Allowance for Loan Losses and Credit Quality Information | 6. ALLOWANCE FOR LOAN LOSSES AND CREDIT QUALITY INFORMATION Allowance for Loan Losses We maintain an allowance for loan losses (allowance) and charge losses to this allowance when such losses are realized. We established our allowance for loan losses in accordance with guidance provided in the SEC’s Staff Accounting Bulletin 102 (SAB 102) and FASB ASC 450, Contingencies • Specific reserves for impaired loans • An allowance for each pool of homogenous loans based on historical loss experience • Adjustments for qualitative and environmental factors allocated to pools of homogenous loans • Allowance for model estimation and complexity risk When it is probable that the Bank will be unable to collect all amounts due (interest and principal) in accordance with the contractual terms of the loan agreement, it assigns a specific reserve to that loan, if necessary. Unless loans are well-secured and collection is imminent, loans greater than 90 days past due are deemed impaired and their respective reserves are generally charged-off once the loss has been confirmed. Estimated specific reserves are based on collateral values, estimates of future cash flows or market valuations. We charge loans off when they are deemed to be uncollectible. During the six months ended June 30, 2015 net charge-offs totaled $3.1 million or 0.19% of average loans, compared to $2.5 million, or 0.17% of average loans annualized, during the six months ended June 30, 2014. A significant portion of the net charge-offs in 2015 was the result of one $9.1 million substandard C&I relationship previously classified as an accruing TDR that was placed in nonaccrual status during the second quarter of 2015. This relationship included a net charge-off of $1.9 million and an incremental increase in the allowance for loan losses of $3.6 million at June 30, 2015. Allowances for pooled homogeneous loans, that are not deemed impaired, are based on historical net loss experience. Estimated losses for pooled portfolios are determined differently for commercial loan pools and retail loan pools. Commercial loans are pooled into the following segments: commercial, owner-occupied, commercial real estate and construction. Each pool is further segmented by internally assessed risk ratings. Loan losses for commercial loans are estimated by determining the probability of default and expected loss severity upon default. During the six months ended June 30, 2015, we increased the look-back period to 18 quarters from the 16 quarters used at December 31, 2014 and prior periods. This change in the look-back period resulted in an increase of $1.7 million to the total allowance at June 30, 2015. Loss severity upon default is calculated as the actual loan losses (net of recoveries) on impaired loans in their respective pool during the same time frame. Retail loans are pooled into the following segments: residential mortgage, consumer secured and consumer unsecured loans. Pooled reserves for retail loans are calculated based solely on average net loss rates over the same 18 quarter look-back period. Qualitative adjustment factors consider various current internal and external conditions which are allocated among loan types and take into consideration the following: • Current underwriting policies, staff, and portfolio mix • Internal trends of delinquency, nonaccrual and criticized loans by segment • Risk rating accuracy, control and regulatory assessments/environment • General economic conditions - locally and nationally • Market trends impacting collateral values • A competitive environment as it could impact loan structure and underwriting The above factors are based on their relative standing compared to the period in which historic losses are used in core reserve estimates and current directional trends. Each individual qualitative factor in our model can add or subtract to core reserves. A special adjustment factor of 10 basis points was created within consumer secured for incremental losses associated with the Home Equity Line of Credit End of Draw bubble not captured within the Bank’s loan loss histories. A special adjustment factor to address the absence of a default