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3. Loans

3 Months Ended

Mar. 31, 2021

Major classifications of loans at March 31, 2021 and December 31, 2020 are summarized as follows:

(Dollars in thousands)

	March 31, 2021		December 31, 2020
Real estate loans:
Construction and land development	$	87,878		94,124
Single-family residential		264,356		272,325
Single-family residential -
Banco de la Gente non-traditional		26,278		26,883
Commercial		337,943		332,971
Multifamily and farmland		57,914		48,880
Total real estate loans		774,369		775,183

Loans not secured by real estate:
Commercial loans		160,892		161,740
Farm loans		860		855
Consumer loans		6,778		7,113
All other loans		3,598		3,748

Total loans		946,497		948,639

Less allowance for loan losses		9,532		9,908

Total net loans	$	936,965		938,731

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, 2021, 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 March 31, 2021, single-family residential loans comprised approximately 31% 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, 2021, commercial real estate loans comprised approximately 36% 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, 2021, commercial loans comprised approximately 17% of the Bank’s total loan portfolio, including $78.2 million in Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”) loans.

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, 2021 and December 31, 2020:

March 31, 2021

(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	$	434		—		434		87,444		87,878		—
Single-family residential		2,314		67		2,381		261,975		264,356		—
Single-family residential -
Banco de la Gente non-traditional		2,709		48		2,757		23,521		26,278		—
Commercial		713		—		713		337,230		337,943		—
Multifamily and farmland		—		—		—		57,914		57,914		—
Total real estate loans		6,170		115		6,285		768,084		774,369		—

Loans not secured by real estate:
Commercial loans		144		—		144		160,748		160,892		—
Farm loans		—		—		—		860		860		—
Consumer loans		33		2		35		6,743		6,778		—
All other loans		—		—		—		3,598		3,598		—
Total loans	$	6,347		117		6,464		940,033		946,497		—

December 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	$	298		—		298		93,826		94,124		—
Single-family residential		3,660		270		3,930		268,395		272,325		—
Single-family residential -
Banco de la Gente non-traditional		3,566		105		3,671		23,212		26,883		—
Commercial		36		—		36		332,935		332,971		—
Multifamily and farmland		—		—		—		48,880		48,880		—
Total real estate loans		7,560		375		7,935		767,248		775,183		—

Loans not secured by real estate:
Commercial loans		—		—		—		161,740		161,740		—
Farm loans		—		—		—		855		855		—
Consumer loans		45		2		47		7,066		7,113		—
All other loans		—		—		—		3,748		3,748		—
Total loans	$	7,605		377		7,982		940,657		948,639		—

The following table presents non-accrual loans as of March 31, 2021 and December 31, 2020:

(Dollars in thousands)

	March 31, 2021		December 31, 2020
Real estate loans:
Single-family residential	$	1,207		1,266
Single-family residential -
Banco de la Gente non-traditional		1,665		1,709
Commercial		429		440
Multifamily and farmland		115		117
Total real estate loans		3,416		3,532

Loans not secured by real estate:
Commercial loans		141		212
Consumer loans		9		14
Total	$	3,566		3,758

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 $20.6 million, $21.3 million and $22.8 million at March 31, 2021, December 31, 2020 and March 31, 2020, respectively. Interest income recognized on accruing impaired loans was $283,000, $1.2 million, and $329,000 for the three months ended March 31, 2021, the year ended December 31, 2020 and the three months ended March 31, 2020, 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, 2021:

March 31, 2021

(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	$	104		—		104		104		4		106		2
Single-family residential		4,837		278		4,248		4,526		30		5,490		60
Single-family residential -
Banco de la Gente non-traditional		13,162		—		12,575		12,575		843		11,832		177
Commercial		2,966		1,071		1,865		2,936		14		2,955		36
Multifamily and farmland		118		—		115		115		—		116		1
Total impaired real estate loans		21,187		1,349		18,907		20,256		891		20,499		276

Loans not secured by real estate:
Commercial loans		430		141		231		372		4		413		6
Consumer loans		24		—		19		19		—		28		1
Total impaired loans	$	21,641		1,490		19,157		20,647		895		20,940		283

The following table presents impaired loans as of and for the year ended December 31, 2020:

December 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	$	108		—		108		108		4		134		8
Single-family residential		5,302		379		4,466		4,845		33		4,741		262
Single-family residential -
Banco de la Gente non-traditional		13,417		—		12,753		12,753		862		13,380		798
Commercial		2,999		1,082		1,891		2,973		14		2,940		139
Multifamily and farmland		119		—		117		117		—		29		6
Total impaired real estate loans		21,945		1,461		19,335		20,796		913		21,224		1,213

Loans not secured by real estate:
Commercial loans		515		211		244		455		5		564		32
Consumer loans		41		—		37		37		1		60		5
Total impaired loans	$	22,501		1,672		19,616		21,288		919		21,848		1,250

Impaired loans collectively evaluated for impairment totaled $5.8 million and $6.1 million at March 31, 2021 and 2020, respectively.

The following tables present changes in the allowance for loan losses for the three months ended March 31, 2021 and 2020. PPP loans are excluded from the allowance for loan losses as PPP loans are 100 percent guaranteed by the SBA.

