3. Loans

3 Months Ended

Mar. 31, 2019

Receivables [Abstract]

3. Loans

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

(Dollars in thousands)
	March 31, 2019		December 31, 2018
Real estate loans:
Construction and land development	$	95,219		94,178
Single-family residential		255,338		252,983
Single-family residential -
Banco de la Gente non-traditional		33,717		34,261
Commercial		278,619		270,055
Multifamily and farmland		39,106		33,163
Total real estate loans		701,999		684,640
Loans not secured by real estate:
Commercial loans		101,572		97,465
Farm loans		984		926
Consumer loans		8,653		9,165
All other loans		10,349		11,827
Total loans		823,557		804,023
Less allowance for loan losses		6,561		6,445
Total net loans	$	816,996		797,578

The Bank grants loans and extensions of credit primarily within the Catawba Valley region of North Carolina, which encompasses Catawba, Alexander, Iredell and Lincoln counties, and also in Mecklenburg, Wake and Durham counties of North Carolina. Although the Bank has a diversified loan portfolio, a substantial portion of the loan portfolio is collateralized by improved and unimproved real estate, the value of which is dependent upon the real estate market. Risk characteristics of the major components of the Bank’s loan portfolio are discussed below:

●  Construction and land development loans – The risk of loss is largely dependent on the initial estimate of whether the property’s value at completion equals or exceeds the cost of property construction and the availability of take-out financing. During the construction phase, a number of factors can result in delays or cost overruns. If the estimate is inaccurate or if actual construction costs exceed estimates, the value of the property securing the loan may be insufficient to ensure full repayment when completed through a permanent loan, sale of the property, or by seizure of collateral. As of March 31, 2019, 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, 2019, single-family residential loans comprised approximately 35% of the Bank’s total loan portfolio, and include Banco’s non-traditional single-family residential loans, which were approximately 4% of the Bank’s total loan portfolio.

●  Commercial real estate loans – Repayment is dependent on income being generated in amounts sufficient to cover operating expenses and debt service. These loans also involve greater risk because they are generally not fully amortizing over a loan period, but rather have a balloon payment due at maturity. A borrower’s ability to make a balloon payment typically will depend on being able to either refinance the loan or timely sell the underlying property. As of March 31, 2019, commercial real estate loans comprised approximately 34% of the Bank’s total loan portfolio.

●  Commercial loans – Repayment is generally dependent upon the successful operation of the borrower’s business. In addition, the collateral securing the loans may depreciate over time, be difficult to appraise, be illiquid or fluctuate in value based on the success of the business. As of March 31, 2019, commercial loans comprised approximately 12% of the Bank’s total loan portfolio.

 Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all 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, 2019 and December 31, 2018:

March 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	$	40		-		40		95,179		95,219		-
Single-family residential		4,331		374		4,705		250,633		255,338		-
Single-family residential -
Banco de la Gente non-traditional		2,903		-		2,903		30,814		33,717		-
Commercial		-		-		-		278,619		278,619		-
Multifamily and farmland		-		-		-		39,106		39,106		-
Total real estate loans		7,274		374		7,648		694,351		701,999		-
Loans not secured by real estate:
Commercial loans		317		12		329		101,243		101,572		-
Farm loans		50		-		50		934		984		-
Consumer loans		99		9		108		8,545		8,653		-
All other loans		-		-		-		10,349		10,349		-
Total loans	$	7,740		395		8,135		815,422		823,557		-

December 31, 2018
(Dollars in thousands)
	Loans 30-89 Days Past Due		Loans 90 or More Days Past Due		Total Past Due Loans		Total Current Loans		Total Loans		Accruing Loans 90 or More Days Past Due
Real estate loans:
Construction and land development	$	3		-		3		94,175		94,178		-
Single-family residential		4,162		570		4,732		248,251		252,983		-
Single-family residential -
Banco de la Gente non-traditional		4,627		580		5,207		29,054		34,261		-
Commercial		228		-		228		269,827		270,055		-
Multifamily and farmland		-		-		-		33,163		33,163		-
Total real estate loans		9,020		1,150		10,170		674,470		684,640		-
Loans not secured by real estate:
Commercial loans		445		90		535		96,930		97,465		-
Farm loans		-		-		-		926		926		-
Consumer loans		99		4		103		9,062		9,165		-
All other loans		-		-		-		11,827		11,827		-
Total loans	$	9,564		1,244		10,808		793,215		804,023		-

