4. Loans and Allowance for Loan Losses

Loan Origination/Risk Management

The Company has certain lending policies and procedures in place that are designed to minimize the level of risk within the loan portfolio. Diversification of the loan portfolio manages the risk associated with fluctuations in economic conditions. The Company maintains an independent loan review department that reviews and validates the risk assessment on a continual basis. Management regularly evaluates the results of the loan reviews. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Company’s policies and procedures.

Commercial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand its business. Commercial loans are made based on the identified cash flows of the borrower and on the underlying collateral provided by the borrower. The cash flows of the borrower, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts from its customers. Commercial credit cards are generally unsecured and are underwritten with criteria similar to commercial loans including an analysis of the borrower’s cash flow, available business capital, and overall credit-worthiness of the borrower.

Commercial real estate loans are subject to underwriting standards and processes similar to commercial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts, and the repayment of these loans is largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. The Company requires an appraisal of the collateral be made at origination on an as-needed basis, in conformity with current market conditions and regulatory requirements. The underwriting standards address both owner and non-owner occupied real estate.

Construction loans are underwritten using feasibility studies, independent appraisal reviews, sensitivity analysis or absorption and lease rates and financial analysis of the developers and property owners. Construction loans are based upon estimates of costs and value associated with the complete project. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term borrowers, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their repayment being sensitive to interest rate changes, governmental regulation of real property, economic conditions, and the availability of long-term financing.

Underwriting standards for residential real estate and home equity loans are based on the borrower’s loan-to-value percentage, collection remedies, and overall credit history.

Consumer loans are underwritten based on the borrower’s repayment ability. The Company monitors delinquencies on all of its consumer loans and leases and periodically reviews the distribution of FICO scores relative to historical periods to monitor credit risk on its credit card loans. The underwriting and review practices combined with the relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Consumer loans and leases that are 90 days past due or more are considered non-performing.

This table provides a summary of loan classes and an aging of past due loans at March 31, 2013 and December 31, 2012 (in thousands):


	March 31, 2013
	30-89 Days Past Due and Accruing		Greater than 90 Days Past Due and Accruing		Non- Accrual Loans		Total Past Due		Current		Total Loans
Commercial:
Commercial	$	17,385	$	28	$	13,764	$	31,177	$	3,155,385	$	3,186,562
Commercial – credit card		2,526		62		84		2,672		115,941		118,613
Real estate:
Real estate – construction		25		—		1,254		1,279		83,589		84,868
Real estate – commercial		9,554		897		8,341		18,792		1,424,471		1,443,263
Real estate – residential		1,151		548		777		2,476		227,016		229,492
Real estate – HELOC		1,299		—		259		1,558		561,207		562,765
Consumer:
Consumer – credit card		2,740		2,668		1,840		7,248		306,899		314,147
Consumer – other		2,069		1,553		1,261		4,883		46,187		51,070
Leases		—		—		—		—		19,901		19,901

Total loans	$	36,749	$	5,756	$	27,580	$	70,085	$	5,940,596	$	6,010,681


	December 31, 2012
	30-89 Days Past Due and Accruing		Greater than 90 Days Past Due and Accruing		Non- Accrual Loans		Total Past Due		Current		Total Loans
Commercial:
Commercial	$	5,170	$	93	$	14,122	$	19,385	$	2,854,309	$	2,873,694
Commercial – credit card		561		43		61		665		103,655		104,320
Real estate:
Real estate – construction		3,750		—		1,263		5,013		73,473		78,486
Real estate – commercial		3,590		113		8,170		11,873		1,423,938		1,435,811
Real estate – residential		1,371		49		666		2,086		210,277		212,363
Real estate – HELOC		1,324		50		225		1,599		572,324		573,923
Consumer:
Consumer – credit card		2,989		2,955		2,285		8,229		326,289		334,518
Consumer – other		1,116		251		1,311		2,678		51,872		54,550
Leases		—		—		—		—		19,084		19,084

Total loans	$	19,871	$	3,554	$	28,103	$	51,528	$	5,635,221	$	5,686,749

The Company sold $37.3 million and $51.9 million of residential real estate and student loans during the periods ended March 31, 2013 and March 31, 2012, respectively.

