Loans and Leases

Loans and leases outstanding include the following as of the dates indicated:



	September 30, 2012		December 31, 2011		September 30, 2011
Covered loans	$	1,897,097	$	2,362,152	$	2,557,450
Noncovered loans and leases:
Commercial:
Construction and land development	319,743		381,163		416,719
Commercial mortgage	5,171,964		5,104,993		4,996,036
Other commercial real estate	158,767		144,771		144,538
Commercial and industrial	1,740,435		1,764,407		1,797,581
Lease financing	321,908		312,869		304,039
Other	131,755		158,369		158,782
Total commercial loans	7,844,572		7,866,572		7,817,695
Non-commercial:
Residential mortgage	814,877		784,118		816,738
Revolving mortgage	2,244,459		2,296,306		2,302,482
Construction and land development	132,352		137,271		139,185
Consumer	418,973		497,370		527,426
Total non-commercial loans	3,610,661		3,715,065		3,785,831
Total noncovered loans and leases	11,455,233		11,581,637		11,603,526
Total loans and leases	$	13,352,330	$	13,943,789	$	14,160,976



	September 30, 2012						December 31, 2011						September 30, 2011
	Impaired at acquisition date		All other covered loans		Total		Impaired at acquisition date		All other covered loans		Total		Impaired at acquisition date		All other covered loans		Total
Covered loans:
Commercial:
Construction and land development	$	72,873	$	185,515	$	258,388	$	117,603	$	221,270	$	338,873	$	172,309	$	233,349	$	405,658
Commercial mortgage	103,219		1,005,829		1,109,048		138,465		1,122,124		1,260,589		125,379		1,184,704		1,310,083
Other commercial real estate	29,769		84,185		113,954		33,370		125,024		158,394		40,514		118,493		159,007
Commercial and industrial	8,767		51,020		59,787		27,802		85,640		113,442		30,611		106,642		137,253
Lease financing	—		—		—		—		57		57		—		162		162
Other	—		1,305		1,305		—		1,330		1,330		—		1,473		1,473
Total commercial loans	214,628		1,327,854		1,542,482		317,240		1,555,445		1,872,685		368,813		1,644,823		2,013,636
Non-commercial:
Residential mortgage	48,245		240,915		289,160		46,130		281,438		327,568		45,384		335,021		380,405
Revolving mortgage	8,787		28,493		37,280		15,350		36,202		51,552		9,939		29,770		39,709
Construction and land development	19,008		7,400		26,408		78,108		27,428		105,536		74,414		40,712		115,126
Consumer	56		1,711		1,767		1,477		3,334		4,811		1,155		7,419		8,574
Total non-commercial loans	76,096		278,519		354,615		141,065		348,402		489,467		130,892		412,922		543,814
Total covered loans	$	290,724	$	1,606,373	$	1,897,097	$	458,305	$	1,903,847	$	2,362,152	$	499,705	$	2,057,745	$	2,557,450

At September 30, 2012, $2,493,677 in noncovered loans were pledged to secure debt obligations, compared to $2,492,644 at December 31, 2011, and $2,346,113 at September 30, 2011.

Description of segment and class risks

Each portfolio segment and the classes within those segments are subject to risks that could have an adverse impact on the credit quality of the loan and lease portfolio. Management has identified the most significant risks as described below which are generally similar among the segments and classes. While the list is not exhaustive, it provides a description of the risks that management has determined are the most significant.

Commercial loans and leases

Each commercial loan or lease is centrally underwritten based primarily upon the customer’s ability to generate the required cash flow to service the debt in accordance with the contractual terms and conditions of the loan agreement. A complete understanding of the borrower’s businesses, including the experience and background of the principals, is obtained prior to approval. To the extent that the loan or lease is secured by collateral, which is true for the majority of commercial loans and leases, the likely value of the collateral and what level of strength the collateral brings to the transaction is evaluated. To the extent that the principals or other parties provide personal guarantees, the relative financial strength and liquidity of each guarantor is assessed. Common risks to each class of commercial loans include general economic conditions within the markets BancShares serves, as well as risks that are specific to each transaction including demand for products and services, personal events such as disability or change in marital status, and reductions in the value of collateral. Due to the concentration of loans in the medical, dental, and related fields, BancShares is susceptible to risks that legislative and governmental actions will fundamentally alter the economic structure of the medical care industry in the United States.

