4. ALLOWANCE FOR LOAN LOSSES AND CREDIT QUALITY INFORMATION

Allowance for Loan Losses

We maintain an allowance for loan losses and charge losses to this allowance when such losses are realized. The determination of the allowance for loan losses requires significant judgment reflecting our best estimate of impairment related to specifically identified impaired loans as well as probable loan losses in the remaining loan portfolio. Our evaluation is based upon a continuing review of these portfolios.

We established our loan loss allowance in accordance with guidance provided in the Securities and Exchange Commission’s Staff Accounting Bulletin 102 (“SAB 102”). Its methodology for assessing the appropriateness of the allowance consists of several key elements which include: specific allowances for identified problem loans; formula allowances for commercial and commercial real estate loans; and allowances for pooled homogenous loans.

Specific reserves are established for certain impaired loans in cases where we have identified significant conditions or circumstances related to a specific credit that indicates a loss is probable to occur.

The formula allowances for commercial, commercial real estate and construction loans are calculated by applying estimates of default and loss severity to outstanding loans based on the risk grade of loans. Default rates are determined through a past twelve quarter migration analysis. Loss severity is based on a three year historical analysis. As a result, changes in risk grades affect the amount of the formula allowance.

Pooled loans are usually smaller, not-individually-graded and homogenous in nature, such as consumer installment loans and residential mortgages. Loan loss allowances for pooled loans are first based on a five-year net charge-off history. The average loss allowance per homogenous pool is based on the product of average annual historical loss rate and the homogeneous pool balances. These separate risk pools are then assigned a reserve for losses based upon this historical loss information.

Qualitative and environmental adjustment factors are taken into consideration when determining the above reserve estimates. These adjustment factors are based upon our evaluation of various current conditions, including those listed below.

•

General economic and business conditions affecting the Bank’s key lending areas,

•

Credit quality trends,

•

Recent loss experience in particular segments of the portfolio,

•

Collateral values and loan-to-value ratios,

•

Loan volumes and concentrations, including changes in mix,

•

Seasoning of the loan portfolio,

•

Specific industry conditions within portfolio segments,

•

Bank regulatory examination results, and

•

Other factors, including changes in quality of the loan origination, servicing and risk management processes.

Our loan officers and risk managers meet at least quarterly to discuss and review these conditions and risks associated with individual problem loans. In addition, various regulatory agencies and loan review consultants periodically review our loan ratings and allowance for loan losses.

During the first quarter of 2012, we made certain improvements to the method in which we determine the allowance for loan loss. These improvements include:

•

Used a three year loss migration analysis to determine the probability of default

•

Segregated the commercial loan segment to more specifically analyze the risks associated with business, owner-occupied CRE, investor CRE and Construction loan portfolios

•

Improved the data used to determine qualitative adjustment factors

•

Established a portion of the allowance for loan losses related to model and complexity risk

•

Revised our loan risk rating system based on recommendations from industry experts

The following table provides the activity of the allowance for loan losses and loan balances for the three and nine months ended September 30, 2012:


	Commercial			Owner Occupied Commercial			Commercial Mortgages			Construction			Residential			Consumer			Complexity Risk (1)			Total
	(In Thousands)
Three months ended September 30, 2012
Allowance for loan losses
Beginning balance	$	9,891		$	4,091		$	9,618		$	5,307		$	6,265		$	10,341		$	916		$	46,429
Charge-offs		(1,281	)		(926	)		(709	)		(676	)		(705	)		(2,573	)		—			(6,870	)
Recoveries		455			184			18			1,314			113			204			—			2,288
Provision		(127	)		(4	)		(2,281	)		(810	)		2,690			4,300			(17	)		3,751

Ending balance	$	8,938		$	3,345		$	6,646		$	5,135		$	8,363		$	12,272		$	899		$	45,598


Nine months ended September 30, 2012
Allowance for loan losses
Beginning balance	$	15,067		$	9,235		$	7,556		$	4,074		$	6,544		$	10,604		$	—		$	53,080
Charge-offs		(11,316	)		(3,614	)		(5,600	)		(10,680	)		(3,344	)		(5,494	)		—			(40,048	)
Recoveries		1,305			190			382			1,642			171			497			—			4,187
Provision		3,882			(2,466	)		4,308			10,099			4,992			6,665			899			28,379

Ending balance	$	8,938		$	3,345		$	6,646		$	5,135		$	8,363		$	12,272		$	899		$	45,598