The Company has ceased the recognition of interest on loans with a carrying value of $27.6 million and $28.1 million at March 31, 2013 and December 31, 2012, respectively. Restructured loans totaled $13.8 million and $12.5 million at March 31, 2013 and December 31, 2012, respectively. Loans 90 days past due and still accruing interest amounted to $5.8 million and $3.6 million at March 31, 2013 and December 31, 2012, respectively. There was an insignificant amount of interest recognized on impaired loans during 2013 and 2012.

Credit Quality Indicators

As part of the on-going monitoring of the credit quality of the Company’s loan portfolio, management tracks certain credit quality indicators including trends related to the risk grading of specified classes of loans, net charge-offs, non-performing loans, and general economic conditions.

The Company utilizes a risk grading matrix to assign a rating to each of its commercial, commercial real estate, and construction real estate loans. The loan rankings are summarized into the following categories: Non-watch list, Watch, Special Mention, and Substandard. Any loan not classified in one of the categories described below is considered to be a Non-watch list loan. The loans in any of the three categories below are considered to be a criticized loan. A description of the general characteristics of the loan ranking categories is as follows:

•

Watch – This rating represents credit exposure that presents higher than average risk and warrants greater than routine attention by Company personnel due to conditions affecting the borrower, the borrower’s industry or the economic environment. These conditions have resulted in some degree of uncertainty that results in higher than average credit risk.

•

Special Mention – This rating reflects a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or the institution’s credit position at some future date. The rating is not adversely classified and does not expose an institution to sufficient risk to warrant adverse classification.

•

Substandard – This rating represents an asset inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged, if any. Assets so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. Loans in this category are characterized by the distinct possibility that the bank will sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified substandard. This category may include loans where the collection of full principal is doubtful or remote.

All other classes of loans are generally evaluated and monitored based on payment activity. Non-performing loans include restructured loans on non-accrual and all other non-accrual loans.

This table provides an analysis of the credit risk profile of each loan class at March 31, 2013 and December 31, 2012 (in thousands):

Credit Exposure

Credit Risk Profile by Risk Rating


	Commercial				Real estate - construction
	March 31, 2013		December 31, 2012		March 31, 2013		December 31, 2012
Non-watch list	$	3,008,416	$	2,670,925	$	81,274	$	75,631
Watch		84,534		98,636		873		518
Special Mention		32,683		29,462		14		14
Substandard		60,929		74,671		2,707		2,323

Total	$	3,186,562	$	2,873,694	$	84,868	$	78,486


	Real estate - commercial
	March 31, 2013		December 31, 2012
Non-watch list	$	1,328,480	$	1,325,460
Watch		65,234		63,278
Special Mention		16,892		11,613
Substandard		32,657		35,460

Total	$	1,443,263	$	1,435,811


Credit Exposure
Credit Risk Profile Based on Payment Activity
	Commercial - credit card				Real estate - residential
	March 31, 2013		December 31, 2012		March 31, 2013		December 31, 2012
Performing	$	118,529	$	104,259	$	228,715	$	211,697
Non-performing		84		61		777		666

Total	$	118,613	$	104,320	$	229,492	$	212,363


	Real estate - HELOC				Consumer - credit card
	March 31, 2013		December 31, 2012		March 31, 2013		December 31, 2012
Performing	$	562,506	$	573,698	$	312,307	$	332,233
Non-performing		259		225		1,840		2,285

Total	$	562,765	$	573,923	$	314,147	$	334,518


	Consumer - other				Leases
	March 31, 2013		December 31, 2012		March 31, 2013		December 31, 2012
Performing	$	49,809	$	53,239	$	19,901	$	19,084
Non-performing		1,261		1,311		—		—

Total	$	51,070	$	54,550	$	19,901	$	19,084

Allowance for Loan Losses

The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management’s judgment of inherent probable losses within the Company’s loan portfolio as of the balance sheet date. The allowance is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. Accordingly, the methodology is based on historical loss trends. The Company’s process for determining the appropriate level of the allowance for loan losses is designed to account for credit deterioration as it occurs. The provision for probable loan losses reflects loan quality trends, including the levels of and trends related to non-accrual loans, past due loans, potential problem loans, criticized loans and net charge-offs or recoveries, among other factors.

