NOTE 6. ALLOWANCE FOR NON-COVERED LOAN LOSS AND CREDIT QUALITY

The Bank has a management Allowance for Loan and Lease Losses (“ALLL”) Committee, which is responsible for, among other things, regularly reviewing the ALLL methodology, including loss factors, and ensuring that it is designed and applied in accordance with generally accepted accounting principles. The ALLL Committee reviews and approves loans and leases recommended for impaired status. The ALLL Committee also approves removing loans and leases from impaired status. The Bank's Audit and Compliance Committee provides board oversight of the ALLL process and reviews and approves the ALLL methodology on a quarterly basis.

Our methodology for assessing the appropriateness of the ALLL consists of three key elements, which include 1) the formula allowance; 2) the specific allowance; and 3) the unallocated allowance. By incorporating these factors into a single allowance requirement analysis, all risk-based activities within the loan portfolio are simultaneously considered.

Formula Allowance

The Bank performs regular credit reviews of the loan and lease portfolio to determine the credit quality and adherence to underwriting standards. When loans and leases are originated, they are assigned a risk rating that is reassessed periodically during the term of the loan through the credit review process. 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 categories are a primary factor in determining an appropriate amount for the formula allowance.

The formula allowance is calculated by applying risk factors to various segments of pools of outstanding loans. Risk factors are assigned to each portfolio segment based on management’s evaluation of the losses inherent within each segment. Segments or regions with greater risk of loss will therefore be assigned a higher risk factor.

Base risk – The portfolio is segmented into loan categories, and these categories are assigned a Base Risk factor based on an evaluation of the loss inherent within each segment.

Extra risk – Additional risk factors provide for an additional allocation of ALLL based on the loan risk rating system and loan delinquency, and reflect the increased level of inherent losses associated with more adversely classified loans.

Changes to risk factors – Risk factors are assigned at origination and may be changed periodically based on management’s evaluation of the following factors: loss experience; changes in the level of non-performing loans; regulatory exam results; changes in the level of adversely classified loans (positive or negative); improvement or deterioration in local economic conditions; and any other factors deemed relevant.

Specific Allowance

Regular credit reviews of the portfolio also identify loans that are considered potentially impaired. Potentially impaired loans are referred to the ALLL Committee which reviews and approves designated loans as impaired. A loan is considered impaired, when based on current information and events, we determine that we will probably not be able to collect all amounts due according to the loan contract, including scheduled interest payments. When we identify a loan as impaired, we measure the impairment using discounted cash flows, except when the sole remaining source of the repayment for the loan is the liquidation of the collateral. In these cases, we use the current fair value of the collateral, less selling costs, instead of discounted cash flows. If we determine that the value of the impaired loan is less than the recorded investment in the loan, we either recognize an impairment reserve as a Specific Allowance to be provided for in the allowance for loan and lease losses or charge-off the impaired balance on collateral dependent loans if it is determined that such amount represents a confirmed loss. Loans determined to be impaired with a specific allowance are excluded from the formula allowance so as not to double-count the loss exposure. The non-accrual impaired loans as of period end have already been partially charged off to their estimated net realizable value, and are expected to be resolved over the coming quarters with no additional material loss, absent further decline in market prices.

The combination of the formula allowance component and the specific allowance component represent the allocated allowance for loan and lease losses.

Unallocated Allowance

The Bank may also maintain an unallocated allowance amount to provide for other credit losses inherent in a loan and lease portfolio that may not have been contemplated in the credit loss factors. This unallocated amount generally comprises less than 10% of the allowance, but may be maintained at higher levels during times of deteriorating economic conditions characterized by falling real estate values. The unallocated amount is reviewed quarterly with consideration of factors including, but not limited to:

• Changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere in estimating credit losses;

• Changes in international, national, regional, and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments;

• Changes in the nature and volume of the portfolio and in the terms of loans;

• Changes in the experience and ability of lending management and other relevant staff;

• Changes in the volume and severity of past due loans, the volume of nonaccrual loans, and the volume and severity of adversely classified or graded loans;

• Changes in the quality of the institution’s loan review system;

• Changes in the value of underlying collateral for collateral-depending loans;

• The existence and effect of any concentrations of credit, and changes in the level of such concentrations;

• The effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the institutions’ existing portfolio.

These factors are evaluated through a management survey of the Chief Credit Officer, Chief Lending Officers, Special Assets Manager, and Credit Review Manager. The survey requests responses to evaluate current changes in the nine qualitative factors. This information is then incorporated into our understanding of the reasonableness of the formula factors and our evaluation of the unallocated portion of the ALLL.

Management believes that the ALLL was adequate as of December 31, 2012. There is, however, no assurance that future loan losses will not exceed the levels provided for in the ALLL and could possibly result in additional charges to the provision for loan and lease losses. In addition, bank regulatory authorities, as part of their periodic examination of the Bank, may require additional charges to the provision for loan and lease losses in future periods if warranted as a result of their review. Approximately 79% of our loan portfolio is secured by real estate, and a significant decline in real estate market values may require an increase in the allowance for loan and lease losses. The U.S. recession, the housing market downturn, and real estate values in our markets have negatively impacted aspects of our loan portfolio. A deterioration in our markets may adversely affect our loan portfolio and may lead to additional charges to the provision for loan and lease losses.