Period-end allowance allocated to:
Loans individually evaluated for impairment	$	1,244		$	222		$	90		$	94		$	1,199		$	24		$	—		$	2,873
Loans collectively evaluated for impairment		7,694			3,123			6,556			5,041			7,164			12,248			899			42,725

Ending balance	$	8,938		$	3,345		$	6,646		$	5,135		$	8,363		$	12,272		$	899		$	45,598


Period-end loan balances evaluated for:
Loans individually evaluated for impairment	$	3,579		$	13,324		$	5,875		$	2,620		$	18,072		$	6,694		$	—		$	50,164	(2)
Loans collectively evaluated for impairment		694,626			737,670			598,681			111,557			232,270			276,791			—			2,651,595

Ending balance	$	698,205		$	750,994		$	604,556		$	114,177		$	250,342		$	283,485		$	—		$	2,701,759

(1)	Represents the portion of the allowance for loan losses established to account for the inherent complexity and uncertainty of estimates.

(2)	The difference between this amount and nonaccruing loans at September 30, 2012, represents accruing troubled debt restructured loans.

The following table provides the activity of the allowance for loan losses and loan balances for the three and nine months ended September 30, 2011:


	Commercial			Commercial Mortgages			Construction			Residential			Consumer			Total
	(In Thousands)
Three months ended September 30, 2011
Allowance for loan losses
Beginning balance	$	25,236		$	12,330		$	5,831		$	3,707		$	9,144		$	56,248
Charge-offs		(1,431	)		(5,302	)		(1,107	)		(877	)		(1,248	)		(9,965	)
Recoveries		71			94			51			25			106			347
Provision		1,645			302			926			427			3,258			6,558

Ending balance	$	25,521		$	7,424		$	5,701		$	3,282		$	11,260		$	53,188


Nine months ended September 30, 2011
Allowance for loan losses
Beginning balance	$	26,480		$	10,564		$	10,019		$	4,028		$	9,248		$	60,339
Charge-offs		(7,641	)		(6,609	)		(8,179	)		(2,183	)		(5,472	)		(30,084	)
Recoveries		409			381			557			116			422			1,885
Provision		6,273			3,088			3,304			1,321			7,062			21,048

Ending balance	$	25,521		$	7,424		$	5,701		$	3,282		$	11,260		$	53,188


Period-end allowance allocated to:
Specific reserves(1)	$	1,810		$	1,604		$	3,005		$	808		$	120		$	7,347
General reserves(2)		23,711			5,820			2,696			2,474			11,140			45,841

Ending balance	$	25,521		$	7,424		$	5,701		$	3,282		$	11,260		$	53,188


Period-end loan balances evaluated for:
Specific reserves(1)	$	21,270		$	20,306		$	21,701		$	17,666		$	3,176		$	84,119	(3)
General reserves(2)		1,376,272			583,564			89,803			267,668			293,991			2,611,298

Ending balance	$	1,397,542		$	603,870		$	111,504		$	285,334		$	297,167		$	2,695,417

(1)	Specific reserves represent loans individually evaluated for impairment.

(2)	General reserves represent loans collectively evaluated for impairment.

(3)	The difference between this amount and nonaccruing loans at September 30, 2011, represents accruing troubled debt restructured loans.

Non-Accrual and Past Due Loans

The following tables show our nonaccrual and past due loans at the dates indicated:

September 30, 2012

(In Thousands)

30–59 Days
Past Due and
Still Accruing

60–89 Days
Past Due and
Still Accruing

Greater Than
90 Days
Past Due and
Still Accruing

Total
Past Due
And Still
Accruing

Accruing
Current
Balances

Nonaccrual
Loans

Total
Loans

Commercial

332

—

1,869

2,201

692,425

3,579

698,205

Owner occupied commercial (1)

—

737,670

13,324

750,994

Commercial mortgages

—

598,601

5,875

604,556

Construction

—

111,557

2,620

114,177

Residential

5,272

1,218

—

6,490

234,498

9,354

250,342

Consumer

1,788

147

—

1,935

276,362

5,188

283,485

Total

7,392

1,445

1,869

10,706

2,651,113

39,940

2,701,759

% of Total Loans

0.28

0.05

0.07

0.40

98.12

1.48

100


December 31, 2011 (In Thousands)	30–59 Days Past Due and Still Accruing			60–89 Days Past Due and Still Accruing			Greater Than 90 Days Past Due and Still Accruing			Total Past Due And Still Accruing			Accruing Current Balances			Nonaccrual Loans			Total Loans
Commercial	$	1,087		$	63		$	78		$	1,228		$	1,435,876		$	23,080		$	1,460,184
Commercial mortgages		479			243			—			722			605,764			15,814			622,300
Construction		3,727			—			—			3,727			80,074			22,124			105,925
Residential		5,501			1,238			887			7,626			258,820			9,057			275,503
Consumer		2,783			709			—			3,492			287,247			1,018			291,757

Total	$	13,577		$	2,253		$	965		$	16,795		$	2,667,781		$	71,093		$	2,755,669

% of Total Loans		0.49	%		0.08	%		0.04	%		0.61	%		96.81	%		2.58	%		100	%

(1)	Prior to 2012, owner-occupied commercial loans were included in commercial loan balances.

