LOANS

12 Months Ended

Dec. 31, 2014

Loans and Leases Receivable Disclosure [Abstract]

Loans, Notes, Trade and Other Receivables Disclosure [Text Block]

NOTE E - LOANS

The following is a summary of loans at December 31, 2014 and 2013:

	2014					2013
			Percent					Percent
	Amount		of total			Amount		of total
	(dollars in thousands)
Real estate loans:
1- to- 4 family residential	$	90,903		16.47	%	$	35,006		10.10	%
Commercial real estate		233,630		42.32	%		169,176		48.82	%
Multi-family residential		42,224		7.65	%		19,739		5.70	%
Construction		83,593		15.14	%		53,325		15.39	%
Home equity lines of credit (“HELOC”)		38,093		6.90	%		31,863		9.20	%
Total real estate loans		488,443		88.48	%		309,109		89.21	%
Other loans:
Commercial and industrial		58,217		10.55	%		29,166		8.42	%
Loans to individuals		5,953		1.08	%		8,584		2.48	%
Overdrafts		64		0.01	%		191		0.05	%
Total other loans		64,234		11.64	%		37,941		10.95	%
Gross loans		552,677					347,050
Less deferred loan origination fees, net		(639)		(.12)	%		(550)		(.16)	%
Total loans		552,038		100.00	%		346,500		100.00	%
Allowance for loan losses		(6,844)					(7,054)
Total loans, net	$	545,194				$	339,446

Loans are primarily made in central and eastern North Carolina. Real estate loans can be affected by the condition of the local real estate market and can be affected by the local economic conditions.

At December 31, 2014, the Company had pre-approved but unused lines of credit totaling $129.7 million. In management’s opinion, these commitments, and undisbursed proceeds on loans reflected above, represent no more than normal lending risk to the Company and will be funded from normal sources of liquidity.

A description of the various loan products provided by the Bank is presented below.

Residential 1-to-4 Family Loans

Residential 1-to-4 family loans are mortgage loans that typically convert from construction loans into permanent financing and are secured by properties within the Bank’s market areas.

Commercial Real Estate Loans

Commercial real estate loans are underwritten based on the borrower’s ability to generate adequate cash flow to repay the subject debt within reasonable terms. Commercial real estate loans typically include both owner and non-owner occupied properties with higher principal loan amounts and the repayment of these loans is generally dependent on the successful management of the property. Commercial real estate loans are sensitive to market and general economic conditions. Repayment analysis must be performed and consists of an identified primary/cash flow source of repayment and a secondary/liquidation source of repayment. The primary source of repayment is cash flow from income generated from rental or lease of the property. However, the cash flow can be supplemented with the borrower's and guarantor's global cash flow position. Other credit issues such as the business fundamentals and financial strength of the borrower/guarantor can be considered in determining adequacy of repayment ability. The secondary source of repayment is liquidation of the collateral, supplemented by liquidation cushion provided by the financial assets of the borrower/guarantor. Management monitors and evaluates commercial real estate loans based on collateral, market area, and risk grade.

Multi-family Residential Loans

Multi-family residential loans are typically nonfarm properties with 5 or more dwelling units in structures which include apartment buildings used primarily to accommodate households on a more or less permanent basis. Successful performance of these types of loans is primarily dependent on occupancy rates, rental rates, and property management.

Construction Loans

Construction loans are non-revolving extensions of credit secured by real property of which the proceeds are used to acquire and develop land and to construct commercial or residential buildings. The primary source of repayment for these types of loans is the sale of the improved property or permanent financing in which case the property is expected to generate the cash flow necessary for repayment on a permanent loan basis. Property cash flow may be supplemented with financial support from the borrowers/guarantors. Proper underwriting of a construction loan consists of the initial process of obtaining, analyzing, and approving various aspects of information pertaining to: the analysis of the permanent financing source, creditworthiness of the borrower and guarantors, ability of contractor to perform under the terms of the contract, and the feasibility, marketability, and valuation of the project.

Also, much consideration needs to be given to the cost of the project and sources of funds needed to complete construction as well as identifying any sources of equity funding. Construction loans are traditionally considered to be higher risk loans involving technical and legal requirements inherently different from other types of loans; however with thorough credit underwriting, proper loan structure, and diligent loan servicing, these risks can be mitigated. Some examples of risks inherent in this type of lending include: underestimated costs, inflation of material and labor costs, site difficulties (i.e. rock, soil), project not built to plans, weather delays and natural disasters, borrower/contractor/subcontractor disputes which prompt liens, interest rates increasing beyond budget.

Home Equity Lines of Credit

Home equity lines of credit are consumer-purpose revolving extensions of credit which are secured by first or second liens on owner-occupied residential real estate. Appropriate risk management and compliance practices are exercised to ensure that loan-to-value, lien perfection, and compliance risks are addressed and managed within the Bank’s established guidelines. The degree of utilization of revolving commitments within this loan segment is reviewed periodically to identify changes in the behavior of this borrowing group.

Commercial and Industrial Loans

Commercial and industrial loans are underwritten after evaluating and understanding the borrower’s ability to generate positive cash flow, operate profitably and prudently expand its business. Underwriting standards are designed to promote relationships to include a full range of loan, deposit, and cash management services. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower and the guarantors. The cash flows of the borrower, however, may not be as expected and the collateral securing these loans may fluctuate in value. In the case of loans secured by accounts receivable, the availability of funds for repayment can be impacted by the borrower’s ability to collect amounts due from its customers.

