6. COVERED ASSETS AND FDIC LOSS SHARING ASSET

FDIC Assisted Acquisition

On October 16, 2009, the Bank acquired SJB and entered into loss sharing agreements with the FDIC that is more fully discussed in Note 3—Summary of Significant Accounting Policies, 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 September 30, 2014, the remaining discount associated with the SJB loans approximated $8.2 million. Based on the Company’s regular forecast of expected cash flows from these loans, approximately $5.7 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 4.2 years and 0.5 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 $331,000 at September 30, 2014 was 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 for commercial loans. Refer to Note 3—Summary of Significant Accounting Policies for a more detailed discussion concerning the FDIC loss sharing agreement.

The following table provides a summary of the components of covered loan and lease finance receivables:


	September 30, 2014			December 31, 2013
	(Dollars in thousands)
Commercial and industrial	$	16,877		$	20,461
Real estate:
Commercial real estate		116,854			141,141
Construction		—			644
SFR mortgage		211			313
Dairy & livestock and agribusiness		3,270			6,000
Municipal lease finance receivables		—			—
Consumer and other loans		3,392			4,545

Gross covered loans		140,604			173,104
Less: Purchase accounting discount		(8,253	)		(12,789	)

Gross covered loans, net of discount		132,351			160,315
Less: Allowance for covered loan losses		—			—

Net covered loans	$	132,351		$	160,315

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 accepted or modified by Credit Management. The risk rating 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:


	September 30, 2014		December 31, 2013
	(Dollars in thousands)
Pass	$	26,503	$	38,961
Watch list		79,635		74,369
Special mention		6,542		15,492
Substandard		27,924		44,241
Doubtful & loss		—		41

Total covered gross loans	$	140,604	$	173,104

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 September 30, 2014 and December 31, 2013, the Company had zero allowance for loan losses recorded for covered loans.