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Covered Assets and FDIC Loss-sharing Asset
6 Months Ended
Jun. 30, 2014
Covered Assets And FDIC Loss Sharing Asset  
Covered Assets and FDIC Loss sharing Asset
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 must 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, 2014, the net present value of the Bank’s estimated clawback liability is $4.0 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, 2014 and December 31, 2013:
 
 
June 30, 2014
 
December 31, 2013
Covered loans:
 
(in thousands)
Commercial business
 
$
60,287

 
$
72,870

Real estate:
 
 
 
 
One-to-four family residential
 
36,711

 
41,642

Commercial and multifamily residential
 
153,765

 
170,879

Total real estate
 
190,476

 
212,521

Real estate construction:
 
 
 
 
One-to-four family residential
 
9,444

 
14,781

Commercial and multifamily residential
 
3,910

 
6,869

Total real estate construction
 
13,354

 
21,650

Consumer
 
30,755

 
34,101

Subtotal of covered loans
 
294,872

 
341,142

Less:
 
 
 
 
Valuation discount resulting from acquisition accounting
 
32,971

 
43,297

Allowance for loan losses
 
19,801

 
20,174

Covered loans, net of allowance for loan losses
 
$
242,100

 
$
277,671


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 remeasures 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 remeasurement date. Loss severity factors are based upon either actual charge-off data within the loan pools or industry averages and recovery lags are based upon the collateral within the loan pools.
Acquired impaired 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.
Losses attributable to 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, 2014 and 2013:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2014
 
2013
 
2014
 
2013
 
 
(in thousands)
Balance at beginning of period
 
$
101,543

 
$
158,786

 
$
103,907

 
$
166,888

Accretion
 
(10,055
)
 
(13,520
)
 
(20,624
)
 
(27,997
)
Disposals
 

 
(1,998
)
 
(2,826
)
 
5,151

Reclassifications (to) from nonaccretable difference
 
1,023

 
(2,757
)
 
12,054

 
(3,531
)
Balance at end of period
 
$
92,511

 
$
140,511

 
$
92,511

 
$
140,511


During the three months ended June 30, 2014, the Company recorded a provision for losses on covered loans of $1.5 million. Of this amount, $1.7 million was impairment calculated in accordance with ASC 310-30 and $200 thousand was a provision recapture to adjust the allowance for loss calculated under ASC 450-20 for draws on acquired loans. The impact to earnings of the $1.5 million of provision for covered loans was partially offset through noninterest income by a $1.2 million favorable adjustment to the change FDIC loss-sharing asset line item.
The changes in the ALLL for covered loans for the three and six months ended June 30, 2014 and 2013 are summarized as follows:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2014
 
2013
 
2014
 
2013
 
 
(in thousands)
Balance at beginning of period
 
$
20,129

 
$
29,489

 
$
20,174

 
$
30,056

Loans charged off
 
(3,842
)
 
(2,642
)
 
(8,115
)
 
(5,024
)
Recoveries
 
1,997

 
1,000

 
3,803

 
1,835

Provision (recapture) for loan losses
 
1,517

 
(1,712
)
 
3,939

 
(732
)
Balance at end of period
 
$
19,801

 
$
26,135

 
$
19,801

 
$
26,135


The following is an analysis of the credit quality of our covered loan portfolio as of June 30, 2014 and December 31, 2013:
 
 
Pass
 
Special Mention
 
Substandard
 
Doubtful
 
Loss
 
Total
June 30, 2014
 
(in thousands)
Covered loans:
 
 
 
 
 
 
 
 
 
 
 
 
Commercial business:
 
 
 
 
 
 
 
 
 
 
 
 
Secured
 
$
42,653

 
$
1,151

 
$
14,206

 
$
7

 
$

 
$
58,017

Unsecured
 
2,168

 

 
102

 

 

 
2,270

Real estate:
 
 
 
 
 
 
 
 
 
 
 
 
One-to-four family residential
 
31,618

 

 
5,093

 

 

 
36,711

Commercial and multifamily residential:
 
 
 
 
 
 
 
 
 
 
 
 
Commercial land
 
10,410

 

 
7,253

 

 

 
17,663

Income property
 
56,858

 
3,220

 
7,695

 

 

 
67,773

Owner occupied
 
61,344

 
362

 
6,623

 

 

 
68,329

Real estate construction:
 
 
 
 
 
 
 
 
 
 
 
 
One-to-four family residential:
 
 
 
 
 
 
 
 
 
 
 
 
Land and acquisition
 
3,589

 

 
1,405

 

 

 
4,994

Residential construction
 
420

 

 
4,030

 

 

 
4,450

Commercial and multifamily residential:
 
 
 
 
 
 
 
 
 
 
 
 
Income property
 
1,478

 

 
1,491

 

 

 
2,969

Owner occupied
 
941

 