Loans to Individuals

Consumer loans are approved using Bank policies and procedures established to evaluate each credit request. All lending decisions and credit risks are clearly documented. Several factors are considered in making these decisions such as credit score, adjusted net worth, liquidity, debt ratio, disposable income, credit history, and loan-to-value of the collateral. This process combined with the relatively smaller loan amounts spreads the risk among many individual borrowers.

Overdrafts

Overdrafts on customer accounts are classified as loans for reporting purposes.

Related Parties

The Bank has loan transactions with its directors and executive officers in the regular course of business. Such loans were made in the ordinary course of business and on substantially the same terms and collateral as those for comparable transactions prevailing at the time and did not involve more than the normal risk of collectability or present other unfavorable features. The following table represents loan transactions for directors and executive officers who held that position as of December 31, 2014 and 2013.  A summary of related party loan transactions, in thousands, is as follows:

	2014		2013
Balance at January 1	$	5,370	$	2,816
Exposure of directors/executive officers added		2,020		-
Borrowings		3,208		3,758
Directors/executive officers resigned or retired from board		(4,631)		(9)
Loan repayments		(2,570)		(1,195)
Balance at December 31	$	3,397	$	5,370

At December 31, 2014, there was $4.8 million of unused lines of credit outstanding to directors and executive officers of the Company and its subsidiaries.

Non-Accrual and Past Due Loans

The following tables present as of December 31, 2014 and 2013 an age analysis of past due loans, segregated by class of loans:

	30+		Non-		Total
	Days		Accrual		Past				Total
2014	Past Due		Loans		Due		Current		Loans
	(dollars in thousands)
Total Loans
Commercial and industrial	$	141	$	632	$	773	$	57,444	$	58,217
Construction		-		816		816		82,777		83,593
Multi-family residential		-		901		901		41,323		42,224
Commercial real estate		3,377		2,576		5,953		227,677		233,630
Loans to individuals & overdrafts		22		-		22		5,995		6,017
1 to 4 family residential		1,464		1,160		2,624		88,279		90,903
HELOC		14		853		867		37,226		38,093
Deferred loan (fees) cost, net		-		-		-		-		(639)
	$	5,018	$	6,938	$	11,956	$	540,721	$	552,038
Loans- PCI
Commercial and industrial	$	2	$	-	$	2	$	655	$	657
Construction		-		-		-		1,463		1,463
Multi-family residential		-		-		-		2,724		2,724
Commercial real estate		562		-		562		11,341		11,903
Loans to individuals & overdrafts		-		-		-		128		128
1 to 4 family residential		283		-		283		9,689		9,972
HELOC		-		-		-		188		188
	$	847	$	-	$	847	$	26,188	$	27,035
Loans- excluding PCI
Commercial and industrial	$	139	$	632	$	771	$	56,789	$	57,560
Construction		-		816		816		81,314		82,130
Multi-family residential		-		901		901		38,599		39,500
Commercial real estate		2,815		2,576		5,391		216,336		221,727
Loans to individuals & overdrafts		22		-		22		5,867		5,889
1 to 4 family residential		1,181		1,160		2,341		78,590		80,931
HELOC		14		853		867		37,038		37,905
Deferred loan (fees) cost, net		-		-		-		-		(639)
	$	4,171	$	6,938	$	11,109	$	514,533	$	525,003

Non-Accrual and Past Due Loans

	30+		Non-		Total
	Days		Accrual		Past				Total
2013	Past Due		Loans		Due		Current		Loans
	(dollars in thousands)
Commercial and industrial	$	70	$	330	$	400	$	28,766	$	29,166
Construction		36		1,206		1,242		52,083		53,325
Multi-family residential		-		1,004		1,004		18,735		19,739
Commercial real estate		446		4,441		4,887		164,289		169,176
Loans to individuals & overdrafts		4		5		9		8,766		8,775
1 to 4 family residential		318		1,092		1,410		33,596		35,006
HELOC		-		1,241		1,241		30,622		31,863
Deferred loan (fees) cost, net		-		-		-		-		(550)
	$	874	$	9,319	$	10,193	$	336,857	$	346,500

There was one loan in the amount of $2.2 million greater than 90 days past due and still accruing interest at December 31, 2014 and there were no loans greater than 90 days past due and still accruing at December 31, 2013.

Loans are placed on non-accrual basis when it has been determined that all contractual principal and interest will not be received. Any payments received on these loans are applied to principal first and then to interest only after all principal has been collected. Impaired loans include all loans in non-accrual status, all troubled debt restructures, all substandard loans that are deemed to be collateral dependent, and other loans that management determines require reserves. In the case of an impaired loan that is still on accrual basis, payments are applied to both principal and interest.

