
	Allowance for Loan and Lease Losses and Unfunded Commitments and Letters of Credit

Loans, excluding PCI loans

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 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 calculated quarterly using quantitative and qualitative information about specific loan classes. The minimum required level with respect to which an entity develops a methodology to determine its ALLL is by general categories of loans, such as commercial business, real estate, and consumer. However, the Company’s methodology in determining its ALLL 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 based upon the consideration of an appropriate look back period.

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 marketplace, 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 or a recovery of previous provisions. 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, 2015 and 2014. 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 make revisions to our ALLL as necessary 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.

PCI Loans

Purchased credit impaired loans that have common risk characteristics are aggregated into loan pools. When required, we record impairment, at the pool-level, to adjust the pool’s carrying value to its net present value of expected future cash flows. Quarterly, we re-measure expected loan pool cash flows. If, due to credit deterioration, the present value of expected cash flows is less than carrying value, we reduce the loan pool’s carrying value by adjusting the ALLL with an impairment charge to earnings which is recorded as provision for loan losses. If credit quality improves and the present value of expected cash flows exceeds carrying value, we increase the loan pool’s carrying value by recapturing previously recorded ALLL, if any. See Note 5, Loans, for further discussion of the accounting for PCI loans.

Credit losses attributable to draws on purchased credit impaired loans, advanced subsequent to the loan purchase date, are accounted for under ASC 450-20 and those amounts are also subject to the Company’s internal and external credit review. An ALLL is estimated in a similar manner as loans, excluding PCI loans, and a provision for loan losses is charged to earnings as necessary.

The following tables show a detailed analysis of the ALLL for the three and nine months ended September 30, 2015 and 2014:



	Beginning Balance		Charge-offs			Recoveries		Provision (Recovery)			Ending Balance		Specific Reserve		General Allocation
Three months ended September 30, 2015	(in thousands)
Commercial business:
Secured	$	27,708	$	(2,439	)	$	530	$	5,189		$	30,988	$	1,020	$	29,968
Unsecured	857		(131		)	93		471			1,290		—		1,290
Real estate:
One-to-four family residential	1,355		—			261		(420		)	1,196		84		1,112
Commercial & multifamily residential:
Commercial land	1,581		—			130		123			1,834		—		1,834
Income property	8,197		(83		)	273		22			8,409		—		8,409
Owner occupied	5,801		(115		)	14		473			6,173		17		6,156
Real estate construction:
One-to-four family residential:
Land and acquisition	497		—			98		(206		)	389		64		325
Residential construction	958		—			7		(250		)	715		—		715
Commercial & multifamily residential:
Income property	407		—			2		(68		)	341		—		341
Owner occupied	441		—			—		(31		)	410		—		410
Consumer	3,182		(311		)	297		49			3,217		14		3,203
Purchased credit impaired	16,174		(3,198		)	1,533		(519		)	13,990		—		13,990
Unallocated	2,099		—			—		(2,002		)	97		—		97
Total	$	69,257	$	(6,277	)	$	3,238	$	2,831		$	69,049	$	1,199	$	67,850
	Beginning Balance		Charge-offs			Recoveries		Provision (Recovery)			Ending Balance		Specific Reserve		General Allocation
Nine months ended September 30, 2015	(in thousands)
Commercial business:
Secured	$	25,923	$	(5,847	)	$	1,242	$	9,670		$	30,988	$	1,020	$	29,968
Unsecured	927		(235		)	208		390			1,290		—		1,290
Real estate:
One-to-four family residential	2,281		(297		)	288		(1,076		)	1,196		84		1,112
Commercial & multifamily residential:
Commercial land	799		—			130		905			1,834		—		1,834
Income property	9,159		(126		)	3,532		(4,156		)	8,409		—		8,409
Owner occupied	5,007		(115		)	36		1,245			6,173		17		6,156
Real estate construction:
One-to-four family residential:
Land and acquisition	1,197		—			101		(909		)	389		64		325
Residential construction	1,860		—			40		(1,185		)	715		—		715
Commercial & multifamily residential:
Income property	622		—			7		(288		)	341		—		341
Owner occupied	434		—			—		(24		)	410		—		410
Consumer	3,180		(1,521		)	707		851			3,217		14		3,203
Purchased credit impaired	16,336		(10,174		)	5,262		2,566			13,990		—		13,990
Unallocated	1,844		—			—		(1,747		)	97		—		97
Total	$	69,569	$	(18,315	)	$	11,553	$	6,242		$	69,049	$	1,199	$	67,850



