Covered Assets and FDIC Loss-sharing Asset

Covered Assets

Covered assets consist of loans and OREO acquired in FDIC assisted acquisitions during 2010 and 2011, for which the Bank entered into loss-sharing agreements, whereby the FDIC will cover a substantial portion of any future losses on loans (and related unfunded loan commitments), OREO and certain accrued interest on loans. Under the terms of the loss-sharing agreements, the FDIC will absorb 80% of losses and share in 80% of loss recoveries up to specified amounts and, with respect to loss-sharing agreements for two acquisitions completed in 2010, will absorb 95% of losses and share in 95% of loss recoveries thereafter. The loss-sharing provisions of the agreements for commercial and single-family mortgage loans are in effect for five and ten years, respectively, from the acquisition dates and the loss recovery provisions are in effect for eight and ten years, respectively, from the acquisition dates.

Ten years and forty-five days after the acquisition dates, the Bank shall pay to the FDIC a clawback in the event the losses from the acquisitions fail to reach stated levels. This clawback shall be in the amount of 50% of the excess, if any, of 20% of the stated threshold amounts, less the sum of 25% of the asset premium (discount), 20% or 25% of the cumulative loss-sharing payments (depending on the particular agreement), and the cumulative servicing amount. As of March 31, 2012, the net present value of the Bank’s estimated clawback liability is $3.6 million, which is included in other liabilities on the consolidated balance sheets.

The following is an analysis of our covered loans, net of related allowance for losses on covered loans as of March 31, 2012 and December 31, 2011:



	March 31, 2012					December 31, 2011
	Covered Loans		Weighted- Average Risk Rating	Allowance for Loan Losses		Covered Loans		Weighted- Average Risk Rating	Allowance for Loan Losses
	(dollars in thousands)
Commercial business	$	175,623	6.00	$	6,320	$	195,737	6.05	$	977
Real estate:
One-to-four family residential	74,733		5.35	2,947		79,328		5.32	678
Commercial and multifamily residential	299,202		5.57	6,840		311,308		5.65	2,683
Total real estate	373,935			9,787		390,636			3,361
Real estate construction:
One-to-four family residential	44,335		7.25	1,604		54,402		7.32	136
Commercial and multifamily residential	21,330		7.04	711		23,661		7.32	86
Total real estate construction	65,665			2,315		78,063			222
Consumer	51,661		4.71	2,082		56,877		4.84	384
Subtotal of covered loans	666,884			$	20,504	721,313			$	4,944
Less:
Valuation discount resulting from acquisition accounting	144,767					184,440
Allowance for loan losses	20,504					4,944
Covered loans, net of valuation discounts and allowance for loan losses	$	501,613				$	531,929

Certain acquired loans are accounted for under ASC 310-30 and initially measured at fair value based on expected future cash flows over the life of the loans. Acquired loans that have common risk characteristics are aggregated into pools. The Company re-measures contractual and expected cash flows, at the pool-level, on a quarterly basis.

Contractual cash flows are calculated based upon the loan pool terms after applying a prepayment factor. Calculation of the applied prepayment factor for contractual cash flows is the same as described below for expected cash flows.

Inputs to the determination of expected cash flows include cumulative default and prepayment data as well as loss severity and recovery lag information. Cumulative default and prepayment data are calculated via a transition matrix. The transition matrix is a matrix of probability values that specifies the probability of a loan pool transitioning into a particular delinquency state (e.g. 0-30 days past due, 31 to 60 days, etc.) given its delinquency state at the re-measurement date. Loss severity factors are based upon actual charge-off data within the loan pools and recovery lags are based upon experience with the collateral within the loan pools.

Acquired loans are also subject to the Company’s internal and external credit review and are risk rated using the same criteria as loans originated by the Company. However, risk ratings are not a clear indicator of losses on acquired loans as a majority of the losses are recoverable from the FDIC under the loss-sharing agreements.

Draws on acquired loans, advanced subsequent to the loan acquisition date, are accounted for under ASC 450-20 and those amounts are also subject to the Company’s internal and external credit review. An allowance for loan losses is estimated in a similar manner as the originated loan portfolio, and a provision for loan losses is charged to earnings as necessary.

