LOANS

3 Months Ended

Mar. 31, 2015

Loans and Leases Receivable Disclosure [Abstract]

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

NOTE G - LOANS

Following is a summary of the composition of the Company’s loan portfolio at March 31, 2015 and December 31, 2014:

	March 31,					December 31,
Total Loans:	2015					2014
			Percent					Percent
	Amount		of total			Amount		of total
	(Dollars in thousands)
Real estate loans:
1 to 4 family residential	$	87,273		15.62	%	$	90,903		16.47	%
Commercial real estate		234,754		42.00	%		233,630		42.32	%
Multi-family residential		41,319		7.39	%		42,224		7.65	%
Construction		85,968		15.38	%		83,593		15.14	%
Home equity lines of credit (“HELOC”)		38,481		6.89	%		38,093		6.90	%
Total real estate loans		487,795		87.28	%		488,443		88.48	%
Other loans:
Commercial and industrial		66,029		11.81	%		58,217		10.55	%
Loans to individuals		5,693		1.02	%		5,953		1.08	%
Overdrafts		82		0.01	%		64		0.01	%
Total other loans		71,804		12.84	%		64,234		11.64	%
Gross loans		559,599					552,677
Less deferred loan origination fees, net		(676)		(0.12)	%		(639)		(0.12)	%
Total loans		558,923		100.00	%		552,038		100.00	%
Allowance for loan losses		(6,919)					(6,844)
Total loans, net	$	552,004				$	545,194

	March 31,					December 31,
	2015					2014
Purchased Credit Impaired (PCI) Loans:			Percent					Percent
	Amount		of total			Amount		of total
	(Dollars in thousands)
Real estate loans:
1 to 4 family residential	$	9,674		36.63	%	$	9,972		36.89	%
Commercial real estate		11,698		44.30	%		11,903		44.03	%
Multi-family residential		2,698		10.22	%		2,724		10.08	%
Construction		1,453		5.50	%		1,463		5.41	%
Home equity lines of credit (“HELOC”)		189		0.72	%		188		0.69	%
Total real estate loans		25,712		97.37	%		26,250		97.10	%
Other loans:
Commercial and industrial		571		2.16	%		657		2.43	%
Loans to individuals		125		0.47	%		128		0.47	%
Overdrafts		-		0.00	%		-		0.00	%
Total other loans		696		2.63	%		785		2.90	%
Gross loans		26,408					27,035
Less deferred loan origination fees, net		-		-	%		-		-	%
Total loans		26,408		100.00	%		27,035		100.00	%
Allowance for loan losses		-					-
Total loans, net	$	26,408				$	27,035

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 March 31, 2015 were:

(Dollars in thousands)	March 31, 2015		July 25, 2014
Contractually required payments	$	31,227	$	34,329
Nonaccretable difference		1,385		1,402
Cash flows expected to be collected		29,842		32,927
Accretable yield		3,434		4,360
Fair value	$	26,408	$	28,567

	March 31,					December 31,
	2015					2014
Loans – excluding PCI:			Percent					Percent
	Amount		of total			Amount		of total
	(Dollars in thousands)
Real estate loans:
1 to 4 family residential	$	77,599		14.57	%	$	80,931		15.42	%
Commercial real estate		223,056		41.89	%		221,727		42.23	%
Multi-family residential		38,621		7.25	%		39,500		7.52	%
Construction		84,515		15.87	%		82,130		15.64	%
Home equity lines of credit (“HELOC”)		38,292		7.19	%		37,905		7.22	%
Total real estate loans		462,083		86.77	%		462,193		88.03	%
Other loans:
Commercial and industrial		65,458		12.29	%		57,560		10.97	%
Loans to individuals		5,568		1.05	%		5,825		1.11	%
Overdrafts		82		0.02	%		64		0.01	%
Total other loans		71,108		13.36	%		63,449		12.09	%
Gross loans		533,191					525,642
Less deferred loan origination fees, net		(676)		(0.13)	%		(639)		(0.12)	%
Total loans		532,515		100.00	%		525,003		100.00	%
Allowance for loan losses		(6,919)					(6,844)
Total loans, net	$	525,596				$	518,159

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

At March 31, 2015, the Company had pre-approved but unused lines of credit for customers totaling $124.1 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.

