4. ALLOWANCE FOR LOAN LOSSES AND CREDIT QUALITY INFORMATION

Allowance for Loan Losses

We maintain an allowance for loan losses and charge losses to this allowance when such losses are realized. We established our loan loss allowance in accordance with guidance provided in the Securities and Exchange Commission’s Staff Accounting Bulletin 102 (“SAB 102”). The determination of the allowance for loan losses requires significant judgment reflecting our best estimate of impairment related to specifically identified impaired loans as well as probable loan losses in the remaining loan portfolio. Our evaluation is based upon a continuing review of these portfolios. The following are included in Allowance for Loan Losses:

•

Specific reserves for impaired loans

•

Allowances for pools of homogenous loans based on historical loss experience

•

Adjustments for qualitative and environmental factors

•

Allowance for model estimation and complexity risk

Specific reserves are established for impaired loans where we have identified significant conditions or circumstances related to specific credits that indicate losses are probable. Unless loans are well-secured and collection is imminent, all loans that are 90 days past due are deemed impaired. Reserves for impaired loans are generally charged-off within 90 days of impairment recognition. Estimated losses are based on collateral values, estimates of future cash flows, or market valuations.

Allowances for pooled homogeneous loans, that are not deemed impaired, are based on historical loss experience. Estimated losses for pooled portfolios are determined differently for commercial loan pools and consumer loan pools. Commercial loans are pooled into following segments: Business Loans (Commercial and Industrial Loans), Commercial Real Estate – Owner-Occupied, Commercial Real Estate – Investor, and Construction Loans. Each pool is further segmented by internally assessed risk ratings. Loan losses for commercial loans are estimated by determining the probability of default and expected loss severity upon default. Probability of default is calculated based on the historical rate of migration to impaired status during the last three years. Loss severity is calculated as the actual loan losses (net of recoveries) on impaired loans in the respective pool during the last three years. Retail loans are pooled into following segments: residential mortgage loans, home equity secured loans, and all other consumer loans. Pooled reserves for retail loans are calculated based solely on the previous three year average loss rate.

Qualitative and environmental adjustment factors are taken into consideration when determining the above reserve estimates or core reserves. These adjustment factors are based upon our evaluation of various current internal and external conditions including:

•

Assessment of current underwriting policies, staff, and portfolio mix

•

Internal trends of delinquency, non-accrual and criticized loans by segment

•

Assessment of risk rating accuracy, control and regulatory assessments/environment

•

General economic conditions — locally and nationally

•

Market trends impacting collateral values

•

Competitive environment as it could impact loan structure and underwriting

The above factors are based on their relative standing compared to the period which historic losses are used in core reserve estimates and current directional trends. Each individual qualitative and environmental factor in our model can add or subtract to core reserves. As of March 31, 2013, these factors, in aggregate, increased core reserves by 7.6%.

The final component of the allowance is a reserve for model estimation and complexity risk. The calculation of reserves is generally quantitative; however, qualitative estimates of valuations and risk assessment are necessary. We currently increase our calculated reserves by 2% to account for model estimation and complexity risk.

Our loan officers and risk managers meet at least quarterly to discuss and review the conditions and risks associated with individual problem loans. In addition, various regulatory agencies and loan review consultants periodically review our loan ratings and allowance for loan losses.

The following tables provide the activity of the allowance for loan losses and loan balances for the three months ended on March 31, 2013 and 2012:


	Commercial			Owner Occupied Commercial			Commercial Mortgages			Construction			Residential			Consumer			Complexity Risk(1)			Total
	(In Thousands)
Three months ended March 31, 2013
Allowance for loan losses
Beginning balance	$	13,663		$	6,108		$	8,079		$	6,456		$	3,124		$	5,631		$	861		$	43,922
Charge-offs		(256	)		(1	)		(1,697	)		(19	)		(440	)		(1,294	)		—			(3,707	)
Recoveries		226			12			3			15			18			228			—			502
Provision		(865	)		219			808			333			579			1,176			(19	)		2,231

Ending balance	$	12,768		$	6,338		$	7,193		$	6,785		$	3,281		$	5,741		$	842		$	42,948

Period-end allowance allocated to:
Loans individually evaluated for impairment	$	868		$	47		$	2,000		$	—		$	922		$	12		$	—		$	3,849
Loans collectively evaluated for impairment		11,900			6,291			5,193			6,785			2,359			5,729			842			39,099

