NOTE 9. ALLOWANCE FOR LOAN LOSSES

We maintain an ALL at a level determined to be adequate to absorb estimated probable credit losses inherent in the loan portfolio as of the balance sheet date. We develop and document a systematic ALL methodology based on the following portfolio segments: 1) CRE, 2) C&I, 3) Commercial Construction, 4) Consumer Real Estate and 5) Other Consumer.

The following are key risks within each portfolio segment:

CRE—Loans secured by commercial purpose real estate, including both owner occupied properties and investment properties for various purposes such as hotels, strip malls and apartments. Operations of the individual projects as well as global cash flows of the debtors are the primary sources of repayment for these loans. The condition of the local economy is an important indicator of risk, but there are also more specific risks depending on the collateral type as well as the business prospects of the lessee, if the project is not owner occupied.

C&I—Loans made to operating companies or manufacturers for the purpose of production, operating capacity, accounts receivable, inventory or equipment financing. Cash flow from the operations of the company is the primary source of repayment for these loans. The condition of the local economy is an important indicator of risk, but there are also more specific risks depending on the industry of the company. Collateral for these types of loans often do not have sufficient value in a distressed or liquidation scenario to satisfy the outstanding debt.

Commercial Construction—Loans made to finance construction of buildings or other structures, as well as to finance the acquisition and development of raw land for various purposes. While the risk of these loans is generally confined to the construction period, if there are problems, the project may not be complete, and as such, may not provide sufficient cash flow on its own to service the debt or have sufficient value in a liquidation to cover the outstanding principal. The condition of the local economy is an important indicator of risk, but there are also more specific risks depending on the type of project and the experience and resources of the developer.

Consumer Real Estate—Loans secured by first and second liens such as home equity loans, home equity lines of credit and 1-4 family residences, including purchase money mortgages. The primary source of repayment for these loans is the income and assets of the borrower. The condition of the local economy, in particular the unemployment rate, is an important indicator of risk for this segment. The state of the local housing market can also have a significant impact on this segment because low demand and/or declining home values can limit the ability of borrowers to sell a property and satisfy the debt.

Other Consumer—Loans made to individuals that may be secured by assets other than 1-4 family residences, as well as unsecured loans. This segment includes auto loans, unsecured loans and lines and credit cards. The primary source of repayment for these loans is the income and assets of the borrower. The condition of the local economy, in particular the unemployment rate, is an important indicator of risk for this segment. The value of the collateral, if there is any, is less likely to be a source of repayment due to less certain collateral values.

We further assess risk within each portfolio segment by pooling loans with similar risk characteristics. For the commercial loan classes, the most important indicator of risk is the internally assigned risk rating, including pass, special mention and substandard. Consumer loans are pooled by type of collateral, lien position and LTV for consumer real estate loans. Historical loss rates are applied to these loan pools to determine the reserve for loans collectively evaluated for impairment. Management monitors various credit quality indicators for both the commercial and consumer loan portfolios, including delinquency, nonperforming status and changes in risk ratings on a monthly basis.

We monitor our ALL methodology to ensure that it is responsive to the current economic environment. Over the past year, the economic conditions within our markets have improved, and we have experienced significant improvement in our credit quality, including lower net charge-offs, lower delinquency, lower nonperforming loans and lower special mention and substandard loans compared to December 31, 2012. Accordingly, the assumptions used within the ALL were reevaluated during the third quarter of 2013 to be responsive to the improved economic environment and the changes in our credit quality.

The ALL methodology for groups of loans collectively evaluated for impairment is comprised of both a quantitative and qualitative analysis. A key assumption in the quantitative component of the reserve is the loss emergence period, or LEP. The LEP is an estimate of the average amount of time from the point at which a loss is incurred on a loan to the point at which the loss is confirmed. In general, the LEP will be shorter in an economic slowdown or recession and longer during times of economic stability or growth, as customers are better able to delay loss confirmation after a potential loss event has occurred. Due to the recent improvement in economic conditions, we completed an internal study utilizing our loan charge-off history to recalibrate the LEPs of the commercial portfolio segments. Consistent with the improved economic conditions, the LEPs have lengthened, and as a result, we lengthened our LEP assumption for each of the commercial portfolio segments. We believe that the consumer portfolio segment LEPs have also lengthened as they are influenced by the same improvement in economic conditions that impacted the commercial portfolio segments. We therefore also lengthened the LEP assumption for the consumer portfolio segments during the third quarter of 2013.

