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Covered Loans Receivable (Covered Loans)
12 Months Ended
Dec. 31, 2014
Covered Loans
 
Accounts, Notes, Loans and Financing Receivable [Line Items]  
Covered Loans Receivable
Covered Loans Receivable
The Company acquired loans through FDIC-assisted transactions which are covered by FDIC shared-loss agreements. These loans are referred to as "covered loans." Covered loans were acquired in the Cowlitz acquisition in July 2010 and with the Washington Banking Merger in May 2014. Included in the covered loans acquired from Washington Banking were loans Washington Banking had acquired from City Bank in April 2010 and North County Bank in September 2010. As part of the Washington Banking Merger, the shared-loss agreements with these acquisitions were transferred to Heritage Bank.
Loans purchased with evidence of credit deterioration since origination for which it is probable that not all contractually required payments will be collected are accounted for under FASB ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality and are identified as PCI loans. Loans purchased that are not accounted for under FASB ASC 310-30 are accounted for under FASB ASC 310-20, Receivables—Nonrefundable Fees and Other Costs.
Disclosures related to the Company’s recorded investment in covered loans receivable generally exclude accrued interest receivable because it is insignificant.
(a) Risk Management
The Company categorizes covered loans in the same four segments as the noncovered portfolio: commercial business, real estate construction and land development, one-to-four family residential and consumer.     
The recorded investment of covered loans receivable at December 31, 2014 and December 31, 2013 consisted of the following portfolio segments and classes:
 
December 31, 2014
 
December 31, 2013
 
(In thousands)
Commercial business:
 
 
 
Commercial and industrial
$
19,110

 
$
14,690

Owner-occupied commercial real estate
59,244

 
24,366

Non-owner occupied commercial real estate
26,879

 
14,625

Total commercial business
105,233

 
53,681

One-to-four family residential
5,990

 
4,777

Real estate construction and land development:
 
 
 
One-to-four family residential
2,446

 
1,556

Five or more family residential and commercial properties
3,560

 

Total real estate construction and land development
6,006

 
1,556

Consumer
8,971

 
3,740

Gross covered loans receivable
126,200

 
63,754

Allowance for loan losses
(5,576
)
 
(6,167
)
Covered loans receivable, net
$
120,624

 
$
57,587


At December 31, 2014 and December 31, 2013, the recorded investment balance of loans which are no longer covered under the FDIC shared-loss agreements, but are included in the covered loan table above as they are included in the loan pool established at the time of acquisition, was $872,000 and $2.6 million, respectively.
(b) Credit Quality Indicators
The following tables present the recorded invested balance of the covered loans receivable by credit quality indicator as of December 31, 2014 and December 31, 2013.
 
December 31, 2014
 
Pass
 
OAEM
 
Substandard
 
Doubtful
 
Total
 
(In thousands)
Commercial business:
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
11,297

 
$
131

 
$
5,442

 
$
2,240

 
$
19,110

Owner-occupied commercial real estate
40,357

 
4,957

 
13,583

 
347

 
59,244

Non-owner occupied commercial real estate
9,656

 
40

 
17,183

 

 
26,879

Total commercial business
61,310

 
5,128

 
36,208

 
2,587

 
105,233

One-to-four family residential
5,414

 
425

 
151

 


 
5,990

Real estate construction and land development:
 
 
 
 
 
 
 
 
 
One-to-four family residential
2,178

 

 
268

 

 
2,446

Five or more family residential and commercial properties
1,758

 

 
1,802

 

 
3,560

Total real estate construction and land development
3,936

 

 
2,070

 

 
6,006

Consumer
7,030

 

 
1,941

 

 
8,971

Gross covered loans receivable
$
77,690

 
$
5,553

 
$
40,370

 
$
2,587

 
$
126,200

 
December 31, 2013
 
Pass
 
OAEM
 
Substandard
 
Doubtful
 
Total
 
(In thousands)
Commercial business:
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
9,516

 
$
3,887

 
$
702

 
$
585

 
$
14,690

Owner-occupied commercial real estate
21,084

 
2,318

 
708

 
256

 
24,366

Non-owner occupied commercial real estate
6,534

 
55

 
4,631

 
3,405

 
14,625

Total commercial business
37,134

 
6,260

 
6,041

 
4,246

 
53,681

One-to-four family residential
3,739

 
882

 
156

 

 
4,777

Real estate construction and land development:
 
 
 
 
 
 
 
 
 
One-to-four family residential
698

 

 
858

 

 
1,556

Five or more family residential and commercial properties

 

 

 

 

