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EX-31.B - EXHIBIT (31)(B) - PEOPLES BANCORP OF NORTH CAROLINA INCex31_b.htm
EX-32 - EXHIBIT (32) - PEOPLES BANCORP OF NORTH CAROLINA INCex32.htm

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:     September 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 October 31, 2014.
 
 
 
 

 
 
 
INDEX
         
PART I.
FINANCIAL INFORMATION
PAGE(S)
 
         
Item 1.
 
Financial Statements
   
         
   
Consolidated Balance Sheets at September 30, 2014 (Unaudited) and
   
   
December 31, 2013 (Audited)
3
 
         
   
Consolidated Statements of Earnings for the three and nine months ended
   
   
September 30, 2014 and 2013 (Unaudited)
4
 
         
   
Consolidated Statements of Comprehensive Income for the three and nine
   
   
months ended September 30, 2014 and 2013 (Unaudited)
5
 
         
   
Consolidated Statements of Cash Flows for the nine months ended
   
   
September 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
24-36
 
         
Item 3.
 
Quantitative and Qualitative Disclosures About Market Risk
37
 
         
Item 4T.
 
Controls and Procedures
38
 
         
PART II.
OTHER INFORMATION
   
         
Item 1.
 
Legal Proceedings
39
 
Item 1A.
 
Risk Factors
39
 
Item 2.
 
Unregistered Sales of Equity Securities and Use of Proceeds
39
 
Item 3.
 
Defaults upon Senior Securities
39
 
Item 5.
 
Other Information
39
 
Item 6.
 
Exhibits
39-42
 
Signatures
43
 
Certifications
44-46
 
 

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 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 1.
Financial Statements
 
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES
         
Consolidated Balance Sheets
         
September 30, 2014 and December 31, 2013
         
(Dollars in thousands)
 
September 30,
December 31,
Assets
2014
2013
 
(Unaudited)
(Audited)
         
Cash and due from banks, including reserve requirements
$ 34,887     49,902  
of $13,041 and $11,472, respectively
           
Interest-bearing deposits
  50,636     26,871  
Cash and cash equivalents
  85,523     76,773  
             
Investment securities available for sale
  279,787     297,890  
Other investments
  4,706     4,990  
Total securities
  284,493     302,880  
             
Mortgage loans held for sale
  887     497  
             
Loans
  650,550     620,960  
Less allowance for loan losses
  (12,343 )   (13,501 )
Net loans
  638,207     607,459  
             
Premises and equipment, net
  17,482     16,358  
Cash surrender value of life insurance
  14,020     13,706  
Other real estate
  1,840     1,679  
Accrued interest receivable and other assets
  11,483     15,332  
Total assets
$ 1,053,935     1,034,684  
             
Liabilities and Shareholders' Equity
           
             
Deposits:
           
Noninterest-bearing demand
$ 211,832     195,265  
NOW, MMDA & savings
  403,240     386,893  
Time, $100,000 or more
  109,489     115,268  
Other time
  92,234     101,935  
Total deposits
  816,795     799,361  
             
Securities sold under agreements to repurchase
  47,020     45,396  
FHLB borrowings
  65,000     65,000  
Junior subordinated debentures
  20,619     20,619  
Accrued interest payable and other liabilities
  8,294     20,589  
Total liabilities
  957,728     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
  43,648     36,758  
Accumulated other comprehensive income (loss)
  4,389     (1,172 )
Total shareholders' equity
  96,207     83,719  
             
Total liabilities and shareholders' equity
$ 1,053,935     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 Nine Months Ended September 30, 2014 and 2013
                 
(Dollars in thousands, except per share amounts)
                 
 
Three months ended
 
Nine months ended
 
 
September 30,
 
September 30,
 
 
2014
 
2013
 
2014
 
2013
 
 
(Unaudited)
 
(Unaudited)
 
(Unaudited)
 
(Unaudited)
 
Interest income:
               
Interest and fees on loans
$ 7,664     7,592     22,556     22,671  
Interest on due from banks
  18     22     42     62  
Interest on investment securities:
                       
U.S. Government sponsored enterprises
  646     307     2,298     970  
States and political subdivisions
  1,168     1,179     3,514     3,233  
Other
  87     88     294     264  
Total interest income
  9,583     9,188     28,704     27,200  
                         
Interest expense:
                       
NOW, MMDA & savings deposits
  124     160     375     578  
Time deposits
  287     396     924     1,285  
FHLB borrowings
  556     618     1,650     1,914  
Junior subordinated debentures
  98     100     291     299  
Other
  11     11     33     43  
Total interest expense
  1,076     1,285     3,273     4,119  
                         