The changes made to the ALL assumptions were applied prospectively and did not result in a material change to the total ALL at September 30, 2013. Lengthening the LEP does increase the historical loss rates and therefore the quantitative component of the ALL. We believe this makes the quantitative component of the ALL more reflective of inherent losses that exist within the loan portfolio, which resulted in a decrease in the qualitative component of the ALL. The changes to the LEPs also improved our insight into the inherent risk of the individual commercial portfolio segments. As the economic conditions have improved, our data indicates that the CRE segment has less inherent loss and that the C&I segment contains greater inherent loss. The ALL at December 31, 2013 reflects these changes within the CRE and C&I portfolio segments.

The following tables present the age analysis of past due loans segregated by class of loans as of the dates presented:


	December 31, 2013
(dollars in thousands)	Current		30-59 Days Past Due		60-89 Days Past Due		Non- performing		Total Past Due Loans		Total Loans

Commercial real estate	$	1,595,590	$	1,209	$	207	$	10,750	$	12,166	$	1,607,756
Commercial and industrial		836,276		2,599		278		3,296		6,173		842,449
Commercial construction		139,133		1,049		751		2,742		4,542		143,675
Residential mortgage		481,260		828		1,666		3,338		5,832		487,092
Home equity		408,777		2,468		659		2,291		5,418		414,195
Installment and other consumer		67,420		382		44		37		463		67,883
Consumer construction		3,149		—		—		—		—		3,149
Total	$	3,531,605	$	8,535	$	3,605	$	22,454	$	34,594	$	3,566,199


	December 31, 2012
(dollars in thousands)	Current		30-59 Days Past Due		60-89 Days Past Due		Non- performing		Total Past Due Loans		Total Loans

Commercial real estate	$	1,418,934	$	2,230	$	413	$	30,556	$	33,199	$	1,452,133
Commercial and industrial		780,315		4,409		237		6,435		11,081		791,396
Commercial construction		150,823		10,542		—		6,778		17,320		168,143
Residential mortgage		416,364		1,713		1,948		7,278		10,939		427,303
Home equity		424,485		2,332		865		3,653		6,850		431,335
Installment and other consumer		73,334		406		95		40		541		73,875
Consumer construction		2,219		—		—		218		218		2,437
Total	$	3,266,474	$	21,632	$	3,558	$	54,958	$	80,148	$	3,346,622

We monitor the commercial loan portfolio through an internal risk rating system. Loan risk ratings are assigned based upon the creditworthiness of the borrower and are reviewed on an ongoing basis according to our internal policies. Loans within the pass rating generally have a lower risk of loss than loans risk rated as special mention and substandard.

Our risk ratings are consistent with regulatory guidance and are as follows:

Pass—The loan is currently performing and is of high quality.

Special Mention—A special mention loan has potential weaknesses that warrant management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects or in the strength of our credit position at some future date. Economic and market conditions, beyond the borrower’s control, may in the future necessitate this classification.

Substandard—A substandard loan is not adequately protected by the net worth and/or paying capacity of the borrower or by the collateral pledged, if any. Substandard loans have a well-defined weakness, or weaknesses that jeopardize the liquidation of the debt. These loans are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected.

The following tables present the recorded investment in commercial loan classes by internally assigned risk ratings as of the dates presented:


	December 31, 2013
(dollars in thousands)	Commercial Real Estate		% of Total			Commercial and Industrial		% of Total			Commercial Construction		% of Total			Total		% of Total

Pass	$	1,519,720		94.5	%	$	792,029		94.0	%	$	119,177		82.9	%	$	2,430,926		93.7	%
Special mention		57,073		3.6	%		34,085		4.1	%		15,621		10.9	%		106,779		4.1	%
Substandard		30,963		1.9	%		16,335		1.9	%		8,877		6.2	%		56,175		2.2	%
Total	$	1,607,756		100.0	%	$	842,449		100.0	%	$	143,675		100.0	%	$	2,593,880		100.0	%


	December 31, 2012
(dollars in thousands)	Commercial Real Estate		% of Total			Commercial and Industrial		% of Total			Commercial Construction		% of Total			Total		% of Total

Pass	$	1,265,810		87.2	%	$	718,070		90.7	%	$	118,841		70.7	%	$	2,102,721		87.2	%
Special mention		96,156		6.6	%		42,016		5.3	%		30,748		18.3	%		168,920		7.0	%
Substandard		90,167		6.2	%		31,310		4.0	%		18,554		11.0	%		140,031		5.8	%
Total	$	1,452,133		100.0	%	$	791,396		100.0	%	$	168,143		100.0	%	$	2,411,672		100.0	%

We monitor the delinquent status of the consumer portfolio on a monthly basis. Loans are considered nonperforming when interest and principal are 90 days or more past due or management has determined that a material deterioration in the borrower’s financial condition exists. The risk of loss is generally highest for nonperforming loans.