1-to-4 Family Residential Loans

Residential 1-to-4 family loans are mortgage loans secured by residential real estate within the Bank’s market areas. These loans may also include loans that 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. 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 a 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 non-farm 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 the 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 often 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, and 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 & Overdrafts

Consumer loans are approved using Bank policies and procedures established to evaluate each credit request. All lending decisions and credit risks are required to be 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 on customer accounts are classified as loans for reporting purposes.

The following tables present an age analysis of past due loans, segregated by class of loans as of March 31, 2015 and December 31, 2014, respectively:

Total Loans:	March 31, 2015
	30+		Non-		Total
	Days		Accrual		Past				Total
	Past Due		Loans		Due		Current		Loans
	(In thousands)
Commercial and industrial	$	370	$	511	$	881	$	65,148	$	66,029
Construction		170		763		933		85,035		85,968
Multi-family residential		-		883		883		40,436		41,319
Commercial real estate		617		4,559		5,176		229,578		234,754
Loans to individuals & overdrafts		-		-		-		5,775		5,775
1-to-4 family residential		442		1,960		2,402		84,871		87,273
HELOC		18		809		827		37,654		38,481
Deferred loan (fees) cost, net		-		-		-		-		(676)
	$	1,617	$	9,485	$	11,102	$	548,497	$	558,923

Total PCI Loans:	March 31, 2015
	30+		Non-		Total
	Days		Accrual		Past				Total
	Past Due		Loans		Due		Current		Loans
	(In thousands)
Commercial and industrial	$	-	$	-	$	-	$	571	$	571
Construction		-		-		-		1,453		1,453
Multi-family residential		-		-		-		2,698		2,698
Commercial real estate		557		-		557		11,141		11,698
Loans to individuals & overdrafts		-		-		-		125		125
1-to-4 family residential		284		-		284		9,390		9,674
HELOC		-		-		-		189		189
	$	841	$	-	$	841	$	25,567	$	26,408

Total Loans (excluding PCI):	March 31, 2015
	30+		Non-		Total
	Days		Accrual		Past				Total
	Past Due		Loans		Due		Current		Loans
	(In thousands)
Commercial and industrial	$	370	$	511	$	881	$	64,577	$	65,458
Construction		170		763		933		83,582		84,515
Multi-family residential		-		883		883		37,738		38,621
Commercial real estate		60		4,559		4,619		218,437		223,056
Loans to individuals & overdrafts		-		-		-		5,650		5,650
1-to-4 family residential		158		1,960		2,118		75,481		77,599
HELOC		18		809		827		37,465		38,292
Deferred loan (fees) cost, net		-		-		-		-		(676)
	$	776	$	9,485	$	10,261	$	522,930	$	532,515

There were three loans that amounted to $400,000 that were more than 90 days past due and still accruing interest at March 31, 2015.

	December 31, 2014
	30+		Non-		Total
	Days		Accrual		Past				Total
	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

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.

Impaired Loans

The following tables present information on loans that were considered to be impaired as of March 31, 2015 and December 31, 2014:

							Three months ended
			Contractual				March 31, 2015
			Unpaid		Related		Average		Interest Income
	Recorded		Principal		Allowance		Recorded		Recognized on
	Investment		Balance		for Loan Losses		Investment		Impaired Loans
	(dollars in thousands)
With no related allowance recorded:
Commercial and industrial	$	604	$	604	$	-	$	541	$	3
Construction		1,055		1,280		-		1,177		13
Commercial real estate		2,770		3,307		-		2,712		73
Multi-family residential		2,200		2,486		-		2,216		22
HELOC		637		778		-		637		11
1 to 4 family residential		2,543		3,010		-		2,422		31
Subtotal:		9,809		11,465		-		9,705		153
With an allowance recorded:
Commercial and industrial		11		12		2		138		-
Construction		166		168		79		166		1
Commercial real estate		4,463		5,382		354		4,671		60
HELOC		284		526		50		283		-
1 to 4 family residential		640		642		90		545		5
Subtotal:		5,564		6,730		575		5,803		66
Totals:
Commercial		11,269		13,239		435		11,621		172
Residential		4,104		4,956		140		3,887		47
Grand Total:	$	15,373	$	18,195	$	575	$	15,508	$	219

