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3. Loans

3 Months Ended

Mar. 31, 2020

Major classifications of loans at March 31, 2020 and December 31, 2019 are summarized as follows:

(Dollars in thousands)
	March 31, 2020		December 31, 2019
Real estate loans:
Construction and land development	$	105,939		92,596
Single-family residential		271,489		269,475
Single-family residential -
Banco de la Gente non-traditional		29,887		30,793
Commercial		301,490		291,255
Multifamily and farmland		48,191		48,090
Total real estate loans		756,996		732,209

Loans not secured by real estate:
Commercial loans		104,221		100,263
Farm loans		1,044		1,033
Consumer loans		8,241		8,432
All other loans		10,062		7,937

Total loans		880,564		849,874

Less allowance for loan losses		8,112		6,680

Total net loans	$	872,452		843,194

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, 2020, construction and land development loans comprised approximately 12% 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, 2020, single-family residential loans comprised approximately 34% of the Bank’s total loan portfolio, and include Banco’s non-traditional single-family residential loans, which were approximately 3% 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, 2020, 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, 2020, 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, 2020 and December 31, 2019:

March 31, 2020
(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	$	1,055		—		1,055		104,884		105,939		—
Single-family residential		5,559		268		5,827		265,662		271,489		34
Single-family residential -
Banco de la Gente non-traditional		5,366		455		5,821		24,066		29,887		—
Commercial		1,526		175		1,701		299,789		301,490		—
Multifamily and farmland		—		—		—		48,191		48,191		—
Total real estate loans		13,506		898		14,404		742,592		756,996		34

Loans not secured by real estate:
Commercial loans		702		254		956		103,265		104,221		—
Farm loans		93		—		93		951		1,044		—
Consumer loans		119		3		122		8,119		8,241		—
All other loans		—		—		—		10,062		10,062		—
Total loans	$	14,420		1,155		15,575		864,989		880,564		34

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		—

The following table presents non-accrual loans as of March 31, 2020 and December 31, 2019:

(Dollars in thousands)
	March 31, 2020		December 31, 2019
Real estate loans:
Construction and land development	$	—		—
Single-family residential		1,132		1,378
Single-family residential -
Banco de la Gente non-traditional		1,946		1,764
Commercial		476		256
Total real estate loans		3,554		3,398

Loans not secured by real estate:
Commercial loans		378		122
Consumer loans		34		33
Total	$	3,966		3,553

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 $22.8 million, $21.3 million and $22.1 million at March 31, 2020, December 31, 2019 and March 31, 2019, respectively. Interest income recognized on accruing impaired loans was $329,000, $1.3 million, and $342,000 for the three months ended March 31, 2020, the year ended December 31, 2019 and the three months ended March 31, 2019, 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, 2020:

March 31, 2020
(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	$	180		—		180		180		8		182		3
Single-family residential		5,027		397		4,189		4,586		36		4,615		58
Single-family residential -
Banco de la Gente non-traditional		14,767		1,034		12,930		13,964		926		14,168		228
Commercial		3,260		—		3,243		3,243		19		2,557		29
Multifamily and farmland		—		—		—		—		—		—		—
Total impaired real estate loans		23,234		1,431		20,542		21,973		989		21,522		318

Loans not secured by real estate:
Commercial loans		702		90		606		696		35		436		9
Consumer loans		92		—		87		87		2		91		2
Total impaired loans	$	24,028		1,521		21,235		22,756		1,026		22,049		329

The following table presents impaired loans as of and for the year ended December 31, 2019:

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

Changes in the allowance for loan losses for the three months ended March 31, 2020 and 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
Three months ended March 31, 2020
Allowance for loan losses:
Beginning balance	$	694			1,274		1,073		1,305			120			688			—		138			1,388			6,680
Charge-offs		(5	)		—		—		(7	)		—			(31	)		—		(167	)		—			(210	)
Recoveries		2			16		—		23			—			25			—		55			—			121
Provision		602			423		11		478			(2	)		335			—		154			(480	)		1,521
Ending balance	$	1,293			1,713		1,084		1,799			118			1,017			—		180			908			8,112

Allowance for loan losses March 31, 2020
Ending balance: individually evaluated for impairment	$	2			6		906		9			—			29			—		—			—			952