The following tables present the recorded investment in consumer loan classes by performing and nonperforming status as of the dates presented:


	December 31, 2013
(dollars in thousands)	Residential Mortgage		% of Total			Home Equity		% of Total			Installment and other consumer		% of Total			Consumer Construction		% of Total			Total		% of Total
Performing	$	483,754		99.3	%	$	411,904		99.4	%	$	67,846		99.9	%	$	3,149		100.0	%	$	966,653		99.4	%
Nonperforming		3,338		0.7	%		2,291		0.6	%		37		0.1	%		—		—			5,666		0.6	%
Total	$	487,092		100.0	%	$	414,195		100.0	%	$	67,883		100.0	%	$	3,149		100.0	%	$	972,319		100.0	%


	December 31, 2012
(dollars in thousands)	Residential Mortgage		% of Total			Home Equity		% of Total			Installment and other consumer		% of Total			Consumer Construction		% of Total			Total		% of Total
Performing	$	420,025		98.3	%	$	427,682		99.2	%	$	73,835		99.9	%	$	2,219		91.1	%	$	923,761		98.8	%
Nonperforming		7,278		1.7	%		3,653		0.8	%		40		0.1	%		218		8.9	%		11,189		1.2	%
Total	$	427,303		100.0	%	$	431,335		100.0	%	$	73,875		100.0	%	$	2,437		100.0	%	$	934,950		100.0	%

We individually evaluate all substandard and nonaccrual commercial loans greater than $0.5 million for impairment. Loans are considered to be impaired when based upon current information and events it is probable that we will be unable to collect all principal and interest payments due according to the original contractual terms of the loan agreement. All TDRs will be reported as an impaired loan for the remaining life of the loan, unless the restructuring agreement specifies an interest rate equal to or greater than the rate that would be accepted at the time of the restructuring for a new loan with comparable risk and it is expected that the remaining principal and interest will be fully collected according to the restructured agreement. For all TDRs, regardless of size, as well as all other impaired loans, we conduct further analysis to determine the probable loss and assign a specific reserve to the loan if deemed appropriate.

The following table presents investments in loans considered to be impaired and related information on those impaired loans as of the dates presented:


	December 31, 2013						December 31, 2012
(dollars in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Recorded Investment		Unpaid Principal Balance		Related Allowance

With a related allowance recorded:
Commercial real estate	$	—	$	—	$	—	$	6,138	$	6,864	$	1,226
Commercial and industrial		—		—		—		1,864		2,790		1,002
Commercial construction		681		1,383		25		799		896		3
Consumer real estate		53		53		53		—		—		—
Other consumer		33		33		19		—		—		—
Total with a Related Allowance Recorded		767		1,469		97		8,801		10,550		2,231

Without a related allowance recorded:
Commercial real estate		26,968		35,474		—		33,856		45,953		—
Commercial and industrial		9,580		9,703		—		11,419		12,227		—
Commercial construction		7,391		12,353		—		17,713		27,486		—
Consumer real estate		8,026		9,464		—		10,827		12,025		—
Other consumer		124		128		—		25		25		—
Total without a Related Allowance Recorded		52,089		67,122		—		73,840		97,716		—
Total:
Commercial real estate		26,968		35,474		—		39,994		52,817		1,226
Commercial and industrial		9,580		9,703		—		13,283		15,017		1,002
Commercial construction		8,072		13,736		25		18,512		28,382		3
Consumer real estate		8,079		9,517		53		10,827		12,025		—
Other consumer		157		161		19		25		25		—
Total	$	52,856	$	68,591	$	97	$	82,641	$	108,266	$	2,231

As of December 31, 2013, $27.0 million of CRE loans comprised 51 percent of the total impaired loans of $52.9 million. These impaired loans are collateralized primarily by commercial real estate properties such as retail or strip malls, office buildings and various other types of commercial purpose properties. These loans are generally considered collateral dependent and charge-offs are recorded when a confirmed loss exists. Approximately $9.9 million of charge-offs have been recorded relating to these CRE loans over the life of these loans. It is our policy to obtain appraisals on an annual basis on impaired loans or sooner if facts and circumstances warrant otherwise. As of December 31, 2013, these loans had collateral with an estimated fair value less cost to sell of approximately $43.7 million. We have current appraisals on all CRE impaired loans except for one loan for $0.7 million. We have not ordered an appraisal as we are currently negotiating a settlement agreement with the borrower which would result in the collection of the remaining recorded investment in the loan.

