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EX-31.A - EXHIBIT (31)(A) - PEOPLES BANCORP OF NORTH CAROLINA INCex31_a.htm
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EXCEL - IDEA: XBRL DOCUMENT - PEOPLES BANCORP OF NORTH CAROLINA INCFinancial_Report.xls

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
     
 
FORM 10-Q
 
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended:      June 30, 2014
 
OR
 
[   ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from __________ to __________
 
PEOPLES BANCORP OF NORTH CAROLINA, INC.
(Exact name of registrant as specified in its charter)
 
North Carolina
(State or other jurisdiction of incorporation or organization)
 
000-27205
56-2132396
(Commission File No.)
(IRS Employer Identification No.)
 
518 West C Street, Newton, North Carolina
28658
(Address of principal executive offices)
(Zip Code)
 
(828) 464-5620
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
Yes
  X  
No
   
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). 
 
Yes
  X  
No
   
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.  (Check one):
 
Large Accelerate Filer
   
Accelerated Filer
   
Non-Accelerated Filer
   
 
Smaller Reporting Company
X
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2 of the Exchange Act).
 
Yes
   
No
  X  
 
Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date.
5,617,125 shares of common stock, outstanding at July 31, 2014.
 
 
 
 

 
 
 
INDEX
       
PART I.
FINANCIAL INFORMATION
PAGE(S)
       
Item 1.
 
Financial Statements
 
       
   
Consolidated Balance Sheets at June 30, 2014 (Unaudited) and December
 
   
31, 2013 (Audited)
3
       
   
Consolidated Statements of Earnings for the three and six months ended
 
   
June 30, 2014 and 2013 (Unaudited)
4
       
   
Consolidated Statements of Comprehensive Income for the three and six
 
   
months ended June 30, 2014 and 2013 (Unaudited)
5
       
   
Consolidated Statements of Cash Flows for the three and six months ended
 
   
June 30, 2014 and 2013 (Unaudited)
6-7
       
   
Notes to Consolidated Financial Statements (Unaudited)
8-23
       
Item 2.
 
Management's Discussion  and Analysis of Financial Condition
 
   
and Results of Operations
24-38
       
Item 3.
 
Quantitative and Qualitative Disclosures About Market Risk
39
       
Item 4T.
 
Controls and Procedures
40
       
PART II.
OTHER INFORMATION
 
       
Item 1.
 
Legal Proceedings
41
Item 1A.
 
Risk Factors
41
Item 2.
 
Unregistered Sales of Equity Securities and Use of Proceeds
41
Item 3.
 
Defaults upon Senior Securities
41
Item 5.
 
Other Information
41
Item 6.
 
Exhibits
41-44
Signatures
45
Certifications
46-48
 
 
Statements made in this Form 10-Q, other than those concerning historical information, should be considered forward-looking statements pursuant to the safe harbor provisions of the Securities Exchange Act of 1934 and the Private Securities Litigation Act of 1995.  These forward-looking statements involve risks and uncertainties and are based on the beliefs and assumptions of management and on the information available to management at the time that this Form 10-Q was prepared.  These statements can be identified by the use of words like “expect,” “anticipate,” “estimate,” and “believe,” variations of these words and other similar expressions.  Readers should not place undue reliance on forward-looking statements as a number of important factors could cause actual results to differ materially from those in the forward-looking statements.  Factors that could cause actual results to differ materially include, but are not limited to, (1) competition in the markets served by Peoples Bank, (2) changes in the interest rate environment, (3) general national, regional or local economic conditions may be less favorable than expected, resulting in, among other things, a deterioration in credit quality and the possible impairment of collectibility of loans, (4) legislative or regulatory changes, including changes in accounting standards, (5) significant changes in the federal and state legal and regulatory environments and tax laws, (6) the impact of changes in monetary and fiscal policies, laws, rules and regulations and (7) other risks and factors identified in other filings with the Securities and Exchange Commission, including but not limited to, those described in Peoples Bancorp of North Carolina, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2013.
 
 
 
2

 
 
 
PART I.
FINANCIAL INFORMATION
   
Item I.
Financial Statements
 
 PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES
 
Consolidated Balance Sheets
           
June 30, 2014 and December 31, 2013
           
(Dollars in thousands)
 
June 30,
   
December 31,
 
Assets
2014
   
2013
 
 
(Unaudited)
   
(Audited)
 
           
Cash and due from banks, including reserve requirements
$ 54,522     49,902  
of $10,561 and $11,472, respectively
           
Interest-bearing deposits
  20,546     26,871  
Cash and cash equivalents
  75,068     76,773  
             
Investment securities available for sale
  297,165     297,890  
Other investments
  4,706     4,990  
Total securities
  301,871     302,880  
             
Mortgage loans held for sale
  2,048     497  
             
Loans
  633,336     620,960  
Less allowance for loan losses
  (12,675 )   (13,501 )
Net loans
  620,661     607,459  
             
Premises and equipment, net
  16,762     16,358  
Cash surrender value of life insurance
  13,914     13,706  
Other real estate
  3,532     1,679  
Accrued interest receivable and other assets
  13,996     15,332  
Total assets
$ 1,047,852     1,034,684  
             
