4. Loans and Allowance for Loan Losses

Loan Origination/Risk Management

The Company has certain lending policies and procedures in place that are designed to minimize the level of risk within the loan portfolio. Diversification of the loan portfolio manages the risk associated with fluctuations in economic conditions. Authority levels are established for the extension of credit to ensure consistency throughout the Company. It is necessary that policies, processes and practices implemented to control the risks of individual credit transactions and portfolio segments are sound and adhered to. The Company maintains an independent loan review department that reviews and validates the risk assessment on a continual basis. Management regularly evaluates the results of the loan reviews. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Company’s policies and procedures.

Commercial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand its business. Commercial loans are made based on the identified cash flows of the borrower and on the underlying collateral provided by the borrower. The cash flows of the borrower, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts from its customers. Commercial credit cards are generally unsecured and are underwritten with criteria similar to commercial loans including an analysis of the borrower’s cash flow, available business capital, and overall credit-worthiness of the borrower.

Asset-based loans are offered primarily in the form of revolving lines of credit to commercial borrowers that do not generally qualify for traditional bank financing. Asset-based loans are underwritten based primarily upon the value of the collateral pledged to secure the loan, rather than on the borrower’s general financial condition. The Company utilizes pre-loan due diligence techniques, monitoring disciplines, and loan management practices common within the asset-based lending industry to underwrite loans to these borrowers.

Factoring loans provide working capital through the purchase and/or financing of accounts receivable to borrowers in the transportation industry and to commercial borrowers that do not generally qualify for traditional bank financing.

Commercial real estate loans are subject to underwriting standards and processes similar to commercial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts, and the repayment of these loans is largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. The Company requires that an appraisal of the collateral be made at origination and on an as-needed basis, in conformity with current market conditions and regulatory requirements. The underwriting standards address both owner and non-owner occupied real estate.

Construction loans are underwritten using feasibility studies, independent appraisal reviews, sensitivity analysis or absorption and lease rates and financial analysis of the developers and property owners. Construction loans are based upon estimates of costs and value associated with the complete project. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their repayment being sensitive to interest rate changes, governmental regulation of real property, economic conditions, and the availability of long-term financing.

Underwriting standards for residential real estate and home equity loans are based on the borrower’s loan-to-value percentage, collection remedies, and overall credit history.

Consumer loans are underwritten based on the borrower’s repayment ability. The Company monitors delinquencies on all of its consumer loans and leases and periodically reviews the distribution of FICO scores relative to historical periods to monitor credit risk on its credit card loans. The underwriting and review practices combined with the relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Consumer loans and leases that are 90 days past due or more are considered non-performing.

Credit risk is a potential loss resulting from nonpayment of either the primary or secondary exposure. Credit risk is mitigated with formal risk management practices and a thorough initial credit-granting process including consistent underwriting standards and approval process. Control factors or techniques to minimize credit risk include knowing the client, understanding total exposure, analyzing the client and debtor’s financial capacity, and monitoring the client’s activities. Credit risk and portions of the portfolio risk are managed through concentration considerations, average risk ratings, and other aggregate characteristics.

Loan Aging Analysis

This table provides a summary of loan classes and an aging of past due loans at September 30, 2017 and December 31, 2016 (in thousands):

	September 30, 2017
	30-89 Days Past Due and Accruing		Greater than 90 Days Past Due and Accruing		Non- Accrual Loans		Total Past Due		Current		Total Loans
Loans
Commercial:
Commercial	$	15,092	$	59	$	39,107	$	54,258	$	4,367,307	$	4,421,565
Asset-based		—		—		—		—		310,030		310,030
Factoring		—		—		—		—		195,882		195,882
Commercial – credit card		325		98		—		423		174,359		174,782
Real estate:
Real estate – construction		547		4		93		644		809,416		810,060
Real estate – commercial		4,522		—		10,769		15,291		3,345,936		3,361,227
Real estate – residential		943		157		745		1,845		612,751		614,596
Real estate – HELOC		397		—		3,138		3,535		658,456		661,991
Consumer:
Consumer – credit card		1,913		1,721		357		3,991		239,744		243,735
Consumer – other		613		49		22		684		178,031		178,715
Leases		—		—		—		—		24,445		24,445
Total loans	$	24,352	$	2,088	$	54,231	$	80,671	$	10,916,357	$	10,997,028