history for C&I loans, previously at 7.5 basis points, was eliminated as problem loans were remedied through refinance. Further, a special adjustment factor within the construction portfolio has been reduced from 92 basis points to 50 basis points as the portfolio continues to perform at a favorable level. These changes in adjustment factors resulted in a decrease of $2.5 million to the total allowance at June 30, 2015. The allowance methodology uses a loss emergence period (LEP), which is the period of time between an event that triggers the probability of a loss and the confirmation of the loss. We estimate the commercial LEP to be 8 quarters as of June 30, 2015. During the six months ended June 30, 2015 we adjusted our model to reflect an LEP in the model calculation of eight quarters. Further, our residential mortgage and consumer LEP remained at four quarters as of June 30, 2015. We evaluate LEP quarterly for reasonableness and complete a detailed historical analysis of our LEP by commercial, commercial real estate, residential and consumer portfolios at least annually. The change in commercial LEP contributed $458,000 to the total allowance at June 30, 2015. The final component of the allowance is a reserve for model estimation and complexity risk. The calculation of this reserve is generally quantitative; however, qualitative estimates of valuations and risk assessment, and methodology judgments are necessary. We review the qualitative estimates of valuation factors quarterly and management uses its judgment to make adjustments based on current trends. The model complexity risk factor was reduced to 3 basis points of total loans for June 30, 2015 and takes into consideration the model improvements made around effective LEP, as well as the continued sophistication and layering of estimates inherent in our model. This change in the model and complexity risk resulted in a decrease of $639,000 on the total allowance at June 30, 2015. Our loan officers and risk managers meet at least quarterly to discuss and review the conditions and risks associated with individual problem loans. In addition, various regulatory agencies periodically review our loan ratings and allowance for loan losses and the Bank’s internal loan review department performs loan reviews. The following tables provide the activity of our allowance for loan losses and loan balances for three and six months ended June 30, 2015: (In Thousands) Commercial Owner- Commercial Construction Residential Consumer Complexity (1) Total Three months ended June 30, 2015 Allowance for loan losses Beginning balance $ 13,048 $ 7,039 $ 6,524 $ 2,952 $ 2,380 $ 6,026 $ 1,538 $ 39,507 Charge-offs (1,903 ) (272 ) — — (147 ) (620 ) — (2,942 ) Recoveries 91 18 28 111 26 233 — 507 Provision (credit) 2,788 (80 ) 50 249 448 149 (579 ) 3,025 Provision for acquired loans 488 28 229 1 2 — — 748 Ending balance $ 14,512 $ 6,733 $ 6,831 $ 3,313 $ 2,709 $ 5,788 $ 959 $ 40,845 Six months ended June 30, 2015 Allowance for loan losses Beginning balance $ 12,837 $ 6,643 $ 7,266 $ 2,596 $ 2,523 $ 6,041 $ 1,520 $ 39,426 Charge-offs (2,037 ) (597 ) (4 ) — (267 ) (1,071 ) — (3,976 ) Recoveries 114 22 69 160 37 434 — 836 Provision (credit) 3,110 637 (729 ) 556 414 384 (561 ) $ 3,811 Provision for acquired loans 488 28 229 1 2 — — 748 Ending balance $ 14,512 $ 6,733 $ 6,831 $ 3,313 $ 2,709 $ 5,788 $ 959 $ 40,845 Period-end allowance allocated to: Loans individually evaluated for impairment $ 4,819 $ 75 $ 177 $ 214 $ 1,178 $ 188 $ — $ 6,651 Loans collectively evaluated for impairment 9,205 6,630 6,425 3,098 1,529 5,600 959 33,446 Acquired loans evaluated for impairment 488 28 229 1 2 — — 748 Ending balance $ 14,512 $ 6,733 $ 6,831 $ 3,313 $ 2,709 $ 5,788 $ 959 $ 40,845 Period-end loan balances evaluated for: Loans individually evaluated for impairment $ 9,938 $ 1,389 $ 7,329 $ 1,419 $ 15,198 $ 6,055 $ — $ 41,328 (2) Loans collectively evaluated for impairment 893,774 750,514 827,381 188,251 181,169 316,213 — 3,157,302 Acquired nonimpaired loans 29,894 39,132 29,558 8,696 15,970 6,608 — 129,858 Acquired impaired loans 3,159 2,027 5,884 3,479 460 8 — 15,017 Ending balance $ 936,765 $ 793,062 $ 870,152 $ 201,845 $ 212,797 $ 328,884 $ — $ 