Net interest income
  8,507     7,903     25,431     23,081  
                         
Provision for loan losses
  256     337     (27 )   2,164  
                         
Net interest income after provision for loan losses
  8,251     7,566     25,458     20,917  
                         
Non-interest income:
                       
Service charges
  1,303     1,189     3,655     3,333  
Other service charges and fees
  213     258     892     900  
Gain on sale of securities
  240     -     266     614  
Mortgage banking income
  256     301     548     1,000  
Insurance and brokerage commissions
  161     161     521     478  
Gain/(loss) on sale and write-down of
                       
 other real estate
  (234 )   (111 )   (384 )   (284 )
Miscellaneous
  1,268     1,313     3,660     3,806  
Total non-interest income
  3,207     3,111     9,158     9,847  
                         
Non-interest expense:
                       
Salaries and employee benefits
  4,301     4,183     12,784     12,614  
Occupancy
  1,489     1,357     4,476     3,988  
Other
  2,751     2,349     7,471     7,004  
Total non-interest expense
  8,541     7,889     24,731     23,606  
                         
Earnings before income taxes
  2,917     2,788     9,885     7,158  
                         
Income tax expense
  475     870     2,313     1,848  
                         
Net earnings
  2,442     1,918     7,572     5,310  
                         
Dividends and accretion on preferred stock
  -       156     -       470  
                         
Net earnings available to common shareholders
$ 2,442     1,762     7,572     4,840  
                         
Basic net earnings per common share
$ 0.43     0.31     1.35     0.86  
Diluted net earnings per common share
$ 0.43     0.31     1.34     0.86  
Cash dividends declared per common share
$ 0.04     0.03     0.12     0.09  
                         
See accompanying Notes to Consolidated Financial Statements.
                   
 
 
 
4

 
 
 
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES
                 
Consolidated Statements of Comprehensive Income (Loss)
                 
Three and Nine Months Ended September 30, 2014 and 2013
                 
 (Dollars in thousands)
                 
 
Three months ended
 
Nine months ended
 
 
September 30,
 
September 30,
 
 
2014
 
2013
 
2014
 
2013
 
 
(Unaudited)
 
(Unaudited)
 
(Unaudited)
 
(Unaudited)
 
                 
Net earnings
$ 2,442   1,918   7,572   5,310  
                   
Other comprehensive income (loss):
                 
Unrealized holding gains (losses) on securities
                 
available for sale
  1,788   (2,084 ) 9,374   (9,881 )
Reclassification adjustment for gains on
                 
securities available for sale
                 
included in net earnings
  (240 ) -     (266 ) (614 )
                   
Total other comprehensive income (loss),
                 
before income taxes
  1,548   (2,084 ) 9,108   (10,495 )
                   
Income tax (benefit) expense related to other
                 
comprehensive (loss) income:
                 
                   
Unrealized holding gains (losses) on securities
                 
available for sale
  696   (812 ) 3,651   (3,849 )
Reclassification adjustment for gains
                 
on securities available for sale
                 
included in net earnings
  (93 ) -     (104 ) (239 )
                   
Total income tax expense (benefit) related to
                 
other comprehensive income (loss)
  603   (812 ) 3,547   (4,088 )
                   
Total other comprehensive income (loss),
                 
net of tax
  945   (1,272 ) 5,561   (6,407 )
                   
Total comprehensive income (loss)
$ 3,387   646   13,133   (1,097 )
                   
See accompanying Notes to Consolidated Financial Statements.
             
 
 
 
5

 
 
 
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES
         
Consolidated Statements of Cash Flows
         
Nine Months Ended  September 30, 2014 and 2013
         
(Dollars in thousands)
         
 
2014
 
2013
 
 
(Unaudited)
 
(Unaudited)
 
         
Cash flows from operating activities:
       
Net earnings
$ 7,572     5,310  
Adjustments to reconcile net earnings to
           
net cash provided by operating activities:
           
Depreciation, amortization and accretion
  5,254     6,099  
Provision for loan losses
  (27 )   2,164  
Gain on sale of investment securities
  (266 )   (614 )
Gain on sale of other real estate
  (43 )   (86 )
Write-down of other real estate
  427     370  
Restricted stock expense
  272     104  
Change in:
           
Mortgage loans held for sale
  (390 )   4,721  
Cash surrender value of life insurance
  (315 )   (324 )
Other assets
  (254 )   897  
Other liabilities
  229     938  
             
Net cash provided by operating activities
  12,459     19,579  
             
Cash flows from investing activities:
           
