General. The Bank provides to its customers a full range of short- to medium-term commercial, agricultural, Small Business Administration guaranteed, mortgage, home equity, and personal loans, both secured and unsecured. The Bank also makes real estate mortgage and construction loans.

The following table presents loans at December 31, 2013 and December 31, 2012 by class:



	December 31,			December 31,
	2013			2012
	(Amounts in thousands)
Construction and land development	$	131,035		$	131,981
Commercial real estate:
Owner occupied	382,766			342,962
Non-owner occupied	196,926			211,489
Residential mortgages:
1-4 family	174,072			168,611
Multifamily	41,713			35,337
Home equity lines of credit	194,145			191,888
Commercial	185,443			174,440
Consumer and other	51,667			51,664
Total	1,357,767			1,308,372
Less: Net deferred loan costs	979			1,132
Allowance for loan losses	(18,063		)	(25,149		)
Loans, net	$	1,340,683		$	1,284,355

Real Estate Loans. Real estate loans include construction and land development loans, commercial real estate loans, home equity lines of credit, and residential mortgages.

Commercial real estate loans totaled $579.7 million and $554.5 million at December 31, 2013 and December 31, 2012, respectively. This lending has involved loans secured by owner-occupied commercial buildings for office, storage and warehouse space, as well as non-owner occupied commercial buildings. The Bank generally requires the personal guaranty of borrowers and a demonstrated cash flow capability sufficient to service the debt. Loans secured by commercial real estate may be larger in size and may involve a greater degree of risk than one-to-four family residential mortgage loans. Payments on such loans are often dependent on successful operation or management of the properties.

Construction/development lending totaled $131.0 million and $132.0 million at December 31, 2013 and December 31, 2012, respectively. The Bank originates one-to-four family residential construction loans for the construction of custom homes (where the home buyer is the borrower) and provides financing to builders and consumers for the construction of pre-sold homes. The Bank generally receives a pre-arranged permanent financing commitment from an outside banking entity prior to financing the construction of pre-sold homes. The Bank also makes commercial real estate construction loans, primarily for owner-occupied properties. The Bank limits its construction lending risk through adherence to established underwriting procedures.

Residential one-to-four family loans amounted to $174.1 million and $168.6 million at December 31, 2013 and December 31, 2012, respectively. The Bank's residential mortgage loans are typically construction loans that convert into permanent financing and are secured by properties located within the Bank's market areas.

Home equity lines of credit totaled $194.1 million and $191.9 million at December 31, 2013 and December 31, 2012, respectively. The Bank's home equity lines of credit generally are variable rate lines of credit secured by junior liens on 1-4 family residential properties.

Commercial Loans. At December 31, 2013 and December 31, 2012, the Bank's commercial loan portfolio totaled $185.4 million and $174.4 million, respectively. Commercial loans include both secured and unsecured loans for working capital, expansion, and other business purposes. Short-term working capital loans are secured by accounts receivable, inventory and/or equipment. The Bank also makes term commercial loans secured by equipment and real estate. Lending decisions are based on an evaluation of the financial strength, cash flow, management and credit history of the borrower, and the quality of the collateral securing the loan. With few exceptions, the Bank requires personal guarantees and secondary sources of repayment. Commercial loans generally provide greater yields and reprice more frequently than other types of loans, such as real estate loans.

Consumer Loans. Loans to individuals (consumer loans) include automobile loans, boat and recreational vehicle financing, and miscellaneous secured and unsecured personal loans and totaled $51.7 million at December 31, 2013 and December 31, 2012, respectively. Consumer loans generally can carry significantly greater risks than other loans, even if secured, if the collateral consists of rapidly depreciating assets such as automobiles, boats, recreational vehicles, and equipment. Repossessed collateral securing a defaulted consumer loan may not provide an adequate source of repayment of the loan. Consumer loan collections are sensitive to job loss, illness and other personal factors. The Bank manages the risks inherent in consumer lending by following established credit guidelines and underwriting practices designed to minimize risk of loss.

In 2012, the Company embarked on an accelerated asset disposition plan (the “disposition plan”) in an effort to reduce nonperforming assets and problem loans that continued to be a strain on the Company's resources and capital. As a result, the Company sold $43 million in loans during the fourth quarter of 2012, and charged down another $11 million in other problem loans, resulting in approximately $35 million in total losses. The sale included $36 million in nonperforming loans consisting primarily of construction and commercial real estate loans. This sale was an effort to reduce overall credit risk within the Bank.

The following table presents loss information related to the sale and charge-off of problem loans as part of the accelerated asset disposition plan. The disposition plan was a strategy that was created and implemented in the fourth quarter 2012 to reduce levels of problem assets. The disposition plan consisted of the sale of three separate pools of loans (which were pooled based on similar size, classification and risk characteristics), and the sale of other individual classified loans.

Actual loss on the sale of impaired loans recognized in the fourth quarter of 2012 was $21.7 million which represents the difference between the recorded investment of the loan at sale date and the sales price received.



