Covered Assets and FDIC Loss-sharing Asset

Covered Assets

Covered assets consist of loans and OREO acquired in certain FDIC-assisted acquisitions during 2010 and 2011, for which the Bank entered into loss-sharing agreements, whereby the FDIC will cover a substantial portion of future losses on loans (and related unfunded loan commitments), OREO and certain accrued interest on loans during the terms of the agreements. Under the terms of the loss-sharing agreements, the FDIC will absorb 80% of losses and share in 80% of loss recoveries up to specified amounts. With respect to loss-sharing agreements for two acquisitions completed in 2010, after those specified amounts, the FDIC will absorb 95% of losses and share in 95% of loss recoveries. The loss-sharing provisions of the agreements for commercial and single-family mortgage loans are in effect for five and ten years, respectively, from the acquisition dates and the loss recovery provisions are in effect for eight and ten years, respectively, from the acquisition dates.

Ten years and forty-five days after the acquisition dates, the Bank shall pay to the FDIC a clawback in the event the losses from the acquisitions fail to reach stated levels. The amount of the clawback is determined by a formula specified in each individual loss-sharing agreement. As of December 31, 2013 and 2012, the net present value of the Bank’s estimated clawback liability is $3.9 million and $3.6 million, respectively, which is included in other liabilities on the Consolidated Balance Sheet.

The following is an analysis of our covered loans, net of related allowance for losses as of December 31, 2013 and 2012:



	December 31, 2013		December 31, 2012
Covered loans:	(dollars in thousands)
Commercial business	$	72,870	$	125,373
Real estate:
One-to-four family residential	41,642		57,150
Commercial and multifamily residential	170,879		233,106
Total real estate	212,521		290,256
Real estate construction:
One-to-four family residential	14,781		25,398
Commercial and multifamily residential	6,869		15,251
Total real estate construction	21,650		40,649
Consumer	34,101		44,516
Subtotal of covered loans	341,142		500,794
Less:
Valuation discount resulting from acquisition accounting	43,297		79,401
Allowance for loan losses	20,174		30,056
Covered loans, net of valuation discounts and allowance for loan losses	$	277,671	$	391,337

Acquired impaired loans are accounted for under ASC 310-30 and initially measured at fair value based on expected future cash flows over the life of the loans. Acquired loans that have common risk characteristics are aggregated into pools. The Company remeasures contractual and expected cash flows, at the pool-level, on a quarterly basis.

Contractual cash flows are calculated based upon the loan pool terms after applying a prepayment factor. Calculation of the applied prepayment factor for contractual cash flows is the same as described below for expected cash flows.

Inputs to the determination of expected cash flows include cumulative default and prepayment data as well as loss severity and recovery lag information. Cumulative default and prepayment data are calculated via a transition matrix. The transition matrix is a matrix of probability values that specifies the probability of a loan pool transitioning into a particular delinquency state (e.g. 0-30 days past due, 31 to 60 days, etc.) given its delinquency state at the remeasurement date. Loss severity factors are based upon either actual charge-off data within the loan pools or industry averages and recovery lags are based upon the collateral within the loan pools.

Acquired impaired loans are also subject to the Company’s internal and external credit review and are risk rated using the same criteria as loans originated by the Company. However, risk ratings are not a clear indicator of losses on acquired loans as the loans were acquired with a significant discount and a majority of the losses are recoverable from the FDIC under the loss-sharing agreements.

Losses attributable to draws on acquired loans, advanced subsequent to the loan acquisition date, are accounted for under ASC 450-20 and those amounts are also subject to the Company’s internal and external credit review. An allowance for loan losses is estimated in a similar manner as the originated loan portfolio, and a provision for loan losses is charged to earnings as necessary.

The excess of cash flows expected to be collected over the initial fair value of acquired impaired loans is referred to as the accretable yield and is accreted into interest income over the estimated life of the acquired loans using the effective yield method. Other adjustments to the accretable yield include changes in the estimated remaining life of the acquired loans, changes in expected cash flows and changes of indices for acquired loans with variable interest rates.

The following table shows the changes in accretable yield for acquired loans for the years ended December 31, 2013, 2012, and 2011:



	Years Ended December 31,
	2013			2012			2011
	(in thousands)
Balance at beginning of period	$	166,888		$	259,669		$	256,572
Additions resulting from acquisitions	—			—			59,810
Accretion	(51,816		)	(86,671		)	(90,378		)
Disposals	(6,898		)	(12,856		)	(31,483		)
Reclassifications from nonaccretable difference	(4,267		)	6,746			65,148
Balance at end of period	$	103,907		$	166,888		$	259,669

During the year ended December 31, 2013, the Company recorded a provision recapture for losses on covered loans of $3.3 million. Of this amount, $1.7 million was impairment recapture calculated in accordance with ASC 310-30 and $1.6 million was a provision recapture to adjust the allowance for loss calculated under ASC 450-20 for draws on acquired loans. The impact to earnings of the $3.3 million of provision recapture for covered loans was substantially offset through noninterest income by a charge to the change in FDIC loss-sharing asset. For the year ended December 31, 2012, the Company recorded a provision for loan losses of $25.9 million which was partially offset by an increase to the FDIC loss-sharing asset and for the year ended December 31, 2011, the Company recorded a provision recapture for losses on covered loans of $1.6 million which was partially offset by a charge to the change in FDIC loss-sharing asset.