Impaired loans at March 31, 2015 were approximately $15.4 million and were composed of $9.5 million in nonaccrual loans and $5.9 million in loans that were still accruing interest. Recorded investment represents the current principal balance of the loan. Approximately $5.6 million in impaired loans had specific allowances provided for them while the remaining $9.8 million had no specific allowances recorded at March 31, 2015. Of the $9.8 million with no allowance recorded, $1.7 million of those loans have had partial charge-offs recorded.

	As of December 31, 2014						Three months ended March 31, 2014
			Contractual
			Unpaid		Related		Average		Interest Income
	Recorded		Principal		Allowance		Recorded		Recognized on
	Investment		Balance		for Loan Losses		Investment		Impaired Loans
	(In thousands)
With no related allowance recorded:
Commercial and industrial	$	478	$	478	$	-	$	161	$	3
Construction		1,300		1,525		-		1,919		23
Commercial real estate		2,652		3,536		-		3,601		70
Loans to individuals & overdrafts		-		2		-		3		-
Multi-family residential		2,232		2,515		-		2,361		38
HELOC		637		768		-		2,445		39
1 to 4 family residential		2,301		2,750		-		761		10
Subtotal:		9,600		11,574		-		11,251		183
With an allowance recorded:
Commercial and industrial		265		267		64		266		-
Construction		167		168		80		248		-
Commercial real estate		4,878		5,761		419		4,183		12
Loans to individuals & overdrafts		-		-		-		1		-
HELOC		284		526		50		487		7
1 to 4 family residential		450		455		74		550		5
Subtotal:		6,044		7,177		687		5,735		24
Totals:
Commercial		11,972		14,250		563		12,739		146
Consumer		-		2		-		4		-
Residential		3,672		4,499		124		4,243		61
Grand Total:	$	15,644	$	18,751	$	687	$	16,986	$	207

Impaired loans at December 31, 2014 were approximately $15.6 million and consisted 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 recorded 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.

Loans are placed on non-accrual status 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. In the case of an impaired loan that is still on accrual basis, payments are applied to both principal and interest.

Troubled Debt Restructurings

The following table presents loans that were modified as troubled debt restructurings (“TDRs”) with a breakdown of the types of concessions made by loan class during the first quarter of 2015 and 2014:

	Three months ended March 31, 2015						Three months ended March 31, 2014
			Pre-		Post-				Pre-		Post-
			Modification		Modification				Modification		Modification
			Outstanding		Outstanding				Outstanding		Outstanding
	Number		Recorded		Recorded		Number		Recorded		Recorded
	of loans		Investment		Investment		of loans		Investment		Investment
	(Dollars in thousands)
Below market interest rate:
1-to-4 family residential		-	$	-	$	-		1	$	22	$	22
Total		-	$	-	$	-		1	$	22	$	22

Loans may be considered troubled debt restructurings for reasons other than below market interest rates, extended payment terms or forgiveness of principal. Loans in the “Other” category are those that were renewed at terms that vary from those that the Bank would enter into for new loans of the same type.

The following table presents loans that were modified as TDRs within the past twelve months with a breakdown of the types for which there was a payment default together with concessions made by loan class during the twelve month period ended March 31, 2015 and 2014:

	Twelve months ended				Twelve months ended
	March 31, 2015				March 31, 2014
	Number		Recorded		Number		Recorded
	of loans		investment		of loans		investment
	(Dollars in thousands)
Below market interest rate:
1-to-4 family residential		-	$	-		4	$	291
Total		-		-		4		291
Extended payment terms:
Commercial and industrial		-		-		3		401
Construction		-		-		2		131
Commercial real estate		2		936		1		645
1-to-4 family residential		1		38		4		1,028
Total		3		974		10		2,205
Other:
Commercial real estate		-		-		1		155
1-to-4 family residential		-		-		1		68
Total		-		-		2		223
Total		3	$	974		16	$	2,719

At March 31, 2015, the Bank had forty loans with an aggregate balance of $6.8 million that were considered to be troubled debt restructurings. Of those TDRs, twenty-three loans with a balance totaling $4.0 million were still accruing as of March 31, 2015. The remaining TDRs with balances totaling $2.8 million as of March 31, 2015 were in non-accrual status.