The reserve for unfunded commitments (“RUC”) is established to absorb inherent losses associated with our commitment to lend funds, such as with a letter or line of credit. The adequacy of the ALLL and RUC are monitored on a regular basis and are based on management's evaluation of numerous factors. For each portfolio segment, these factors include:

• The quality of the current loan portfolio;

• The trend in the loan portfolio's risk ratings;

• Current economic conditions;

• Loan concentrations;

• Loan growth rates;

• Past-due and non-performing trends;

• Evaluation of specific loss estimates for all significant problem loans;

• Historical short (one year), medium (three year), and long-term charge-off rates;

• Recovery experience;

• Peer comparison loss rates.

There have been no significant changes to the Bank’s methodology or policies in the periods presented.

Activity in the Non-Covered Allowance for Loan and Lease Losses

The following table summarizes activity related to the allowance for non-covered loan and lease losses by non-covered loan portfolio segment for the years ended December 31, 2012 and 2011, respectively:


(in thousands)
	December 31, 2012
	Commercial						Consumer
	Real Estate		Commercial		Residential		& Other		Unallocated		Total
Balance, beginning of period	$	59,574	$	20,485	$	7,625	$	867	$	4,417	$	92,968
Charge-offs		(22,349)		(12,209)		(5,282)		(1,499)		-		(41,339)
Recoveries		5,409		5,356		762		439		-		11,966
Provision		12,275		9,293		3,820		825		(4,417)		21,796
Balance, end of period	$	54,909	$	22,925	$	6,925	$	632	$	-	$	85,391


(in thousands)
	December 31, 2011
	Commercial						Consumer
	Real Estate		Commercial		Residential		& Other		Unallocated		Total
Balance, beginning of period	$	64,405	$	22,146	$	5,926	$	803	$	8,641	$	101,921
Charge-offs		(36,011)		(21,071)		(6,333)		(1,636)		-		(65,051)
Recoveries		5,906		3,348		239		385		-		9,878
Provision		25,274		16,062		7,793		1,315		(4,224)		46,220
Balance, end of period	$	59,574	$	20,485	$	7,625	$	867	$	4,417	$	92,968

The following table presents the allowance and recorded investment in non-covered loans by portfolio segment and balances individually or collectively evaluated for impairment as of December 31, 2012 and 2011, respectively:


(in thousands)
	December 31, 2012
	Commercial						Consumer
	Real Estate		Commercial		Residential		& Other		Unallocated		Total
Allowance for non-covered loans and leases:
Collectively evaluated for impairment	$	53,513	$	22,925	$	6,920	$	632	$	-	$	83,990
Individually evaluated for impairment		1,396		-		5		-		-		1,401
Total	$	54,909	$	22,925	$	6,925	$	632	$	-	$	85,391

Non-covered loans and leases:
Collectively evaluated for impairment	$	4,073,935	$	1,702,752	$	737,201	$	37,306			$	6,551,194
Individually evaluated for impairment		123,835		18,378		175		21				142,409
Total	$	4,197,770	$	1,721,130	$	737,376	$	37,327			$	6,693,603


(in thousands)
	December 31, 2011
	Commercial						Consumer
	Real Estate		Commercial		Residential		& Other		Unallocated		Total
Allowance for non-covered loans and leases:
Collectively evaluated for impairment	$	58,402	$	17,877	$	7,621	$	867	$	4,417	$	89,184
Individually evaluated for impairment		1,172		2,608		4		-		-		3,784
Total	$	59,574	$	20,485	$	7,625	$	867	$	4,417	$	92,968

Non-covered loans and leases:
Collectively evaluated for impairment	$	3,673,455	$	1,432,594	$	587,990	$	38,860			$	5,732,899
Individually evaluated for impairment		139,979		26,171		129		-				166,279
Total	$	3,813,434	$	1,458,765	$	588,119	$	38,860			$	5,899,178

The gross non-covered loan and lease balance excludes deferred loans fees of $12.5 million at December 31, 2012 and $11.1 million at December 31, 2011.

Summary of Reserve for Unfunded Commitments Activity

The following table presents a summary of activity in the reserve for unfunded commitments (“RUC”) and unfunded commitments for the years ended December 31, 2012 and 2011, respectively:


(in thousands)
	December 31, 2012
	Commercial						Consumer
	Real Estate		Commercial		Residential		& Other		Total
Balance, beginning of period	$	59	$	633	$	185	$	63	$	940
Net change to other expense		113		174		(12)		8		283
Balance, end of period	$	172	$	807	$	173	$	71	$	1,223


(in thousands)
	December 31, 2011
	Commercial						Consumer
	Real Estate		Commercial		Residential		& Other		Total
Balance, beginning of period	$	33	$	575	$	158	$	52	$	818
Net change to other expense		26		58		27		11		122
Balance, end of period	$	59	$	633	$	185	$	63	$	940