Impaired Loans

The following tables provide an analysis of our impaired loans at September 30, 2012 and December 31, 2011:


September 30, 2012 (In Thousands)	Ending Loan Balances		Loans with No Specific Reserve (1)		Loans with Specific Reserve		Related Specific Reserve		Contractual Principal Balances		Average Loan Balances

Commercial	$	3,579	$	1,735	$	1,844	$	1,244	$	10,714	$	8,530
Owner-Occupied Commercial (2)		13,324		12,088		1,236		222		16,293		13,918
Commercial mortgages		5,875		5,243		632		90		9,316		15,394
Construction		2,620		2,121		499		94		19,245		25,446
Residential		18,072		15,126		2,946		1,199		19,919		18,502
Consumer		6,694		5,988		706		24		8,242		4,113


Total	$	50,164	$	42,301	$	7,863	$	2,873	$	83,729	$	85,903


December 31, 2011 (In Thousands)	Ending Loan Balances		Loans with No Specific Reserve (1)		Loans with Specific Reserve		Related Specific Reserve		Contractual Principal Balances		Average Loan Balances
Commercial	$	23,193	$	19,353	$	3,840	$	2,630	$	26,815	$	22,396
Commercial mortgages		15,814		13,602		2,212		295		21,278		16,237
Construction		22,124		14,166		7,958		723		34,862		27,323
Residential		16,227		9,649		6,578		964		19,312		17,480
Consumer		2,621		1,336		1,285		101		2,788		3,916


Total	$	79,979	$	58,106	$	21,873	$	4,713	$	105,055	$	87,352

(1)	Reflects loan balances at their remaining book balance.

(2)	Prior to 2012, owner-occupied commercial loans were included in commercial loan balances.

Interest income of $150,000 and $478,000 was recognized on impaired loans during the three and nine months ended September 30, 2012, respectively.

Credit Quality Indicators

Below is a description of each of our risk ratings for all commercial loans:

Pass. These borrowers presently show no current or potential problems and their loans are considered fully collectible.

Special Mention. Borrowers have potential weaknesses that deserve management’s close attention. Borrowers in this category may be experiencing adverse operating trends, e.g.: declining revenues or margins, high leverage, tight liquidity, or increasing inventory without increasing sales. These adverse trends can have a potential negative effect on the borrower’s repayment capacity. These assets are not adversely classified and do not expose the Bank to significant risk that would warrant a more severe rating. Borrowers in this category may also be experiencing significant management problems, pending litigation, or other structural credit weaknesses.

Substandard. Borrowers have well-defined weaknesses that require extensive oversight by management. Borrowers in this category may exhibit one or more of the following: inadequate debt service coverage, unprofitable operations, insufficient liquidity, high leverage, and weak or inadequate capitalization. Relationships in this category are not adequately protected by the sound financial worth and paying capacity of the obligor or the collateral pledged on the loan, if any. The distinct possibility exists that the Bank will sustain some loss if the deficiencies are not corrected.

Doubtful. Borrowers have well-defined weaknesses inherent in the Substandard category with the added characteristic that the possibility of loss is extremely high. Current circumstances in the credit relationship make collection or liquidation in full highly questionable. A doubtful asset has some pending event that may strengthen the asset that defers the loss classification. Such impending events include: perfecting liens on additional collateral, obtaining collateral valuations, an acquisition or liquidation preceding, proposed merger, or refinancing plan.

Loss. Borrowers are uncollectible or of such negligible value that continuance as a bankable asset is not supportable. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical to defer writing off this asset even though partial recovery may be recognized sometime in the future.

Residential and Consumer Loans

The residential and consumer loan portfolios are monitored on an ongoing basis using delinquency information and loan type as credit quality indicators. These credit quality indicators are assessed in the aggregate in these relatively homogeneous portfolios. Loans that are greater than 90 days past due are generally considered nonperforming and placed in nonaccrual status.