	Beginning Balance		Charge-offs			Recoveries		Provision (Recovery)			Ending Balance		Specific Reserve		General Allocation
Three months ended September 30, 2014	(in thousands)
Commercial business:
Secured	$	25,519	$	(1,348	)	$	333	$	243		$	24,747	$	39	$	24,708
Unsecured	754		—			23		112			889		11		878
Real estate:
One-to-four family residential	1,083		—			63		230			1,376		124		1,252
Commercial & multifamily residential:
Commercial land	470		—			51		(124		)	397		—		397
Income property	10,511		—			83		(784		)	9,810		—		9,810
Owner occupied	4,990		(7		)	5		(193		)	4,795		31		4,764
Real estate construction:
One-to-four family residential:
Land and acquisition	403		—			3		876			1,282		68		1,214
Residential construction	677		—			18		1,103			1,798		—		1,798
Commercial & multifamily residential:
Income property	414		—			—		535			949		—		949
Owner occupied	166		—			—		168			334		—		334
Consumer	2,643		(620		)	340		502			2,865		—		2,865
Purchased credit impaired	19,801		(3,236		)	1,888		(520		)	17,933		—		17,933
Unallocated	1,864		—			—		(1,168		)	696		—		696
Total	$	69,295	$	(5,211	)	$	2,807	$	980		$	67,871	$	273	$	67,598
	Beginning Balance		Charge-offs			Recoveries		Provision (Recovery)			Ending Balance		Specific Reserve		General Allocation
Nine months ended September 30, 2014	(in thousands)
Commercial business:
Secured	$	31,027	$	(3,188	)	$	2,216	$	(5,308	)	$	24,747	$	39	$	24,708
Unsecured	696		(110		)	342		(39		)	889		11		878
Real estate:
One-to-four family residential	1,252		(207		)	103		228			1,376		124		1,252
Commercial & multifamily residential:
Commercial land	489		(29		)	70		(133		)	397		—		397
Income property	9,234		(1,934		)	601		1,909			9,810		—		9,810
Owner occupied	3,605		(1,030		)	44		2,176			4,795		31		4,764
Real estate construction:
One-to-four family residential:
Land and acquisition	610		—			44		628			1,282		68		1,214
Residential construction	822		—			461		515			1,798		—		1,798
Commercial & multifamily residential:
Income property	285		—			—		664			949		—		949
Owner occupied	58		—			—		276			334		—		334
Consumer	2,547		(2,256		)	931		1,643			2,865		—		2,865
Purchased credit impaired	20,174		(11,350		)	5,690		3,419			17,933		—		17,933
Unallocated	1,655		—			—		(959		)	696		—		696
Total	$	72,454	$	(20,104	)	$	10,502	$	5,019		$	67,871	$	273	$	67,598

Changes in the allowance for unfunded commitments and letters of credit, a component of other liabilities in the consolidated balance sheet, are summarized as follows:



	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2015		2014		2015		2014
	(in thousands)
Balance at beginning of period	$	2,930	$	2,355	$	2,655	$	2,505
Net changes in the allowance for unfunded commitments and letters of credit	—		150		275		—
Balance at end of period	$	2,930	$	2,505	$	2,930	$	2,505

Risk Elements

The extension of credit in the form of loans or other credit products to individuals and businesses is one of our principal business 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 and type of borrower and by limiting the aggregation of debt to a single borrower.

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 nonaccrual 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.

Pass loans are generally considered to have sufficient sources of repayment in order to repay the loan in full in accordance with all terms and conditions. Special mention loans have 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. Loans with a risk rating of Substandard or worse are reported as classified loans in our ALLL 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. Substandard loans reflect loans where a loss is possible if loan weaknesses are not corrected. Doubtful loans have a high probability of loss, however, the amount of loss has not yet been determined. Loss loans are considered uncollectable and when identified, are charged off.