Ending balance	$	12,768		$	6,338		$	7,193		$	6,785		$	3,281		$	5,741		$	842		$	42,948

Period-end loan balances evaluated for:
Loans individually evaluated for impairment	$	4,991		$	13,263		$	11,240		$	1,216		$	19,578		$	6,210		$	—		$	56,498	(2)
Loans collectively evaluated for impairment		727,831		$	752,961			622,510			132,265			218,276			277,096			—			2,730,939

Ending balance	$	732,822		$	766,224		$	633,750		$	133,481		$	237,854		$	283,306		$	—		$	2,787,437	(3)


	Commercial			Owner Occupied Commercial			Commercial Mortgages			Construction			Residential			Consumer			Complexity Risk(1)		Total
	(In Thousands)
Three months ended March 31, 2012
Allowance for loan losses
Beginning balance	$	15,067		$	9,235		$	7,556		$	4,074		$	6,544		$	10,604		$	—	$	53,080
Charge-offs		(2,331	)		(502	)		(190	)		(1,506	)		(324	)		(1,229	)		—		(6,082	)
Recoveries		53			6			313			28			25			130			—		555
Provision		(1,164	)		(1,734	)		2,851			6,321			155			748			1,068		8,245

Ending balance	$	11,625		$	7,005		$	10,530		$	8,917		$	6,400		$	10,253		$	1,068	$	55,798

Period-end allowance allocated to:
Loans individually evaluated for impairment	$	1,615		$	2,191		$	1,156		$	2,750		$	869		$	96		$	—	$	8,677
Loans collectively evaluated for impairment		10,010			4,814			9,374			6,167			5,531			10,157			1,068		47,121

Ending balance	$	11,625		$	7,005		$	10,530		$	8,917		$	6,400		$	10,253		$	1,068	$	55,798

Period-end loan balances evaluated for:
Loans individually evaluated for impairment	$	6,526		$	21,760		$	11,625		$	24,246		$	15,723		$	2,912		$	—	$	82,792	(2)
Loans collectively evaluated for impairment		792,293			665,180			605,601			99,937			251,310			282,548			—		2,696,869

Ending balance	$	798,819		$	686,940		$	617,226		$	124,183		$	267,033		$	285,460		$	—	$	2,779,661	(3)

(1)	Represents the portion of the allowance for loan losses established to account for the inherent complexity and uncertainty of estimates.

(2)	The difference between this amount and nonaccruing loans at March 31, 2013, represents accruing troubled debt restructured loans.

(3)	Ending loan balances do not include deferred costs.

Non-Accrual and Past Due Loans

The following tables show our nonaccrual and past due loans at the dates indicated:


March 31, 2013 (In Thousands)	30–59 Days Past Due and Still Accruing			60–89 Days Past Due and Still Accruing			Greater Than 90 Days Past Due and Still Accruing			Total Past Due And Still Accruing			Accruing Current Balances			Nonaccrual Loans			Total Loans
Commercial	$	900		$	223		$	103		$	1,226		$	726,605		$	4,991		$	732,822
Owner occupied commercial		511			—			—			511			752,450			13,263			766,224
Commercial mortgages		—			—			—			—			622,510			11,240			633,750
Construction		—			—			—			—			132,265			1,216			133,481
Residential		2,925			315			297			3,537			223,507			10,810			237,854
Consumer		627			167			—			794			278,311			4,201			283,306

Total	$	4,963		$	705		$	400		$	6,068		$	2,735,648		$	45,721		$	2,787,437

% of Total Loans		0.18	%		0.03	%		0.01	%		0.22	%		98.14	%		1.64	%		100	%


December 31, 2012 (In Thousands)	30–59 Days Past Due and Still Accruing			60–89 Days Past Due and Still Accruing			Greater Than 90 Days Past Due and Still Accruing			Total Past Due And Still Accruing			Accruing Current Balances			Nonaccrual Loans			Total Loans
Commercial	$	1,214		$	—		$	—		$	1,214		$	698,416		$	4,861		$	704,491
Owner occupied commercial		1,264			—			—			1,264			755,316			14,001			770,581
Commercial mortgages		—			—			—			—			618,731			12,634			631,365
Construction		269			70			—			339			131,489			1,547			133,375
Residential		5,383			606			786			6,775			226,863			9,989			243,627
Consumer		971			526			—			1,497			282,776			4,728			289,001

