NOTE 7 — COVERED ASSETS AND FDIC INDEMNIFICATION ASSET

Covered Assets

Covered assets consist of loans receivable and OREO that were acquired in the Washington First International Bank (“WFIB”) Acquisition on June 11, 2010 and in the United Commercial Bank (“UCB”) Acquisition on November 6, 2009 for which the Company entered into shared-loss agreements (the “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 of these agreements continue on and 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 terminate 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 expiration 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 June 30, 2013 and December 31, 2012, the Company’s recorded estimate in the balance sheet, for this liability to the FDIC for WFIB and UCB was $50.7 million and $27.7 million, respectively.

At each date of acquisition, we accounted for 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 June 30, 2013 and December 31, 2012 are as follows:

	June 30,			December 31,
	2013			2012
	(In thousands)
Real estate loans:
Residential single-family	$	314,483		$	362,345
Residential multifamily	513,141			647,440
Commercial and industrial real estate	1,190,964			1,348,556
Construction and land	329,397			417,631
Total real estate loans	2,347,985			2,775,972
Other loans:
Commercial business	481,255			587,333
Other consumer	79,533			87,651
Total other loans	560,788			674,984
Total principal balance	2,908,773			3,450,956
Covered discount	(394,829		)	(510,208		)
Net valuation of loans	2,513,944			2,940,748
Allowance on covered loans	(9,629		)	(5,153		)
Total covered loans, net	$	2,504,315		$	2,935,595

Credit Quality Indicators — 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 June 30, 2013, 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 multifamily 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.

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 subsequent to the initial valuations. 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.

The Company acquired UCB and WFIB approximately 3.5 and 3 years ago, respectively. The majority of the covered loan portfolio accounted for under ASC 310-30, is still performing as expected from the day one valuation or better than expected. However, the Company has experienced some concentrated credit deterioration in certain loan pools. Thus, during the first half of 2013, due to the concentrated credit deterioration beyond the respective acquisition date fair value of these covered loans under ASC 310-30, a provision for credit losses was recorded through earnings. As of June 30, 2013, there was an allowance of $2.5 million for these loans under ASC 310-30 due to credit deterioration, which resulted from a provision of $2.5 million for the six months ended June 30, 2013. This $2.5 million in allowance is allocated mainly to the portfolio’s commercial real estate segment.

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 are $358.8 million and $431.7 million of additional advances under the shared-loss agreements which are not accounted for under ASC 310-30 at June 30, 2013 and December 31, 2012, respectively. The Bank has considered these additional advances on commitments covered under the shared-loss agreements in the allowance for loan losses calculation. These additional advances are within our loan segments as follows: $248.3 million of commercial and industrial loans, $67.3 million of commercial real estate loans, $31.9 million of consumer loans and $11.3 million of residential loans. In comparison, at December 31, 2012, these additional advances were 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.

During the three and six months ended June 30, 2013, the Company recorded $1.2 million and $1.3 million, respectively, of charge-offs on loans outside of the scope of ASC 310-30. There were no charge-offs during the three and six months ended June 30, 2012. The resulting provision on covered loans outside the scope of ASC 310-30 was $186 thousand and $3.3 million, respectively, for the three and six months ended June 30, 2013. In comparison, there was a provision reversal of $1.1 million and provision of $526 thousand for the three and six months ended June 30, 2012. Refer to Note 8 for additional discussion of these covered charge-offs. As of June 30, 2013, $7.1 million, or 2.9%, of the total allowance is allocated to these additional advances on loans covered under the shared-loss agreements. This $7.1 million in allowance is allocated within our loan segments as follows: $4.1 million for commercial and industrial loans, $2.4 million for commercial real estate loans, $407 thousand for consumer loans, and $174 thousand for residential loans. At December 31, 2012, $5.2 million, or 2.2% of the total allowance was 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. The $2.5 million allowance for loans under ASC 310-30 discussed above and the $7.1 million in allowance for loans outside the scope of ASC 310-30 together comprise the total covered allowance of $9.6 million or 4.0% of total allowance as of June 30, 2013.

The tables below present the covered loan portfolio by credit quality indicator as of June 30, 2013 and December 31, 2012.