Impaired Loans

The following tables present information on loans, excluding PCI loans and loans evaluated collectively as a homogenous group, that were considered to be impaired as of December 31, 2014 and December 31, 2013:

							December 31, 2014
			Contractual				Year to Date
			Unpaid		Related		Average		Interest Income
	Recorded		Principal		Allowance		Recorded		Recognized on
	Investment		Balance		for Loan Losses		Investment		Impaired Loans
2014:	(dollars in thousands)
With no related allowance recorded:
Commercial and industrial	$	478	$	478	$	-	$	337	$	26
Construction		1,300		1,525		-		1,679		81
Commercial real estate		2,652		3,536		-		3,329		184
Loans to individuals & overdrafts		-		2		-		1		-
Multi-family residential		2,232		2,515		-		2,308		125
HELOC		637		768		-		702		39
1 to 4 family residential		2,301		2,750		-		2,928		147
Subtotal:		9,600		11,574		-		11,284		602
With an allowance recorded:
Commercial and industrial		265		267		64		266		-
Construction		167		168		80		247		1
Commercial real estate		4,878		5,761		419		5,287		214
Loans to individuals & overdrafts		-		-		-		1		-
Multi-family Residential		-		-		-		-		-
HELOC		284		526		50		418		8
1 to 4 family residential		450		455		74		502		30
Subtotal:		6,044		7,177		687		6,721		253
Totals:
Commercial		11,972		14,250		563		13,453		631
Consumer		-		2		-		2		-
Residential		3,672		4,499		124		4,550		224
Grand Total:	$	15,644	$	18,751	$	687	$	18,005	$	855

Impaired loans at December 31, 2014 were approximately $15.6 million and were comprised of $6.9 million in non-accrual loans and $8.7 million in loans still in accruing status. Recorded investment represents the current principal balance for the loan. Approximately, $6.0 million of the $15.6 million in impaired loans at December 31, 2014 had specific allowances provided while the remaining $9.6 million had no specific allowances recorded. Of the $9.6 million with no allowance recorded, $1.6 million of those loans have had partial charge-offs recorded.

							December 31, 2013
			Contractual				Year to Date
			Unpaid		Related		Average		Interest Income
	Recorded		Principal		Allowance		Recorded		Recognized on
	Investment		Balance		for Loan Losses		Investment		Impaired Loans
2013:	(dollars in thousands)
With no related allowance recorded:
Commercial and industrial	$	196	$	257	$	-	$	473	$	15
Construction		2,059		2,311		-		2,016		18
Commercial real estate		3,748		4,971		-		4,987		-
Loans to individuals & overdrafts		3		3		-		2		-
Multi-family residential		2,384		2,384		-		2,009		-
HELOC		767		854		-		595		98
1 to 4 family residential		2,427		2,731		-		2,788		5
Subtotal:		11,584		13,511		-		12,870		136
With an allowance recorded:
Commercial and industrial		267		267		63		101		18
Construction		328		406		91		426		2
Commercial real estate		5,695		5,695		541		4,761		39
Loans to individuals & overdrafts		2		2		-		14		-
Multi-family Residential		-		-		-		8		-
HELOC		553		553		320		314		-
1 to 4 family residential		553		553		88		885		9
Subtotal:		7,398		7,476		1,103		6,509		68
Totals:
Commercial		14,677		16,291		695		14,782		92
Consumer		5		5		-		16		-
Residential		4,300		4,691		408		4,581		112
Grand Total:	$	18,982	$	20,987	$	1,103	$	19,379	$	204

Impaired loans at December 31, 2013 were approximately $19.0 million and were comprised of $9.3 million in non-accrual loans and $9.7 million in loans still in accruing status. Recorded investment represents the current principal balance for the loan. Approximately, $7.4 million of the $19.0 million in impaired loans at December 31, 2013 had specific allowances provided while the remaining $11.6 million had no specific allowances recorded. Of the $11.6 million with no allowance recorded, $2.1 million of those loans have had partial charge-offs recorded.

Troubled Debt Restructurings

The following table presents loans that were modified as troubled debt restructurings (“TDRs”) within the previous twelve months with a breakdown of the types of concessions made by loan class during the twelve months ended December 31, 2014 and 2013:

	Twelve Months Ended December 31, 2014
		Pre-Modification		Post-Modification
	Number	Outstanding		Outstanding
	of	Recorded		Recorded
	loans	investments		investments
	(dollars in thousands)
Below market interest rate:
Commercial and industrial	-	$	-	$	-
Construction	-		-		-
Commercial real estate	-		-		-
Loans to individuals and overdrafts	-		-		-
1 to 4 family residential	1		21		20
HELOC	-		-		-
Total	1		21		20
Extended payment terms:
Commercial and industrial	-		-		-
Construction	-		-		-
Commercial real estate	2		1,125		970
Multi-family residential	-		-		-
Loans to individuals and overdrafts	-		-		-
1 to 4 family residential	1		45		40
HELOC	-		-		-
Total	3		1,170		1,010
Other:
Commercial and industrial	-		-		-
Construction	-		-		-
Commercial real estate	-		-		-
Loans to individuals and overdrafts	-		-		-
1 to 4 family residential	-		-		-
HELOC	-		-		-
Total	-		-		-
Total	4	$	1,191	$	1,030

	Twelve Months Ended December 31, 2013
		Pre-Modification		Post-Modification
	Number	Outstanding		Outstanding
	of	Recorded		Recorded
	loans	investments		investments
	(dollars in thousands)
Below market interest rate:
Commercial and industrial	-	$	-	$	-
Construction	-		-		-
Commercial real estate	-		-		-
Loans to individuals and overdrafts	-		-		-
1 to 4 family residential	3		276		272
HELOC	-		-		-
Total	3		276		272
Extended payment terms:
Commercial and industrial	4		537		402
Construction	2		134		131
Commercial real estate	1		645		645
Multi-family residential	-		-		-
Loans to individuals and overdrafts	-		-		-
1 to 4 family residential	4		1,084		1,053
HELOC	-		-		-
Total	11		2,400		2,231
Other:
Commercial and industrial	-		-		-
Construction	-		-		-
Commercial real estate	1		163		159
Loans to individuals and overdrafts	-		-		-
1 to 4 family residential	3		203		195
HELOC	-		-		-
Total	4		366		354
Total	18	$	3,042	$	2,857

As noted in the tables above, there were four loans that were considered TDRs at December 31, 2013, for reasons other than below market interest rates, extended terms or forgiveness of principal. These loans were renewed at terms that vary from those that the Company would enter into for new loans of this type.

