6. ALLOWANCE FOR LOAN LOSSES AND CREDIT QUALITY INFORMATION

Allowance for Loan Losses

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 our allowance for loan losses:

•

Specific reserves for impaired loans

•

Allowances for pools of homogenous loans based on historical net loss experience

•

Adjustments for qualitative and environmental factors allocated to pools of homogenous loans

•

Allowance for model estimation and complexity risk

When it is probable that the Bank will be unable to collect all amounts due (interest and principal) in accordance with the contractual terms of the loan agreement, it assigns a specific reserve to that loan if necessary. Unless loans are well-secured and collection is imminent, loans greater than 90 days past due are deemed impaired and their respective reserves are generally charged-off once the loss has been confirmed. Estimated specific reserves are based on collateral values, estimates of future cash flows or market valuations. During the twelve months ended December 31, 2014, net charge-offs totaled $5.4 million, or 0.18% of average loans, compared to $9.9 million, or 0.34% of average loans during the twelve months ended December 31, 2013. We charge loans off when they are deemed to be uncollectible.

Allowances for pooled homogeneous loans, that are not deemed impaired, are based on historical net loss experience. Estimated losses for pooled portfolios are determined differently for commercial loan pools and retail loan pools. Commercial loans are pooled into the following segments: Commercial, Owner-Occupied, Commercial Real Estate and Construction. 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 16 quarters. 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 and consumer loans. Pooled reserves for retail loans are calculated based solely on the previous four year average net loss rate.

Qualitative adjustment factors consider various current internal and external conditions, are allocated among loan types and take into consideration the following:

•

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 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 factor in our model can add or subtract to core reserves. A special adjustment factor of 7.5 basis points was applied to the commercial portfolio as additional qualitative consideration not taken into consideration in the qualitative factors. In addition, management has established a new special adjustment factor to address the absence of default history within the construction segment for certain risk ratings. This additional adjustment factor added $1.2 million in reserves to this segment which is equal to a 1.25% reserve for construction loans. Finally, a continued economic trend relative to the three and five year averages as well as current trends have resulted in the further reduction of other applied factors.

The allowance methodology uses a loss emergence period (the period of time between an event that triggers the probability of a loss and the confirmation of the loss, LEP) of nine quarters based on generally improving economic conditions. Industry and historical data indicates that the LEP lengthens in an improving economy as the length of time between an adverse financial event and subsequent loss is extended.

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, and methodology judgements, are necessary. We review the qualitative estimates of valuation factors quarterly and management uses its judgment to make adjustments based on current trends. The model complexity risk factor was 5 basis points of total loans for December 31, 2014.

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 periodically review our loan ratings and allowance for loan losses and the Bank’s internal loan review department performs loan reviews.

The following tables provide an analysis of the allowance for loan losses and loan balances as of and for the year ended December 31, 2014 and December 31, 2013:


(In Thousands)	Commercial			Owner Occupied Commercial			Commercial Mortgages			Construction			Residential			Consumer			Complexity Risk ⁽¹⁾		Total
Twelve months ended December 31, 2014
Allowance for loan losses
Beginning balance	$	12,751		$	7,638		$	6,932		$	3,326		$	3,078		$	6,494		$	1,025	$	41,244
Charge-offs		(3,587	)		(1,085	)		(425	)		(88	)		(811	)		(2,855	)		—		(8,851	)
Recoveries		1,611			249			202			242			168			981			—		3,453
Provision (credit) for loan losses		2,062			(159	)		557			(884	)		88			1,421			495		3,580

Ending balance	$	12,837		$	6,643		$	7,266		$	2,596		$	2,523		$	6,041		$	1,520	$	39,426

Period-end allowance allocated to:
Loans individually evaluated for impairment	$	3,034			609			319			334			790			231			—		5,317
Loans collectively evaluated for impairment		9,803			6,034			6,947			2,262			1,733			5,810			1,520		34,109

Ending balance	$	12,837		$	6,643		$	7,266		$	2,596		$	2,523		$	6,041		$	1,520	$	39,426

Period-end loan balances evaluated for:
Loans individually evaluated for impairment	$	12,381		$	2,474		$	8,335		$	1,419		$	15,666		$	6,376		$	—	$	46,651	⁽²⁾
Loans collectively evaluated for impairment		872,398			743,680			753,451			127,324			184,788			312,539			—		2,994,180
Acquired nonimpaired loans		32,024			40,180			37,697			9,891			17,363			8,619			—		145,774
Acquired impaired loans		3,269			2,264			5,976			3,863			512			9			—		15,893

Ending balance	$	920,072		$	788,598		$	805,459		$	142,497		$	218,329		$	327,543		$	—	$	3,202,498	⁽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 December 31, 2014, represents accruing troubled debt restructured loans of $22.6 million which are considered to be impaired.