At March 31, 2014, the Bank had forty-one loans with a total balance of $7.4 million that were considered to be troubled debt restructurings. Of those TDRs, twenty-five loans with balances totaling $5.6 million were still accruing as of March 31, 2014. The remaining TDRs with balances totaling $1.8 million as of March 31, 2014 were in non-accrual status.

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: Conformity in all respects with Bank policy, guidelines, underwriting standards, and Federal and State regulations (no exceptions of any kind). Loans assigned this risk grade will demonstrate the following characteristics:

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

Credit Quality Indicators

· 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 appear 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 nine 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 present information on risk ratings of the commercial and consumer loan portfolios, segregated by loan class as of March 31, 2015 and December 31, 2014, respectively:

Total loans:

March 31, 2015
Commercial
Credit
Exposure By	Commercial				Commercial
Internally	and				real		Multi-family
Assigned Grade	industrial		Construction		estate		residential
			(In thousands)
Superior	$	1,379	$	-	$	-	$	-
Very good		2,046		-		-		-
Good		6,134		2,700		14,679		-
Acceptable		27,687		13,648		126,687		31,214
Acceptable with care		27,669		67,751		79,044		7,216
Special mention		185		725		7,915		2,006
Substandard		929		1,144		6,429		883
Doubtful		-		-		-		-
Loss		-		-		-		-
	$	66,029	$	85,968	$	234,754	$	41,319

Consumer Credit
Exposure By
Internally	1-to-4 family
Assigned Grade	residential		HELOC
Pass	$	79,236	$	36,800
Special mention		3,834		631
Substandard		4,203		1,050
	$	87,273	$	38,481

Consumer Credit
Exposure Based	Loans to
On Payment	individuals &
Activity	overdrafts
Pass	$	5,747
Non –pass		28
	$	5,775

Total PCI loans: 

March 31, 2015
Commercial
Credit
Exposure By	Commercial				Commercial
Internally	and				real		Multi-family
Assigned Grade	industrial		Construction		estate		residential
			(In thousands)
Superior	$	-	$	-	$	-	$	-
Very good		-		-		-		-
Good		-		-		-		-
Acceptable		-		-		-		-
Acceptable with care		523		1,388		9,203		2,698
Special mention		-		65		1,937		-
Substandard		48		-		558		-
Doubtful		-		-		-		-
Loss		-		-		-		-
	$	571	$	1,453	$	11,698	$	2,698

Consumer Credit
Exposure By
Internally	1-to-4 family
Assigned Grade	residential		HELOC
Pass	$	6,058	$	189
Special mention		3,011		-
Substandard		605		-
	$	9,674	$	189

Consumer Credit
Exposure Based	Loans to
On Payment	individuals &
Activity	overdrafts
Pass	$	115
Non –pass		10
	$	125

Total loans, excluding PCI loans:

March 31, 2015
Commercial
Credit
Exposure By	Commercial				Commercial
Internally	and				real		Multi-family
Assigned Grade	industrial		Construction		estate		residential
			(In thousands)
Superior	$	1,379	$	-	$	-	$	-
Very good		2,046		-		-		-
Good		6,134		2,700		14,679		-
Acceptable		27,687		13,648		126,687		31,214
Acceptable with care		27,146		66,363		69,841		4,518
Special mention		185		660		5,978		2,006
Substandard		881		1,144		5,871		883
Doubtful		-		-		-		-
Loss		-		-		-		-
	$	65,458	$	84,515	$	223,056	$	38,621

Consumer Credit
Exposure By
Internally	1-to-4 family
Assigned Grade	residential		HELOC
Pass	$	73,178	$	36,611
Special mention		823		631
Substandard		3,598		1,050
	$	77,599	$	38,292

Consumer Credit
Exposure Based	Loans to
On Payment	individuals &
Activity	overdrafts
Pass	$	5,632
Non –pass		18
	$	5,650

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

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.