In addition to these common risks for the majority of commercial loans and leases, additional risks are inherent in certain classes of commercial loans and leases.

Commercial construction and land development

Commercial construction and land development loans are highly dependent on the supply and demand for commercial real estate in the markets served by BancShares as well as the demand for newly constructed residential homes and lots that customers are developing. Continuing deterioration in demand could result in significant decreases in the underlying collateral values and make repayment of the outstanding loans more difficult for customers.

Commercial mortgage, commercial and industrial, and lease financing

Commercial mortgage, commercial and industrial loans, and lease financing are primarily dependent on the ability of borrowers to achieve business results consistent with those projected at loan origination, resulting in cash flow sufficient to service the debt. To the extent that a customer’s business results are significantly unfavorable versus the original projections, the ability for the loan to be serviced on a basis consistent with the contractual terms may be at risk. While these loans and leases are generally secured by real property, personal property, or business assets such as inventory or accounts receivable, it is possible that the liquidation of the collateral will not fully satisfy the obligation.

Other commercial real estate

Other commercial real estate loans consist primarily of loans secured by multifamily housing and agricultural loans. The primary risk associated with multifamily loans is the ability of the income-producing property that collateralizes the loan to produce adequate cash flow to service the debt. High unemployment or generally weak economic conditions may result in customers having to provide rental rate concessions to achieve adequate occupancy rates. The performance of agricultural loans is highly dependent on favorable weather, reasonable costs for seed and fertilizer, and the ability to successfully market the product at a profitable margin. The demand for these products is also dependent on macroeconomic conditions that are beyond the control of the borrower.

Non-commercial loans

Each non-commercial loan is centrally underwritten using automated credit scoring and analysis tools. These credit scoring tools take into account factors such as payment history, credit utilization, length of credit history, types of credit currently in use, and recent credit inquiries. To the extent that the loan is secured by collateral, the likely value of that collateral is evaluated. Common risks to each class of non-commercial loans include risks that are not specific to individual transactions such as general economic conditions within the markets BancShares serves, particularly unemployment and potential declines in real estate values. Personal events such as disability or change in marital status also add risk to non-commercial loans.

In addition to these common risks for the majority of non-commercial loans, additional risks are inherent in certain classes of non-commercial loans.

Revolving mortgage

Revolving mortgage loans are often secured by second liens on residential real estate, thereby making such loans particularly susceptible to declining collateral values. A substantial decline in collateral value could render a second lien position to be effectively unsecured. Additional risks include lien perfection inaccuracies, disputes with first lienholders, and uncertainty regarding the customer's performance with respect to the first lien that may further weaken the collateral position. Further, the open-end structure of these loans creates the risk that customers may draw on the lines in excess of the collateral value if there have been significant declines since origination.

Consumer

The consumer loan portfolio includes loans secured by personal property such as automobiles, marketable securities, other titled recreational vehicles including boats and motorcycles, as well as unsecured consumer debt. The value of underlying collateral within this class is especially volatile due to potential rapid depreciation in values since date of loan origination in excess of principal repayment.

Residential mortgage and non-commercial construction and land development

Residential mortgage and non-commercial construction and land development loans are made to individuals and are typically secured by 1-4 family residential property, undeveloped land, and partially developed land in anticipation of pending construction of a personal residence. Significant and rapid declines in real estate values can result in residential mortgage loan borrowers having debt levels in excess of the current market value of the collateral. Such a decline in values has led to unprecedented levels of foreclosures and losses within the banking industry. Non-commercial construction and land development projects can experience delays in completion and cost overruns that exceed the borrower’s financial ability to complete the project. Such cost overruns can routinely result in foreclosure of partially completed and unmarketable collateral.

Covered loans

The risks associated with covered loans are generally consistent with the risks identified for commercial and non-commercial loans and the classes of loans within those segments. An additional risk with respect to covered loans relates to the FDIC loss share agreements, specifically the ability to receive timely and full reimbursement from the FDIC for losses and related expenses that are believed to be covered by the loss share agreements. Further, these loans were underwritten by other institutions with weaker lending standards. Therefore, there is a significant risk that the loans are not adequately supported by the paying capacity of the borrower or the values of underlying collateral at the time of origination.