(3)	Ending loan balances do not include deferred costs of $6.4 million and $6.0 million for December 31, 2014 and for December 31, 2013.


(In Thousands)	Commercial			Owner Occupied Commercial			Commercial Mortgages			Construction			Residential			Consumer			Complexity Risk ⁽¹⁾		Total
Twelve months ended December 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		(2,636	)		(1,225	)		(1,915	)		(1,749	)		(1,226	)		(4,913	)		—		(13,664	)
Recoveries		1,003			128			685			989			122			887			—		3,814
Provision (credit) for loan losses		721			2,627			83			(2,370	)		1,058			4,889			164		7,172

Ending balance	$	12,751		$	7,638		$	6,932		$	3,326		$	3,078		$	6,494		$	1,025	$	41,244

Period-end allowance allocated to:
Loans individually evaluated for impairment	$	1,781		$	12		$	1,987		$	—		$	989		$	134		$	—	$	4,903
Loans collectively evaluated for impairment		10,970			7,626			4,945			3,326			2,089			6,360			1,025		36,341

Ending balance	$	12,751		$	7,638		$	6,932		$	$3,326		$	3,078		$	6,494		$	1,025	$	41,244

Period-end loan balances evaluated for:
Loans individually evaluated for impairment	$	5,003		$	5,197		$	8,661		$	1,158		$	17,852		$	5,411		$	—	$	43,282	⁽²⁾
Loans collectively evaluated for impairment		805,879			781,163			716,532			104,916			203,668			296,823			—		2,908,981

Ending balance	$	810,882		$	786,360		$	725,193		$	106,074		$	221,520		$	302,234		$	—	$	2,952,263

(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 December 31, 2013 represents accruing troubled debt restructured loans which are considered to be impaired loans of $12.3 million

Non-Accrual and Past Due Loans

Nonaccruing loans are those on which the accrual of interest has ceased. We discontinue accrual of interest on originated loans after payments become more than 90 days past due or earlier if we do not expect the full collection of principal or interest in accordance with the terms of the loan agreement. Interest accrued but not collected at the date a loan is placed on nonaccrual status is reversed and charged against interest income. In addition, the accretion of net deferred loan fees is suspended when a loan is placed on nonaccrual status. Subsequent cash receipts are applied either to the outstanding principal balance or recorded as interest income, depending on our assessment of the ultimate collectability of principal and interest. Loans greater than 90 days past due and still accruing are defined as loans contractually past due 90 days or more as to principal or interest payments, but remain in accrual status because they are considered well secured and in the process of collection.

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

At Dec. 31, 2014

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

Acquired
Impaired
Loans

Nonaccrual
Loans

Total
Loans

(In Thousands)

Commercial

715

—

715

913,382

3,269

2,706

920,072

Owner occupied commercial

393

—

393

783,466

2,264

2,475

788,598

Commercial mortgages

203

—

203

791,035

5,976

8,245

805,459

Construction

—

138,634

3,863

—

142,497

Residential

3,879

604

—

4,483

206,266

512

7,068

218,329

Consumer

1,241

342

1,587

322,390

3,557

327,543

Total ⁽¹⁾

6,431

946

7,381

3,155,173

15,893

24,051

3,202,498

% of Total Loans

0.20

0.03

0.00

0.23

98.52

0.50

0.75

100.00

(1)	Balances in table above includes $145.8 million in acquired non-impaired loans.


