6. 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 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). When we have reason to believe it is probable that we will not be able to collect all contractually due amounts of principal and interest, loans are evaluated for impairment on an individual basis and a specific allocation of the allowance is assigned in accordance with ASC 310-10. We also maintain an allowance for loan losses on acquired loans when: (i) for loans accounted for under ASC 310-30, there is deterioration in credit quality subsequent to acquisition and (ii) for loans accounted for under ASC 310-20, the inherent losses in the loans exceed the remaining credit discount recorded at the time of acquisition. 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. We charge loans off when they are deemed to be uncollectible. During the nine months ended September 30, 2015, net charge-offs totaled $9.0 million or 0.27% of average loans, compared to $4.7 million, or 0.21% of average loans annualized, during the nine months ended September 30, 2014. A significant portion of the net charge-offs in 2015 was the result of one $9.1 million substandard C&I relationship previously classified as an accruing TDR that was placed in nonaccrual status during the second quarter of 2015. This relationship included a net charge-off of $5.7 million during the nine months ending September 30, 2015.

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. During the nine months ended September 30, 2015, we increased the look-back period to 19 quarters from the 16 quarters used at December 31, 2014 and prior periods. This change in the look-back period resulted in an increase of $1.3 million to the total allowance at September 30, 2015.

Loss severity upon default is calculated as the actual loan losses (net of recoveries) on impaired loans in their respective pool during the same time frame. Retail loans are pooled into the following segments: residential mortgage, consumer secured and consumer unsecured loans. Pooled reserves for retail loans are calculated based solely on average net loss rates over the same 19 quarter look-back period.

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. Qualitative factors in our model can add or subtract to core reserves. Continued economic improvement and continued refinement of the quantitative model have driven an overall reduction in qualitative factors during the period.

The allowance methodology uses a loss emergence period (LEP), which is the period of time between an event that triggers the probability of a loss and the confirmation of the loss. We estimate the commercial LEP to be 8 quarters as of September 30, 2015. Further, our residential mortgage and consumer LEP remained at four quarters as of September 30, 2015. We evaluate LEP quarterly for reasonableness and complete a detailed historical analysis of our LEP by commercial and retail portfolios at least annually.

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 judgments 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 remained at 3 basis points of total loans for September 30, 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 and nine months ended September 30, 2015:


(In Thousands)	Commercial			Owner- Occupied Commercial			Commercial Mortgages			Construction		Residential			Consumer			Complexity Risk ⁽¹⁾			Total
Three months ended September 30, 2015
Allowance for loan losses
Beginning balance	$	14,512		$	6,733		$	6,831		$	3,313	$	2,709		$	5,788		$	959		$	40,845
Charge-offs		(4,147	)		(26	)		(804	)		—		(130	)		(1,499	)		—			(6,606	)
Recoveries		84			40			14			19		158			405			—			720
Provision (credit)		303			(62	)		231			306		(362	)		1,086			11			1,513
Provision for acquired loans		—			—			(71	)		104		(92	)		(1	)		—			(60	)

Ending balance	$	10,752		$	6,685		$	6,201		$	3,742	$	2,283		$	5,779		$	970		$	36,412

Nine months ended September 30, 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		(6,184	)		(623	)		(808	)		—		(397	)		(2,570	)		—			(10,582	)
Recoveries		198			62			83			179		195			839			—			1,556
Provision (credit)		3,485			574			(508	)		863		50			1,460			(550	)	$	5,374
Provision for acquired loans		416			29			168			104		(88	)		9			—			638

Ending balance	$	10,752		$	6,685		$	6,201		$	3,742	$	2,283		$	5,779		$	970		$	36,412

Period-end allowance allocated to:
Loans individually evaluated for impairment	$	993		$	—		$	241		$	214	$	934		$	202		$	—		$	2,584
Loans collectively evaluated for impairment		9,406			6,657			5,907			3,527		1,348			5,577			970			33,392
Acquired loans evaluated for impairment		353			28			53			1		1			—			—			436

Ending balance	$	10,752		$	6,685		$	6,201		$	3,742	$	2,283		$	5,779		$	970		$	36,412

Period-end loan balances evaluated for:
Loans individually evaluated for impairment	$	5,775		$	1,170		$	6,805		$	1,419	$	14,613		$	7,749		$	—		$	37,531	⁽²⁾
Loans collectively evaluated for impairment		900,660			770,246			836,556			190,925		169,566			327,524			—			3,195,477
Acquired nonimpaired loans		28,998			37,937			25,555			8,223		15,137			5,930			—			121,780
Acquired impaired loans		2,627			2,195			5,400			2,594		380			7			—			13,203