Loan Sales	Recorded Investment of Loans Sold		Charge-offs (Losses) Recorded on the Sales		Additional Provisions Resulting from the Sale of Loans
	(Amounts in thousands)
Construction	$	16,211	$	7,625	$	6,100
Commercial Real Estate:
Owner Occupied	8,871		3,917		4,313
Non-owner Occupied	8,675		4,531		3,755
Mortgages:
1-4 Family	4,557		2,825		2,380
Multifamily	249		113		86
Home Equity Line of Credit	2,204		1,284		746
Commercial	2,291		1,329		1,290
Consumer and other	151		91		57
	$	43,209	$	21,715	$	18,727

Additional charge-offs of $11.0 million were also taken during the fourth quarter 2012 on other problem loans that were not sold. The following table presents a summary of charge-offs on other problem loans.



Loan Sales	Additional Charge-offs on Other Problem Loans
	(Amounts in thousands)
Construction	$	1,601
Commercial Real Estate:
Owner Occupied	1,599
Non-owner Occupied	2,267
Mortgages:
1-4 Family	291
Multifamily	—
Home Equity Line of Credit	1,309
Commercial	3,908
Consumer and other	24
	$	10,999

Other losses related to contingencies for warranties on loans sold and property taxes owed for 2012 (per the terms of the loan purchase agreement) were also recorded in the amount of $2.1 million. No purchase credit impaired loans were included in the sale of loans.

Loan Approvals. The Bank's loan policies and procedures establish the basic guidelines governing its lending operations. The guidelines address the type of loans that the Bank seeks, target markets, underwriting and collateral requirements, terms, interest rate and yield considerations and compliance with laws and regulations. All loans or credit lines are subject to approval procedures and amount limitations. These limitations apply to the borrower's total outstanding indebtedness to the Bank, including any indebtedness as a guarantor. The policies are reviewed and approved at least annually by the Board of Directors of the Bank. The Bank supplements its own supervision of the loan underwriting and approval process with periodic loan reviews by independent, outside professionals experienced in loan review. Responsibility for loan review, loan underwriting, and approval resides with the Chief Credit Officer position. On an annual basis, the Board of Directors of the Bank determines officers lending authority. Authorities may include loans, letters of credit, overdrafts, uncollected funds and such other authorities as determined by the Board of Directors.

Substantially all of the Company's loans have been granted to customers in the Piedmont, foothills, northwestern mountains, and the Research Triangle regions of North Carolina and the upstate region of South Carolina.

In the normal course of business, the Company makes loans to directors and officers of the Company and its subsidiaries. All loans and commitments made to such officers and directors and to companies in which they are officers, or have significant ownership interest, have been made on substantially the same terms and conditions, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other customers. Loans to directors, officers and related parties are subject to comparable loan features and present the same credit risk as those of non-related parties. An analysis of these related party loans for the year ended December 31, 2013 and 2012 is as follows:



	2013			2012
	(Amounts in thousands)
Balance, beginning of year	$	15,550		$	15,783
New loans	3,233			2,436
Repayments	(2,824		)	(2,669		)
Balance, end of year	$	15,959		$	15,550

Credit Review and Evaluation. The Bank has a credit risk review department that reports to the Chief Credit Officer. The focus of the department is on policy compliance and proper grading of higher credit risk loans as well as new and existing loans on a sample basis. Additional reporting for problem/criticized assets has been developed along with an after-the-fact loan review.

The Bank uses a risk grading program to facilitate the evaluation of probable inherent loan losses and the adequacy of the allowance for loan losses for real estate, commercial and consumer loans. In this program, risk grades are initially assigned by loan officers, reviewed by regional credit officers, and further reviewed by internal credit review analysts on a test basis. The Bank strives to maintain the loan portfolio in accordance with conservative loan underwriting policies that result in loans specifically tailored to the needs of the Bank's market area. Every effort is made to identify and minimize the credit risks associated with such lending strategies.

Loans over $20,000 are risk graded on a scale from 1 (highest quality) to 8 (loss). Acceptable loans at inception are grades 1 through 4, and these grades have underwriting requirements that at least meet the minimum requirements of a secondary market source. If borrowers do not meet credit history requirements, other mitigating criteria such as substantial liquidity and low loan-to-value ratios could be considered and would generally have to be met in order to make the loan. The Bank's loan policy states that a guarantor may be necessary if reasonable doubt exists as to the borrower's ability to repay. The Board of Directors has authorized the loan officers to have individual approval authority for risk grade 1 through 4 loans up to maximum exposure limits for each customer. New or renewed loans that are graded 5 (special mention) or lower must have approval from a regional credit officer. Any changes in risk assessments as determined by loan officers, credit administrators, regulatory examiners and management are also considered.