The excess of cash flows expected to be collected over the initial fair value of acquired loans is referred to as the accretable yield and is accreted into interest income over the estimated life of the acquired loans using the effective yield method. Other adjustments to the accretable yield include changes in the estimated remaining life of the acquired loans, changes in expected cash flows and changes of indices for acquired loans with variable interest rates.

The following table shows the changes in accretable yield for acquired loans for the three months ended March 31, 2012 and 2011:



	Three Months Ended March 31,
	2012			2011
	(in thousands)
Balance at beginning of period	$	259,669		$	256,572
Accretion	(27,658		)	(21,303		)
Disposals	(1,799		)	(3,159		)
Reclassifications from (to) nonaccretable difference	9,465			(14,759		)
Balance at end of period	$	239,677		$	217,351

During the three months ended March 31, 2012, the Company recorded a provision expense for losses on covered loans of $15.7 million. Of this amount, $16.1 million was impairment expense calculated in accordance with ASC 310-30 and $400 thousand was a negative provision to adjust the allowance for loss calculated under ASC 450-20 for draws on acquired loans. The impact to earnings of the $15.7 million of provision expense for covered loans was partially offset through noninterest income by a $12.5 million increase in the FDIC loss-sharing asset.

The changes in the ALLL for covered loans for the three months ended March 31, 2012 and 2011 are summarized as follows:



	Three Months Ended March 31,
	2012			2011
	(in thousands)
Beginning balance	$	4,944		$	6,055
Loans charged off	(562		)	—
Recoveries	437			—
Provision charged to expense	15,685			(422		)
Ending balance	$	20,504		$	5,633

The following table sets forth activity in covered OREO at carrying value for the three months ended March 31, 2012 and 2011:



	Three Months Ended March 31,
	2012			2011
	(in thousands)
Covered OREO:
Balance, beginning of period	$	28,126		$	14,443
Transfers in	2,468			3,425
Additional OREO write-downs	(1,505		)	(15		)
Proceeds from sale of OREO property	(8,025		)	(6,959		)
Gain on sale of OREO	3,366			2,633
Total covered OREO, end of period	$	24,430		$	13,527

The covered OREO is covered by loss-sharing agreements with the FDIC in which the FDIC will assume 80% of additional write-downs and losses on covered OREO sales, or 95%, if applicable, of additional write-downs and losses on covered OREO sales if the minimum loss share thresholds are met.

FDIC Loss-sharing Asset

At March 31, 2012, the FDIC loss-sharing asset is comprised of a $135.6 million FDIC indemnification asset and a $23.5 million FDIC receivable. The indemnification represents the cash flows the Company expects to collect from the FDIC under the loss-sharing agreements and the FDIC receivable represents the reimbursable amounts from the FDIC that have not yet been received.

For covered loans, the Company remeasures contractual and expected cash flows on a quarterly basis. When the quarterly re-measurement process results in a decrease in expected cash flows due to an increase in expected credit losses, impairment is recorded. As a result of this impairment, the indemnification asset is increased to reflect anticipated future cash to be received from the FDIC. Consistent with the loss-sharing agreements between the Company and the FDIC, the amount of the increase to the indemnification asset is measured as 80% of the resulting impairment.

Alternatively, when the quarterly re-measurement results in an increase in expected future cash flows due to a decrease in expected credit losses, the nonaccretable difference decreases and the effective yield of the related loan portfolio is increased. As a result of the improved expected cash flows, the indemnification asset would be reduced first by the amount of any impairment previously recorded and, second, by increased amortization over the remaining life of the related loan pool.

The following table shows a detailed analysis of the FDIC loss-sharing asset for the three months ended March 31, 2012 and 2011:



	Three Months Ended March 31,
	2012			2011
	(in thousands)
Balance at beginning of period	$	175,071		$	205,991
Adjustments not reflected in income
Cash received from the FDIC	(14,804		)	—
FDIC reimbursable losses, net	462			1,836
Adjustments reflected in income
Amortization, net	(13,873		)	(13,569		)
Impairment	12,548			(338		)
Sale of other real estate	(2,067		)	(867		)
Other	1,724			—
Balance at end of period	$	159,061		$	193,053