Purchases of investment securities available for sale
  (25,439 )   (89,169 )
Proceeds from calls, maturities and paydowns of investment securities
           
available for sale
  29,263     52,666  
Proceeds from sales of investment securities available for sale
  20,202     17,463  
FHLB stock redemption
  284     384  
Net change in loans
  (34,213 )   (1,448 )
Purchases of premises and equipment
  (2,927 )   (1,575 )
Proceeds from sales of other real estate and repossessions
  3,230     4,823  
             
Net cash used by investing activities
  (9,600 )   (16,856 )
             
Cash flows from financing activities:
           
Net change in deposits
  17,434     16,766  
Net change in securities sold under agreements to repurchase
  1,624     13,596  
Proceeds from FHLB borrowings
  -       15,000  
Repayments of FHLB borrowings
  -       (15,000 )
Preferred stock repurchase
  (12,524 )   -    
Proceeds from stock options exercised
  38     -    
Cash dividends paid on preferred stock
  -       (470 )
Cash dividends paid on common stock
  (681 )   (508 )
             
Net cash provided by financing activities
  5,891     29,384  
             
Net change in cash and cash equivalents
  8,750     32,107  
             
Cash and cash equivalents at beginning of period
  76,773     48,843  
             
Cash and cash equivalents at end of period
$ 85,523     80,950  
             
 
 
 
6

 
 
 
PEOPLES BANCORP OF NORTH CAROLINA, INC. AND SUBSIDIARIES
           
Consolidated Statements of Cash Flows, continued
           
Nine Months Ended September 30, 2014 and 2013
           
(Dollars in thousands)
           
           
 
2014
   
2013
 
(Unaudited)
   
(Unaudited)
           
Supplemental disclosures of cash flow information:
         
Cash paid during the period for:
         
Interest
$ 3,290     4,179  
Income taxes
$ 1,637     1,937  
             
Noncash investing and financing activities:
           
Change in unrealized gain (loss) on investment securities
           
 available for sale, net
$ 5,561     (6,407 )
Transfers of loans to other real estate and repossessions
$ 3,774     2,153  
Financed portion of sales of other real estate
$ 282     525  
             
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, 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, 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. 2014-11 (a) requires entities to account for repurchase-to-maturity transactions as secured borrowings (rather than as sales with forward repurchase agreements), (b) eliminates accounting guidance on linked repurchase financing transactions, and (c) 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. 2014-11 provides 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

 
 
In August 2014, FASB issued ASU No. 2014-14, (Subtopic 310-40): Receivables – Troubled debt Restructurings by Creditors.  ASU No. 2014-14 provides guidance on the classification and measurement of certain government-guaranteed mortgage loans upon foreclosure by a creditor.  ASU No. 2014-14 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.

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 September 30, 2014 and December 31, 2013 are as follows:

(Dollars in thousands)
             
 
September 30, 2014
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
Mortgage-backed securities
$ 94,571   1,591   141   96,021
U.S. Government
               
sponsored enterprises
  27,939   185   147   27,977
State and political subdivisions
  146,108   5,612   711   151,009
Corporate bonds
  2,482   14   22   2,474
Trust preferred securities
  750   -     -     750
Equity securities
  748   808   -     1,556
Total
$ 272,598   8,210   1,021   279,787
                 
(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 September 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.
 
 
9

 
 

(Dollars in thousands)
                     
 
September 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
$ 11,266   14   8,126   127   19,392   141
U.S. Government
                       
sponsored enterprises
  8,113   74   3,926   73   12,039   147
State and political subdivisions
  -     -     31,377   711   31,377   711
Corporate bonds
  -     -     527   22   527   22
Total
$ 19,379   88   43,956   933   63,335   1,021
                         
(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 September 30, 2014, unrealized losses in the investment securities portfolio relating to debt securities totaled $1.0 million.  The unrealized losses on these debt securities arose due to changing interest rates and are considered to be temporary.  From the September 30, 2014 tables above, 35 out of 175 securities issued by state and political subdivisions contained unrealized losses, 14 out of 79 securities issued by U.S. Government sponsored enterprises, including mortgage-backed securities, contained unrealized losses, and one out of four securities issued by corporations contained unrealized losses.  These unrealized losses are considered temporary because of acceptable financial condition and results of operations of entities that issued 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 September 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.

