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 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, 2016, net charge-offs totaled $1.3 million or 0.07% of average loans, compared to $3.1 million, or 0.19% of average loans annualized, during the six months ended 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. Probability of default is calculated based on the historical rate of migration to impaired status during the last 22 quarters. During the six months ended June 30 2016, we increased the look-back period to 22 quarters from the 20 quarters used at December 31, 2015. This increase in the look-back period allows us to continue to anchor to the fourth quarter of 2010 to ensure that the core reserves calculated by the ALLL model are adequately considering the losses within a full credit cycle. 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 22 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. Qualitative factors in our model can add or subtract to core reserves. Continued economic improvement and continued refinement of the quantitative model have driven an overall reduction in qualitative factors during the period. 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, 2016. Further, our residential mortgage and consumer LEP remained at 4 quarters as of June 30, 2016. We evaluate LEP quarterly for reasonableness and complete a detailed historical analysis of our commercial LEP at least annually. The final component of the allowance is 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 in order to capture factors not already included in other components in our allowance for loan losses methodology. We review qualitative estimates of valuation factors quarterly and management uses its judgement to make adjustments based on current trends. During the second quarter of 2016 as a result of continued improvement in the model and normal review of the factors, we removed the model estimation and complexity risk reserve from our calculation of the allowance of loan losses. 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, 2016: Owner- Occupied Commercial Complexity (1) (In Thousands) Commercial Construction Residential Consumer Total Three months ended June 30, 2016 Allowance for loan losses Beginning balance $ 11,482 $ 6,702 $ 6,516 $ 3,609 $ 2,269 $ 5,954 $ 1,024 $ 37,556 Charge-offs (727 ) (141 ) (61 ) (3 ) (15 ) (818 ) — (1,765 ) Recoveries 224 13 34 — 57 373 — 701 Provision (credit) 353 133 1,598 (352 ) 22 317 (1,024 ) 1,047 Provision for acquired loans 70 16 48 54 19 — — 207 Ending balance $ 11,402 $ 6,723 $ 8,135 $ 3,308 $ 2,352 $ 5,826 $ — $ 37,746 Six months ended June 30, 2016 Allowance for loan losses Beginning balance $ 11,156 $ 6,670 $ 6,487 $ 3,521 $ 2,281 $ 5,964 $ 1,010 $ 37,089 Charge-offs (906 ) (141 ) (78 ) (29 ) (29 ) (1,449 ) — (2,632 ) Recoveries 334 51 113 46 79 632 — 1,255 Provision (credit) 837 127 1,561 (280 ) 2 717 (1,010 ) $ 1,954 Provision for acquired loans (19 ) 16 52 50 19 (38 ) — 80 Ending balance $ 11,402 $ 6,723 $ 8,135 $ 3,308 $ 2,352 $ 5,826 $ — $ 37,746 Period-end allowance allocated to: Loans individually evaluated for impairment $ 426 $ — $ — $ 211 $ 992 $ 205 $ — $ 1,834 Loans collectively evaluated for impairment 10,923 6,686 8,009 3,038 1,340 5,621 — 35,617 Acquired loans evaluated for impairment 53 37 126 59 20 — — 295 Ending balance $ 11,402 $ 6,723 $ 8,135 $ 3,308 $ 2,352 $ 5,826 $ — $ 37,746 Period-end loan balances evaluated for: Loans individually evaluated for impairment $ 2,558 $ 838 $ 1,702 $ 1,419 $ 14,416 $ 7,965 $ — $ 28,898 (2) Loans collectively evaluated for impairment 1,045,918 857,270 869,771 181,440 153,811 352,675 — 3,460,885 Acquired nonimpaired loans 58,423 70,465 108,212 12,086 67,484 13,990 — 330,660 Acquired impaired loans 1,711 9,757 