3,343,505 (3) The following table provides the activity of the allowance for loan losses and loan balances for the three and six months ended June 30, 2014: (In Thousands) Commercial Owner Commercial Construction Residential Consumer Complexity (1) Total Three months ended June 30, 2014 Allowance for loan losses Beginning balance $ 12,404 $ 8,789 $ 7,363 $ 2,716 $ 2,765 $ 6,249 $ 1,042 $ 41,328 Charge-offs (382 ) (124 ) — — (163 ) (490 ) — (1,159 ) Recoveries 483 161 2 177 25 314 — 1,162 Provision (credit) 841 (840 ) 252 (574 ) 132 226 13 50 Ending balance $ 13,346 $ 7,986 $ 7,617 $ 2,319 $ 2,759 $ 6,299 $ 1,055 $ 41,381 Six months ended June 30, 2014 Allowance for loan losses Beginning balance $ 12,751 $ 7,638 $ 6,932 $ 3,326 $ 3,078 $ 6,494 $ 1,025 $ 41,244 Charge-offs (1,495 ) (321 ) (160 ) (88 ) (527 ) (1,723 ) — (4,314 ) Recoveries 807 167 39 184 43 531 — 1,771 Provision (credit) 1,283 502 806 (1,103 ) 165 997 30 2,680 Ending balance $ 13,346 $ 7,986 $ 7,617 $ 2,319 $ 2,759 $ 6,299 $ 1,055 $ 41,381 Period-end allowance allocated to: Loans individually evaluated for impairment $ 1,881 $ 1,157 $ 307 $ — $ 872 $ 184 $ — $ 4,401 Loans collectively evaluated for impairment 11,465 6,829 7,310 2,319 1,887 6,115 1,055 36,980 Ending balance $ 13,346 $ 7,986 $ 7,617 $ 2,319 $ 2,759 $ 6,299 $ 1,055 $ 41,381 Period-end loan balances evaluated for: Loans individually evaluated for impairment $ 4,109 $ 4,928 $ 13,483 $ — $ 17,743 $ 5,577 $ — $ 45,840 (2) Loans collectively evaluated for impairment 853,245 773,329 749,607 119,333 193,180 306,943 — 2,995,637 Ending balance $ 857,354 $ 778,257 $ 763,090 $ 119,333 $ 210,923 $ 312,520 $ — $ 3,041,477 (3) (1) Represents the portion of the allowance for loan losses established to account for the inherent complexity and uncertainty of estimates. (2) The difference between this amount and nonaccruing loans represents accruing troubled debt restructured loans of $13.6 million and $11.8 million for the periods ending June 30, 2015 and June 30, 2014, respectively. Accruing troubled debt restructured loans are considered impaired loans. (3) Ending loan balances do not include deferred costs. Nonaccrual and Past Due Loans Nonaccruing loans are those on which the accrual of interest has ceased. We discontinue accrual of interest on originated loans after payments become more than 90 days past due or earlier if we do not expect the full collection of principal or interest in accordance with the terms of the loan agreement. Interest accrued but not collected at the date a loan is placed on nonaccrual status is reversed and charged against interest income. In addition, the accretion of net deferred loan fees is suspended when a loan is placed on nonaccrual status. Subsequent cash receipts are applied either to the outstanding principal balance or recorded as interest income, depending on our assessment of the ultimate collectability of principal and interest. Loans greater than 90 days past due and still accruing are defined as loans contractually past due 90 days or more as to principal or interest payments, but remain in accrual status because they are considered well secured and in the process of collection. The following tables show our nonaccrual and past due loans at the dates indicated: Greater Than Total 30–59 Days 60–89 Days 90 Days Due Accruing Acquired June 30, 2015 Past Due and Past Due and Past Due and And Still Current Impaired Nonaccrual Total (In Thousands) Still Accruing Still Accruing Still Accruing Accruing Balances Loans Loans Loans Commercial $ 135 $ — $ — $ 135 $ 923,924 $ 3,159 $ 9,547 $ 936,765 Owner-Occupied commercial 144 — — 144 789,501 2,027 1,390 793,062 Commercial mortgages 390 86 — 476 856,549 5,884 7,243 870,152 Construction — — — — 198,366 3,479 — 201,845 Residential 2,706 933 153 3,792 201,878 460 6,667 212,797 Consumer 1,050 113 — 1,163 324,841 8 2,872 328,884 Total (1) $ 4,425 $ 1,132 $ 153 $ 5,710 $ 3,295,059 $ 15,017 $ 27,719 $ 3,343,505 % of Total Loans 0.13 % 0.03 % 0.01 % 0.17 % 98.55 % 0.45 % 0.83 % 100 % (1) The balances of above include $129.9 million of acquired nonimpaired loans. Greater Than Total Past 30–59 Days 60–89 Days 90 Days Due Accruing Acquired December 31, 2014 Past Due and Past