	December 31, 2016
	30-89 Days Past Due and Accruing		Greater than 90 Days Past Due and Accruing		Non- Accrual Loans		Total Past Due		PCI Loans		Current		Total Loans
Loans
Commercial:
Commercial	$	3,285	$	49	$	35,777	$	39,111	$	—	$	4,371,695	$	4,410,806
Asset-based		—		—		—		—		—		225,878		225,878
Factoring		—		—		—		—		—		139,902		139,902
Commercial – credit card		612		10		8		630		—		146,105		146,735
Real estate:
Real estate – construction		3		—		181		184		—		741,620		741,804
Real estate – commercial		1,303		1,004		16,423		18,730		—		3,147,192		3,165,922
Real estate – residential		1,034		6		1,344		2,384		—		545,966		548,350
Real estate – HELOC		588		—		4,736		5,324		—		706,470		711,794
Consumer:
Consumer – credit card		2,228		2,115		475		4,818		—		265,280		270,098
Consumer – other		1,061		181		11,315		12,557		800		126,205		139,562
Leases		—		—		—		—		—		39,532		39,532
Total loans	$	10,114	$	3,365	$	70,259	$	83,738	$	800	$	10,455,845	$	10,540,383

The Company had total purchased credit impaired (PCI) loans from its acquisition of Marquette Financial Companies (Marquette) of $800 thousand as of December 31, 2016. The PCI loans are accounted for in accordance with ASC Topic 310-30, Loans and Debt Securities Purchased with Deteriorated Credit Quality. All of the PCI loans were considered to be performing based on payment activity as of December 31, 2016. Of this amount, $713 thousand were current with their payment terms and $87 thousand were between 30-89 days past due.

The Company sold residential real estate loans with proceeds of $55.1 million and $61.7 million in the secondary market without recourse during the nine months ended September 30, 2017 and September 30, 2016, respectively.

The Company has ceased the recognition of interest on loans with a carrying value of $54.2 million and $70.3 million at September 30, 2017 and December 31, 2016, respectively. Restructured loans totaled $49.2 million and $52.5 million at September 30, 2017 and December 31, 2016, respectively. Loans 90 days past due and still accruing interest amounted to $2.1 million and $3.4 million at September 30, 2017 and December 31, 2016, respectively. There was an insignificant amount of interest recognized on impaired loans during 2017 and 2016.

Credit Quality Indicators

As part of the on-going monitoring of the credit quality of the Company’s loan portfolio, management tracks certain credit quality indicators including trends related to the risk grading of specified classes of loans, net charge-offs, non-performing loans, and general economic conditions.

The Company utilizes a risk grading matrix to assign a rating to each of its commercial, commercial real estate, and construction real estate loans. The loan ratings are summarized into the following categories: Non-watch list, Watch, Special Mention, and Substandard. Any loan not classified in one of the categories described below is considered to be a Non-watch list loan. A description of the general characteristics of the loan rating categories is as follows:

•

Watch – This rating represents credit exposure that presents higher than average risk and warrants greater than routine attention by Company personnel due to conditions affecting the borrower, the borrower’s industry or the economic environment. These conditions have resulted in some degree of uncertainty that results in higher than average credit risk.

•

Special Mention – This rating reflects a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or the borrower’s credit position at some future date. The rating is not adversely classified and does not expose an institution to sufficient risk to warrant adverse classification.

•

Substandard – This rating represents an asset inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged, if any. Assets so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. Loans in this category are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified substandard. This category may include loans where the collection of full principal is doubtful or remote.

All other classes of loans are generally evaluated and monitored based on payment activity. Non-performing loans include restructured loans on non-accrual and all other non-accrual loans.

