Allowance for Non-Covered Loan Losses and Credit Quality

Activity in the Allowance for Non-Covered Loan Losses

The following table summarizes activity related to the allowance for loan losses on non-covered loans, by portfolio segment, for the three and nine months ended September 30, 2013 and 2012:



(dollars in thousands)	Three Months Ended September 30, 2013
	Commercial			Real estate mortgage			Real estate construction		Consumer			Total
Beginning balance	$	4,316		$	7,055		$	2,575	$	3,021		$	16,967
Provision	(290		)	(194		)	501		508			525
Charge-offs	(70		)	—			—		(700		)	(770		)
Recoveries	48			70			3		99			220
Ending Balance	$	4,004		$	6,931		$	3,079	$	2,928		$	16,942



(dollars in thousands)	Three Months Ended September 30, 2012
	Commercial			Real estate mortgage			Real estate construction			Consumer			Total
Beginning balance	$	4,471		$	5,844		$	3,983		$	3,267		$	17,565
Provision	63			901			142			144			1,250
Charge-offs	(258		)	(655		)	(1,308		)	(278		)	(2,499		)
Recoveries	81			68			7			98			254
Ending Balance	$	4,357		$	6,158		$	2,824		$	3,231		$	16,570



(dollars in thousands)	Nine Months Ended September 30, 2013
	Commercial			Real estate mortgage			Real estate construction			Consumer			Total
Beginning balance	$	4,405		$	6,516		$	3,050		$	3,176		$	17,147
Provision	(45		)	467			92			1,311			1,825
Charge-offs	(506		)	(194		)	(70		)	(1,960		)	(2,730		)
Recoveries	150			142			7			401			700
Ending Balance	$	4,004		$	6,931		$	3,079		$	2,928		$	16,942



(dollars in thousands)	Nine Months Ended September 30, 2012
	Commercial			Real estate mortgage			Real estate construction			Consumer			Total
Beginning balance	$	4,034		$	6,500		$	4,046		$	3,452		$	18,032
Provision	1,443			2,766			809			582			5,600
Charge-offs	(1,234		)	(3,220		)	(2,041		)	(1,192		)	(7,687		)
Recoveries	114			112			10			389			625
Ending Balance	$	4,357		$	6,158		$	2,824		$	3,231		$	16,570

The following tables provides a summary of the allowance for non-covered loan losses and related non-covered loans, by portfolio segment, at September 30, 2013 and December 31, 2012:



(dollars in thousands)	September 30, 2013
	Commercial		Real estate mortgage		Real estate construction		Consumer		Total
Allowance for non-covered loan losses:
Individually evaluated for impairment	$	1,276	$	1,625	$	1,258	$	48	$	4,207
Collectively evaluated for impairment	2,728		5,306		1,821		2,880		12,735
Total allowance for non-covered loan losses	$	4,004	$	6,931	$	3,079	$	2,928	$	16,942
Non-covered loans:
Individually evaluated for impairment	$	8,759	$	12,929	$	12,533	$	611	$	34,832
Collectively evaluated for impairment	164,244		473,665		38,569		159,623		836,101
Total non-covered loans ⁽¹⁾	$	173,003	$	486,594	$	51,102	$	160,234	$	870,933

⁽¹⁾ Total non-covered loans excludes deferred loan costs of $1.7 million.



(dollars in thousands)	December 31, 2012
	Commercial		Real estate mortgage		Real estate construction		Consumer		Total
Allowance for non-covered loan losses:
Individually evaluated for impairment	$	1,468	$	1,154	$	881	$	52	$	3,555
Collectively evaluated for impairment	2,937		5,362		2,169		3,124		13,592
Total allowance for non-covered loan losses	$	4,405	$	6,516	$	3,050	$	3,176	$	17,147
Non-covered loans:
Individually evaluated for impairment	$	9,974	$	11,357	$	19,607	$	916	$	41,854
Collectively evaluated for impairment	152,507		441,270		61,791		153,974		809,542
Total non-covered loans ⁽¹⁾	$	162,481	$	452,627	$	81,398	$	154,890	$	851,396

⁽¹⁾ Total non-covered loans excludes deferred loan costs of $1.7 million.