Total real estate construction and land development
698

 

 
858

 

 
1,556

Consumer
3,116

 
106

 
518

 

 
3,740

Gross covered loans receivable
$
44,687

 
$
7,248

 
$
7,573

 
$
4,246

 
$
63,754



(c) Nonaccrual Loans
The recorded investment balance of covered nonaccrual loans, segregated by segments and classes of loans, were as follows as of December 31, 2014 and December 31, 2013:
 
December 31, 2014
 
December 31, 2013
 
(In thousands)
Commercial business:
 
 
 
Commercial and industrial
$
2,321

 
$

Owner-occupied commercial real estate
1,132

 

Non-owner-occupied commercial real estate
424

 

Total commercial business
3,877

 

Real estate construction and land development:
 
 
 
One-to-four family residential
179

 

Consumer
6

 
7

Gross covered nonaccrual loans
$
4,062

 
$
7


Covered PCI loans are not included in the nonaccrual table above because the loans are accounted for under ASC 310-30, whereby accretable yield is calculated based on a loan's expected cash flow even if the loan is not performing under its contractual terms.
(d) Past Due Loans
The balances of covered past due loans, segregated by segments and classes of loans, as of December 31, 2014 and December 31, 2013 were as follows:
 
December 31, 2014
 
30-89 Days
 
90 Days or
Greater
 
Total Past 
Due
 
Current
 
Total
 
90 Days or More
and  Still
Accruing (1)
 
(In thousands)
Commercial business:
 
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
2,262

 
$
1,163

 
$
3,425

 
$
15,685

 
$
19,110

 
$

Owner-occupied commercial real estate
645

 
2,680

 
3,325

 
55,919

 
59,244

 

Non-owner occupied commercial real estate
1,713

 
456

 
2,169

 
24,710

 
26,879

 

Total commercial business
4,620

 
4,299

 
8,919

 
96,314

 
105,233

 

One-to-four family residential
112

 

 
112

 
5,878

 
5,990

 

Real estate construction and land development:
 
 
 
 
 
 
 
 
 
 
 
One-to-four family residential
178

 
90

 
268

 
2,178

 
2,446

 

Five or more family residential and commercial properties

 
220

 
220

 
3,340

 
3,560

 

Total real estate construction and land development
178

 
310

 
488

 
5,518

 
6,006

 

Consumer
263

 
727

 
990

 
7,981

 
8,971

 

Gross covered loans receivable
$
5,173

 
$
5,336

 
$
10,509

 
$
115,691

 
$
126,200

 
$

(1)
Excludes covered PCI loans.
 
December 31, 2013
 
30-89 Days
 
90 Days or
Greater
 
Total Past 
Due
 
Current
 
Total
 
90 Days or More
and  Still
Accruing (1)
 
(In thousands)
Commercial business:
 
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
726

 
$
1,156

 
$
1,882

 
$
12,808

 
$
14,690

 
$

Owner-occupied commercial real estate
28

 
147

 
175

 
24,191

 
24,366

 

Non-owner occupied commercial real estate

 
3,540

 
3,540

 
11,085

 
14,625

 

Total commercial business
754

 
4,843

 
5,597

 
48,084

 
53,681

 

One-to-four family residential
113

 

 
113

 
4,664

 
4,777

 

Real estate construction and land development:
 
 
 
 
 
 
 
 
 
 
 
One-to-four family residential
213

 
644

 
857

 
699

 
1,556

 

Five or more family residential and commercial properties

 

 

 

 

 

Total real estate construction and land development
213

 
644

 
857

 
699

 
1,556

 

Consumer
67

 
78

 
145

 
3,595

 
3,740

 

Gross covered loans receivable
$
1,147

 
$
5,565

 
$
6,712

 
$
57,042

 
$
63,754

 
$

(1)
Excludes covered PCI loans.

(e) Impaired Loans
A covered loan, not initially classified as PCI, generally becomes impaired when classified as nonaccrual or when its modification results in a TDR. Covered impaired loans as of December 31, 2014 and December 31, 2013 are set forth in the following tables.
 