This table provides an analysis of the credit risk profile of each loan class excluded from ASC 310-30 at September 30, 2017 and December 31, 2016 (in thousands):

Credit Exposure

Credit Risk Profile by Risk Rating

	Commercial				Asset-based				Factoring
	September 30,		December 31,		September 30,		December 31,		September 30,		December 31,
	2017		2016		2017		2016		2017		2016
Non-watch list	$	3,987,758	$	4,043,704	$	270,418	$	198,695	$	193,264	$	139,358
Watch		69,066		99,815		—		—		—		—
Special Mention		110,140		32,240		39,612		24,809		2,224		129
Substandard		254,601		235,047		—		2,374		394		415
Total	$	4,421,565	$	4,410,806	$	310,030	$	225,878	$	195,882	$	139,902

	Real estate – construction				Real estate – commercial
	September 30,		December 31,		September 30,		December 31,
	2017		2016		2017		2016
Non-watch list	$	804,932	$	741,022	$	3,233,122	$	3,071,804
Watch		1,445		149		48,898		43,015
Special Mention		3,281		—		33,901		5,140
Substandard		402		633		45,306		45,963
Total	$	810,060	$	741,804	$	3,361,227	$	3,165,922

Credit Exposure

Credit Risk Profile Based on Payment Activity

	Commercial – credit card				Real estate – residential				Real estate – HELOC
	September 30,		December 31,		September 30,		December 31,		September 30,		December 31,
	2017		2016		2017		2016		2017		2016
Performing	$	174,782	$	146,727	$	613,851	$	547,006	$	658,853	$	707,058
Non-performing		—		8		745		1,344		3,138		4,736
Total	$	174,782	$	146,735	$	614,596	$	548,350	$	661,991	$	711,794

	Consumer – credit card				Consumer – other				Leases
	September 30,		December 31,		September 30,		December 31,		September 30,		December 31,
	2017		2016		2017		2016		2017		2016
Performing	$	243,378	$	269,623	$	178,693	$	127,447	$	24,445	$	39,532
Non-performing		357		475		22		11,315		—		—
Total	$	243,735	$	270,098	$	178,715	$	138,762	$	24,445	$	39,532

Allowance for Loan Losses

The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management’s judgment of inherent probable losses within the Company’s loan portfolio as of the balance sheet date. The allowance is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. Accordingly, the methodology is based on historical loss trends. The Company’s process for determining the appropriate level of the allowance for loan losses is designed to account for credit deterioration as it occurs. The provision for probable loan losses reflects loan quality trends, including the levels of, and trends related to, non-accrual loans, past due loans, potential problem loans, criticized loans and net charge-offs or recoveries, among other factors.

The level of the allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and estimated losses inherent in the current loan portfolio. Portions of the allowance may be allocated for specific loans; however, the entire allowance is available for any loan that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available at the time, the adequacy of the allowance is dependent upon a variety of factors beyond the Company’s control, including, among other things, the performance of the Company’s loan portfolio, the economy, changes in interest rates and changes in the regulatory environment.

The Company’s allowance for loan losses consists of specific valuation allowances and general valuation allowances based on historical loan loss experience for similar loans with similar characteristics and trends, general economic conditions and other qualitative risk factors both internal and external to the Company.

The allowances established for probable losses on specific loans are based on a regular analysis and evaluation of impaired loans. Loans are classified based on an internal risk grading process that evaluates the obligor’s ability to repay, the underlying collateral, if any, and the economic environment and industry in which the borrower operates. When a loan is considered impaired, the loan is analyzed to determine the need, if any, to specifically allocate a portion of the allowance for loan losses to the loan. Specific valuation allowances are determined by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies, the relative risk rating of the loan and economic conditions affecting the borrower’s industry.

General valuation allowances are calculated based on the historical loss experience of specific types of loans including an evaluation of the time span and volume of the actual charge-off. The Company calculates historical loss ratios for pools of similar loans with similar characteristics based on the proportion of actual charge-offs experienced to the total population of loans in the pool. The historical loss ratios are updated based on actual charge-off experience. A valuation allowance is established for each pool of similar loans based upon the product of the historical loss ratio, time span to charge-off, and the total dollar amount of the loans in the pool. The Company’s pools of similar loans include similarly risk-graded groups of commercial loans, commercial real estate loans, commercial credit card, home equity loans, consumer real estate loans and consumer and other loans. The Company also considers a loan migration analysis for criticized loans. This analysis includes an assessment of the probability that a loan will move to a loss position based on its risk rating. The consumer credit card pool is evaluated based on delinquencies and credit scores. In addition, a portion of the allowance is determined by a review of qualitative factors by management.