Credit Quality and Nonperforming Non-Covered Loans

The Company manages credit quality and controls its credit risk through lending limits, credit review, approval policies and extensive, ongoing internal monitoring. Through this monitoring process, nonperforming loans are identified. Non-covered nonperforming loans consist of non-covered nonaccrual loans. Non-covered nonperforming loans are assessed for potential loss exposure on an individual or homogeneous group basis.

A loan is considered impaired when, based upon currently known information, it is deemed probable that the Company will be unable to collect all amounts due as scheduled according to the original terms of the agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a practical expedient, based on the loan’s observable market price or the fair value of collateral, if the loan is collateral dependent.

Loans are placed on nonaccrual status when collection of principal or interest is considered doubtful (generally when loans are 90 days or more past due). Loans placed on nonaccrual will typically remain on nonaccrual status until all principal and interest payments are brought current, there has been a sustained period of repayment performance (generally six months) and the prospects for future payments, in accordance with the loan agreement, appear relatively certain.

Interest income previously accrued on nonaccrual loans, but not yet received, is reversed in the period the loan is placed on nonaccrual status. Payments received are generally applied to principal. However, based on management’s assessment of the ultimate collectability of an impaired or nonaccrual loan, interest income may be recognized on a cash basis. Nonaccrual loans are returned to an accrual status when management determines the circumstances have improved to the extent that there has been a sustained period of repayment performance and both principal and interest are deemed collectible.

Non-Covered Impaired Loans

At September 30, 2013 and December 31, 2012, the Company had non-covered impaired loans which consisted of nonaccrual loans and restructured loans. As of September 30, 2013, the Company had no commitments to extend additional credit on these non-covered impaired loans. Non-covered impaired loans and the related allowance for loan losses at September 30, 2013 and December 31, 2012 were as follows:



(dollars in thousands)	September 30, 2013				December 31, 2012
	Recorded investment		Allowance		Recorded investment		Allowance
With no related allowance recorded:
Nonaccrual loans	$	9,603	$	—	$	15,479	$	—
Restructured loans	4,255		—		8,635		—
Total with no related allowance	$	13,858	$	—	$	24,114	$	—
With an allowance recorded:
Nonaccrual loans	$	304	$	15	$	72	$	5
Restructured loans	20,670		4,192		17,668		3,550
Total with an allowance recorded	20,974		4,207		17,740		3,555
Total	$	34,832	$	4,207	$	41,854	$	3,555

The following table further summarizes impaired non-covered loans, by class, at September 30, 2013 and December 31, 2012:



(dollars in thousands)	September 30, 2013						December 31, 2012
	Recorded investment		Unpaid principal balance		Related allowance		Recorded investment		Unpaid principal balance		Related allowance
With no related allowance recorded:
Commercial	$	3,040	$	3,535	$	—	$	3,737	$	4,231	$	—
Real estate mortgages:
One-to-four family residential	555		632		—		938		1,132		—
Multi-family and commercial	2,744		3,137		—		3,605		4,283		—
Total real estate mortgages	3,299		3,769		—		4,543		5,415		—
Real estate construction:
One-to-four family residential	7,234		11,592		—		15,251		23,133		—
Total real estate construction	7,234		11,592		—		15,251		23,133		—
Consumer:
Direct	285		551		—		583		1,017		—
Total consumer	285		551		—		583		1,017		—
Total with no related allowance recorded	$	13,858	$	19,447	$	—	$	24,114	$	33,796	$	—
With an allowance recorded:
Commercial	$	5,719	$	5,731	$	1,276	$	6,237	$	6,237	$	1,468
Real estate mortgages:
One-to-four family residential	731		731		87		524		524		53
Multi-family and commercial	8,900		9,277		1,538		6,290		6,657		1,101
Total real estate mortgages	9,631		10,008		1,625		6,814		7,181		1,154
Real estate construction:
One-to-four family residential	5,046		5,046		1,211		4,094		4,112		855
Multi-family and commercial	253		253		47		262		262		26
Total real estate construction	5,299		5,299		1,258		4,356		4,374		881
Consumer:
Direct	325		325		48		333		333		52
Total consumer	325		325		48		333		333		52
Total with an allowance recorded	20,974		21,363		4,207		17,740		18,125		3,555
Total impaired non-covered loans	$	34,832	$	40,810	$	4,207	$	41,854	$	51,921	$	3,555

