10-Q 1 form10qforjune302015.htm FORM 10-Q FOR JUNE 30, 2015 form10qforjune302015.htm
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
     
 
FORM 10-Q
 
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended:      June 30, 2015
 
OR
 
[   ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from __________ to __________
 
PEOPLES BANCORP OF NORTH CAROLINA, INC.
(Exact name of registrant as specified in its charter)
 
North Carolina
(State or other jurisdiction of incorporation or organization)
 
000-27205
56-2132396
(Commission File No.)
(IRS Employer Identification No.)
 
518 West C Street, Newton, North Carolina
28658
(Address of principal executive offices)
(Zip Code)
 
(828) 464-5620
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
Yes
 
No
   
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). 
 
Yes
 X  
No
   
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.  (Check one):
 
Large Accelerate Filer
   
Accelerated Filer
   
Non-Accelerated Filer
   
 
Smaller Reporting Company
X
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2 of the Exchange Act).
 
Yes
   
No
  X  
 
Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date.
5,540,838 shares of common stock, outstanding at July 31, 2015.
 
 
 
 

 
 
 
INDEX
       
PART I.
FINANCIAL INFORMATION
PAGE(S)
       
Item 1.
 
Financial Statements
 
       
   
Consolidated Balance Sheets at June 30, 2015 (Unaudited) and December
 
   
31, 2014 (Audited)
3
       
   
Consolidated Statements of Earnings for the three and six months ended
 
   
June 30, 2015 and 2014 (Unaudited)
4
       
   
Consolidated Statements of Comprehensive Income for the three and six
 
   
months ended June 30, 2015 and 2014 (Unaudited)
5
       
   
Consolidated Statements of Cash Flows for the six months ended June 30,
 
   
2015 and 2014 (Unaudited)
6-7
       
   
Notes to Consolidated Financial Statements (Unaudited)
8-22
       
Item 2.
 
Management's Discussion  and Analysis of Financial Condition
 
   
and Results of Operations
23-35
       
Item 3.
 
Quantitative and Qualitative Disclosures About Market Risk
36
       
Item 4T.
 
Controls and Procedures
37
       
PART II.
OTHER INFORMATION
 
       
Item 1.
 
Legal Proceedings
38
Item 1A.
 
Risk Factors
38
Item 2.
 
Unregistered Sales of Equity Securities and Use of Proceeds
38
Item 3.
 
Defaults upon Senior Securities
38
Item 5.
 
Other Information
38
Item 6.
 
Exhibits
38-41
Signatures
 
42
Certifications
 
43-45

 
Statements made in this Form 10-Q, other than those concerning historical information, should be considered forward-looking statements pursuant to the safe harbor provisions of the Securities Exchange Act of 1934 and the Private Securities Litigation Act of 1995.  These forward-looking statements involve risks and uncertainties and are based on the beliefs and assumptions of management and on the information available to management at the time that this Form 10-Q was prepared.  These statements can be identified by the use of words like “expect,” “anticipate,” “estimate,” and “believe,” variations of these words and other similar expressions.  Readers should not place undue reliance on forward-looking statements as a number of important factors could cause actual results to differ materially from those in the forward-looking statements.  Factors that could cause actual results to differ  include, but are not limited to, (1) competition in the markets served by Peoples Bank, (2) changes in the interest rate environment, (3) general national, regional or local economic conditions may be less favorable than expected, resulting in, among other things, a deterioration in credit quality and the possible impairment of collectibility of loans, (4) legislative or regulatory changes, including changes in accounting standards, (5) significant changes in the federal and state legal and regulatory environments and tax laws, (6) the impact of changes in monetary and fiscal policies, laws, rules and regulations and (7) other risks and factors identified in other filings with the Securities and Exchange Commission, including but not limited to, those described in Peoples Bancorp of North Carolina, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2014.