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

(Dollars in thousands)
	March 31, 2019		December 31, 2018
Real estate loans:
Construction and land development	$	-		1
Single-family residential		1,075		1,530
Single-family residential -
Banco de la Gente non-traditional		1,549		1,440
Commercial		89		244
Multifamily and farmland		-		-
Total real estate loans		2,713		3,215
Loans not secured by real estate:
Commercial loans		75		89
Consumer loans		14		10
Total	$	2,802		3,314

At each reporting period, the Bank determines which loans are impaired. Accordingly, the Bank’s impaired loans are reported at their estimated fair value on a non-recurring basis. An allowance for each impaired loan that is collateral-dependent is calculated based on the fair value of its collateral. The fair value of the collateral is based on appraisals performed by REAS, a subsidiary of the Bank. REAS is staffed by certified appraisers that also perform appraisals for other companies. Factors, including the assumptions and techniques utilized by the appraiser, are considered by management. If the recorded investment in the impaired loan exceeds the measure of fair value of the collateral, a valuation allowance is recorded as a component of the allowance for loan losses. An allowance for each impaired loan that is not collateral dependent is calculated based on the present value of projected cash flows. If the recorded investment in the impaired loan exceeds the present value of projected cash flows, a valuation allowance is recorded as a component of the allowance for loan losses. Impaired loans under $250,000 are not individually evaluated for impairment with the exception of the Bank’s troubled debt restructured (“TDR”) loans in the residential mortgage loan portfolio, which are individually evaluated for impairment. Accruing impaired loans were $22.1 million, $22.8 million and $23.8 million at March 31, 2019, December 31, 2018 and March 31, 2018, respectively. Interest income recognized on accruing impaired loans was $342,000, $1.3 million, and $352,000 for the three months ended March 31, 2019, the year ended December 31, 2018 and the three months ended March 31, 2018, respectively. No interest income is recognized on non-accrual impaired loans subsequent to their classification as non-accrual.

The following table presents impaired loans as of March 31, 2019:

March 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	$	275		—		275		275		5		277		4
Single-family residential		4,596		418		3,711		4,129		30		5,090		61
Single-family residential -
Banco de la Gente non-traditional		16,399		—		15,719		15,719		1,026		15,027		252
Commercial		1,754		—		1,749		1,749		1		1,837		23
Multifamily and farmland		—		—		—		—		13		—
Total impaired real estate loans		23,024		418		21,454		21,872		1,075		22,231		340
Loans not secured by real estate:
Commercial loans		270		63		47		110		—		100		1
Consumer loans		111		—		107		107		2		110		1
Total impaired loans	$	23,405		481		21,608		22,089		1,077		22,441		342

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

December 31, 2018
(Dollars in thousands)
	Unpaid Contractual Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Recorded Investment in Impaired Loans		Related Allowance		Average Outstanding Impaired Loans		YTD Interest Income Recognized
Real estate loans:
Construction and land development	$	281		—		279		279		5		327		19
Single-family residential		5,059		422		4,188		4,610		32		6,271		261
Single-family residential -
Banco de la Gente non-traditional		16,424		—		15,776		15,776		1,042		14,619		944
Commercial		1,995		—		1,925		1,925		17		2,171		111
Multifamily and farmland		—		—		—		—		—		—		—
Total impaired real estate loans		23,759		422		22,168		22,590		1,096		23,388		1,335
Loans not secured by real estate:
Commercial loans		251		89		1		90		—		96		—
Consumer loans		116		—		113		113		2		137		7
Total impaired loans	$	24,126		511		22,282		22,793		1,098		23,621		1,342

Changes in the allowance for loan losses for the three months ended March 31, 2019 and 2018 were as follows:

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

(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, 2018
Allowance for loan losses:
Beginning balance	$	804			1,812			1,280			1,193		72			574		-		155			476		6,366
Charge-offs		-			-			-			-		(5	)		-		-		(101	)		-		(106	)
Recoveries		1			5			-			4		1			8		-		63			-		82
Provision		(154	)		(177	)		(15	)		101		5			124		-		19			128		31
Ending balance	$	651			1,640			1,265			1,298		73			706		-		136			604		6,373
Allowance for loan losses March 31, 2018
Ending balance: individually
evaluated for impairment	$	-			-			1,079			12		-			-		-		-			-		1,091
Ending balance: collectively
evaluated for impairment		651			1,640			186			1,286		73			706		-		136			604		5,282
Ending balance	$	651			1,640			1,265			1,298		73			706		-		136			604		6,373
Loans March 31, 2018:
Ending balance	$	82,046			244,061			36,540			261,636		29,108			89,304		1,095		22,034			-		765,824
Ending balance: individually
evaluated for impairment	$	96			1,832			15,190			1,915		-			97		-		-			-		19,130
Ending balance: collectively
evaluated for impairment	$	81,950			242,229			21,350			259,721		29,108			89,207		1,095		22,034			-		746,694

The provision for loan losses for the three months ended March 31, 2019 was $178,000, compared to $31,000 for the three months ended March 31, 2018. The increase in the provision for loan losses is primarily attributable to a $57.8 million increase in loans from March 31, 2018 to March 31, 2019.

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, 2019 and December 31, 2018:

March 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	$	329		5,561		-		-		-		545		-		650		-		7,085
2- High Quality		28,895		127,160		-		24,617		361		19,688		-		2,995		2,064		205,780
3- Good Quality		56,203		96,684		13,373		216,741		34,361		74,164		852		4,467		7,540		504,385
4- Management Attention		6,441		19,531		14,946		34,198		3,819		6,764		132		505		745		87,081
5- Watch		3,199		3,496		2,236		2,974		565		327		-		11		-		12,808
6- Substandard		152		2,906		3,162		89		-		84		-		25		-		6,418
7- Doubtful		-		-		-		-		-		-		-		-		-		-
8- Loss		-		-		-		-		-		-		-		-		-		-
Total	$	95,219		255,338		33,717		278,619		39,106		101,572		984		8,653		10,349		823,557

December 31, 2018
(Dollars in thousands)
	Real Estate Loans
	Construction and Land Development		Single- Family Residential		Single- Family Residential - Banco de la Gente non-traditional		Commercial		Multifamily and Farmland		Commercial		Farm		Consumer		All Other		Total
1- Excellent Quality	$	504		5,795		-		-		-		605		-		673		-		7,577
2- High Quality		24,594		128,588		-		25,321		395		20,520		-		3,229		2,145		204,792
3- Good Quality		59,549		92,435		13,776		211,541		27,774		69,651		785		4,699		8,932		489,142
4- Management Attention		5,707		19,200		15,012		30,333		3,906		6,325		141		529		750		81,903
5- Watch		3,669		3,761		2,408		2,616		1,088		264		-		18		-		13,824
6- Substandard		155		3,204		3,065		244		-		100		-		17		-		6,785
7- Doubtful		-		-		-		-		-		-		-		-		-		-
8- Loss		-		-		-		-		-		-		-		-		-		-
Total	$	94,178		252,983		34,261		270,055		33,163		97,465		926		9,165		11,827		804,023

Current year TDR modifications, past due TDR loans and non-accrual TDR loans totaled $3.5 million and $4.7 million at March 31, 2019 and December 31, 2018, respectively. The terms of these loans have been renegotiated to provide a concession to original terms, including a reduction in principal or interest as a result of the deteriorating financial position of the borrower. There was zero and $92,000 in performing loans classified as TDR loans at March 31, 2019 and December 31, 2018, respectively.

There were no new TDR modifications during the three months ended March 31, 2019 and 2018.

There were no loans modified as TDR that defaulted during the three months ended March 31, 2019 and 2018, which were within 12 months of their modification date. Generally, a TDR loan is considered to be in default once it becomes 90 days or more past due following a modification.