At Dec. 31, 2013	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			Acquired Impaired Loans			Nonaccrual Loans			Total Loans
(In Thousands)
Commercial	$	1,447		$	—		$	—		$	1,447		$	805,132		$	—		$	4,303		$	810,882
Owner occupied commercial		538			—			—			538			780,625			—			5,197			786,360
Commercial mortgages		83			1,049			—			1,132			715,496			—			8,565			725,193
Construction		—			—			—			—			104,916			—			1,158			106,074
Residential		1,952			1,348			533			3,833			209,255			—			8,432			221,520
Consumer		1,095			177			—			1,272			297,669			—			3,293			302,234

Total	$	5,115		$	2,574		$	533		$	8,222		$	2,913,093			—		$	30,948		$	2,952,263

% of Total Loans		0.17	%		0.09	%		0.02	%		0.28	%		98.67	%		—	%		1.05	%		100.00	%

Impaired Loans

Loans for which it is probable we will not collect all principal and interest due according to contractual terms, which is assessed based on the credit characteristics of the loan and/or payment status, are measured for impairment in accordance with the provisions of SAB 102. The amount of impairment is required to be measured using one of three methods: (1) the present value of expected future cash flows discounted at the loan’s effective interest rate; (2) the fair value of collateral, if the loan is collateral dependent or (3) the loan’s observable market price. If the measure of the impaired loan is less than the recorded investment in the loan, a related allowance is allocated for the impairment.

The following tables provide an analysis of our impaired loans at December 31, 2014 and December 31, 2013:


2014 (In Thousands)	Ending Loan Balances		Loans with No Related Reserve ⁽¹⁾		Loan with Related Reserve		Related Reserve		Contractual Principal Balance		Average Loan Balances
Commercial	$	12,381	$	580	$	11,801	$	3,034	$	20,924	$	5,952
Owner-occupied commercial		2,474		1,865		609		609		3,708		4,461
Commercial mortgages		8,335		4,732		3,603		319		14,383		11,005
Construction		1,419		—		1,419		334		1,419		1,013
Residential		15,666		7,068		8,598		790		18,967		17,296
Consumer		6,376		3,557		2,819		231		7,162		5,902

Total	$	46,651	$	17,802	$	28,849	$	5,317	$	66,563	$	45,629


2013 (In Thousands)	Ending Loan Balances		Loans with No Related Reserve ⁽¹⁾		Loan with Related Reserve		Related Reserve		Contractual Principal Balance		Average Loan Balances
Commercial	$	5,003	$	2,362	$	2,641	$	1,781	$	13,013	$	5,347
Owner-occupied commercial		5,197		5,184		12		12		8,293		11,542
Commercial mortgages		8,661		2,784		5,877		1,987		16,566		10,444
Construction		1,158		1,158		—		—		1,563		968
Residential		17,852		9,750		8,103		989		20,153		18,047
Consumer		5,411		4,767		644		134		6,056		5,455

Total	$	43,282	$	26,005	$	17,277	$	4,903	$	65,644	$	51,803

(1)	Reflects loan balances at or written down to their recorded investment.

Interest income of $1.8 million and $922,000 was recognized on impaired loans during 2014 and 2013 respectively.

Reserves On Acquired Nonimpaired Loans

In accordance with FASB ASC 310, Receivables, loans acquired by the Bank through its merger with FNBW are required to be reflected on the balance sheet at their fair values as opposed to their book values on the date of acquisition. Therefore, on the date of acquisition establishing an allowance for acquired loans is prohibited. After the acquisition date the bank performs a separate allowance analysis on a quarterly basis to determine if an allowance for loan loss is necessary. Should the credit risk calculated exceed the purchased loan portfolio’s fair value, additional reserves will be added to the Bank’s allowance. When a purchased loan becomes impaired after its acquisition, it is evaluated as part of the Bank’s reserve analysis and a specific reserve is established to be included in the Bank’s allowance.

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 greater than 90 days past due are generally considered nonperforming and placed on nonaccrual status.

The following tables provide an analysis of loans by portfolio segment based on the credit quality indicators used to determine the Allowance at December 31:

Commercial Credit Exposure


																	Total Commercial
	Commercial				Owner Occupied Commercial				Commercial Mortgages				Construction				2014					2013
(In Thousands)	2014		2013		2014		2013		2014		2013		2014		2013		Amount		Percent			Amount		Percent
Risk Rating:
Special mention	$	4,744	$	12,566	$	6,989	$	4,747	$	9,065	$	2,092	$	—	$	226		20,798				$	19,631
Substandard:
Accrual		42,377		56,806		14,436		45,181		9,167		8,146		1,085		3,599		67,065					113,732
Nonaccrual		1,225		2,362		1,865		5,185		7,927		2,784		—		1,158		11,017					11,489
Doubtful/nonaccrual		3,034		2,641		609		12		319		5,877		334		—		4,296					8,530