The level of the allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. Portions of the allowance may be allocated for specific loans; however, the entire allowance is available for any loan that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the adequacy of the allowance is dependent upon a variety of factors beyond the Company’s control, including, among other things, the performance of the Company’s loan portfolio, the economy, changes in interest rates and changes in the regulatory environment.

The Company’s allowance for loan losses consists of specific valuation allowances and general valuation allowances based on historical loan loss experience for similar loans with similar characteristics and trends, general economic conditions and other qualitative risk factors both internal and external to the Company.

The allowances established for probable losses on specific loans are based on a regular analysis and evaluation of problem loans. Loans are classified based on an internal risk grading process that evaluates the obligor’s ability to repay, the underlying collateral, if any, and the economic environment and industry in which the borrower operates. When a loan is considered impaired, the loan is analyzed to determine the need, if any, to specifically allocate a portion of the allowance for loan losses to the loan. Specific valuation allowances are determined by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies, the relative risk ranking of the loan and economic conditions affecting the borrower’s industry.

General valuation allowances are calculated based on the historical loss experience of specific types of loans including an evaluation of the time span and volume of the actual charge-off. The Company calculates historical loss ratios for pools of similar loans with similar characteristics based on the proportion of actual charge-offs experienced to the total population of loans in the pool. The historical loss ratios are updated based on actual charge-off experience. A valuation allowance is established for each pool of similar loans based upon the product of the historical loss ratio, time span to charge-off, and the total dollar amount of the loans in the pool. The Company’s pools of similar loans include similarly risk-graded groups of commercial loans, commercial real estate loans, commercial credit card, home equity loans, consumer real estate loans and consumer and other loans. The Company also considers a loan migration analysis for criticized loans. This analysis includes an assessment of the probability that a loan will move to a loss position based on its risk rating. The consumer credit card pool is evaluated based on delinquencies and credit scores. In addition, a portion of the allowance is determined by a review of qualitative factors by Management.

ALLOWANCE FOR LOAN LOSSES AND RECORDED INVESTMENT IN LOANS

This table provides a rollforward of the allowance for loan losses by portfolio segment for three months ended March 31, 2013 (in thousands):


	Three Months Ended March 31, 2013
	Commercial			Real estate			Consumer			Leases		Total
Allowance for loan losses:
Beginning balance	$	43,390		$	15,506		$	12,470		$	60	$	71,426
Charge-offs		(1,397	)		(195	)		(3,257	)		—		(4,849	)
Recoveries		374			9			921			—		1,304
Provision		978			(374	)		1,395			1		2,000

Ending Balance	$	43,345		$	14,946		$	11,529		$	61	$	69,881

Ending Balance: individually evaluated for impairment	$	3,206		$	309		$	—		$	—	$	3,515
Ending Balance: collectively evaluated for impairment		40,139			14,637			11,529			61		66,366
Loans:
Ending Balance: loans	$	3,305,175		$	2,320,388		$	365,217		$	19,901	$	6,010,681
Ending Balance: individually evaluated for impairment		15,974			10,140			46			—		26,160
Ending Balance: collectively evaluated for impairment		3,289,201			2,310,248			365,171			19,901		5,984,521

ALLOWANCE FOR LOAN LOSSES AND RECORDED INVESTMENT IN LOANS (in thousands)

This table provides a rollforward of the allowance for loan losses by portfolio segment for three months ended March 31, 2012 (in thousands):


	Three Months Ended March 31, 2012
	Commercial			Real estate			Consumer			Leases		Total
Allowance for loan losses:
Beginning balance	$	37,927		$	20,486		$	13,593		$	11	$	72,017
Charge-offs		(269	)		(339	)		(3,490	)		—		(4,098	)
Recoveries		237			6			824			—		1,067
Provision		(514	)		3,083			1,921			10		4,500

