6. ALLOWANCE FOR LOAN LOSSES AND CREDIT QUALITY INFORMATION

Allowance for Loan Losses

We maintain an allowance for loan losses (allowance) and charge losses to this allowance when such losses are realized. We established our allowance for loan losses in accordance with guidance provided in the SEC’s Staff Accounting Bulletin 102 (SAB 102) and FASB ASC 450, Contingencies (ASC 450). 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

•

An allowance for each pool of homogenous loans based on historical 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 three months ended March 31, 2015 net charge-offs totaled $705,000, or 0.09% of average loans, compared to $2.5 million, or 0.34% of average loans, during the three months ended March 31, 2014. 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 17 quarters. During the quarter ended March 31, 2015 we increased the look-back period to 17 quarters rather than the 16 quarters used at December 31, 2014. 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 which are allocated among loan types and take into consideration the following:

•

Current underwriting policies, staff, and portfolio mix

•

Internal trends of delinquency, nonaccrual and criticized loans by segment

•

Risk rating accuracy, control and regulatory assessments/environment

•

General economic conditions - locally and nationally

•

Market trends impacting collateral values

•

A competitive environment as it could impact loan structure and underwriting

The above factors are based on their relative standing compared to the period in 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 10 basis points was created within consumer secured for incremental losses associated with the Home Equity Line of Credit End of Draw bubble not captured within the Bank’s loan loss histories. A special adjustment factor to address the absence of a default history for C&I loans remains unchanged from the prior quarter at 7.5 basis points. These additional adjustment factors contributed $1.0 million to the total allowance.

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 for commercial portfolios and four quarters for consumer portfolios.

The final component of the allowance is a reserve for model estimation and complexity risk. The calculation of this reserve 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 March 31, 2015.

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 the activity of our allowance for loan losses and loan balances for three months ended March 31, 2015 and 2014:


				Owner- Occupied Commercial			Commercial Mortgages											Complexity Risk (1)
(In Thousands)	Commercial			Owner- Occupied Commercial			Commercial Mortgages			Construction		Residential			Consumer			Complexity Risk (1)		Total
Three months ended March 31, 2015
Allowance for loan losses
Beginning balance	$	12,837		$	6,643		$	7,266		$	2,596	$	2,523		$	6,041		$	1,520	$	39,426
Charge-offs		(131	)		(330	)		(39	)		—		(125	)		(450	)		—		(1,075	)
Recoveries		26			4			79			49		11			201			—		370
Provision (credit)		316			722			(782	)		307		(29	)		234			18		786

Ending balance	$	13,048		$	7,039		$	6,524		$	2,952	$	2,380		$	6,026		$	1,538	$	39,507

Period-end allowance allocated to:
Loans individually evaluated for impairment	$	3,169		$	284		$	223		$	210	$	751		$	197		$	—	$	4,834
Loans collectively evaluated for impairment		9,879			6,755			6,301			2,742		1,629			5,829			1,538		34,673

Ending balance	$	13,048		$	7,039		$	6,524		$	2,952	$	2,380		$	6,026		$	1,538	$	39,507

Period-end loan balances evaluated for:
Loans individually evaluated for impairment	$	11,707		$	1,552		$	7,595		$	1,419	$	14,749		$	6,157		$	—	$	43,179	⁽²⁾
Loans collectively evaluated for impairment		876,434			754,044			770,991			138,495		184,337			310,427			—		3,034,728
Acquired nonimpaired loans		31,737			39,671			36,373			9,680		16,615			7,640			—		141,716
Acquired impaired loans		3,192			2,133			5,877			3,630		496			8			—		15,336

Ending balance	$	923,070		$	797,400		$	820,836		$	153,224	$	216,197		$	324,232		$	—	$	3,234,959	⁽³⁾


				Owner- Occupied Commercial			Commercial Mortgages												Complexity Risk (1)
(In Thousands)	Commercial			Owner- Occupied Commercial			Commercial Mortgages			Construction			Residential			Consumer			Complexity Risk (1)		Total
Three months ended March 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		(1,113	)		(197	)		(160	)		(88	)		(364	)		(1,233	)		—		(3,155	)
Recoveries		324			6			37			7			18			217			—		609
Provision (credit)		442			1,342			554			(529	)		33			771			17		2,630