 
2

 
 
 
PART I.
FINANCIAL INFORMATION
   
Item 1.
Financial Statements
 
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES
 
Consolidated Balance Sheets
         
June 30, 2015 and December 31, 2014
         
(Dollars in thousands)
 
June 30,
 
December 31,
Assets
2015
 
2014
 
(Unaudited)
 
(Audited)
         
Cash and due from banks, including reserve requirements
$ 45,725     51,213  
of $12,390 and $12,569
           
Interest-bearing deposits
  9,954     17,885  
Cash and cash equivalents
  55,679     69,098  
             
Investment securities available for sale
  273,469     281,099  
Other investments
  3,911     4,031  
Total securities
  277,380     285,130  
             
Mortgage loans held for sale
  2,063     1,375  
             
Loans
  666,767     651,891  
Less allowance for loan losses
  (10,378 )   (11,082 )
Net loans
  656,389     640,809  
             
Premises and equipment, net
  16,503     17,000  
Cash surrender value of life insurance
  14,333     14,125  
Other real estate
  3,424     2,016  
Accrued interest receivable and other assets
  11,440     10,941  
Total assets
$ 1,037,211     1,040,494  
             
Liabilities and Shareholders' Equity
           
             
Deposits:
           
Noninterest-bearing demand
$ 216,475     210,758  
NOW, MMDA & savings
  417,026     407,504  
Time, $250,000 or more
  33,252     47,872  
Other time
  142,048     148,566  
Total deposits
  808,801     814,700  
             
Securities sold under agreements to repurchase
  48,285     48,430  
FHLB borrowings
  50,000     50,000  
Junior subordinated debentures
  20,619     20,619  
Accrued interest payable and other liabilities
  9,120     8,080  
Total liabilities
  936,825     941,829  
             
Commitments
           
             
Shareholders' equity:
           
Series A preferred stock, $1,000 stated value; authorized
           
5,000,000 shares; no shares issued and outstanding
  -       -    
Common stock, no par value; authorized
           
20,000,000 shares; issued and outstanding 5,540,838
           
shares at 6/30/15, and 5,612,588 shares at 12/31/14
  46,748     48,088  
Retained earnings
  49,397     45,124  
Accumulated other comprehensive income
  4,241     5,453  
Total shareholders' equity
  100,386     98,665  
             
Total liabilities and shareholders' equity
$ 1,037,211     1,040,494  
             
See accompanying Notes to Consolidated Financial Statements.
           
 
 
 
3

 
 
 
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES
                 
Consolidated Statements of Earnings
                 
Three and Six Months Ended June 30, 2015 and 2014
                 
(Dollars in thousands, except per share amounts)
                 
 
Three months ended
 
Six months ended
 
 
June 30,
 
June 30,
 
 
2015
 
2014
 
2015
 
2014
 
 
(Unaudited)
 
(Unaudited)
 
(Unaudited)
 
(Unaudited)
 
Interest income:
               
Interest and fees on loans
$ 7,333     7,491     14,926     14,893  
Interest on due from banks
  7     12     17     24  
Interest on investment securities:
                       
U.S. Government sponsored enterprises
  613     804     1,326     1,651  
States and political subdivisions
  1,157     1,169     2,320     2,346  
Other
  81     100     169     207  
Total interest income
  9,191     9,576     18,758     19,121  
                         
Interest expense:
                       
NOW, MMDA & savings deposits
  106     125     218     251  
Time deposits
  226     303     474     637  
FHLB borrowings
  433     549     851     1,094  
Junior subordinated debentures
  99     97     196     193  
Other
  11     11     20     21  
Total interest expense
  875     1,085     1,759     2,196  
                         
Net interest income
  8,316     8,491     16,999     16,925  
                         
Provision for (reduction of provision for) loan losses
  (214 )   67     (41 )   (282 )
                         
Net interest income after provision for loan losses
  8,530     8,424     17,040     17,207  
                         
Non-interest income:
                       
Service charges
  1,171     1,223     2,305     2,352  
Other service charges and fees
  190     260     545     679  
Gain on sale of securities
  -     -     -     26  
Mortgage banking income
  271     188     510     292  
Insurance and brokerage commissions
  203     162     365     361  
Gain/(loss) on sale and write-down of
                       
 other real estate
  79     12     166     (150 )
Miscellaneous
  1,383     1,265     2,651     2,392  
Total non-interest income
  3,297     3,110     6,542     5,952  
                         
Non-interest expense:
                       