(in thousands)
		Commercial						Consumer
		Real Estate		Commercial		Residential		& Other		Total
Unfunded loan commitments:
December 31, 2012	$	196,292	$	925,642	$	257,508	$	52,170	$	1,431,612
December 31, 2011	$	58,013	$	605,001	$	233,990	$	47,577	$	944,581

Non-covered loans sold

In the course of managing the loan portfolio, at certain times, management may decide to sell loans prior to resolution. The following table summarizes loans sold by loan portfolio during the years ended December 31, 2012 and 2011, respectively:

(In thousands)


(in thousands)
	2012		2011
Commercial real estate
Term & multifamily	$	12,096	$	7,143
Construction & development		-		28
Residential development		12		1,123
Commercial
Term		-		151
LOC & other		1,942		2,740
Residential
Mortgage		192		-
Home equity loans & lines		-		-
Consumer & other		-		-
Total	$	14,242	$	11,185

Asset Quality and Non-Performing Loans

We manage asset quality and control credit risk through diversification of the non-covered loan portfolio and the application of policies designed to promote sound underwriting and loan monitoring practices. The Bank's Credit Quality Group is charged with monitoring asset quality, establishing credit policies and procedures and enforcing the consistent application of these policies and procedures across the Bank. Reviews of non-performing, past due non-covered loans and larger credits, designed to identify potential charges to the allowance for loan and lease losses, and to determine the adequacy of the allowance, are conducted on an ongoing basis. These reviews consider such factors as the financial strength of borrowers, the value of the applicable collateral, loan loss experience, estimated loan losses, growth in the loan portfolio, prevailing economic conditions and other factors.

A loan is considered impaired when, based on current information and events, we determine it is probable that we will not be able to collect all amounts due according to the loan contract, including scheduled interest payments. Generally, when non-covered loans are identified as impaired, they are moved to our Special Assets Division. When we identify a loan as impaired, we measure the loan for potential impairment using discounted cash flows, except when the sole remaining source of the repayment for the loan is the liquidation of the collateral. In these cases, we use the current fair value of collateral, less selling costs. The starting point for determining the fair value of collateral is through obtaining external appraisals. Generally, external appraisals are updated every six to nine months. We obtain appraisals from a pre-approved list of independent, third party, local appraisal firms. Approval and addition to the list is based on experience, reputation, character, consistency and knowledge of the respective real estate market. At a minimum, it is ascertained that the appraiser is: (a) currently licensed in the state in which the property is located, (b) is experienced in the appraisal of properties similar to the property being appraised, (c) is actively engaged in the appraisal work, (d) has knowledge of current real estate market conditions and financing trends, (e) is reputable, and (f) is not on Freddie Mac’s or the Bank’s Exclusionary List of appraisers and brokers. In certain cases appraisals will be reviewed by our Real Estate Valuation Services Group to ensure the quality of the appraisal and the expertise and independence of the appraiser. Upon receipt and review, an external appraisal is utilized to measure a loan for potential impairment. Our impairment analysis documents the date of the appraisal used in the analysis, whether the officer preparing the report deems it current, and, if not, allows for internal valuation adjustments with justification. Typical justified adjustments might include discounts for continued market deterioration subsequent to appraisal date, adjustments for the release of collateral contemplated in the appraisal, or the value of other collateral or consideration not contemplated in the appraisal. An appraisal over one year old in most cases will be considered stale dated and an updated or new appraisal will be required. Any adjustments from appraised value to net realizable value are detailed and justified in the impairment analysis, which is reviewed and approved by senior credit quality officers and the Company's Allowance for Loan and Lease Losses (“ALLL”) Committee. Although an external appraisal is the primary source to value collateral dependent loans, we may also utilize values obtained through purchase and sale agreements, negotiated short sales, broker price opinions, or the sales price of the note. These alternative sources of value are used only if deemed to be more representative of value based on updated information regarding collateral resolution. Impairment analyses are updated, reviewed and approved on a quarterly basis at or near the end of each reporting period. Appraisals or other alternative sources of value received subsequent to the reporting period, but prior to our filing of periodic reports, are considered and evaluated to ensure our periodic filings are materially correct and not misleading. Based on these processes, we do not believe there are significant time lapses for the recognition of additional loan loss provisions or charge-offs from the date they become known.

Loans are classified as non-accrual when collection of principal or interest is doubtful—generally if they are past due as to maturity or payment of principal or interest by 90 days or more—unless such loans are well-secured and in the process of collection. Additionally, all loans that are impaired are considered for non-accrual status. Loans placed on non-accrual will typically remain on non-accrual status until all principal and interest payments are brought current and the prospects for future payments in accordance with the loan agreement appear relatively certain.

Loans are reported as restructured when the Bank grants a concession(s) to a borrower experiencing financial difficulties that it would not otherwise consider. Examples of such concessions include a reduction in the loan rate, forgiveness of principal or accrued interest, extending the maturity date or providing a lower interest rate than would be normally available for a transaction of similar risk. As a result of these concessions, restructured loans are impaired as the Bank will not collect all amounts due, both principal and interest, in accordance with the terms of the original loan agreement. Impairment reserves on non-collateral dependent restructured loans are measured by comparing the present value of expected future cash flows on the restructured loans discounted at the interest rate of the original loan agreement to the loan’s carrying value. These impairment reserves are recognized as a specific component to be provided for in the allowance for loan and lease losses.