Ending balance	$	12,404		$	8,789		$	7,363		$	2,716		$	2,765		$	6,249		$	1,042	$	41,328

Period-end allowance allocated to:
Loans individually evaluated for impairment	$	1,865		$	1,191		$	1,019		$	—		$	807		$	186			—	$	5,068
Loans collectively evaluated for impairment		10,539			7,598			6,344			2,716			1,958			6,063			1,042		36,260

Ending balance	$	12,404		$	8,789		$	7,363		$	2,716		$	2,765		$	6,249		$	1,042	$	41,328

Period-end loan balances evaluated for:
Loans individually evaluated for impairment	$	4,583		$	6,318			15,786		$	1,070			18,413		$	5,537			—	$	51,707	⁽²⁾
Loans collectively evaluated for impairment		833,598			792,895			730,543			100,415			199,740			295,774			—		2,952,965

Ending balance	$	838,181		$	799,213		$	746,329		$	101,485		$	218,153		$	301,311		$	—	$	3,004,672	⁽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 represents accruing troubled debt restructured loans of $ 22.5 million and $11.6 million for the periods ending March 31, 2015 and March 31, 2014, respectively. Accruing troubled debt restructured loans are considered impaired loans.

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

Nonaccrual 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:

March 31, 2015

(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

Acquired
Impaired
Loans

Nonaccrual
Loans

Total
Loans

Commercial

3,085

—

3,094

914,677

3,192

2,107

923,070

Owner-Occupied commercial

1,362

—

1,362

792,353

2,133

1,552

797,400

Commercial mortgages

—

100

807,351

5,877

7,508

820,836

Construction

—

149,594

3,630

—

153,224

Residential

3,618

674

492

4,784

204,690

496

6,227

216,197

Consumer

739

191

102

1,032

319,905

3,287

324,232

Total (1)

8,804

874

694

10,372

3,188,570

15,336

20,681

3,234,959

% of Total Loans

0.27

0.03

0.02

0.32

98.57

0.47

0.64

100

(1)	The balances of above include $141.7 million of acquired nonimpaired loans.


December 31, 2014 (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			Acquired Impaired Loans			Nonaccrual Loans			Total Loans
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			4			1,587			322,390			9			3,557			327,543

Total (1)	$	6,431		$	946		$	4		$	7,381		$	3,155,173		$	15,893		$	24,051		$	3,202,498

% of Total Loans		0.20	%		0.03	%		—	%		0.23	%		98.52	%		0.50	%		0.75	%		100	%

(1)	The balances of above include $145.8 million of acquired nonimpaired loans

Impaired Loans

Loans for which it is probable we will not collect all principal and interest due according to their 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 and FASB ASC 310, Receivables (ASC 310). 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 March 31, 2015 and December 31, 2014:


March 31, 2015 (In Thousands)	Ending Loan Balances		Loans with No Related Reserve (1)		Loans with Related Reserve		Related Reserve		Contractual Principal Balances		Average Loan Balances
Commercial	$	11,707	$	592	$	11,115	$	3,169	$	12,491	$	7,293
Owner-occupied commercial		1,552		1,268		284		284		2,625		3,732
Commercial mortgages		7,595		4,167		3,428		223		10,516		10,792
Construction		1,419		—		1,419		210		1,419		1,065
Residential		14,749		7,987		6,762		751		16,815		16,676
Consumer		6,157		4,875		1,282		197		6,768		6,051

Total	$	43,179	$	18,889	$	24,290	$	4,834	$	50,634	$	45,609


December 31, 2014 (In Thousands)	Ending Loan Balances		Loans with No Related Reserve (1)		Loans with Related Reserve		Related Reserve		Contractual Principal Balances		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

(1)	Reflects loan balances at or written down to their remaining book balance.

Interest income of $472,000 and $353,000 was recognized on impaired loans during the three months ended March 31, 2015 and 2014, respectively.

As of March 31, 2015, there were 28 residential loans and 15 commercial loans in the process of foreclosure. The total outstanding balance on the loans was $3.1 million and $3.3 million, respectively. As of December 31, 2014, there were 36 residential loans and 12 commercial loans in the process of foreclosure. The total outstanding balance on the loans was $4.4 million and $1.1 million, respectively

Reserves on Acquired Nonimpaired Loans

In accordance with FASB ASC 310-40, 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 contractual 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 remaining credit mark, 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 that are greater than 90 days past due are generally considered nonperforming and placed on nonaccrual status.