Generally, the unsecured portion of a commercial or commercial real estate loan is charged off when, after analyzing the borrower’s financial condition, it is determined that the borrower is incapable of servicing the debt, little or no prospect for near term improvement exists, and no realistic and significant strengthening action is pending. For collateral dependent commercial or commercial real estate loans, an analysis is completed regarding the Company’s collateral position to determine if the amounts due from the borrower are in excess of the calculated current fair value of the collateral. Specific allocations of the allowance for loan losses are made for any collateral deficiency. If a collateral deficiency is ultimately deemed to be uncollectible, the amount is charged off. Revolving commercial loans (such as commercial credit cards) which are past due 90 cumulative days are classified as a loss and charged off.

Generally, a consumer loan, or a portion thereof, is charged off in accordance with regulatory guidelines which provide that such loans be charged off when the Company becomes aware of the loss, such as from a triggering event that may include, but is not limited to, new information about a borrower’s intent and ability to repay the loan, bankruptcy, fraud, or death. However, the charge-off timeframe should not exceed the specified delinquency time frames, which state that closed-end retail loans (such as real estate mortgages, home equity loans and consumer installment loans) that become past due 120 cumulative days and open-end retail loans (such as home equity lines of credit and consumer credit cards) that become past due 180 cumulative days are classified as a loss and charged off.

ALLOWANCE FOR LOAN LOSSES AND RECORDED INVESTMENT IN LOANS

This table provides a rollforward of the allowance for loan losses by portfolio segment for the three and nine months ended September 30, 2017 (in thousands):

	Three Months Ended September 30, 2017
	Commercial			Real estate			Consumer			Leases			Total
Allowance for loan losses:
Beginning balance	$	76,858		$	11,905		$	8,961		$	73		$	97,797
Charge-offs		(9,151	)		(439	)		(2,281	)		—			(11,871	)
Recoveries		190			201			572			—			963
Provision		8,166			1,844			1,495			(5	)		11,500
Ending balance	$	76,063		$	13,511		$	8,747		$	68		$	98,389

	Nine Months Ended September 30, 2017
	Commercial			Real estate			Consumer			Leases			Total
Allowance for loan losses:
Beginning balance	$	71,657		$	10,569		$	9,311		$	112		$	91,649
Charge-offs		(24,734	)		(888	)		(7,442	)		—			(33,064	)
Recoveries		2,519			620			1,665			—			4,804
Provision		26,621			3,210			5,213			(44	)		35,000
Ending balance	$	76,063		$	13,511		$	8,747		$	68		$	98,389
Ending balance: individually evaluated for impairment	$	3,060		$	125		$	—		$	—		$	3,185
Ending balance: collectively evaluated for impairment		73,003			13,386			8,747			68			95,204
Loans:
Ending balance: loans	$	5,102,259		$	5,447,874		$	422,450		$	24,445		$	10,997,028
Ending balance: individually evaluated for impairment		62,872			8,310			—			—			71,182
Ending balance: collectively evaluated for impairment		5,039,387			5,439,564			422,450			24,445			10,925,846

This table provides a rollforward of the allowance for loan losses by portfolio segment for the three and nine months ended September 30, 2016 (in thousands):

	Three Months Ended September 30, 2016
	Commercial			Real estate			Consumer			Leases			Total
Allowance for loan losses:
Beginning balance	$	64,561		$	10,683		$	9,319		$	103		$	84,666
Charge-offs		(5,667	)		(142	)		(2,335	)		—			(8,144	)
Recoveries		129			209			544			—			882
Provision		4,844			6,280			1,888			(12	)		13,000
Ending balance	$	63,867		$	17,030		$	9,416		$	91		$	90,404

