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

We record an allowance for loan and lease losses (the “allowance”) to recognize management’s estimate of credit losses incurred in the loan portfolio at each balance sheet date. Management’s allowance estimate is measured quarterly and the primary components include allowances related to:


1.	Loans collectively evaluated for impairment under the Contingencies topic of the FASB ASC.


2.	Loans individually determined to be impaired in accordance with the Receivables topic of the FASB ASC.


3.	Purchased credit impaired loans accounted for under the Receivables topic of the FASB ASC.

The allowance for loans collectively evaluated for impairment is measured using quantitative information adjusted by qualitative factors. Quantitative information includes credit loss experience over a historical base period and a loss emergence period estimated by loan product category such as commercial business, commercial real estate, etc. Historical loss experience by loan class incorporates the loan’s risk rating migration from origination to the point of loss. Loan risk ratings are assigned based upon an assessment of the borrower’s ability to service the debt. In the event a borrower experiences financial deterioration such that the primary source of loan repayment is at risk, secondary sources of loan repayment, such as guarantors, are considered.

As conditions likely differ between the historical base period and the balance sheet date, management qualitatively adjusts the historical loss rate to assist in ensuring our allowance estimate reflects current conditions. Such qualitative adjustments include general economic and business conditions affecting our marketplace, seasoning of the loan portfolio, duration of the business cycle, trends with respect to delinquencies and problem loans, etc. In addition, the allowance may include an unallocated amount to recognize factors inherent in our loan portfolio but not otherwise contemplated. Any unallocated amount generally comprises less than 5% of the allowance.

For loans individually determined to be impaired, the Company measures impairment on a loan-by-loan basis using either 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. A specific reserve for such loans is recognized to the extent the measured value is less than the loan’s recorded investment.

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 allowance 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 allowance, if any. See Note 4, 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 the Contingencies topic of the FASB ASC as described above.

We have used the same methodology for allowance calculations during the six months ended June 30, 2016 and 2015. The Company carefully monitors the loan portfolio and continues to emphasize the importance of credit quality. We recognize loan charge-offs when management determines that all or a portion of a loan balance is uncollectable and the uncollectable amount can be reasonably estimated.

The following tables show a detailed analysis of the allowance for the three and six months ended June 30, 2016 and 2015:



	Beginning Balance		Charge-offs			Recoveries		Provision (Recovery)			Ending Balance		Specific Reserve		General Allocation
Three months ended June 30, 2016	(in thousands)
Commercial business:
Secured	$	32,114	$	(2,900	)	$	728	$	1,866		$	31,808	$	2,486	$	29,322
Unsecured	1,300		(41		)	25		(19		)	1,265		—		1,265
Real estate:
One-to-four family residential	654		(35		)	20		35			674		1		673
Commercial & multifamily residential:
Commercial land	1,262		(26		)	2		184			1,422		—		1,422
Income property	7,402		—			120		524			8,046		100		7,946
Owner occupied	6,086		—			8		242			6,336		—		6,336
Real estate construction:
One-to-four family residential:
Land and acquisition	640		—			2		(55		)	587		—		587
Residential construction	1,449		—			3		(76		)	1,376		—		1,376
Commercial & multifamily residential:
Income property	715		—			1		188			904		—		904
Owner occupied	1,210		—			—		174			1,384		—		1,384
Consumer	3,368		(334		)	201		325			3,560		118		3,442
Purchased credit impaired	13,064		(2,898		)	1,524		91			11,781		—		11,781
Unallocated	—		—			—		161			161		—		161
Total	$	69,264	$	(6,234	)	$	2,634	$	3,640		$	69,304	$	2,705	$	66,599
	Beginning Balance		Charge-offs			Recoveries		Provision (Recovery)			Ending Balance		Specific Reserve		General Allocation
Six months ended June 30, 2016	(in thousands)
Commercial business:
Secured	$	32,321	$	(6,670	)	$	1,339	$	4,818		$	31,808	$	2,486	$	29,322
Unsecured	1,299		(44		)	76		(66		)	1,265		—		1,265
Real estate:
One-to-four family residential	916		(35		)	61		(268		)	674		1		673
Commercial & multifamily residential:
Commercial land	1,178		(26		)	2		268			1,422		—		1,422
Income property	6,616		—			181		1,249			8,046		100		7,946
Owner occupied	5,550		—			16		770			6,336		—		6,336
Real estate construction:
One-to-four family residential:
Land and acquisition	339		—			53		195			587		—		587
Residential construction	733		—			206		437			1,376		—		1,376
Commercial & multifamily residential:
Income property	388		—			2		514			904		—		904
Owner occupied	1,006		—			—		378			1,384		—		1,384
Consumer	3,531		(600		)	366		263			3,560		118		3,442
Purchased credit impaired	13,726		(5,764		)	3,075		744			11,781		—		11,781
Unallocated	569		—			—		(408		)	161		—		161
Total	$	68,172	$	(13,139	)	$	5,377	$	8,894		$	69,304	$	2,705	$	66,599



