ALLOWANCE FOR LOAN LOSSES AND CREDIT QUALITY INFORMATION

Allowance for Loan Losses

We maintain an allowance for loan losses which represents our best estimate of probable losses within our loan portfolio. As losses are realized, they are charged to this allowance. We established our allowance in accordance with guidance provided in the SEC’s Staff Accounting Bulletin 102 (SAB 102), Selected Loan Loss Allowance Methodology and Documentation Issues, Accounting Standard Codification ("ASC") Contingencies (ASC 450) and Receivables (ASC 310). When we have reason to believe it is probable that we will not be able to collect all contractually due amounts of principal and interest, loans are evaluated for impairment on an individual basis and a specific allocation of the allowance is assigned in accordance with ASC 310-10. We also maintain an allowance for loan losses on acquired loans when: (i) for loans accounted for under ASC 310-30, there is deterioration in credit quality subsequent to acquisition and (ii) for loans accounted for under ASC 310-20, the inherent losses in the loans exceed the remaining credit discount recorded at the time of acquisition. 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 on a continuing review of these portfolios. The following are included in our allowance for loan losses:


•	Specific reserves for impaired loans


•	An allowance for each pool of homogenous loans based on historical loss experience


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

When it is probable that the Bank will be unable to collect all amounts due (interest and principal) in accordance with the contractual terms of the loan agreement, it assigns a specific reserve to that loan, if necessary. Unless loans are well-secured and collection is imminent, loans greater than 90 days past due are deemed impaired and their respective reserves are generally charged-off once the loss has been confirmed. Estimated specific reserves are based on collateral values, estimates of future cash flows or market valuations. We charge loans off when they are deemed to be uncollectible. During the three months ended March 31, 2017 and 2016, net charge-offs totaled $2.1 million or 0.19% of average loans annualized, and $0.3 million, or 0.03% of average loans annualized, respectively.

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 as follows: commercial, owner-occupied commercial, commercial mortgages and construction. 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 25 quarters. During the three months ended March 31, 2017, we increased the look-back period to 25 quarters from the 24 quarters used at December 31, 2016. This increase in the look-back period allows us to continue to anchor to the fourth quarter of 2010 to ensure that the core reserves calculated by the ALLL model are adequately considering the losses within a full credit cycle.

Loss severity upon default is calculated as the actual loan losses (net of recoveries) on impaired loans in their respective pool during the same time frame. Retail loans are pooled into the following segments: residential mortgage, consumer secured and consumer unsecured loans. Pooled reserves for retail loans are calculated based solely on average net loss rates over the same 25 quarter look-back period.

Qualitative adjustment factors consider various current internal and external conditions which are allocated among loan types and take into consideration:


•	Current underwriting policies, staff, and portfolio mix,


•	Internal trends of delinquency, nonaccrual and criticized loans by segment,


•	Risk rating accuracy, control and regulatory assessments/environment,


•	General economic conditions - locally and nationally,


•	Market trends impacting collateral values,


•	The competitive environment, as it could impact loan structure and underwriting, and


•	Valuation complexity by segment.

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

The allowance methodology uses a loss emergence period (LEP), which is the period of time between an event that triggers the probability of a loss and the confirmation of the loss. We estimate the commercial LEP to be approximately 8 quarters as of March 31, 2017. Our residential mortgage and consumer LEP remained at 4 quarters as of March 31, 2017. We evaluate LEP quarterly for reasonableness and complete a detailed historical analysis of our LEP annually for our commercial portfolio and review the current 4 quarter LEP for the retail portfolio to determine the continued reasonableness of this assumption.

In prior periods, we had a component of the allowance for model estimation and complexity risk reserve. During the second quarter of 2016 as a result of continued improvement in the model and normal review of the factors, we removed the model estimation and complexity risk reserve from our calculation of the allowance of loan losses.

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 periodically review our loan ratings and allowance for loan losses and the Bank’s internal loan review department performs loan reviews.