  Liabilities and Shareholders' Equity
           
             
Deposits:
           
Noninterest-bearing demand
$ 206,655     195,265  
NOW, MMDA & savings
  397,305     386,893  
Time, $100,000 or more
  112,201     115,268  
Other time
  95,318     101,935  
Total deposits
  811,479     799,361  
             
Securities sold under agreements to repurchase
  46,764     45,396  
FHLB borrowings
  65,000     65,000  
Junior subordinated debentures
  20,619     20,619  
Accrued interest payable and other liabilities
  10,943     20,589  
Total liabilities
  954,805     950,965  
             
Commitments
           
             
Shareholders' equity:
           
Common stock, no par value; authorized
           
20,000,000 shares; issued and outstanding
           
5,617,125 and 5,613,495 shares, respectively
  48,170     48,133  
Retained earnings
  41,433     36,758  
Accumulated other comprehensive income (loss)
  3,444     (1,172 )
Total shareholders' equity
  93,047     83,719  
             
Total liabilities and shareholders' equity
$ 1,047,852     1,034,684  
             
See accompanying Notes to Consolidated Financial Statements.
           
 
 
 
3

 
 
 
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES
                 
Consolidated Statements of Earnings
                 
Three and Six Months Ended June 30, 2014 and 2013
                 
(Dollars in thousands, except per share amounts)
                 
 
Three months ended
 
Six months ended
 
 
June 30,
 
June 30,
 
 
2014
 
2013
 
2014
 
2013
 
 
(Unaudited)
 
(Unaudited)
 
(Unaudited)
 
(Unaudited)
 
Interest income:
               
Interest and fees on loans
$ 7,491   7,439   14,893   15,079  
Interest on due from banks
  12   28   24   40  
Interest on investment securities:
                 
U.S. Government sponsored enterprises
  804   286   1,651   664  
States and political subdivisions
  1,169   1,069   2,346   2,053  
Other
  100   87   207   176  
Total interest income
  9,576   8,909   19,121   18,012  
                   
Interest expense:
                 
NOW, MMDA & savings deposits
  125   200   251   418  
Time deposits
  303   422   637   889  
FHLB borrowings
  549   635   1,094   1,296  
Junior subordinated debentures
  97   100   193   199  
Other
  11   15   21   32  
Total interest expense
  1,085   1,372   2,196   2,834  
                   
Net interest income
  8,491   7,537   16,925   15,178  
                   
Provision for loan losses
  67   773   (282 ) 1,827  
                   
Net interest income after provision for loan losses
  8,424   6,764   17,207   13,351  
                   
Non-interest income:
                 
Service charges
  1,223   1,104   2,352   2,143  
Other service charges and fees
  260   268   679   642  
Gain on sale of securities
  -     352   26   614  
Mortgage banking income
  188   315   292   699  
Insurance and brokerage commissions
  162   178   361   317  
Gain/(loss) on sale and write-down of
                 
 other real estate
  12   (184   (150 ) (173 )
Miscellaneous
  1,265   1,276   2,392   2,494  
Total non-interest income
  3,110   3,309   5,952   6,736  
                   
Non-interest expense:
                 
Salaries and employee benefits
  4,207   4,240   8,483   8,430  
Occupancy
  1,466   1,320   2,988   2,632  
Other
  2,394   2,419   4,720   4,655  
Total non-interest expense
  8,067   7,979   16,191   15,717  
                   
Earnings before income taxes
  3,467   2,094   6,968   4,370  
                   
Income tax expense
  916   461   1,838   979  
                   
Net earnings
  2,551   1,633   5,130   3,391  
                   
Dividends and accretion on preferred stock
  -     156   -     313  
                   
Net earnings available to common shareholders
$ 2,551   1,477   5,130   3,078  
                   
Basic and diluted net earnings per common share
$ 0.45   0.26   0.91   0.55  
Cash dividends declared per common share
$ 0.04   0.03   0.08   0.06  
                   
See accompanying Notes to Consolidated Financial Statements.
             
 
 
 
4

 
 
 
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES
                 
Consolidated Statements of Comprehensive (Loss) Income
                 
Three and Six Months Ended June 30, 2014 and 2013
                 
 (Dollars in thousands)
                 
 
Three months ended
 
Six months ended
 
 
June 30,
 
June 30,
 
 
2014
 
2013
 
2014
 
2013
 
 
(Unaudited)
 
(Unaudited)
 
(Unaudited)
 
(Unaudited)
 
                 
Net earnings
$ 2,551   1,633   5,130   3,391  
                   
Other comprehensive income (loss):
                 
Unrealized holding gains (losses) on securities
                 
available for sale
  3,726   (6,583 ) 7,586   (7,798 )
Reclassification adjustment for gains on
                 
securities available for sale
                 
included in net earnings
  -     (352 ) (26)   (614 )
                   
Total other comprehensive income (loss),
                 
before income taxes
  3,726   (6,935 ) 7,560   (8,412 )
                   
Income tax (benefit) expense related to other
                 
comprehensive (loss) income:
                 
                   
Unrealized holding gains (losses) on securities
                 
available for sale
  1,451   (2,564 ) 2,954   (3,038 )
Reclassification adjustment for gains
                 
on securities available for sale
                 
included in net earnings
  -     (137 ) (10)   (239 )
                   
Total income tax expense (benefit) related to
                 
other comprehensive income (loss)
  1,451   (2,701 ) 2,944   (3,277 )
                   
Total other comprehensive income (loss),
                 
net of tax
  2,275   (4,234 ) 4,616   (5,135 )
                   
Total comprehensive income (loss)
$ 4,826   (2,601 ) 9,746   (1,744 )
                   
See accompanying Notes to Consolidated Financial Statements.
             