The average recorded investment in non-covered impaired loans was $36.2 million and $38.3 million for the three and nine months ended September 30, 2013, compared to $47.2 million and $47.0 million for the same periods a year ago. For the three and nine months ended September 30, 2013, the Company recognized interest income on non-covered impaired loans of $112 thousand and $400 thousand, respectively. For the same periods a year ago, interest income on non-covered impaired loans was $202 thousand and $406 thousand, respectively. Additional interest income of $70 thousand and $128 thousand would have been recognized had the non-covered impaired loans accrued interest, in accordance with their original terms, for the three and nine months ended September 30, 2013, compared to $282 thousand and $514 thousand for the three and nine months ended September 30, 2012, respectively.

Troubled Debt Restructurings

A troubled debt restructured loan is classified as a restructuring when the Company grants a concession(s) to a borrower experiencing financial difficulties that it would not otherwise consider. Examples of such concessions include forgiveness of principal or accrued interest, extending the maturity date(s) or providing a lower interest rate than would be normally available for a transaction of similar risk. As a result of these concessions, restructured loans are considered impaired as the Company will not collect all amounts due, both principal and interest, in accordance with the terms of the original loan agreement.

Troubled debt restructurings at September 30, 2013 and December 31, 2012 were as follows:



(dollars in thousands)	September 30, 2013						December 31, 2012
	Accrual status		Nonaccrual status		Total modifications		Accrual status		Nonaccrual status		Total modifications
Troubled debt restructurings:
Commercial	$	6,324	$	636	$	6,960	$	7,008	$	1,160	$	8,168
Real estate mortgages:
One-to-four family residential	768		326		1,094		573		340		913
Multi-family and commercial	10,544		1,052		11,596		7,993		1,823		9,816
Total real estate mortgage	11,312		1,378		12,690		8,566		2,163		10,729
Real estate construction:
One-to-four family residential	6,710		5,506		12,216		10,135		9,013		19,148
Multi-family and commercial	253		—		253		262		—		262
Total real estate construction	6,963		5,506		12,469		10,397		9,013		19,410
Consumer:
Direct	326		14		340		332		20		352
Total consumer	326		14		340		332		20		352
Total restructured loans	$	24,925	$	7,534	$	32,459	$	26,303	$	12,356	$	38,659

The Company’s policy is that loans placed on nonaccrual will typically remain on nonaccrual status until all principal and interest payments are brought current and the prospect for future payment in accordance with the loan agreement appear relatively certain. The Company’s policy generally refers to six months of payment performance as sufficient to warrant a return to accrual status.

Troubled Debt Restructurings Modification Terms

The Company offers a variety of modifications to borrowers. In restructuring a loan with a borrower, the Company normally employs several types of modifications terms. The modification terms offered by the Company are as follows:

Rate Modification: A modification in which the interest rate is changed.

Term Modification: A modification in which the maturity date, the timing of payments, or frequency of payments is changed.

Interest Only Modification: A modification in which the loan is converted to interest only payments for a period of time.

Payment Modification: A modification in which the dollar amount of the payment is changed, other than an interest only modification described above.

Combination Modification: Any other type of modification, including the use of multiple terms above.

The following tables present loans restructured during the nine months ended September 30, 2013 and the three and nine months ended September 30, 2012. There were no loans restructured during the three months ended September 30, 2013. During the periods presented, all modification terms were a combination of terms employed by the Company.