The following tables provide the activity of our allowance for loan losses and loan balances for the three months ended March 31, 2017:



	Three months ended March 31, 2017
(Dollars in thousands)	Commercial			Owner-occupied Commercial			Commercial Mortgages			Construction			Residential⁽¹⁾			Consumer			Total
Allowance for loan losses
Beginning balance	$	13,339		$	6,588		$	8,915		$	2,838		$	2,059		$	6,012		$	39,751
Charge-offs	(1,255		)	(192		)	(104		)	(14		)	(11		)	(1,143		)	(2,719		)
Recoveries	84			75			46			2			120			305			632
Provision (credit)	1,949			(441		)	(518		)	158			(114		)	1,080			2,114
Provision for acquired loans	88			—			(4		)	(23		)	—			(13		)	48
Ending balance	$	14,205		$	6,030		$	8,335		$	2,961		$	2,054		$	6,241		$	39,826
Period-end allowance allocated to:
Loans individually evaluated for impairment	$	1,860		$	—		$	1,395		$	500		$	887		$	194		$	4,836
Loans collectively evaluated for impairment	12,165			6,015			6,763			2,397			1,144			6,042			34,526
Acquired loans evaluated for impairment	180			15			177			64			23			5			464
Ending balance	$	14,205		$	6,030		$	8,335		$	2,961		$	2,054		$	6,241		$	39,826
Period-end loan balances evaluated for:
Loans individually evaluated for impairment ⁽²⁾	$	16,767		$	4,020		$	9,771		$	3,130		$	14,280		$	9,029		$	56,997
Loans collectively evaluated for impairment	1,175,911			919,508			928,925			225,718			158,430			405,285			3,813,777
Acquired nonimpaired loans	141,933			156,724			216,410			24,540			85,679			50,321			675,607
Acquired impaired loans	5,256			12,040			10,450			2,372			866			263			31,247
Ending balance⁽³⁾	$	1,339,867		$	1,092,292		$	1,165,556		$	255,760		$	259,255		$	464,898		$	4,577,628


⁽¹⁾	Period-end loan balance excludes Reverse Mortgages, at fair value of $22.5 million.


⁽²⁾	The difference between this amount and nonaccruing loans represents accruing troubled debt restructured loans of $17.3 million for the period ending March 31, 2017. Accruing troubled debt restructured loans are considered impaired loans.


⁽³⁾	Ending loan balances do not include net deferred fees.

The following table provides the activity of the allowance for loan losses and loan balances for the three months ended March 31, 2016:



	Three months ended March 31, 2016
(Dollars in thousands)	Commercial			Owner - occupied Commercial			Commercial Mortgages			Construction			Residential⁽¹⁾			Consumer			Complexity Risk⁽²⁾		Total
Allowance for loan losses
Beginning balance	$	11,156		$	6,670		$	6,487		$	3,521		$	2,281		$	5,964		$	1,010	$	37,089
Charge-offs	(179		)	—			(17		)	(26		)	(14		)	(631		)	—		(867		)
Recoveries	110			38			79			46			22			259			—		554
Provision (credit)	484			(6		)	(37		)	72			(20		)	400			14		907
Provision for acquired loans	(89		)	—			4			(4		)	—			(38		)	—		(127		)
Ending balance	$	11,482		$	6,702		$	6,516		$	3,609		$	2,269		$	5,954		$	1,024	$	37,556
Period-end allowance allocated to:
Loans individually evaluated for impairment	$	1,473		$	—		$	—		$	211		$	911		$	208		$	—	$	2,803
Loans collectively evaluated for impairment	10,005			6,680			6,427			3,398			1,354			5,746			1,024		34,634
Acquired loans evaluated for impairment	4			22			89			—			4			—			—		119
Ending balance	$	11,482		$	6,702		$	6,516		$	3,609		$	2,269		$	5,954		$	1,024	$	37,556
Period-end loan balances:
Loans individually evaluated for impairment ⁽³⁾	$	5,278		$	1,270		$	2,678		$	1,419		$	15,260		$	7,795		$	—	$	33,700
Loans collectively evaluated for impairment	957,863			839,819			893,036			194,654			161,610			336,053			—		3,383,035
Acquired nonimpaired loans	107,380			49,765			80,795			27,711			73,240			15,803			—		354,694
Acquired impaired loans	12,600			4,603			10,557			3,564			955			5			—		32,284
Ending balance⁽⁴⁾	$	1,083,121		$	895,457		$	987,066		$	227,348		$	251,065		$	359,656		$	—	$	3,803,713


⁽¹⁾	Period-end loan balance excludes Reverse Mortgages, at fair value of $24.7 million.


