		84		176		—		134		9
Consumer loans		100		—		96		96		2		105		7
Total impaired loans	$	22,659		495		20,848		21,343		996		21,895		1,344

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

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 non-traditional		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
Farm loans (non RE)						—
Consumer loans		158		—		154		154		2		194		9
All other loans (not secured by real estate)		—		—		—		—		—		—		—
Total impaired loans	$	26,129		2,042		22,599		24,641		1,199		26,015		1,362

The fair value measurements for mortgage loans held for sale, impaired loans and other real estate on a non-recurring basis at December 31, 2019 and 2018 are presented below. The Company’s valuation methodology is discussed in Note 15.

(Dollars in thousands)

	Fair Value Measurements December 31, 2019		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
Mortgage loans held for sale	$	4,417		—		—		4,417
Impaired loans	$	20,347		—		—		20,347
Other real estate	$	—		—		—		—

(Dollars in thousands)

	Fair Value Measurements December 31, 2018		Level 1 Valuation		Level 2 Valuation		Level 3 Valuation
Mortgage loans held for sale	$	680		—		—		680
Impaired loans	$	21,695		—		—		21,695
Other real estate	$	27		—		—		27

Changes in the allowance for loan losses for the year ended December 31, 2019 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
Allowance for loan losses:
Beginning balance	$	813		1,325		1,177		1,278		83	626		—	161		982	6,445
Charge-offs		(21	)	(42	)	—		(1	)	—	(389	)	—	(623	)	—	(1,076	)
Recoveries		45		66		—		49		—	83		—	205		—	448
Provision		(143	)	(75	)	(104	)	(21	)	37	368		—	395		406	863
Ending balance	$	694		1,274		1,073		1,305		120	688		—	138		1,388	6,680


Ending balance: individually
evaluated for impairment	$	2		6		925		4		—	—		—	—		—	937
Ending balance: collectively
evaluated for impairment		692		1,268		148		1,301		120	688		—	138		1,388	5,743
Ending balance	$	694		1,274		1,073		1,305		120	688		—	138		1,388	6,680

Loans:
Ending balance	$	92,596		269,475		30,793		291,255		48,090	100,263		1,033	16,369		—	849,874

Ending balance: individually
evaluated for impairment	$	10		1,697		12,899		1,365		—	92		—	—		—	16,063
Ending balance: collectively
evaluated for impairment	$	92,586		267,778		17,894		289,890		48,090	100,171		1,033	16,369		—	833,811

Changes in the allowance for loan losses for the year ended December 31, 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
Allowance for loan losses:
Beginning balance	$	804		1,812		1,280		1,193		72		574		—	155		476	6,366
Charge-offs		(53	)	(116	)	—		(453	)	(5	)	(54	)	—	(452	)	—	(1,133	)
Recoveries		10		106		—		105		1		32		—	168		—	422
Provision		52		(477	)	(103	)	433		15		74		—	290		506	790
Ending balance	$	813		1,325		1,177		1,278		83		626		—	161		982	6,445


Ending balance: individually
evaluated for impairment	$	—		—		1,023		15		—		—		—	—		—	1,038
Ending balance: collectively
evaluated for impairment		813		1,325		154		1,263		83		626		—	161		982	5,407
Ending balance	$	813		1,325		1,177		1,278		83		626		—	161		982	6,445

Loans:
Ending balance	$	94,178		252,983		34,261		270,055		33,163		97,465		926	20,992		—	804,023

Ending balance: individually
evaluated for impairment	$	96		1,779		14,310		1,673		—		89		—	—		—	17,947
Ending balance: collectively
evaluated for impairment	$	94,082		251,204		19,951		268,382		33,163		97,376		926	20,992		—	786,076

Changes in the allowance for loan losses for the year ended December 31, 2017 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
Allowance for loan losses:
Beginning balance	$	1,152		2,126		1,377		1,593		52		675		—	204		371	7,550
Charge-offs		—		(249	)	—		—		(66	)	(194	)	—	(473	)	—	(982	)
Recoveries		14		85		—		21		—		31		—	154		—	305
Provision		(362	)	(150	)	(97	)	(421	)	86		62		—	270		105	(507	)
Ending balance	$	804		1,812		1,280		1,193		72		574		—	155		476	6,366


Ending balance: individually
evaluated for impairment	$	—		—		1,093		37		—		—		—	—		—	1,130
Ending balance: collectively
evaluated for impairment		804		1,812		187		1,156		72		574		—	155		476	5,236
Ending balance	$	804		1,812		1,280		1,193		72		574		—	155		476	6,366

Loans:
Ending balance	$	84,987		246,703		37,249		248,637		28,937		89,022		1,204	23,025		—	759,764

Ending balance: individually
evaluated for impairment	$	98		1,855		15,460		2,251		—		100		—	—		—	19,764
Ending balance: collectively
evaluated for impairment	$	84,889		244,848		21,789		246,386		28,937		88,922		1,204	23,025		—	740,000

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, 2019 and 2018.

December 31, 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	$	—	8,819	—	—	—	330	—	693	—	9,842
2- High Quality		32,029	128,757	—	21,829	256	20,480	—	2,708	1,860	207,919
3- Good Quality		52,009	107,246	12,103	231,003	42,527	72,417	948	4,517	5,352	528,122
4- Management Attention		5,487	18,409	13,737	35,095	4,764	6,420	85	458	725	85,180
5- Watch		3,007	3,196	2,027	3,072	543	492	—	8	—	12,345
6- Substandard		64	3,048	2,926	256	—	124	—	48	—	6,466
7- Doubtful		—	—	—	—	—	—	—	—	—	—
8- Loss		—	—	—	—	—	—	—	—	—	—
Total	$	92,596	269,475	30,793	291,255	48,090	100,263	1,033	8,432	7,937	849,874

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

TDR loans modified in 2019, past due TDR loans and non-accrual TDR loans totaled $4.3 million and $4.7 million at December 31, 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 were zero and $92,000 in performing loans classified as TDR loans at December 31, 2019 and December 31, 2018, respectively.

There were no new TDR modifications during the year ended December 31, 2019.

The following table presents an analysis of loan modifications during the year ended December 31, 2018:

Year ended December 31, 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 TDR loans		2	$	94		94

During the year ended December 31, 2018, two 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, 2019 and 2018. TDR loans are deemed to be in default if they become past due by 90 days or more.