(dollars in thousands)	For the Three Months Ended September 30, 2012
	Number of contracts	Pre-modification recorded investment		Post-modification recorded investment
Troubled debt restructurings:
Commercial	8	$	4,013	$	3,892
Real estate mortgages:
One-to-four family residential	1	173		173
Multi-family and commercial	1	376		376
Total real estate mortgage	2	549		549
Real estate construction:
One-to-four family residential	1	631		631
Multi-family and commercial	1	265		265
Total real estate construction	2	896		896
Total restructured loans	12	$	5,458	$	5,337



(dollars in thousands)	For the Nine Months Ended September 30, 2013
	Number of contracts	Pre-modification recorded investment		Post-modification recorded investment
Troubled debt restructurings:
Commercial	2	$	108	$	106
Real estate mortgages:
One-to-four family residential	1	214		214
Multi-family and commercial	7	3,296		3,296
Total real estate mortgage	8	3,510		3,510
Real estate construction:
One-to-four family residential	2	176		89
Total real estate construction	2	176		89
Total restructured loans	12	$	3,794	$	3,705



(dollars in thousands)	For the Nine Months Ended September 30, 2012
	Number of contracts	Pre-modification recorded investment		Post-modification recorded investment
Troubled debt restructurings:
Commercial	13	$	5,042	$	4,884
Real estate mortgages:
One-to-four family residential	2	221		221
Multi-family and commercial	1	374		374
Total real estate mortgage	3	595		595
Real estate construction:
One-to-four family residential	2	1,070		947
Multi-family and commercial	1	265		265
Total real estate construction	3	1,335		1,212
Total restructured loans	19	$	6,972	$	6,691

There were no loans modified as troubled debt restructurings, within the previous twelve months, for which there was a payment default for the three and nine months ended September 30, 2013. For the three and nine months ended September 30, 2012, there was a $37 thousand commercial loan that had been restructured within the previous twelve months that subsequently defaulted.

Non-Covered Nonaccrual Loans and Loans Past Due

The following table summarizes non-covered nonaccrual loans and past due loans, by class, as of September 30, 2013 and December 31, 2012:



(dollars in thousands)	September 30, 2013
	30 - 59 Days past due		60 - 89 Days past due		Greater than 90 days and accruing		Total past due		Nonaccrual		Current		Total non-covered loans
Commercial	$	873	$	59	$	—	$	932	$	2,435	$	169,636	$	173,003
Real estate mortgages:
One-to-four family residential	—		214		—		214		518		39,294		40,026
Multi-family and commercial	—		—		—		—		1,099		445,469		446,568
Total real estate mortgages	—		214		—		214		1,617		484,763		486,594
Real estate construction:
One-to-four family residential	—		—		—		—		5,570		30,043		35,613
Multi-family and commercial	—		—		—		—		—		15,489		15,489
Total real estate construction	—		—		—		—		5,570		45,532		51,102
Consumer:
Indirect	734		168		44		946		—		77,835		78,781
Direct	355		9		—		364		285		80,804		81,453
Total consumer	1,089		177		44		1,310		285		158,639		160,234
Total	$	1,962	$	450	$	44	$	2,456	$	9,907	$	858,570	870,933
Deferred loan costs, net													1,703
Total non-covered loans													$	872,636



(dollars in thousands)	December 31, 2012
	30 - 59 Days past due		60 - 89 Days past due		Greater than 90 days and accruing		Total past due		Nonaccrual		Current		Total non-covered loans
Commercial	$	232	$	373	$	—	$	605	$	2,966	$	158,910	$	162,481
Real estate mortgages:
One-to-four family residential	—		—		—		—		889		35,984		36,873
Multi-family and commercial	—		—		—		—		1,903		413,851		415,754
Total real estate mortgages	—		—		—		—		2,792		449,835		452,627
Real estate construction:
One-to-four family residential	—		63		—		63		9,210		37,199		46,472
Multi-family and commercial	—		—		—		—		—		34,926		34,926
Total real estate construction	—		63		—		63		9,210		72,125		81,398
Consumer:
Indirect	966		112		—		1,078		—		76,518		77,596
Direct	469		415		—		884		583		75,827		77,294
Total consumer	1,435		527		—		1,962		583		152,345		154,890
Total	$	1,667	$	963	$	—	$	2,630	$	15,551	$	833,215	851,396
Deferred loan costs, net													1,738
Total non-covered loans													$	853,134