The risk grades, normally assigned by the loan officers when the loan is originated and reviewed by the regional credit officers, are based on several factors including historical data, current economic factors, composition of the portfolio, and evaluations of the total loan portfolio and assessments of credit quality within specific loan types. In some cases, the risk grades are assigned by regional executives, depending upon dollar exposure. Because these factors are dynamic, the provision for loan losses can fluctuate. Credit quality reviews are based primarily on analysis of borrowers' cash flows, with asset values considered only as a second source of payment. Regional credit officers work with lenders in underwriting, structuring and risk grading the Bank's credits. The Risk Review Officer focuses on lending policy compliance, credit risk grading, and credit risk reviews on larger dollar exposures. Management uses the information developed from the procedures above in evaluating and grading the loan portfolio. This continual grading process is used to monitor the credit quality of the loan portfolio and to assist management in determining the appropriate levels of the allowance for loan losses.

The following is a summary of the credit risk grade definitions for all loan types:

“1” - High Quality- These loans represent a credit extension of the highest quality. The borrower's historic (at least five years) cash flows manifest extremely large and stable margins of coverage. Balance sheets are conservative, well capitalized, and liquid. After considering debt service for proposed and existing debt, projected cash flows continue to be strong and provide ample coverage. The borrower typically reflects broad geographic and product diversification and has access to alternative financial markets.

“2” - Good Quality- These loans have a sound primary and secondary source of repayment. The borrower may have access to alternative sources of financing, but sources are not as widely available as they are to a higher graded borrower. This loan carries a normal level of risk, with minimal loss exposure. The borrower has the ability to perform according to the terms of the credit facility. The margins of cash flow coverage are satisfactory but vulnerable to more rapid deterioration than the highest quality loans.

“3” - Satisfactory- The borrowers are a reasonable credit risk and demonstrate the ability to repay the debt from normal business operations. Risk factors may include reliability of margins and cash flows, liquidity, dependence on a single product or industry, cyclical trends, depth of management, or limited access to alternative financing sources. Historic financial information may indicate erratic performance, but current trends are positive. Quality of financial information is adequate, but is not as detailed and sophisticated as information found on higher graded loans. If adverse circumstances arise, the impact on the borrower may be significant.

“4” - Satisfactory - Merits Attention- These credit facilities have potential developing weaknesses that deserve extra attention from the account manager and other management personnel. If the developing weakness is not corrected or mitigated, there may be deterioration in the ability of the borrower to repay the bank's debt in the future.

“5” - Watch or Special Mention - These loans are typically existing loans, made using the passing grades outlined above, that have deteriorated to the point that cash flow is not consistently adequate to meet debt service or current debt service coverage is based on projections. Secondary sources of repayment may include specialized collateral or real estate that is not readily marketable or undeveloped, making timely collection in doubt.

“6” - Substandard- Loans and other credit extensions bearing this grade are considered inadequately protected by the current sound worth and debt service capacity of the borrower or of any pledged collateral. These obligations, even if apparently protected by collateral value, have well-defined weaknesses related to adverse financial, managerial, economic, market, or political conditions jeopardizing repayment of principal and interest as originally intended. Clear loss potential, however, does not have to exist in any individual assets classified as substandard.

“7” - Substandard Impaired (also includes any loans over 90 days past due, excluding sold mortgages )- Loans and other credit extensions graded “7” have all the weaknesses inherent in those graded “6,” with the added characteristic that the severity of the weaknesses makes collection or liquidation in full highly questionable or improbable based upon currently existing facts, conditions, and values. The probability of some loss is extremely high, but because of certain important and reasonably specific factors, the amount of loss cannot be determined. All loans in this category are considered impaired and all material loans are evaluated for a specific reserve in accordance with FAS 114 and the bank's ALLL methodology and specific reserve guidelines.

"7B"- Doubtful- Loans and other credit extensions graded “7b” have all the weaknesses inherent in those graded “7,” with the added characteristic that the severity of the weaknesses makes collection or liquidation in full highly questionable or improbable based upon currently existing facts, conditions, and values. The probability of some loss is extremely high, but because of certain important and reasonably specific factors, the amount of loss cannot be determined. Such pending factors could include merger or liquidation, additional capital injection, refinancing plans, or perfection of liens on additional collateral. Loans in this classification are placed in non-accrual status, with collections applied to principal on the bank's books and evaluated for impairment. All loans in this category are considered impaired and all material loans are evaluated for a specific reserve in accordance with FAS 114 and the bank's ALLL methodology and specific reserve guidelines.

“8” - Loss- Loans in this classification are considered uncollectible and cannot be justified as a viable asset of the Bank. Such loans are to be charged-off or charged-down. This classification does not mean the loan has absolutely no recovery value, but that it is neither practical nor desirable to defer writing off this loan even though partial recovery may be obtained in the future.