Credit quality indicators

Loans and leases are monitored for credit quality on a recurring basis. The credit quality indicators used are dependent on the portfolio segment to which the loan relates. Commercial loans and leases, non-commercial loans and leases, and covered loans have different credit quality indicators as a result of the methods used to monitor each of these loan segments.

The credit quality indicators for commercial loans and leases and all covered loans and leases are developed through review of individual borrowers on an ongoing basis. Each borrower is evaluated at least annually with more frequent evaluation of more severely criticized loans or leases. The indicators represent the rating for loans or leases as of the date presented based on the most recent assessment performed. These credit quality indicators are defined as follows:

Pass – A pass rated asset is not adversely classified because it does not display any of the characteristics for adverse classification.

Special mention – A special mention asset has potential weaknesses that deserve management’s close attention. If left uncorrected, such potential weaknesses may result in deterioration of the repayment prospects or collateral position at some future date. Special mention assets are not adversely classified and do not warrant adverse classification.

Substandard – A substandard asset is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Assets classified as substandard generally have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the debt. These assets are characterized by the distinct possibility of loss if the deficiencies are not corrected.

Doubtful – An asset classified as doubtful has all the weaknesses inherent in an asset classified substandard with the added characteristic that the weaknesses make collection or liquidation in full highly questionable and improbable on the basis of currently existing facts, conditions, and values.

Loss – Assets classified as loss are considered uncollectible and of such little value that it is inappropriate to be carried as an asset. This classification is not necessarily equivalent to no potential for recovery or salvage value, but rather that it is not appropriate to defer a full write-off even though partial recovery may be effected in the future.

Ungraded – Ungraded loans represent loans that are not included in the individual credit grading process due to their relatively small balances or borrower type. The majority of noncovered, ungraded loans at September 30, 2012, relate to business credit cards and tobacco buyout loans classified as commercial and industrial loans. Business credit card loans with an outstanding balance of $78,535 at September 30, 2012, are subject to automatic charge off when they become 120 days past due in the same manner as unsecured consumer lines of credit. Tobacco buyout loans with an outstanding balance of $42,601 at September 30, 2012, are secured by assignments of receivables made pursuant to the Fair and Equitable Tobacco Reform Act of 2004. The credit risk associated with these loans is considered low as the payments that began in 2005 and continue through 2014 are to be made by the Commodity Credit Corporation which is part of the United States Department of Agriculture.

The credit quality indicators for noncovered, non-commercial loans are based on the delinquency status of the borrower. As the borrower becomes more delinquent, the likelihood of loss increases.

The composition of the loans and leases outstanding at September 30, 2012, and December 31, 2011, and September 30, 2011, by credit quality indicator is provided below:



	Commercial noncovered loans and leases
Grade:	Construction and land development		Commercial mortgage		Other commercial real estate		Commercial and industrial		Lease financing		Other		Total commercial noncovered loans and leases
September 30, 2012
Pass	$	283,804	$	4,846,921	$	148,075	$	1,567,505	$	317,545	$	130,768	$	7,294,618
Special mention	8,953		169,041		3,989		19,694		1,851		251		203,779
Substandard	25,722		141,461		6,317		23,049		1,827		730		199,106
Doubtful	940		12,078		98		2,553		583		—		16,252
Ungraded	324		2,463		288		127,634		102		6		130,817
Total	$	319,743	$	5,171,964	$	158,767	$	1,740,435	$	321,908	$	131,755	$	7,844,572
December 31, 2011
Pass	$	332,742	$	4,749,254	$	130,586	$	1,556,651	$	306,225	$	157,089	$	7,232,547
Special mention	18,973		220,235		5,821		36,951		4,537		1,271		287,788
Substandard	28,793		129,391		7,794		28,240		2,107		—		196,325
Doubtful	17		1,164		377		643		—		—		2,201
Ungraded	638		4,949		193		141,922		—		9		147,711
Total	$	381,163	$	5,104,993	$	144,771	$	1,764,407	$	312,869	$	158,369	$	7,866,572
September 30, 2011
Pass	$	371,906	$	4,632,698	$	130,591	$	1,585,106	$	296,420	$	157,742	$	7,174,463
Special mention	18,431		232,537		8,672		38,844		4,765		1,020		304,269
Substandard	26,249		123,968		4,629		27,700		2,854		—		185,400
Doubtful	133		4,307		401		270		—		—		5,111
Ungraded	—		2,526		245		145,661		—		20		148,452
Total	$	416,719	$	4,996,036	$	144,538	$	1,797,581	$	304,039	$	158,782	$	7,817,695



