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 nine months ended September 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 nine months ended September 30, 2016 and 2015:



	Beginning Balance		Charge-offs			Recoveries		Provision (Recovery)			Ending Balance		Specific Reserve		General Allocation
Three months ended September 30, 2016	(in thousands)
Commercial business:
Secured	$	31,808	$	(2,128	)	$	787	$	2,008		$	32,475	$	873	$	31,602
Unsecured	1,265		(31		)	67		(128		)	1,173		—		1,173
Real estate:
One-to-four family residential	675		—			81		221			977		353		624
Commercial & multifamily residential:
Commercial land	1,422		—			—		92			1,514		—		1,514
Income property	8,046		—			10		149			8,205		28		8,177
Owner occupied	6,336		—			10		487			6,833		—		6,833
Real estate construction:
One-to-four family residential:
Land and acquisition	587		—			2		(134		)	455		—		455
Residential construction	1,376		—			19		(393		)	1,002		—		1,002
Commercial & multifamily residential:
Income property	904		—			107		(480		)	531		—		531
Owner occupied	1,384		—			—		57			1,441		—		1,441
Consumer	3,559		(383		)	399		168			3,743		46		3,697
Purchased credit impaired	11,781		(2,062		)	2,216		(433		)	11,502		—		11,502
Unallocated	161		—			—		252			413		—		413
Total	$	69,304	$	(4,604	)	$	3,698	$	1,866		$	70,264	$	1,300	$	68,964
	Beginning Balance		Charge-offs			Recoveries		Provision (Recovery)			Ending Balance		Specific Reserve		General Allocation
Nine months ended September 30, 2016	(in thousands)
Commercial business:
Secured	$	32,321	$	(8,798	)	$	2,126	$	6,826		$	32,475	$	873	$	31,602
Unsecured	1,299		(75		)	143		(194		)	1,173		—		1,173
Real estate:
One-to-four family residential	916		(35		)	142		(46		)	977		353		624
Commercial & multifamily residential:
Commercial land	1,178		(26		)	2		360			1,514		—		1,514
Income property	6,616		—			191		1,398			8,205		28		8,177
Owner occupied	5,550		—			26		1,257			6,833		—		6,833
Real estate construction:
One-to-four family residential:
Land and acquisition	339		—			55		61			455		—		455
Residential construction	733		—			225		44			1,002		—		1,002
Commercial & multifamily residential:
Income property	388		—			109		34			531		—		531
Owner occupied	1,006		—			—		435			1,441		—		1,441
Consumer	3,531		(983		)	765		430			3,743		46		3,697
Purchased credit impaired	13,726		(7,826		)	5,291		311			11,502		—		11,502
Unallocated	569		—			—		(156		)	413		—		413
Total	$	68,172	$	(17,743	)	$	9,075	$	10,760		$	70,264	$	1,300	$	68,964



	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

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,
	2016		2015		2016			2015
	(in thousands)
Balance at beginning of period	$	2,780	$	2,930	$	2,930		$	2,655
Net changes in the allowance for unfunded commitments and letters of credit	125		—		(25		)	275
Balance at end of period	$	2,905	$	2,930	$	2,905		$	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 September 30, 2016 and December 31, 2015:



	Pass		Special Mention		Substandard		Doubtful		Loss		Total
September 30, 2016	(in thousands)
Loans, excluding PCI loans:
Commercial business:
Secured	$	2,417,653	$	48,462	$	61,544	$	—	$	—	$	2,527,659
Unsecured	96,402		800		335		—		—		97,537
Real estate:
One-to-four family residential	164,102		458		1,380		—		—		165,940
Commercial and multifamily residential:
Commercial land	233,795		5,276		950		—		—		240,021
Income property	1,354,651		17,048		7,083		—		—		1,378,782
Owner occupied	1,027,356		5,745		14,494		—		—		1,047,595
Real estate construction:
One-to-four family residential:
Land and acquisition	12,052		—		—		—		—		12,052
Residential construction	116,187		—		1,119		—		—		117,306
Commercial and multifamily residential:
Income property	89,373		—		—		—		—		89,373
Owner occupied	106,310		—		4,543		—		—		110,853
Consumer	312,602		—		7,273		—		—		319,875
Total	$	5,930,483	$	77,789	$	98,721	$	—	$	—	6,106,993
Less:
Allowance for loan and lease losses											58,762
Loans, excluding PCI loans, net											$	6,048,231



	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 September 30, 2016 and December 31, 2015:



	Pass		Special Mention		Substandard		Doubtful		Loss		Total
September 30, 2016	(in thousands)
PCI loans:
Commercial business:
Secured	$	21,420	$	94	$	2,191	$	—	$	—	$	23,705
Unsecured	731		—		—		—		—		731
Real estate:
One-to-four family residential	20,996		—		1,231		—		—		22,227
Commercial and multifamily residential:
Commercial land	7,745		—		392		—		—		8,137
Income property	31,481		—		2,445		—		—		33,926
Owner occupied	54,471		—		1,644		—		—		56,115
Real estate construction:
One-to-four family residential:
Land and acquisition	767		—		100		—		—		867
Residential construction	—		—		—		—		—		—
Commercial and multifamily residential:
Income property	1,239		—		—		—		—		1,239
Owner occupied	515		—		—		—		—		515
Consumer	17,168		—		464		—		—		17,632
Total	$	156,533	$	94	$	8,467	$	—	$	—	165,094
Less:
Valuation discount resulting from acquisition accounting											12,330
Allowance for loan losses											11,502
PCI loans, net											$	141,262



	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