Salaries and employee benefits
  4,286     4,207     9,086     8,483  
Occupancy
  1,482     1,466     2,966     2,988  
    Professional fees   276     239     506     445  
    Advertising and marketing   218     186     403     359  
    Debit card expense   246     224     482     442  
    FDIC insurance   172     182     348     396  
Other
  1,657     1,563     3,294     3,078  
Total non-interest expense
  8,337     8,067     17,085     16,191  
                         
Earnings before income taxes
  3,490     3,467     6,497     6,968  
                         
Income tax expense
  866     916     1,545     1,838  
                         
Net earnings
$ 2,624     2,551     4,952     5,130  
                         
Basic net earnings per share
$ 0.47     0.45     0.89     0.91  
Diluted net earnings per share
$ 0.47     0.45     0.88     0.91  
Cash dividends declared per share
$ 0.06     0.04     0.12     0.08  
                         
See accompanying Notes to Consolidated Financial Statements.
                   
 
 
 
4

 
 
 
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES
                 
Consolidated Statements of Comprehensive Income
                 
Three and Six Months Ended June 30, 2015 and 2014
                 
 (Dollars in thousands)
                 
 
Three months ended
 
Six months ended
 
 
June 30,
 
June 30,
 
 
2015
 
2014
 
2015
 
2014
 
 
(Unaudited)
 
(Unaudited)
 
(Unaudited)
 
(Unaudited)
 
                 
Net earnings
$ 2,624     2,551     4,952     5,130  
                         
Other comprehensive income (loss):
                       
Unrealized holding (losses) gains on securities
                       
available for sale
  (3,399 )   3,726     (1,985 )   7,586  
Reclassification adjustment for gains on
                       
securities available for sale
                       
included in net earnings
  -        -        -        (26 )
                         
Total other comprehensive (loss) income,
                       
before income taxes
  (3,399 )   3,726     (1,985 )   7,560  
                         
Income tax (benefit) expense related to other
                       
comprehensive (loss) income:
                       
                         
Unrealized holding (losses) gains on securities
                       
available for sale
  (1,324 )   1,451     (773 )   2,954  
Reclassification adjustment for gains
                       
on securities available for sale
                       
included in net earnings
  -        -        -        (10 )
                         
Total income tax expense (benefit) related to
                       
other comprehensive income (loss)
  (1,324 )   1,451     (773 )   2,944  
                         
Total other comprehensive (loss) income,
                       
net of tax
  (2,075 )   2,275     (1,212 )   4,616  
                         
Total comprehensive income
$ 549     4,826     3,740     9,746  
                         
See accompanying Notes to Consolidated Financial Statements.
                   
 
 
 
5

 
 
 
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES
         
Consolidated Statements of Cash Flows
         
Six Months Ended June 30, 2015 and 2014
         
(Dollars in thousands)
         
 
2015
 
2014
 
 
(Unaudited)
 
(Unaudited)
 
         
Cash flows from operating activities:
       
Net earnings
$ 4,952     5,130  
Adjustments to reconcile net earnings to
           
net cash provided by operating activities:
           
Depreciation, amortization and accretion
  3,000     3,258  
Provision for (reduction of provision for) loan losses
  (41 )   (282 )
Gain on sale of investment securities
  -       (26 )
(Gain)/loss on sale of other real estate
  (183 )   (2 )
Write-down of other real estate
  17     152  
Restricted stock expense
  218     167  
            Originations of mortgage loans held for sale   (24,478 )   (17,636 )
            Sales of mortgage loans held for sale   23,790     16,084  
Change in:
           
Cash surrender value of life insurance
  (208 )   (208 )
Other assets
  56     (2,274 )
Other liabilities
  1,040     2,877  
             
Net cash provided by operating activities
  8,163     7,240  
             
Cash flows from investing activities:
           
Purchases of investment securities available for sale
  (10,485 )   (13,070 )
Proceeds from calls, maturities and paydowns of investment securities
           
available for sale
  14,233     18,415  
Proceeds from sales of investment securities available for sale
  -       677  
Purchases of FHLB stock
  (5 )   -    
FHLB stock redemption
  125     284  
Net change in loans
  (19,362 )   (15,978 )
Purchases of premises and equipment
  (606 )   (1,372 )
Proceeds from sales of other real estate and repossessions
  2,581     1,554  
             
Net cash used by investing activities
  (13,519 )   (9,490 )
             