The following is a summary of credit quality indicators by class at December 31, 2013 and December 31, 2012:



Real Estate Credit Exposure as of December 31, 2013
			Commercial Real Estate
	Construction		Owner occupied		Non-owner occupied		1-4 Family		Multifamily		Home Equity
	(in thousands)
High Quality	$	—	$	—	$	—	$	90	$	—	$	161
Good Quality	356		—		1,587		982		957		6,627
Satisfactory	22,403		125,560		47,453		99,578		7,691		118,339
Merits Attention	90,343		226,320		133,072		62,242		31,686		61,026
Special Mention	14,434		20,284		7,392		5,307		551		5,075
Substandard	1,168		4,244		2,624		3,005		572		1,632
Substandard impaired	2,331		6,358		4,798		2,868		256		1,285
Doubtful	—		—		—		—		—		—
Loss	—		—		—		—		—		—
	$	131,035	$	382,766	$	196,926	$	174,072	$	41,713	$	194,145



Other Credit Exposures as of December 31, 2013
	Commercial		Consumer and other		Total Loans
	(in thousands)
High Quality	$	2,640	$	2,162	$	5,053
Good Quality	5,084		1,160		16,753
Satisfactory	63,674		21,221		505,919
Merits Attention	94,313		26,126		725,128
Special Mention	7,874		676		61,593
Substandard	9,553		32		22,830
Substandard impaired	2,305		290		20,491
Doubtful	—		—		—
Loss	—		—		—
	$	185,443	$	51,667	$	1,357,767



Real Estate Credit Exposure as of December 31, 2012
			Commercial Real Estate
	Construction		Owner occupied		Non-owner occupied		1-4 Family		Multifamily		Home Equity
	(in thousands)
High Quality	$	—	$	119	$	—	$	375	$	—	$	111
Good Quality	464		—		—		1,301		—		6,756
Satisfactory	22,284		115,347		58,577		95,727		7,945		118,497
Merits Attention	78,668		191,958		129,283		56,629		25,681		59,568
Special Mention	16,797		23,396		16,084		7,862		571		4,228
Substandard	3,939		4,286		2,136		2,850		601		1,687
Substandard impaired	9,829		7,856		5,409		3,867		539		1,041
Doubtful	—		—		—		—		—		—
Loss	—		—		—		—		—		—
	$	131,981	$	342,962	$	211,489	$	168,611	$	35,337	$	191,888



Other Credit Exposures as of December 31, 2012
	Commercial		Consumer and other		Total Loans
	(in thousands)
High Quality	$	2,430	$	2,289	$	5,324
Good Quality	5,738		1,316		15,575
Satisfactory	62,071		22,459		502,907
Merits Attention	82,243		24,425		648,455
Special Mention	16,809		551		86,298
Substandard	1,009		122		16,630
Substandard impaired	4,140		502		33,183
Doubtful	—		—		—
Loss	—		—		—
	$	174,440	$	51,664	$	1,308,372

Nonaccrual loans and past due loans. Nonperforming assets include loans classified as nonaccrual, foreclosed bank-owned property and loans past due 90 days or more on which interest is still being accrued. It is the general policy of the Bank to stop accruing interest for all classes of loans past due 90 days or when it is apparent that the collection of principal and/or interest is doubtful. In addition, certain restructured loans are placed on nonaccrual status until sufficient evidence of timely payment is obtained. When a loan is placed on nonaccrual status, any interest previously accrued but not collected is reversed against interest income in the current period. Amounts received on nonaccrual loans generally are applied first to principal and then to interest only after all principal has been collected. There were no financing receivables past due over 90 days accruing interest as of December 31, 2013 and December 31, 2012.

Nonperforming loans as of December 31, 2013 totaled $15.4 million, or 1.12% of total loans, compared with $22.8 million, or 1.71% of total loans, as of December 31, 2012. The Bank aggressively pursues the collection and repayment of all loans. Other nonperforming assets, such as repossessed and foreclosed collateral is aggressively liquidated by the Bank's collection department. The total number of loans on nonaccrual status has decreased from 315 at December 31, 2012 to 195 at December 31, 2013.

The following is a breakdown of nonaccrual loans as of December 31, 2013 and December 31, 2012:



	December 31, 2013		December 31, 2012
	(in thousands)
Financing Receivables on Nonaccrual status
Construction	$	2,331	$	7,385
Commercial Real Estate:
Owner occupied	4,417		5,787
Non-owner occupied	1,806		1,697
Mortgages:
1-4 Family first lien	2,734		3,123
Multifamily	256		539
Home Equity lines of credit	1,285		1,041
Commercial	2,306		2,790
Consumer and other	258		455
Total	$	15,393	$	22,817

Past due loans reported in the following table do not include loans granted forbearance terms since payments terms have been modified or extended, although the loans are past due based on original contract terms. All loans with forbearance terms are included and reported as impaired loans. Loans are considered past due if the required principal and interest income have not been received as of the date such payments were due.