Commercial Credit Exposure


					Owner-Occupied				Commercial								Total
(In Thousands)	Commercial				Commercial				Mortgages				Construction				Commercial(1)
																	March 31,					December 31,
	Mar. 31		Dec. 31		Mar. 31		Dec. 31		Mar. 31		Dec. 31		Mar. 31		Dec. 31		2015					2014
	2015		2014		2015		2014		2015		2014		2015		2014		Amount		%			Amount		%
Risk Rating:
Special mention	$	6,085	$	4,744	$	18,858	$	6,989	$	9,048	$	9,065	$	—	$	—	$	33,991				$	20,798
Substandard:
Accrual		49,520		42,377		15,677		14,436		4,527		9,167		1,304		1,085		71,028					67,065
Nonaccrual		811		1,225		1,268		1,865		7,284		7,927						9,363					11,017
Doubtful/nonaccrual		3,169		3,034		284		609		223		319		210		334		3,886					4,296

Total Special and Substandard		59,585		51,380		36,087		23,899		21,082		26,478		1,514		1,419		118,268		4	%		103,176		4	%
Acquired impaired		3,192		3,269		2,133		2,264		5,877		5,976		3,630		3,863		14,832		1			15,372		—
Pass		860,293		865,423		759,180		762,435		793,877		773,005		148,080		137,215		2,561,430		95			2,538,078		96

Total	$	923,070	$	920,072	$	797,400	$	788,598	$	820,836	$	805,459	$	153,224	$	142,497	$	2,694,530		100	%	$	2,656,626		100	%

(1)	Table includes $117.5 million and $119.8 million of acquired nonimpaired loans as of March 31, 2015 and December 31, 2014, respectively.

Consumer Credit Exposure


(In Thousands)	Residential				Consumer				Total Residential and Consumer(2)
	Mar 31.		Dec. 31		Mar 31.		Dec. 31		March 31, 2015					December 31, 2014
	2015		2014		2015		2014		Amount		Percent			Amount		Percent
Nonperforming(1)	$	14,749	$	15,666	$	6,157	$	6,376	$	20,906		4	%	$	22,042		4	%
Acquired impaired Loans		496		512		8		9		504					521
Performing		200,952		202,151		318,067		321,158		519,019		96			523,309		96

Total	$	216,197	$	218,329	$	324,232	$	327,543	$	540,429		100	%	$	545,872		100	%

(1)	Includes $11.4 million as of March 31, 2015 and $11.4 million as of December 31, 2014 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 $24.3 million and $26.0 million in acquired nonimpaired loans as of March 31, 2015 and December 31, 2014, respectively.

Troubled Debt Restructurings (TDR)

TDRs are recorded in accordance with FASB ASC 310-40, Troubled Debt Restructuring by Creditors (ASC 310-40). The balance of TDRs at March 31, 2015 and December 31, 2014 was $34.8 million and $36.2 million, respectively. The balance at March 31, 2015 included approximately $12.3 million of TDRs in nonaccrual status and $22.5 million of TDRs in accrual status compared to $13.6 million in nonaccrual status and $22.6 million in accrual status at December 31, 2014. Approximately $4.3 million and $4.2 million in related reserves have been established for these loans at March 31, 2015 and December 31, 2014, respectively.

During the three months ended March 31, 2015, six loans were classified as TDRs. One was a consumer loan in which the maturity date was modified. Five were discharged bankruptcies of which three were residential real estate and two were consumer loans. Our concessions on restructured loans typically consist of forbearance agreements, reduction in interest rates or extensions of maturities. Principal balances are generally not forgiven 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 and payment is reasonably assured.

The following table presents loans identified as TDRs during the three months ended March 31, 2015 and 2014:


	Three		Three
	Months Ended		Months Ended
	March 31,		March 31,
(In Thousands)	2015		2014
Commercial	$	—	$	—
Commercial mortgages		—		—
Construction		—		—
Residential		212		279
Consumer		135		363

Total	$	347	$	642

The TDR set forth in the table above did not change our allowance for loan losses through allocation of a related reserve and did not result in additional charge-offs during the three months ended March 31, 2015 compared to an increase in our allowance of $1,000 and charge-offs of $40,000 for the same period of 2014.