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 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 nine months ended September 30, 2016, net charge-offs totaled $5.9 million or 0.20% of average loans annualized, compared to $9.0 million, or 0.36% of average loans annualized, during the nine months ended September 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 as follows: 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 23 quarters. During 2016, we increased the look-back period to 23 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 23 quarter look-back period. Qualitative adjustment factors consider various current internal and external conditions which are allocated among loan types and take into consideration: • 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, • The competitive environment, as it could impact loan structure and underwriting, and • Valuation complexity by segment. 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 to or subtract from 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 approximately 8 quarters as of September 30, 2016. Our residential mortgage and consumer LEP remained at 4 quarters as of September 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 in prior periods is the 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 nine months ended September 30, 2016: (Dollars in thousands) Commercial Owner-Occupied Commercial Construction Residential Consumer Complexity Risk (1) Total Three months ended September 30, 2016 Allowance for loan losses Beginning balance $ 11,402 $ 6,723 $ 8,135 $ 3,308 $ 2,352 $ 5,826 $ — $ 37,746 Charge-offs (3,737 ) (1,415 ) (1 ) (30 ) (43 ) (518 ) — (5,744 ) Recoveries 223 15 197 440 33 290 — 1,198 Provision (credit) 3,714 1,437 1,089 (824 ) (179 ) 401 — 5,638 Provision for acquired loans 117 185 (48 ) (76 ) 12 — — 190 Ending balance $ 11,719 $ 6,945 $ 9,372 $ 2,818 $ 2,175 $ 5,999 $ — $ 39,028 Nine months ended September 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 (4,643 ) (1,556 ) (79 ) (59 ) (72 ) (1,967 ) — (8,376 ) Recoveries 557 66 310 486 112 922 — 2,453 Provision (credit) 4,551 1,564 2,650 (1,104 ) (177 ) 1,118 (1,010 ) $ 7,592 Provision for acquired loans 98 201 4 (26 ) 31 (38 ) — 270 Ending balance $ 11,719 $ 6,945 $ 9,372 $ 2,818 $ 2,175 $ 5,999 $ — $ 39,028 Period-end allowance allocated to: Loans individually evaluated for impairment $ 692 $ — $ 1,264 $ 215 $ 989 $ 201 $ — $ 3,361 Loans collectively evaluated for impairment 10,974 6,923 7,982 2,549 1,167 5,798 — 35,393 Acquired loans evaluated for impairment 53 22 126 54 19 — — 274 Ending balance $ 11,719 $ 6,945 $ 9,372 $ 2,818 $ 2,175 $ 5,999 $ — $ 39,028 Period-end loan balances evaluated for: Loans individually evaluated for impairment $ 4,198 $ 2,510 $ 7,165 $ 1,419 $ 13,957 $ 8,105 $ — $ 37,354 (2) Loans collectively evaluated for impairment 1,077,258 869,051 904,328 182,338 150,318 368,428 — 3,551,721 Acquired nonimpaired loans 175,570 175,411 229,530 21,627 103,537 61,257 — 766,932 Acquired impaired loans 9,691 10,673 12,880 3,592 899 368 — 38,103 Ending balance $ 1,266,717 $ 1,057,645 $ 1,153,903 $ 208,976 $ 268,711 $ 438,158 $ — $ 4,394,110 (3) The following table provides the activity of the allowance for loan losses and loan balances for the three and nine months ended September 30, 2015: (Dollars in thousands) Commercial Owner Occupied Commercial Construction Residential Consumer Complexity Risk Total Three months ended September 30, 2015 Allowance for loan losses Beginning balance $ 14,512 $ 6,733 $ 6,831 $ 3,313 $ 2,709 $ 5,788 $ 959 $ 40,845 Charge-offs (4,147 ) (26 ) (804 ) — (130 ) (1,499 ) — (6,606 ) Recoveries 84 40 14 19 158 405 — 720 Provision (credit) 