5. 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. We established our allowance for loan losses in accordance with guidance provided in the SEC’s Staff Accounting Bulletin 102 (“SAB 102”). 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. The following are included in our allowance for loan losses:

•

Specific reserves for impaired loans

•

Allowances for pools of homogenous loans based on historical loss experience

•

Adjustments for qualitative and environmental factors allocated to pools of homogenous loans

•

Allowance for model estimation and complexity risk

Specific reserves are established for impaired loans where we have identified significant conditions or circumstances related to specific credits that indicate losses are probable. Unless loans are well-secured and collection is imminent, all loans that are 90 days past due are deemed impaired. Reserves for impaired loans are generally charged-off within 90 days of impairment recognition. Estimated losses are based on collateral values, estimates of future cash flows or market valuations. During the first quarter of 2014, net charge-offs totaled $2.5 million, or .34% of average loans annualized, compared to $9.9 million, or .34%, of average loans in 2013. We charge loans off when they are deemed to be uncollectable.

Allowances for pooled homogeneous loans, that are not deemed impaired, are based on historical net loss experience. Estimated losses for pooled portfolios are determined differently for commercial loan pools and retail loan pools. Commercial loans are pooled into following segments: Business Loans (Commercial and Industrial Loans), Commercial Real Estate—Owner-Occupied, Commercial Real Estate—Investor, and Construction Loans. Each pool is further segmented by internally assessed risk ratings. Loan losses for commercial loans are estimated by determining the probability of default and expected loss severity upon default. Probability of default is calculated based on the historical rate of migration to impaired status during the last 16 quarters. Loss severity is calculated as the actual loan losses (net of recoveries) on impaired loans in the respective pool during the same time frame. Retail loans are pooled into the following segments: residential mortgage loans, home equity secured loans, and all other consumer loans. Pooled reserves for retail loans are calculated based solely on the previous three year average net loss rate.

Qualitative and environmental adjustment factors are taken into consideration when determining the above reserve estimates or core reserves. These adjustment factors are based upon our evaluation of various current internal and external conditions and are allocated among loan types and take into consideration the following:

•

Assessment of current underwriting policies, staff, and portfolio mix

•

Internal trends of delinquency, nonaccrual and criticized loans by segment

•

Assessment of risk rating accuracy, control and regulatory assessments/environment

•

General economic conditions—locally and nationally

•

Market trends impacting collateral values

•

Competitive environment as it could impact loan structure and underwriting

The above factors are based on their relative standing compared to the period which historic losses are used in core reserve estimates and current directional trends. Each individual qualitative and environmental factor in our model can add or subtract to core reserves.

The final component of the allowance is a reserve for model estimation and complexity risk. The calculation of reserves is generally quantitative; however, qualitative estimates of valuations and risk assessment are necessary. We review the qualitative estimates of valuation factors quarterly and adjust based on current trends.

Our loan officers and risk managers meet at least quarterly to discuss and review the 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.

The following tables provide the activity of our allowance for loan losses and loan balances for three months ended March 31, 2014 and 2013:


	Commercial			Owner - Occupied Commercial			Commercial Mortgages			Construction			Residential			Consumer			Estimation/ Complexity Risk (1)		Total
	(in thousands)
Three months ended March 31, 2014
Allowance for loan losses
Beginning balance	$	12,751		$	7,638		$	6,932		$	3,326		$	3,078		$	6,494		$	1,025	$	41,244
Charge-offs		(1,113	)		(197	)		(160	)		(88	)		(364	)		(1,233	)		—		(3,155	)
Recoveries		324			6			37			7			18			217			—		609
Provision (credit)		442			1,342			554			(529	)		33			771			17		2,630

Ending balance	$	12,404		$	8,789		$	7,363		$	2,716		$	2,765		$	6,249		$	1,042	$	41,328

Period-end allowance allocated to:
Loans individually evaluated for impairment	$	1,865		$	1,191		$	1,019		$	—		$	807		$	186		$	—	$	5,068
Loans collectively evaluated for impairment		10,539			7,598			6,344			2,716			1,958			6,063			1,042		36,260

Ending balance	$	12,404		$	8,789		$	7,363		$	2,716		$	2,765		$	6,249		$	1,042	$	41,328

Period-end loan balances evaluated for:
Loans individually evaluated for impairment	$	4,583		$	6,318		$	15,786		$	1,070		$	18,413		$	5,537		$	—	$	51,707	(2)
Loans collectively evaluated for impairment		833,598			792,895			730,543			100,415			199,740			295,774			—	$	2,952,965