Non-Covered Credit Quality Indicators

The Company’s internal risk rating methodology assigns risk ratings from 1 to 9, where a higher rating represents higher risk. The nine risk ratings can be generally described by the following groups:

Pass/Watch: Pass/watch loans, risk rated 1 through 5, range from minimal credit risk to lower than average, but still acceptable, credit risk.

Special Mention: Special mention loans, risk rated 6, are loans that present certain potential weaknesses that require management’s attention. Those weaknesses, if left uncorrected, may result in deterioration of the borrower’s repayment ability or the Company’s credit position in the future.

Substandard: Substandard loans, risk rated 7, are inadequately protected by the current worth and paying capacity of the borrower or of the collateral pledged, if any. There are well-defined weaknesses that may jeopardize the repayment of debt. Such weaknesses include deteriorated financial condition of the borrower resulting from insufficient income, excessive expenses or other factors that result in inadequate cash flows to meet all scheduled obligations.

Doubtful/Loss: Doubtful/loss loans are risk rated 8 and 9. Loans assigned as doubtful have all the weaknesses inherent with substandard loans, with the added characteristic that the weaknesses make collection in full, on the basis of currently existing facts, conditions and values, highly questionable. The possibility of loss is high, but because of certain important and reasonably specific pending factors that may work to the advantage of, and strengthen the credit, its classification as an estimated loss is deferred until a more exact status may be determined. The Company charges off loans that would otherwise be classified loss.

The following table summarizes our internal risk rating, by class, as of September 30, 2013 and December 31, 2012:



(dollars in thousands)	September 30, 2013
	Pass/Watch		Special mention		Substandard		Doubtful/Loss		Total
Commercial	$	153,047	$	4,016	$	15,940	$	—	$	173,003
Real estate mortgages:
One-to-four family residential	35,110		31		4,885		—		40,026
Multi-family and commercial	386,400		30,489		29,679		—		446,568
Total real estate mortgages	421,510		30,520		34,564		—		486,594
Real estate construction:
One-to-four family residential	21,866		3,155		10,592		—		35,613
Multi-family and commercial	13,312		59		2,118		—		15,489
Total real estate construction	35,178		3,214		12,710		—		51,102
Consumer:
Indirect	77,540		13		1,228		—		78,781
Direct	75,788		1,544		4,121		—		81,453
Total consumer	153,328		1,557		5,349		—		160,234
Total	$	763,063	$	39,307	$	68,563	$	—	870,933
Deferred loan costs, net									1,703
									$	872,636



(dollars in thousands)	December 31, 2012
	Pass/Watch		Special mention		Substandard		Doubtful/Loss		Total
Commercial	$	140,809	$	4,412	$	17,260	$	—	$	162,481
Real estate mortgages:
One-to-four family residential	31,511		1,139		4,223		—		36,873
Multi-family and commercial	363,408		26,287		26,059		—		415,754
Total real estate mortgages	394,919		27,426		30,282		—		452,627
Real estate construction:
One-to-four family residential	25,389		776		20,307		—		46,472
Multi-family and commercial	32,166		472		2,288		—		34,926
Total real estate construction	57,555		1,248		22,595		—		81,398
Consumer:
Indirect	76,076		16		1,504		—		77,596
Direct	71,176		450		5,668		—		77,294
Total consumer	147,252		466		7,172		—		154,890
Total	$	740,535	$	33,552	$	77,309	$	—	851,396
Deferred loan costs, net									1,738
									$	853,134