Note 5 – Covered Assets and Indemnification Asset

Covered Loans

Loans acquired in a FDIC-assisted acquisition that are subject to a loss-share agreement are referred to as “covered loans” and reported separately in our statements of financial condition. Covered loans are reported exclusive of the cash flow reimbursements expected from the FDIC.

Acquired loans are valued as of acquisition date in accordance with ASC 805. Loans purchased with evidence of credit deterioration since origination for which it is probable that all contractually required payments will not be collected are accounted for under FASB ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (“ASC 310-30”). Because of the significant fair value discounts associated with the acquired portfolios, the concentration of real estate related loans (to finance or secured by real estate collateral) and the decline in real estate values in the regions serviced, and after considering the underwriting standards of the acquired originating bank, the Company elected to account for all acquired loans under ASC 310-30. Under ASC 805 and ASC 310-30, loans are to be recorded at fair value at acquisition date, factoring in credit losses expected to be incurred over the life of the loan. Accordingly, an allowance for loan losses is not carried over or recorded as of the acquisition date. We have aggregated the acquired loans into various loan pools based on multiple layers of common risk characteristics for the purpose of determining their respective fair values as of their acquisition dates, and for applying the subsequent recognition and measurement provisions for income accretion and impairment testing.

The covered loans acquired are, and will continue to be, subject to the Company’s internal and external credit review and monitoring. To the extent there is experienced or projected credit deterioration on the acquired loan pools subsequent to amounts estimated at the previous remeasurement date, this deterioration will be measured, and a provision for credit losses will be charged to earnings. Additionally, provision for credit losses will be recorded on advances on covered loans subsequent to acquisition date in a manner consistent with the allowance for non-covered loan and lease losses. These provisions will be mostly offset by an increase to the FDIC indemnification asset, which is recognized in non-interest income.

Covered Loans

The following table presents the major types of covered loans as of June 30, 2012 and December 31, 2011:

(in thousands)



	June 30, 2012
	Evergreen		Rainier		Nevada Security		Total
Commercial real estate
Term & multifamily	$	88,007	$	222,962	$	115,024	$	425,993
Construction & development		5,315		665		8,103		14,083
Residential development		5,574		239		6,800		12,613
Commercial
Term		12,140		3,694		14,897		30,731
LOC & other		5,646		9,974		4,997		20,617
Residential
Mortgage		4,348		24,079		1,842		30,269
Home equity loans & lines		3,741		18,996		3,123		25,860
Consumer & other		2,009		4,726		39		6,774
Total	$	126,780	$	285,335	$	154,825	$	566,940
Allowance for covered loans								(12,977)
Total							$	553,963



	December 31, 2011
	Evergreen		Rainier		Nevada Security		Total
Commercial real estate
Term & multifamily	$	99,346	$	248,206	$	126,502	$	474,054
Construction & development		7,241		711		6,868		14,820
Residential development		7,809		227		9,727		17,763
Commercial
Term		14,911		5,807		13,432		34,150
LOC & other		8,776		8,854		5,796		23,426
Residential
Mortgage		6,320		27,320		1,863		35,503
Home equity loans & lines		4,660		21,055		3,370		29,085
Consumer & other		2,394		5,541		35		7,970
Total	$	151,457	$	317,721	$	167,593	$	636,771
Allowance for covered loans								(14,320)
Total							$	622,451

The outstanding contractual unpaid principal balance, excluding purchase accounting adjustments, at June 30, 2012 was $173.1 million, $353.3 million and $239.9 million, for Evergreen, Rainier, and Nevada Security, respectively, as compared to $209.5 million, $379.0 million and $260.2 million, for Evergreen, Rainier, and Nevada Security, respectively, at December 31, 2011.

In estimating the fair value of the covered loans at the acquisition date, we (a) calculated the contractual amount and timing of undiscounted principal and interest payments and (b) estimated the amount and timing of undiscounted expected principal and interest payments. The difference between these two amounts represents the nonaccretable difference.

On the acquisition date, the amount by which the undiscounted expected cash flows exceed the estimated fair value of the acquired loans is the “accretable yield”. The accretable yield is then measured at each financial reporting date and represents the difference between the remaining undiscounted expected cash flows and the current carrying value of the loans.