December 31, 2014
 
Recorded
Investment With
No Specific
Valuation
Allowance
 
Recorded
Investment With
Specific
Valuation
Allowance
 
Total
Recorded
Investment
 
Unpaid
Contractual
Principal
Balance
 
Related
Specific
Valuation
Allowance
 
(In thousands)
Commercial business:
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
2,240

 
$
94

 
$
2,334

 
$
3,696

 
$
9

Owner-occupied commercial real estate

 
1,132

 
1,132

 
1,156

 
295

Non-owner occupied commercial real estate

 
424

 
424

 
440

 
66

Total commercial business
2,240

 
1,650

 
3,890

 
5,292

 
370

Real estate construction and land development:
 
 
 
 
 
 
 
 
 
One-to-four family residential

 
179

 
179

 
182

 
51

Total real estate construction and land development

 
179

 
179

 
182

 
51

Consumer

 
6

 
6

 
8

 
2

Gross covered impaired loans
$
2,240

 
$
1,835

 
$
4,075

 
$
5,482

 
$
423


 
December 31, 2013
 
Recorded
Investment With
No Specific
Valuation
Allowance
 
Recorded
Investment With
Specific
Valuation
Allowance
 
Total
Recorded
Investment
 
Unpaid
Contractual
Principal
Balance
 
Related
Specific
Valuation
Allowance
 
(In thousands)
Commercial business:
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
10

 
$
3,751

 
$
3,761

 
$
3,761

 
$
629

Total commercial business
10

 
3,751

 
3,761

 
3,761

 
629

One-to-four family residential

 
450

 
450

 
423

 
31

Consumer
7

 

 
7

 
8

 

Gross covered impaired loans
$
17

 
$
4,201

 
$
4,218

 
$
4,192

 
$
660


The average recorded investment of covered impaired loans for the years ended December 31, 2014 and 2013 are set forth in the following table.
 
 
Years Ended December 31,
 
 
2014
 
2013
 
2012
 
 
(In thousands)
Commercial business:
 
 
 
 
 
 
Commercial and industrial
 
$
3,421

 
$
1,484

 
$
21

Owner-occupied commercial real estate
 
367

 

 

Non-owner occupied commercial real estate
 
171

 

 

Total commercial business
 
3,959

 
1,484

 
21

One-to-four family residential
 
90

 
459

 
187

Real estate construction and land development:
 
 
 
 
 
 
One-to-four family residential
 
36

 

 

Total real estate construction and land development
 
36

 

 

Consumer
 
7

 
20

 
26

Gross covered impaired loans
 
$
4,092

 
$
1,963

 
$
234


For the years ended December 31, 2014, 2013 and 2012, no interest income was recognized subsequent to a covered loan’s classification as nonaccrual. For the years ended December 31, 2014, 2013 and 2012, the Bank recorded $5,000, $16,000 and $7,000, respectively, of interest income related to covered performing TDR loans.

(f) Troubled Debt Restructured Loans
The recorded investment balance and related allowance for loan losses of covered performing and covered nonaccrual TDRs as of December 31, 2014 and December 31, 2013 were as follows:
 
December 31, 2014
 
December 31, 2013
 
Performing
TDRs
 
Nonaccrual
TDRs
 
Performing
TDRs
 
Nonaccrual
TDRs
 
(In thousands)
Covered TDRs
$
10,289

 
$
2,246

 
$
4,211

 
$
7

Allowance for loan losses on covered TDRs
1

 
2

 
660

 


There were no unfunded commitments related to credits classified as covered TDRs at December 31, 2014 and December 31, 2013.
Covered loans that were modified as TDRs during the years ended December 31, 2014 and 2013 are set forth in the following table:
 
Years Ended December 31,
 
2014
 
2013
 
Number of
Contracts
(1)
 
Outstanding
Principal Balance
(1)(2)
 
Number of
Contracts
(1)
 
Outstanding
Principal Balance 
(1)(2)
 
(Dollars in thousands)
Commercial business:
 
 
 
 
 
 
 
Commercial and industrial
7

 
$
3,394

 
3

 
$
3,792

Owner-occupied commercial real estate
2

 
1,133

 

 

Non-owner occupied commercial real estate
2

 
7,561

 

 

Total commercial business
11

 
12,088

 
3

 
3,792

One-to-four family residential

 

 

 

Real estate construction and land development:
 
 
 
 
 
 
 
One-to-four family residential

 

 

 

Five or more family residential and commercial properties
1

 
428

 

 

Total real estate construction and land development
1

 
428

 

 

Consumer

 

 

 