September 30, 2014
     
(Dollars in thousands)
     
 
Amortized 
Cost
 
Estimated
Fair Value
Due within one year
$ 5,362   5,393
Due from one to five years
  41,153   43,023
Due from five to ten years
  113,866   116,443
Due after ten years
  16,898   17,351
Mortgage-backed securities
  94,571   96,021
Equity securities
  748   1,556
Total
$ 272,598   279,787
 
Proceeds from sales of securities available for sale during the nine months ended September 30, 2014 were $20.2 million and resulted in gross gains of $291,000 and gross losses of $25,000.  Proceeds from sales of securities available for sale during the nine months ended September 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 $103.0 million and $86.0 million at September 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 September 30, 2014 and December 31, 2013 are summarized as follows:
 
(Dollars in thousands)
     
 
September 30, 2014
 
December 31, 2013
Real estate loans
     
Construction and land development
$ 56,959   63,742
Single-family residential
  202,797   195,975
Single-family residential -
       
Banco de la Gente stated income
  47,665   49,463
Commercial
  227,183   209,287
Multifamily and farmland
  10,887   11,801
Total real estate loans
  545,491   530,268
         
Loans not secured by real estate
       
Commercial loans
  78,139   68,047
Farm loans
  10   19
Consumer loans
  10,210   9,593
All other loans
  16,700   13,033
         
Total loans
  650,550   620,960
         
Less allowance for loan losses
  12,343   13,501
         
Total net loans
$ 638,207   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 September 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 September 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 7% 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 September 30, 2014, commercial real estate loans comprised approximately 35% 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 September 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 September 30, 2014 and December 31, 2013:
 
September 30, 2014
                 
(Dollars in thousands)
                 
 
Loans 30
to 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
$ 231   3,546   3,777   53,182   56,959   -  
Single-family residential
  2,663   973   3,636   199,161   202,797   120
Single-family residential -
                       
Banco de la Gente stated income
  1,155   1,006   2,161   45,504   47,665   -  
Commercial
  1,864   416   2,280   224,903   227,183   -  
Multifamily and farmland
  -     167   167   10,720   10,887   -  
Total real estate loans
  5,913   6,108   12,021   533,470   545,491   120
                         
Loans not secured by real estate
                       
Commercial loans
  444   256   700   77,439   78,139   -  
Farm loans
  -     -     -     10   10   -  
Consumer loans
  148   11   159   10,051   10,210   -  
All other loans
  -     -     -     16,700   16,700   -  
Total loans
$ 6,505   6,375   12,880   637,670   650,550   120
 
December 31, 2013
                 
(Dollars in thousands)
                 
 
Loans 30
to 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 September 30, 2014 and December 31, 2013:
 
(Dollars in thousands)
     
 
September 30, 2014
 
December 31, 2013
Real estate loans
     
Construction and land development
$ 3,888   6,546
Single-family residential
  2,325   2,980
Single-family residential -
       
Banco de la Gente stated income
  1,955   1,990
Commercial
  1,818   2,043
     Multifamily and farmland
  166   -  
Total real estate loans
  10,152   13,559
         
Loans not secured by real estate
       
Commercial loans
  421   250
Consumer loans
  61   27
Total
$ 10,634   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 $26.8 million, $27.6 million and $27.1 million at September 30, 2014, December 31, 2013 and September 30, 2013, respectively.  Interest income recognized on accruing impaired loans was $992,000, $916,000 and $1.3 million for the nine months ended September 30, 2014, the nine months ended September 30, 2013 and the year ended December 31, 2013, respectively.  Interest income recognized on accruing impaired loans was $311,000 and $337,000 for the three months ended September 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 September 30, 2014 and December 31, 2013:
 
September 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
$ 5,704   3,808   645   4,453   40   5,990
Single-family residential
  6,520   941   5,360   6,301   139   7,690
Single-family residential -
                       
Banco de la Gente stated income
  21,706  
-  
 
21,129   21,129   1,210   19,998
Commercial
  4,733   2,845   1,548   4,393   192   4,445
Multifamily and farmland
  166   -     166   166   1   171
Total impaired real estate loans
  38,829   7,594   28,848   36,442   1,582   38,294
                         
Loans not secured by real estate
                       
Commercial loans
  760   -     659   659   13   836
Consumer loans
  311   -     307   307   5   305
Total impaired loans
$ 39,900   7,594   29,814   37,408   1,600   39,435
 
 
 
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 nine months ended September 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
 
Nine months ended September 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
  (772 (223 ) (148 ) (181 ) -   (197 ) -   (399 ) -   (1,920 )
Recoveries
  389   64   17   165   -   42   -   112   -   789  
Provision
  239   (230 ) (60 ) (435 ) (29 ) 240   -   282   (34 ) (27 )
Ending balance
$ 3,074   2,734   1,672   1,768   8   1,154   -   240   1,693   12,343  
                                           
Three months ended September 30, 2014
                                     
Allowance for loan losses:
                                         