Total special mention and substandard		51,380		74,375		23,899		55,125		26,478		18,899		1,419		4,983		103,176		4	%		153,382		6	%
Acquired impaired loans		3,269		—		2,264		—		5,976		—		3,863		—		15,372		1	%		—		—
Pass		865,423		736,507		762,435		731,235		773,005		706,294		137,215		101,091		2,538,078		95	%		2,275,127		94	%

Total	$	920,072	$	810,882	$	788,598	$	786,360	$	805,459	$	725,193	$	142,497	$	106,074	$	2,656,626		100	%	$	2,428,509		100	%

(1)	Table includes $119.8 million in acquired non-impaired loans.

Consumer Credit Exposure


									Total Residential and Consumer
	Residential				Consumer				2014					2013
(In Thousands)	2014		2013		2014		2013		Amount		Percent			Amount		Percent
Nonperforming ⁽¹⁾	$	15,666	$	17,852	$	6,376	$	5,411	$	22,042		4	%	$	23,263		4	%
Acquired impaired loans		512		—		9		—		521		—	%		—		—	%
Performing		202,151		203,668		321,158		296,823		523,309		96	%		500,491		96	%

Total	$	218,329	$	221,520	$	327,543	$	302,234	$	545,872		100	%	$	523,754		100	%

(1)	Includes $11.4 million as of December 31, 2014 and $11.5 million as of December 31, 2013 of troubled debt restructured mortgages and home equity installment loans that are performing in accordance with the loans modified terms and are accruing interest.

(2)	Total includes $26.0 million in acquired non-impaired loans.

Troubled Debt Restructurings (TDR)

The balance of TDRs at December 31, 2014 and December 31, 2013 was $36.2 million and $27.6 million, respectively. The balances at December 31, 2014 include approximately $13.6 million of TDRs in nonaccrual status and $22.6 million of TDRs in accrual status compared to $15.3 million of TDRs in nonaccrual status and $12.3 million of TDRs in accrual status at December 31, 2013. Approximately $4.2 million and $4.1 million in related reserves have been established for these loans at December 31, 2014 and December 31, 2013, respectively.

A modification is classified as a TDR if both of the following exist: (1) the borrower is experiencing financial difficulty and (2) the Bank has granted a concession to the borrower. Many aspects of the borrower’s financial situation are assessed when determining whether they are experiencing financial difficulty. Concessions may include the reduction of an interest rate at a rate lower than current market rate for a new loan with similar risk, extension of the maturity date, reduction of accrued interest, or principal forgiveness. The assessments of whether a borrower is experiencing (or is likely to experience) financial difficulty and whether a concession has been granted is subjective in nature and management’s judgment is required when determining whether a modification is a TDR.

During 2014, the terms of 25 loans were modified in TDRs, of which seven were commercial loans and the remaining were residential and consumer loans. Our concessions on the restructured loans consisted of eight extensions of maturities, seven reductions in interest rates and four reductions of interest rates with extensions of maturities. Additionally, the TDRs included four bankruptcies and two forbearance agreements. Principal balances are generally not forgiven by us when a loan is modified as a TDR. Nonaccruing restructured loans may return to accrual status, if there has been a period of sustained repayment performance, typically six months, and repayment is reasonably assured.

The following table presents loans identified as TDRs during the twelve months ended December 31, 2014 and December 31, 2013:


(In Thousands)	Twelve Months Ended December 31, 2014		Twelve Months Ended December 31, 2013
Commercial	$	9,356	$	9,241
Commercial mortgages		3,430		7,056
Construction		1,419		—
Residential		2,062		1,076
Consumer		1,612		1,323

	$	17,879	$	18,696

The TDRs set forth in the table above increased our allowance for loan losses by $2.2 million through allocation of a related reserve, and resulted in charge-offs of $54,000 during the twelve months ended December 31, 2014. For the twelve months ended December 31, 2013, the TDRs set forth in the table above increased our allowance for loan losses by $82,000 through allocation of a related reserve, and resulted in charge-offs of $381,000.