	Non-commercial noncovered loans and leases
	Residential mortgage		Revolving mortgage		Construction and land development		Consumer		Total non-commercial noncovered loans
September 30, 2012
Current	$	780,440	$	2,223,765	$	128,557	$	414,392	$	3,547,154
30-59 days past due	16,281		12,894		2,588		2,508		34,271
60-89 days past due	6,635		4,033		127		959		11,754
90 days or greater past due	11,521		3,767		1,080		1,114		17,482
Total	$	814,877	$	2,244,459	$	132,352	$	418,973	$	3,610,661
December 31, 2011
Current	$	757,113	$	2,286,511	$	135,774	491,142		$	3,670,540
30-59 days past due	11,790		3,437		798		3,514		19,539
60-89 days past due	2,686		2,042		127		1,271		6,126
90 days or greater past due	12,529		4,316		572		1,443		18,860
Total	$	784,118	$	2,296,306	$	137,271	$	497,370	$	3,715,065
September 30, 2011
Current	$	795,578	$	2,291,490	$	134,467	$	522,155	$	3,743,690
30-59 days past due	2,303		3,987		4,204		2,369		12,863
60-89 days past due	3,022		924		—		1,361		5,307
90 days or greater past due	15,835		6,081		514		1,541		23,971
Total	$	816,738	$	2,302,482	$	139,185	$	527,426	$	3,785,831



	Covered loans
Grade:	Construction and land development - commercial		Commercial mortgage		Other commercial real estate		Commercial and industrial		Lease financing		Residential mortgage		Revolving mortgage		Construction and land development non-commercial		Consumer and other		Total covered loans
September 30, 2012
Pass	$	25,234	$	394,945	$	37,879	$	26,896	$	—	$	172,162	$	28,125	$	1,458	$	1,901	$	688,600
Special mention	76,849		306,106		17,040		13,976		—		15,169		1,993		1,160		135		432,428
Substandard	64,741		341,185		48,635		11,100		—		69,510		7,162		17,675		23		560,031
Doubtful	88,612		65,920		10,400		7,728		—		10,137		—		6,115		253		189,165
Ungraded	2,952		892		—		87		—		22,182		—		—		760		26,873
Total	$	258,388	$	1,109,048	$	113,954	$	59,787	$	—	$	289,160	$	37,280	$	26,408	$	3,072	$	1,897,097
December 31, 2011
Pass	$	29,321	$	397,526	$	49,259	$	36,409	$	57	$	189,794	$	34,164	$	4,958	$	2,393	$	743,881
Special mention	92,758		348,482		33,754		32,257		—		25,464		3,566		13,394		942		550,617
Substandard	125,158		427,996		58,351		21,914		—		70,582		9,863		72,349		1,096		787,309
Doubtful	87,936		84,871		17,030		22,862		—		13,833		3,959		14,835		982		246,308
Ungraded	3,700		1,714		—		—		—		27,895		—		—		728		34,037
Total	$	338,873	$	1,260,589	$	158,394	$	113,442	$	57	$	327,568	$	51,552	$	105,536	$	6,141	$	2,362,152
September 30, 2011
Pass	$	43,851	$	486,673	$	48,460	$	46,898	$	162	$	226,160	$	15,547	$	7,791	$	4,147	$	879,689
Special mention	97,960		342,876		24,951		34,894		—		25,686		316		23,955		577		551,215
Substandard	134,126		395,806		55,083		31,213		—		68,289		6,930		60,957		797		753,201
Doubtful	125,766		81,984		30,513		24,248		—		11,129		1,690		22,422		1,122		298,874
Ungraded	3,955		2,744		—		—		—		49,141		15,226		1		3,404		74,471
Total	$	405,658	$	1,310,083	$	159,007	$	137,253	$	162	$	380,405	$	39,709	$	115,126	$	10,047	$	2,557,450