Cash flows from financing activities:
           
Net change in deposits
  (5,899 )   12,118  
Net change in securities sold under agreements to repurchase
  (145 )   1,368  
Proceeds from FHLB borrowings
  20,000     -    
Repayments of FHLB borrowings
  (20,000 )   -    
Preferred stock repurchase
  -       (12,524 )
Stock options exercised
  -       37  
Common stock repurchased
  (1,340 )   -    
Cash dividends paid on common stock
  (679 )   (454 )
             
Net cash (used) provided by financing activities
  (8,063 )   545  
             
Net change in cash and cash equivalents
  (13,419 )   (1,705 )
             
Cash and cash equivalents at beginning of period
  69,098     76,773  
             
Cash and cash equivalents at end of period
$ 55,679     75,068  
 
 
 
6

 
 
 
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES
           
Consolidated Statements of Cash Flows, continued
           
Six Months Ended June 30, 2015 and 2014
           
(Dollars in thousands)
           
           
 
2015
   
2014
 
 
(Unaudited)
   
(Unaudited)
 
           
Supplemental disclosures of cash flow information:
         
Cash paid during the period for:
         
Interest
$ 1,747     2,217  
Income taxes
$ 749     827  
             
Noncash investing and financing activities:
           
Change in unrealized gain on investment securities
           
 available for sale, net
$ (1,212 )   4,616  
Transfers of loans to other real estate and repossessions
$ 3,823     3,288  
Financed portion of sales of other real estate
$ -       230  
             
See accompanying Notes to Consolidated Financial Statements.
           
 
 
 
7

 
 
 
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

(1)
    Summary of Significant Accounting Policies

The consolidated financial statements include the financial statements of Peoples Bancorp of North Carolina, Inc. and its wholly owned subsidiaries, Peoples Bank (the “Bank”) and Community Bank Real Estate Solutions, LLC, along with the Bank’s wholly owned subsidiaries, Peoples Investment Services, Inc., Real Estate Advisory Services, Inc. ("REAS") and PB Real Estate Holdings, LLC (collectively called the “Company”).  All significant intercompany balances and transactions have been eliminated in consolidation.

The Bank operates four offices focused on the Latino population under the name Banco de la Gente.  These offices are operated as a division of the Bank.  Banco de la Gente offers normal and customary banking services as are offered in the Bank's other branches such as the taking of deposits and the making of loans and therefore is not considered a reportable segment of the Company.
 
The consolidated financial statements in this report (other than the Consolidated Balance Sheet at December 31, 2014) are unaudited.  In the opinion of management, all adjustments (none of which were other than normal accruals) necessary for a fair presentation of the financial position and results of operations for the periods presented have been included.  Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with generally accepted accounting principles in the United States (“GAAP”).  Actual results could differ from those estimates.

The Company’s accounting policies are fundamental to understanding management’s discussion and analysis of results of operations and financial condition.  Many of the Company’s accounting policies require significant judgment regarding valuation of assets and liabilities and/or significant interpretation of the specific accounting guidance.  A description of the Company’s significant accounting policies can be found in Note 1 of the Notes to Consolidated Financial Statements in the Company’s 2014 Annual Report to Shareholders which is Appendix A to the Proxy Statement for the May 7, 2015 Annual Meeting of Shareholders.

Recently Issued Accounting Pronouncements
In January 2015, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2015-01, (Subtopic 225-20):  Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items.  ASU No. 2015-01 eliminates the concept of extraordinary items from GAAP.  ASU No. 2015-01 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015.  The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.

In February 2015, FASB issued ASU No. 2015-02, (Topic 810):  Amendments to the Consolidation Analysis.  ASU No. 2015-02 provides amendments to respond to stakeholders’ concerns about the current accounting for consolidation of certain legal entities.  Stakeholders expressed concerns that GAAP might require a reporting entity to consolidate another legal entity in situations in which the reporting entity’s contractual rights do not give it the ability to act primarily on its own behalf, the reporting entity does not hold a majority of the legal entity’s voting rights, or the reporting entity is not exposed to a majority of the legal entity’s economic benefits or obligations.  ASU No. 2015-02 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015.  The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
 
In June 2015, FASB issued ASU No. 2015-10, Technical Corrections and Improvements.  ASU No. 2015-10 contains amendments to clarify the Accounting Standards Codification (ASC), correct unintended application of guidance, and make minor improvements to the ASC that are not expected to have a significant effect on current accounting practice or create a significant administrative cost to most entities. The amendments were effective upon issuance (June 12, 2015) for amendments that do not have transition guidance. Amendments that are subject to transition guidance will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted, including adoption in an interim period.  The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
 
 
8

 

Other accounting standards that have been issued or proposed by FASB or other standards-setting bodies are not expected to have a material impact on the Company’s results of operations, financial position or disclosures.