Loans are reported as past due when installment payments, interest payments, or maturity payments are past due based on contractual terms. All loans determined to be impaired are individually assessed for impairment except for impaired consumer loans which are collectively evaluated for impairment in accordance with FASB ASC 450, Contingencies (“ASC 450”). The specific factors considered in determining that a loan is impaired include borrower financial capacity, current economic, business and market conditions, collection efforts, collateral position and other factors deemed relevant. Generally, impaired loans are placed on non-accrual status and all cash receipts are applied to the principal balance. Continuation of accrual status and recognition of interest income is generally limited to performing restructured loans.

The Company has written down impaired, non-accrual loans as of December 31, 2012 to their estimated net realizable value, generally based on disposition value, and expects resolution with no additional material loss, absent further decline in market prices.

Non-Covered Non-Accrual Loans and Loans Past Due

The following table summarizes our non-covered non-accrual loans and loans past due by loan class as of December 31, 2012 and December 31, 2011:


(in thousands)
	December 31, 2012
		30-59		60-89		Greater Than								Total Non-
		Days		Days		90 Days and		Total						covered Loans
		Past Due		Past Due		Accruing		Past Due		Nonaccrual		Current		and Leases
Commercial real estate
Term & multifamily	$	7,747	$	2,784	$	-	$	10,531	$	43,290	$	3,884,622	$	3,938,443
Construction & development		283		-		-		283		4,177		197,658		202,118
Residential development		479		-		-		479		5,132		51,598		57,209
Commercial
Term		3,009		746		81		3,836		7,040		786,926		797,802
LOC & other		1,647		1,503		-		3,150		7,027		913,151		923,328
Residential
Mortgage		2,906		602		3,303		6,811		-		469,768		476,579
Home equity loans & lines		1,398		214		758		2,370		49		258,378		260,797
Consumer & other		282		191		90		563		21		36,743		37,327
Total	$	17,751	$	6,040	$	4,232	$	28,023	$	66,736	$	6,598,844	$	6,693,603
Deferred loan fees, net														(12,523)
Total													$	6,681,080


(in thousands)
	December 31, 2011
		30-59		60-89		Greater Than								Total Non-
		Days		Days		90 Days and		Total						covered Loans
		Past Due		Past Due		Accruing		Past Due		Nonaccrual		Current		and Leases
Commercial real estate
Term & multifamily	$	7,319	$	11,184	$	-	$	18,503	$	44,486	$	3,495,306	$	3,558,295
Construction & development		-		662		575		1,237		3,348		160,481		165,066
Residential development		4,171		-		-		4,171		15,836		70,066		90,073
Commercial
Term		2,075		738		1,179		3,992		8,120		613,654		625,766
LOC & other		5,435		1,697		1,397		8,529		8,772		815,698		832,999
Residential
Mortgage		215		965		4,343		5,523		-		310,404		315,927
Home equity loans & lines		492		191		2,648		3,331		-		268,861		272,192
Consumer & other		67		16		679		762		-		38,098		38,860
Total	$	19,774	$	15,453	$	10,821	$	46,048	$	80,562	$	5,772,568	$	5,899,178
Deferred loan fees, net														(11,080)
Total													$	5,888,098

Non-Covered Impaired Loans

Loans with no related allowance reported generally represent non-accrual loans. The Company recognizes the charge-off of impairment reserves on impaired loans in the period it arises for collateral dependent loans. Therefore, the non-accrual loans as of December 31, 2012 have already been written-down to their estimated net realizable value, based on disposition value, and are expected to be resolved with no additional material loss, absent further decline in market prices. The valuation allowance on impaired loans primarily represents the impairment reserves on performing restructured loans, and is measured by comparing the present value of expected future cash flows on the restructured loans discounted at the interest rate of the original loan agreement to the loan’s carrying value.

At December 31, 2012 and December 31, 2011, impaired loans of $70.6 million and $80.6 million were classified as accruing restructured loans, respectively. The restructurings were granted in response to borrower financial difficulty, and generally provide for a temporary modification of loan repayment terms. The restructured loans on accrual status represent the only impaired loans accruing interest at December 31, 2012. The restructured loans on accrual status and two loans included in loans past due 30+ days and accruing represent the only impaired loans accruing interest at December 31, 2011. In order for a restructured loan to be considered for accrual status, the loan’s collateral coverage generally will be greater than or equal to 100% of the loan balance, the loan is current on payments, and the borrower must either prefund an interest reserve or demonstrate the ability to make payments from a verified source of cash flow. The Company had no obligation to lend additional funds on the restructured loans as of December 31, 2012.