 
 
 
5

 
 
 
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES
         
Consolidated Statements of Cash Flows
         
Six Months Ended June 30, 2014 and 2013
         
(Dollars in thousands)
         
 
2014
2013
 
(Unaudited)
(Unaudited)
         
Cash flows from operating activities:
       
Net earnings
$ 5,130   3,391  
Adjustments to reconcile net earnings to
         
net cash (used) provided by operating activities:
         
Depreciation, amortization and accretion
  3,258   4,438  
Provision for loan losses
  (282 ) 1,827  
Gain on sale of investment securities
  (26 ) (614 )
Gain on sale of other real estate
  (2 ) (86 )
Write-down of other real estate
  152   259  
Restricted stock expense
  167   70  
Change in:
         
Mortgage loans held for sale
  (1,552 ) 920  
Cash surrender value of life insurance
  (208 ) (214 )
Other assets
  (2,274 ) 2,217  
Other liabilities
  2,877   (1,381 )
           
Net cash provided by operating activities
  7,240   10,827  
           
Cash flows from investing activities:
         
Purchases of investment securities available for sale
  (13,070 ) (59,154 )
Proceeds from calls, maturities and paydowns of investment securities
         
available for sale
  18,415   35,031  
Proceeds from sales of investment securities available for sale
  677   17,463  
FHLB stock redemption
  284   384  
Net change in loans
  (15,978 ) 7,718  
Purchases of premises and equipment
  (1,372 ) (1,666 )
Proceeds from sales of other real estate and repossessions
  1,554   3,619  
           
Net cash (used) provided by investing activities
  (9,490 ) 3,395  
           
Cash flows from financing activities:
         
Net change in deposits
  12,118   6,908  
Net change in securities sold under agreements to repurchase
  1,368   11,393  
Proceeds from FHLB borrowings
  -     15,000  
Repayments of FHLB borrowings
  -     (15,000 )
    Preferred stock repurchase   (12,524 )    
Proceeds from stock options exercised
  37   -    
Cash dividends paid on preferred stock
  -     (313 )
Cash dividends paid on common stock
  (454 ) (337 )
           
Net cash provided by financing activities
  545   17,651  
           
Net change in cash and cash equivalent
  (1,705 ) 31,873  
           
Cash and cash equivalents at beginning of period
  76,773   48,843  
           
Cash and cash equivalents at end of period
$ 75,068   80,716  
 
 
 
6

 
 
 
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES
         
Consolidated Statements of Cash Flows, continued
         
Six Months Ended June 30, 2014 and 2013
         
(Dollars in thousands)
         
         
 
2014
2013
 
(Unaudited)
(Unaudited)
         
Supplemental disclosures of cash flow information:
       
Cash paid during the period for:
       
Interest
$ 2,217   2,889  
Income taxes
$ 837   1,112  
           
Noncash investing and financing activities:
         
Change in unrealized gain on investment securities
         
 available for sale, net
$ 4,616   (5,135 )
Transfers of loans to other real estate and repossessions
$ 3,288   2,003  
Financed portion of sales of other real estate
$ 230   40  
           
See accompanying Notes to Consolidated Financial Statements.
         
 
 
 
7

 
 
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

(1)
    Summary of Significant Accounting Policies

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

The consolidated financial statements in this report (other than the Consolidated Balance Sheet at December 31, 2013) are unaudited.  In the opinion of management, all adjustments (none of which were other than normal accruals) necessary for a fair presentation of the financial position and results of operations for the periods presented have been included.  Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these consolidated financial statements in conformity with generally accepted accounting principles in the United States (“GAAP”).  Actual results could differ from those estimates.

The Company’s accounting policies are fundamental to understanding management’s discussion and analysis of results of operations and financial condition.  Many of the Company’s accounting policies require significant judgment regarding valuation of assets and liabilities and/or significant interpretation of the specific accounting guidance.  A description of the Company’s significant accounting policies can be found in Note 1 of the Notes to Consolidated Financial Statements in the Company’s 2013 Annual Report to Shareholders which is Appendix A to the Proxy Statement for the May 1, 2014 Annual Meeting of Shareholders.

Recently Issued Accounting Pronouncements
In January 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-04, (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure.  ASU No. 2014-04 provides additional guidance to clarify when an in substance repossession or foreclosure occurs, that is, when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan should be derecognized and the real estate property recognized.  ASU No. 2014-04 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2014.  The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.