Ending balance: collectively evaluated for impairment		1,291			1,707		178		1,790			118			988			—		180			908			7,160
Ending balance	$	1,293			1,713		1,084		1,799			118			1,017			—		180			908			8,112

Loans March 31, 2020:
Ending balance	$	105,939			271,489		29,887		301,490			48,191			104,221			1,044		18,303			—			880,564

Ending balance: individually evaluated for impairment	$	8			1,678		12,489		2,095			—			344			—		—			—			16,614

Ending balance: collectively evaluated for impairment	$	105,931			269,811		17,398		299,395			48,191			103,877			1,044		18,303			—			863,950

(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
Three months ended March 31, 2019
Allowance for loan losses:
Beginning balance	$	813	1,325		1,177		1,278	83	626		—	161		982	6,445
Charge-offs		—	(13	)	—		—	—	(1	)	—	(150	)	—	(164	)
Recoveries		1	48		—		4	—	6		—	43		—	102
Provision		17	(104	)	(3	)	10	15	(21	)	—	108		156	178
Ending balance	$	831	1,256		1,174		1,292	98	610		—	162		1,138	6,561

Allowance for loan losses March 31, 2019
Ending balance: individually
evaluated for impairment	$	—	2		1,008		13	—	—		—	—		—	1,023
Ending balance: collectively
evaluated for impairment		831	1,254		166		1,279	98	610		—	162		1,138	5,538
Ending balance	$	831	1,256		1,174		1,292	98	610		—	162		1,138	6,561

Loans March 31, 2019:
Ending balance	$	95,219	255,338		33,717		278,619	39,106	101,572		984	19,002		—	823,557

Ending balance: individually
evaluated for impairment	$	95	1,758		14,127		1,658	—	63		—	—		—	17,701
Ending balance: collectively
evaluated for impairment	$	95,124	253,580		19,590		276,961	39,106	101,509		984	19,002		—	805,856

The provision for loan losses for the three months ended March 31, 2020 was $1.5 million, compared to $178,000 for the three months ended March 31, 2019. The increase in the provision for loan losses is primarily attributable to increases in the qualitative factors applied in the Company’s Allowance for Loan and Lease Losses (“ALLL”) model due to the impact to the current economic implications and rising unemployment rate from the COVID-19 pandemic and a $57.0 million increase in loans from March 31, 2019 to March 31, 2020. The ALLL model also includes reserves on $57.4 million in loans with payment modifications made in March 2020 as a result of the COVID-19 pandemic. Loans with payment modifications associated with the COVID-19 pandemic include $51.5 million in loans secured by real estate, $5.1 million in commercial loans not secured by real estate and $764,000 in consumer loans not secured by real estate at March 31, 2020. These payment modifications are primarily interest only payments for three to six months. Loan payment modifications associated with the COVID-19 pandemic are not classified as TDR due to Section 4013 of the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”), which provides that a qualified loan modification is exempt by law from classification as a TDR pursuant to GAAP.

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 March 31, 2020 and December 31, 2019:

March 31, 2020
(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	$	65	8,378	—	—	—	353	—	672	—	9,468
2- High Quality		33,845	129,848	—	22,109	220	20,070	—	2,523	1,785	210,400
3- Good Quality		63,525	108,720	11,685	237,118	42,810	75,457	964	4,558	7,557	552,394
4- Management Attention		5,454	18,167	13,351	38,116	4,626	7,625	80	435	720	88,574
5- Watch		2,988	3,405	1,938	3,289	535	288	—	8	—	12,451
6- Substandard		62	2,971	2,913	858	—	428	—	45	—	7,277
7- Doubtful		—	—	—	—	—	—	—	—	—	—
8- Loss		—	—	—	—	—	—	—	—	—	—
Total	$	105,939	271,489	29,887	301,490	48,191	104,221	1,044	8,241	10,062	880,564

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

Current year TDR modifications, past due TDR loans and non-accrual TDR loans totaled $4.8 million and $4.3 million at March 31, 2020 and December 31, 2019, 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 in performing loans classified as TDR loans at March 31, 2020 and December 31, 2019.

There were no new TDR modifications during the three months ended March 31, 2020 and 2019.

There were no loans modified as TDR that defaulted during the three months ended March 31, 2020 and 2019, 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.