Ending balance	$	938,060		$	811,548		$	874,316		$	203,161	$	199,696		$	341,210		$	—		$	3,367,991	⁽³⁾

The following table provides the activity of the allowance for loan losses and loan balances for the three and nine months ended September 30, 2014:


(In Thousands)	Commercial			Owner Occupied Commercial			Commercial Mortgages			Construction			Residential			Consumer			Complexity Risk ⁽¹⁾			Total
Three months ended September 30, 2014
Allowance for loan losses
Beginning balance	$	13,346		$	7,986		$	7,617		$	2,319		$	2,759		$	6,299		$	1,055		$	41,381
Charge-offs		(1,840	)		(272	)		(101	)		—			(147	)		(372	)		—			(2,732	)
Recoveries		66			77			4			8			86			261			—			502
Provision (credit)		1,833			454			(1,097	)		(897	)		(6	)		56			(10	)		333

Ending balance	$	13,405		$	8,245		$	6,423		$	1,430		$	2,692		$	6,244		$	1,045		$	39,484

Nine months ended September 30, 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		(3,335	)		(593	)		(261	)		(88	)		(674	)		(2,095	)		—			(7,046	)
Recoveries		873			244			43			192			129			792			—			2,273
Provision (credit)		3,116			956			(291	)		(2,000	)		159			1,053			20			3,013

Ending balance	$	13,405		$	8,245		$	6,423		$	1,430		$	2,692		$	6,244		$	1,045		$	39,484

Period-end allowance allocated to:
Loans individually evaluated for impairment	$	1,573		$	993		$	240		$	—		$	850		$	211		$	—		$	3,867
Loans collectively evaluated for impairment		11,832			7,252			6,183			1,430			1,842			6,033			1,045			35,617

Ending balance	$	13,405		$	8,245		$	6,423		$	1,430		$	2,692		$	6,244		$	1,045		$	39,484


Period-end loan balances evaluated for:
Loans individually evaluated for impairment	$	3,683		$	3,390		$	8,760		$	1,419		$	16,807		$	6,610		$	—		$	40,669	⁽²⁾
Loans collectively evaluated for impairment		839,753			760,680			737,394			131,996			193,792			309,478			—			2,973,093
Acquired nonimpaired loans		35,300			41,858			41,071			10,666			18,105			9,671			—			156,671
Acquired impaired loans		3,534			2,329			6,687			4,135			517			27			—			17,229

Ending balance	$	882,270		$	808,257		$	793,912		$	148,216		$	229,221		$	325,786		$	—		$	3,187,662	⁽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 $13.6 million and $11.8 million for the periods ending September 30, 2015 and 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:

September 30, 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

587

—

587

929,432

2,627

5,414

938,060

Owner-Occupied commercial

1,300

—

1,300

806,883

2,195

1,170

811,548

Commercial mortgages

—

862,196

5,400

6,720

874,316

Construction

—

200,567

2,594

—

203,161

Residential

4,436

1,081

423

5,940

186,788

380

6,588

199,696

Consumer

1,034

245

495

1,774

335,405

4,024

341,210

Total ⁽¹⁾

7,357

1,326

918

9,601

3,321,271

13,203

23,916

3,367,991

% of Total Loans

0.22

0.04

0.03

0.29

98.61

0.39

0.71

100

⁽¹⁾	The balances of above include $121.8 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	%		0.00	%		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 September 30, 2015 and December 31, 2014:


September 30, 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	$	6,138	$	3,783	$	2,355	$	1,346	$	12,836	$	8,900
Owner-occupied commercial		2,090		1,170		920		28		2,468		2,364
Commercial mortgages		7,896		3,524		4,372		294		11,269		8,361
Construction		1,492		—		1,492		215		1,520		1,448
Residential		14,711		8,185		6,526		935		17,187		15,483
Consumer		7,749		6,575		1,174		202		9,290		6,590

Total ⁽²⁾	$	40,076	$	23,237	$	16,839	$	3,020	$	54,570	$	43,146


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.

⁽²⁾	The above includes acquired impaired loans totaling $2.5 million in the ending loan balance and $3.3 million in the contractual principal balance.

Interest income of $372,000 and $1.3 million was recognized on impaired loans during the three and nine months ended September 30, 2015, respectively. Interest income of $401,000 and $1.1 million was recognized on impaired loans during the three and nine months ended September 30, 2014.