Due and Past Due and And Still Current Impaired Nonaccrual Total (In Thousands) Still Accruing Still Accruing Still Accruing Accruing Balances Loans Loans Loans Commercial $ 715 $ — $ — $ 715 $ 913,382 $ 3,269 $ 2,706 $ 920,072 Owner-occupied commercial 393 — — 393 783,466 2,264 2,475 788,598 Commercial mortgages 203 — — 203 791,035 5,976 8,245 805,459 Construction — — — — 138,634 3,863 — 142,497 Residential 3,879 604 — 4,483 206,266 512 7,068 218,329 Consumer 1,241 342 4 1,587 322,390 9 3,557 327,543 Total (1) $ 6,431 $ 946 $ 4 $ 7,381 $ 3,155,173 $ 15,893 $ 24,051 $ 3,202,498 % of Total Loans 0.20 % 0.03 % 0.00 % 0.23 % 98.52 % 0.50 % 0.75 % 100 % (1) The balances of above include $107.3 million of acquired nonimpaired loans Impaired Loans Loans for which it is probable we will not collect all principal and interest due according to their contractual terms, which is assessed based on the credit characteristics of the loan and/or payment status, are measured for impairment in accordance with the provisions of SAB 102 and FASB ASC 310, Receivables The following tables provide an analysis of our impaired loans at June 30, 2015 and December 31, 2014: Ending Loans with Loans with Contractual Average June 30, 2015 Loan No Related Related Related Principal Loan (In Thousands) Balances Reserve (1) Reserve Reserve Balances Balances Commercial $ 10,590 $ 1,188 $ 9,402 $ 5,234 $ 13,089 $ 8,494 Owner-occupied commercial 2,313 1,314 999 103 3,251 2,931 Commercial mortgages 9,221 3,946 5,275 465 12,867 9,479 Construction 1,492 — 1,492 215 1,520 1,150 Residential 15,484 8,407 7,077 1,180 17,815 16,090 Consumer 6,057 4,838 1,219 190 6,648 6,155 Total (2) $ 45,157 $ 19,693 $ 25,464 $ 7,387 $ 55,190 $ 44,299 Ending Loans with Loans with Contractual Average December 31, 2014 Loan No Related Related Related Principal Loan (In Thousands) Balances Reserve (1) Reserve Reserve Balances Balances Commercial $ 12,381 $ 580 $ 11,801 $ 3,034 $ 20,924 $ 5,952 Owner-occupied commercial 2,474 1,865 609 609 3,708 4,461 Commercial mortgages 8,335 4,732 3,603 319 14,383 11,005 Construction 1,419 — 1,419 334 1,419 1,013 Residential 15,666 7,068 8,598 790 18,967 17,296 Consumer 6,376 3,557 2,819 231 7,162 5,902 Total $ 46,651 $ 17,802 $ 28,849 $ 5,317 $ 66,563 $ 45,629 (1) Reflects loan balances at or written down to their remaining book balance. (2) The above includes acquired impaired loans totaling $3.8 million in the ending loan balance and $5.2 million in the contractual principal balance. Interest income of $449,000 and $921,000 was recognized on impaired loans during the three and six months ended June 30, 2015, respectively. Interest income of $393,000 and $747,000 was recognized on impaired loans during the three and six months ended June 30, 2014. As of June 30, 2015, there were 32 residential loans and 15 commercial loans in the process of foreclosure. The total outstanding balance on the loans was $3.4 million and $3.4 million, respectively. As of December 31, 2014, there were 36 residential loans and 12 commercial loans in the process of foreclosure. The total outstanding balance on the loans was $4.4 million and $1.1 million, respectively Reserves on Acquired Nonimpaired Loans In accordance with FASB ASC 310-40, loans acquired by the Bank through its merger with FNBW are required to be reflected on the balance sheet at their fair values on the date of acquisition as opposed to their contractual values. Therefore, on the date of acquisition establishing an allowance for acquired loans is prohibited. After the acquisition date the Bank performs a separate allowance analysis on a quarterly basis to determine if an allowance for loan loss is necessary. Should the credit risk calculated exceed the purchased loan portfolio’s remaining credit mark, additional reserves will be added to the Bank’s allowance. When a purchased loan becomes impaired after its acquisition, it is evaluated as part of the Bank’s reserve analysis and a specific reserve is established to be included in the Bank’s allowance. Credit Quality Indicators Below is a description of each of our risk ratings for all commercial loans: Pass Special Mention. Substandard. Doubtful. Loss. Residential and Consumer Loans The