In May 2014, the FASB issued ASU No. 2014-09, (Topic 606):  Revenue from Contracts with Customers.  ASU No. 2014-09 provides guidance on the recognition of revenue from contracts with customers. The core principle of the new guidance is that an entity should recognize revenue to reflect the transfer of goods and services to customers in an amount equal to the consideration the entity receives or expects to receive.  ASU No. 2014-09 is effective for reporting periods beginning after December 15, 2016.  The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.

In June 2014, the FASB issued ASU No. 2014-11, (Subtopic 860-10): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures.  ASU No. 2014-11 makes limited amendments to the guidance in FASB Accounting Standards Codification ("ASC") 860, Transfers and Servicing, on accounting for certain repurchase agreements (repos). ASU No. 2014-1 (1) requires entities to account for repurchase-to-maturity transactions as secured borrowings (rather than as sales with forward repurchase agreements), (2) eliminates accounting guidance on linked repurchase financing transactions, and (3) expands disclosure requirements related to certain transfers of financial assets that are accounted for as sales and certain transfers (specifically, repos, securities lending transactions, and repurchase-to-maturity transactions) accounted for as secured borrowings. ASU 2014-11 also amends FASB ASC 860 to clarify that repos and securities lending transactions that do not meet all of the derecognition criteria should be accounted for as secured borrowings. In addition, ASU No. 2014-11provides examples of repurchase and securities lending arrangements that illustrate whether a transferor has maintained effective control over the transferred financial assets.  ASU No. 2014-11 is effective for reporting periods beginning the first interim or annual period after December 15, 2014.  The adoption of this guidance is not expected to have a material impact on the Company’s results of operations, financial position or disclosures.
 
 
8

 

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

(2)
   Investment Securities

Investment securities available for sale at June 30, 2014 and December 31, 2013 are as follows:
 
(Dollars in thousands)
             
 
June 30, 2014
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
Mortgage-backed securities
$ 115,747   1,937   170   117,514
U.S. Government
               
sponsored enterprises
  25,211   107   217   25,101
State and political subdivisions
  145,573   4,398   1,342   148,629
Corporate bonds
  3,495   14   22   3,487
Trust preferred securities
  750   -     -     750
Equity securities
  748   936   -     1,684
Total
$ 291,524   7,392   1,751   297,165
                 
(Dollars in thousands)
               
 
December 31, 2013
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
 Fair Value
Mortgage-backed securities
$ 123,706   1,040   769   123,977
U.S. Government
               
sponsored enterprises
  22,115   97   69   22,143
State and political subdivisions
  148,468   1,987   5,087   145,368
Corporate bonds
  3,522   11   70   3,463
Trust preferred securities
  1,250   -     -     1,250
Equity securities
  748   941   -     1,689
Total
$ 299,809   4,076   5,995   297,890

The current fair value and associated unrealized losses on investments in securities with unrealized losses at June 30, 2014 and December 31, 2013 are summarized in the tables below, with the length of time the individual securities have been in a continuous loss position.

(Dollars in thousands)
                     
 
June 30, 2014
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair Value
 
Unrealized
 Losses
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
Mortgage-backed securities
$ 8,550   6   18,386   164   26,936   170
U.S. Government
                       
sponsored enterprises
  16,483   217   -     -     16,483   217
State and political subdivisions
  12,495   40   38,905   1,302   51,400   1,342
Corporate bonds
  1,000   -     533   22   1,533   22
Total
$ 38,528   263   57,824   1,488   96,352   1,751
 
 
 
9

 
 
 
(Dollars in thousands)
                     
 
December 31, 2013
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
 Losses
 
Fair Value
 
Unrealized
Losses
Mortgage-backed securities
$ 40,857   691   10,128   78   50,985   769
U.S. Government
                       
sponsored enterprises
  9,714   69   -     -     9,714   69
State and political subdivisions
  77,187   4,863   1,824   224   79,011   5,087
Corporate bonds
  1,984   16   511   54   2,495   70
Total
$ 129,742   5,639   12,463   356   142,205   5,995
 
At June 30, 2014, unrealized losses in the investment securities portfolio relating to debt securities totaled $1.8 million.  The unrealized losses on these debt securities arose due to changing interest rates and are considered to be temporary.  From the June 30, 2014 tables above, 50 out of 175 securities issued by state and political subdivisions contained unrealized losses, 17 out of 95 securities issued by U.S. Government sponsored enterprises, including mortgage-backed securities, contained unrealized losses, and two out of five securities issued by corporations contained unrealized losses.  These unrealized losses are considered temporary because of acceptable financial condition and results of operations on each security and the repayment sources of principal and interest on U.S. Government sponsored enterprises, including mortgage-backed securities, are government backed.

The amortized cost and estimated fair value of investment securities available for sale at June 30, 2014, by contractual maturity, are shown below. Expected maturities of mortgage-backed securities will differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
 
June 30, 2014
     
(Dollars in thousands)
     
 
Amortized
Cost
 
Estimated
Fair Value
Due within one year
$ 4,392   4,401
Due from one to five years
  37,594   38,956
Due from five to ten years
  114,940   116,246
Due after ten years
  18,103   18,364
Mortgage-backed securities
  115,747   117,514
Equity securities
  748   1,684
Total
$ 291,524   297,165
 
Proceeds from sales of securities available for sale during the six months ended June 30, 2014 were $677,000 and resulted in gross gains of $26,000.  Proceeds from sales of securities available for sale during the six months ended June 30, 2013 were $17.5 million and resulted in gross gains of $738,000 and gross losses of $124,000.