Ending balance	$	838,181		$	799,213		$	746,329		$	101,485		$	218,153		$	301,311		$	—	$	3,004,672	(3)


	Commercial			Owner Occupied Commercial			Commercial Mortgages			Construction			Residential			Consumer			Estimation/ Complexity Risk (1)			Total
	(In Thousands)
Three months ended March 31, 2013
Allowance for loan losses
Beginning balance	$	13,663		$	6,108		$	8,079		$	6,456		$	3,124		$	5,631		$	861		$	43,922
Charge-offs		(256	)		(1	)		(1,697	)		(19	)		(440	)		(1,294	)		—			(3,707	)
Recoveries		226			12			3			15			18			228			—			502
Provision		(865	)		219			808			333			579			1,176			(19	)		2,231

Ending balance	$	12,768		$	6,338		$	7,193		$	6,785		$	3,281		$	5,741		$	842		$	42,948

Period-end allowance allocated to:
Loans individually evaluated for impairment	$	868		$	47		$	2,000		$	—		$	922		$	12		$	—		$	3,849
Loans collectively evaluated for impairment		11,900			6,291			5,193			6,785			2,359			5,729			842			39,099

Ending balance	$	12,768		$	6,338		$	7,193		$	6,785		$	3,281		$	5,741		$	842		$	42,948

Period-end loan balances evaluated for:
Loans individually evaluated for impairment	$	4,991		$	13,263		$	11,240		$	1,216		$	19,578		$	6,210		$	—		$	56,498	(2)
Loans collectively evaluated for impairment		727,831			752,961			622,510			132,265			218,276			277,096			—			2,730,939

Ending balance	$	732,822		$	766,224		$	633,750		$	133,481		$	237,854		$	283,306		$	—		$	2,787,437	(3)

(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 March 31, 2013, represents accruing troubled debt restructured loans which are considered to be impaired loans.

(3)	Ending loan balances do not include deferred costs.

Nonaccrual and Past Due Loans

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


March 31, 2014 (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	$	788		$	—		$	—		$	788		$	833,364		$	4,029		$	838,181
Owner-Occupied commercial		—			—			—			—			792,895			6,318			799,213
Commercial mortgages		—			—			—			—			730,637			15,692			746,329
Construction		—			—			—			—			100,415			1,070			101,485
Residential		1,788			438			403			2,629			206,153			9,371			218,153
Consumer		736			353			—			1,089			296,574			3,648			301,311

Total	$	3,312		$	791		$	403		$	4,506		$	2,960,038		$	40,128		$	3,004,672

% of Total Loans		0.11	%		0.03	%		0.01	%		0.15	%		98.51	%		1.34	%		100	%


December 31, 2013 (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	$	1,447		$	—		$	—		$	1,447		$	805,132		$	4,303		$	810,882
Owner-Occupied commercial		538			—			—			538			780,625			5,197			786,360
Commercial mortgages		83			1,049			—			1,132			715,496			8,565			725,193
Construction		—			—			—			—			104,916			1,158			106,074
Residential		1,952			1,348			533			3,833			209,255			8,432			221,520
Consumer		1,095			177			—			1,272			297,669			3,293			302,234

Total	$	5,115		$	2,574		$	533		$	8,222		$	2,913,093		$	30,948		$	2,952,263

% of Total Loans		0.17	%		0.09	%		0.02	%		0.28	%		98.67	%		1.05	%		100	%

Impaired Loans

The following tables provide an analysis of our impaired loans at March 31, 2014 and December 31, 2013:


March 31, 2014 (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	$	4,583	$	2,347	$	2,236	$	1,865	$	6,146	$	5,292
Owner-Occupied commercial		6,318		4,564		1,754		1,191		6,906		10,005
Commercial mortgages		15,786		10,513		5,273		1,019		20,587		11,074
Construction		1,070		1,070		—		—		1,563		873
Residential		18,413		10,994		7,419		807		21,030		18,033
Consumer		5,537		4,153		1,384		186		6,218		5,297

Total	$	51,707	$	33,641	$	18,066	$	5,068	$	62,450	$	50,574


December 31, 2013 (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	$	5,003	$	2,362	$	2,641	$	1,781	$	13,013	$	5,347
Owner-Occupied commercial		5,197		5,184		12		12		8,293		11,542
Commercial mortgages		8,661		2,784		5,877		1,987		16,566		10,444
Construction		1,158		1,158		—		—		1,563		968
Residential		17,852		9,750		8,103		989		20,153		18,047
Consumer		5,411		4,767		644		134		6,056		5,455

Total	$	43,282	$	26,005	$	17,277	$	4,903	$	65,644	$	51,803

(1)	Reflects loan balances at or written down to their remaining book balance.