The following table presents the changes in the accretable yield for the three and six months ended June 30, 2012 and 2011 for each respective acquired loan portfolio:


(in thousands)

	Three months ended June 30, 2012
	Evergreen		Rainier		Nevada Security		Total
Balance, beginning of period	$	53,470	$	112,845	$	59,801	$	226,116
Accretion to interest income		(4,544)		(7,147)		(4,694)		(16,385)
Disposals		(2,585)		(4,689)		(1,149)		(8,423)
Reclassifications (to)/from nonaccretable difference		1,723		22,492		665		24,880
Balance, end of period	$	48,064	$	123,501	$	54,623	$	226,188



	Three months ended June 30, 2011
	Evergreen		Rainier		Nevada Security		Total
Balance, beginning of period	$	75,081	$	155,285	$	69,301	$	299,667
Accretion to interest income		(7,737)		(8,144)		(5,872)		(21,753)
Disposals		(4,181)		(2,803)		(1,403)		(8,387)
Reclassifications (to)/from nonaccretable difference		4,306		(341)		6,568		10,533
Balance, end of period	$	67,469	$	143,997	$	68,594	$	280,060



	Six months ended June 30, 2012
	Evergreen		Rainier		Nevada Security		Total
Balance, beginning of period	$	56,479	$	120,333	$	61,021	$	237,833
Accretion to interest income		(8,778)		(14,855)		(9,609)		(33,242)
Disposals		(3,682)		(8,686)		(1,419)		(13,787)
Reclassifications (to)/from nonaccretable difference		4,045		26,709		4,630		35,384
Balance, end of period	$	48,064	$	123,501	$	54,623	$	226,188



	Six months ended June 30, 2011
	Evergreen		Rainier		Nevada Security		Total
Balance, beginning of period	$	90,771	$	172,615	$	73,515	$	336,901
Accretion to interest income		(15,313)		(16,640)		(10,948)		(42,901)
Disposals		(6,973)		(9,447)		(2,807)		(19,227)
Reclassifications (to)/from nonaccretable difference		(1,016)		(2,531)		8,834		5,287
Balance, end of period	$	67,469	$	143,997	$	68,594	$	280,060

Allowance for Covered Loan and Lease Losses

The following table summarizes activity related to the allowance for covered loan and lease losses by covered loan portfolio segment for the three and six months ended June 30, 2012 and 2011, respectively:

(in thousands)



	Three Months Ended June 30, 2012
	Commercial						Consumer
	Real Estate		Commercial		Residential		& Other		Total
Balance, beginning of period	$	8,298	$	3,275	$	740	$	322	$	12,635
Charge-offs		(1,159)		(299)		(134)		(55)		(1,647)
Recoveries		304		212		47		20		583
Provision		18		1,359		11		18		1,406
Balance, end of period	$	7,461	$	4,547	$	664	$	305	$	12,977



	Three Months Ended June 30, 2011
	Commercial						Consumer
	Real Estate		Commercial		Residential		& Other		Total
Balance, beginning of period	$	5,068	$	1,800	$	962	$	413	$	8,243
Charge-offs		(1,128)		(224)		(254)		(719)		(2,325)
Recoveries		386		40		60		60		546
Provision		1,388		1,016		425		926		3,755
Balance, end of period	$	5,714	$	2,632	$	1,193	$	680	$	10,219



	Six Months Ended June 30, 2012
	Commercial						Consumer
	Real Estate		Commercial		Residential		& Other		Total
Balance, beginning of period	$	8,939	$	3,964	$	991	$	426	$	14,320
Charge-offs		(2,090)		(807)		(437)		(533)		(3,867)
Recoveries		641		381		79		48		1,149
Provision		(29)		1,009		31		364		1,375
Balance, end of period	$	7,461	$	4,547	$	664	$	305	$	12,977

(in thousands)



	Six Months Ended June 30, 2011
	Commercial						Consumer
	Real Estate		Commercial		Residential		& Other		Total
Balance, beginning of period	$	2,465	$	176	$	56	$	24	$	2,721
Charge-offs		(2,564)		(322)		(903)		(623)		(4,412)
Recoveries		669		78		80		60		887
Provision		5,144		2,700		1,960		1,219		11,023
Balance, end of period	$	5,714	$	2,632	$	1,193	$	680	$	10,219

The following table presents the allowance and recorded investment in covered loans by portfolio segment as of June 30, 2012 and 2011:

(in thousands)