(2)
    Investment Securities

Investment securities available for sale at June 30, 2015 and December 31, 2014 are as follows:
 
(Dollars in thousands)
             
 
June 30, 2015
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
Mortgage-backed securities
$ 80,685   1,969   9   82,645
U.S. Government
               
sponsored enterprises
  38,934   380   143   39,171
State and political subdivisions
  143,458   4,696   712   147,442
Corporate bonds
  1,947   12   5   1,954
Trust preferred securities
  750   -     -     750
Equity securities
  748   759   -     1,507
Total
$ 266,522   7,816   869   273,469
 
(Dollars in thousands)
             
 
December 31, 2014
 
Amortized
Cost
 
Gross
 Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
Mortgage-backed securities
$ 88,496   1,766   52   90,210
U.S. Government
               
sponsored enterprises
  33,766   418   136   34,048
State and political subdivisions
  145,938   6,534   226   152,246
Corporate bonds
  2,469   16   18   2,467
Trust preferred securities
  750   -     -     750
Equity securities
  748   630   -     1,378
Total
$ 272,167   9,364   432   281,099
 
The current fair value and associated unrealized losses on investments in securities with unrealized losses at June 30, 2015 and December 31, 2014 are summarized in the tables below, with the length of time the individual securities have been in a continuous loss position.
 
(Dollars in thousands)
                     
 
June 30, 2015
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
Mortgage-backed securities
$ 4,705   9   -     -     4,705   9
U.S. Government
                       
sponsored enterprises
  6,462   53   9,316   90   15,778   143
State and political subdivisions
  30,553   459   6,612   253   37,165   712
Corporate bonds
  -     -     527   5   527   5
Total
$ 41,720   521   16,455   348   58,175   869
 
 
 
9

 

 
(Dollars in thousands)
                     
 
December 31, 2014
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
Mortgage-backed securities
$ 436   1   2,963   51   3,399   52
U.S. Government
                       
sponsored enterprises
  2,996   4   9,850   132   12,846   136
State and political subdivisions
  567   1   14,998   225   15,565   226
Corporate bonds
  -   -   525   18   525   18
Total
$ 3,999   6   28,336   426   32,335   432
 
At June 30, 2015, unrealized losses in the investment securities portfolio relating to debt securities totaled $869,000.  The unrealized losses on these debt securities arose due to changing interest rates and are considered to be temporary.  From the June 30, 2015 tables above, 41 out of 173 securities issued by state and political subdivisions contained unrealized losses, nine out of 79 securities issued by U.S. Government sponsored enterprises, including mortgage-backed securities, contained unrealized losses, and one out of three securities issued by corporations contained unrealized losses.  These unrealized losses are considered temporary because of acceptable financial condition and results of operations of entities that issued each security and the repayment sources of principal and interest on U.S. Government sponsored enterprises, including mortgage-backed securities, are government backed.

The amortized cost and estimated fair value of investment securities available for sale at June 30, 2015, by contractual maturity, are shown below. Expected maturities of mortgage-backed securities will differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
 
June 30, 2015
     
(Dollars in thousands)
     
 
Amortized
 Cost
 
Estimated
Fair Value
Due within one year
$ 5,058   5,073
Due from one to five years
  54,229   56,563
Due from five to ten years
  110,910   112,421
Due after ten years
  14,892   15,260
Mortgage-backed securities
  80,685   82,645
Equity securities
  748   1,507
Total
$ 266,522   273,469
 
No securities available for sale were sold during the six months ended June 30, 2015.  Proceeds from sales of securities available for sale during the six months ended June 30, 2014 were $677,000 and resulted in gross gains of $26,000.
 