The following table summarizes our non-covered impaired loans, including average recorded investment and interest income recognized on impaired non-covered loans, by loan class for the years ended December 31, 2012 and 2011:


(in thousands)
	December 31, 2012
	Unpaid						Average		Interest
	Principal		Recorded		Related		Recorded		Income
	Balance		Investment		Allowance		Investment		Recognized
With no related allowance recorded:
Commercial real estate
Term & multifamily	$	49,953	$	43,406	$	-	$	45,051	$	-
Construction & development		18,526		15,638		-		17,899		-
Residential development		9,293		6,091		-		15,518		-
Commercial
Term		13,729		10,532		-		11,966		-
LOC & other		10,778		7,846		-		7,949		-
Residential
Mortgage		-		-		-		-		-
Home equity loans & lines		50		49		-		301		-
Consumer & other		21		21		-		4		-

With an allowance recorded:
Commercial real estate
Term & multifamily		41,016		41,016		1,198		28,936		1,113
Construction & development		1,091		1,091		14		2,400		672
Residential development		16,593		16,593		184		18,417		747
Commercial
Term		-		-		-		443		182
LOC & other		-		-		-		795		9
Residential
Mortgage		-		-		-		-		-
Home equity loans & lines		126		126		5		127		6
Consumer & other		-		-		-		-		-

Total:
Commercial real estate		136,472		123,835		1,396		128,221		2,532
Commercial		24,507		18,378		-		21,153		191
Residential		176		175		5		428		6
Consumer & other		21		21		-		4		-
Total	$	161,176	$	142,409	$	1,401	$	149,806	$	2,729


(in thousands)
	December 31, 2011
	Unpaid						Average		Interest
	Principal		Recorded		Related		Recorded		Income
	Balance		Investment		Allowance		Investment		Recognized
With no related allowance recorded:
Commercial real estate
Term & multifamily	$	54,673	$	44,486	$	-	$	50,459	$	-
Construction & development		22,553		20,602		-		21,498		-
Residential development		30,575		23,473		-		33,864		-
Commercial
Term		14,205		11,311		-		9,339		-
LOC & other		23,132		8,772		-		16,121		-
Residential
Mortgage		-		-		-		-		-
Home equity loans & lines		-		-		-		-		-
Consumer & other		-		-		-		-		-

With an allowance recorded:
Commercial real estate
Term & multifamily		22,611		22,612		681		18,792		894
Construction & development		3,762		2,742		27		6,560		798
Residential development		26,326		26,326		464		32,810		1,120
Commercial
Term		1,851		1,851		608		627		140
LOC & other		3,975		3,975		2,000		3,642		-
Residential
Mortgage		-		-		-		143		-
Home equity loans & lines		129		129		4		52		3
Consumer & other		-		-		-		-		-

Total:
Commercial real estate		160,500		140,241		1,172		163,983		2,812
Commercial		43,163		25,909		2,608		29,729		140
Residential		129		129		4		195		3
Consumer & other		-		-		-		-		-
Total	$	203,792	$	166,279	$	3,784	$	193,907	$	2,955

The impaired loans for which these interest income amounts were recognized primarily relate to accruing restructured loans.

Non-Covered Credit Quality Indicators

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 Bank differentiates its lending portfolios into homogeneous loans (generally consumer loans) and non-homogeneous loans (generally all non-consumer loans). The 10 risk rating categories can be generally described by the following groupings for non-homogeneous loans:

Minimal Risk—A minimal risk loan, risk rated 1, is to a borrower of the highest quality. The borrower has an unquestioned ability to produce consistent profits and service all obligations and can absorb severe market disturbances with little or no difficulty.

Low Risk—A low risk loan, risk rated 2, is similar in characteristics to a minimal risk loan. Margins may be smaller or protective elements may be subject to greater fluctuation. The borrower will have a strong demonstrated ability to produce profits, provide ample debt service coverage and to absorb market disturbances.

Modest Risk—A modest risk loan, risk rated 3, is a desirable loan with excellent sources of repayment and no currently identifiable risk of collection. The borrower exhibits a very strong capacity to repay the credit in accordance with the repayment agreement. The borrower may be susceptible to economic cycles, but will have reserves to weather these cycles.

Average Risk—An average risk loan, risk rated 4, is an attractive loan with sound sources of repayment and no material collection or repayment weakness evident. The borrower has an acceptable capacity to pay in accordance with the agreement. The borrower is susceptible to economic cycles and more efficient competition, but should have modest reserves sufficient to survive all but the most severe downturns or major setbacks.

Acceptable Risk—An acceptable risk loan, risk rated 5, is a loan with lower than average, but still acceptable credit risk. These borrowers may have higher leverage, less certain but viable repayment sources, have limited financial reserves and may possess weaknesses that can be adequately mitigated through collateral, structural or credit enhancement. The borrower is susceptible to economic cycles and is less resilient to negative market forces or financial events. Reserves may be insufficient to survive a modest downturn.

