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 SEC’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 the 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 thirteen quarters. This was an increase of one quarter over the previous period’s analysis. This adjustment provides a more representative period and accurate estimation of the allowance at the current point in this credit cycle. Loss severity is calculated as the actual loan losses (net of recoveries) on impaired loans in the respective pool during the same time frame. Retail loans are pooled into the 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 thirteen quarter average net 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, nonaccrual 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 underwriting and loan portfolio mix

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.

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 and six months ended June 30, 2013 and 2012:


	Commercial			Owner- Occupied Commercial			Commercial Mortgages			Construction			Residential			Consumer			Complexity Risk (1)			Total
	(in thousands)
Three Months Ended June 30, 2013
Allowance for loan losses
Beginning balance	$	12,768		$	6,338		$	7,193		$	6,785		$	3,281		$	5,741		$	842		$	42,948
Charge-offs		(883	)		(36	)		(24	)		(1,321	)		(255	)		(1,516	)		—			(4,035	)
Recoveries		401			33			106			70			23			268			—			901
Provision (credit)		681			1,714			(930	)		(1,582	)		181			1,644			(28	)		1,680

Ending balance	$	12,967		$	8,049		$	6,345		$	3,952		$	3,230		$	6,137		$	814		$	41,494


Six Months Ended June 30, 2013
Allowance for loan losses
Beginning balance	$	13,663		$	6,108		$	8,079		$	6,456		$	3,124		$	5,631		$	861		$	43,922
Charge-offs		(1,139	)		(37	)		(1,721	)		(1,340	)		(695	)		(2,810	)		—			(7,742	)
Recoveries		627			45			109			85			41			496			—			1,403
Provision (credit)		(184	)		1,933			(122	)		(1,249	)		760			2,820			(47	)		3,911

Ending balance	$	12,967		$	8,049		$	6,345		$	3,952		$	3,230		$	6,137		$	814		$	41,494


Period-end allowance allocated to:
Loans individually evaluated for impairment	$	2,171		$	977		$	1,995		$	—		$	1,006		$	12		$	—		$	6,161
Loans collectively evaluated for impairment		10,796			7,072			4,350			3,952			2,224			6,125			814			35,333

Ending balance	$	12,967		$	8,049		$	6,345		$	3,952		$	3,230		$	6,137		$	814		$	41,494


Period-end loan balances evaluated for:
Loans individually evaluated for impairment	$	6,048		$	12,681		$	10,791		$	646		$	16,961		$	4,925		$	—		$	52,052	(2)
Loans collectively evaluated for impairment		733,581			755,261			677,442			124,892			216,755			280,314			—		$	2,788,245

Ending balance	$	739,629		$	767,942		$	688,233		$	125,538		$	233,716		$	285,239		$	—		$	2,840,297

(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 June 30, 2013, represents accruing troubled debt restructured loans.

The following table provides the activity of the allowance for loan losses and loan balances for the three and six months ended June 30, 2012:


	Commercial			Owner- Occupied Commercial			Commercial Mortgages			Construction			Residential			Consumer			Complexity Risk (1)			Total
	(in thousands)
Three months ended June 30, 2012
Allowance for loan losses
Beginning balance	$	11,625		$	7,005		$	10,530		$	8,917		$	6,400		$	10,253		$	1,068		$	55,798
Charge-offs		(7,704	)		(2,186	)		(4,701	)		(8,498	)		(2,315	)		(1,692	)		—			(27,096	)
Recoveries		797			—			51			300			33			163			—			1,344
Provision (credit)		5,173			(728	)		3,738			4,588			2,147			1,617			(152	)		16,383

Ending balance	$	9,891		$	4,091		$	9,618		$	5,307		$	6,265		$	10,341		$	916		$	46,429


Six months ended June 30, 2012
Allowance for loan losses
Beginning balance	$	15,067		$	9,235		$	7,556		$	4,074		$	6,544		$	10,604		$	—		$	53,080
Charge-offs		(10,035	)		(2,688	)		(4,891	)		(10,004	)		(2,639	)		(2,921	)		—			(33,178	)
Recoveries		850			6			364			328			58			293			—			1,899
Provision (credit)		4,009			(2,462	)		6,589			10,909			2,302			2,365			916			24,628

Ending balance	$	9,891		$	4,091		$	9,618		$	5,307		$	6,265		$	10,341		$	916		$	46,429


Period-end allowance allocated to:
Loans individually evaluated for impairment	$	629		$	10		$	309		$	139		$	882		$	45		$	—		$	2,014
Loans collectively evaluated for impairment		9,262			4,081			9,309			5,168			5,383			10,296			916			44,415

Ending balance	$	9,891		$	4,091		$	9,618		$	5,307		$	6,265		$	10,341		$	916		$	46,429


Period-end loan balances evaluated for:
Loans individually evaluated for impairment	$	4,020		$	17,980		$	5,219		$	5,656		$	16,083		$	4,014		$	—		$	52,972	(2)
Loans collectively evaluated for impairment		807,981			619,004			613,648			90,520			239,515			280,302			—			2,650,970

Ending balance	$	812,001		$	636,984		$	618,867		$	96,176		$	255,598		$	284,316		$	—		$	2,703,942

(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 June 30, 2012, represents accruing troubled debt restructured loans.