Securities with a fair value of approximately $89.9 million and $89.9 million at June 30, 2015 and December 31, 2014, respectively, were pledged to secure public deposits and for other purposes as required by law.
 
 
10

 
 

(3)
    Loans

Major classifications of loans at June 30, 2015 and December 31, 2014 are summarized as follows:
 
(Dollars in thousands)
     
 
June 30, 2015
 
December 31, 2014
Real estate loans:
     
Construction and land development
$ 60,066   57,617
Single-family residential
  208,653   206,417
Single-family residential -
       
Banco de la Gente stated income
  45,252   47,015
Commercial
  231,684   228,558
Multifamily and farmland
  12,402   12,400
Total real estate loans
  558,057   552,007
         
Loans not secured by real estate:
       
Commercial loans
  85,124   76,262
Farm loans
  4   7
Consumer loans
  10,069   10,060
All other loans
  13,513   13,555
         
Total loans
  666,767   651,891
         
Less allowance for loan losses
  10,378   11,082
         
Total net loans
$ 656,389   640,809
 
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, Union, 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 June 30, 2015, 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 June 30, 2015, single-family residential loans comprised approximately 38% of the Bank’s total loan portfolio, and include Banco de la Gente single-family residential stated income loans, which were approximately 7% 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 June 30, 2015, commercial real estate loans comprised approximately 35% 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 June 30, 2015, commercial loans comprised approximately 13% of the Bank’s total loan portfolio.
 
 
 
11

 
 
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 June 30, 2015 and December 31, 2014:
 
June 30, 2015
                     
(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
$ 313   227   540   59,526   60,066   -  
Single-family residential
  1,869   641   2,510   206,143   208,653   100
Single-family residential -
                       
Banco de la Gente stated income
  999   205   1,204   44,048   45,252   -   
Commercial
  36   326   362   231,322   231,684   -   
Multifamily and farmland
  -     -     -     12,402   12,402   -   
Total real estate loans
  3,217   1,399   4,616   553,441   558,057   100
                         
Loans not secured by real estate:
                       
Commercial loans
  69   5   74   85,050   85,124   -   
Farm loans
  -     -     -     4   4   -   
Consumer loans
  150   9   159   9,910   10,069   -   
All other loans
  -     -     -     13,513   13,513   -   
Total loans
$ 3,436   1,413   4,849   661,918   666,767   100
 
December 31, 2014
                     
(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
$ 294   3,540   3,834   53,783   57,617   -  
Single-family residential
  5,988   268   6,256   200,161   206,417   -  
Single-family residential -
                       
Banco de la Gente stated income
  8,998   610   9,608   37,407   47,015   -  
Commercial
  3,205   366   3,571   224,987   228,558   -  
Multifamily and farmland
  85   -     85   12,315   12,400   -  
Total real estate loans
  18,570   4,784   23,354   528,653   552,007   -  
                         
Loans not secured by real estate:
                       
Commercial loans
  241   49   290   75,972   76,262   -  
Farm loans
  -     -     -     7   7   -  
Consumer loans
  184   -     184   9,876   10,060   -  
All other loans
  -     -     -     13,555   13,555   -  
Total loans
$ 18,995   4,833   23,828   628,063   651,891   -  
 
 
 
12

 
 
The following table presents the Company’s non-accrual loans as of June 30, 2015 and December 31, 2014:
 
(Dollars in thousands)
     
 
June 30, 2015
 
December 31, 2014
Real estate loans:
     
Construction and land development
$ 546   3,854
Single-family residential
  3,171   2,370
Single-family residential -
       
Banco de la Gente stated income
  1,062   1,545
Commercial
  2,641   2,598
Multifamily and farmland
  -     110
Total real estate loans
  7,420   10,477
         
Loans not secured by real estate:
       
Commercial loans
  109   176
Consumer loans
  67   75
Total
$ 7,596   10,728
 
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 $26.2 million, $25.6 million and $27.7 million at June 30, 2015, December 31, 2014 and June 30, 2014, respectively.  Interest income recognized on accruing impaired loans was $662,000, $681,000 and $1.3 million for the six months ended June 30, 2015, the six months ended June 30, 2014 and the year ended December 31, 2014, respectively.  Interest income recognized on accruing impaired loans was $327,000 and $325,000 for the three months ended June 30, 2015 and 2014, respectively.  No interest income is recognized on non-accrual impaired loans subsequent to their classification as non-accrual.

