NOTE 8 — 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 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 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 loan shared-loss agreements will end on December 31, 2014 and June 30, 2015, respectively. The loss recovery provisions of the UCB and WFIB commercial loan shared-loss agreements will extend for an additional three years, ending on 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, ending on 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. However, due to the performance of the covered loan portfolio, the Company does not expect the expiration of the shared-loss coverage 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 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 $96.3 million and $74.7 million, respectively, as of September 30, 2014 and December 31, 2013.

The Company’s covered loan portfolio consists of (1) purchased credit-impaired (“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 Subtopic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (“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 commercial real estate, 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 September 30, 2014 and December 31, 2013:

	September 30,			December 31,
	2014			2013
	(In thousands)
Residential:
Residential single-family	$	248,377		$	290,095
Residential multifamily	331,451			403,508
Total residential	579,828			693,603
Commercial Real Estate (“CRE”):
Commercial and industrial real estate	773,098			1,103,530
Construction and land	63,691			163,833
Total CRE	836,789			1,267,363
Other Loans:
Commercial business	307,147			426,621
Other consumer	65,375			73,973
Total other loans	372,522			500,594
Total covered loans	1,789,139		(1)	2,461,560		(2)
Covered discount	(148,830		)	(265,917		)
Net valuation of loans	1,640,309			2,195,643
Allowance for loan losses on covered loans	(3,910		)	(7,745		)
Total covered loans, net	$	1,636,399		$	2,187,898
Collectively evaluated for impairment	$	290,446	(1)	$	320,185	(2)
Acquired with deteriorated credit quality	1,349,863			1,875,458
	$	1,640,309		$	2,195,643

⁽¹⁾ Includes $290.4 million of covered advances comprised of $191.1 million, $59.6 million, $27.6 million and $12.1 million of commercial and industrial, commercial real estate, 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 commercial and industrial, commercial real estate, 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 September 30, 2014 and December 31, 2013, the majority of the PCI covered loan portfolio was performing better than expected from the day one valuation. 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 may 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 September 30, 2014, the Company has established an allowance of $424 thousand on $64.9 million of PCI covered loans. As of December 31, 2013, an allowance of $2.2 million was established on $129.7 million of PCI covered loans. The allowance balances for both periods were allocated mainly to the PCI covered commercial real estate 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 three and nine months ended September 30, 2014 and 2013:

	Three Months Ended September 30,
	2014									2013
	Covered			PCI Covered						Covered			PCI Covered
	Advances			Loans			Total			Advances			Loans			Total
	(In thousands)
Beginning balance	$	3,692		$	1,188		$	4,880		$	7,100		$	2,529		$	9,629
Provision for (reversal of) loan losses	8,433			(764		)	7,669			(772		)	(192		)	(964		)
Charge-offs	(9,360		)	—			(9,360		)	—			—			—
Recoveries	721			—			721			—			—			—
Ending balance	$	3,486	(1)	$	424		$	3,910		$	6,328	(2)	$	2,337		$	8,665
Ending balance allocated to:
Collectively evaluated for impairment	3,486		(1)	—			3,486		(1)	6,328		(2)	—			6,328		(2)
Acquired with deteriorated credit quality	—			424			424			—			2,337			2,337
Ending balance	$	3,486	(1)	$	424		$	3,910		$	6,328	(2)	$	2,337		$	8,665

	Nine Months Ended September 30,
	2014									2013
	Covered			PCI Covered						Covered			PCI Covered
	Advances			Loans			Total			Advances			Loans		Total
	(In thousands)
Beginning balance	$	5,476		$	2,269		$	7,745		$	5,153		$	—	$	5,153
Provision for (reversal of) loan losses	7,549			(1,845		)	5,704			2,511			2,337		4,848
Charge-offs	(10,260		)	—			(10,260		)	(1,336		)	—		(1,336		)
Recoveries	721			—			721			—			—		—
Ending balance	$	3,486	(1)	$	424		$	3,910		$	6,328	(2)	$	2,337	$	8,665
Ending balance allocated to:
Collectively evaluated for impairment	3,486		(1)	—			3,486		(1)	6,328		(2)	—		6,328		(2)
Acquired with deteriorated credit quality	—			424			424			—			2,337		2,337
Ending balance	$	3,486	(1)	$	424		$	3,910		$	6,328	(2)	$	2,337	$	8,665

⁽¹⁾ Allowance for loan losses of $2.4 million, $645 thousand, $232 thousand and $163 thousand are allocated to commercial and industrial, commercial real estate, consumer and residential loans, respectively.

⁽²⁾ Allowance for loan losses of $3.7 million, $2.2 million, $376 thousand and $161 thousand are allocated to commercial and industrial, commercial real estate, consumer and residential loans, respectively.

