NOTE 8 — COVERED ASSETS AND FDIC INDEMNIFICATION ASSET

Covered Assets

Covered assets consist of loans receivable and OREO that were acquired in the WFIB acquisition on June 11, 2010 and in the UCB acquisition on November 6, 2009 for which the Company entered into shared-loss agreements with the FDIC. The shared-loss agreements covered over 99% of the loans originated by WFIB and all of the loans originated by UCB, excluding the loans originated by UCB in China under its United Commercial Bank China (Limited) subsidiary. The Company shares in the losses, which began with the first dollar of loss incurred, on covered assets under the shared-loss agreements.

Pursuant to the terms of the shared-loss agreements, the FDIC is obligated to reimburse the Company 80% of eligible losses for both UCB and WFIB with respect to covered assets. For the UCB covered assets, the FDIC will reimburse the Company for 95% of eligible losses in excess of $2.05 billion. The Company has a corresponding obligation to reimburse the FDIC for 80% or 95%, as applicable, of eligible recoveries with respect to covered assets. The commercial loan and single-family residential mortgage loan shared-loss provisions are in effect for 5 years and 10 years, respectively, from the acquisition date and the loss recovery provisions are in effect for 8 years and 10 years, respectively, from the acquisition date.

The shared-loss coverage for the commercial loans acquired from the UCB and WFIB acquisitions end on the fifth anniversary of the shared-loss agreements with the FDIC. Accordingly, the shared-loss coverage of the UCB and WFIB commercial loans and other assets shared-loss agreements was extended to December 31, 2014 and will extend through June 30, 2015, respectively. Covered loans, net of discount was $1.48 billion as of December 31, 2014. The balance of the UCB commercial loans and other assets, net of discount was $1.10 billion as of December 31, 2014. The loss recovery provisions of the UCB and WFIB commercial loans’ shared-loss agreements will extend for an additional three years, through December 31, 2017 and June 30, 2018, respectively. Additionally, both the shared-loss coverage and loss recovery provisions of the UCB and WFIB residential loan shared-loss agreements are in effect for a 10-year period, extending through November 30, 2019 and June 30, 2020, respectively. Upon expiration of the shared-loss coverage periods, any losses on loans will no longer be shared with the FDIC.

Forty-five days following the 10th anniversary of the respective acquisition date, the Company will be required to pay to the FDIC a calculated amount, based on the specific thresholds of losses not being reached. The calculation of this potential liability as stated in the shared-loss agreements is 50% of the excess, if any of (i) 20% of the Intrinsic Loss Estimate less (ii) the sum of (a) 25% of the asset discount plus (b) 25% of the Cumulative Shared-Loss Payments plus (c) the Cumulative Servicing Amount, if net losses on covered assets subject to the stated threshold are not reached. The Company recorded a liability related to both UCB and WFIB shared-loss agreements of $110.3 million and $74.7 million, respectively, as of December 31, 2014 and December 31, 2013.

The Company’s covered loan portfolio consists of (1) PCI loans and (2) covered advances drawn down on existing commitment lines, subsequent to the UCB and WFIB acquisition dates (“covered advances”). PCI covered loans represent acquired loans, which the Company elected to account for in accordance with ASC 310-30. As of the respective acquisition dates, the UCB and WFIB loan portfolios included unfunded commitments for commercial lines of credit, construction draws and other lending activities. These commitments are covered under the shared-loss agreements. However, the covered advances are not accounted for under ASC 310-30.