The following table presents the Bank's aged analysis of past due loans:



	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans
December 31, 2013	(in thousands)
Construction	$	855	$	207	$	541	$	1,603	$	129,432	$	131,035
Commercial real estate:
Owner occupied	1,973		—		58		2,031		380,735		382,766
Non-owner occupied	1,172		129		432		1,733		195,193		196,926
Commercial	2,029		742		142		2,913		182,530		185,443
Mortgages:
Secured 1-4 family- first lien	2,738		1,190		1,186		5,114		168,958		174,072
Multifamily	—		249		—		249		41,464		41,713
Home equity lines of credit	909		341		75		1,325		192,820		194,145
Consumer and other	322		62		52		436		51,231		51,667
Total	$	9,998	$	2,920	$	2,486	$	15,404	$	1,342,363	$	1,357,767

December 31, 2012
Construction	$	4,395	$	345	$	1,865	$	6,605	$	125,376	$	131,981
Commercial real estate:
Owner occupied	838		114		4,237		5,189		337,773		342,962
Non-owner occupied	1,688		500		1,098		3,286		208,203		211,489
Commercial	2,027		34		2,660		4,721		169,719		174,440
Mortgages:
Secured 1-4 family- first lien	2,767		910		2,226		5,903		162,708		168,611
Multifamily	12		—		10		22		35,315		35,337
Home equity lines of credit	1,980		52		924		2,956		188,932		191,888
Consumer and other	236		45		342		623		51,041		51,664
Total	$	13,943	$	2,000	$	13,362	$	29,305	$	1,279,067	$	1,308,372

Impaired Loans. Management considers certain loans graded “substandard impaired” (loans graded 7), "doubtful" (loans graded 7B) or “loss” (loans graded 8) to be individually impaired and may consider “substandard” loans (loans graded 6) individually impaired depending on the borrower's payment history. The Bank measures impairment based upon probable cash flows or the value of the collateral. Collateral value is assessed based on collateral value trends, liquidation value trends, and other liquidation expenses to determine logical and credible discounts that may be needed. Updated appraisals are required for all impaired loans and typically at renewal or modification of larger loans if the appraisal is more than 12 months old.

Impaired loans for all classes of loans typically include nonaccrual loans, loans over 90 days past due still accruing, troubled debt restructured loans and other potential problem loans considered impaired based on other underlying factors. Troubled debt restructured loans are those for which concessions, including the reduction of interest rates below a rate otherwise available to that borrower or the deferral of interest or principal have been granted due to the borrower's weakened financial condition. Interest on troubled debt restructured loans is accrued at the restructured rates when it is anticipated that no loss of remaining principal will occur and a sustained payment performance period is obtained. Due to the borrowers' inability to make the payments required under the original loan terms, the Bank modifies the terms by granting a longer amortized repayment structure or reduced interest rates. Potential problem loans are loans which are currently performing and are not included in nonaccrual or restructured loans above, but about which we have serious doubts as to the borrower's ability to comply with present repayment terms. These loans are likely to be included later in nonaccrual, past due or troubled debt restructured loans, so they are considered by management in assessing the adequacy of the allowance for loan losses.

Impaired loans under $250,000 are collectively reviewed for impairment based on homogeneous pools established for each class of impaired loans with similar risk characteristics in accordance with ASC 310-10-35-21 and are not included with non-impaired loans. Separate loss given probability of default rates are calculated for each impaired pool representing the risk associated with impaired loans less than $250,000 for that pool of loans. Total impaired loans under $250,000 collectively evaluated were $6.2 million and $7.8 million, respectively, as of December 31, 2013 and December 31, 2012. Reserves on impaired loans collectively evaluated were $2.1 million and $2.2 million as of December 31, 2013 and December 31, 2012, respectively. The following table presents the Bank's investment in loans individually reviewed for impairment and related information on those impaired loans as of December 31, 2013 and December 31, 2012:



	As of December 31, 2013						Year to Date December 31, 2013
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
	(in thousands)
Impaired loans without a related allowance for loan losses
Construction	$	2,816	$	2,997	$	—	$	4,764	$	107
Commercial real estate:
Owner occupied	5,445		5,981		—		4,449		117
Non-owner occupied	4,469		4,537		—		5,202		210
Commercial	4,095		4,502		—		4,416		171
Mortgages:
Secured 1-4 family real estate	661		731		—		692		29
Multifamily	—		—		—		197		—
Home equity lines of credit	425		477		—		454		—
Consumer and other	—		—		—		—		—
Impaired loans with a related allowance for loan losses
Construction	$	200	$	215	$	40	$	915	$	25
Commercial real estate:
Owner occupied	5,131		5,172		201		6,380		237
Non-owner occupied	645		645		50		399		10
Commercial	308		313		105		715		2
Mortgages:
Secured 1-4 family real estate	331		341		161		442		4
Multifamily	—		—		—		—		—
Home equity lines of credit	—		—		—		400		2
Consumer and other	—		—		—		—		—
Total impaired loans
Construction	$	3,016	$	3,212	$	40	$	5,679	$	132
Commercial real estate:
Owner occupied	10,576		11,153		201		10,829		354
Non-owner occupied	5,114		5,182		50		5,601		220
Commercial	4,403		4,815		105		5,131		173
Mortgages:
Secured 1-4 family real estate	992		1,072		161		1,134		33
Multifamily	—		—		—		197		—
Home equity lines of credit	425		477		—		854		2
Consumer and other	—		—		—		—		—
Total impaired loans individually reviewed for impairment	$	24,526	$	25,911	$	557	$	29,425	$	914