			Special
	Pass/Watch		Mention		Substandard		Doubtful		Total
	(In thousands)
June 30, 2013
Real estate loans:
Residential single-family	$	300,876	$	1,253	$	12,354	$	—	$	314,483
Residential multifamily	466,014		2,868		44,259		—		513,141
Commercial and industrial real estate	884,924		8,031		291,368		6,641		1,190,964
Construction and land	140,619		9,554		178,325		899		329,397
Total real estate loans	1,792,433		21,706		526,306		7,540		2,347,985
Other loans:
Commercial business	399,075		11,880		70,105		195		481,255
Other consumer	78,207		128		1,198		—		79,533
Total other loans	477,282		12,008		71,303		195		560,788
Total principal balance	$	2,269,715	$	33,714	$	597,609	$	7,735	$	2,908,773

			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

As of June 30, 2013 and December 31, 2012, $178.4 million and $204.3 million, respectively, of the ASC 310-30 credit impaired loans were considered to be nonaccrual loans in accordance with the contractual terms of the individual loans.

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

	June 30,		December 31,
	2013		2012
	(In thousands)
Covered nonaccrual loans(1) (2) (3)	$	178,431	$	204,310
Covered loans past due 90 days or more but not on nonaccrual	—		—
Total nonperforming loans	178,431		204,310
Other real estate owned covered, net	29,836		26,808
Total covered nonperforming assets	$	208,267	$	231,118

(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 $31.1 million and $29.6 million of loans at June 30, 2013 and December 31, 2012, respectively, accounted for under ASC 310-10, of which some loans have additional partial balances accounted for under ASC 310-30.

As of June 30, 2013, we had covered OREO properties with a combined aggregate carrying value of $29.8 million. Approximately 54% and 15% of covered OREO properties as of June 30, 2013 were located in California and Washington, respectively. As of December 31, 2012, we had covered OREO properties with an aggregate carrying value of $26.8 million. During the first six months of 2013, 15 properties with an aggregate carrying value of $20.2 million were added through foreclosure. The carrying value at June 30, 2013 is net of adjustments on covered OREO of $750 thousand. During the first six months of 2013, we sold 31 covered OREO properties for total proceeds of $19.2 million resulting in a total net gain on sale of $2.8 million.

Changes in the accretable yield for the covered loans are as follows for the periods shown:

	Three Months Ended June 30,
	2013			2012
	(In thousands)
Balance at beginning of period	$	503,476		$	696,666
Additions	—			—
Accretion	(84,811		)	(105,416		)
Changes in expected cash flows	40,052			29,218
Balance at end of period	$	458,717		$	620,468

	Six Months Ended June 30,
	2013			2012
	(In thousands)
Balance at beginning of period	$	556,986		$	785,165
Additions	—			—
Accretion	(166,438		)	(184,822		)
Changes in expected cash flows	68,169			20,125
Balance at end of period	$	458,717		$	620,468

The excess of cash flows expected to be collected over the initial fair value 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.

From December 31, 2012 to June 30, 2013, excluding scheduled principal payments, a total of $392.7 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 was adjusted by $74.3 million related to payoffs and removals offset by charge-offs.

From December 31, 2011 to June 30, 2012, excluding scheduled principal payments, a total of $459.0 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 was adjusted by $42.4 million related to payoffs and removals offset by charge-offs.

FDIC Indemnification Asset

Due to the reductions of the nonaccretable difference on the UCB covered loan portfolio, the expected reimbursement from the FDIC under the loss-sharing agreement decreased. As such, 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. For the three and six months ended June 30, 2013, the Company recorded $12.7 million and $21.4 million, respectively, of amortization against income, compared to $7.8 million and $17.9 million of amortization for the three and six months ended June 30, 2012. For the three and six months ended June 30, 2013, the Company recorded reductions of $28.8 million and $52.1 million, respectively. For the three and six months ended June 30, 2012, the Company recorded reductions of $36.1 million and $77.0 million, respectively.

The table below shows FDIC indemnification asset activity for the periods shown:

	Three Months Ended June 30,						Six Months Ended June 30,
	2013			2012			2013			2012
	(In thousands)						(In thousands)
Balance at beginning of period	$	276,834		$	457,265		$	316,313		$	511,135
(Amortization)	(12,696		)	(7,787		)	(21,382		)	(17,858		)
Reductions (1)	(28,820		)	(36,050		)	(52,055		)	(77,018		)
Estimate of FDIC repayment (2)	(15,376		)	(4,141		)	(22,934		)	(6,972		)
Balance at end of period	$	219,942		$	409,287		$	219,942		$	409,287

(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 loss share agreements, due to lower thresholds of losses.

FDIC Receivable

As of June 30, 2013, the FDIC loss-sharing receivable was $47.1 million as compared to $73.1 million as of December 31, 2012. 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 also 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 condensed consolidated balance sheet.