⁽²⁾	Represents the portion of the allowance for loan losses established to capture factors not already included in other components in our allowance for loan losses methodology.


⁽³⁾	The difference between this amount and nonaccruing loans represents accruing troubled debt restructured loans of $13.9 million for the period ending March 31, 2016. Accruing troubled debt restructured loans are considered impaired loans.


⁽⁴⁾	Ending loan balances do not include net deferred fees.

Nonaccrual and Past Due Loans

Nonaccruing loans are those on which the accrual of interest has ceased. Typically, we discontinue accrual of interest on originated loans after payments become more than 90 days past due or earlier if we do not expect the full collection of principal or interest in accordance with the terms of the loan agreement. Interest accrued but not collected at the date a loan is placed on nonaccrual status is reversed and charged against interest income. In addition, the accretion of net deferred loan fees and amortization of net deferred loan costs is suspended when a loan is placed on nonaccrual status. Subsequent cash receipts are applied either to the outstanding principal balance or recorded as interest income, depending on our assessment of the ultimate collectability of principal and interest. Loans greater than 90 days past due and still accruing are defined as loans contractually past due 90 days or more as to principal or interest payments, but which remain in accrual status because they are considered well secured and are in the process of collection.

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



	March 31, 2017
(Dollars 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			Acquired Impaired Loans			Nonaccrual Loans			Total Loans
Commercial	$	783		$	467		$	—		$	1,250		$	1,316,841		$	5,256		$	16,520		$	1,339,867
Owner-occupied commercial	341			500			—			841			1,075,391			12,040			4,020			1,092,292
Commercial mortgages	451			—			343			794			1,144,617			10,450			9,695			1,165,556
Construction	37			—			466			503			252,885			2,372			—			255,760
Residential⁽¹⁾	2,020			119			850			2,989			250,443			866			4,957			259,255
Consumer	374			612			106			1,092			459,057			263			4,486			464,898
Total ⁽²⁾	$	4,006		$	1,698		$	1,765		$	7,469		$	4,499,234		$	31,247		$	39,678		$	4,577,628
% of Total Loans	0.08		%	0.04		%	0.04		%	0.16		%	98.29		%	0.68		%	0.87		%	100		%


⁽¹⁾	Residential accruing current balances excludes Reverse Mortgages at fair value of $22.5 million.


⁽²⁾	The balances above include a total of $675.6 million of acquired nonimpaired loans.



	December 31, 2016
(Dollars 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			Acquired Impaired Loans			Nonaccrual Loans			Total Loans
Commercial	$	1,507		$	278		$	—		$	1,785		$	1,277,748		$	6,183		$	2,015		$	1,287,731
Owner-occupied commercial	116			540			—			656			1,063,306			12,122			2,078			1,078,162
Commercial mortgages	167			—			—			167			1,143,180			10,386			9,821			1,163,554
Construction	132			—			—			132			218,886			3,694			—			222,712
Residential⁽¹⁾	3,176			638			153			3,967			257,234			860			4,967			267,028
Consumer	392			346			285			1,023			444,642			369			3,995			450,029
Total⁽²⁾	$	5,490		$	1,802		$	438		$	7,730		$	4,404,996		$	33,614		$	22,876		$	4,469,216
% of Total Loans	0.12		%	0.04		%	0.01		%	0.17		%	98.56		%	0.75		%	0.51		%	100		%


⁽¹⁾	Residential accruing current balances excludes Reverse Mortgages, at fair value of $22.6 million.


⁽²⁾	The balances above include a total of $724.1 million of acquired nonimpaired loans.

Impaired Loans

Loans for which it is probable we will not collect all principal and interest due according to their contractual terms, which is assessed based on the credit characteristics of the loan and/or payment status, are measured for impairment in accordance with the provisions of SAB 102 and FASB ASC 310, Receivables (ASC 310). The amount of impairment is required to be measured using one of three methods: (1) the present value of expected future cash flows discounted at the loan’s effective interest rate; (2) the fair value of collateral, if the loan is collateral dependent or (3) the loan’s observable market price. If the measure of the impaired loan is less than the recorded investment in the loan, a related allowance is allocated for the impairment.

