7. 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 WFIB and UCB 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 shared-loss agreement and single-family residential mortgage loan shared-loss agreement 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 commercial loan shared-loss agreements related to the UCB and WFIB acquisitions will mature on November 6, 2014 and June 11, 2015, respectively. The single-family residential mortgage loan shared-loss agreements carry expiration dates of November 6, 2019 and June 11, 2020 for UCB and WFIB, respectively. Upon the completion of these agreements, any losses on loans left in the portfolio will belong solely to the Company. However, due to the performance of the covered loan portfolio, the Company does not expect the maturity of these agreements to have a material impact.

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 and (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 loans subject to the stated threshold is not reached. As of December 31, 2012 and 2011, the Company’s estimate for this liability to the FDIC for WFIB and UCB was $27.7 million and $10.7 million, respectively.

At each date of acquisition, we initially recognized the loan portfolio acquired from the respective bank at fair value. This represents the discounted value of the expected cash flows from the portfolio. In estimating the nonaccretable difference, we (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, we assume no prepayment on the ASC 310-30 nonaccrual loan pools as we do not anticipate any significant prepayments on credit impaired loans. For the ASC 310-30 accrual loans for single-family, multifamily and commercial real estate, we used a third party vendor to obtain prepayment speeds, in order to be consistent with market participant’s information. The third party vendor is recognized in the mortgage-industry for the delivery of prepayment and default models for the secondary market to identify loan level prepayment, delinquency, default, and loss propensities. The prepayment rates for the construction, land, and commercial and consumer pools have historically been low and so we applied the prepayment assumptions of our current portfolio using our internal modeling. The difference between the undiscounted contractual cash flows and the undiscounted expected cash flows is the nonaccretable difference. The nonaccretable difference represents our estimate of the credit losses expected and was considered in determining the fair value of the loans as of the acquisition date. 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 Company has elected to account for all covered loans acquired in the FDIC-assisted acquisitions under ASC 310-30.

The carrying amounts and the composition of the covered loans as of December 31, 2012 and 2011 are as follows:

	December 31,
	2012			2011
	(In thousands)
Real estate loans:
Residential single-family	$	362,345		$	442,732
Residential multifamily	647,440			918,941
Commercial and industrial real estate	1,348,556			1,773,760
Construction and land	417,631			653,045
Total real estate loans	2,775,972			3,788,478

Other loans:
Commercial business	587,333			831,762
Other consumer	87,651			97,844
Total other loans	674,984			929,606
Total principal balance	3,450,956			4,718,084
Covered discount	(510,208		)	(788,295		)
Net valuation of loans	2,940,748			3,929,789
Allowance on covered loans	(5,153		)	(6,647		)
Total covered loans, net	$	2,935,595		$	3,923,142

Credit Quality Indicators—The covered loans acquired are and will continue to be subject to the Bank’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 review of all sources of repayment, 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 or Watch, Special Mention, Substandard, Doubtful and Loss. The risk ratings reflect the relative strength of the sources of repayment. Refer to Note 8 for full discussion of risk ratings.

The Company reduced the nonaccretable difference due to the performance of the portfolio and expectation for the inherent losses in the portfolio in the fourth quarter of 2010. By lowering the nonaccretable discount, the overall accretable yield will increase thus increasing the interest income recognized over the remaining life of the loans. This reduction was primarily calculated based on the risk ratings of the loans. If credit deteriorates beyond the respective acquisition date fair value amount of the covered loans under ASC 310-30, such deterioration will be reserved for and a provision for credit losses will be charged to earnings with a partially offsetting noninterest income item reflected in the increase to the FDIC indemnification asset or receivable. As of December, 2012, there is no allowance for the covered loans accounted for under ASC 310-30 related to deterioration as the credit has not deteriorated beyond fair value at acquisition date.