Ending Balance	$	37,381		$	23,236		$	12,848		$	21	$	73,486

Ending Balance: individually evaluated for impairment	$	3,918		$	454		$	—		$	—	$	4,372
Ending Balance: collectively evaluated for impairment		33,463			22,782			12,848			21		69,114
Loans:
Ending Balance: loans	$	2,583,911		$	2,184,881		$	368,175		$	7,799	$	5,144,766
Ending Balance: individually evaluated for impairment		11,571			12,054			27			—		23,652
Ending Balance: collectively evaluated for impairment		2,572,340			2,172,827			368,148			7,799		5,121,114

Impaired Loans

This table provides an analysis of impaired loans by class at March 31, 2013 and December 31, 2012 (in thousands):


	Three Months Ended March 31, 2013
	Unpaid Principal Balance		Recorded Investment with No Allowance		Recorded Investment with Allowance		Total Recorded Investment		Related Allowance		Average Recorded Investment
Commercial:
Commercial	$	22,285	$	1,680	$	14,294	$	15,974	$	3,206	$	15,515
Commercial – credit card		—		—		—		—		—		—
Real estate:
Real estate – construction		1,569		1,219		123		1,342		64		1,346
Real estate – commercial		8,185		7,362		472		7,834		245		8,412
Real estate – residential		1,174		964		—		964		—		913
Real estate – HELOC		—		—		—		—		—		—
Consumer:
Consumer – credit card		—		—		—		—		—		—
Consumer – other		47		46		—		46		—		48
Leases		—		—		—		—		—		—

Total	$	33,260	$	11,271	$	14,889	$	26,160	$	3,515	$	26,234


	Year Ended December 31, 2012
	Unpaid Principal Balance		Recorded Investment with No Allowance		Recorded Investment with Allowance		Total Recorded Investment		Related Allowance		Average Recorded Investment
Commercial:
Commercial	$	22,453	$	12,119	$	2,938	$	15,057	$	1,393	$	13,287
Commercial – credit card		—		—		—		—		—		—
Real estate:
Real estate – construction		276		276		—		276		—		118
Real estate – commercial		9,334		6,777		2,213		8,990		733		9,925
Real estate – residential		2,357		1,714		223		1,937		48		2,622
Real estate – HELOC		—		—		—		—		—		—
Consumer:
Consumer – credit card		—		—		—		—		—		—
Consumer – other		51		49		—		49		—		43
Leases		—		—		—		—		—		—

Total	$	34,471	$	20,935	$	5,374	$	26,309	$	2,174	$	25,995

Troubled Debt Restructurings

A loan modification is considered a troubled debt restructuring (TDR) when a concession is granted to a debtor experiencing financial difficulties. The Company’s modifications generally include interest rate adjustments, amortization and maturity date extensions, and principal reductions. These modifications allow the debtor short-term cash relief to allow them to improve their financial condition. The Company’s restructured loans are individually evaluated for impairment and evaluated as part of the allowance for loan loss as described above in the Allowance for Loan Losses section of this note.

The Company had $383 thousand in commitments to lend to borrowers with loan modifications classified as TDR’s. The Company made no TDR’s in the last 12 months that had payment defaults for the three month period ended March 31, 2013.

This table provides a summary of loans restructured by class for the three months ended March 31, 2013 and 2012 (in thousands):


	Three Months Ended March 31, 2013						Three Months Ended March 31, 2012
	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment		Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment
Troubled Debt Restructurings
Commercial:
Commercial		—	$	—	$	—		1	$	800	$	800
Commercial – credit card		—		—		—		—		—		—
Real estate:
Real estate – construction		—		—		—		—		—		—
Real estate – commercial		2		1,408		1,407		—		—		—
Real estate – residential		—		—		—		—		—		—
Real estate – HELOC		—		—		—		—		—		—
Consumer:
Consumer – credit card		—		—		—		—		—		—
Consumer – other		—		—		—		—		—		—
Leases		—		—		—		—		—		—

Total		2	$	1,408	$	1,407		1	$	800	$	800