
5.	Allowance for Noncovered Loan and Lease Losses and Unfunded Commitments and Letters of Credit

We maintain an allowance for loan and lease losses (“ALLL”) to absorb losses inherent in the loan portfolio. The size of the ALLL is determined through quarterly assessments of the probable estimated losses in the loan portfolio. Our methodology for making such assessments and determining the adequacy of the ALLL includes the following key elements:


1.	General valuation allowance consistent with the Contingencies topic of the FASB Accounting Standards Codification ("ASC").


2.	Classified loss reserves on specific relationships. Specific allowances for identified problem loans are determined in accordance with the Receivables topic of the FASB ASC.


3.	The unallocated allowance provides for other factors inherent in our loan portfolio that may not have been contemplated in the general and specific components of the allowance. This unallocated amount generally comprises less than 5% of the allowance. The unallocated amount is reviewed quarterly based on trends in credit losses, the results of credit reviews and overall economic trends.

The general valuation allowance is systematically calculated quarterly using quantitative and qualitative information about specific loan classes. The minimum required level an entity develops a methodology to determine its allowance for loan and lease losses is by general categories of loans, such as commercial business, real estate, and consumer. However, the Company’s methodology in determining its allowance for loan and lease losses is prepared in a more detailed manner at the loan class level, utilizing specific categories such as commercial business secured, commercial business unsecured, real estate commercial land, and real estate income property multifamily. The quantitative information uses historical losses from a specific loan class and incorporates the loan’s risk rating migration from origination to the point of loss.

A loan’s risk rating is primarily determined based upon the borrower’s ability to fulfill its debt obligation from a cash flow perspective. In the event there is financial deterioration of the borrower, the borrower’s other sources of income or repayment are also considered, including recent appraisal values for collateral dependent loans. The qualitative information takes into account general economic and business conditions affecting our market place, seasoning of the loan portfolio, duration of the business cycle, etc. to ensure our methodologies reflect the current economic environment and other factors as using historical loss information exclusively may not give an accurate estimate of inherent losses within the Company’s loan portfolio.

When a loan is deemed to be impaired, the Company has to determine if a specific valuation allowance is required for that loan. The specific valuation allowance is a reserve, calculated at the individual loan level, for each loan determined to be both impaired and containing a value less than its recorded investment. The Company measures the impairment based on the discounted expected future cash flows, observable market price, or the fair value of the collateral less selling costs if the loan is collateral dependent or if foreclosure is probable. The specific reserve for each loan is equal to the difference between the recorded investment in the loan and its determined impairment value.

The ALLL is increased by provisions for loan and lease losses (“provision”) charged to expense, and is reduced by loans charged off, net of recoveries. While the Company’s management believes the best information available is used to determine the ALLL, changes in market conditions could result in adjustments to the ALLL, affecting net income, if circumstances differ from the assumptions used in determining the ALLL.

We have used the same methodology for ALLL calculations during the nine months ended September 30, 2012 and 2011. Adjustments to the percentages of the ALLL allocated to loan categories are made based on trends with respect to delinquencies and problem loans within each class of loans. The Company reviews the ALLL quantitative and qualitative methodology on a quarterly basis and makes adjustments when appropriate. The Company continues to strive towards maintaining a conservative approach to credit quality and will continue to prudently adjust our ALLL as necessary in order to maintain adequate reserves. The Company carefully monitors the loan portfolio and continues to emphasize the importance of credit quality.

Once it is determined that all or a portion of a loan balance is uncollectable, and the amount can be reasonably estimated, the uncollectable portion of the loan is charged-off.

The following tables show a detailed analysis of the allowance for loan and lease losses for noncovered loans for the three and nine months ended September 30, 2012 and 2011:



	Beginning Balance		Charge-offs			Recoveries		Provision (Recovery)			Ending Balance		Specific Reserve		General Allocation
Three months ended September 30, 2012	(in thousands)
Noncovered loans:
Commercial business
Secured	$	26,505	$	(3,744	)	$	194	$	3,007		$	25,962	$	315	$	25,647
Unsecured	772		(31		)	83		(56		)	768		100		668
Real estate:
One-to-four family residential	673		(49		)	157		(216		)	565		69		496
Commercial & multifamily residential
Commercial land	270		(55		)	—		207			422		1		421
Income property multifamily	8,726		(436		)	357		387			9,034		—		9,034
Owner occupied	9,037		(101		)	89		(694		)	8,331		245		8,086
Real estate construction:
One-to-four family residential
Land and acquisition	1,651		(307		)	404		(279		)	1,469		—		1,469
Residential construction	1,197		(18		)	—		3			1,182		—		1,182
Commercial & multifamily residential
Income property multifamily	755		—			63		(456		)	362		—		362
Owner occupied	68		—			—		23			91		—		91
Consumer	2,049		(500		)	350		267			2,166		—		2,166
Unallocated	493		—			—		682			1,175		—		1,175
Total	$	52,196	$	(5,241	)	$	1,697	$	2,875		$	51,527	$	730	$	50,797
	Beginning Balance		Charge-offs			Recoveries		Provision (Recovery)			Ending Balance		Specific Reserve		General Allocation
Nine months ended September 30, 2012	(in thousands)
Noncovered loans:
Commercial business
Secured	$	24,745	$	(8,126	)	$	1,184	$	8,159		$	25,962	$	315	$	25,647
Unsecured	689		(52		)	130		1			768		100		668
Real estate:
One-to-four family residential	654		(499		)	202		208			565		69		496
Commercial & multifamily residential
Commercial land	488		(437		)	—		371			422		1		421
Income property multifamily	9,551		(3,959		)	710		2,732			9,034		—		9,034
Owner occupied	9,606		(712		)	628		(1,191		)	8,331		245		8,086
Real estate construction:
One-to-four family residential
Land and acquisition	2,331		(809		)	827		(880		)	1,469		—		1,469
Residential construction	864		(617		)	79		856			1,182		—		1,182
Commercial & multifamily residential
Income property multifamily	665		(93		)	64		(274		)	362		—		362
Owner occupied	35		—			—		56			91		—		91
Consumer	2,719		(1,968		)	809		606			2,166		—		2,166
Unallocated	694		—			—		481			1,175		—		1,175
Total	$	53,041	$	(17,272	)	$	4,633	$	11,125		$	51,527	$	730	$	50,797



	Beginning Balance		Charge-offs			Recoveries		Provision (Recovery)			Ending Balance		Specific Reserve		General Allocation
Three months ended September 30, 2011	(in thousands)
Noncovered loans:
Commercial business
Secured	$	22,320	$	(1,904	)	$	420	$	2,462		$	23,298	$	54	$	23,244
Unsecured	573		(42		)	40		167			738		—		738
Real estate:
One-to-four family residential	847		(53		)	78		70			942		—		942
Commercial & multifamily residential
Commercial land	894		(4		)	—		(130		)	760		—		760
Income property multifamily	14,709		(339		)	10		(5,407		)	8,973		297		8,676
Owner occupied	6,479		(100		)	—		311			6,690		408		6,282
Real estate construction:
One-to-four family residential
Land and acquisition	2,852		(169		)	63		269			3,015		175		2,840
Residential construction	1,704		(14		)	56		(222		)	1,524		—		1,524
Commercial & multifamily residential
Income property multifamily	43		(145		)	—		157			55		—		55
Owner occupied	34		—			—		(7		)	27		—		27
Consumer	2,748		(2,102		)	70		2,985			3,701		32		3,669
Unallocated	854		—			—		(155		)	699		—		699
Total	$	54,057	$	(4,872	)	$	737	$	500		$	50,422	$	966	$	49,456
	Beginning Balance		Charge-offs			Recoveries		Provision (Recovery)			Ending Balance		Specific Reserve		General Allocation
Nine months ended September 30, 2011	(in thousands)
Noncovered loans:
Commercial business
Secured	$	21,811	$	(6,025	)	$	749	$	6,763		$	23,298	$	54	$	23,244
Unsecured	738		(126		)	408		(282		)	738		—		738
Real estate:
One-to-four family residential	1,100		(717		)	78		481			942		—		942
Commercial & multifamily residential
Commercial land	634		(660		)	—		786			760		—		760
Income property multifamily	15,210		(979		)	65		(5,323		)	8,973		297		8,676
Owner occupied	9,692		(723		)	31		(2,310		)	6,690		408		6,282
Real estate construction:
One-to-four family residential
Land and acquisition	3,769		(1,347		)	1,831		(1,238		)	3,015		175		2,840
Residential construction	2,292		(1,068		)	92		208			1,524		—		1,524
Commercial & multifamily residential
Income property multifamily	274		(1,710		)	—		1,491			55		—		55
Owner occupied	70		—			—		(43		)	27		—		27
Consumer	2,120		(3,298		)	178		4,701			3,701		32		3,669
Unallocated	3,283		—			—		(2,584		)	699		—		699
Total	$	60,993	$	(16,653	)	$	3,432	$	2,650		$	50,422	$	966	$	49,456

Changes in the allowance for unfunded commitments and letters of credit are summarized as follows:



	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2012		2011		2012		2011
	(in thousands)
Balance at beginning of period	$	1,665	$	1,460	$	1,535	$	1,165
Net changes in the allowance for unfunded commitments and letters of credit	250		—		380		295
Balance at end of period	$	1,915	$	1,460	$	1,915	$	1,460

Risk Elements

The extension of credit in the form of loans to individuals and businesses is one of our principal commerce activities. Our policies and applicable laws and regulations require risk analysis as well as ongoing portfolio and credit management. We manage our credit risk through lending limit constraints, credit review, approval policies and extensive, ongoing internal monitoring. We also manage credit risk through diversification of the loan portfolio by type of loan, type of industry, type of borrower and by limiting the aggregation of debt to a single borrower.