	As of December 31, 2012						Year to Date December 31, 2012
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
	(in thousands)
Impaired loans without a related allowance for loan losses
Construction	$	6,212	$	7,676	$	—	$	18,748	$	307
Commercial real estate:
Owner occupied	6,563		7,071		—		15,175		228
Non-owner occupied	4,976		5,358		—		7,399		254
Commercial	4,460		4,482		—		6,350		143
Mortgages:
Secured 1-4 family real estate	1,435		1,503		—		2,364		42
Multifamily	530		565		—		701		—
Home equity lines of credit	705		800		—		1,424		13
Consumer and other	—		—		—		—		—
Impaired loans with a related allowance for loan losses
Construction	$	1,958	$	2,136	$	191	$	2,929	$	4
Commercial real estate:
Owner occupied	4,961		5,082		189		5,163		326
Non-owner occupied	561		643		89		2,212		63
Commercial	1,193		1,245		928		2,249		8
Mortgages:
Secured 1-4 family real estate	—		—		—		347		10
Multifamily	—		—		—		—		2
Home equity lines of credit	—		—		—		36		—
Consumer and other	—		—		—		51		—
Total impaired loans
Construction	$	8,170	$	9,812	$	191	$	21,677	$	311
Commercial real estate:
Owner occupied	11,524		12,153		189		20,338		554
Non-owner occupied	5,537		6,001		89		9,611		317
Commercial	5,653		5,727		928		8,599		151
Mortgages:
Secured 1-4 family real estate	1,435		1,503		—		2,711		52
Multifamily	530		565		—		701		2
Home equity lines of credit	705		800		—		1,460		13
Consumer and other	—		—		—		51		—
Total impaired loan individually reviewed for impairment	$	33,554	$	36,561	$	1,397	$	65,148	$	1,400

Impaired loans acquired in business combinations without a related allowance for loan losses includes loans for which no additional reserves have been recorded in excess of credit discounts for purchased impaired loans. Impaired loans acquired with subsequent deterioration and related allowance for loan losses are loans in which additional impairment has been identified in excess of credit discounts resulting in additional reserves. These additional reserves are included in the allowance for loan losses related to purchased impaired loans and were $3,567 and $6,672 as of December 31, 2013 and December 31, 2012, respectively.

At December 31, 2013, the outstanding balance of purchased impaired loans from American Community Bancshares, Inc. ("American Community"), which includes principal, interest and fees due, was $90,741. Because of the uncertainty of the expected cash flows, the Company is accounting for each purchased impaired loan under the cost recovery method, in which all cash payments are applied to principal. Thus, there is no accretable yield associated with the above loans.

Troubled Debt Restructured Loans. Total amount of troubled debt restructured loans outstanding as of December 31, 2013 was $21.5 million with related reserves of $1.2 million. Approximately $15.3 million of troubled debt restructured loans are accruing interest as of December 31, 2013, as these loans have sufficient evidence of paying according to the new restructured terms to warrant a return to accrual status. Total amount of troubled debt restructured loans outstanding as of December 31, 2012 was $23.7 million with related reserves of $746,581. Approximately $17.7 million of troubled debt restructured loans are accruing interest as of December 31, 2012, as these loans have sufficient evidence of paying according to the new restructured terms.

The following tables include the recorded investment and number of modifications for troubled debt restructured loans for the year ended December 31, 2013 and December 31, 2012. The Company reports the recorded investment in the loans prior to a modification and also the recorded investment in the loans after the loans were restructured. Reductions in the recorded investment are primarily due to the partial charge-off of the principal balance prior to modification.



	Year ended December 31, 2013					Year ended December 31, 2012
	Number of Loans	Recorded Investment Prior to Modification		Recorded Investment After Modification		Number of Loans	Recorded Investment Prior to Modification		Recorded Investment After Modification
		(in thousands)					(in thousands)
Below market interest rate
Construction	1	$	215	$	200	—	$	—	$	—
Commercial real estate:
Non-owner occupied	2	1,220		1,139		—	—		—
Total	3	1,435		1,339		—	—		—
Extended payment terms
Construction	—	—		—		5	1,231		872
Commercial real estate:
Non-owner occupied	1	167		165		6	5,329		4,990
Owner occupied	4	1,319		1,316		9	2,443		2,379
Commercial	—	—		—		7	2,676		2,286
1-4 Family Residential	—	—		—		4	1,259		1,130
Consumer	—	—		—		1	27		24
Total	5	1,486		1,481		32	12,965		11,681
Principal payment reduction
Commercial real estate:
Owner occupied	—	—		—		2	571		571
Consumer	—	—		—		1	165		9
Total	—	—		—		3	736		580

Total	8	$	2,921	$	2,820	35	$	13,701	$	12,261

The following tables present loans that were modified as troubled debt restructurings during the previous twelve months and for which there was a payment default during the year ended December 31, 2012. There were no loans modified as troubled debt restructurings during the previous twelve months and for which there was a payment default during the year ended December 31, 2013.