Securities with a fair value of approximately $83.9 million and $86.0 million at June 30, 2014 and December 31, 2013, respectively, were pledged to secure public deposits and for other purposes as required by law.
 
 
10

 

 
(3)
    Loans

Major classifications of loans at June 30, 2014 and December 31, 2013 are summarized as follows:
 
(Dollars in thousands)
     
 
June 30, 2014
 
December 31, 2013
Real estate loans
     
Construction and land development
$ 59,843   63,742
Single-family residential
  196,192   195,975
Single-family residential -
       
Banco de la Gente stated income
  48,165   49,463
Commercial
  214,378   209,287
Multifamily and farmland
  11,821   11,801
Total real estate loans
  530,399   530,268
         
Loans not secured by real estate
       
Commercial loans
  78,056   68,047
Farm loans
  93   19
Consumer loans
  10,143   9,593
All other loans
  14,645   13,033
         
Total loans
  633,336   620,960
         
Less allowance for loan losses
  12,675   13,501
         
Total net loans
$ 620,661   607,459
 
The Bank grants loans and extensions of credit primarily within the Catawba Valley region of North Carolina, which encompasses Catawba, Alexander, Iredell and Lincoln counties, and also in Mecklenburg, Union and Wake counties of North Carolina.  Although the Bank has a diversified loan portfolio, a substantial portion of the loan portfolio is collateralized by improved and unimproved real estate, the value of which is dependent upon the real estate market.  Risk characteristics of the major components of the Bank’s loan portfolio are discussed below:

·  
Construction and land development loans – The risk of loss is largely dependent on the initial estimate of whether the property’s value at completion equals or exceeds the cost of property construction and the availability of take-out financing.  During the construction phase, a number of factors can result in delays or cost overruns.  If the estimate is inaccurate or if actual construction costs exceed estimates, the value of the property securing the loan may be insufficient to ensure full repayment when completed through a permanent loan, sale of the property, or by seizure of collateral.  As of June 30, 2014, construction and land development loans comprised approximately 9% of the Bank’s total loan portfolio.
 
·  
Single-family residential loans – Declining home sales volumes, decreased real estate values and higher than normal levels of unemployment could contribute to losses on these loans.  As of June 30, 2014, single-family residential loans comprised approximately 39% of the Bank’s total loan portfolio, and include Banco de la Gente single-family residential stated income loans, which were approximately 8% of the Bank’s total loan portfolio.

·  
Commercial real estate loans – Repayment is dependent on income being generated in amounts sufficient to cover operating expenses and debt service.  These loans also involve greater risk because they are generally not fully amortizing over a loan period, but rather have a balloon payment due at maturity.  A borrower’s ability to make a balloon payment typically will depend on being able to either refinance the loan or timely sell the underlying property.  As of June 30, 2014, commercial real estate loans comprised approximately 34% of the Bank’s total loan portfolio.

·  
Commercial loans – Repayment is generally dependent upon the successful operation of the borrower’s business.   In addition, the collateral securing the loans may depreciate over time, be difficult to appraise, be illiquid, or fluctuate in value based on the success of the business.  As of June 30, 2014, commercial loans comprised approximately 12% of the Bank’s total loan portfolio.
 
 
 
11

 
 
Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
 
The following tables present an age analysis of past due loans, by loan type, as of June 30, 2014 and December 31, 2013:

June 30, 2014
                     
(Dollars in thousands)
                     
 
Loans 30-
89 Days
Past Due
 
Loans 90
or More
Days Past
Due
 
Total
Past Due
Loans
 
Total
Current
Loans
 
Total
 Loans
 
Accruing
 Loans 90 or
More Days
Past Due
Real estate loans
                     
Construction and land development
$ 830   4,862   5,692   54,151   59,843   -  
Single-family residential
  1,453   667   2,120   194,072   196,192   392
Single-family residential -
                       
Banco de la Gente stated income
  1,874   719   2,593   45,572   48,165   -  
Commercial
  1,652   289   1,941   212,437   214,378   -  
Multifamily and farmland
  169   -     169   11,652   11,821   -  
Total real estate loans
  5,978   6,537   12,515   517,884   530,399   392
                         
Loans not secured by real estate
                       
Commercial loans
  1,001   49   1,050   77,006   78,056   -  
Farm loans
  -     -     -     93   93   -  
Consumer loans
  129   -     129   10,014   10,143   -  
All other loans
  -     -     -     14,645   14,645   -  
Total loans
$ 7,108   6,586   13,694   619,642   633,336   392
                         
                         
December 31, 2013
                       
(Dollars in thousands)
                       
 
Loans 30-
89 Days
Past Due
 
Loans 90
 or More
Days Past
Due
 
Total
 Past Due
Loans
 
Total
Current
Loans
 
Total
Loans
 
Accruing
Loans 90 or
More Days
Past Due
Real estate loans
                       
Construction and land development
$ 3,416   5,426   8,842   54,900   63,742   -  
Single-family residential
  4,518   1,555   6,073   189,902   195,975   -  
Single-family residential -
                       