Interest income of $353,000 and $238,000 was recognized on impaired loans during the three months ended March 31, 2014 and 2013, 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, for example, 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 on nonaccrual status.

The following tables provide an analysis of loans by credit risk profile using internally assigned risk ratings, as of March 31, 2014 and December 31, 2013


	Commercial				Owner-Occupied Commercial				Commercial Mortgages				Construction				Total Commercial
																	March 31,					December 31,
	Mar. 30		Dec. 31		Mar. 30		Dec. 31		Mar. 30		Dec. 31		Mar. 30		Dec. 31		2014					2013
	2014		2013		2014		2013		2014		2013		2014		2013		Amount		%			Amount		%
Risk Rating:
Special mention	$	14,696	$	12,566	$	3,967	$	4,747	$	501	$	2,092	$	260	$	226	$	19,424				$	19,631
Substandard:
Accrual		58,610		56,806		44,357		45,181		13,180		8,146		3,587		3,599		119,734					113,732
Nonaccrual		2,347		2,362		4,564		5,185		10,513		2,784		1,070		1,158		18,494					11,489
Doubtful / Nonaccrual		2,236		2,641		1,754		12		5,273		5,877		—		—		9,263					8,530

Total Special Mention, Substandard and Doubtful		77,889		74,375		54,642		55,125		29,467		18,899		4,917		4,983		166,915		7	%		153,382		6	%
Pass		760,292		736,507		744,571		731,235		716,862		706,294		96,568		101,091		2,318,293		93	%		2,275,127		94

Total Commercial Loans	$	838,181	$	810,882	$	799,213	$	786,360	$	746,329	$	725,193	$	101,485	$	106,074	$	2,485,208		100	%	$	2,428,509		100	%

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


	Residential				Consumer				Total Residential and Consumer
	Mar 31.		Dec. 31		Mar 31.		Dec. 31		March 31, 2014					December 31, 2013
	2014		2013		2014		2013		Amount		Percent			Amount		Percent
Nonperforming (1)	$	18,413	$	17,852	$	5,537	$	5,411	$	23,950		5	%	$	23,263		4	%
Performing		199,740		203,668		295,774		296,823		495,514		95	%		500,491		96

Total	$	218,153	$	221,520	$	301,311	$	302,234	$	519,464		100	%	$	523,754		100	%

(1)	Includes $9.0 million as of March 31, 2014 and $11.5 million as of December 31, 2013 of troubled debt restructured mortgages and home equity installment loans that are performing in accordance with modified terms and are accruing interest.

Troubled Debt Restructurings (TDR)

The balance of TDRs at March 31, 2014 and December 31, 2013 was $26.7 million and $27.6 million, respectively. The balance at March 31, 2014 included approximately $15.1 million in nonaccrual status and $11.6 million in accrual status compared to $15.3 million in nonaccrual status and $12.3 million in accrual status at December 31, 2013. Approximately $2.2 million and $4.1 million in related reserves have been established for these loans at March 31, 2014 and December 31, 2013, respectively.

A modification is classified as a troubled debt restructuring (“TDR”) if both of the following exist: (1) the borrower is experiencing financial difficulty and (2) the Bank has granted a concession to the borrower. Many aspects of the borrower’s financial situation are assessed when determining whether they are experiencing financial difficulty. Concessions may include the reduction of an interest rate at a rate lower than current market rate for a new loan with similar risk, extension of the maturity date, reduction of accrued interest, or principal forgiveness. The assessments of whether a borrower is experiencing (or is likely to experience) financial difficulty and whether a concession has been granted is subjective in nature and management’s judgment is required when determining whether a modification is a TDR.

During the three months ended March 31, 2014, the terms of 6 loans were modified in TDRs, These 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. Nonaccruing restructured loans remain in nonaccrual status until there has been a period of sustained repayment performance, typically six months.

The following table presents loans identified as TDRs during the three months ended March 31, 2014 and 2013:


(In Thousands)	Three Months Ended March 31, 2014		Three Months Ended March 31, 2013
Commercial	$	—	$	—
Commercial mortgages		—		235
Construction		—		—
Residential		279		—
Consumer		363		474

Total	$	642	$	709

The TDRs described in the table above increased our allowance for loan losses by $1,000 through allocation of a related reserve, and resulted in charge-offs of $40,000 during the three months ended March 31, 2014, compared to no increase and charge-offs of $119,000 million for the same period of 2013.