(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, 2021
Allowance for loan losses:
Beginning balance	$	1,196		1,843		1,052		2,212	122	1,345		—	128		2,010		9,908
Charge-offs		—		—		—		—	—	—		—	(85	)	—		(85	)
Recoveries		50		60		—		12	—	3		—	39		—		164
Provision		(185	)	(53	)	(19	)	28	23	(104	)	—	9		(154	)	(455	)
Ending balance	$	1,061		1,850		1,033		2,252	145	1,244		—	91		1,856		9,532

Allowance for loan losses March 31, 2021
Ending balance: individually
evaluated for impairment	$	2		4		826		8	—	—		—	—		—		840
Ending balance: collectively
evaluated for impairment		1,059		1,846		207		2,244	145	1,244		—	91		1,856		8,692
Ending balance	$	1,061		1,850		1,033		2,252	145	1,244		—	91		1,856		9,532

Loans March 31, 2021:
Ending balance	$	87,878		264,356		26,278		337,943	57,914	160,892		860	10,376		—		946,497

Ending balance: individually
evaluated for impairment	$	7		1,444		11,193		2,098	—	141		—	—		—		14,883
Ending balance: collectively
evaluated for impairment	$	87,871		262,912		15,085		335,845	57,914	160,751		860	10,376		—		931,614

(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

The provision for loan losses for the three months ended March 31, 2021 was a credit of $455,000, compared to an expense of $1.5 million for the three months ended March 31, 2020. The decrease in the provision for loan losses is primarily attributable to a decrease in reserves on loans with payment modifications made as a result of the COVID-19 pandemic and a decrease in reserves due to generally flat volumes of loans in the general reserve pools. At March 31, 2021, the balance of loans with existing modifications as a result of COVID-19 was $1.9 million, of which $602,000 represents the balance of loans under the terms of a first modification and $1.3 million represents the balance of outstanding loans under the terms of a second or third modification. At December 31, 2020, the balance of loans with existing modifications as a result of COVID-19 was $18.3 million. The Company continues to track all loans that are currently modified or have been modified as a result of COVID-19. At March 31, 2021, the balance for all loans that are currently modified or previously modified but have returned to their original terms was $114.8 million. The loan balances associated with COVID-19 related modifications have been grouped into their own pool within the Company’s Allowance for Loan and Lease Losses (“ALLL”) model as they have a higher likelihood of risk, and a higher reserve rate has been applied to that pool. Of all loans modified as a result of COVID-19, $112.9 million have returned to their original terms; however, the effects of stimulus in the current environment are still unknown, and additional losses may be present in loans that are currently modified and/or loans that were once modified. These payment modifications are primarily interest only payments for three to nine months. Loans with COVID-19 related payment modifications that have reverted to their original terms are still included with reserves associated with COVID-19 payment modifications at March 31, 2021. There is still uncertainty about the ongoing and future effects of national and local policy decisions on these borrowers that could still limit their ability to adhere to their original payment terms. At December 31, 2020, the balance for all loans that were then currently modified or previously modified but returned to their original terms was $119.6 million. 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 (the “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, 2021 and December 31, 2020:

March 31, 2021

(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	$	—	5,196	—	—	—	436	—	701	—	6,333
2- High Quality		10,147	113,727	—	39,402	20	16,955	—	2,150	1,486	183,887
3- Good Quality		71,651	119,255	9,856	249,646	54,014	132,296	839	3,540	1,420	642,517
4- Management Attention		3,413	19,477	11,998	37,337	3,196	8,761	21	345	692	85,240
5- Watch		2,586	3,633	1,883	10,684	569	2,248	—	5	—	21,608
6- Substandard		81	3,068	2,541	874	115	196	—	37	—	6,912
7- Doubtful		—	—	—	—	—	—	—	—	—	—
8- Loss		—	—	—	—	—	—	—	—	—	—
Total	$	87,878	264,356	26,278	337,943	57,914	160,892	860	6,778	3,598	946,497

December 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	$	228	9,867	—	—	—	406	—	678	—	11,179
2- High Quality		9,092	121,331	—	40,569	22	19,187	—	2,237	1,563	194,001
3- Good Quality		76,897	115,109	10,170	241,273	44,890	128,727	832	3,826	1,477	623,201
4- Management Attention		4,917	20,012	12,312	39,370	3,274	11,571	23	336	708	92,523
5- Watch		2,906	2,947	1,901	10,871	694	1,583	—	6	—	20,908
6- Substandard		84	3,059	2,500	888	—	266	—	30	—	6,827
7- Doubtful		—	—	—	—	—	—	—	—	—	—
8- Loss		—	—	—	—	—	—	—	—	—	—
Total	$	94,124	272,325	26,883	332,971	48,880	161,740	855	7,113	3,748	948,639

Current year TDR modifications, past due TDR loans and non-accrual TDR loans totaled $3.4 million and $3.8 million at March 31, 2021 and December 31, 2020, 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, 2021 and December 31, 2020.

There were no new TDR modifications during the three months ended March 31, 2021 and 2020.

There were no loans modified as TDR that defaulted during the three months ended March 31, 2021 and 2020, 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.

On March 27, 2020, President Trump signed the CARES Act, which established a $2 trillion economic stimulus package, including cash payments to individuals, supplemental unemployment insurance benefits and a $349 billion loan program administered through the PPP. Under the PPP, small businesses, sole proprietorships, independent contractors and self-employed individuals may apply for loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria. A second round of PPP funding, signed into law by President Trump on April 24, 2020, provided $320 billion additional funding for the PPP. The Bank is participating as a lender in the PPP. Total PPP loans originated as of March 31, 2021 amounted to $124.8 million. The outstanding balance of PPP loans was $78.2 million at March 31, 2021. The Bank has received $5.1 million in fees from the SBA for PPP loans originated as of March 31, 2021. The Bank has recognized PPP loan fee income totaling $2.4 million, including $999,000 PPP fee income recognized during the three months ended March 31, 2021.