Total	$	9,101		$	1,202		$	786		$	11,089		$	2,713,591		$	47,760		$	2,772,440

% of Total Loans		0.33	%		0.04	%		0.03	%		0.40	%		97.88	%		1.72	%		100	%

Impaired Loans

The following tables provide an analysis of our impaired loans at March 31, 2013 and December 31, 2012:


March 31, 2013 (In Thousands)	Ending Loan Balances		Loans with No Specific Reserve (1)		Loans with Specific Reserve		Related Specific Reserve		Contractual Principal Balances		Average Loan Balances
Commercial	$	4,991	$	1,691	$	3,300	$	868	$	12,162	$	4,795
Owner-Occupied Commercial		13,263		12,171		1,092		47		15,592		16,066
Commercial mortgages		11,240		5,130		6,110		2,000		21,777		9,319
Construction		1,216		1,216		—		—		17,377		7,057
Residential		19,578		11,834		7,744		922		22,059		17,588
Consumer		6,210		5,554		656		12		7,025		5,232

Total	$	56,498	$	37,596	$	18,902	$	3,849	$	95,992	$	60,057


December 31, 2012 (In Thousands)	Ending Loan Balances		Loans with No Specific Reserve (1)		Loans with Specific Reserve		Related Specific Reserve		Contractual Principal Balances		Average Loan Balances
Commercial	$	4,861	$	1,598	$	3,263	$	2,100	$	12,060	$	4,993
Owner-Occupied Commercial		14,001		13,827		174		1		18,658		16,856
Commercial mortgages		12,634		5,422		7,212		1,887		22,192		10,233
Construction		1,547		1,172		375		28		17,711		11,239
Residential		18,483		11,053		7,430		919		20,771		16,917
Consumer		6,329		5,635		694		16		7,265		4,514

Total	$	57,855	$	38,707	$	19,148	$	4,951	$	98,657	$	64,752

(1)	Reflects loan balances at their remaining book balance.

Interest income of $238,000 was recognized on impaired loans during the three months ended March 31, 2013 compared to $93,000 during the three months ended March 31, 2012.

Credit Quality Indicators

Commercial Loans

Below is a description of each of our risk ratings for all commercial loans including commercial mortgages:

Pass. These borrowers presently show no current or potential problems and their loans are considered fully collectible. We further segment Pass ratings into six classifications ranging from Substantially Risk Free (secured by marketable securities within margin and cash secured) to Acceptable Risk.

Special Mention. Borrowers have potential weaknesses that deserve management’s close attention. Borrowers in this category may be experiencing adverse operating trends, e.g.: declining revenues or margins, high leverage, tight liquidity, or increasing inventory without increasing sales. These adverse trends can have a potential negative effect on the borrower’s repayment capacity. These assets are not adversely classified and do not expose the Bank to significant risk that would warrant a more severe rating. Borrowers in this category may also be experiencing significant management problems, pending litigation, or other structural credit weaknesses.

Substandard. Borrowers have well-defined weaknesses that require extensive oversight by management. Borrowers in this category may exhibit one or more of the following: inadequate debt service coverage, unprofitable operations, insufficient liquidity, high leverage, and weak or inadequate capitalization. Relationships in this category are not adequately protected by the sound financial worth and paying capacity of the obligor or the collateral pledged on the loan, if any. The distinct possibility exists that the Bank will sustain some loss if the deficiencies are not corrected.

Doubtful. Borrowers have well-defined weaknesses inherent in the Substandard category with the added characteristic that the possibility of loss is extremely high. Current circumstances in the credit relationship make collection or liquidation in full highly questionable. A doubtful asset has some pending event that may strengthen the asset that defers the loss classification. Such impending events include: perfecting liens on additional collateral, obtaining collateral valuations, an acquisition or liquidation preceding, proposed merger, or refinancing plan.

Loss. Borrowers are uncollectible or of such negligible value that continuance as a bankable asset is not supportable. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical to defer writing off this asset even though partial recovery may be recognized sometime in the future.

Residential and Consumer Loans

The residential and consumer loan portfolios are monitored on an ongoing basis using delinquency information and loan type as credit quality indicators. These credit quality indicators are assessed in the aggregate in these relatively homogeneous portfolios. Loans that are greater than 90 days past due are generally considered nonperforming and placed in nonaccrual status.