The following table summarizes investments in loans considered to be impaired and related information on those impaired loans for the years presented:


	For the Year Ended
	December 31, 2013				December 31, 2012
(dollars in thousands)	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized

With a related allowance recorded:
Commercial real estate	$	1,895	$	—	$	5,796	$	218
Commercial and industrial		—		—		1,826		—
Commercial construction		1,652		49		4,446		—
Consumer real estate		60		6		—		—
Other consumer		24		4		—		—
Total with a Related Allowance Recorded		3,631		59		12,068		218

Without a related allowance recorded:
Commercial real estate		29,314		929		41,138		1,112
Commercial and industrial		11,439		254		11,672		329
Commercial construction		14,112		326		22,299		571
Consumer real estate		8,714		436		20,533		68
Other consumer		114		6		6		—
Total without a Related Allowance Recorded		63,693		1,951		95,648		2,080
Total:
Commercial real estate		31,209		929		46,934		1,330
Commercial and industrial		11,439		254		13,498		329
Commercial construction		15,764		375		26,745		571
Consumer real estate		8,774		442		20,533		68
Other consumer		138		10		6		—
Total	$	67,324	$	2,010	$	107,716	$	2,298

The following tables detail activity in the ALL for the periods presented:


	2013
(dollars in thousands)	Commercial Real Estate			Commercial and Industrial			Commercial Construction			Consumer Real Estate			Other Consumer			Total Loans

Balance at beginning of year	$	25,246		$	7,759		$	7,500		$	5,058		$	921		$	46,484
Charge-offs		(4,601	)		(2,714	)		(4,852	)		(2,407	)		(1,002	)		(15,576	)
Recoveries		3,388			2,142			531			651			324			7,036
Net (Charge-offs)/ Recoveries		(1,213	)		(572	)		(4,321	)		(1,756	)		(678	)		(8,540	)
Provision for loan losses		(5,112	)		7,246			2,195			3,060			922			8,311
Balance at End of Year	$	18,921		$	14,433		$	5,374		$	6,362		$	1,165		$	46,255


	2012
(dollars in thousands)	Commercial Real Estate			Commercial and Industrial			Commercial Construction			Consumer Real Estate			Other Consumer			Total Loans

Balance at beginning of year	$	29,804		$	11,274		$	3,703		$	3,166		$	894		$	48,841
Charge-offs		(9,627	)		(5,278	)		(10,521	)		(2,509	)		(1,078	)		(29,013	)
Recoveries		1,259			1,153			891			197			341			3,841
Net (Charge-offs)/ Recoveries		(8,368	)		(4,125	)		(9,630	)		(2,312	)		(737	)		(25,172	)
Provision for loan losses		3,810			610			13,427			4,204			764			22,815
Balance at End of Year	$	25,246		$	7,759		$	7,500		$	5,058		$	921		$	46,484

The following tables present the ALL and recorded investments in loans by category as of December 31:


	2013
	Allowance for Loan Losses						Portfolio Loans
(dollars in thousands)	Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Total		Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Total

Commercial real estate	$	—	$	18,921	$	18,921	$	26,968	$	1,580,788	$	1,607,756
Commercial and industrial		—		14,433		14,433		9,580		832,869		842,449
Commercial construction		25		5,349		5,374		8,072		135,603		143,675
Consumer real estate		53		6,309		6,362		8,079		896,357		904,436
Other consumer		19		1,146		1,165		157		67,726		67,883
Total	$	97	$	46,158	$	46,255	$	52,856	$	3,513,343	$	3,566,199


	2012
	Allowance for Loan Losses						Portfolio Loans
(dollars in thousands)	Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Total		Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Total
Commercial real estate	$	1,226	$	24,020	$	25,246	$	39,994	$	1,412,139	$	1,452,133
Commercial and industrial		1,002		6,757		7,759		13,283		778,113		791,396
Commercial construction		3		7,497		7,500		18,512		149,631		168,143
Consumer real estate		—		5,058		5,058		10,827		850,248		861,075
Other consumer		—		921		921		25		73,850		73,875
Total	$	2,231	$	44,253	$	46,484	$	82,641	$	3,263,981	$	3,346,622