Watch—A watch loan, risk rated 6, is still pass-rated, but represents the lowest level of acceptable risk due to an emerging risk element or declining performance trend. Watch ratings are expected to be temporary, with issues resolved or manifested to the extent that a higher or lower rating would be appropriate. The borrower should have a plausible plan, with reasonable certainty of success, to correct the problems in a short period of time. Borrowers rated watch are characterized by elements of uncertainty, such as:

• Borrower may be experiencing declining operating trends, strained cash flows or less-than anticipated performance. Cash flow should still be adequate to cover debt service, and the negative trends should be identified as being of a short-term or temporary nature.

• The borrower may have experienced a minor, unexpected covenant violation.

• Companies who may be experiencing tight working capital or have a cash cushion deficiency.

• Loans may also be a Watch if financial information is late, there is a documentation deficiency, the borrower has experienced unexpected management turnover, or if they face industry issues that, when combined with performance factors create uncertainty in their future ability to perform.

• Delinquent payments, increasing and material overdraft activity, request for bulge and/or out-of-formula advances may be an indicator of inadequate working capital and may suggest a lower rating.

• Failure of the intended repayment source to materialize as expected, or renewal of a loan (other than cash/marketable security secured or lines of credit) without reduction are possible indicators of a watch or worse risk rating.

Special Mention—A special mention loan, risk rated 7, has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or the institution’s credit position at some future date. They contain unfavorable characteristics and are generally undesirable. Loans in this category are currently protected but are potentially weak and constitute an undue and unwarranted credit risk, but not to the point of a Substandard classification. A special mention loan has potential weaknesses, which if not checked or corrected, weaken the asset or inadequately protect the Bank’s position at some future date. Such weaknesses include:

• Performance is poor or significantly less than expected. There may be a temporary debt-servicing deficiency or inadequate working capital as evidenced by a cash cushion deficiency, but not to the extent that repayment is compromised. Material violation of financial covenants is common.

• Loans with unresolved material issues that significantly cloud the debt service outlook, even though a debt servicing deficiency does not currently exist.

• Modest underperformance or deviation from plan for real estate loans where absorption of rental/sales units is necessary to properly service the debt as structured. Depth of support for interest carry provided by owner/guarantors may mitigate and provide for improved rating.

• This rating may be assigned when a loan officer is unable to supervise the credit properly, an inadequate loan agreement, an inability to control collateral, failure to obtain proper documentation, or any other deviation from prudent lending practices.

• Unlike a Substandard credit, there should be a reasonable expectation that these temporary issues will be corrected within the normal course of business, rather than liquidation of assets, and in a reasonable period of time.

Substandard—A substandard asset, risk rated 8, is inadequately protected by the current sound worth and paying capacity of the obligor 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. They are characterized by the distinct possibility that the Bank 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. Loans are classified as substandard when they have unsatisfactory characteristics causing unacceptable levels of risk. A substandard loan normally has one or more well-defined weaknesses that could jeopardize repayment of the debt. The likely need to liquidate assets to correct the problem, rather than repayment from successful operations is the key distinction between special mention and substandard. The following are examples of well-defined weaknesses:

• Cash flow deficiencies or trends are of a magnitude to jeopardize current and future payments with no immediate relief. A loss is not presently expected, however the outlook is sufficiently uncertain to preclude ruling out the possibility.

• Borrower has been unable to adjust to prolonged and unfavorable industry or economic trends.

• Material underperformance or deviation from plan for real estate loans where absorption of rental/sales units is necessary to properly service the debt and risk is not mitigated by willingness and capacity of owner/guarantor to support interest payments.

• Management character or honesty has become suspect. This includes instances where the borrower has become uncooperative.

• Due to unprofitable or unsuccessful business operations, some form of restructuring of the business, including liquidation of assets, has become the primary source of loan repayment. Cash flow has deteriorated, or been diverted, to the point that sale of collateral is now the Bank’s primary source of repayment (unless this was the original source of repayment). If the collateral is under the Bank’s control and is cash or other liquid, highly marketable securities and properly margined, then a more appropriate rating might be special mention or watch.

• The borrower is bankrupt, or for any other reason, future repayment is dependent on court action.

• There is material, uncorrectable faulty documentation or materially suspect financial information.

Doubtful—Loans classified as doubtful, risk rated 9, have all the weaknesses inherent in one classified substandard with 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. The possibility of loss is extremely high, but because of certain important and reasonably specific pending factors, which may work towards strengthening of the asset, classification as a loss (and immediate charge-off) is deferred until more exact status may be determined. Pending factors include proposed merger, acquisition, liquidation procedures, capital injection, and perfection of liens on additional collateral and refinancing plans. In certain circumstances, a doubtful rating will be temporary, while the Bank is awaiting an updated collateral valuation. In these cases, once the collateral is valued and appropriate margin applied, the remaining un-collateralized portion will be charged off. The remaining balance, properly margined, may then be upgraded to Substandard, however must remain on non-accrual.

Loss—Loans classified as loss, risk rated 10, are considered un-collectible and of such little value that the continuance as an active Bank asset is not warranted. This rating does not mean that the loan has no recovery or salvage value, but rather that the loan should be charged off now, even though partial or full recovery may be possible in the future.

Impaired—Loans are classified as impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal and interest when due, in accordance with the terms of the original loan agreement, without unreasonable delay. This generally includes all loans classified as non-accrual and troubled debt restructurings. Impaired loans are risk rated for internal and regulatory rating purposes, but presented separately for clarification.