	Year ended December 31, 2013			Year ended December 31, 2012
	Number of loans	Recorded investment		Number of loans	Recorded investment
Extended payment terms
Commercial real estate:
Non-owner occupied	—	$	—	1	$	—
Owner occupied	—	—		1	93
Secured 1-4 family mortgages	—	—		1	170
Consumer	—	—		1	24
Total	—	—		4	287

Total	—	$	—	4	$	287

Allowance for Loan Losses. The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management's best estimate for probable losses that have been incurred within the existing portfolio of loans. The primary risks inherent in the Bank's loan portfolio, including the adequacy of the allowance or reserve for loan losses, are based on management's assumptions regarding, among other factors, general and local economic conditions, which are difficult to predict and are beyond the Bank's control. In estimating these risks, and the related loss reserve levels, management also considers the financial conditions of specific borrowers and credit concentrations with specific borrowers, groups of borrowers, and industries.

The allowance for loan losses is adjusted by direct charges to provision expense. Losses on loans are charged against the allowance for loan losses in the accounting period in which they are determined by management to be uncollectible. Recoveries during the period are credited to the allowance for loan losses. The provision for loan losses was a recovery of losses of $(2.7) million for the year ended December 31, 2013 as compared to a provision of $40.4 million for the year ended December 31, 2012 and $20.8 million for the year ended December 31, 2011. The provision expense is determined by management with the use of the Bank's allowance for loan losses model. The components of the model are specific reserves for impaired loans and a general allocation for unimpaired loans. The general allocation has two components, an estimate based on historical loss experience and an additional estimate based on internal and external environmental factors due to the uncertainty of historical loss experience in predicting current embedded losses in the portfolio that will be realized in the future.

The portion of the general allocation on environmental factors includes estimates of losses related to interest rate trends, unemployment trends, real estate characteristics, past due and nonaccrual trends, watch list trends, charge-off trends, and underwriting and servicing assessments. Markets served by the Bank continue to experience softening from the general economy and declines in real estate values. The real estate characteristics component includes trends in real estate concentrations, exceptions to FDIC guidelines for loan-to-value ratios, and changes in real estate market values. Other factors impacting the allowance at December 31, 2013 were watch list trends, unemployment rate trends, and underwriting and servicing assessments.

The following table presents changes in the allowance for loan losses for the years ended December 31, 2013 and 2012:



	December 31, 2012		Charge-offs		Recoveries		Provision (Recovery)			December 31, 2013
	(Amounts in thousands)
Construction	$	4,269	$	2,104	$	1,007	$	(3	)	$	3,169
Commercial real estate:
Owner occupied	4,374		383		120		(1,022		)	3,089
Non-owner occupied	3,935		224		134		(1,764		)	2,081
Commercial	4,291		2,923		1,287		1,078			3,733
Mortgages:
Secured 1-4 family- first lien	3,191		871		253		(205		)	2,368
Multifamily	594		—		—		(158		)	436
Home equity lines of credit	3,822		1,037		568		(697		)	2,656
Consumer and other	673		330		102		86			531
	$	25,149	$	7,872	$	3,471	$	(2,685	)	$	18,063

	December 31, 2011		Charge-offs		Recoveries		Provision			December 31, 2012
	(Amounts in thousands)
Construction	$	8,214	$	17,825	$	1,138	$	12,742		$	4,269
Commercial real estate:
Owner occupied	5,792		7,334		165		5,751			4,374
Non-owner occupied	4,668		9,830		664		8,433			3,935
Commercial	5,712		7,796		956		5,419			4,291
Mortgages:
Secured 1-4 family- first lien	3,726		3,512		215		2,762			3,191
Multifamily	805		347		—		136			594
Home equity lines of credit	3,310		4,360		186		4,686			3,822
Consumer and other	621		752		359		445			673
	$	32,848	$	51,756	$	3,683	$	40,374		$	25,149

The following tables provide the breakdown of allowance for loan losses for collectively evaluated and individually evaluated loans by type as of December 31, 2013 and December 31, 2012.