Banco de la Gente stated income
  9,833   1,952   11,785   37,678   49,463   881
Commercial
  1,643   486   2,129   207,158   209,287   -  
Multifamily and farmland
  177   -     177   11,624   11,801   -  
Total real estate loans
  19,587   9,419   29,006   501,262   530,268   881
                         
Loans not secured by real estate
                       
Commercial loans
  424   29   453   67,594   68,047   -  
Farm loans
  -     -     -     19   19   -  
Consumer loans
  181   3   184   9,409   9,593   1
All other loans
  -     -     -     13,033   13,033   -  
Total loans
$ 20,192   9,451   29,643   591,317   620,960   882
 
 
 
12

 
 
The following table presents the Company’s non-accrual loans as of June 30, 2014 and December 31, 2013:

(Dollars in thousands)
     
 
June 30, 2014
 
December 31, 2013
Real estate loans
     
Construction and land development
$ 5,216   6,546
Single-family residential
  1,563   2,980
Single-family residential -
       
Banco de la Gente stated income
  1,780   1,990
Commercial
  1,804   2,043
Total real estate loans
  10,363   13,559
         
Loans not secured by real estate
       
Commercial loans
  511   250
Consumer loans
  47   27
Total
$ 10,921   13,836
 
At each reporting period, the Bank determines which loans are impaired.  Accordingly, the Bank’s impaired loans are reported at their estimated fair value on a non-recurring basis.  An allowance for each impaired loan that is collateral-dependent is calculated based on the fair value of its collateral.  The fair value of the collateral is based on appraisals performed by REAS, a subsidiary of the Bank.  REAS is staffed by certified appraisers that also perform appraisals for other companies.  Factors including the assumptions and techniques utilized by the appraiser are considered by management.  If the recorded investment in the impaired loan exceeds the measure of fair value of the collateral, a valuation allowance is recorded as a component of the allowance for loan losses.  An allowance for each impaired loan that is non-collateral dependent is calculated based on the present value of projected cash flows.  If the recorded investment in the impaired loan exceeds the present value of projected cash flows, a valuation allowance is recorded as a component of the allowance for loan losses.  Impaired loans under $250,000 are not individually evaluated for impairment, with the exception of the Bank’s troubled debt restructured (“TDR”) loans in the residential mortgage loan portfolio, which are individually evaluated for impairment.  Accruing impaired loans were $27.7 million, $27.6 million and $26.2 million at June 30, 2014, December 31, 2013 and June 30, 2013, respectively.  Interest income recognized on accruing impaired loans was $681,000, $579,000 and $1.3 million for the six months ended June 30, 2014, the six months ended June 30, 2013 and the year ended December 31, 2013, respectively.  Interest income recognized on accruing impaired loans was $325,000 and $286,000 for the three months ended June 30, 2014 and 2013, respectively.  No interest income is recognized on non-accrual impaired loans subsequent to their classification as non-accrual.

The following tables present the Company’s impaired loans as of June 30, 2014 and December 31, 2013:

June 30, 2014
                     
(Dollars in thousands)
                     
                       
 
Unpaid
Contractual
Principal
Balance
 
Recorded
Investment
With No
Allowance
 
Recorded
Investment
With
Allowance
 
Recorded
Investment
in Impaired
Loans
 
Related
Allowance
 
Average
Outstanding
 Impaired
Loans
Real estate loans
                     
Construction and land development
$ 6,963   3,784   2,355   6,139   56   6,502
Single-family residential
  5,972   947   4,827   5,774   132   7,507
Single-family residential -
                       
Banco de la Gente stated income
  21,758   -     21,129   21,129   1,217   20,303
Commercial
  4,665   2,251   2,145   4,396   256   4,463
Multifamily and farmland
  169   -     169   169   1   172
Total impaired real estate loans
  39,527   6,982   30,625   37,607   1,662   38,947
                         
Loans not secured by real estate
                       
Commercial loans
  849   -     755   755   16   895
Consumer loans
  303   249   51   300   1   305
Total impaired loans
$ 40,679   7,231   31,431   38,662   1,679   40,147
 
 
 
13

 
 
 
December 31, 2013
                     
(Dollars in thousands)
                     
 
Unpaid
Contractual
Principal
Balance
 
Recorded
Investment
With No
Allowance
 
Recorded
Investment
With
Allowance
 
Recorded
Investment
in Impaired
Loans
 
Related
Allowance
 
Average
Outstanding
Impaired
Loans
Real estate loans
                     
Construction and land development
$ 9,861   6,293   868   7,161   53   8,289
Single-family residential
  7,853   1,428   5,633   7,061   123   7,859
Single-family residential -
                       
Banco de la Gente stated income
  22,034   -     21,242   21,242   1,300   21,242
Commercial
  5,079   3,045   1,489   4,534   182   4,171
Multifamily and farmland
  177   -     177   177   1   184
Total impaired real estate loans
  45,004   10,766   29,409   40,175   1,659   41,745
                         