At acquisition, loans were pooled and accounted for at fair value, which represents the discounted value of the expected cash flows of the loan portfolio. Nonaccretable difference represents the Company’s estimate of the expected credit losses, which was considered in determining the fair value of the loans as of the respective acquisition dates. In estimating nonaccretable difference, the Company (a) calculated the contractual amount and timing of undiscounted principal and interest payments (the “undiscounted contractual cash flows”) and (b) estimated the amount and timing of undiscounted expected principal and interest payments (the “undiscounted expected cash flows”). In the determination of contractual cash flows and cash flows expected to be collected, the Company assumed no prepayments on the PCI nonaccrual loan pools since the Company does not anticipate any significant prepayments on credit impaired loans. For the PCI accrual loans for single-family, multifamily and CRE, the Company utilized a recognized third party vendor to obtain prepayment speeds. As the prepayment rates for the construction, land, and commercial and consumer loan pools have historically been low, the Company applied the prepayment assumptions of the current portfolio using internal modeling. The difference between the undiscounted contractual cash flows and the undiscounted expected cash flows is the nonaccretable difference. The amount by which the undiscounted expected cash flows exceed the estimated fair value (the “accretable yield”) is accreted into interest income over the life of the loans.

The following table presents the composition of the covered loans as of December 31, 2014 and 2013:



	Year Ended December 31,
	2014				2013
	(In thousands)
CRE	$	705,665			$	1,103,530
Construction and land	46,054				163,833
Total CRE	751,719				1,267,363
C&I	252,986				426,621
Residential single-family	240,650				290,095
Residential multifamily	296,599				403,508
Total residential	537,249				693,603
Other consumer	62,986				73,973
Total covered loans	1,604,940			⁽¹⁾	2,461,560			⁽²⁾
Covered discount	(127,246		)		(265,917		)
Net valuation of loans	1,477,694				2,195,643
Allowance for loan losses on covered loans	(3,505		)		(7,745		)
Total covered loans, net	$	1,474,189			$	2,187,898
Collectively evaluated for impairment	$	253,312		⁽¹⁾	$	320,185		⁽²⁾
Acquired with deteriorated credit quality	1,224,382				1,875,458
Total	$	1,477,694			$	2,195,643


(1)	Includes $253.3 million of covered advances comprised of $154.8 million, $59.4 million, $27.3 million and $11.8 million of C&I, CRE, consumer and residential loans, respectively.


(2)	Includes $320.2 million of covered advances comprised of $230.6 million, $46.7 million, $30.9 million and $12.0 million of C&I, CRE, consumer and residential loans, respectively.

Credit Quality Indicators

Covered loans acquired are subject to the Company’s internal and external credit review and monitoring. The same credit quality indicators are reviewed for the covered portfolio as the non-covered portfolio, to enable the monitoring of the borrower’s credit and the likelihood of repayment.

Loans are risk rated based on analysis of the current state of the borrower’s credit quality. The analysis of credit quality includes a review of all repayment sources, the borrower’s current financial and liquidity status and all other relevant information. The Company utilizes an eight grade risk rating system, where a higher grade represents a higher level of credit risk. The eight grade risk rating system can be generally classified by the following categories: Pass, Watch, Special Mention, Substandard, Doubtful and Loss. The risk ratings reflect the relative strength of the repayment sources. Refer to Note 9 for a full discussion of risk ratings.

As of December 31, 2014 and December 31, 2013, the majority of the PCI covered loan portfolio was performing better than expected from the initial estimates on acquisition. As a result, the Company reduced the nonaccretable difference due to the improved performance of the portfolio. By decreasing the nonaccretable difference, the overall accretable yield will increase, thus increasing the interest income recognized over the remaining life of the loans. This reduction was primarily due to the lower loss rate and loan paydowns. However, the Company has experienced some credit deterioration in certain PCI covered loan pools. Based on the Company’s estimates of cash flows expected to be collected, the Company will establish an allowance for the PCI covered pool of loans, with a charge to income through the provision for loan losses, where appropriate. As of December 31, 2014, the Company has established an allowance of $424 thousand on $61.6 million of PCI covered loans. As of December 31, 2013, an allowance of $2.3 million was established on $129.7 million of PCI covered loans. The allowance balances for both periods were allocated mainly to the PCI covered CRE loans. With respect to the covered advances, losses are estimated collectively for groups of loans with similar characteristics. Refer to Note 9 for a discussion on the Company’s allowance for loan losses methodology.