Troubled Debt Restructurings (Continued)

The following table presents loans that were modified as TDRs within the previous twelve months for which there was a payment default together with a breakdown of the types of concessions made by loan class during the twelve months ended December 31, 2014 and 2013:

	Twelve months ended
	December 31, 2014
	Number	Recorded
	of loans	investment
	(dollars in thousands)
Below market interest rate:
Commercial and industrial	-	$	-
Construction	-		-
Commercial real estate	-		-
Loans to individuals and overdrafts	-		-
1 to 4 family residential	1		21
HELOC	-		-
Total	1		21
Extended payment terms:
Commercial and industrial	-		-
Construction	-		-
Commercial real estate	1		947
Loans to individuals and overdrafts	-		-
Multi-family residential	-		-
1 to 4 family residential	-		-
HELOC	-		-
Total	1		947
Forgiveness of principal:
Commercial and industrial	-		-
Construction	-		-
Commercial real estate	-		-
Loans to individuals and overdrafts	-		-
1 to 4 family residential	-		-
HELOC	-		-
Total	-		-
Other:
Commercial and industrial	-		-
Construction	-		-
Commercial real estate			-
Loans to individuals and overdrafts	-		-
1-to-4 family residential	-		-
Multi-family residential	-		-
HELOC	-		-
Total	-		-
Total	2	$	968

	Twelve months ended
	December 31, 2013
	Number	Recorded
	of loans	investment
	(dollars in thousands)
Below market interest rate:
Commercial and industrial	-	$	-
Construction	-		-
Commercial real estate	-		-
Loans to individuals and overdrafts	-		-
1 to 4 family residential	-		-
HELOC	-		-
Total	-		-
Extended payment terms:
Commercial and industrial	3		402
Construction	2		131
Commercial real estate	-		-
Loans to individuals and overdrafts	-		-
Multi-family residential	-		-
1 to 4 family residential	1		47
HELOC	-		-
Total	6		580
Forgiveness of principal:
Commercial and industrial	-		-
Construction	-		-
Commercial real estate	-		-
Loans to individuals and overdrafts	-		-
1 to 4 family residential	-		-
HELOC	-		-
Total	-		-
Other:
Commercial and industrial	-		-
Construction	-		-
Commercial real estate	1		159
Loans to individuals and overdrafts	-		-
1-to-4 family residential	-		-
Multi-family residential	-		-
HELOC	-		-
Total	1		159
Total	7	$	739

At December 31, 2014, the Company had forty loans with an aggregate balance of $7.3 million that were considered to be troubled debt restructurings. Of those TDRs, twenty-four loans with a balance totaling $4.9 million were still accruing as of December, 2014. The remaining sixteen TDRs with a balance totaling $2.4 million were in non-accrual status. All TDRs are included in non-performing assets and impaired loans.

Credit Quality Indicators

As part of the on-going monitoring of the credit quality of the loan portfolio, management utilizes a risk grading matrix to assign a risk grade to each of the Company’s loans. All non-consumer loans are graded on a scale of 1 to 9. A description of the general characteristics of these nine different risk grades is as follows:

· Risk Grade 1 (Superior) - Credits in this category are virtually risk-free and are well-collateralized by cash-equivalent instruments. The repayment program is well-defined and achievable. Repayment sources are numerous. No material documentation deficiencies or exceptions exist.

· Risk Grade 2 (Very Good) - This grade is reserved for loans secured by readily marketable collateral, or loans within guidelines to borrowers with liquid financial statements. A liquid financial statement is a financial statement with substantial liquid assets relative to debts. These loans have excellent sources of repayment, with no significant identifiable risk of collection, and conform in all respects to Bank policy, guidelines, underwriting standards, and Federal and State regulations (no exceptions of any kind).

· Risk Grade 3 (Good) - These loans have excellent sources of repayment, with no significant identifiable risk of collection. Generally, loans assigned this risk grade will demonstrate the following characteristics:

o Conformity in all respects with Bank policy, guidelines, underwriting standards, and Federal and State regulations (no exceptions of any kind).

o Documented historical cash flow that meets or exceeds required minimum Bank guidelines, or that can be supplemented with verifiable cash flow from other sources.

o Adequate secondary sources to liquidate the debt, including combinations of liquidity, liquidation of collateral, or liquidation value to the net worth of the borrower or guarantor.

· Risk Grade 4 (Acceptable) - This grade is given to acceptable loans. These loans have adequate sources of repayment, with little identifiable risk of collection. Loans assigned this risk grade will demonstrate the following characteristics:

o General conformity to the Bank's policy requirements, product guidelines and underwriting standards, with limited exceptions. Any exceptions that are identified during the underwriting and approval process have been adequately mitigated by other factors.

o Documented historical cash flow that meets or exceeds required minimum Bank guidelines, or that can be supplemented with verifiable cash flow from other sources.  

o Adequate secondary sources to liquidate the debt, including combinations of liquidity, liquidation of collateral, or liquidation value to the net worth of the borrower or guarantor.