The following tables provide an analysis of problem loans as of September 30, 2012 and December 31, 2011:

Commercial credit exposure credit risk profile by internally assigned risk rating (in thousands):


	Commercial				Owner-Occupied Commercial (1)				Commercial Mortgages				Construction				Total Commercial
	Sept. 30, 2012		Dec. 31, 2011		Sept. 30, 2012		Dec. 31, 2011		Sept. 30, 2012		Dec. 31, 2011		Sept. 30, 2012		Dec. 31, 2011		September 30, 2012					December 31, 2011
	Sept. 30, 2012		Dec. 31, 2011		Sept. 30, 2012		Dec. 31, 2011		Sept. 30, 2012		Dec. 31, 2011		Sept. 30, 2012		Dec. 31, 2011		Amount		Percent			Amount		Percent
Risk Rating:
Special mention	$	14,758	$	85,848	$	29,413		—	$	30,722	$	50,044	$	429	$	9,747	$	75,322				$	145,639
Substandard:
Accrual		73,204		107,896		54,344		—		13,812		13,664		13,053		19,039		154,413					140,599
Nonaccrual		1,334		23,193		12,088		—		5,243		15,814		2,121		22,124		20,786					61,131
Doubtful/Nonaccrual		2,245		—		1,236		—		632		—		499		—		4,612					—

Total Special Mention, Substandard and Doubtful		91,541		216,937		97,081		—		50,409		79,522		16,102		50,910		255,133		12	%		347,369		16	%
Pass		606,664		1,242,519		653,913		—		554,147		543,277		98,075		55,244		1,912,799		88			1,841,040		84

Total Commercial Loans	$	698,205	$	1,459,456	$	750,994		—	$	604,556	$	622,799	$	114,177	$	106,154	$	2,167,932		100	%	$	2,188,409		100	%

Consumer credit exposure credit risk profile based on payment activity (in thousands):


	Residential				Consumer				Total Residential and Consumer
	Sept. 30, 2012		Dec. 31, 2011		Sept. 30, 2012		Dec. 31, 2011		September 30, 2012					December 31, 2011
	Sept. 30, 2012		Dec. 31, 2011		Sept. 30, 2012		Dec. 31, 2011		Amount		Percent			Amount		Percent

Nonperforming (2)	$	18,072	$	16,227	$	6,694	$	2,621	$	24,766		5	%	$	18,848		3	%
Performing		232,270		259,276		276,791		289,136		509,061		95			548,412		97

Total	$	250,342	$	275,503	$	283,485	$	291,757	$	533,827		100	%	$	567,260		100	%

(1)	Prior to 2012, owner-occupied commercial loans were included in commercial loan balances.

(2)	Includes $10.2 million at September 30, 2012 and $8.9 million at December 31, 2011 of troubled debt restructured mortgages and home equity installment loans performing in accordance with modified terms and are accruing interest

Troubled Debt Restructurings (TDR)

The book balance of TDRs at September 30, 2012 and December 31, 2011 was $22.3 million and $27.7 million, respectively. The balances at September 30, 2012 include approximately $12.1 million in nonaccrual status and $10.2 million in accrual status compared to $18.8 million in nonaccrual status and $8.9 million of in accrual status at December 31, 2011. Approximately $1.2 million and $1.3 million in specific reserves have been established for these loans as of September 30, 2012 and December 31, 2011, respectively.

During the nine months ending September 30, 2012, the terms of 104 loans were either modified or identified as troubled debt restructurings, of which 15 were related to commercial loans that were already placed on nonaccrual. Nonaccruing restructured loans remain in nonaccrual status until there has been a period of sustained repayment performance for a reasonable period, usually six months. The remaining 89 loans represented residential and consumer loans. Our concessions on restructured loans consisted mainly of forbearance agreements, reduction in interest rates or extensions of maturities. Principal balances are generally not forgiven by us when a loan is modified as a TDR.

The following table presents loans identified as TDRs during the three and nine months ended September 30, 2012:


(In Thousands)	Three Months Ended Sept. 30, 2012		Nine Months Ended Sept. 30, 2012

Commercial	$	710	$	9,986
Construction		—		378
Residential		2,779		4,170
Consumer		2,165		2,312

Total	$	5,654	$	16,846

The TDRs described above increased the allowance for loan losses by $357,000 through allocation of a specific reserve, and resulted in charge offs of $8.1 million during the nine months ending September 30, 2012.

There was one residential TDR in the amount of $84,000 which defaulted (defined as past due 90 days) during the three and nine months ended September 30, 2012 that was restructured within the last twelve months prior to September 30, 2012.