As of September 30, 2015, there were 37 residential loans and 13 commercial loans in the process of foreclosure. The total outstanding balance on the loans was $4.3 million and $2.2 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, loans acquired by the Bank through its merger with FNBW are required to be reflected on the balance sheet at their fair values on the date of acquisition as opposed to their contractual values. 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.

The tables below provide information about the credit quality of loans in our commercial and residential and consumer portfolios.

Commercial Credit Exposure


(In Thousands)	Commercial				Owner-Occupied Commercial				Commercial Mortgages				Construction				Total Commercial⁽¹⁾
																	September 30,					Dec. 31,
	Sept. 30,		Dec. 31		Sept. 30,		Dec. 31		Sept. 30,		Dec. 31		Sept. 30,		Dec. 31		2015					2014
	2015		2014		2015		2014		2015		2014		2015		2014		Amount		%			Amount		%
Risk Rating:
Special mention	$	13,759	$	4,744	$	16,048	$	6,989	$	10,239	$	9,065	$	—	$	—	$	40,046				$	20,798
Substandard:
Accrual		36,048		42,377		14,348		14,436		1,252		9,167		8,194		1,085		59,842					67,065
Nonaccrual		4,426		1,225		1,170		1,865		6,479		7,927		—				12,075					11,017
Doubtful		988		3,034		—		609		241		319		—		334		1,229					4,296

Total Special and Substandard		55,221		51,380		31,566		23,899		18,211		26,478		8,194		1,419		113,192		4	%		103,176		4	%
Acquired impaired		2,627		3,269		2,195		2,264		5,400		5,976		2,594		3,863		12,816		0			15,372		—
Pass		880,212		865,423		777,787		762,435		850,705		773,005		192,373		137,215		2,701,077		96			2,538,078		96

Total	$	938,060	$	920,072	$	811,548	$	788,598	$	874,316	$	805,459	$	203,161	$	142,497	$	2,827,085		100	%	$	2,656,626		100	%

⁽¹⁾	Table includes $100.7 million and $119.8 million of acquired nonimpaired loans as of September 30, 2015 and December 31, 2014, respectively.

Residential and Consumer Credit Exposure


(In Thousands)	Residential				Consumer				Total Residential and Consumer⁽²⁾
	Sept. 30,		Dec. 31		Sept. 30,		Dec. 31		30-Sep-15					Dec. 31, 2014
	2015		2014		2015		2014		Amount		Percent			Amount		Percent
Nonperforming⁽¹⁾	$	14,613	$	15,666	$	7,749	$	6,376	$	22,362		4	%	$	22,042		4	%

Acquired impaired loans		380		512		7		9		387		—			521		—
Performing		184,703		202,151		333,454		321,158		518,157		96			523,309		96

Total	$	199,696	$	218,329	$	341,210	$	327,543	$	540,906		100	%	$	545,872		100	%

⁽¹⁾	Includes $11.8 million as of September 30, 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 $21.1 million and $26.0 million in acquired nonimpaired loans as of September 30, 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 September 30, 2015 and December 31, 2014 was $32.5 million and $36.2 million, respectively. The balance at September 30, 2015 included approximately $18.9 million of TDRs in nonaccrual status and $13.6 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 $2.3 million and $4.2 million in related reserves have been established for these loans at September 30, 2015 and December 31, 2014, respectively.

During the nine months ended September 30, 2015, the terms of 23 loans were modified in TDRs. Sixteen modifications were for consumer loans in which seven had their maturity dates extended, six were discharged bankruptcies, one was a rate concession and two were HELOC conversions. Six were residential mortgages in which three were discharged bankruptcies, two were maturity date extensions and one was a forbearance agreement. One commercial loan received a maturity date extension. 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 and nine months ended September 30, 2015 and 2014.


(In Thousands)	Three Months Ended September 30, 2015		Three Months Ended September 30, 2014		Nine Months Ended September 30, 2015		Nine Months Ended September 30, 2014
Commercial	$	—	$	88	$	—	$	209
Owner Occupied Commercial		—		—		577		—
Commercial mortgages		—		3,430		—		3,430
Construction		—		1,419		—		1,419
Residential		38		72		447		1,916
Consumer		643		1,097		1,306		1,612

Total	$	681	$	6,106	$	2,330	$	8,586

During the nine months ended September 30, 2015, the TDRs set forth in the table above increased our allowance $23,000 through the allocation of a related reserve, and resulted in charge-offs of $69,000 compared to an increase in our allowance of $395,000 and charge-offs of $49,000 for the same period of 2014.