	June 30, 2012
	Commercial						Consumer
	Real Estate		Commercial		Residential		& Other		Total
Allowance for covered loans and leases:
Loans acquired with deteriorated credit quality (1)	$	6,926	$	3,936	$	619	$	261	$	11,742
Collectively evaluated for impairment (2)		535		611		45		44		1,235
Total	$	7,461	$	4,547	$	664	$	305	$	12,977
Covered loans and leases:
Loans acquired with deteriorated credit quality (1)	$	449,784	$	34,690	$	51,243	$	4,104	$	539,821
Collectively evaluated for impairment (2)		2,905		16,658		4,886		2,670		27,119
Total	$	452,689	$	51,348	$	56,129	$	6,774	$	566,940



	June 30, 2011
	Commercial						Consumer
	Real Estate		Commercial		Residential		& Other		Total
Allowance for covered loans and leases:
Loans acquired with deteriorated credit quality (1)	$	5,303	$	2,019	$	1,163	$	657	$	9,142
Collectively evaluated for impairment (2)		411		613		30		23		1,077
Total	$	5,714	$	2,632	$	1,193	$	680	$	10,219
Covered loans and leases:
Loans acquired with deteriorated credit quality (1)	$	549,771	$	42,352		68,291	$	6,555	$	666,969
Collectively evaluated for impairment (2)		1,943		23,379		4,231		2,154		31,707
Total	$	551,714	$	65,731	$	72,522	$	8,709	$	698,676

(1) In accordance with ASC 310-30, the valuation allowance is netted against the carrying value of the covered loan and lease balance.

(2) The allowance on covered loan and lease losses includes an allowance on covered loan advances on acquired loans subsequent to acquisition.

The valuation allowance on covered loans was reduced by recaptured provision of $2.3 million and $3.5 million for the three and six months ended June 30, 2012, respectively, and $1.0 million and $1.1 million for the three and six months ended June 30, 2011.

Covered Credit Quality Indicators

Covered loans are risk rated in a manner consistent with non-covered loans. As previously noted, the Company’s risk rating methodology assigns risk ratings ranging from 1 to 10, where a higher rating represents higher risk. The 10 risk rating groupings are described fully in Note 4. The below table includes both loans acquired with deteriorated credit quality accounted for under ASC 310-30 and covered loan advances on acquired loans subsequent to acquisition.

The following table summarizes our internal risk rating grouping by covered loans, net as of June 30, 2012 and December 31, 2011:

(in thousands)



	June 30, 2012
			Special
	Pass/Watch		Mention		Substandard		Doubtful		Loss		Total
Commercial real estate
Term & multifamily	$	294,889	$	45,682	$	63,588	$	17,377	$	-	$	421,536
Construction & development		2,005		228		5,197		4,871		-		12,301
Residential development		152		406		8,834		1,999		-		11,391
Commercial
Term		12,645		1,715		10,702		2,075		-		27,137
LOC & other		14,950		8		4,295		411		-		19,664
Residential
Mortgage		30,073		-		-		-		-		30,073
Home equity loans & lines		25,249		-		143		-		-		25,392
Consumer & other		6,469		-		-		-		-		6,469
Total	$	386,432	$	48,039	$	92,759	$	26,733	$	-	$	553,963



	December 31, 2011
			Special
	Pass/Watch		Mention		Substandard		Doubtful		Loss		Total
Commercial real estate
Term & multifamily	$	329,273	$	58,610	$	68,521	$	12,343	$	-	$	468,747
Construction & development		1,552		1,410		6,733		3,410		-		13,105
Residential development		1,187		405		8,394		5,808		-		15,794
Commercial
Term		18,006		1,661		8,244		3,228		-		31,139
LOC & other		13,605		2,756		5,607		556		-		22,524
Residential
Mortgage		35,233		-		-		-		-		35,233
Home equity loans & lines		28,223		-		143		-		-		28,366
Consumer & other		7,543		-		-		-		-		7,543
Total	$	434,622	$	64,842	$	97,642	$	25,345	$	-	$	622,451

Covered Other Real Estate Owned

All other real estate owned (“OREO”) acquired in FDIC-assisted acquisitions that are subject to a FDIC loss-share agreement are referred to as “covered OREO” and reported separately in our statements of financial position. Covered OREO is reported exclusive of expected reimbursement cash flows from the FDIC. Foreclosed covered loan collateral is transferred into covered OREO at the collateral’s net realizable value, less selling costs.