The following tables present the Company’s impaired loans as of June 30, 2015 and December 31, 2014:
 
June 30, 2015
             
(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
Real estate loans:
                     
Construction and land development
$ 1,083   241   627   868   44   1,992
Single-family residential
  8,396   1,606   6,442   8,048   176   8,535
Single-family residential -
                       
Banco de la Gente stated income
  20,375   -     19,798   19,798   1,167   19,421
Commercial
  4,797   1,753   2,626   4,379   243   4,404
Multifamily and farmland
  101   -     98   98   -     103
Total impaired real estate loans
  34,752   3,600   29,591   33,191   1,630   34,455
                         
Loans not secured by real estate:
                       
Commercial loans
  159   -     133   133   2   156
Consumer loans
  296   -     288   288   5   304
Total impaired loans
$ 35,207   3,600   30,012   33,612   1,637   34,915
 
 
 
13

 
 
 
December 31, 2014
                   
(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
Real estate loans:
                     
Construction and land development
$ 5,481   3,639   555   4,194   31   5,248
Single-family residential
  6,717   933   5,540   6,473   154   7,430
Single-family residential -
                       
Banco de la Gente stated income
  21,243   -   20,649   20,649   1,191   19,964
Commercial
  4,752   1,485   2,866   4,351   272   4,399
Multifamily and farmland
  111   -   110   110   1   154
Total impaired real estate loans
  38,304   6,057   29,720   35,777   1,649   37,195
                         
Loans not secured by real estate:
                       
Commercial loans
  218   -   201   201   4   641
Farm loans (non RE)
          -            
Consumer loans
  318   -   313   313   5   309
All other loans (not secured by real estate)
  -   -   -   -   -   -
Total impaired loans
$ 38,840   6,057   30,234   36,291   1,658   38,145
 
Changes in the allowance for loan losses for the three and six months ended June 30, 2015 and 2014 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
 
Six months ended June 30, 2015
                                     
Allowance for loan losses:
                                       
Beginning balance
$ 2,785   2,566   1,610   1,902   7   1,098   -   233   881   11,082  
Charge-offs
  (73 ) (400 ) (59 ) (62 ) -   (15 ) -   (253 ) -   (862 )
Recoveries
  23   10   22   10   -   53   -   81   -   199  
Provision
  189   280   (45 ) (101 ) (5 ) (234 ) -   170   (295 ) (41 )
Ending balance
$ 2,924   2,456   1,528   1,749   2   902   -   231   586   10,378  
                                           
Three months ended June 30, 2015
                                     
Allowance for loan losses:
                                         
Beginning balance
$ 2,758   2,599   1,586   1,786   6   1,181   -   208   719   10,843  
Charge-offs
  -   (109 ) (17 ) (59 ) -   (15 ) -   (132 ) -   (332 )
Recoveries
  18   4   -   5   -   17   -   37   -   81  
Provision
  148   (38 ) (41 ) 17   (4 ) (281 ) -   118   (133 ) (214 )
Ending balance
$ 2,924   2,456   1,528   1,749   2   902   -   231   586   10,378  
                                           
Allowance for loan losses June 30, 2015:
                                     
Ending balance: individually
                                         
evaluated for impairment
$ -   92   1,135   235   -   -   -   -   -   1,462  
Ending balance: collectively
                                         
evaluated for impairment
  2,924   2,364   393   1,514   2   902   -   231   586   8,916  
Ending balance
$ 2,924   2,456   1,528   1,749   2   902   -   231   586   10,378  
                                           
Loans June 30, 2015:
                                         
Ending balance
$ 60,066   208,653   45,252   231,684   12,402   85,124   4   23,582   -   666,767  
                                           
Ending balance: individually
                                         
evaluated for impairment
$ 241   2,998   18,346   3,575   -   -   -   -   -   25,160  
Ending balance: collectively
                                         
evaluated for impairment
$ 59,825   205,655   26,906   228,109   12,402   85,124   4   23,582   -   641,607  
 