 

 

 

 
941

Consumer
 
27,531

 

 
3,224

 

 

 
30,755

Total
 
$
239,010

 
$
4,733

 
$
51,122

 
$
7

 
$

 
294,872

Less:
 
 
 
 
 
 
 
 
 
 
 
 
Valuation discount resulting from acquisition accounting
 
32,971

Allowance for loan losses
 
19,801

Covered loans, net
 
$
242,100

 
 
Pass
 
Special Mention
 
Substandard
 
Doubtful
 
Loss
 
Total
December 31, 2013
 
(in thousands)
Covered loans:
 
 
 
 
 
 
 
 
 
 
 
 
Commercial business:
 
 
 
 
 
 
 
 
 
 
 
 
Secured
 
$
48,510

 
$
2,849

 
$
18,291

 
$

 
$

 
$
69,650

Unsecured
 
2,732

 
396

 
92

 

 

 
3,220

Real estate:
 
 
 
 
 
 
 
 
 
 
 
 
One-to-four family residential
 
35,066

 
1,842

 
4,734

 

 

 
41,642

Commercial and multifamily residential:
 
 
 
 
 
 
 
 
 
 
 
 
Commercial land
 
10,778

 
198

 
7,589

 

 

 
18,565

Income property
 
55,985

 
3,950

 
10,657

 

 

 
70,592

Owner occupied
 
67,653

 
111

 
13,958

 

 

 
81,722

Real estate construction:
 
 
 
 
 
 
 
 
 
 
 
 
One-to-four family residential:
 
 
 
 
 
 
 
 
 
 
 
 
Land and acquisition
 
4,674

 
2,739

 
1,936

 

 

 
9,349

Residential construction
 
3,008

 

 
2,424

 

 

 
5,432

Commercial and multifamily residential:
 
 
 
 
 
 
 
 
 
 
 
 
Income property
 
3,806

 

 
1,709

 

 

 
5,515

Owner occupied
 
1,074

 

 
280

 

 

 
1,354

Consumer
 
30,722

 
33

 
3,319

 
27

 

 
34,101

Total
 
$
264,008

 
$
12,118

 
$
64,989

 
$
27

 
$

 
341,142

Less:
 
 
 
 
 
 
 
 
 
 
 
 
Valuation discount resulting from acquisition accounting
 
43,297

Allowance for loan losses
 
20,174

Covered loans, net
 
$
277,671


The following table sets forth activity in covered OREO at carrying value for the three and six months ended June 30, 2014 and 2013:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2014
 
2013
 
2014
 
2013
 
 
(in thousands)
Covered OREO:
 
 
 
 
 
 
 
 
Balance at beginning of period
 
$
14,712

 
$
13,811

 
$
12,093

 
$
16,311

Transfers in
 

 
3,125

 
5,507

 
4,530

Write-downs
 
(338
)
 
(29
)
 
(989
)
 
(94
)
Proceeds from sale of OREO property
 
(2,530
)
 
(7,376
)
 
(5,634
)
 
(13,814
)
Net gain on sale of OREO
 
1,207

 
3,323

 
2,074

 
5,921

Total covered OREO at end of period
 
$
13,051

 
$
12,854

 
$
13,051

 
$
12,854


The covered OREO is subject to loss-sharing agreements with the FDIC in which the FDIC will share in 80% of additional write-downs, as well as gains and losses on covered OREO sales, or 95%, if applicable, of additional write-downs, as wells as gains and losses on covered OREO sales if the minimum loss share thresholds are met.
FDIC Loss-sharing Asset
At June 30, 2014, the FDIC loss-sharing asset is comprised of a $25.0 million FDIC indemnification asset and a $2.9 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 remeasurement 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 remeasurement 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, 2014 and 2013:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2014
 
2013
 
2014
 
2013
 
 
(in thousands)
Balance at beginning of period
 
$
36,837

 
$
83,115

 
$
39,846

 
$
96,354

Adjustments not reflected in income:
 
 
 
 
 
 
 
 
Cash payments from the FDIC
 
(3,442
)
 
(3,268
)
 
(1,765
)
 
(6,387
)
FDIC reimbursable losses (recoveries), net
 
(364
)
 
664

 
(231
)
 
1,027

Adjustments reflected in income:
 
 
 
 
 
 
 
 
Amortization, net
 
(5,764
)
 
(9,801
)
 
(12,216
)
 
(19,580
)
Loan impairment (recapture)
 
1,214

 
(1,370
)
 
3,151

 
(585
)
Sale of other real estate
 
(965
)
 
(2,251
)
 
(1,721
)
 
(3,597
)
Write-downs of other real estate
 
276

 
102

 
792

 
154

Other
 
189

 
183

 
125

 
(12
)
Balance at end of period
 
$
27,981

 
$
67,374

 
$
27,981

 
$
67,374