Homogeneous loans are not risk rated until they are greater than 30 days past due, and risk rating is based primarily on the past due status of the loan. The risk rating categories can be generally described by the following groupings for commercial and commercial real estate homogeneous loans:

Special Mention –A homogeneous special mention loan, risk rated 7, is 30-59 days past due from the required payment date at month-end.

Substandard –A homogeneous substandard loan, risk rated 8, is 60-119 days past due from the required payment date at month-end.

Doubtful –A homogeneous doubtful loan, risk rated 9, is 120-149 days past due from the required payment date at month-end.

Loss –A homogeneous loss loan, risk rated 10, is 150 days and more past due from the required payment date. These loans are generally charged-off in the month in which the 150 day time period elapses.

The risk rating categories can be generally described by the following groupings for residential and consumer and other homogeneous loans:

Special Mention – A homogeneous retail special mention loan, risk rated 7, is 30-89 days past due from the required payment date at month-end.

Substandard – A homogeneous retail substandard loan, risk rated 8, is an open-end loan 90-180 days past due from the required payment date at month-end or a closed-end loan 90-120 days past due from the required payment date at month-end.

Loss – A homogeneous retail loss loan, risk rated 10, is a closed-end loan that becomes past due 120 cumulative days or an open-end retail loan that becomes past due 180 cumulative days from the contractual due date. These loans are generally charged-off in the month in which the 120 or 180 day period elapses.

The following table summarizes our internal risk rating by loan class for the non-covered loan portfolio as of December 31, 2012 and December 31, 2011:

(in thousands)



	December 31, 2012
	Pass/Watch		Special Mention		Substandard		Doubtful		Loss		Impaired		Total
Commercial real estate
Term & multifamily	$	3,515,753	$	203,643	$	134,625	$	-	$	-	$	84,422	$	3,938,443
Construction & development		166,660		12,666		6,063		-		-		16,729		202,118
Residential development		25,082		4,379		5,064		-		-		22,684		57,209
Commercial
Term		718,122		22,255		46,893		-		-		10,532		797,802
LOC & other		880,385		19,521		15,576		-		-		7,846		923,328
Residential
Mortgage		469,325		3,507		1,120		-		2,627		-		476,579
Home equity loans & lines		258,252		1,612		-		-		758		175		260,797
Consumer & other		36,797		419		57		-		33		21		37,327
Total	$	6,070,376	$	268,002	$	209,398	$	-	$	3,418	$	142,409	$	6,693,603
Deferred loan fees, net														(12,523)
Total													$	6,681,080


(in thousands)
	December 31, 2011
	Pass/Watch		Special Mention		Substandard		Doubtful		Loss		Impaired		Total
Commercial real estate
Term & multifamily	$	3,068,803	$	275,475	$	146,919	$	-	$	-	$	67,098	$	3,558,295
Construction & development		109,434		19,946		12,342		-		-		23,344		165,066
Residential development		24,801		6,740		8,733		-		-		49,799		90,073
Commercial
Term		586,365		16,631		9,608		-		-		13,162		625,766
LOC & other		775,495		22,051		22,706		-		-		12,747		832,999
Residential
Mortgage		309,478		2,106		296		-		4,047		-		315,927
Home equity loans & lines		268,731		683		773		-		1,876		129		272,192
Consumer & other		38,098		82		254		-		426		-		38,860
Total	$	5,181,205	$	343,714	$	201,631	$	-	$	6,349	$	166,279	$	5,899,178
Deferred loan fees, net														(11,080)
Total													$	5,888,098

The percentage of non-covered impaired loans classified as watch, special mention, and substandard was 9.0%, 1.7%, and 89.3%, respectively, as of December 31, 2012. The percentage of non-covered impaired loans classified as special mention, substandard, and loss was 3.8%, 96.0%, and 0.2%, respectively, as of December 31, 2011.

Troubled Debt Restructurings

At December 31, 2012 and December 31, 2011, impaired loans of $70.6 million and $80.6 million were classified as accruing restructured loans, respectively. The restructurings were granted in response to borrower financial difficulty, and generally provide for a temporary modification of loan repayment terms. The restructured loans on accrual status represent the only impaired loans accruing interest. In order for a restructured loan to be considered for accrual status, the loan’s collateral coverage generally will be greater than or equal to 100% of the loan balance, the loan is current on payments, and the borrower must either prefund an interest reserve or demonstrate the ability to make payments from a verified source of cash flow. Impaired restructured loans carry a specific allowance and the allowance on impaired restructured loans is calculated consistently across the portfolios.