The following tables present a summary of the activity in the allowance for loan losses on the PCI covered loans and the covered advances for the years ended December 31, 2014, 2013 and 2012:



	Year Ended December 31,
	2014										2013									2012
	Covered Advances			PCI Covered Loans			Total				Covered Advances			PCI Covered Loans		Total				Covered Advances			PCI Covered Loans		Total
	(In thousands)
Beginning balance	$	5,476		$	2,269		$	7,745			$	5,153		$	—	$	5,153			$	6,647		$	—	$	6,647
Provision for (reversal of) loan losses	6,878			(1,845		)	5,033				1,759			2,269		4,028				5,016			—		5,016
Charge-offs	(10,836		)	—			(10,836		)		(1,436		)	—		(1,436		)		(6,510		)	—		(6,510		)
Recoveries	1,563			—			1,563				—			—		—				—			—		—
Ending balance	$	3,081		$	424		$	3,505			$	5,476		$	2,269	$	7,745			$	5,153		$	—	$	5,153
Ending balance allocated to:
Collectively evaluated for impairment	$	3,081		$	—		$	3,081		⁽¹⁾	$	5,476		$	—	$	5,476		⁽²⁾	$	5,153		$	—	$	5,153		⁽³⁾
Acquired with deteriorated credit quality	—			424			424				—			2,269		2,269				—			—		—
Ending balance	$	3,081		$	424		$	3,505			$	5,476		$	2,269	$	7,745			$	5,153		$	—	$	5,153


(1)	Allowance for loan losses of $2.0 million, $676 thousand, $223 thousand and $166 thousand are allocated to C&I, CRE, consumer and residential loans, respectively.


(2)	Allowance for loan losses of $3.2 million, $1.8 million, $341 thousand and $176 thousand are allocated to C&I, CRE, consumer and residential loans, respectively.


(3)	Allowance for loan losses of $2.4 million, $2.5 million and $194 thousand and $87 thousand are allocated to C&I, CRE, consumer and residential loans, respectively.

The following tables present the credit risk rating categories for the covered loans by portfolio segments as of December 31, 2014 and 2013:



	Pass/Watch		Special Mention		Substandard		Doubtful		Total
	(In thousands)
December 31, 2014
CRE	$	579,133	$	12,575	$	113,957	$	—	$	705,665
Construction and land	18,090		8,515		19,449		—		46,054
Total CRE	597,223		21,090		133,406		—		751,719
C&I	217,975		5,723		29,288		—		252,986
Residential single-family	232,139		474		8,037		—		240,650
Residential multifamily	247,893		—		48,706		—		296,599
Total residential	480,032		474		56,743		—		537,249
Other consumer	62,010		141		835		—		62,986
Total principal balance	$	1,357,240	$	27,428	$	220,272	$	—	$	1,604,940



	Pass/Watch		Special Mention		Substandard		Doubtful		Total
	(In thousands)
December 31, 2013
CRE	$	857,376	$	27,851	$	211,835	$	6,468	$	1,103,530
Construction and land	41,847		9,472		111,616		898		163,833
Total CRE	899,223		37,323		323,451		7,366		1,267,363
C&I	378,086		4,635		43,797		103		426,621
Residential single-family	281,246		733		8,116		—		290,095
Residential multifamily	373,024		785		29,699		—		403,508
Total residential	654,270		1,518		37,815		—		693,603
Other consumer	72,053		128		1,792		—		73,973
Total principal balance	$	2,003,632	$	43,604	$	406,855	$	7,469	$	2,461,560

