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 2015, 2014 and 2013. 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 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 loans for the years ended December 31, 2015, 2014 and 2013:



	Beginning Balance		Charge-offs			Recoveries		Provision (Recovery)			Ending Balance		Specific Reserve		General Allocation
Year Ended December 31, 2015	(in thousands)
Commercial business:
Secured	$	25,923	$	(7,486	)	$	2,069	$	11,815		$	32,321	$	321	$	32,000
Unsecured	927		(780		)	267		885			1,299		—		1,299
Real estate:
One-to-four family residential	2,281		(376		)	307		(1,296		)	916		314		602
Commercial and multifamily residential:
Commercial land	799		—			291		88			1,178		—		1,178
Income property	9,159		(390		)	3,568		(5,721		)	6,616		—		6,616
Owner occupied	5,007		(115		)	116		542			5,550		—		5,550
Real estate construction:
One-to-four family residential:
Land and acquisition	1,197		—			103		(961		)	339		—		339
Residential construction	1,860		—			90		(1,217		)	733		3		730
Commercial and multifamily residential:
Income property	622		—			8		(242		)	388		—		388
Owner occupied	434		—			—		572			1,006		—		1,006
Consumer	3,180		(2,066		)	931		1,486			3,531		15		3,516
Purchased credit impaired	16,336		(13,854		)	7,329		3,915			13,726		—		13,726
Unallocated	1,844		—			—		(1,275		)	569		—		569
Total	$	69,569	$	(25,067	)	$	15,079	$	8,591		$	68,172	$	653	$	67,519



	Beginning Balance		Charge-offs			Recoveries		Provision (Recovery)			Ending Balance		Specific Reserve		General Allocation
Year Ended December 31, 2014	(in thousands)
Commercial business:
Secured	$	31,027	$	(4,159	)	$	2,637	$	(3,582	)	$	25,923	$	25	$	25,898
Unsecured	696		(130		)	370		(9		)	927		2		925
Real estate:
One-to-four family residential	1,252		(230		)	159		1,100			2,281		120		2,161
Commercial and multifamily residential:
Commercial land	489		(29		)	70		269			799		—		799
Income property	9,234		(1,934		)	819		1,040			9,159		—		9,159
Owner occupied	3,605		(1,030		)	51		2,381			5,007		27		4,980
Real estate construction:
One-to-four family residential:
Land and acquisition	610		—			740		(153		)	1,197		67		1,130
Residential construction	822		—			1,190		(152		)	1,860		—		1,860
Commercial and multifamily residential:
Income property	285		—			—		337			622		—		622
Owner occupied	58		—			—		376			434		—		434
Consumer	2,547		(2,774		)	1,353		2,054			3,180		—		3,180
Purchased credit impaired	20,174		(14,436		)	7,721		2,877			16,336		—		16,336
Unallocated	1,655		—			—		189			1,844		—		1,844
Total	$	72,454	$	(24,722	)	$	15,110	$	6,727		$	69,569	$	241	$	69,328



	Beginning Balance		Charge-offs			Recoveries		Provision (Recovery)			Ending Balance		Specific Reserve		General Allocation
Year ended December 31, 2013	(in thousands)
Commercial business:
Secured	$	27,270	$	(4,148	)	$	1,512	$	6,393		$	31,027	$	343	$	30,684
Unsecured	753		(794		)	932		(195		)	696		35		661
Real estate:
One-to-four family residential	694		(228		)	270		516			1,252		138		1,114
Commercial and multifamily residential:
Commercial land	460		(20		)	169		(120		)	489		—		489
Income property	11,033		(1,405		)	489		(883		)	9,234		26		9,208
Owner occupied	6,362		(1,118		)	375		(2,014		)	3,605		1,073		2,532
Real estate construction:
One-to-four family residential:
Land and acquisition	1,171		(32		)	2,553		(3,082		)	610		71		539
Residential construction	635		(101		)	112		176			822		—		822
Commercial and multifamily residential:
Income property	316		—			—		(31		)	285		—		285
Owner occupied	102		—			—		(44		)	58		—		58
Consumer	2,437		(2,242		)	552		1,800			2,547		4		2,543
Purchased credit impaired	30,056		(13,853		)	7,232		(3,261		)	20,174		—		20,174
Unallocated	1,011		—			—		644			1,655		—		1,655
Total	$	82,300	$	(23,941	)	$	14,196	$	(101	)	$	72,454	$	1,690	$	70,764

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:



	Years Ended December 31,
	2015		2014		2013
	(in thousands)
Beginning balance	$	2,655	$	2,505	$	1,915
Net changes in the allowance for unfunded commitments and letters of credit	275		150		590
Ending balance	$	2,930	$	2,655	$	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 December 31, 2015 and 2014:



	Pass		Special Mention		Substandard		Doubtful		Loss		Total
December 31, 2015	(in thousands)
Loans, excluding PCI loans
Commercial business:
Secured	$	2,146,729	$	59,746	$	56,217	$	—	$	—	$	2,262,692
Unsecured	93,347		278		1,323		—		—		94,948
Real estate:
One-to-four family residential	171,945		52		1,439		—		—		173,436
Commercial and multifamily residential:
Commercial land	207,768		4,966		424		—		—		213,158
Income property	1,296,043		5,889		8,847		—		—		1,310,779
Owner occupied	918,986		9,668		17,662		—		—		946,316
Real estate construction:
One-to-four family residential:
Land and acquisition	14,388		—		362		—		—		14,750
Residential construction	119,243		—		1,132		—		—		120,375
Commercial and multifamily residential:
Income property	83,634		—		—		—		—		83,634
Owner occupied	81,270		—		401		—		—		81,671
Consumer	328,286		—		4,076		—		—		332,362
Total	$	5,461,639	$	80,599	$	91,883	$	—	$	—	5,634,121
Less:
Allowance for loan losses											54,446
Loans, excluding PCI loans, net											$	5,579,675



	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 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 December 31, 2015 and 2014:



	Pass		Special Mention		Substandard		Doubtful		Loss		Total
December 31, 2015	(in thousands)
PCI loans:
Commercial business:
Secured	$	31,468	$	101	$	5,995	$	—	$	—	$	37,564
Unsecured	1,218		—		2		—		—		1,220
Real estate:
One-to-four family residential	25,018		—		2,177		—		—		27,195
Commercial and multifamily residential:
Commercial land	8,234		—		664		—		—		8,898
Income property	36,426		—		5,916		—		—		42,342
Owner occupied	53,071		261		1,736		—		—		55,068
Real estate construction:
One-to-four family residential:
Land and acquisition	1,086		—		479		—		—		1,565
Residential construction	427		—		334		—		—		761
Commercial and multifamily residential:
Income property	1,303		—		—		—		—		1,303
Owner occupied	531		—		—		—		—		531
Consumer	20,122		—		781		—		—		20,903
Total	$	178,904	$	362	$	18,084	$	—	$	—	197,350
Less:
Valuation discount resulting from acquisition accounting											16,444
Allowance for loan losses											13,726
PCI loans, net											$	167,180



	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