 
 
14

 
 
 
(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
 
Six months ended June 30, 2014
                                     
Allowance for loan losses:
                                       
Beginning balance
$ 3,218   3,123   1,863   2,219   37   1,069   -   245   1,727   13,501  
Charge-offs
  (260 ) (194 ) (140 ) (131 ) -   (193 ) -   (254 ) -   (1,172 )
Recoveries
  282   60   17   161   -   26   -   82   -   628  
Provision
  147   (141 ) (32 ) (410 ) (30 ) 179   -   180   (175 ) (282 )
Ending balance
$ 3,387   2,848   1,708   1,839   7   1,081   -   253   1,552   12,675  
                                           
Three months ended June 30, 2014
                                     
Allowance for loan losses:
                                         
Beginning balance
$ 3,133   3,132   1,767   2,196   36   945   -   230   1,539   12,978  
Charge-offs
  -   (171 ) (108 ) (20 ) -   (181 ) -   (117 ) -   (597 )
Recoveries
  3   52   5   101   -   21   -   45   -   227  
Provision
  251   (165 ) 44   (438 ) (29 ) 296   -   95   13   67  
Ending balance
$ 3,387   2,848   1,708   1,839   7   1,081   -   253   1,552   12,675  
                                           
Allowance for loan losses June 30, 2014:
                                     
Ending balance: individually
                                         
evaluated for impairment
$ -   67   1,175   -   -   242   -   -   -   1,484  
Ending balance: collectively
                                         
evaluated for impairment
  3,387   2,781   533   1,839   7   839   -   253   1,552   11,191  
Ending balance
$ 3,387   2,848   1,708   1,839   7   1,081   -   253   1,552   12,675  
                                           
Loans June 30, 2014:
                                         
Ending balance
$ 59,843   196,192   48,165   214,378   11,821   78,056   93   24,788   -   633,336  
                                           
Ending balance: individually
                                         
evaluated for impairment
$ 5,297   2,325   19,287   -   -   3,307   -   250   -   30,466  
Ending balance: collectively
                                         
evaluated for impairment
$ 54,546   193,867   28,878   214,378   11,821   74,749   93   24,538   -   602,870  
 
The provision for loan losses for the three months ended June 30, 2015 was a credit of $214,000, as compared to an expense of $67,000 for the three months ended June 30, 2014.  The decrease in the provision for loan losses is primarily attributable to a $3.3 million reduction in non-accrual loans from June 30, 2014 to June 30, 2015 and a $119,000 reduction in net charge-offs during the three months ended June 30, 2015, as compared to the same period one year ago.

The provision for loan losses for the six months ended June 30, 2015 was a credit of $41,000, as compared to a credit of $282,000 for the six months ended June 30, 2014.  The credit to the provision for loan losses for the six months ended June 30, 2015 was less than the credit to the provision for loan losses for the six months ended June 30, 2014 primarily due to a $33.5 million increase in loans from June 30, 2014 to June 30, 2015 and a $119,000 increase in net charge-offs during the six months ended June 30, 2015, as compared to the same period one year ago.  The credit to provision for loan losses in the three and six months ended June 30, 2015 resulted from, and was considered appropriate as part of, management’s assessment and estimate of the risks in the total loan portfolio and determination of the total allowance for loan losses.  The primary factors contributing to the decrease in the allowance for loan losses at June 30, 2015 to $10.4 million from $11.1 million at December 31, 2014 were the continuing positive trends in indicators of potential losses on loans, primarily non-accrual loans and the declining trend in net charge-offs.

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.  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).
 
 
 
15

 
 

·  
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 June 30, 2015 and December 31, 2014:
 
June 30, 2015
                                   
(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
$ -   14,306   -   -   -   984   -   1,222   -   16,512
2- High Quality
  9,578   80,824   -   41,564   218   26,392   -   3,698   1,741   164,015
3- Good Quality
  28,682   71,510   20,081   142,618   9,096   44,283   4   4,499   9,997   330,770
4- Management Attention
  12,361   30,906   12,510   37,876   358   12,839   -   540   1,775   109,165
5- Watch
  8,817   4,674   5,746   5,604   2,730   473   -   42   -   28,086
6- Substandard
  628   6,433   6,915