	Reserves for loans individually evaluated for impairment		Loans individually evaluated for impairment		Reserves for loans collectively evaluated for impairment		Loans collectively evaluated for impairment
As of December 31, 2013	(Amounts in thousands)
Construction	$	40	$	3,016	$	3,129	$	128,019
Commercial real estate:
Owner occupied	201		10,576		2,888		372,190
Non-owner occupied	50		5,114		2,031		191,812
Commercial	105		4,403		3,628		181,040
Mortgages:
Secured 1-4 family- first lien	161		992		2,207		173,080
Multifamily	—		—		436		41,713
Home equity lines of credit	—		425		2,656		193,720
Consumer and other	—		—		531		51,667
	$	557	$	24,526	$	17,506	$	1,333,241

	Reserves for loans individually evaluated for impairment		Loans individually evaluated for impairment		Reserves for loans collectively evaluated for impairment		Loans collectively evaluated for impairment
As of December 31, 2012	(Amounts in thousands)
Construction	$	191	$	8,170	$	4,078	$	123,811
Commercial real estate:
Owner occupied	189		11,524		4,185		331,438
Non-owner occupied	89		5,537		3,846		205,952
Commercial	928		5,653		3,363		168,787
Mortgages:
Secured 1-4 family- first lien	—		1,435		3,191		167,176
Multifamily	—		530		594		34,807
Home equity lines of credit	—		705		3,822		191,183
Consumer and other	—		—		673		51,664
	$	1,397	$	33,554	$	23,752	$	1,274,818

The allowance model is applied to determine the specific allowance balance for impaired loans and the general allowance balance for unimpaired loans grouped by loan type.

The Company's loan charge-off policy for all loan classes is to charge down loans to net realizable value once a portion of the loan is determined to be uncollectable, and the underlying collateral shortfall is assessed. Unsecured loans (primarily consumer loans) are charged off against the reserve once the loan becomes 90 days past due or it is determined that a portion of the loan is uncollectable. Secured loans (primarily construction, real estate, commercial and other loans) are moved to nonaccrual status when the loan becomes 90 days delinquent or a portion of the loan is determined to be uncollectable and supporting collateral is not considered to be sufficient to cover potential losses. Nonaccrual loans are reviewed at least quarterly to determine if all or a portion of the loan is uncollectable. Nonaccrual loans that are determined to be solely collateral dependent are promptly charged down to net realizable value upon determination that they are impaired.

In addition to the allowance for loan losses, the Company also estimates probable losses related to unfunded lending commitments, such as letters of credit, financial guarantees and unfunded loan commitments. Unfunded lending commitments are analyzed and segregated by loan classification. These classifications, in conjunction with an analysis of historical loss experience, current economic conditions, performance trends within specific portfolio segments and any other pertinent information, result in the estimation of the reserve for unfunded lending commitments. The reserve for credit losses related to unfunded lending commitments was $116,309 and $182,489 as of December 31, 2013 and December 31, 2012, respectively.

The Company maintains reserves for mortgage loans sold to agencies and investors in the event that, either through error or disagreement between the parties, the Company is required to indemnify the purchase. The reserves take into consideration risks associated with underwriting, key factors in the mortgage industry, loans with specific reserve requirements, past due loans and potential indemnification by the Company. Reserves are estimated based on consideration of factors in the mortgage industry such as declining collateral values and rising levels of delinquency, default and foreclosure, coupled with increased incidents of quality reviews at all levels of the mortgage industry seeking justification for pushing back losses to loan originators and wholesalers. As of December 31, 2013, the Company had reserves for mortgage loans sold of $216,687, and charges against reserves for the year ended December 31, 2013 were $83,198. For the year ended December 31, 2013, the Company recorded $1.4 million in negative provision expense related to potential repurchase and warranties exposure on the $254.5 million in loan sales that occurred during that period, respectively. Reduction in provisions for the year ended December 31, 2013 were primarily the result of decreased mortgage activity as Sidus Financial, LLC ("Sidus") started to significantly scale back its wholesale operations and completely exited the wholesale market in 2012. The Company also saw improvements in historical loss experience, and declines in specific reserves as claims were paid and settled from previously established reserves. The historical loss factor decreased from 1.37%% in 2011 to 1.16%% in 2012. Further, the historical loss factor was adjusted to take into account lower exposure to loss by Sidus due to limitations on loss events included in the purchase agreement pursuant to which the loans were sold. The adjustment factor also is weighted to take into account the greater likelihood of loan “put-backs” originated in the years most recently preceding the current year. Given both the decrease in the historical loss factor and the reduction in volume of Sidus’ wholesale operations in the most recent years of 2011 and 2012, the general component of the reserve correspondingly was reduced. In early 2013, three of the largest claims were settled and paid out of the specific reserves, which resulted in a reduction of the specific component of the reserves by approximately $125,000. In addition, Sidus Financial discontinued its business and was dissolved in 2013 in accordance with the provisions of the North Carolina Limited Liability Company Act which limited future liability for loans previously sold by Sidus Financial. As of December 31, 2012, the Company had reserves for mortgage loans sold of $1.7 million, and charges against the reserves for the year ended December 31, 2012 were $488,012. For the year ended December 31, 2012, the Company recorded $392,103 in provision expense related to potential repurchase and warranties exposure. For the years ended December 31, 2013 and 2012, the Company did not repurchase any mortgage loans sold. As of December 31, 2011, the Company had reserves for mortgage loans sold of $1.8 million, and charges against the reserves for the year ended December 31, 2011 were $809,282. For the year ended December 31, 2011, the Company recorded $640,893 in provision expense related to potential repurchase and warranties exposure.