· Risk Grade 5 (Acceptable With Care) - This grade is given to acceptable loans that show signs of weakness in either adequate sources of repayment or collateral, but have demonstrated mitigating factors that minimize the risk of delinquency or loss.  Loans assigned this grade may demonstrate some or all of the following characteristics:

o Additional exceptions to the Bank's policy requirements, product guidelines or underwriting standards that present a higher degree of risk to the Bank.  Although the combination and/or severity of identified exceptions is greater, all exceptions have been properly mitigated by other factors.

o Unproven, insufficient or marginal primary sources of repayment that appears sufficient to service the debt at this time.  Repayment weaknesses may be due to minor operational issues, financial trends, or reliance on projected (not historic) performance.

o Marginal or unproven secondary sources to liquidate the debt, including combinations of liquidation of collateral and liquidation value to the net worth of the borrower or guarantor.

· Risk Grade 6 (Watch List or Special Mention) – Loans in this category can have the following characteristics:

o Loans with underwriting guideline tolerances and/or exceptions and with no mitigating factors.

o Extending loans that are currently performing satisfactorily but with potential weaknesses that may, if not corrected, weaken the asset or inadequately protect the Bank's position at some future date. Potential weaknesses are the result of deviations from prudent lending practices.

o Loans where adverse economic conditions that develop subsequent to the loan origination that don't jeopardize liquidation of the debt but do substantially increase the level of risk may also warrant this rating.

· Risk Grade 7 (Substandard) - A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified as Substandard must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt; they are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected. Loans consistently not meeting the repayment schedule should be downgraded to substandard. Loans in this category are characterized by deterioration in quality exhibited by any number of well-defined weaknesses requiring corrective action.

· Risk Grade 8 (Doubtful) - Loans classified Doubtful have all the weaknesses inherent in loans classified Substandard, plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values highly questionable and improbable. However, these loans are not yet rated as loss because certain events may occur which would salvage the debt.

· Risk Grade 9 (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 the loan even though partial recovery may be affected in the future.

Consumer loans are graded on a scale of 1 to 9. A description of the general characteristics of the 9 risk grades is as follows: 

· Risk Grades 1 – 5 (Pass) – The loans in this category range from loans secured by cash with no risk of principal deterioration (Risk Grade 1) to loans that show signs of weakness in either adequate sources of repayment or collateral but have demonstrated mitigating factors that minimize the risk of delinquency or loss (Risk Grade 5).

· Risk Grade 6 (Watch List or Special Mention) - Watch list or Special Mention loans include the following characteristics:

o Loans within guideline tolerances or with exceptions of any kind that have not been mitigated by other economic or credit factors.

o Extending loans that are currently performing satisfactorily but with potential weaknesses that may, if not corrected, weaken the asset or inadequately protect the Bank's position at some future date. Potential weaknesses are the result of deviations from prudent lending practices.

o Loans where adverse economic conditions that develop subsequent to the loan origination that don't jeopardize liquidation of the debt but do substantially increase the level of risk may also warrant this rating.

· Risk Grade 7 (Substandard) - A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified as Substandard must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt; they are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

· Risk Grade 8 (Doubtful) - Loans classified Doubtful have all the weaknesses inherent in loans classified Substandard, plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values highly questionable and improbable. However, these loans are not yet rated as loss because certain events may occur which would salvage the debt.

· Risk Grade 9 (Loss) - Loans classified 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 affected in the future.

The following tables presents information on risk ratings of the commercial and consumer loan portfolios, segregated by loan class as of December 31, 2014 and 2013:

Total Loans:

December 31, 2014
Commercial
Credit
Exposure By	Commercial				Commercial
Internally	and				real		Multi-family
Assigned Grade	industrial		Construction		estate		residential
	(dollars in thousands)
Superior	$	1,241	$	-	$	-	$	-
Very good		1,110		-		-		-
Good		5,282		2,705		15,276		-
Acceptable		26,132		13,579		128,056		31,619
Acceptable with care		23,404		65,717		75,554		8,374
Special mention		221		384		8,036		1,330
Substandard		827		1,208		6,708		901
Doubtful		-		-		-		-
Loss		-		-		-		-
	$	58,217	$	83,593	$	233,630	$	42,224

Consumer Credit
Exposure By
Internally	1-to-4 family
Assigned Grade	residential		HELOC
Pass	$	82,794	$	36,357
Special mention		3,978		695
Substandard		4,131		1,041
	$	90,903	$	38,093

Consumer Credit
Exposure Based	Loans to
On Payment	individuals &
Activity	overdrafts
Pass	$	5,969
Non-pass		48
	$	6,017

PCI Loans:

December 31, 2014
Commercial
Credit
Exposure By	Commercial				Commercial
Internally	and				real		Multi-family
Assigned Grade	industrial		Construction		estate		residential
	(dollars in thousands)
Superior	$	-	$	-	$	-	$	-
Very good		-		-		-		-
Good		-		-		-		-
Acceptable		-		-		-		-
Acceptable with care		602		1,397		9,368		2,724
Special mention		-		66		1,973		-
Substandard		55		-		562		-
Doubtful		-		-		-		-
Loss		-		-		-		-
	$	657	$	1,463	$	11,903	$	2,724

Consumer Credit
Exposure By
Internally	1-to-4 family
Assigned Grade	residential		HELOC
Pass	$	6,437	$	188
Special mention		2,926		-
Substandard		609		-
	$	9,972	$	188

Consumer Credit
Exposure Based	Loans to
On Payment	individuals &
Activity	overdrafts
Pass	$	117
Non-pass		11
	$	128

Total Loans, excluding PCI Loans:

December 31, 2014
Commercial
Credit
Exposure By	Commercial				Commercial
Internally	and				real		Multi-family
Assigned Grade	industrial		Construction		estate		residential
	(dollars in thousands)
Superior	$	1,241	$	-	$	-	$	-
Very good		1,110		-		-		-
Good		5,282		2,705		15,276		-
Acceptable		26,132		13,579		128,056		31,619
Acceptable with care		22,802		64,320		66,186		5,650
Special mention		221		318		6,063		1,330
Substandard		772		1,208		6,146		901
Doubtful		-		-		-		-
Loss		-		-		-		-
	$	57,560	$	82,130	$	221,727	$	39,500

Consumer Credit
Exposure By
Internally	1-to-4 family
Assigned Grade	residential		HELOC
Pass	$	76,357	$	36,169
Special mention		1,052		695
Substandard		3,522		1,041
	$	80,931	$	37,905

Consumer Credit
Exposure Based	Loans to
On Payment	individuals &
Activity	overdrafts
Pass	$	5,852
Non-pass		37
	$	5,889

December 31, 2013
Commercial
Credit
Exposure By	Commercial				Commercial
Internally	and				real		Multi-family
Assigned Grade	industrial		Construction		estate		residential
	(dollars in thousands)
Superior	$	830	$	40	$	-	$	-
Very good		-		-		-		-
Good		5,793		1,133		19,301		4,203
Acceptable		11,572		2,838		63,447		6,812
Acceptable with care		5,307		46,597		57,768		6,340
Special mention		5,122		1,126		21,305		1,380
Substandard		542		1,591		7,355		1,004
Doubtful		-		-		-		-
Loss		-		-		-		-
	$	29,166	$	53,325	$	169,176	$	19,739

Consumer Credit
Exposure By
Internally	1-to-4 family
Assigned Grade	residential		HELOC
Pass	$	29,364	$	30,116
Special mention		1,632		245
Substandard		4,010		1,502
	$	35,006	$	31,863

Consumer Credit
Exposure Based	Loans to
On Payment	individuals &
Activity	overdrafts
Pass	$	7,629
Non-pass		1,146
	$	8,775

The process of determining the allowance for credit losses is driven by the risk grade system and the loss experience on non-risk graded homogeneous types of loans. The Bank’s allowance for credit losses is calculated and determined, at a minimum, each fiscal quarter end. The allowance for credit losses represents management’s estimate of the appropriate level of reserve to provide for probable losses inherent in the loan portfolio. In determining the allowance for credit losses and any resulting provision to be charged against earnings, particular emphasis is placed on the results of the loan review process. Consideration is also given to a review of individual loans, historical loan loss experience, the value and adequacy of collateral and economic conditions in the Bank’s market areas. For loans determined to be impaired, the impairment is based on discounted expected cash flows using the loan’s initial effective interest rate or the fair value of the collateral (less selling costs) for certain collateral dependent loans. This evaluation is inherently subjective as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for credit losses. Such agencies may require the Bank to recognize changes to the allowance based on their judgments about information available to them at the time of their examinations. Loans are charged off when in the opinion of management, they are deemed to be uncollectible. Recognized losses are charged against the allowance, and subsequent recoveries are added to the allowance. The Credit Management Committee of the Board of Directors has responsibility for oversight.

Management believes the allowance for credit losses of $6.8 million at December 31, 2014 is adequate to cover inherent losses in the loan portfolio; however, assessing the adequacy of the allowance is a process that requires continuous evaluation and considerable judgment. Management’s judgments are based on numerous assumptions about current events which it believes to be reasonable, but which may or may not be valid. Thus, there can be no assurance that credit losses in future periods will not exceed the current allowance or that future increases in the allowance will not be required. No assurance can be given that management’s ongoing evaluation of the loan portfolio in light of changing economic conditions and other relevant circumstances will not require significant future additions to the allowance, thus adversely affecting future operating results of the Bank.

Determining the fair value of PCI loans at acquisition required the Company to estimate cash flows expected to result from those loans and to discount those cash flows at appropriate rates of interest. For such loans, the excess of cash flows expected to be collected at acquisition over the estimated fair value is recognized as interest income over the remaining lives of the loans and is called the accretable yield. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition reflects the impact of estimated credit losses and is called the nonaccretable difference. In accordance with GAAP, there was no carry-over of previously established allowance for credit losses from the acquired company.

In 2014, the Company implemented a methodology for calculating the credit marks for loans acquired in the merger with Legacy Select to cover estimated credit losses on those loans. These enhancements included several refinements to the data accumulation processes for determining the probability of default and loss given default for the various classes of loans that are more statistically sound than those previously employed. In addition, commercial risk graded loans are now segregated between those that are real estate secured and those that are not. A robust identification of various factors has also been embedded in the estimation process. Management believes these enhancements will improve the precision of the process for estimating the inherent loss in the loan portfolio. The revisions did not have a material impact on the allowance recorded at December 31, 2014.