The aging of the outstanding loans and leases, by class, at September 30, 2012, December 31, 2011, and September 30, 2011, (excluding loans and leases acquired with deteriorated credit quality) is provided in the table below. The calculation of days past due begins on the day after payment is due and includes all days through which all required interest or principal has not been paid. Loans and leases 30 days or less past due are considered current due to various grace periods that allow borrowers to make payments within a stated period after the due date and still remain in compliance with the loan agreement.



	30-59 days past due		60-89 days past due		90 days or greater		Total past due		Current		Total loans and leases
September 30, 2012
Noncovered loans and leases:
Construction and land development - commercial	$	340	$	235	$	7,685	$	8,260	$	311,483	$	319,743
Commercial mortgage	19,329		10,223		15,021		44,573		5,127,391		5,171,964
Other commercial real estate	783		—		1,049		1,832		156,935		158,767
Commercial and industrial	6,734		965		1,826		9,525		1,730,910		1,740,435
Lease financing	947		153		514		1,614		320,294		321,908
Other	—		—		—		—		131,755		131,755
Residential mortgage	16,281		6,635		11,521		34,437		780,440		814,877
Revolving mortgage	12,894		4,033		3,767		20,694		2,223,765		2,244,459
Construction and land development - non-commercial	2,588		127		1,080		3,795		128,557		132,352
Consumer	2,508		959		1,114		4,581		414,392		418,973
Total noncovered loans and leases	$	62,404	$	23,330	$	43,577	$	129,311	$	11,325,922	$	11,455,233
December 31, 2011
Noncovered loans and leases:
Construction and land development - commercial	$	2,623	$	1,494	$	2,177	$	6,294	$	374,869	$	381,163
Commercial mortgage	18,308		4,438		15,626		38,372		5,066,621		5,104,993
Other commercial real estate	657		147		561		1,365		143,406		144,771
Commercial and industrial	5,235		1,230		1,438		7,903		1,756,504		1,764,407
Lease financing	637		212		620		1,469		311,400		312,869
Other	—		—		—		—		158,369		158,369
Residential mortgage	11,790		2,686		12,529		27,005		757,113		784,118
Revolving mortgage	3,437		2,042		4,316		9,795		2,286,511		2,296,306
Construction and land development - non-commercial	798		127		572		1,497		135,774		137,271
Consumer	3,514		1,271		1,443		6,228		491,142		497,370
Total noncovered loans and leases	$	46,999	$	13,647	$	39,282	$	99,928	$	11,481,709	$	11,581,637
September 30, 2011
Noncovered loans and leases:
Construction and land development - commercial	$	1,506	$	131	$	2,089	$	3,726	$	412,993	$	416,719
Commercial mortgage	13,381		3,765		16,838		33,984		4,962,052		4,996,036
Other commercial real estate	93		—		965		1,058		143,480		144,538
Commercial and industrial	1,417		1,092		1,548		4,057		1,793,524		1,797,581
Lease financing	879		180		96		1,155		302,884		304,039
Other	18		—		—		18		158,764		158,782
Residential mortgage	2,303		3,022		15,835		21,160		795,578		816,738
Revolving mortgage	3,987		924		6,081		10,992		2,291,490		2,302,482
Construction and land development - non-commercial	4,204		—		514		4,718		134,467		139,185
Consumer	2,369		1,361		1,541		5,271		522,155		527,426
Total noncovered loans and leases	$	30,157	$	10,475	$	45,507	$	86,139	$	11,517,387	$	11,603,526

The recorded investment, by class, in loans and leases on nonaccrual status, and loans and leases greater than 90 days past due and still accruing at September 30, 2012, December 31, 2011, and September 30, 2011, (excluding loans and leases acquired with deteriorated credit quality) are as follows:



	September 30, 2012				December 31, 2011				September 30, 2011
	Nonaccrual loans and leases		Loans and leases > 90 days and accruing		Nonaccrual loans and leases		Loans and leases > 90 days and accruing		Nonaccrual loans and leases		Loans and leases > 90 days and accruing
Noncovered loans and leases:
Construction and land development - commercial	$	7,930	$	268	$	15,102	$	313	$	18,569	$	418
Commercial mortgage	44,784		3,601		23,748		3,107		25,993		2,390
Commercial and industrial	9,480		361		1,864		320		1,792		380
Lease financing	627		—		200		554		83		17
Other commercial real estate	298		951		1,170		—		1,217		—
Construction and land development - non-commercial	741		338		—		572		—		514
Residential mortgage	11,350		3,701		10,657		4,227		11,949		6,604
Revolving mortgage	—		3,760		—		4,306		—		6,066
Consumer	45		1,091		—		1,441		—		1,498
Total noncovered loans and leases	$	75,255	$	14,071	$	52,741	$	14,840	$	59,603	$	17,887

Acquired Loans

The following table provides changes in the carrying value of acquired loans impaired at acquisition date and all other acquired loans during the nine months ended September 30, 2012 and 2011:



	2012						2011
	Impaired at acquisition date			All other acquired loans			Impaired as acquisition date			All other acquired loans
Balance, January 1	$	458,305		$	1,903,847		$	330,705		$	1,676,747
Fair value of acquired loans covered by loss share agreements	—			—			303,713			777,800
Reductions for repayments, foreclosures and changes in carrying value, net of accretion	(167,581		)	(297,474		)	(134,713		)	(396,802		)
Balance, September 30	$	290,724		$	1,606,373		$	499,705		$	2,057,745
Outstanding principal balance at September 30	$	1,077,975		$	2,253,660		$	1,943,770		$	2,705,324

Analyses of the timing and amounts of cash flows were prepared at the acquisition dates for all acquired loans deemed impaired at acquisition (except loans acquired in the Venture Bank (VB) and Temecula Valley Bank (TVB) transactions), and those analyses are used to determine the amount of accretable yield recognized on those loans. Subsequent changes in cash flow estimates result in changes to the amount of accretable yield to be recognized. The timing of cash flows for nonperforming loans acquired in the VB and TVB transactions were not estimated due to relative unfamiliarity with the markets in which the collateral was located, inexperience with the type of borrowers, and general uncertainty of the time required for disposition of the assets. These factors were alleviated to a large degree in later transactions where prior experience provided the ability to make reasonable estimates as to the timing of future cash flows.

The carrying value of loans on the cost recovery method was $66,087 at September 30, 2012, $200,819 at December 31, 2011, and $298,071 at September 30, 2011. Prior to the third quarter of 2012, the cost recovery method was being applied to nonperforming loans acquired from the TVB and VB transactions unless cash flow estimates in periods following acquisition indicated subsequent improvement that would lead to the recognition of accretable yield. During the third quarter of 2012, loans acquired in the TVB and VB transactions were installed on an automated acquired loan accounting system that estimated cash flows for all loans, resulting in a $65,615 reduction in loans accounted for under the cost recovery method. The cost recovery method continues to be applied to loans when the timing of the cash flows is no longer reasonably estimable due to subsequent nonperformance by the borrower or uncertainty in the ultimate disposition of the asset.

The following table documents changes to the amount of accretable yield for the first nine months of 2012 and 2011. For acquired loans, improved cash flow estimates and receipt of unscheduled loan payments result in the reclassification of nonaccretable difference to accretable yield. During 2012, the improved ability to estimate cash flows due to expanded use of an acquired loan accounting system also contributed to significant increases in accretable yield. Accretable yield resulting from the improved ability to estimate future cash flows generally does not represent amounts previously identified as nonaccretable difference.



	2012			2011
Balance, January 1	$	276,690		$	164,586
Additions	—			79,526
Accretion	(193,438		)	(192,556		)
Reclassifications from nonaccretable difference	292,773			128,535
Changes in expected cash flows that do not affect nonaccretable difference	206,101			—
Disposals	—			—
Balance, September 30	$	582,126		$	180,091