6. Covered Assets and Indemnification Asset

As discussed in Note 2 to the consolidated financial statements, the Bank assumed substantially all of the liabilities, including all of the deposits, and acquired substantially all of the assets of FNB in an FDIC-assisted transaction on September 13, 2013. As part of the loss-share agreements entered into by the Bank with the FDIC in connection therewith, the Bank and the FDIC agreed to share the losses on loans and OREO covered under the agreements. The asset arising from the loss-share agreements, which we refer to as the “FDIC Indemnification Asset” is measured separately from the covered loan portfolio because the agreements are not contractually embedded in the covered loans and are not transferable should the Bank choose to dispose of the covered loans.

In accordance with the loss-share agreements, the Bank may be required to make a “true-up” payment to the FDIC, approximately ten years following the Bank Closing Date, if the FDIC’s initial estimate of losses on covered assets is greater than the actual realized losses. The “true-up” payment is calculated using a defined formula set forth in the P&A Agreement.

Covered Loans and Allowance for Covered Loan Losses

Loans acquired in a FDIC-assisted acquisition that are subject to a loss-share agreement are referred to as “covered loans” and reported separately in our consolidated balance sheets. Covered loans are reported exclusive of the cash flow reimbursements that may be received from the FDIC.

Based on preliminary purchase date valuations, the Bank’s portfolio of acquired covered loans had a fair value of $1.1 billion as of the Bank Closing Date, with no carryover of any allowance for loan losses. Acquired covered loans were preliminarily segregated between those considered to be PCI loans and those deemed performing.

In connection with the FNB Transaction, the Bank acquired loans both with and without evidence of credit quality deterioration since origination. The Company’s accounting policies for acquired covered loans, including covered PCI loans, are consistent with that of acquired non-covered loans, as described in Note 5 to the consolidated financial statements. The Company has established under its PCI accounting policy a framework to aggregate certain acquired covered loans into various loan pools based on a minimum of two layers of common risk characteristics for the purpose of determining their respective fair values as of their acquisition dates, and for applying the subsequent recognition and measurement provisions for income accretion and impairment testing.

The following table presents the carrying value of the covered loans summarized by portfolio segment at September 30, 2013 (in thousands).

Commercial and industrial	$		74,581
Real estate	833,493
Construction and land development	188,505
Consumer	11
Total covered loans	$	1,096,590

The following table presents the carrying value and the outstanding contractual balance of the covered PCI loans at September 30, 2013 (in thousands).

Carrying amount		$	782,560
Oustanding balance		1,082,315

At September 30, 2013, the preliminary total nonaccretable difference and accretable yield for covered PCI loans were $561.7 million and $226.8 million, respectively. The change in the accretable yield for the covered PCI loans for the period from September 14, 2013 through September 30, 2013 included accretion of the discount on loans of $0.1 million, which was recorded as a component of interest income within the consolidated statements of operations.

Interest income recorded on non-accrual covered loans was nominal. All covered PCI loans are considered to be performing due to the application of the accretion method. Additionally, no acquired covered loans have been modified in a TDR.

An analysis of the aging of the Bank’s covered loan portfolio at September 30, 2013 is shown in the following table (in thousands).

															Accruing Loans
	Loans Past Due		Loans Past Due		Loans Past Due		Total		Current		PCI		Total		Past Due
	30-59 Days		60-89 Days		90 Days or More		Past Due Loans		Loans		Loans		Loans		90 Days or More
Commercial and industrial:
Secured	$	54	$	—	$	—	$	54	$	28,529	$	34,994	$	63,577	$	—
Unsecured	—		—		—		—		2,854		8,150		11,004		—
Real estate:
Secured by commercial properties	37		—		—		37		80,627		373,849		454,513		—
Secured by residential properties	—		—		—		—		163,514		215,466		378,980		—
Construction and land development:
Residential construction loans	—		—		—		—		6,490		4,651		11,141		—
Commercial construction loans and land development	—		—		—		—		31,914		145,450		177,364		—
Consumer	—		—		—		—		11		—		11		—
	$	91	$	—	$	—	$	91	$	313,939	$	782,560	$	1,096,590	$	—

The Bank assigns a risk grade to each of its covered loans in a manner consistent with the existing loan review program and risk grading matrix used for non-covered loans, as described in Note 5 to the consolidated financial statements. However, given the short period of time that has elapsed between the Bank Closing Date and September 30, 2013, the Bank’s assessment of individual loan factors and assignment of an internal risk grade to each of the loans in its covered loan portfolio is preliminary.

The Bank’s impairment methodology for the covered loans is consistent with that of non-covered loans as discussed in Note 5 to the consolidated financial statements. To the extent there is experienced or projected credit deterioration on the acquired covered loan pools subsequent to amounts estimated at the previous quarterly recast date, this deterioration will be measured, and a provision for credit losses will be charged to earnings. Additionally, provision for credit losses will be recorded on advances on covered loans subsequent to the acquisition date in a manner consistent with the allowance for non-covered loan losses. These provisions will be partially offset by an increase to the FDIC Indemnification Asset in an amount equal to the FDIC’s loss sharing percentage under the loss-share agreements, which is recognized in noninterest income within the consolidated statement of operations.

There were no specific reserves in the allowance for loan losses related to covered loans at September 30, 2013.

Covered Other Real Estate Owned

At September 30, 2013, covered OREO was $119.7 million. Between the Bank Closing Date and September 30, 2013, the Company sold covered OREO properties with a carrying amount of $1.3 million, substantially at book value.

FDIC Indemnification Asset

At September 30, 2013, the FDIC Indemnification Asset was $190.0 million. The Company recorded accretion of $0.3 million since acquisition, which was included as a component of other noninterest income within the consolidated statements of operations.