303 (62 ) 231 306 (362 ) 1,086 11 1,513 Provision for acquired loans — — (71 ) 104 (92 ) (1 ) — (60 ) Ending balance $ 10,752 $ 6,685 $ 6,201 $ 3,742 $ 2,283 $ 5,779 $ 970 $ 36,412 Nine months ended September 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 (6,184 ) (623 ) (808 ) — (397 ) (2,570 ) — (10,582 ) Recoveries 198 62 83 179 195 839 — 1,556 Provision (credit) 3,485 574 (508 ) 863 50 1,460 (550 ) 5,374 Provision for acquired loans 416 29 168 104 (88 ) 9 — 638 Ending balance $ 10,752 $ 6,685 $ 6,201 $ 3,742 $ 2,283 $ 5,779 $ 970 $ 36,412 Period-end allowance allocated to: Loans individually evaluated for impairment $ 993 $ — $ 241 $ 214 $ 934 $ 202 $ — $ 2,584 Loans collectively evaluated for impairment 9,406 6,657 5,907 3,527 1,348 5,577 970 33,392 Acquired loans evaluated for impairment 353 28 53 1 1 — — 436 Ending balance $ 10,752 $ 6,685 6,201 $ 3,742 $ 2,283 $ 5,779 $ 970 $ 36,412 Period-end loan balances: Loans individually evaluated for impairment $ 5,775 $ 1,170 $ 6,805 $ 1,419 $ 14,613 $ 7,749 $ — $ 37,531 (2) Loans collectively evaluated for impairment 900,660 770,246 836,556 190,925 169,566 327,524 — 3,195,477 Acquired nonimpaired loans 28,998 37,937 25,555 8,223 15,137 5,930 — 121,780 Acquired impaired loans 2,627 2,195 5,400 2,594 380 7 — 13,203 Ending balance $ 938,060 $ 811,548 $ 874,316 $ 203,161 $ 199,696 $ 341,210 $ — $ 3,367,991 (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 $14.2 million and $13.6 million for the periods ending September 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 which remain in accrual status because they are considered well secured and are in the process of collection. The following tables show our nonaccrual and past due loans at the dates indicated: September 30, 2016 (In Thousands) 30–59 Days Past Due and Still Accruing 60–89 Days Past Due and Still Accruing Greater Than 90 Days Past Due and Still Accruing Total Past Due And Still Accruing Accruing Acquired Nonaccrual Total Loans Commercial $ 354 $ 1,297 $ — $ 1,651 $ 1,251,430 $ 9,691 $ 3,945 $ 1,266,717 Owner-occupied commercial 572 — — 572 1,043,890 10,673 2,510 1,057,645 Commercial mortgages 3,096 6,902 — 9,998 1,123,939 12,880 7,086 1,153,903 Construction — — — — 205,384 3,592 — 208,976 Residential 4,867 157 — 5,024 257,308 899 5,480 268,711 Consumer 788 135 271 1,194 432,445 368 4,151 438,158 Total (1) $ 9,677 $ 8,491 $ 271 $ 18,439 $ 4,314,396 $ 38,103 $ 23,172 $ 4,394,110 % of Total Loans 0.22 % 0.19 % 0.01 % 0.42 % 98.18 % 0.87 % 0.53 % 100 % (1) The balances above include $766.9 million of acquired nonimpaired loans. December 31, 2015 (In Thousands) 30–59 Days 60–89 Days Greater Than Total Past Accruing Acquired Nonaccrual Total 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 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 September 30, 2016 and December 31, 2015: Ending Loans with Loans with Contractual Average September 30, 2016 Loan No Related Related Related Principal Loan (Dollars in thousands) Balances Reserve (1) Reserve Reserve Balances Balances Commercial $ 5,383 $ 1,578 $ 3,805 $ 745 $ 6,616 $ 5,430 Owner-occupied commercial 4,153 2,510 1,643 22 4,340 2,827 Commercial mortgages 9,152 1,614 7,538 1,390 11,529 5,889 Construction 2,524 — 2,524 269 2,625 1,942 Residential 14,776 6,967 7,809 1,008 16,994 15,174 Consumer 8,105 6,791 1,314 201 9,922 7,856 Total (2) $ 44,093 $ 19,460 $ 24,633 $ 3,635 $ 52,026 $ 39,118 (1) Reflects loan balances at or written down to their remaining book balance. (2) The above includes acquired impaired loans totaling $6.7 million in the ending loan balance and $7.8 million in the contractual principal balance. December 31, 2015 (Dollars 