Loans not secured by real estate
                       
Commercial loans
  999   257   724   981   15   826
Consumer loans
  302   264   35   299   1   247
Total impaired loans
$ 46,305   11,287   30,168   41,455   1,675   42,818
 
Changes in the allowance for loan losses for the three and six months ended June 30, 2014 and 2013 were as follows:
 
(Dollars in thousands)
                                 
 
Real Estate Loans
                     
 
Construction
and Land
Development
 
Single-
Family
Residential
 
Single-
Family
Residential -
Banco de la
Gente
Stated
 Income
 
Commercial
 
Multifamily
and
Farmland
 
Commercial
 
Farm
 
Consumer
and All
Other
 
Unallocated
 
Total
 
Six months ended June 30, 2014
                                     
Allowance for loan losses:
                                       
Beginning balance
$ 3,218   3,123   1,863   2,219   37   1,069   -   245   1,727   13,501  
Charge-offs
  (260 ) (194 ) (140 ) (131 ) -   (193 ) -   (254 ) -   (1,172 )
Recoveries
  282   60   17   161   -   26   -   82   -   628  
Provision
  147   (141 ) (32 ) (410 ) (30 ) 179   -   180   (175 ) (282 )
Ending balance
$ 3,387   2,848   1,708   1,839   7   1,081   -   253   1,552   12,675  
                                           
Three months ended June 30, 2014
                                     
Allowance for loan losses:
                                         
Beginning balance
$ 3,133   3,132   1,767   2,196   36   945   -   230   1,539   12,978  
Charge-offs
  -   (171 ) (108 ) (20 ) -   (181 ) -   (117 ) -   (597 )
Recoveries
  3   52   5   101   -   21   -   45   -   227  
Provision
  251   (165 ) 44   (438 ) (29 ) 296   -   95   13   67  
Ending balance
$ 3,387   2,848   1,708   1,839   7   1,081   -   253   1,552   12,675  
                                           
Allowance for loan losses June 30, 2014:
                                     
Ending balance: individually
                                         
evaluated for impairment
$ -   67   1,175   -   -   242   -   -   -   1,484  
Ending balance: collectively
                                         
evaluated for impairment
  3,387   2,781   533   1,839   7   839   -   253   1,552   11,191  
Ending balance
$ 3,387   2,848   1,708   1,839   7   1,081   -   253   1,552   12,675  
                                           
Loans June 30, 2014:
                                         
Ending balance
$ 59,843   196,192   48,165   214,378   11,821   78,056   93   24,788   -   633,336  
                                           
Ending balance: individually
                                         
evaluated for impairment
$ 5,297   2,325   19,287       -   3,307   -   250   -   30,466  
Ending balance: collectively
                                         
evaluated for impairment
$ 54,546   193,867   28,878   214,378   11,821   74,749   93   24,538   -   602,870  
 
 
 
14

 
 
 
(Dollars in thousands)
                                 
 
Real Estate Loans
                     
 
Construction
and Land
Development
 
Single-
Family
Residential
 
Single-
Family
Residential -
Banco de la
Gente
Stated
 Income
 
Commercial
 
Multifamily
and
Farmland
 
Commercial
 
Farm
 
Consumer
and All
Other
 
Unallocated
 
Total
 
Six months ended June 30, 2013
                                     
Allowance for loan losses:
                                       
Beginning balance
$ 4,399   3,231   1,998   2,049   28   1,088   -   245   1,385   14,423  
Charge-offs
  (715 ) (636 ) (224 ) (275 ) -   (382 ) -   (281 ) -   (2,513 )
Recoveries
  26   43   70   50   -   25   -   78   -   292  
Provision
  1,015   666   80   34   6   91   -   187   (252 ) 1,827  
Ending balance
$ 4,725   3,304   1,924   1,858   34   822   -   229   1,133   14,029  
                                           
Three months ended June 30, 2013
                                     
Allowance for loan losses:
                                         
Beginning balance
$ 4,785   3,182   1,976   1,811   30   1,209   -   232   1,187   14,412  
Charge-offs
  (218 ) (274 ) (72 ) (275 ) -   (361 ) -   (134 ) -   (1,334 )
Recoveries
  25   24   70   2   -   14   -   43   -   178  
Provision
  133   372   (50 ) 320   4   (40 ) -   88   (54 ) 773  
Ending balance
$ 4,725   3,304   1,924   1,858   34   822   -   229   1,133   14,029  
                                           
Allowance for loan losses June 30, 2013:
                                     
Ending balance: individually
                                         
evaluated for impairment
$ 6   343   1,234   -   -   -   -   -   -   1,583  
Ending balance: collectively
                                         
evaluated for impairment
  4,719   2,961   690   1,858   34   822   -   229   1,133   12,446  
Ending balance
$ 4,725   3,304   1,924   1,858   34   822   -   229   1,133   14,029  
                                           
Loans June 30, 2013:
                                         
Ending balance
$ 70,112   192,601   50,454   191,368   10,918   66,161   24   26,434   -   608,072  
                                           
Ending balance: individually
                                         
evaluated for impairment
$ 7,626   3,480   19,912   3,125   -   -   -   279   -   34,422  
Ending balance: collectively
                                         
evaluated for impairment
$ 62,486   189,121   30,542   188,243   10,918   66,161   24   26,155   -   573,650  
 
The provision for loan losses for the three months ended June 30, 2014 was $67,000, as compared to $773,000 for the same period one year ago.  The decrease in the provision for loan losses is primarily attributable to a $5.2 million reduction in non-accrual loans from June 30, 2013 to June 30, 2014 and a reduction in net charge-offs of $786,000 during the three months ended June 30, 2014, as compared to the same period one year ago.