The following table documents changes to the amount of the accretable yield on PCI loans for the three months ended March 31, 2015 (dollars in thousands):

Accretable yield, beginning of period	$	3,762
Accretion		(328)
Reclassification from (to) nonaccretable difference		-
Accretable yield, end of period	$	3,434

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 probable loan losses that have been incurred 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.

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 the 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 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 likely incurred losses, 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, and calculations are documented. Assigning specific individual reserve amounts, formula reserve factors, or unallocated amounts based on unsupported assumptions or conclusions is not permitted.

The following tables present a roll forward of the Company’s allowance for loan losses by loan class for the three month periods ended March 31, 2015 and March 31, 2014, respectively:

	Three months ended March 31, 2015
	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	$	803	$	1,103	$	2,914	$	630	$	930	$	185	$	279	$	6,844
Provision for loan losses		173		102		(40)		(40)		(42)		(3)		(20)		130
Loans charged-off		-		-		(29)		-		(40)		(24)		-		(93)
Recoveries		6		4		-		16		3		9		-		38
Balance, end of period	$	982	$	1,209	$	2,845	$	606	$	851	$	167	$	259	$	6,919
PCI Loans
Balance, beginning of period	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-
Provision for loan losses		-		-		-		-		-		-		-		-
Loans charged-off		-		-		-		-		-		-		-		-
Recoveries		-		-		-		-		-		-		-		-
Balance, end of period	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-
Total Loans
Balance, beginning of period	$	803	$	1,103	$	2,914	$	630	$	930	$	185	$	279	$	6,844
Provision for loan losses		173		102		(40)		(40)		(42)		(3)		(20)		130
Loans charged-off		-		-		(29)		-		(40)		(24)		-		(93)
Recoveries		6		4		-		16		3		9		-		38
Balance, end of period	$	982	$	1,209	$	2,845	$	606	$	851	$	167	$	259	$	6,919
Ending Balance: individually evaluated for impairment	$	2	$	79	$	354	$	90	$	50	$	-	$	-	$	575
Ending Balance: collectively evaluated for impairment	$	980	$	1,130	$	2,491	$	516	$	801	$	167	$	259	$	6,344
Loans:
Ending Balance: collectively evaluated for impairment	$	65,414	$	84,747	$	227,521	$	84,090	$	37,560	$	5,775	$	39,119	$	544,226
Ending Balance: individually evaluated for impairment	$	615	$	1,221	$	7,233	$	3,183	$	921	$	-	$	2,200	$	15,373
Ending Balance	$	66,029	$	85,968	$	234,754	$	87,273	$	38,481	$	5,775	$	41,319	$	559,599

There is no allowance for PCI loans as of March 31, 2015.

	Three months ended March 31, 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
	(In thousands)
Balance, beginning of period	$	245	$	565	$	4,599	$	826	$	680	$	65	$	74	$	7,054
Provision (recovery) for loan losses		322		266		(1,340)		(265)		645		106		217		(49)
Loans charged-off		(63)		-		-		(1)		(40)		(6)		-		(110)
Recoveries		9		58		24		25		8		6		-		130
Balance, end of period	$	513	$	889	$	3,283	$	585	$	1,293	$	171	$	291	$	7,025
Ending balance: individually evaluated for impairment	$	66	$	81	$	538	$	21	$	313	$	-	$	-	$	1,019
Ending balance: collectively evaluated for impairment	$	447	$	808	$	2,745	$	564	$	980	$	171	$	291	$	6,006
Loans:
Ending balance: collectively evaluated for impairment	$	29,443	$	54,737	$	161,393	$	29,666	$	29,864	$	7,556	$	18,742	$	331,401
Ending balance: individually evaluated for impairment	$	392	$	1,946	$	6,124	$	2,885	$	1,300	$	4	$	2,339	$	14,990
Ending balance	$	29,835	$	56,683	$	167,517	$	32,551	$	31,164	$	7,560	$	21,081	$	346,391

During the three months ended March 31, 2015 the Company recorded net charge-offs of $55,000. Total loans outstanding during the first quarter of 2015 increased, resulting in a $130,000 provision for loan losses.