As of the acquisition date, WFIB’s and UCB’s loan portfolios included unfunded commitments for commercial lines of credit, construction draws and other lending activity. The total commitment outstanding as of the acquisition date is covered under the shared-loss agreements. However, any additional advances on these loans subsequent to acquisition date are not accounted for under ASC 310-30. Included in the table below for the years ended December 31, 2012, and 2011, are $431.7 million and $583.8 million, respectively, of additional advances, under the shared-loss agreements which are not accounted for under ASC 310-30. The bank has considered these additional advances on commitments covered under the shared-loss agreements in the allowance for loan losses calculation. At December 31, 2012, these additional advances are within our loan segments as follows: $302.3 million of commercial and industrial loans, $83.4 million of commercial real estate loans, $34.5 million of consumer loans and $11.5 million of residential loans. In comparison, at December 31, 2011, these additional advances were within our loan segments as follows: $390.3 million of commercial and industrial loans, $149.1 million of commercial real estate loans, $31.6 million of consumer loans and $12.7 million of residential loans. During the year ended December 31, 2012, the Company recorded $6.5 million of charge-offs on a few specific covered loans outside of the scope of ASC 310-30. There were no charge-offs in prior periods. The provision on covered loans for the years ended December 31, 2012, 2011 and 2010 was $5.0 million, $2.4 million and $4.2 million, respectively. Refer to Note 8 for additional discussion of these covered charge-offs. As of December 31, 2012, $5.2 million, or 2.2%, of the total allowance is allocated to these additional advances on loans covered under the shared-loss agreements. This $5.2 million in allowance is allocated within our loan segments as follows: $2.5 million for commercial real estate loans, $2.4 million for commercial and industrial loans, $194 thousand for consumer loans and $87 thousand for residential loans. At December 31, 2011, $6.6 million or 3.1%, of the total allowance was allocated within our loan segments as follows: $4.0 million for commercial real estate loans, $2.4 million for commercial and industrial loans, $174 thousand for consumer loans and $70 thousand for residential loans.

			Special
	Pass/Watch		Mention		Substandard		Doubtful		Total
	(In thousands)
December 31, 2012
Real estate loans:
Residential single-family	$	345,568	$	982	$	15,795	$	—	$	362,345
Residential multifamily	571,061		8,074		68,305		—		647,440
Commercial and industrial real estate	963,069		10,777		367,869		6,841		1,348,556
Construction and land	170,548		15,135		230,776		1,172		417,631
Total real estate loans	2,050,246		34,968		682,745		8,013		2,775,972
Other loans:
Commercial business	434,138		22,533		130,467		195		587,333
Other consumer	85,534		515		1,602		—		87,651
Total other loans	519,672		23,048		132,069		195		674,984
Total principal balance	$	2,569,918	$	58,016	$	814,814	$	8,208	$	3,450,956

			Special
	Pass/Watch		Mention		Substandard		Doubtful		Total
	(In thousands)
December 31, 2011
Real estate loans:
Residential single-family	$	427,918	$	1,085	$	13,729	$	—	$	442,732
Residential multifamily	779,694		26,124		113,123		—		918,941
Commercial and industrial real estate	1,249,781		43,810		472,003		8,166		1,773,760
Construction and land	242,996		40,859		362,958		6,232		653,045
Total real estate loans	2,700,389		111,878		961,813		14,398		3,788,478
Other loans:
Commercial business	643,117		34,707		149,253		4,685		831,762
Other consumer	96,342		—		1,502		—		97,844
Total other loans	739,459		34,707		150,755		4,685		929,606
Total principal balance	$	3,439,848	$	146,585	$	1,112,568	$	19,083	$	4,718,084

Credit Risk and Concentrations—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, 2012 UCB covered loans represent approximately 94% of total covered loans. For the UCB acquisition, the loans were further segregated among the former UCB domestic, Hong Kong, and China portfolios, representing the three general geographic regions. In addition, 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 our historical experience of real estate loans within the non-covered portfolio. As of the date of acquisition 64% of the UCB portfolio was located in California, 10% was located in Hong Kong and 11% was located in New York. This assessment was factored into the day one valuation and discount applied to the loans. As such, geographic concentration risk is considered in the covered loan discount. As of December 31, 2012, credit related to the covered loans has not deteriorated beyond the fair value at acquisition date.

At December 31, 2012 and 2011, $204.3 million and $194.5 million, respectively, of the ASC 310-30 credit impaired loans were considered to be nonaccrual loans.

The following table sets forth information regarding covered nonperforming assets as of the dates indicated:

	December 31,		December 31,
	2012		2011
	(In thousands)

Covered nonaccrual loans(1) (2) (3)	$	204,310	$	194,506
Covered loans past due 90 days or more but not on nonaccrual	—		—
Total nonperforming loans	204,310		194,506
Other real estate owned covered, net	26,808		63,624
Total covered nonperforming assets	$	231,118	$	258,130

(1)

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

(2)

Represents principal balance net of discount.

(3)

Includes $29.6 million and $18.9 million of loans at December 31, 2012 and 2011, respectively, accounted for under ASC 310-10, of which some loans have additional partial balances accounted for under ASC 310-30.