The provision for loan losses for the six months ended June 30, 2014 was a credit of $282,000, as compared to an expense of $1.8 million for the same period one year ago.  The decrease in the provision for loan losses is primarily attributable to a $1.7 million decrease in net charge-offs during the six months ended June 30, 2014 compared to the same period one year ago and a $5.2 million reduction in non-accrual loans from June 30, 2013 to June 30, 2014.  The credit to provision for loan losses in the six months ended June 30, 2014 resulted from, and was considered appropriate as part of, management’s assessment and estimate of the risks in the total loan portfolio and determination of the total allowance for loan losses.  The primary factors contributing to the decrease in the allowance for loan losses at June 30, 2014 to $12.7 million from $13.5 million at December 31, 2013 were the continuing positive trends in indicators of potential losses on loans, primarily non-accrual loans and the reduction in net charge-offs.

The Company utilizes an internal risk grading matrix to assign a risk grade to each of its loans.  Loans are graded on a scale of 1 to 8.  These risk grades are evaluated on an ongoing basis.  A description of the general characteristics of the eight risk grades is as follows:

·  
Risk Grade 1 – Excellent Quality: Loans are well above average quality and a minimal amount of credit risk exists.  CD or cash secured loans or properly margined actively traded stock or bond secured loans would fall in this grade.
·  
Risk Grade 2 – High Quality: Loans are of good quality with risk levels well within the Company’s range of acceptability.  The organization or individual is established with a history of successful performance though somewhat susceptible to economic changes.
·  
Risk Grade 3 – Good Quality: Loans of average quality with risk levels within the Company’s range of acceptability but higher than normal. This may be a new organization or an existing organization in a transitional phase (e.g. expansion, acquisition, market change).
·  
Risk Grade 4 – Management Attention: These loans have higher risk and servicing needs but still are acceptable. Evidence of marginal performance or deteriorating trends is observed.  These are not problem credits presently, but may be in the future if the borrower is unable to change its present course.
 
 
 
15

 
 

·  
Risk Grade 5 – Watch: These loans are currently performing satisfactorily, but there has been some recent past due history on repayment and there are potential weaknesses that may, if not corrected, weaken the asset or inadequately protect the Company’s position at some future date.
·  
Risk Grade 6 – Substandard: A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the obligor or the collateral pledged (if there is any).  There is a well-defined weakness or weaknesses that jeopardize the liquidation of the debt.  There is a distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.
·  
Risk Grade 7 – Doubtful: Loans classified as Doubtful have all the weaknesses inherent in loans classified Substandard, plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values highly questionable and improbable. Doubtful is a temporary grade where a loss is expected but is presently not quantified with any degree of accuracy. Once the loss position is determined, the amount is charged off.
·  
Risk Grade 8 – Loss: Loans classified as Loss are considered uncollectable and of such little value that their continuance as bankable assets is not warranted.  This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this worthless loan even though partial recovery may be realized in the future.  Loss is a temporary grade until the appropriate authority is obtained to charge the loan off.
 
The following tables present the credit risk profile of each loan type based on internally assigned risk grades as of June 30, 2014 and December 31, 2013:

June 30, 2014
                               
(Dollars in thousands)
                               
 
Real Estate Loans
                   
 
Construction
and Land Development
 
Single-
Family
Residential
 
Single-
Family
Residential -
Banco de la
Gente
Stated
 Income
 
Commercial
 
Multifamily
and
Farmland
 
Commercial
 
Farm
 
Consumer
 
All Other
 
Total
                                       
1- Excellent Quality
$ -   15,376   -   -   -   720   -   1,386   -   17,482
2- High Quality
  8,224   66,361   -   37,883   682   11,404   -   3,659   1,972   130,185
3- Good Quality
  23,249   71,086   21,528   129,951   6,621   51,697   93   4,424   10,439   319,088
4- Management Attention
  12,949   32,416   8,293   35,900   1,643   12,452   -   575   2,234   106,462
5- Watch
  7,355   5,914   7,040   6,661   2,706   944   -   20   -   30,640
6- Substandard
  8,066   5,039   11,304   3,983   169   770   -   77   -   29,408
7- Doubtful
  -   -   -   -   -   -   -   -   -   -
8- Loss
  -   -   -   -   -   69   -   2   -   71
Total
$ 59,843   196,192   48,165   214,378   11,821   78,056   93   10,143   14,645   633,336
                                         
                                         
December 31, 2013
                                 
(Dollars in thousands)
                                 
 
Real Estate Loans
                   
 
Construction
and Land Development
 
Single-
Family