Covered OREO was initially recorded at its estimated fair value on the acquisition date based on similar market comparable valuations less estimated selling costs. Subsequent to acquisition, loan collateral transferred to OREO is at its net realizable value. Any subsequent valuation adjustments due to declines in fair value will be charged to non-interest expense, and will be mostly offset by non-interest income representing the corresponding increase to the FDIC indemnification asset for the offsetting loss reimbursement amount. Any recoveries of previous valuation adjustments will be credited to non-interest expense with a corresponding charge to non-interest income for the portion of the recovery that is due to the FDIC.

The following table summarizes the activity related to the covered OREO for the three and six months ended June 30, 2012 and 2011:

(in thousands)



	Three months ended				Six months ended
	June 30,				June 30,
	2012		2011		2012		2011
Balance, beginning of period	$	12,787	$	27,689	$	19,491	$	29,863
Additions to covered OREO		562		5,632		1,346		8,668
Dispositions of covered OREO		(3,718)		(2,503)		(8,300)		(6,457)
Valuation adjustments in the period		(440)		(665)		(3,346)		(1,921)
Balance, end of period	$	9,191	$	30,153	$	9,191	$	30,153

FDIC Indemnification Asset

The Company has elected to account for amounts receivable under the loss-share agreement as an indemnification asset in accordance with FASB ASC 805, Business Combinations. The FDIC indemnification asset is initially recorded at fair value, based on the discounted value of expected future cash flows under the loss-share agreement. The difference between the present value and the undiscounted cash flows the Company expects to collect from the FDIC will be accreted into non-interest income over the life of the FDIC indemnification asset.

Subsequent to initial recognition, the FDIC indemnification asset is reviewed quarterly and adjusted for any changes in expected cash flows based on recent performance and expectations for future performance of the covered assets. These adjustments are measured on the same basis as the related covered loans and covered other real estate owned. Any increases in cash flow of the covered assets over those expected will reduce the FDIC indemnification asset and any decreases in cash flow of the covered assets under those expected will increase the FDIC indemnification asset. Increases and decreases to the FDIC indemnification asset are recorded as adjustments to non-interest income. The resulting carrying value of the indemnification asset represents the amounts recoverable from the FDIC for future expected losses, and the amounts due from the FDIC for claims related to covered losses the Company have incurred less amounts due back to the FDIC relating to shared recoveries.

The following table summarizes the activity related to the FDIC indemnification asset for each respective acquired portfolio for the three and six months ended June 30, 2012 and 2011:


(in thousands)
	Three months ended June 30, 2012
	Evergreen		Rainier		Nevada Security		Total
Balance, beginning of period	$	24,851	$	24,362	$	29,204	$	78,417
Change in FDIC indemnification asset		(2,251)		(2,272)		483		(4,040)
Transfers to due from FDIC and other		(299)		(1,519)		(3,754)		(5,572)
Balance, end of period	$	22,301	$	20,571	$	25,933	$	68,805



	Three months ended June 30, 2011
	Evergreen		Rainier		Nevada Security		Total
Balance, beginning of period	$	40,379	$	37,875	$	53,618	$	131,872
Change in FDIC indemnification asset		(2,895)		(811)		(1,845)		(5,551)
Transfers to due from FDIC and other		(1,366)		(1,065)		(6,962)		(9,393)
Balance, end of period	$	36,118	$	35,999	$	44,811	$	116,928



	Six months ended June 30, 2012
	Evergreen		Rainier		Nevada Security		Total
Balance, beginning of period	$	28,547	$	28,272	$	34,270	$	91,089
Change in FDIC indemnification asset		(4,098)		(2,917)		1,130		(5,885)
Transfers to due from FDIC and other		(2,148)		(4,784)		(9,467)		(16,399)
Balance, end of period	$	22,301	$	20,571	$	25,933	$	68,805


(in thousands)
	Six months ended June 30, 2011
	Evergreen		Rainier		Nevada Security		Total
Balance, beginning of period	$	40,606	$	43,726	$	62,081	$	146,413
Change in FDIC indemnification asset		1,850		(4,921)		425		(2,646)
Transfers to due from FDIC and other		(6,338)		(2,806)		(17,695)		(26,839)
Balance, end of period	$	36,118	$	35,999	$	44,811	$	116,928