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 $0.5 million and $0.8 million was recognized on impaired loans during the three and nine months ended September 30, 2016, respectively. Interest income of $0.4 million and $1.3 million was recognized on impaired loans during the three and nine months ended September 30, 2015. As of September 30, 2016, there were 27 residential loans and 12 commercial loans in the process of foreclosure. The total outstanding balance on the loans was $4.9 million and $2.0 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 $0.7 million, respectively. Reserves on Acquired Nonimpaired Loans In accordance with FASB ASC 310, loans acquired by the Bank through its merger with FNBW, Alliance and Penn Liberty 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 (Dollars in thousands) Commercial Owner-Occupied Commercial Mortgages Construction Total Commercial (1) Sept. 30, 2016 Dec. 31, Sept. 30, Dec. 31 Sept. 30, Dec. 31 Sept. 30, Dec. 31 Sept. 30, Dec. 31 Amount % Amount % Risk Rating: Special mention $ 16,925 $ 5,620 $ 16,744 $ 9,535 $ 34,368 $ 12,323 $ 188 $ — $ 68,225 $ 27,478 Substandard: Accrual 28,630 33,883 18,941 22,901 11,170 2,547 2,011 8,296 60,752 67,627 Nonaccrual 3,253 4,164 2,510 1,090 5,822 3,326 — — 11,585 8,580 Doubtful 692 1,164 — — 1,264 — — — 1,956 1,164 Total Special and Substandard 49,500 44,831 38,195 33,526 52,624 18,196 2,199 8,296 142,518 4 % 104,849 3 % Acquired impaired 9,691 12,985 10,673 4,688 12,880 10,513 3,592 3,544 36,836 1 31,730 1 Pass 1,207,526 1,003,781 1,008,777 842,429 1,088,399 937,989 203,185 233,933 3,507,887 95 3,018,132 96 Total $ 1,266,717 $ 1,061,597 $ 1,057,645 $ 880,643 $ 1,153,903 $ 966,698 $ 208,976 $ 245,773 $ 3,687,241 100 % $ 3,154,711 100 % (1) Table includes $602.1 million and $277.0 million of acquired nonimpaired loans as of September 30, 2016 and December 31, 2015, respectively. Residential and Consumer Credit Exposure (Dollars in thousands) Residential Consumer Total Residential and Consumer (2) Sept. 30, Dec. 31 Sept. 30, Dec. 31 Sept. 30, 2016 Dec. 31, 2015 2016 2015 2016 2015 Amount Percent Amount Percent Nonperforming(1) $ 13,957 $ 15,548 $ 8,105 $ 7,664 $ 22,062 3 % $ 23,212 4 % Acquired impaired loans 899 950 368 7 1,267 — 957 — Performing 253,855 243,181 429,685 352,578 683,540 97 595,759 96 Total $ 268,711 $ 259,679 $ 438,158 $ 360,249 $ 706,869 100 % $ 619,928 100 % (1) Includes $14.2 million as of September 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 $164.8 million and $94.2 million in acquired nonimpaired loans as of September 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 nine months ended September 30, 2016, the terms of 20 loans were modified in TDRs. Twelve modifications were for consumer loans of which ten were HELOC conversions and two loans were discharged in bankruptcy. Six were residential mortgages; three received rate reduction and maturity date extension, 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 nine months ended September 30, 2016 and 2015. (Dollars in thousands) Three Three Nine Nine Commercial $ — $ — $ 1,125 $ — Owner Occupied Commercial — — — 577 Commercial mortgages — — — — Construction — — — — Residential 797 38 1,523 447 Consumer 278 643 733 1,306 Total $ 1,075 $ 681 $ 3,381 $ 2,330 During the nine months ended September 30, 2016, the TDRs set forth in the table above increased our allowance for loan losses less than $0.1 million, and resulted in charge-offs of less than $0.1 million. For the same period of 2015, the TDRs set forth in the table above increased our allowance for loan losses less than $0.1 million through the allocation of a related reserve and resulted in charge-offs of less than $0.1 million. |