The following is an analysis of the credit quality of our loan portfolio, excluding PCI loans, as of September 30, 2015 and December 31, 2014:



	Pass		Special Mention		Substandard		Doubtful		Loss		Total
September 30, 2015	(in thousands)
Loans, excluding PCI loans:
Commercial business:
Secured	$	2,162,946	$	48,884	$	54,138	$	—	$	—	$	2,265,968
Unsecured	81,902		17		1,820		—		—		83,739
Real estate:
One-to-four family residential	170,685		53		3,379		—		—		174,117
Commercial and multifamily residential:
Commercial land	200,404		6,850		1,158		—		—		208,412
Income property	1,307,536		6,580		8,348		—		—		1,322,464
Owner occupied	870,085		7,363		18,866		—		—		896,314
Real estate construction:
One-to-four family residential:
Land and acquisition	14,379		—		156		—		—		14,535
Residential construction	120,011		—		1,296		—		—		121,307
Commercial and multifamily residential:
Income property	63,182		—		—		—		—		63,182
Owner occupied	68,371		—		872		—		—		69,243
Consumer	333,721		—		2,443		—		—		336,164
Total	$	5,393,222	$	69,747	$	92,476	$	—	$	—	5,555,445
Less:
Allowance for loan and lease losses											55,059
Loans, excluding PCI loans, net											$	5,500,386



	Pass		Special Mention		Substandard		Doubtful		Loss		Total
December 31, 2014	(in thousands)
Loans, excluding PCI loans:
Commercial business:
Secured	$	1,963,210	$	15,790	$	54,628	$	—	$	—	$	2,033,628
Unsecured	79,534		—		559		—		—		80,093
Real estate:
One-to-four family residential	163,914		55		7,795		—		—		171,764
Commercial and multifamily residential:
Commercial land	183,701		4,217		1,861		—		—		189,779
Income property	1,287,729		5,885		8,385		—		—		1,301,999
Owner occupied	825,694		7,876		11,171		—		—		844,741
Real estate construction:
One-to-four family residential:
Land and acquisition	15,307		167		1,036		—		—		16,510
Residential construction	96,031		909		1,581		—		—		98,521
Commercial and multifamily residential:
Income property	73,783		—		—		—		—		73,783
Owner occupied	58,055		—		889		—		—		58,944
Consumer	339,695		68		5,269		—		—		345,032
Total	$	5,086,653	$	34,967	$	93,174	$	—	$	—	5,214,794
Less:
Allowance for loan and lease losses											53,233
Loans, excluding PCI loans, net											$	5,161,561

The following is an analysis of the credit quality of our PCI loan portfolio as of September 30, 2015 and December 31, 2014:



	Pass		Special Mention		Substandard		Doubtful		Loss		Total
September 30, 2015	(in thousands)
PCI loans:
Commercial business:
Secured	$	34,524	$	198	$	8,070	$	—	$	—	$	42,792
Unsecured	1,422		—		20		—		—		1,442
Real estate:
One-to-four family residential	25,581		—		2,994		—		—		28,575
Commercial and multifamily residential:
Commercial land	8,711		—		665		—		—		9,376
Income property	39,457		—		7,007		—		—		46,464
Owner occupied	51,073		—		1,982		—		—		53,055
Real estate construction:
One-to-four family residential:
Land and acquisition	1,168		—		500		—		—		1,668
Residential construction	767		—		12		—		—		779
Commercial and multifamily residential:
Income property	1,322		—		—		—		—		1,322
Owner occupied	903		—		—		—		—		903
Consumer	21,369		—		1,108		—		—		22,477
Total	$	186,297	$	198	$	22,358	$	—	$	—	208,853
Less:
Valuation discount resulting from acquisition accounting											17,787
Allowance for loan losses											13,990
PCI loans, net											$	177,076



	Pass		Special Mention		Substandard		Doubtful		Loss		Total
December 31, 2014	(in thousands)
PCI loans:
Commercial business:
Secured	$	37,927	$	937	$	9,223	$	—	$	—	$	48,087
Unsecured	2,156		—		91		—		—		2,247
Real estate:
One-to-four family residential	28,822		—		3,159		—		—		31,981
Commercial and multifamily residential:
Commercial land	9,104		—		6,240		—		—		15,344
Income property	51,435		1,892		7,186		—		—		60,513
Owner occupied	58,629		346		5,566		—		—		64,541
Real estate construction:
One-to-four family residential:
Land and acquisition	1,595		—		913		—		—		2,508
Residential construction	741		—		1,104		—		—		1,845
Commercial and multifamily residential:
Income property	1,435		—		227		—		—		1,662
Owner occupied	926		—		—		—		—		926
Consumer	24,037		—		2,777		—		—		26,814
Total	$	216,807	$	3,175	$	36,486	$	—	$	—	256,468
Less:
Valuation discount resulting from acquisition accounting											25,884
Allowance for loan losses											16,336
PCI loans, net											$	214,248