5. COVERED ASSETS AND FDIC LOSS SHARING ASSET

FDIC Assisted Acquisition

On October 16, 2009, the Bank acquired SJB and entered into a loss sharing agreements with the FDIC that is more fully discussed in the Significant Accounting Policies (Note 3) included herein. The acquisition has been accounted for under the purchase method of accounting. The assets and liabilities were recorded at their estimated fair values as of the October 16, 2009 acquisition date. The application of the purchase method of accounting resulted in an after-tax gain of $12.3 million which was included in 2009 earnings. The gain is the negative goodwill resulting from the acquired assets and liabilities recognized at fair value.

At December 31, 2013, the remaining discount associated with the SJB loans approximated $12.8 million. Based on the Company’s regular forecast of expected cash flows from these loans, approximately $8.8 million of the related discount is expected to accrete into interest income over the remaining average lives of the respective pools and individual loans, which approximates 4.4 years and 1.3 years, respectively. Due to the decrease in estimated losses to be incurred in the remaining portfolio, the expected reimbursement from the FDIC under the loss sharing agreement decreased. The FDIC loss sharing asset of $4.8 million at December 31, 2013 will continue to be reduced by loss claims submitted to the FDIC with the remaining balance amortized on the same basis as the discount on the related loans, not to exceed its remaining contract life, which expires in October of 2014.

The following table provides a summary of the components of covered loan and lease finance receivables as of December 31, 2013 and 2012:


	December 31, 2013			December 31, 2012
	(Dollars in thousands)
Commercial and industrial	$	20,461		$	26,149
Real estate:
Commercial real estate		141,141			179,428
Construction		644			1,579
SFR mortgage		313			1,415
Dairy & livestock and agribusiness		6,000			5,651
Municipal lease finance receivables		—			—
Consumer and other loans		4,545			6,337

Gross covered loans		173,104			220,559
Less: Purchase accounting discount		(12,789	)		(25,344	)

Gross covered loans, net of discount		160,315			195,215
Less: Allowance for covered loan losses		—			—

Net covered loans	$	160,315		$	195,215

Covered Loans Held-for-Sale

The following table provides a summary of the activity related to covered loans held-for-sale for the years ended December 31, 2013, and 2012:


	For the Year Ended December 31,
	2013		2012
	(Dollars in thousands)
Balance, beginning of period	$	—	$	5,664
Sales of other loans		—		(3,745	)
Write-down of loans held for sale		—		(1,219	)
Payment on other loans		—		(700	)

Balance, end of period	$	—	$	—

Credit Quality Indicators

Central to our credit risk management is our loan risk rating system. The originating credit officer assigns borrowers an initial risk rating, which is reviewed and possibly changed by Credit Management, which is based primarily on a thorough analysis of each borrower’s financial capacity in conjunction with industry and economic trends. Approvals are made based upon the amount of inherent credit risk specific to the transaction and are reviewed for appropriateness by senior line and credit management personnel. Credits are monitored by line and credit management personnel for deterioration in a borrower’s financial condition, which would impact the ability of the borrower to perform under the contract. Risk ratings are adjusted as necessary.

Credit risk ratings are also used by Management in deriving expectations for future cash flows of covered loans, in addition to managing the underlying credit quality and collection efforts for these loans. Changes in credit risk ratings on covered loans assist the Company in establishing assumptions used in estimating expected future cash flows, and do not necessarily represent a need to establish or reverse an allowance for loan losses for these loans.

The following table summarizes covered loans by internal risk ratings as of December 31, 2013 and 2012:


	December 31, 2013		December 31, 2012
	(Dollars in thousands)
Pass	$	38,961	$	52,637
Watch list		74,369		72,803
Special mention		15,492		31,689
Substandard		44,241		63,354
Doubtful & loss		41		76

Total gross covered loans	$	173,104	$	220,559

Allowance for Loan Losses

The Company’s Credit Management Division is responsible for regularly reviewing the ALLL methodology for covered loans. The ALLL for covered loans is determined separately from non-covered loans, and is based on expectations of future cash flows from the underlying pools of loans or individual loans in accordance with ASC 310-30, as more fully discussed in Note 3—Summary of Significant Accounting Policies. As of December 31, 2013, and 2012, the Company had zero allowance for loan losses recorded for covered loans.

Other Real Estate Owned

The following table summarizes the activity related to covered other real estate owned for the years ended December 31, 2013, and 2012:


	For the Year Ended December 31,
	2013			2012
	(Dollars in thousands)
Balance, beginning of period	$	1,067		$	9,782
Additions		1,492			1,738
Dispositions		(1,639	)		(9,867	)
Valuation adjustments		(416	)		(586	)

Balance, end of period	$	504		$	1,067

FDIC Loss Sharing Asset

The following table summarizes the activity related to the FDIC loss sharing asset for the years ended December 31, 2013, and 2012:


	For the Year Ended December 31,
	2013			2012
	(Dollars in thousands)
Balance, beginning of period	$	18,489		$	59,453
FDIC share of additional losses, net of recoveries		(81	)		1,111
Cash received from FDIC, net of refund		(4	)		(18,974	)
Net amortization (1)		(12,779	)		(23,027	)
Other reductions, net		(861	)		(74	)

Balance, end of period	$	4,764		$	18,489

(1)	Net amortization included accelerated amortization as a result of loans being paid off in full, sold, or transferred to covered OREO.

Through December 31, 2013, the Bank has submitted claims to the FDIC for net losses on covered loans totaling $122.8 million.