	Nine Months Ended September 30, 2016
	Commercial			Real estate			Consumer			Leases			Total
Allowance for loan losses:
Beginning balance	$	63,847		$	8,220		$	8,949		$	127		$	81,143
Charge-offs		(11,542	)		(2,938	)		(6,951	)		—			(21,431	)
Recoveries		3,477			540			1,675			—			5,692
Provision		8,085			11,208			5,743			(36	)		25,000
Ending balance	$	63,867		$	17,030		$	9,416		$	91		$	90,404
Ending balance: individually evaluated for impairment	$	1,759		$	4,726		$	—		$	—		$	6,485
Ending balance: collectively evaluated for impairment		62,108			12,304			9,416			91			83,919
Loans:
Ending balance: loans	$	4,948,341		$	4,926,253		$	387,371		$	31,529		$	10,293,494
Ending balance: individually evaluated for impairment		80,769			16,122			2,158			—			99,049
Ending balance: collectively evaluated for impairment		4,867,572			4,910,131			384,178			31,529			10,193,410
Ending balance: PCI Loans		—			—			1,035			—			1,035

Impaired Loans

This table provides an analysis of impaired loans by class at September 30, 2017 and December 31, 2016 (in thousands):

	As of September 30, 2017
	Unpaid Principal Balance		Recorded Investment with No Allowance		Recorded Investment with Allowance		Total Recorded Investment		Related Allowance		Average Recorded Investment
Commercial:
Commercial	$	83,289	$	42,987	$	19,885	$	62,872	$	3,060	$	68,724
Asset-based		—		—		—		—		—		—
Factoring		—		—		—		—		—		—
Commercial – credit card		—		—		—		—		—		—
Real estate:
Real estate – construction		108		93		—		93		—		199
Real estate – commercial		11,586		6,825		1,173		7,998		51		10,592
Real estate – residential		223		121		98		219		74		174
Real estate – HELOC		—		—		—		—		—		—
Consumer:
Consumer – credit card		—		—		—		—		—		—
Consumer – other		—		—		—		—		—		8
Leases		—		—		—		—		—		—
Total	$	95,206	$	50,026	$	21,156	$	71,182	$	3,185	$	79,697

	As of December 31, 2016
	Unpaid Principal Balance		Recorded Investment with No Allowance		Recorded Investment with Allowance		Total Recorded Investment		Related Allowance		Average Recorded Investment
Commercial:
Commercial	$	80,405	$	43,260	$	31,091	$	74,351	$	7,866	$	69,776
Asset-based		—		—		—		—		—		—
Factoring		—		—		—		—		—		—
Commercial – credit card		—		—		—		—		—		—
Real estate:
Real estate – construction		510		181		113		294		68		405
Real estate – commercial		18,107		12,303		487		12,790		—		8,956
Real estate – residential		231		230		—		230		—		520
Real estate – HELOC		—		—		—		—		—		79
Consumer:
Consumer – credit card		—		—		—		—		—		—
Consumer – other		—		—		—		—		—		1,981
Leases		—		—		—		—		—		—
Total	$	99,253	$	55,974	$	31,691	$	87,665	$	7,934	$	81,717

Troubled Debt Restructurings

A loan modification is considered a troubled debt restructuring (TDR) when a concession has been granted to a debtor experiencing financial difficulties. The Company’s modifications generally include interest rate adjustments, principal reductions, and amortization and maturity date extensions. These modifications allow the debtor short-term cash relief to allow them to improve their financial condition. The Company’s restructured loans are individually evaluated for impairment and evaluated as part of the allowance for loan loss as described above in the Allowance for Loan Losses section of this note.

The Company had $2.4 million and $148 thousand in commitments to lend to borrowers with loan modifications classified as TDRs as of September 30, 2017 and September 30, 2016, respectively. The Company monitors loan payments on an on-going basis to determine if a loan is considered to have a payment default. Determination of payment default involves analyzing the economic conditions that exist for each customer and their ability to generate positive cash flows during the loan term.

For the three month period ended September 30, 2017, the Company had one residential real estate TDR with a pre-modification loan balance of $97 thousand and a post-modification loan balance of $98 thousand. For the three month period ended September 30, 2016, the Company had one one commercial TDR with a pre- and post-modification loan balance of $12.7 million. For the nine months ended September 30, 2017, the Company had one commercial and one residential real estate TDR with a pre- and post-modification loan balance of $7.3 million. For the nine months ended September 30, 2016, the Company had three commercial TDRs with a pre- and post-modification balance of $24.8 million.