The following tables provide an analysis of our impaired loans at March 31, 2017 and December 31, 2016:



	March 31, 2017
(Dollars in thousands)	Ending Loan Balances		Loans with No Related Reserve ⁽¹⁾		Loans with Related Reserve		Related Reserve		Contractual Principal Balances		Average Loan Balances
Commercial	$	18,550	$	2,598	$	15,952	$	2,040	$	20,197	$	7,535
Owner-occupied commercial	6,210		4,020		2,190		15		6,372		4,155
Commercial mortgages	14,478		4,220		10,258		1,572		19,906		9,288
Construction	4,435		1,117		3,318		564		4,546		2,979
Residential	15,000		8,056		6,944		910		17,904		14,941
Consumer	9,070		7,526		1,544		199		11,578		8,191
Total (2)	$	67,743	$	27,537	$	40,206	$	5,300	$	80,503	$	47,089


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


⁽²⁾	The above includes acquired impaired loans totaling $10.7 million in the ending loan balance and $11.8 million in the contractual principal balance.



	December 31, 2016
(Dollars in thousands)	Ending Loan Balances		Loans with No Related Reserve⁽¹⁾		Loans with Related Reserve		Related Reserve		Contractual Principal Balances		Average Loan Balances
Commercial	$	4,250	$	1,395	$	2,855	$	505	$	5,572	$	5,053
Owner-occupied commercial	4,650		2,078		2,572		15		5,129		3,339
Commercial mortgages	15,065		4,348		10,717		1,433		20,716		7,323
Construction	3,662		—		3,662		303		3,972		2,376
Residential	14,256		7,122		7,134		934		17,298		15,083
Consumer	8,021		6,561		1,460		215		11,978		7,910
Total ⁽²⁾	$	49,904	$	21,504	$	28,400	$	3,405	$	64,665	$	41,084


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


⁽²⁾	The above includes acquired impaired loans totaling $12.8 million in the ending loan balance and $15.0 million in the contractual principal balance.

Interest income of $0.3 million and $0.2 million was recognized on impaired loans during the three months ended March 31, 2017 and March 31, 2016, respectively.

As of March 31, 2017, there were 39 residential loans and 7 commercial loans in the process of foreclosure. The total outstanding balance on the loans was $4.9 million and $2.2 million, respectively. As of December 31, 2016, there were 29 residential loans and 7 commercial loans in the process of foreclosure. The total outstanding balance on the loans was $3.7 million and $3.6 million, respectively.

Reserves on Acquired Nonimpaired Loans

In accordance with FASB ASC 310, loans acquired by the Bank through its mergers with FNBW, Alliance and Penn Liberty are required to be reflected on the balance sheet at their fair values on the date of acquisition as opposed to their contractual values. Therefore, on the date of acquisition establishing an allowance for acquired loans is prohibited. After the acquisition date the Bank performs a separate allowance analysis on a quarterly basis to determine if an allowance for loan loss is necessary. Should the credit risk calculated exceed the purchased loan portfolio’s remaining credit mark, additional reserves will be added to the Bank’s allowance. When a purchased loan becomes impaired after its acquisition, it is evaluated as part of the Bank’s reserve analysis and a specific reserve is established to be included in the Bank’s allowance.

Credit Quality Indicators

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


•	Pass. These borrowers currently show no indication of deterioration 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. A 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 portfolio segment based on the credit quality indicators used to determine the Allowance for Loan Loss.

Commercial Credit Exposure



	March 31, 2017
(Dollars in thousands)	Commercial		Owner-occupied Commercial		Commercial Mortgages		Construction		Total Commercial⁽¹⁾
									Amount		%
Risk Rating:
Special mention	$	17,590	$	6,849	$	21,931	$	1,008	$	47,378
Substandard:
Accrual	41,136		20,162		3,216		4,489		69,003
Nonaccrual	14,660		4,020		8,300		—		26,980
Doubtful	1,860		—		1,395		—		3,255
Total Special Mention and Substandard	75,246		31,031		34,842		5,497		146,616		4	%
Acquired impaired	5,256		12,040		10,450		2,372		30,118		1	%
Pass	1,259,365		1,049,221		1,120,264		247,891		3,676,741		95	%
Total	$	1,339,867	$	1,092,292	$	1,165,556	$	255,760	$	3,853,475	100	%


⁽¹⁾	Table includes $539.6 million of acquired nonimpaired loans as of March 31, 2017.