Credit Risk and Concentration

At each respective acquisition date, the covered loans were grouped into pools of loans with similar characteristics and risk factors per ASC 310-30. The pools were first developed based on loan categories and performance status. As of December 31, 2014 and December 31, 2013, UCB covered loans comprised approximately 93% of total covered loans. In respect of the UCB acquisition, the loans were further segregated among the former UCB domestic, Hong Kong and China portfolios, representing three general geographic regions. The Company evaluated the make-up of geographic regions within the construction, land, and multi-family loan portfolios and further segregated these pools into distressed and non-distressed regions, based on the Company’s historical experience with real estate loans within the non-covered portfolio. As of the UCB acquisition date, 64%, 10% and 11% of the UCB portfolio were located in California, Hong Kong and New York, respectively. This assessment was factored into the initial estimates on acquisition and the discount applied to the loans. As such, geographic concentration risk is considered in the covered loan discount.

Covered Nonperforming Assets

The following table presents the Company’s covered nonperforming assets as of December 31, 2014 and December 31, 2013:



	December 31,
	2014		2013
	(In thousands)
Covered nonaccrual loans^{(1) (2) (3)}	$	62,665	$	126,895
Other real estate owned covered, net	4,499		21,373
Total covered nonperforming assets	$	67,164	$	148,268


(1)	Covered nonaccrual loans include loans that meet the criteria for nonaccrual but have a yield accreted through interest income under ASC 310-30. All losses on covered loans are 80% reimbursed by the FDIC.


(2)	Net of discount.


(3)	Includes $10.1 million and $17.7 million of covered advances as of December 31, 2014 and December 31, 2013, respectively; and $52.6 million and $109.2 million of PCI loans as of December 31, 2014 and December 31, 2013, respectively.

As of December 31, 2014 and December 31, 2013, there were no accruing covered loans that were past due 90 days or more.

Troubled Debt Restructurings

The following table presents the Company’s troubled debt restructurings related to covered loans activity rollforward for the years ended December 31, 2014 and 2013:



	Year Ended December 31,
	2014			2013
	(In thousands)
Beginning balance	$	116,007		$	157,736
Additions	1,264			35,865
Transfers to covered OREO	(1,230		)	—
Charge-offs	(1,504		)	(10,167		)
Paydowns/Reductions	(71,810		)	(67,427		)
Ending Balance	$	42,727		$	116,007

Covered OREO

Covered OREO balances were $4.5 million and $21.4 million, net of valuation adjustments of $1.3 million and $2.4 million as of December 31, 2014 and December 31, 2013, respectively. During the year ended December 31, 2014, 17 properties with an aggregate carrying value of $28.0 million were added through foreclosure. During the year ended December 31, 2014, the Company sold 29 covered OREO properties for total proceeds of $52.1 million resulting in a total net gain on sale of $8.5 million.

Accretable Yield

The following table presents the changes in the accretable yield for the PCI covered loans for the years ended December 31, 2014, 2013 and 2012:



	Year Ended December 31,
	2014			2013			2012
	(In thousands)
Beginning balance	$	461,545		$	556,986		$	785,165
Additions	—			—			—
Accretion	(214,209		)	(347,010		)	(382,132		)
Changes in expected cash flows	59,188			251,569			153,953
Ending balance	$	306,524		$	461,545		$	556,986

The excess cash flows expected to be collected over the initial fair value of the PCI loans is referred to as the accretable yield and is accreted into interest income using an effective yield method over the remaining life of the acquired loans. The accretable yield will change due to:


•	estimate of the remaining life of acquired loans which may change the amount of future interest income;


•	estimate of the amount of contractually required principal and interest payments over the estimated life that will not be collected (the nonaccretable difference); and


•	indices for acquired loans with variable rates of interest.

During the year ended December 31, 2014, the estimated amount of contractually required principal and interest payments over the estimated life that will not be collected (the nonaccretable difference) was reduced as the losses on certain loan pools were evaluated and determined to be lower than expected. As a result of the reduction in the nonaccretable yield, the accretable yield increased, as did the amortization of the FDIC indemnification asset. Consequently, $52.5 million and $190.3 million were reclassified from nonaccretable yield to accretable yield due to changes in loss rate assumptions for the years ended December 31, 2014 and 2013. Due to ongoing improvement in credit quality of the remaining covered loans, the accrued liability to the FDIC increased during 2014.