The changes in the ALLL for covered loans for the years ended December 31, 2013, 2012, and 2011 are summarized as follows:



	Years Ended December 31,
	2013			2012			2011
	(in thousands)
Balance at beginning of year	$	30,056		$	4,944		$	6,055
Loans charged off	(13,853		)	(5,112		)	(1,488		)
Recoveries	7,232			4,332			2,025
Provision charged to expense	(3,261		)	25,892			(1,648		)
Balance at end of year	$	20,174		$	30,056		$	4,944

The following is an analysis of the credit quality of our covered loan portfolio as of December 31, 2013 and 2012:



	Pass		Special Mention		Substandard		Doubtful		Loss		Total
December 31, 2013	(in thousands)
Covered loans:
Commercial business:
Secured	$	48,510	$	2,849	$	18,291	$	—	$	—	$	69,650
Unsecured	2,732		396		92		—		—		3,220
Real estate:
One-to-four family residential	35,066		1,842		4,734		—		—		41,642
Commercial and multifamily residential:
Commercial land	10,778		198		7,589		—		—		18,565
Income property	55,985		3,950		10,657		—		—		70,592
Owner occupied	67,653		111		13,958		—		—		81,722
Real estate construction:
One-to-four family residential:
Land and acquisition	4,674		2,739		1,936		—		—		9,349
Residential construction	3,008		—		2,424		—		—		5,432
Commercial and multifamily residential:
Income property	3,806		—		1,709		—		—		5,515
Owner occupied	1,074		—		280		—		—		1,354
Consumer	30,722		33		3,319		27		—		34,101
Total	$	264,008	$	12,118	$	64,989	$	27	$	—	341,142
Less:
Valuation discount resulting from acquisition accounting											43,297
Allowance for loan losses											20,174
Covered loans, net											$	277,671



	Pass		Special Mention		Substandard		Doubtful		Loss		Total
December 31, 2012	(in thousands)
Covered loans:
Commercial business:
Secured	$	71,621	$	1,823	$	45,150	$	—	$	—	$	118,594
Unsecured	4,988		—		1,791		—		—		6,779
Real estate:
One-to-four family residential	44,782		1,344		11,024		—		—		57,150
Commercial and multifamily residential:
Commercial land	16,336		—		10,292		—		—		26,628
Income property	81,205		864		23,315		—		—		105,384
Owner occupied	82,222		3,318		15,554		—		—		101,094
Real estate construction:
One-to-four family residential:
Land and acquisition	4,817		3,273		5,743		—		—		13,833
Residential construction	6,050		—		5,515		—		—		11,565
Commercial and multifamily residential:
Income property	4,419		—		7,901		—		—		12,320
Owner occupied	1,107		—		1,824		—		—		2,931
Consumer	38,973		381		5,162		—		—		44,516
Total	$	356,520	$	11,003	$	133,271	$	—	$	—	500,794
Less:
Valuation discount resulting from acquisition accounting											79,401
Allowance for loan losses											30,056
Covered loans, net											$	391,337

The Company did not acquire any loans accounted for under ASC 310-30 during 2013 or 2012.

The following table sets forth activity in covered OREO at carrying value for the years ended December 31, 2013 and 2012:



	December 31, 2013			December 31, 2012
	(in thousands)
Covered OREO:
Balance, beginning of period	$	16,311		$	28,126
Transfers in	8,827			14,166
Additional OREO write-downs	(282		)	(3,484		)
Proceeds from sale of OREO property	(22,046		)	(33,315		)
Net gain on sale of OREO	9,283			10,818
Total covered OREO, end of period	$	12,093		$	16,311

The covered OREO is covered by loss-sharing agreements with the FDIC in which the FDIC will assume 80% of additional write-downs and losses on covered OREO sales, or 95%, if applicable, of additional write-downs and losses on covered OREO sales if the minimum loss share thresholds are met.

FDIC Loss-sharing Asset

At December 31, 2013 and 2012, the FDIC loss-sharing asset is comprised of an FDIC indemnification asset of $37.9 million and $87.7 million, respectively, and an FDIC receivable of $2.0 million and $8.6 million, respectively. The indemnification represents the cash flows the Company expects to collect from the FDIC under the loss-sharing agreements and the FDIC receivable represents the reimbursable amounts from the FDIC that have not yet been received.

For covered loans, the Company remeasures contractual and expected cash flows on a quarterly basis. When the quarterly remeasurement process results in a decrease in expected cash flows due to an increase in expected credit losses, impairment is recorded. As a result of this impairment, the indemnification asset is increased to reflect anticipated future cash to be received from the FDIC. Consistent with the loss-sharing agreements between the Company and the FDIC, the amount of the increase to the indemnification asset is measured as 80% of the resulting impairment.

Alternatively, when the quarterly remeasurement results in an increase in expected future cash flows due to a decrease in expected credit losses, the nonaccretable difference decreases and the effective yield of the related loan portfolio is increased. As a result of the improved expected cash flows, the indemnification asset would be reduced first by the amount of any impairment previously recorded and, second, by increased amortization over the remaining life of the related loss-sharing agreement.

The following table shows a detailed analysis of the FDIC loss-sharing asset for the years ending December 31, 2013 and 2012:



	2013			2012
	(in thousands)
Balance at beginning of period	$	96,354		$	175,071
Adjustments not reflected in income:
Cash received from the FDIC	(9,246		)	(54,649		)
FDIC reimbursable losses, net	(2,245		)	399
Adjustments reflected in income:
Amortization, net	(36,729		)	(42,940		)
Loan impairment (recapture)	(2,609		)	20,714
Sale of other real estate	(6,177		)	(7,789		)
Write-downs of other real estate	364			5,190
Other	134			358
Balance at end of period	$	39,846		$	96,354