	Beginning Balance		Charge-offs			Recoveries		Provision (Recovery)			Ending Balance		Specific Reserve		General Allocation
Three months ended June 30, 2015	(in thousands)
Commercial business:
Secured	$	25,761	$	(2,022	)	$	200	$	3,769		$	27,708	$	1,161	$	26,547
Unsecured	1,012		(64		)	9		(100		)	857		—		857
Real estate:
One-to-four family residential	1,364		(289		)	15		265			1,355		111		1,244
Commercial & multifamily residential:
Commercial land	827		—			—		754			1,581		—		1,581
Income property	8,440		(43		)	7		(207		)	8,197		—		8,197
Owner occupied	5,612		—			13		176			5,801		20		5,781
Real estate construction:
One-to-four family residential:
Land and acquisition	1,026		—			1		(530		)	497		66		431
Residential construction	1,790		—			7		(839		)	958		—		958
Commercial & multifamily residential:
Income property	827		—			2		(422		)	407		—		407
Owner occupied	499		—			—		(58		)	441		—		441
Consumer	2,835		(319		)	137		529			3,182		—		3,182
Purchased credit impaired	16,531		(2,876		)	2,043		476			16,174		—		16,174
Unallocated	3,710		—			—		(1,611		)	2,099		—		2,099
Total	$	70,234	$	(5,613	)	$	2,434	$	2,202		$	69,257	$	1,358	$	67,899
	Beginning Balance		Charge-offs			Recoveries		Provision (Recovery)			Ending Balance		Specific Reserve		General Allocation
Six months ended June 30, 2015	(in thousands)
Commercial business:
Secured	$	25,923	$	(3,408	)	$	712	$	4,481		$	27,708	$	1,161	$	26,547
Unsecured	927		(104		)	115		(81		)	857		—		857
Real estate:
One-to-four family residential	2,281		(297		)	27		(656		)	1,355		111		1,244
Commercial & multifamily residential:
Commercial land	799		—			—		782			1,581		—		1,581
Income property	9,159		(43		)	3,259		(4,178		)	8,197		—		8,197
Owner occupied	5,007		—			22		772			5,801		20		5,781
Real estate construction:
One-to-four family residential:
Land and acquisition	1,197		—			3		(703		)	497		66		431
Residential construction	1,860		—			33		(935		)	958		—		958
Commercial & multifamily residential:
Income property	622		—			5		(220		)	407		—		407
Owner occupied	434		—			—		7			441		—		441
Consumer	3,180		(1,210		)	410		802			3,182		—		3,182
Purchased credit impaired	16,336		(6,976		)	3,729		3,085			16,174		—		16,174
Unallocated	1,844		—			—		255			2,099		—		2,099
Total	$	69,569	$	(12,038	)	$	8,315	$	3,411		$	69,257	$	1,358	$	67,899

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					Six Months Ended
	June 30,					June 30,
	2016			2015		2016			2015
	(in thousands)
Balance at beginning of period	$	2,930		$	2,655	$	2,930		$	2,655
Net changes in the allowance for unfunded commitments and letters of credit	(150		)	275		(150		)	275
Balance at end of period	$	2,780		$	2,930	$	2,780		$	2,930

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 rated 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 rated 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 allowance 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. Loans risk rated as Substandard reflect loans where a loss is possible if loan weaknesses are not corrected. Doubtful rated loans have a high probability of loss, however, the amount of loss has not yet been determined. Loss rated 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 June 30, 2016 and December 31, 2015:



	Pass		Special Mention		Substandard		Doubtful		Loss		Total
June 30, 2016	(in thousands)
Loans, excluding PCI loans:
Commercial business:
Secured	$	2,297,510	$	76,014	$	43,897	$	—	$	—	$	2,417,421
Unsecured	96,551		277		62		—		—		96,890
Real estate:
One-to-four family residential	168,559		514		1,099		—		—		170,172
Commercial and multifamily residential:
Commercial land	227,322		6,544		341		—		—		234,207
Income property	1,344,005		17,095		11,007		—		—		1,372,107
Owner occupied	1,005,059		5,791		13,596		—		—		1,024,446
Real estate construction:
One-to-four family residential:
Land and acquisition	10,708		—		—		—		—		10,708
Residential construction	117,022		—		842		—		—		117,864
Commercial and multifamily residential:
Income property	78,867		—		—		—		—		78,867
Owner occupied	100,341		—		4,555		—		—		104,896
Consumer	309,831		—		8,627		—		—		318,458
Total	$	5,755,775	$	106,235	$	84,026	$	—	$	—	5,946,036
Less:
Allowance for loan and lease losses											57,523
Loans, excluding PCI loans, net											$	5,888,513



	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 and lease losses											54,446
Loans, excluding PCI loans, net											$	5,579,675

The following is an analysis of the credit quality of our PCI loan portfolio as of June 30, 2016 and December 31, 2015:



	Pass		Special Mention		Substandard		Doubtful		Loss		Total
June 30, 2016	(in thousands)
PCI loans:
Commercial business:
Secured	$	24,135	$	96	$	3,298	$	—	$	—	$	27,529
Unsecured	919		—		1		—		—		920
Real estate:
One-to-four family residential	21,966		—		1,742		—		—		23,708
Commercial and multifamily residential:
Commercial land	7,877		—		395		—		—		8,272
Income property	30,893		—		4,496		—		—		35,389
Owner occupied	55,866		—		1,674		—		—		57,540
Real estate construction:
One-to-four family residential:
Land and acquisition	794		—		144		—		—		938
Residential construction	401		—		321		—		—		722
Commercial and multifamily residential:
Income property	1,263		—		—		—		—		1,263
Owner occupied	520		—		—		—		—		520
Consumer	18,470		—		327		—		—		18,797
Total	$	163,104	$	96	$	12,398	$	—	$	—	175,598
Less:
Valuation discount resulting from acquisition accounting											14,491
Allowance for loan losses											11,781
PCI loans, net											$	149,326



	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