10,560 4,094 946 4 — 27,072 Ending balance $ 1,108,610 $ 938,330 $ 990,245 $ 199,039 $ 236,657 $ 374,634 $ — $ 3,847,515 (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, 2015: Owner Commercial Complexity (1) (In Thousands) Commercial Construction Residential Consumer 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) (1) Represents the portion of the allowance for loan losses established to capture factors not already included in other components in our allowance for loan losses methodology. (2) The difference between this amount and nonaccruing loans represents accruing troubled debt restructured loans of $14.1 million and $13.6 million for the periods ending June 30, 2016 and 2015, 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: June 30, 2016 (In Thousands) 30–59 Days 60–89 Greater Than Past Due and Total Past Due And Still Accruing Current Acquired Loans Nonaccrual Total Loans Commercial $ 720 $ 132 $ 85 $ 937 $ 1,103,908 $ 1,711 $ 2,054 $ 1,108,610 Owner-occupied commercial — — — — 927,735 9,757 838 938,330 Commercial mortgages 2,424 5,643 — 8,067 969,996 10,560 1,622 990,245 Construction — — — — 194,945 4,094 — 199,039 Residential 4,598 533 416 5,547 224,341 946 5,823 236,657 Consumer 734 224 219 1,177 369,209 4 4,244 374,634 Total (1) $ 8,476 $ 6,532 $ 720 $ 15,728 $ 3,790,134 $ 27,072 $ 14,581 $ 3,847,515 % of Total Loans 0.22 % 0.17 % 0.02 % 0.41 % 98.51 % 0.70 % 0.38 % 100 % (1) The balances of above include $330.7 million of acquired nonimpaired loans. December 31, 2015 (In Thousands) 30–59 Days 60–89 Greater Than Total Past Accruing Acquired Nonaccrual Total Loans Commercial $ 1,686 $ 270 $ 12,355 $ 14,311 $ 1,028,973 $ 12,985 $ 5,328 $ 1,061,597 Owner-occupied commercial 713 217 4,886 5,816 869,048 4,688 1,091 880,643 Commercial mortgages 141 4 288 433 952,426 10,513 3,326 966,698 Construction — — — — 242,229 3,544 — 245,773 Residential 5,263 621 251 6,135 245,307 950 7,287 259,679 Consumer 1,222 36 252 1,510 354,599 7 4,133 360,249 Total (1) $ 9,025 $ 1,148 $ 18,032 $ 28,205 $ 3,692,582 $ 32,687 $ 21,165 $ 3,774,639 % of Total Loans 0.24 % 0.03 % 0.48 % 0.75 % 97.83 % 0.86 % 0.56 % 100 % (1) The balances of above include $371.1 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, 2016 and December 31, 2015: June 30, 2016 (In Thousands) Ending Loan Balances Loans with (1) Loans with Related Contractual Average Commercial $ 3,765 $ 1,565 $ 2,200 $ 479 $ 4,567 $ 6,472 Owner-occupied commercial 3,483 486 2,997 37 3,833 2,459 Commercial mortgages 3,765 1,703 2,062 126 6,271 5,903 Construction 2,856 — 2,856 270 2,979 1,736 Residential 15,254 7,823 7,431 1,012 17,768 15,316 Consumer 7,965 6,785 1,180 205 9,714 7,446 Total (2) $ 37,088 $ 18,362 $ 18,726 $ 2,129 $ 45,132 $ 39,332 (1) Reflects loan balances at or written down to their remaining book balance. (2) The above includes acquired impaired loans totaling $8.2 million in the ending loan balance and $9.4 million in the contractual principal balance. December 31, 2015 (In Thousands) Ending Loans with (1) Loans with Related Contractual Average Commercial $ 6,137 $ 951 $ 5,186 $ 1,168 $ 20,206 $ 9,391 Owner-occupied commercial 2,127 1,090 1,037 22 2,947 2,111 Commercial mortgages 4,652 3,410 1,242 103 11,826 7,540 Construction 1,419 — 1,419 211 1,419 1,448 Residential 15,710 9,034 6,676 920 18,655 15,264 Consumer 7,665 6,498 1,167 200 9,353 6,801 Total (2) $ 37,710 $ 20,983 $ 16,727 $ 2,624 $ 64,406 $ 42,555 (1) Reflects loan balances at or written down to their remaining book balance. (2) The above includes acquired impaired loans totaling $2.9 million in the ending loan balance and $3.5 million in the contractual principal balance. Interest income of $180,000, and $336,000 was recognized on impaired loans during the three and six months ended June 