The monitoring process for the loan portfolio includes periodic reviews of individual loans with risk ratings assigned to each loan. Based on the analysis, loans are given a risk rating of 1-10 based on the following criteria:


•	ratings of 1-3 indicate minimal to low credit risk,


•	ratings of 4-5 indicate an average credit risk with adequate repayment capacity when prolonged periods of adversity do not exist,


•	rating of 6 indicate higher than average risk requiring greater than routine attention by bank personnel due to conditions affecting the borrower, the borrower's industry or economic environment,


•	rating of 7 indicate potential weaknesses that, if left uncorrected, may result in deterioration of the repayment prospects for the asset or in the Company's credit position at some future date,


•	rating of 8 indicates a loss is possible if loan weaknesses are not corrected,


•	rating of 9 indicates loss is highly probable; however, the amount of loss has not yet been determined,


•	and a rating of 10 indicates the loan is uncollectable, and when identified is charged-off.

Loans with a risk rating of 1-6 are considered Pass loans and loans with risk ratings of 7, 8, 9 and 10 are considered Special Mention, Substandard, Doubtful and Loss, respectively. Loans with a risk rating of Substandard or worse are reported as classified loans in our allowance for loan and lease losses analysis. We review these loans to assess the ability of our borrowers to service all interest and principal obligations and, as a result, the risk rating may be adjusted accordingly. Risk ratings are reviewed and updated whenever appropriate, with more periodic reviews as the risk and dollar value of loss on the loan increases. In the event full collection of principal and interest is not reasonably assured, the loan is appropriately downgraded and, if warranted, placed on non-accrual status even though the loan may be current as to principal and interest payments. Additionally, we assess whether an impairment of a loan warrants specific reserves or a write-down of the loan.

The following is an analysis of the credit quality of our noncovered loan portfolio as of September 30, 2012 and December 31, 2011:



	Pass		Special Mention		Substandard		Doubtful		Loss		Total
September 30, 2012	(in thousands)
Noncovered loans:
Commercial business:
Secured	$	1,024,510	$	18,596	$	53,893	$	—	$	—	$	1,096,999
Unsecured	41,496		26		544		—		—		42,066
Real estate:
One-to-four family residential	45,393		407		2,025		—		—		47,825
Commercial and multifamily residential:
Commercial land	39,842		—		4,047		—		—		43,889
Income property multifamily	557,868		8,496		19,514		—		—		585,878
Owner occupied	356,582		3,940		37,797		—		—		398,319
Real estate construction:
One-to-four family residential:
Land and acquisition	11,467		2,035		5,580		—		—		19,082
Residential construction	25,130		476		5,324		—		—		30,930
Commercial and multifamily residential:
Income property multifamily	27,027		—		—		—		—		27,027
Owner occupied	23,974		—		—		—		—		23,974
Consumer	154,853		298		5,634		70		—		160,855
Total	$	2,308,142	$	34,274	$	134,358	$	70	$	—	2,476,844
Less:
Allowance for loan losses											51,527
Noncovered loans, net											$	2,425,317



	Pass		Special Mention		Substandard		Doubtful		Loss		Total
December 31, 2011	(in thousands)
Noncovered loans:
Commercial business:
Secured	$	908,883	$	18,703	$	53,447	$	384	$	—	$	981,417
Unsecured	46,732		318		356		—		—		47,406
Real estate:
One-to-four family residential	58,517		2,040		3,506		—		—		64,063
Commercial and multifamily residential:
Commercial land	44,166		5		6,510		—		—		50,681
Income property multifamily	492,922		16,002		25,069		—		—		533,993
Owner occupied	351,928		13,590		39,266		—		5		404,789
Real estate construction:
One-to-four family residential:
Land and acquisition	12,349		2,684		10,168		—		—		25,201
Residential construction	16,764		1,649		5,518		—		—		23,931
Commercial and multifamily residential:
Income property multifamily	12,812		—		8,065		—		—		20,877
Owner occupied	12,790		—		—		—		—		12,790
Consumer	176,304		859		6,060		—		—		183,223
Total	$	2,134,167	$	55,850	$	157,965	$	384	$	5	2,348,371
Less:
Allowance for loan losses											53,041
Noncovered loans, net											$	2,295,330