	December 31, 2016
(Dollars in thousands)	Commercial		Owner-occupied Commercial		Commercial Mortgages		Construction		Total Commercial⁽¹⁾
									Amount		%
Risk Rating:
Special mention	$	17,630	$	11,419	$	34,198	$	—	$	63,247
Substandard:
Accrual	45,067		19,871		239		2,193		67,370
Nonaccrual	1,693		2,078		8,574		—		12,345
Doubtful	322		—		1,247		—		1,569
Total Special Mention and Substandard	64,712		33,368		44,258		2,193		144,531		4	%
Acquired impaired	6,183		12,122		10,386		3,694		32,385		1	%
Pass	1,216,836		1,032,672		1,108,910		216,825		3,575,243		95	%
Total	$	1,287,731	$	1,078,162	$	1,163,554	$	222,712	$	3,752,159	100	%


⁽¹⁾	Table includes $573.5 million of acquired nonimpaired loans as of December 31, 2016.

Residential and Consumer Credit Exposure



(Dollars in thousands)	Residential⁽²⁾				Consumer				Total Residential and Consumer⁽³⁾
	March 31,		December 31,		March 31,		December 31,		March 31, 2017				December 31, 2016
	2017		2016		2017		2016		Amount		Percent		Amount		Percent
Nonperforming⁽¹⁾	$	14,280	$	13,547	$	9,030	$	7,863	$	23,310	3	%	$	21,410	3	%
Acquired impaired loans	866		860		263		369		1,129		—	%	1,229		—	%
Performing	244,109		252,621		455,605		441,797		699,714		97	%	694,418		97	%
Total	$	259,255	$	267,028	$	464,898	$	450,029	$	724,153	100	%	$	717,057	100	%


⁽¹⁾	Includes $13.7 million as of March 31, 2017 and $12.4 million as of December 31, 2016 of troubled debt restructured mortgages and home equity installment loans that are performing in accordance with the loans’ modified terms and are accruing interest.


⁽²⁾	Residential performing loans excludes $22.5 million and $22.6 million of Reverse Mortgages at fair value as of March 31, 2017 and December 31, 2016, respectively.


⁽³⁾	Total includes $136.0 million and $150.5 million in acquired nonimpaired loans as of March 31, 2017 and December 31, 2016, respectively.

Troubled Debt Restructurings (TDRs)

TDRs are recorded in accordance with FASB ASC 310-40, Troubled Debt Restructuring by Creditors (ASC 310-40).

The following table presents the balance of TDRs as of the indicated dates:



(Dollars in thousands)	March 31, 2017		December 31, 2016
Performing TDRs	$	17,260	$	14,336
Nonperforming TDRs	10,778		8,451
Total TDRs	28,038		22,787

Approximately $1.9 million and $1.3 million in related reserves have been established for these loans at March 31, 2017 and December 31, 2016, respectively.

The following table presents information regarding the types of loan modifications made for the three months ended March 31, 2017:



(Dollars in thousands)	Maturity Date Extension	Discharged in bankruptcy	Other ⁽¹⁾	Total
Commercial	1	—	—	1
Owner-occupied commercial	1	—	—	1
Construction	2	—	—	2
Residential	—	1	—	1
Consumer	—	6	1	7
	4	7	1	12


⁽¹⁾	Other includes underwriting exception.

Principal balances are generally not forgiven 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 and payment is reasonably assured.

The following table presents loans identified as TDRs during the three months ended March 31, 2017 and 2016.



	Three Months Ended March 31,
	2017				2016
(Dollars in thousands)	Pre Modification		Post Modification		Pre Modification		Post Modification
Commercial	$	443	$	443	$	984	$	984
Owner-occupied commercial	3,071		3,071		—		—
Commercial mortgages	—		—		—		—
Construction	1,712		1,712		—		—
Residential	242		242		614		614
Consumer	584		584		215		215
Total	$	6,052	$	6,052	$	1,813	$	1,813

During the three months ended March 31, 2017, the TDRs set forth in the table above increased our allowance for loan losses less than $0.3 million, and resulted in no additional charge-offs. For the same period of 2016, the TDRs set forth in the table above had no change on our allowance for loan losses allocation of the related reserve and resulted in charge-offs of less than $0.1 million. During the three months ended March 31, 2017, three TDRs defaulted that had received troubled debt modification during the past twelve months with a total loan amount $0.7 million.