As of December 31, 2012, we had 37 covered OREO properties with a combined aggregate carrying value of $26.8 million. Approximately 59% and 22% of the carrying value of covered OREO properties as of December 31, 2012 were located in California and Washington, respectively. As of December 31, 2011, we had 82 covered OREO properties with an aggregate carrying value of $63.6 million. During 2012, 54 properties with an aggregate carrying value of $40.8 million were added through foreclosure. The aggregate carrying value at December 31, 2012 includes $10.9 million in net write-downs on covered OREO. During 2012, we sold 99 covered OREO properties for total proceeds of $72.2 million resulting in a total combined net gain on sale of $5.5 million.

Changes in the accretable yield for the covered loans for the years ended December 31, 2012 and 2011 is as follows:

	2012			2011
	(In thousands)

Balance at beginning of period	$	785,165		$	1,153,272
Additions	—			—
Accretion	(193,591		)	(208,887		)
Changes in expected cash flows	(34,588		)	(159,220		)
Balance at end of period	$	556,986		$	785,165

The excess of cash flows expected to be collected over the recorded investment of acquired loans is referred to as the accretable yield and is accreted into interest income over the estimated life of the acquired loans using the effective yield method. 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 fourth quarter 2012, the estimate of the amount of contractually required principal and interest payments over the estimated life that will not be collected (the nonaccretable difference) was reduced as the loss on certain loan pools was evaluated to be lower than expected.

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 under ASC 310-30 due to loans being paid in full, sold, transferred to covered OREO or charged-off. Interest income was adjusted by $124.7 million related to payoffs and removals offset by charge-offs.

From December 31, 2010 to December 31, 2011, excluding scheduled principal payments, a total of $932.2 million of loans were removed from the covered loans accounted under ASC 310-30 due to loans being paid in full, sold, transferred to covered OREO or charged-off. Interest income was adjusted by $102.1 million related to payoffs and removals offset by charge-offs.

From December 31, 2009 to December 31, 2010, excluding scheduled principal payments, a total of $1.33 billion of loans were removed from the covered loans accounted under ASC 310-30 due to loans being paid in full, sold, transferred to covered OREO or charged-off. Interest income was adjusted by $135.0 million related to payoffs and removals offset by charge-offs.

FDIC Indemnification Asset

Due to the fourth quarter 2010 reduction of the nonaccretable difference on the UCB covered loan portfolio, the expected reimbursement from the FDIC under the loss-sharing agreement decreased. 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. The amortization is in line with the improved accretable yield as discussed above. As such, the Company has net amortization of the FDIC indemnification asset against income. For the years ended December 31, 2012 and 2011, the Company recorded $33.8 million and $59.9 million, respectively, of amortization against non-interest income. For the years ended December 31, 2012 and 2011, the Company also recorded $144.0 million and $210.4 million, respectively, reduction to the FDIC indemnification asset resulting from paydowns, payoffs, loan sales, and charge-offs. Additionally, during 2012 and 2011, respectively, $17.0 million and $3.6 million were recorded as the increase in the estimate of liability owed to the FDIC at the completion of the FDIC loss share agreements.

The table below shows FDIC indemnification asset activity for 2012 and 2011:

	2012			2011
	(In thousands)

Balance at beginning of period	$	511,135		$	785,035
(Amortization) Accretion	(33,815		)	(59,929		)
Reductions(1)	(143,988		)	(210,365		)
Estimate of FDIC repayment (2)	(17,019		)	(3,606		)
Balance at end of period	$	316,313		$	511,135

(1)

Reductions relate to higher cash flows received from principal amortization, partial prepayments, loan payoffs and loan sales.

(2)

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

FDIC Receivable

As of December 31, 2012, the FDIC loss sharing receivable was $73.1 million as compared to $76.6 million as of December 31, 2011. This receivable represents 80% of reimbursable amounts from the FDIC, under the FDIC loss-sharing agreements that have not yet been received. These reimbursable amounts include net charge-offs, loan-related expenses and OREO-related expenses. 100% of the loan-related and OREO expenses are recorded as noninterest expense, 80% of any reimbursable expense is recorded as noninterest income, netting to the 20% of actual expense paid by the Company. The FDIC shares in 80% of recoveries received. Thus, the FDIC receivable is reduced when we receive payment from the FDIC as well as when recoveries occur. The FDIC loss-sharing receivable is included in other assets on the consolidated balance sheet.