For PCI loans acquired from Legacy Select, the contractually required payments including principal and interest, cash flows expected to be collected and fair values as of the closing date of the merger and December 31, 2014 were:

(Dollars in thousands)	July 25, 2014		December 31, 2014
Contractually required payments	$	34,329	$	32,233
Nonaccretable difference		1,402		1,436
Cash flows expected to be collected		32,927		30,797
Accretable yield		4,360		3,762
Fair value	$	28,567	$	27,035

The following table documents changes to the amount of the PCI accretable yield from the acquisition date to December 31, 2014 (dollars in thousands):

Accretable yield, beginning of period	$	-
Addition from Legacy Select acquisition		4,360
Accretion		(598)
Reclassification from (to) nonaccretable difference		-
Accretable yield, end of period	$	3,762

Allowance for Loan Losses

The allowance for loan losses is a reserve established through provisions for loan losses charged to income and represents management’s best estimate of loans losses inherent within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated losses and risk inherent in the loan portfolio. The Company’s allowance for loan loss methodology is based on historical loss experience by type of credit and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions. The Company’s process for determining the appropriate level of reserves is designed to account for changes in credit quality as they occur The provision for loan losses reflects loan quality trends, including the levels of, and trends related to, past due loans and economic conditions at the local and national levels. It also considers the quality and risk characteristics of the Company’s loan origination and servicing policies and practices.

Individual reserves are calculated according to ASC Section 310-10-35 against loans evaluated individually and deemed to most likely be impaired. Impaired loans include all loans in non-accrual status, all troubled debt restructures, all substandard loans that are deemed to be collateral dependent, and other loans that management determines require reserves.

As of March 31, 2014, the Company elected to change the allowance for loan loss model it uses to calculate historical loss rates and qualitative and environmental factors in its allowance for loan losses. The Company elected to change the model used for allowance for loan losses in order to utilize the loss migration, improve the objectivity of loss projections, and increase reliability of identifying losses inherent in the portfolio. The impact of the change to the model resulted in a $177,000 increase to our loan loss reserves as of the time of the change. In determining the loss history to be applied to its ASC 450 loan pools within the allowance for loan losses, the Company has previously used loss history based on the weighted average net charge off history for the most recent fourteen consecutive quarters, based on the risk-graded pool to which the loss was assigned. Historical loss rates are now calculated by using a loss migration analysis associating losses to the risk-graded pool to which they relate for each of the previous twelve quarters. Then, using a twelve quarter look back period, loss factors are calculated for each risk-graded pool.

The new model continues to incorporate various internal and external qualitative and environmental factors as described in the Interagency Policy Statement on the Allowance for Loan and Lease Losses, dated December 2006. Input for these factors is determined on the basis of management observation, judgment, and experience. The factors utilized by the Company in the new model for all loan classes are as follows:

Internal Factors

⋅ Concentrations – Measures the increased risk derived from concentration of credit exposure in particular industry segments within the portfolio.

⋅ Policy exceptions – Measures the risk derived from granting terms outside of underwriting guidelines.

⋅ Compliance exceptions– Measures the risk derived from granting terms outside of regulatory guidelines.

⋅ Document exceptions– Measures the risk exposure resulting from the inability to collect due to improperly executed documents and collateral imperfections.

⋅ Financial information monitoring – Measures the risk associated with not having current borrower financial information.

⋅ Nonaccrual – Reflects increased risk of loans with characteristics that merit nonaccrual status.

⋅ Delinquency – Reflects the increased risk deriving from higher delinquency rates.

⋅ Personnel turnover – Reflects staff competence in various types of lending.

⋅ Portfolio growth – Measures the impact of growth and potential risk derived from new loan production.

External Factors

⋅ GDP growth rate – Impact of general economic factors that affect the portfolio.

⋅ North Carolina unemployment rate – Impact of local economic factors that affect the portfolio.

⋅ Peer group delinquency rate – Measures risk associated with the credit requirements of competitors.

⋅ Prime rate change – Measures the effect on the portfolio in the event of changes in the prime lending rate.

 

Each pool is assigned an adjustment to the potential loss percentage by assessing its characteristics against each of the factors listed above.

Reserves are generally divided into three allocation segments:

1. Individual reserves. These are calculated according to ASC Section 310-10-35 against loans evaluated individually and deemed to most likely be impaired.  All loans in non-accrual status and all substandard loans that are deemed to be collateral dependent are assessed for impairment. Loans are deemed uncollectible based on a variety of credit, collateral, documentation and other issues. In the case of uncollectible receivables, the collateral is considered unsecured and therefore fully charged off.

2. Formula reserves. Formula reserves are held against loans evaluated collectively. Loans are grouped by type or by risk grade, or some combination of the two. Loss estimates are based on historical loss rates for each respective loan group. Formula reserves represent the Company’s best estimate of losses that may be inherent, or embedded, within the group of loans, even if it is not apparent at this time which loans within any group or pool represent those embedded losses.

3. Qualitative and external reserves. If individual reserves represent estimated losses tied to specific loans, and formula reserves represent estimated losses tied to a pool of loans but not yet to any specific loan, then these reserves represent an estimate of losses that are expected, but are not yet tied to any loan or group of loans.

All information related to the calculation of the three segments, including data analysis, assumptions, calculations, etc. are documented. Assigning specific individual reserve amounts, formula reserve factors, or unallocated amounts based on unsupported assumptions or conclusions is not permitted.

In determining the loss history to be applied to its ASC 450 loan pools within the allowance for loan losses, the Company has previously used net charge-off history for most recent ten consecutive quarters prior to December 31, 2013. In determining the appropriate level of the allowance for loan losses at December 31, 2013, the loss history was expanded to fourteen consecutive quarters of net charge-offs. Since the most recent quarters contain a declining amount of charge offs coupled with a large number of recoveries and thus have a lower loss history than quarters from 2011 and 2012, management determined that the expansion of loss history better reflects the inherent losses in the current loan portfolio. The impact of this adjustment to the allowance for loan losses resulted in a $1.2 million increase to our 2013 loan loss reserves as compared to the methodology previously used. Loan loss provisions in 2013 were also affected by the decline in overall loan balances during the year.