Beginning balance
$ 3,387   2,848   1,708   1,839   7   1,081   -   253   1,552   12,675  
Charge-offs
  (513 ) (30 ) (7 ) (51 ) -   (4 ) -   (144 ) -   (749 )
Recoveries
  107   2   -   4   -   15   -   33   -   161  
Provision
  93   (86 ) (29 ) (24 ) 1   62   -   98   141   256  
Ending balance
$ 3,074   2,734   1,672   1,768   8   1,154   -   240   1,693   12,343  
                                           
Allowance for loan losses at September 30, 2014:
                                 
Ending balance: individually
                                         
evaluated for impairment
$ -   67   1,164   182   -   -   -   -   -   1,413  
Ending balance: collectively
                                         
evaluated for impairment
  3,074   2,667   508   1,586   8   1,154   -   240   1,693   10,930  
Ending balance
$ 3,074   2,734   1,672   1,768   8   1,154   -   240   1,693   12,343  
                                           
Loans at September 30, 2014:
                                         
Ending balance
$ 56,959   202,797   47,665   227,183   10,887   78,139   10   26,910   -   650,550  
                                           
Ending balance: individually
                                         
evaluated for impairment
$ 3,808   2,312   19,083   3,563   -   -   -   -   -   28,766  
Ending balance: collectively
                                         
evaluated for impairment
$ 53,151   200,485   28,582   223,620   10,887   78,139   10   26,910   -   621,784  
 
 
 
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
 
Nine months ended September 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
  (732 ) (1,204 ) (252 ) (327 ) -   (483 ) -   (485 ) -   (3,483 )
Recoveries
  374   75   101   50   -   39   -   111   -   750  
Provision
  99   864   67   240   8   140   -   379   367   2,164  
Ending balance
$ 4,140   2,966   1,914   2,012   36   784   -   250   1,752   13,854  
                                           
Three months ended September 30, 2013
                                     
Allowance for loan losses:
                                         
Beginning balance
$ 4,725   3,304   1,924   1,858   34   822   -   229   1,133   14,029  
Charge-offs
  (17 ) (569 ) (28 ) (51 ) -   (101 ) -   (204 ) -   (970 )
Recoveries
  348   31   31   -   -   14   -   34   -   458  
Provision
  (916   200   (13 ) 205   2   49   -   191   619   337  
Ending balance
$ 4,140   2,966   1,914   2,012   36   784   -   250   1,752   13,854  
                                           
Allowance for loan losses at September 30, 2013:
                                 
Ending balance: individually
                                         
evaluated for impairment
$ 1   60   1,233   -   -   -   -   -   -   1,294  
Ending balance: collectively
                                         
evaluated for impairment
  4,139   2,906   681   2,012   36   784   -   250   1,752   12,560  
Ending balance
$ 4,140   2,966   1,914   2,012   36   784   -   250   1,752   13,854  
                                           
Loans at September 30, 2013:
                                         
Ending balance
$ 67,870   191,338   50,035   205,911   11,541   64,957   22   25,387   -   617,061  
                                           
Ending balance: individually
                                         
evaluated for impairment
$ 6,790   3,079   19,803   3,100   -   -   -   272   -   33,044  
Ending balance: collectively
                                         
evaluated for impairment
$ 61,080   188,259   30,232   202,811   11,541   64,957   22   25,115   -   584,017  
 
The provision for loan losses for the three months ended September 30, 2014 was $256,000, as compared to $337,000 for the same period one year ago.  The decrease in the provision for loan losses is primarily attributable to a $3.5 million reduction in non-accrual loans from September 30, 2013 to September 30, 2014.

The provision for loan losses for the nine months ended September 30, 2014 was a credit of $27,000, as compared to an expense of $2.2 million for the same period one year ago.  The decrease in the provision for loan losses is primarily attributable to a $1.6 million decrease in net charge-offs during the nine months ended September 30, 2014 compared to the same period one year ago and a $3.5 million reduction in non-accrual loans from September 30, 2013 to September 30, 2014.  The credit to provision for loan losses in the nine months ended September 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 September 30, 2014 to $12.3 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 as Substandard, plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values highly questionable and improbable. Doubtful is a temporary grade where a loss is expected but is presently not quantified with any degree of accuracy. Once the loss position is determined, the amount is charged off.
·  
Risk Grade 8 – Loss: Loans classified as Loss are considered uncollectable and of such little value that their continuance as bankable assets is not warranted.  This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this worthless loan even though partial recovery may be realized in the future.  Loss is a temporary grade until the appropriate authority is obtained to charge the loan off.
 
The following tables present the credit risk profile of each loan type based on internally assigned risk grades as of September 30, 2014 and December 31, 2013:
 
September 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