Nonaccrual and Past Due Loans

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

June 30, 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

257

—

257

733,348

6,024

739,629

Owner-Occupied commercial

—

755,261

12,681

767,942

Commercial mortgages

102

—

102

677,340

10,791

688,233

Construction

—

124,892

646

125,538

Residential

4,012

937

129

5,078

220,661

7,977

233,716

Consumer

671

—

700

281,625

2,914

285,239

Total

5,042

966

129

6,137

2,793,127

41,033

2,840,297

% of Total Loans

0.18

0.03

—

0.21

98.34

1.45

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 June 30, 2013 and December 31, 2012:

Ending

Loans with

Related

Contractual

Average

June 30, 2013

Loan

No Specific

Specific

Principal

Loan

(In Thousands)

Balances

Reserve (1)

Reserve

Balances

Commercial

6,048

2,008

4,040

2,171

7,332

4,700

Owner-Occupied commercial

12,681

5,390

7,291

977

14,828

14,250

Commercial mortgages

10,791

4,740

6,051

1,995

19,401

9,152

Construction

646

—

16,416

2,337

Residential

16,961

9,231

7,730

1,006

19,357

17,835

Consumer

4,925

4,794

131

5,941

5,634

Total

52,052

26,809

25,243

6,161

83,275

53,908


	Ending		Loans with		Loans with		Related		Contractual		Average
December 31, 2012	Loan		No Specific		Specific		Specific		Principal		Loan
(In Thousands)	Balances		Reserve (1)		Reserve		Reserve		Balances		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 $235,000 and $473,000 was recognized on impaired loans during the three and six months ended June 30, 2013, respectively.

Credit Quality Indicators

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

Pass. These borrowers presently show no current or potential problems and their loans are considered fully collectible.

Special Mention. Borrowers have potential weaknesses that deserve management’s close attention. Borrowers in this category may be experiencing adverse operating trends, for example, 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 June 30, 2013 and December 31, 2012:

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


	Commercial				Owner-Occupied Commercial				Commercial Mortgages				Construction				Total Commercial
	Jun 30, 2013		Dec. 31, 2012		Jun 30, 2013		Dec. 31, 2012		Jun 30, 2013		Dec. 31, 2012		Jun 30, 2013		Dec. 31, 2012		June 30, 2013					December 31, 2012
	Jun 30, 2013		Dec. 31, 2012		Jun 30, 2013		Dec. 31, 2012		Jun 30, 2013		Dec. 31, 2012		Jun 30, 2013		Dec. 31, 2012		Amount		Percent			Amount		Percent
Risk Rating:
Special mention	$	19,413	$	14,611	$	15,134	$	27,398	$	304	$	29,267	$	—	$	2,453	$	34,851				$	73,729
Substandard:
Accrual		63,699		63,074		43,465		44,899		5,111		6,222		3,012		5,755		115,287					119,950
Nonaccrual		1,984		1,598		5,390		13,827		4,740		5,422		646		1,172		12,760					22,019
Doubtful/Nonaccrual		4,040		3,263		7,291		174		6,051		7,212		—		375		17,382					11,024

Total Special Mention, Substandard and Doubtful		89,136		82,546		71,280		86,298		16,206		48,123		3,658		9,755		180,280		8	%		226,722		10	%
Pass		650,493		621,945		696,662		684,283		672,027		583,242		121,880		123,620		2,141,062		92			2,013,090		90

Total Commercial Loans	$	739,629	$	704,491	$	767,942	$	770,581	$	688,233	$	631,365	$	125,538	$	133,375	$	2,321,342		100	%	$	2,239,812		100	%

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


	Residential				Consumer				Total Residential and Consumer
	Jun 30, 2013		Dec.31, 2012		Jun 30, 2013		Dec. 31, 2012		June 30, 2013					December 31, 2012
	Jun 30, 2013		Dec.31, 2012		Jun 30, 2013		Dec. 31, 2012		Amount		Percent			Amount		Percent

Nonperforming (1)	$	16,961	$	18,483	$	4,925	$	6,329	$	21,886		4	%	$	24,812		5	%
Performing		216,755		225,144		280,314		282,672		497,069		96			507,816		95

Total	$	233,716	$	243,627	$	285,239	$	289,001	$	518,955		100	%	$	532,628		100	%

(1)	Includes $11.0 million as of June 30, 2013 and $10.1 million as of December 31, 2012 of troubled debt restructured mortgages and home equity installment loans that are performing in accordance with modified terms and are accruing interest.

Troubled Debt Restructurings (TDR)

The balance of TDRs at June 30, 2013 and December 31, 2012 was $22.2 million and $22.0 million, respectively. The balance at June 30, 2013 included approximately $11.2 million in nonaccrual status and $11.0 million in accrual status compared to $11.9 million in nonaccrual status and $10.1 million in accrual status at December 31, 2012. Approximately $1.0 million and $936,000 in related reserves have been established for these loans at June 30, 2013 and December 31, 2012, respectively.

During the six months ended June 30, 2013, the terms of sixteen loans were modified in TDRs, four of which were commercial loans 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 and six months ended June 30, 2013 and 2012:


	Three Months Ended		Three Months Ended		Six Months Ended		Six Months Ended
(In Thousands)	June 30, 2013		June 30, 2012		June 30, 2013		June 30, 2012
Commercial	$	24	$	—	$	24	$	9,276
Commercial mortgages		826		—		1,061		—
Construction		—		—		—		378
Residential		173		827		599		1,278
Consumer		44		—		717		—

Total	$	1,067	$	827	$	2,401	$	10,932

The TDRs described in the table increased the allowance for loan losses by $28,000 through allocation of a related reserve, and resulted in charge-offs of $363,000 during the six months ended June 30, 2013, compared to increased reserves of $130,000 and charge-offs of $5.3 million for the same period of 2012.

There was one residential TDR in the amount of $130,000, which defaulted (defined as past due 90 days) during the three and six months ended June 30, 2013, that was restructured within the last twelve months prior to June 30, 2013.