residential and consumer loan portfolios are monitored on an ongoing basis using delinquency information and loan type as credit quality indicators. These credit quality indicators are assessed in the aggregate in these relatively homogeneous portfolios. Loans that are greater than 90 days past due are generally considered nonperforming and placed on nonaccrual status. The tables below provide information about the credit quality of loans in our commercial and residential and consumer portfolios. Commercial Credit Exposure Owner-Occupied Commercial Total (In Thousands) Commercial Commercial Mortgages Construction Commercial (1) June 30, Dec. 31, June 30, Dec. 31 June 30, Dec. 31 June 30, Dec. 31 June 30, Dec. 31 2015 2014 2015 2014 2015 2014 2015 2014 2015 2014 Amount % Amount % Risk Rating: Special mention $ 16,078 $ 4,744 $ 18,713 $ 6,989 $ 10,302 $ 9,065 $ — $ — $ 45,093 $ 20,798 Substandard: Accrual 35,061 42,377 15,567 14,436 4,515 9,167 1,205 1,085 56,348 67,065 Nonaccrual 4,742 1,225 1,314 1,865 7,066 7,927 — 13,122 11,017 Doubtful/nonaccrual 4,814 3,034 75 609 177 319 214 334 5,280 4,296 Total Special and Substandard 60,695 51,380 35,669 23,899 22,060 26,478 1,419 1,419 119,843 4 % 103,176 4 % Acquired impaired 3,159 3,269 2,027 2,264 5,884 5,976 3,479 3,863 14,549 1 15,372 — Pass 872,911 865,423 755,366 762,435 842,208 773,005 196,947 137,215 2,667,432 95 2,538,078 96 Total $ 936,765 $ 920,072 $ 793,062 $ 788,598 $ 870,152 $ 805,459 $ 201,845 $ 142,497 $ 2,801,824 100 % $ 2,656,626 100 % (1) Table includes $107.3 million and $119.8 million of acquired nonimpaired loans as of June 30, 2015 and December 31, 2014, respectively. Residential and Consumer Credit Exposure (In Thousands) Residential Consumer Total Residential and Consumer (2) June 30, Dec. 31 June 30, Dec. 31 June 30, 2015 Dec. 31, 2014 2015 2014 2015 2014 Amount Percent Amount Percent Nonperforming (1) $ 15,198 $ 15,666 $ 6,055 $ 6,376 $ 21,253 4 % $ 22,042 4 % Acquired impaired Loans 460 512 8 9 468 — 521 — Performing 197,139 202,151 322,821 321,158 519,960 96 523,309 96 Total $ 212,797 $ 218,329 $ 328,884 $ 327,543 $ 541,681 100 % $ 545,872 100 % (1) Includes $11.7 million as of June 30, 2015 and $11.4 million as of December 31, 2014 of troubled debt restructured mortgages and home equity installment loans that are performing in accordance with the loans’ modified terms and are accruing interest. (2) Total includes $22.6 million and $26.0 million in acquired nonimpaired loans as of June 30, 2015 and December 31, 2014, respectively. Troubled Debt Restructurings (TDR) TDRs are recorded in accordance with FASB ASC 310-40, Troubled Debt Restructuring by Creditors (ASC 310-40) During the six months ended June 30, 2015, the terms of 18 loans were modified in TDRs. Twelve modifications were for consumer loans in which five had their maturity dates extended, six were discharged bankruptcies and one was a rate concession. Five were residential mortgages in which three were discharged bankruptcies, one was a forbearance agreement and one was a maturity date extension. One commercial loan received a maturity date extension. Our concessions on restructured loans typically consist of forbearance agreements, reduction in interest rates or extensions of maturities. Principal balances are generally not forgiven when a loan is modified as a TDR. Nonaccruing restructured loans remain in nonaccrual status until there has been a period of sustained repayment performance, typically six months and payment is reasonably assured. The following table presents loans identified as TDRs during the three and six months ended June 30, 2015 and 2014: Three Three Six Six Months Ended Months Ended Months Ended Months Ended June 30, June 30, June 30, June 30, (In Thousands) 2015 2014 2015 2014 Commercial $ 557 $ 121 $ 557 $ 121 Residential 197 1,565 409 1,844 Consumer 528 152 663 515 Total $ 1,282 $ 1,838 $ 1,629 $ 2,480 During the six months ended June 30, 2015 the TDRs set forth in the table above increased our allowance $13,000 through the allocation of a related reserve, and resulted in charge-offs of $69,000 compared to an increase in our allowance of $1.4 million and charge-offs of $41,000 for the same period of 2014. |