The following tables present a roll forward of the Company’s allowance for loan losses by loan segment for the twelve month periods ended December 31, 2014, 2013 and 2012, respectively (in thousands):

2014	Commercial						1 to 4				Loans to		Multi-
	and				Commercial		family				individuals &		family
Allowance for loan losses	industrial		Construction		real estate		residential		HELOC		overdrafts		residential		Total
Loans – excluding PCI
Balance, beginning of period 01/01/2014	$	245	$	565	$	4,599	$	826	$	680	$	65	$	74	$	7,054
Provision for loan losses		589		479		(1,899)		(262)		499		195		205		(194)
Loans charged-off		(63)		(4)		(150)		(26)		(327)		(98)		-		(668)
Recoveries		32		63		364		92		78		23		-		652
Total	$	803	$	1,103	$	2,914	$	630	$	930	$	185	$	279	$	6,844
PCI Loans
Balance, beginning of period 01/01/2014	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-
Provision for loan losses		-		-		-		-		-		-		-		-
Loans charged-off		-		-		-		-		-		-		-		-
Recoveries		-		-		-		-		-		-		-		-
Total	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-
Total Loans
Balance, beginning of period 01/01/2014	$	245	$	565	$	4,599	$	826	$	680	$	65	$	74	$	7,054
Provision for loan losses		589		479		(1,899)		(262)		499		195		205		(194)
Loans charged-off		(63)		(4)		(150)		(26)		(327)		(98)		-		(668)
Recoveries		32		63		364		92		78		23		-		652
Balance, end of period 12/31/2014	$	803	$	1,103	$	2,914	$	630	$	930	$	185	$	279	$	6,844
Ending Balance: individually evaluated for impairment	$	64	$	80	$	419	$	74	$	50	$	-	$	-	$	687
Ending Balance: collectively evaluated for impairment	$	739	$	1,023	$	2,495	$	556	$	880	$	185	$	279	$	6,157
Loans:
Ending Balance	$	58,217	$	83,593	$	233,630	$	90,903	$	38,093	$	6,017	$	42,224	$	552,677
Ending Balance: individually evaluated for impairment	$	743	$	1,467	$	7,530	$	2,751	$	921	$	-	$	2,232	$	15,644
Ending Balance: collectively evaluated for impairment	$	57,474	$	82,126	$	226,100	$	88,152	$	37,172	$	6,017	$	39,992	$	537,033

2013	Commercial						1 to 4				Loans to		Multi-
	and				Commercial		family				individuals &		family
Allowance for loan losses	industrial		Construction		real estate		residential		HELOC		overdrafts		residential		Total
Balance, beginning of period 01/01/2013	$	278	$	798	$	4,946	$	1,070	$	627	$	72	$	106	$	7,897
Provision for loan losses		(35)		(230)		(59)		(317)		288		60		(32)		(325)
Loans charged-off		(135)		(28)		(384)		(325)		(316)		(135)		-		(1,323)
Recoveries		137		25		96		398		81		68		-		805
Balance, end of period 12/31/2013	$	245	$	565	$	4,599	$	826	$	680	$	65	$	74	$	7,054
Ending Balance: individually evaluated for impairment	$	63	$	91	$	541	$	88	$	320	$	-	$	-	$	1,103
Ending Balance: collectively evaluated for impairment	$	182	$	474	$	4,058	$	738	$	360	$	65	$	74	$	5,951
Loans:
Ending Balance	$	29,166	$	53,325	$	169,176	$	35,006	$	31,863	$	8,775	$	19,739	$	347,050
Ending Balance: individually evaluated for impairment	$	463	$	2,387	$	9,443	$	2,980	$	1,320	$	5	$	2,384	$	18,982
Ending Balance: collectively evaluated for impairment	$	28,703	$	50,938	$	159,733	$	32,026	$	30,543	$	8,770	$	17,355	$	328,068

2012	Commercial						1 to 4				Loans to		Multi-
	and				Commercial		family				individuals &		family
Allowance for loan losses	industrial		Construction		real estate		residential		HELOC		overdrafts		residential		Total
Balance, beginning of period 01/01/2012	$	719	$	1,540	$	4,771	$	1,661	$	1,122	$	94	$	127	$	10,034
Provision for loan losses		(2,962)		(339)		1,468		(591)		(110)		(42)		(21)		(2,597)
Loans charged-off		(193)		(720)		(1,580)		(232)		(459)		(70)		-		(3,254)
Recoveries		2,714		317		287		232		74		90		-		3,714
Balance, end of period 12/31/2012	$	278	$	798	$	4,946	$	1,070	$	627	$	72	$	106	$	7,897
Ending Balance: individually evaluated for impairment	$	51	$	64	$	581	$	157	$	43	$	4	$	9	$	909
Ending Balance: collectively evaluated for impairment	$	227	$	734	$	4,365	$	913	$	584	$	68	$	97	$	6,988
Loans:
Ending Balance	$	29,297	$	48,220	$	186,949	$	41,017	$	34,603	$	8,734	$	19,524	$	368,344
Ending Balance: individually evaluated for impairment	$	611	$	2,642	$	10,492	$	3,651	$	819	$	24	$	1,482	$	19,721
Ending Balance: collectively evaluated for impairment	$	28,686	$	45,578	$	176,457	$	37,366	$	33,784	$	8,710	$	18,042	$	348,623