(3) Loans

Major classifications of loans at September 30, 2011 and December 31, 2010 are summarized as follows:

(Dollars in thousands)
	September 30, 2011		December 31, 2010
Real estate loans
Construction and land development	$	103,901	124,048
Single-family residential		271,019	287,307
Commercial		211,352	213,487
Multifamily and farmland		4,923	6,456
Total real estate loans		591,195	631,298

Commercial loans (not secured by real estate)		53,082	60,994
Consumer loans (not secured by real estate)		10,634	11,500
All other loans (not secured by real estate)		22,754	22,368

Total loans		677,665	726,160

Less allowance for loan losses		16,348	15,493

Total net loans	$	661,317	710,667

The Company 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.

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, 2011 and December 31, 2010:

September 30, 2011
(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	$	1,138	3,636	4,774	99,127	103,901	-
Single-family residential		8,170	4,490	12,660	258,359	271,019	1,411
Commercial		1,367	1,962	3,329	208,023	211,352	-
Multifamily and farmland		215	-	215	4,708	4,923	-
Total real estate loans		10,890	10,088	20,978	570,217	591,195	1,411

Commercial loans (not secured by real estate)		306	35	341	52,741	53,082	-
Consumer loans (not secured by real estate)		123	6	129	10,505	10,634	-
All other loans (not secured by real estate)		-	-	-	22,754	22,754	-
Total loans	$	11,319	10,129	21,448	656,217	677,665	1,411

December 31, 2010
(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	$	2,306	8,870	11,176	112,872	124,048	197
Single-family residential		19,377	5,936	25,313	261,994	287,307	-
Commercial		382	1,482	1,864	211,623	213,487	-
Multifamily and farmland		-	-	-	6,456	6,456	-
Total real estate loans		22,065	16,288	38,353	592,945	631,298	197

Commercial loans (not secured by real estate)		1,098	720	1,818	59,176	60,994	13
Farm loans (not secured by real estate)		-	-	-	-	-	-
Consumer loans (not secured by real estate)		98	13	111	11,389	11,500	-
All other loans (not secured by real estate)		-	-	-	22,368	22,368	-
Total loans	$	23,261	17,021	40,282	685,878	726,160	210

The following table presents the Company's non-accrual loans as of September 30, 2011 and December 31, 2010:

(Dollars in thousands)
	September 30, 2011		December 31, 2010
Real estate loans
Construction and land development	$	17,088	22,916
Single-family residential		5,665	10,837
Commercial		4,174	5,351
Multifamily and farmland		-	-
Total real estate loans		26,927	39,104

Commercial loans (not secured by real estate)		437	816
Consumer loans (not secured by real estate)		127	142
All other loans (not secured by real estate)		-	-
Total	$	27,491	40,062

At each reporting period, the Company determines which loans are impaired. Accordingly, the Company's impaired loans are reported at their estimated fair value on a non-recurring basis. An allowance for each impaired loan, which is generally collateral-dependent, is calculated based on the fair value of its collateral. The fair value of the collateral is based on appraisals performed by third-party valuation specialists. 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. No interest income is recognized on impaired loans subsequent to their classification as impaired.

The following tables present the Company's impaired loans as of September 30, 2011 and December 31, 2010:

September 30, 2011
(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	$	27,114	17,088	-	17,088	-	19,753
Single-family residential		6,792	5,148	517	5,665	1,316	7,846
Commercial		5,237	3,196	978	4,174	1	4,482
Multifamily and farmland		-	-	-	-	-	-
Total impaired real estate loans		39,143	25,432	1,495	26,927	1,317	32,081

Commercial loans (not secured by real estate)		494	437	-	437	-	631
Consumer loans (not secured by real estate)		143	127	-	127	-	138
All other loans (not secured by real estate)		-	-	-	-	-	-
Total impaired loans	$	39,780	25,996	1,495	27,491	1,317	32,850

December 31, 2010
(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		31,346	20,787	2,130	22,916	1,055	18,767
Single-family residential		12,376	9,847	990	10,837	168	12,573
Commercial		6,018	4,991	359	5,351	148	4,769
Multifamily and Farmland		-	-	-	-	-	27
Total impaired real estate loans		49,740	35,625	3,479	39,104	1,371	36,136

Commercial loans (not secured by real estate)		1,243	811	5	816	5	1,479
Farm loans (non RE)					-
Consumer loans (not secured by real estate)		152	142	-	142	-	79
All other loans (not secured by real estate)		-	-	-	-		-
Total impaired loans	$	51,135	36,578	3,484	40,062	1,376	37,694

Changes in the allowance for loan losses for the nine months ended September 30, 2011 were as follows:

(Dollars in thousands)