The following tables provide an analysis of problem loans as of March 31, 2013 and December 31, 2012:

Commercial credit exposure credit risk profile by internally assigned risk rating (in thousands):


	Commercial				Owner-Occupied Commercial				Commercial Mortgages				Construction				Total Commercial
	Mar 31, 2013		Dec. 31, 2012		Mar 31, 2013		Dec. 31, 2012		Mar 31, 2013		Dec. 31, 2012		Mar 31, 2013		Dec. 31, 2012		March 31, 2013					December 31, 2012
	Mar 31, 2013		Dec. 31, 2012		Mar 31, 2013		Dec. 31, 2012		Mar 31, 2013		Dec. 31, 2012		Mar 31, 2013		Dec. 31, 2012		Amount		Percent			Amount		Percent
Risk Rating:
Special mention	$	9,091	$	14,611	$	26,906	$	27,398	$	14,908	$	29,267	$	2,318	$	2,453	$	53,223				$	73,729
Substandard:
Accrual		66,483		63,074		45,129		44,899		6,078		6,222		5,990		5,755		123,680					119,950
Nonaccrual		1,691		1,598		12,171		13,827		5,130		5,422		1,216		1,172		20,208					22,019
Doubtful/ Nonaccrual		3,300		3,263		1,092		174		6,110		7,212		—		375		10,502					11,024

Total Special Mention and Substandard		80,565		82,546		85,298		86,298		32,226		48,123		9,524		9,755		207,613		9	%		226,722		10	%
Pass		652,257		621,945		680,926		684,283		601,524		583,242		123,957		123,620		2,058,664		91			2,013,090		90

Total Commercial Loans	$	732,822	$	704,491	$	766,224	$	770,581	$	633,750	$	631,365	$	133,481	$	133,375	$	2,266,277		100	%	$	2,239,812		100	%

Consumer credit exposure credit risk profile based on payment activity (in thousands):


	Residential					Consumer					Total Residential and Consumer
	Mar 31, 2013			Dec. 31, 2012		Mar 31, 2013			Dec. 31, 2012		March 31, 2013					December 31, 2012
	Mar 31, 2013			Dec. 31, 2012		Mar 31, 2013			Dec. 31, 2012		Amount		Percent			Amount		Percent
Nonperforming	$	19,578	(1)	$	18,483	$	6,210	(1)	$	6,329	$	25,788		5	%	$	24,812		5	%
Performing		218,276			225,144		277,096			282,672		495,372		95			507,816		95

Total	$	237,854		$	243,627	$	283,306		$	289,001	$	521,160		100	%	$	532,628		100	%

(1)	Includes $10.8 million of troubled debt restructured mortgages and home equity installment loans performing in accordance with modified terms and are accruing interest

Troubled Debt Restructurings (TDR)

The balance of TDRs at March 31, 2013 and December 31, 2012 was $22.8 million and $22.0 million, respectively. The balances at March 31, 2013 include approximately $12.0 million of TDRs in nonaccrual status and $10.8 million of TDRs in accrual status compared to $11.9 million of TDRs in nonaccrual status and $10.1 million of TDRs in accrual status at December 31, 2012. Approximately $1.9 million and $936,000 in related reserves have been established for these loans at March 31, 2013 and December 31, 2012, respectively.

During the first quarter of 2013, the terms of three loans were modified in TDR’s one of which was a commercial loan that had already been placed on nonaccrual. The remaining loans represented residential and consumer loans. Our concessions on restructured loans consisted mainly of forbearance agreements, reduction in interest rates or extensions of maturities. Principal balances are generally not forgiven by us when a loan is modified as a TDR. Nonaccruing restructured loans remain in nonaccrual status until there has been a period of sustained repayment performance, typically six months.

The following table presents loans identified as TDRs during the three months ended March 31, 2013 and 2012:


(In Thousands)	Three Months Ended March 31, 2013		Three Months Ended March 31, 2012
Commercial	$	—	$	9,276
Commercial mortgages		235		—
Construction		—		378
Residential		—		451
Consumer		474		—

Total	$	709	$	10,105

The TDRs described did not have a related allowance for loan losses through allocation of a related reserve, and resulted in charge offs of $119,000 during the three months ending March 31, 2013, compared to increased reserves of $38,000 and charge-off’s of $795,000 for the same period of 2012.

There were no TDR’s that defaulted (defined as past due 90 days) during the three months ended March 31, 2013.