The following tables present the credit risk rating categories for the covered loans by portfolio segments as of September 30, 2014 and December 31, 2013:

			Special
	Pass/Watch		Mention		Substandard		Doubtful		Total
	(In thousands)
September 30, 2014
Residential:
Residential single-family	$	240,954	$	555	$	6,868	$	—	$	248,377
Residential multifamily	296,864		—		34,587		—		331,451
Total residential	537,818		555		41,455		—		579,828
Commercial Real Estate (“CRE”):
Commercial and industrial real estate	658,095		2,790		112,213		—		773,098
Construction and land	23,800		10,057		29,834		—		63,691
Total CRE	681,895		12,847		142,047		—		836,789
Other Loans:
Commercial business	267,073		13,613		26,461		—		307,147
Other consumer	63,931		244		1,200		—		65,375
Total other loans	331,004		13,857		27,661		—		372,522
Total principal balance	$	1,550,717	$	27,259	$	211,163	$	—	$	1,789,139

			Special
	Pass/Watch		Mention		Substandard		Doubtful		Total
	(In thousands)
December 31, 2013
Residential:
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
Commercial Real Estate (“CRE”):
Commercial and industrial real estate	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
Other Loans:
Commercial business	378,086		4,635		43,797		103		426,621
Other consumer	72,053		128		1,792		—		73,973
Total other loans	450,139		4,763		45,589		103		500,594
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 September 30, 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 day one valuation and 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 September 30, 2014 and December 31, 2013:

	September 30,		December 31,
	2014		2013
	(In thousands)
Covered nonaccrual loans(1) (2) (3)	$	79,980	$	126,895
Other real estate owned covered, net	7,433		21,373
Total covered nonperforming assets	$	87,413	$	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 $9.2 million and $17.7 million of covered advances as of September 30, 2014 and December 31, 2013, respectively; and $70.8 million and $109.2 million of PCI loans as of September 30, 2014 and December 31, 2013, respectively.

As of September 30, 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 for the three and nine months ended September 30, 2014 and 2013:

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2014			2013			2014			2013
	(In thousands)
Balance at beginning of period	$	60,024		$	120,248		$	116,007		$	157,736
Additions	477			3,453			1,264			29,246
Transfers to covered OREO	—			—			(1,230		)	—
Charge-offs	—			—			(1,323		)	(7,466		)
Paydowns/ Reductions	(13,960		)	(4,839		)	(68,177		)	(60,654		)
Balance at end of period	$	46,541		$	118,862		$	46,541		$	118,862

Covered Other Real Estate Owned (“OREO”)

Covered OREO balances were $7.4 million and $21.4 million, net of valuation adjustments of $1.1 million and $2.4 million as of September 30, 2014 and December 31, 2013, respectively. Approximately 47%, 15% and 13% of the covered OREO were located in Washington, Wyoming and Georgia, respectively, as of September 30, 2014. Approximately 31% of covered OREO were each located in California and Massachusetts as of December 31, 2013. During the nine months ended September 30, 2014, 15 properties with an aggregate carrying value of $25.0 million were added through foreclosure. During the nine months ended September 30, 2014, the Company sold 21 covered OREO properties for total proceeds of $42.9 million resulting in a total net gain on sale of $5.0 million.

Accretable Yield

The following table presents the changes in the accretable yield for the PCI covered loans for the three and nine months ended September 30, 2014 and 2013:

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2014			2013			2014			2013
	(In thousands)
Balance at beginning of period	$	387,127		$	458,717		$	461,545		$	556,986
Additions	—			—			—			—
Accretion	(51,296		)	(100,596		)	(176,600		)	(267,035		)
Changes in expected cash flows	10,563			122,140			61,449			190,310
Balance at end of period	$	346,394		$	480,261		$	346,394		$	480,261

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 three months ended September 30, 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, $11.6 million and $50.2 million were reclassified from nonaccretable yield to accretable yield due to changes in loss rate assumptions for the three and nine months ended September 30, 2014. In comparison, $113.9 million and $153.5 million were reclassified from nonaccretable yield to accretable yield due to changes in loss rate assumptions for the three and nine months ended September 30, 2013. Due to ongoing improvement in credit quality of the remaining covered loans, the accrued liability to the FDIC increased during the three months ended September 30, 2014.

From December 31, 2013 to September 30, 2014, excluding scheduled principal payments, a total of $524.5 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 $73.9 million related to payoffs and removals offset by charge-offs was recorded.

From December 31, 2012 to September 30, 2013, excluding scheduled principal payments, a total of $560.6 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 $130.7 million related to payoffs and removals offset by charge-offs was recorded.

FDIC Indemnification Asset/(Payable to FDIC, net)

Due to the improved credit performance of the covered loan portfolio, the expected reimbursement from the FDIC under the shared-loss agreements has 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, in line with the improved accretable yield as discussed above. In prior periods, 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 June 30, 2014, due to the ongoing improvement in credit quality of the covered portfolio, the Company recorded a net liability to the FDIC. As of September 30, 2014, the net liability to the FDIC was $64.5 million compared to a net asset of $145.0 million as of September 30, 2013. The following table presents a summary of the FDIC indemnification asset/(net payable to FDIC) for the three and nine months ended September 30, 2014 and 2013:

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2014			2013			2014			2013
	(In thousands)
Balance at beginning of period	$	(24,337	)	$	219,942		$	74,708		$	316,313
Amortization	(28,175		)	(39,109		)	(85,968		)	(60,491		)
Reductions (1)	(5,676		)	(20,606		)	(31,629		)	(72,661		)
Estimate of FDIC repayment (2)	(6,272		)	(15,193		)	(21,571		)	(38,127		)
Balance at end of period	$	(64,460	)	$	145,034		$	(64,460	)	$	145,034

⁽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 September 30, 2014, the FDIC shared-loss receivable was $17.8 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 three and nine months ended September 30, 2014 and 2013:

	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2014		2013			2014			2013
	(In thousands)
Balance at beginning of period	$	15,747	$	47,125		$	30,261		$	73,091
Net addition (reduction) due to recovery or eligible expense/loss	443		467			(11,671		)	16,995
Payments to (received from) the FDIC	1,613		(9,396		)	(787		)	(51,890		)
Balance at end of period	$	17,803	$	38,196		$	17,803		$	38,196