	Real Estate Loans
	Construction and land development			Single- family residential		Commercial		Multifamily and farmland		Commercial		Consumer		Unallocated	Total
Allowance for loan losses:
Beginning balance	$	5,774		6,097		1,409		17		1,174		430		592	15,493
Charge-offs		(5,028	)	(2,579	)	(1,180	)	-		(313	)	(434	)	-	(9,534	)
Recoveries		235		198		23		-		114		122		-	693
Provision		5,134		2,400		1,404		(4	)	23		173		566	9,696
Ending balance	$	6,115		6,116		1,656		13		998		292		1,158	16,348

Ending balance: Individually
evaluated for impairment	$	-		1,316		1		-		-		-		-	1,317
Ending balance: Collectively
evaluated for impairment		6,115		4,800		1,655		13		998		292		1,158	15,031
Ending balance	$	6,115		6,116		1,656		13		998		292		1,158	16,348

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 9. A description of the general characteristics of the nine 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 very high risk and servicing needs but still are acceptable. Evidence of marginal performance or deteriorating trends are evident. These are not problem credits presently, but may be in the future if the borrower is unable to change its present course.

Risk Grade 5 – Watch: These loans are currently performing satisfactorily, but there are potential weaknesses that may, if not corrected, weaken the asset or inadequately protect the Company's position at some future date. This frequently results from deviating from prudent lending practices, for instance over-advancing on collateral.

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 – Low Substandard: These loans have the general characteristics of a Grade 6 Substandard loan, with heightened potential concerns. The exact amount of loss is not yet known because neither the liquidation value of the collateral nor the borrower's predicted repayment ability is known with confidence.

Risk Grade 8 – Doubtful: Loans classified Doubtful have all the weaknesses inherent in loans classified Substandard, plus the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions, and values highly questionable and improbable. 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 9 – Loss: Loans classified Loss are considered uncollectable and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this worthless loan even though partial recovery may be 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 grade as of September 30, 2011 and December 31, 2010.

September 30, 2011
(Dollars in thousands)
	Real Estate Loans
	Construction and land development		Single- family residential	Commercial	Multifamily and farmland	Commercial	Consumer	All other	Total

1- Excellent Quality	$	199	21,428	-	-	738	1,075	-	23,440
2- High Quality	$	5,088	65,657	21,969	134	10,410	4,201	3,298	110,757
3- Good Quality	$	27,736	108,619	137,239	3,482	33,647	4,711	19,449	334,883
4- Management Attention	$	45,272	52,572	40,570	365	6,847	501	7	146,134
5- Watch	$	6,037	9,833	1,898	727	499	9	-	19,003
6- Substandard	$	19,569	12,910	9,676	215	941	137	-	43,448
7- Low Substandard	$	-	-	-	-	-	-	-	-
8- Doubtful	$	-	-	-	-	-	-	-	-
9- Loss	$	-	-	-	-	-	-	-	-
Total	$	103,901	271,019	211,352	4,923	53,082	10,634	22,754	677,665

December 31, 2010
(Dollars in thousands)
	Real Estate Loans
	Construction and land development		Single- family residential	Commercial	Multifamily and farmland	Commercial	Consumer	All other	Total

1- Excellent Quality	$	19	27,698	102	-	630	1,006	-	29,455
2- High Quality	$	5,789	70,990	21,591	2,856	9,673	4,491	5,145	120,535
3- Good Quality	$	33,991	109,800	129,530	2,256	39,248	5,360	17,223	337,408
4- Management Attention	$	46,283	55,001	43,731	1,121	8,143	454		154,733
5- Watch	$	8,076	7,959	5,569	-	1,590	38		23,232
6- Substandard	$	29,502	15,022	12,605	223	1,678	145		59,175
7- Low Substandard	$	-	756	359	-	-	-		1,115
8- Doubtful	$	388	81	-	-	17	-		486
9- Loss	$	-	-	-	-	15	6	-	21
Total	$	124,048	287,307	213,487	6,456	60,994	11,500	22,368	726,160

At September 30, 2011, troubled debt restructured (“TDR”) loans amounted to $48.5 million, including $16.0 million in performing TDR loans. The terms of these loans have been renegotiated to provide a reduction in principal or interest as a result of the deteriorating financial position of the borrower. At December 31, 2010, TDR loans amounted to $56.7 million, including $10.0 million in performing TDR loans.

The following table presents an analysis of TDR loans by loan type as of September 30, 2011.

(Dollars in thousands)
	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Real estate loans
Construction and land development	31	$	24,708	17,311
Single-family residential	240		26,285	24,955
Commercial	18		8,695	4,783
Multifamily and farmland	1		322	215
Total real estate TDR loans	290		60,010	47,264

Commercial loans (not secured by real estate)	22		1,776	1,157
Consumer loans (not secured by real estate)	8		142	127
All other loans (not secured by real estate)	-		-	-
Total TDR loans	320	$	61,928	48,548