30, 2016, respectively. Interest income of $449,000, and $921,000 was recognized on impaired loans during the three and six months ended June 30, 2015. As of June 30, 2016, there were 32 residential loans and 9 commercial loans in the process of foreclosure. The total outstanding balance on the loans was $5.2 million and $1.9 million, respectively. As of December 31, 2015, there were 32 residential loans and 3 commercial loans in the process of foreclosure. The total outstanding balance on the loans was $5.0 million and $675,000, respectively. Reserves on Acquired Nonimpaired Loans In accordance with FASB ASC 310, loans acquired by the Bank through its merger with FNBW and Alliance 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 following tables provide an analysis of loans by portfolio segment based on the credit quality indicators used to determine the Allowance for Loan Loss. Commercial Credit Exposure Owner-Occupied Commercial Total (In Thousands) Commercial Commercial Mortgages Construction Commercial (1) June 30, Dec. 31 2015 June 30, Dec. 31 June 30, Dec. 31 June 30, Dec. 31 June 30, 2016 Dec. 31, Amount % Amount % Risk Rating: Special mention $ 4,379 $ 5,620 $ 6,427 $ 9,535 $ 21,185 $ 12,323 $ — $ — $ 31,991 $ 27,478 Substandard: Accrual 40,140 33,883 23,351 22,901 9,868 2,547 — 8,296 73,359 67,627 Nonaccrual 1,627 4,164 838 1,090 1,622 3,326 — — 4,087 8,580 Doubtful 427 1,164 — — — — — — 427 1,164 Total Special and Substandard 46,573 44,831 30,616 33,526 32,675 18,196 — 8,296 109,864 3 % 104,849 3 % Acquired impaired 1,711 12,985 9,757 4,688 10,560 10,513 4,094 3,544 26,122 1 31,730 1 Pass 1,060,326 1,003,781 897,957 842,429 947,010 937,989 194,945 233,933 3,100,238 96 3,018,132 96 Total $ 1,108,610 $ 1,061,597 $ 938,330 $ 880,643 $ 990,245 $ 966,698 $ 199,039 $ 245,773 $ 3,236,224 100 % $ 3,154,711 100 % (1) Table includes $249.2 million and $277.0 million of acquired nonimpaired loans as of June 30, 2016 and December 31, 2015, respectively. Residential and Consumer Credit Exposure (In Thousands) Residential Consumer Total Residential and Consumer (2) June 30, Dec. 31 June 30, Dec. 31 30-Jun-16 Dec. 31, 2015 Amount Percent Amount Percent Nonperforming(1) $ 14,416 $ 15,548 $ 7,965 $ 7,664 $ 22,381 4 % $ 23,212 4 % Acquired impaired loans 946 950 4 7 950 — 957 — Performing 221,295 243,181 366,665 352,578 587,960 96 595,759 96 Total $ 236,657 $ 259,679 $ 374,634 $ 360,249 $ 611,291 100 % $ 619,928 100 % (1) Includes $14.1 million as of June 30, 2016 and $13.6 million as of December 31, 2015 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 $81.5 million and $94.2 million in acquired nonimpaired loans as of June 30, 2016 and December 31, 2015, 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, 2016, the terms of 14 loans were modified in TDRs. Nine modifications were for consumer loans of which eight were HELOC conversions with interest rate reductions and one loan was discharged in bankruptcy. Three were residential mortgages, two received forbearance agreements and one residential mortgage was discharged in bankruptcy. One commercial loan in bankruptcy was granted interest only payments and one commercial loan was granted 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, 2016 and 2015. (In Thousands) Three Three Six Six Commercial $ 141 $ 557 $ 1,125 $ 557 Owner Occupied Commercial — — — — Commercial mortgages — — — — Construction — — — — Residential 112 197 726 409 Consumer 240 528 455 663 Total $ 493 $ 1,282 $ 2,306 $ 1,629 During the six months ended June 30, 2016, the TDRs set forth in the table above had no change on our allowance for loan losses allocation of a related reserve, and resulted in charge-offs of $80,000. For the same period of 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. |