As a result of adopting the amendments in Accounting Standards Update No. 2011-02 on January 1, 2011, the Company reassessed all restructurings that occurred on or after the beginning of January 1, 2011 for identification as troubled debt restructurings. The Company identified as troubled debt restructurings certain receivables for which the allowance for credit losses had previously been measured under a general allowance for credit losses methodology. Upon identifying those receivables as troubled debt restructurings, the Company identified them as impaired under the guidance in Section 310-10-35. The amendments in Accounting Standards Update No. 2011-02 require prospective application of the impairment measurement guidance in Section 310-10-35 for those receivables newly identified as impaired. At the end of December 31, 2012 and December 31, 2011, the recorded investment in receivables for which the allowance for credit losses was previously measured under a general allowance for credit losses methodology and are now impaired under Section 310-10-35 was $0.3 million and $5.4 million, respectively and there was no allowance for credit losses associated with those receivables, on the basis of a current evaluation of loss, respectively. In evaluating concessions made during the year, the Company frequently obtained adequate compensation for concessions made. Adequate compensation includes any or a combination of additional collateral or guarantor(s), pre-funded payment reserves, shortened amortization, principal paydown and adjustment to or above current market interest rate. As a result, few loans qualified as troubled debt restructuring under the new definitions outlined in Section 310-10-35.

There were no available commitments for troubled debt restructurings outstanding as of December 31, 2012 and there were $205,000 as of December 31, 2011.

The following tables present troubled debt restructurings by accrual versus non-accrual status and by loan class as of December 31, 2012 and December 31, 2011:


(in thousands)
	December 31, 2012
	Accrual		Non-Accrual		Total
	Status		Status		Modifications
Commercial real estate
Term & multifamily	$	39,613	$	16,605	$	56,218
Construction & development		12,552		3,516		16,068
Residential development		17,141		4,921		22,062
Commercial
Term		350		4,641		4,991
LOC & other		820		1,493		2,313
Residential
Mortgage		-		-		-
Home equity loans & lines		126		-		126
Consumer & other		-		-		-
Total	$	70,602	$	31,176	$	101,778


(in thousands)
	December 31, 2011
	Accrual		Non-Accrual		Total
	Status		Status		Modifications
Commercial real estate
Term & multifamily	$	22,611	$	21,951	$	44,562
Construction & development		19,996		921		20,917
Residential development		33,964		11,969		45,933
Commercial
Term		3,863		1,762		5,625
LOC & other		-		6,973		6,973
Residential
Mortgage		-		-		-
Home equity loans & lines		129		-		129
Consumer & other		-		-		-
Total	$	80,563	$	43,576	$	124,139

The Bank’s policy is that loans placed on non-accrual will typically remain on non-accrual status until all principal and interest payments are brought current and the prospect for future payment in accordance with the loan agreement appear relatively certain. The Bank’s policy generally refers to six months of payment performance as sufficient to warrant a return to accrual status.

The types of modifications offered can generally be described in the following categories:

Rate Modification—A modification in which the interest rate is modified.

Term Modification —A modification in which the maturity date, timing of payments, or frequency of payments is changed.

Interest Only Modification—A modification in which the loan is converted to interest only payments for a period of time.

Payment Modification—A modification in which the payment amount is changed, other than an interest only modification described above.

Combination Modification—Any other type of modification, including the use of multiple types of modifications.

The following tables present newly non-covered restructured loans that occurred during the years ended December 31, 2012 and 2011, respectively:


(in thousands)
	December 31, 2012
	Rate		Term		Interest Only		Payment		Combination		Total
	Modifications		Modifications		Modifications		Modifications		Modifications		Modifications
Commercial real estate
Term & multifamily	$	14,920	$	-	$	-	$	-	$	7,317	$	22,237
Construction & development		-		-		-		-		-		-
Residential development		-		-		-		-		-		-
Commercial
Term		-		-		-		-		-		-
LOC & other		-		-		-		820		-		820
Residential
Mortgage		-		-		-		-		-		-
Home equity loans & lines		-		-		-		-		-		-
Consumer & other		-		-		-		-		-		-
Total	$	14,920	$	-	$	-	$	820	$	7,317	$	23,057


(in thousands)
	December 31, 2011
	Rate		Term		Interest Only		Payment		Combination		Total
	Modifications		Modifications		Modifications		Modifications		Modifications		Modifications
Commercial real estate
Term & multifamily	$	-	$	-	$	-	$	-	$	34,943	$	34,943
Construction & development		-		-		-		-		13,760		13,760
Residential development		279		354		-		-		9,090		9,723
Commercial
Term		-		-		-		70		5,311		5,381
LOC & other		-		-		-		-		4,050		4,050
Residential
Mortgage		-		-		-		-		-		-
Home equity loans & lines		-		130		-		-		-		130
Consumer & other		-		-		-		-		-		-
Total	$	279	$	484	$	-	$	70	$	67,154	$	67,987

For the periods presented in the tables above, the outstanding recorded investment was the same pre and post modification.

The following tables represent financing receivables modified as troubled debt restructurings within the previous 12 months for which there was a payment default during the years ended December 31, 2012 and 2011, respectively:


(in thousands)
	2012		2011
Commercial real estate
Term & multifamily	$	217	$	9,642
Construction & development		-		-
Residential development		633		1,767
Commercial
Term		-		140
LOC & other		26		-
Residential
Mortgage		-		-
Home equity loans & lines		-		-
Consumer & other		-		-
Total	$	876	$	11,549