Total covered TDRs
12

 
$
12,516

 
3

 
$
3,792

(1)
Number of contracts and outstanding principal balance represent loans which have balances as of year end as certain loans may have been paid-down or charged-off during the years ended December 31, 2014 and 2013.
(2)
Includes subsequent payments after modifications and reflects the balance as of period end. As the Bank did not forgive any principal or interest balance as part of the loan modification, the Bank’s recorded investment in each loan at the date of modification (pre-modification) did not change as a result of the modification (post-modification).
Of the twelve covered loans modified as TDRs during the year ended December 31, 2014, eleven loans totaling $10.3 million were related to PCI loans acquired in the Washington Banking Merger. There was no allowance for loan losses at December 31, 2014 on these modified loans as the recorded investment was less than the estimated net present value of future cash flows. Four of these modified loans totaling $7.7 million at December 31, 2014 were modified as a result of bankruptcy rulings and the courts dictated the future payment terms. One covered TDR totaling $2.2 million at December 31, 2014 was modified during both the years ended December 31, 2014 and 2013 because the loan's maturity date was extended in each modification. The Bank provided for a shorter maturity date than it expected to receive the cash flows to more closely monitor the borrower. At December 31, 2014, this loan did not have a specific valuation allowance as the loan had been charged-down to the net realizable value during fourth quarter 2014. The other two loans modified as TDRs during the year ended December 31, 2013 also had maturity date extensions. These two loans have outstanding principal balances of $13,000 and specific valuation of $1,000 at December 31, 2014.
There were no covered loans modified during the previous twelve months ended December 31, 2014 and December 31, 2013 that subsequently defaulted during the years ended December 31, 2014 and 2013.

(g) Covered Purchased Credit Impaired Loans
The Company acquired covered loans which the Bank accounts for under FASB ASC 310-30 as they were deemed PCI at the time of acquisition.
The following tables reflect the outstanding principal balance and recorded investment at December 31, 2014 and December 31, 2013 of the covered PCI loans:
 
December 31, 2014
 
December 31, 2013
 
Outstanding Principal
 
Recorded Investment
 
Outstanding Principal
 
Recorded Investment
 
(In thousands)
Commercial business:
 
 
 
 
 
 
 
Commercial and industrial
$
9,635

 
$
7,134

 
$
10,608

 
$
8,680

Owner-occupied commercial real estate
23,071

 
20,666

 
11,538

 
10,923

Non-owner occupied commercial real estate
20,607

 
20,257

 
10,611

 
12,187

Total commercial business
53,313

 
48,057

 
32,757

 
31,790

One-to-four family residential
3,837

 
3,478

 
3,966

 
3,530

Real estate construction and land development:
 
 
 
 
 
 
 
One-to-four family residential
103

 
1,308

 
1,298

 
1,556

Five or more family residential and commercial properties
2,140

 
1,802

 

 

Total real estate construction and land development
2,243

 
3,110

 
1,298

 
1,556

Consumer
2,945

 
2,717

 
2,022

 
2,000

Gross covered PCI loans
$
62,338

 
$
57,362

 
$
40,043

 
$
38,876

The Bank has the option to modify covered PCI loans; however, modifying the loan may terminate the FDIC shared-loss coverage on those loans. At December 31, 2014 and December 31, 2013, the recorded investment balance of covered PCI loans which are no longer covered under the FDIC shared-loss agreements was $476,000 and $1.7 million, respectively. The Bank continues to report these loans in the covered portfolio as they are in a pool and they continue to be accounted for under FASB ASC 310-30. The FDIC indemnification asset has been adjusted to reflect the change in the loan status.

(h) Accretable Yield
The following table summarizes the accretable yield on the covered PCI loans resulting from the Cowlitz Acquisition and Washington Banking Merger for the years ended December 31, 2014, 2013 and 2012.
 
Years Ended December 31,
 
2014
 
2013
 
2012
 
(In thousands)
Balance at the beginning of the year
$
9,535

 
$
14,286

 
$
19,912

Accretion
(3,749
)
 
(4,210
)
 
(6,679
)
Disposal and other
(1,718
)
 
(4,902
)
 
(1,140
)
Change in accretable yield (1)
4,452

 
4,361

 
2,193

Balance at the end of the year
$
8,520

 
$
9,535

 
$
14,286

(1)
Includes accretable difference at acquisition.
    
On the May 1, 2014 merger date of the Washington Banking Merger, the contractual cash flows on covered PCI loans acquired in the Washington Banking Merger were $75.1 million and the expected cash flows were $52.2 million, resulting in a $22.9 million non-accretable difference. The fair value was estimated at $48.7 million, resulting in a $3.5 million accretable yield which is included in the table above as a change in accretable yield for the year ended December 31, 2014. The contractual cash flows on the covered non-PCI loans were $70.3 million and the expected cash flows were $66.5 million, resulting in $3.8 million of cash flows not expected to be collected. The fair value of the covered non-PCI loans acquired in the Washington Banking Merger at May 1, 2014 was $58.4 million.