Covered Assets and FDIC Loss-sharing Asset

Covered Assets

Covered assets consist of loans and OREO acquired in certain 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 future losses on loans (and related unfunded loan commitments), OREO and certain accrued interest on loans during the terms of the agreements. 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. With respect to loss-sharing agreements for two acquisitions completed in 2010, after those specified amounts, the FDIC will absorb 95% of losses and share in 95% of loss recoveries. 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. The amount of the clawback is determined by a formula specified in each individual loss-sharing agreement. As of June 30, 2012, the net present value of the Bank’s estimated clawback liability is $3.4 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 as of June 30, 2012 and December 31, 2011:



	June 30, 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	$	160,250	5.95	$	9,984	$	195,737	6.05	$	977
Real estate:
One-to-four family residential	68,175		5.27	4,655		79,328		5.32	678
Commercial and multifamily residential	276,844		5.46	10,139		311,308		5.65	2,683
Total real estate	345,019			14,794		390,636			3,361
Real estate construction:
One-to-four family residential	35,137		6.89	2,202		54,402		7.32	136
Commercial and multifamily residential	19,558		7.01	1,340		23,661		7.32	86
Total real estate construction	54,695			3,542		78,063			222
Consumer	49,123		4.73	3,464		56,877		4.84	384
Subtotal of covered loans	609,087			$	31,784	721,313			$	4,944
Less:
Valuation discount resulting from acquisition accounting	114,309					184,440
Allowance for loan losses	31,784					4,944
Covered loans, net of allowance for loan losses	$	462,994				$	531,929

Acquired impaired 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 the loans were acquired with a significant discount and 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 and six months ended June 30, 2012 and 2011:



	Three Months Ended June 30,						Six Months Ended June 30,
	2012			2011			2012			2011
	(in thousands)
Balance at beginning of period	$	239,677		$	217,351		$	259,669		$	256,572
Accretion	(21,817		)	(15,458		)	(49,474		)	(36,761		)
Disposals	(3,273		)	(1,254		)	(5,072		)	(4,413		)
Reclassifications from (to) nonaccretable difference	(526		)	53,884			8,938			39,125
Balance at end of period	$	214,061		$	314,333		$	214,061		$	314,333

During the six months ended June 30, 2012, the Company recorded a provision expense for losses on covered loans of $27.4 million. Of this amount, $28.3 million was impairment expense calculated in accordance with ASC 310-30 and $900 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 $27.4 million of provision expense for covered loans was partially offset through noninterest income by a $21.9 million increase in the FDIC loss-sharing asset.

The changes in the ALLL for covered loans for the three and six months ended June 30, 2012 and 2011 are summarized as follows:



	Three Months Ended June 30,						Six Months Ended June 30,
	2012			2011			2012			2011
	(in thousands)
Balance at beginning of period	$	20,504		$	5,633		$	4,944		$	6,055
Loans charged off	(1,035		)	(56		)	(1,597		)	(56		)
Recoveries	627			70			1,064			70
Provision charged to expense	11,688			2,301			27,373			1,879
Balance at end of period	$	31,784		$	7,948		$	31,784		$	7,948

The following table sets forth activity in covered OREO at carrying value for the three and six months ended June 30, 2012 and 2011:



	Three Months Ended June 30,						Six Months Ended June 30,
	2012			2011			2012			2011
	(in thousands)
Covered OREO:
Balance at beginning of period	$	24,430		$	13,527		$	28,126		$	14,443
Established through acquisitions	—			10,896			—			10,896
Transfers in	2,933			1,668			5,401			5,092
Additional OREO write-downs	(533		)	(99		)	(2,038		)	(113		)
Proceeds from sale of OREO property	(10,356		)	(4,122		)	(18,381		)	(11,081		)
Gain on sale of OREO	2,605			2,369			5,971			5,002
Total covered OREO at end of period	$	19,079		$	24,239		$	19,079		$	24,239

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 June 30, 2012, the FDIC loss-sharing asset is comprised of a $120.3 million FDIC indemnification asset and a $19.8 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 loss-sharing agreement.

The following table shows a detailed analysis of the FDIC loss-sharing asset for the three and six months ended June 30, 2012 and 2011:



	Three Months Ended June 30,						Six Months Ended June 30,
	2012			2011			2012			2011
	(in thousands)
Balance at beginning of period	$	159,061		$	193,053		$	175,071		$	205,991
Adjustments not reflected in income
Established through acquisitions	—			68,734			—			68,734
Cash received from the FDIC	(19,508		)	(44,892		)	(34,313		)	(44,892		)
FDIC reimbursable losses, net	618			(782		)	1,081			1,054
Adjustments reflected in income
Amortization, net	(9,851		)	(8,059		)	(23,725		)	(21,628		)
Impairment	9,350			1,841			21,898			1,503
Sale of other real estate	(1,498		)	(1,149		)	(3,565		)	(2,016		)
Write-downs of other real estate	1,732			443			3,362			443
Other	99			505			194			505
Balance at end of period	$	140,003		$	209,694		$	140,003		$	209,694