From December 31, 2013 to December 31, 2014, excluding scheduled principal payments, a total of $647.0 million of loans were removed from the covered loans accounted for under ASC 310-30 due to loans being paid in full, sold, transferred to covered OREO or charged-off. Interest income of $87.5 million related to payoffs and removals offset by charge-offs was recorded.

From December 31, 2012 to December 31, 2013, excluding scheduled principal payments, a total of $739.3 million of loans were removed from the covered loans accounted for under ASC 310-30 due to loans being paid in full, sold, transferred to covered OREO or charged-off. Interest income of $168.1 million related to payoffs and removals offset by charge-offs was recorded.

From December 31, 2011 to December 31, 2012, excluding scheduled principal payments, a total of $924.7 million of loans were removed from the covered loans accounted for under ASC 310-30 due to loans being paid in full, sold, transferred to covered OREO or charged-off. Interest income of $124.7 million related to payoffs and removals offset by charge-offs was recorded.

FDIC Indemnification Asset/Payable to FDIC, net

The Company is amortizing the difference between the recorded amount of the FDIC indemnification asset and the expected reimbursement from the FDIC over the life of the indemnification asset, in line with the improved accretable yield as discussed above. As of December 31, 2014, due to continued payoffs and improved credit performance of the covered portfolio as compared to the Company's original estimates, the expected reimbursement from the FDIC under the shared-loss agreements has decreased and a payable to FDIC, net has been recorded. In prior year, due to the estimated losses from the covered portfolio and the corresponding expected payments from the FDIC, the Company recorded an FDIC indemnification asset. As of December 31, 2014, the net liability to the FDIC was $96.1 million compared to a net asset of $74.7 million as of December 31, 2013.

The following table presents a summary of the FDIC indemnification asset/Payable to FDIC, net for the years ended December 31, 2014 and 2013:



	Year Ended December 31,
	2014			2013
	(In thousands)
Beginning balance	$	74,708		$	316,313
Amortization	(101,638		)	(99,055		)
Reductions ⁽¹⁾	(33,595		)	(95,536		)
Estimate of FDIC repayment ⁽²⁾	(35,581		)	(47,014		)
Ending Balance	$	(96,106	)	$	74,708


(1)	Reductions relate to charge-offs, partial prepayments, loan payoffs and loan sales which result in a corresponding reduction of the indemnification asset.


(2)	This represents the change in the calculated estimate the Company will be required to pay the FDIC at the end of the FDIC shared-loss agreements, due to lower thresholds of losses.

FDIC Receivable

As of December 31, 2014, the FDIC shared-loss receivable was $1.0 million as compared to $30.3 million as of December 31, 2013. This receivable represents current reimbursable amounts from the FDIC, under the FDIC shared-loss agreements that have not yet been received. These reimbursable amounts include net charge-offs, loan related expenses and OREO-related expenses. Consequently, 100% of the loan related and OREO expenses are recorded as noninterest expense, 80% of reimbursable expense is recorded as noninterest income, netting to the 20% of actual expense paid by the Company. The FDIC also shares in 80% of recoveries received. Thus, the FDIC receivable is reduced when the Company receives payment from the FDIC as well as when recoveries occur. The FDIC shared-loss receivable is included in other assets on the consolidated balance sheet.

The following table presents a summary of the activity in the FDIC receivable for the years ended December 31, 2014 and 2013:



	Year Ended December 31,
	2014			2013
	(In thousands)
Beginning balance	$	30,261		$	73,091
Net (reduction) addition due to recovery or eligible expense/loss	(30,601		)	12,996
Payments to (received from) the FDIC	1,343			(55,826		)
Ending balance	$	1,003		$	30,261