UMPQ-2014.06.30-10Q

United States  
Securities and Exchange Commission 
Washington, D.C. 20549 
 
FORM 10-Q
[X]
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
for the quarterly period ended: June 30, 2014
 
or
[  ]
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
for the transition period from                                        to                                       .
 
Commission File Number: 001-34624 
 
Umpqua Holdings Corporation 
 
(Exact Name of Registrant as Specified in Its Charter)
OREGON 
93-1261319 
(State or Other Jurisdiction
(I.R.S. Employer Identification Number)
of Incorporation or Organization)
 
 
One SW Columbia Street, Suite 1200 
Portland, Oregon 97258 
(Address of Principal Executive Offices)(Zip Code) 
 
(503) 727-4100 
(Registrant's Telephone Number, Including Area Code) 
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
[X]   Yes   [  ]   No 
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 
[X]   Yes   [  ]   No 
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
 
[X]   Large accelerated filer   [    ]   Accelerated filer   [    ]   Non-accelerated filer   [  ]   Smaller reporting company 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
[  ]   Yes   [X]   No 
 
Indicate the number of shares outstanding for each of the issuer's classes of common stock, as of the latest practical date:
 
Common stock, no par value: 217,244,246 shares outstanding as of July 31, 2014

Table of Contents

UMPQUA HOLDINGS CORPORATION 
FORM 10-Q 
Table of Contents 
 
Item 1.
Item 2.
Item 3.
Item 4.
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.

2
Table of Contents

PART I.        FINANCIAL INFORMATION
Item 1.        Financial Statements (unaudited) 

UMPQUA HOLDINGS CORPORATION AND SUBSIDIARIES 
CONDENSED CONSOLIDATED BALANCE SHEETS 
(UNAUDITED) 
(in thousands, except shares)
 
 
 
 
June 30,
 
December 31,
 
2014
 
2013
ASSETS
 
 
 
Cash and due from banks
$
347,152

 
$
178,685

Interest bearing deposits and temporary investments (restricted cash of $37,149 and $13,384)
493,268

 
611,738

Total cash and cash equivalents
840,420

 
790,423

Investment securities
 
 
 
Trading, at fair value
9,420

 
5,958

Available for sale, at fair value
2,588,969

 
1,790,978

Held to maturity, at amortized cost
5,519

 
5,563

Loans held for sale ($322,912 and $104,664 at fair value)
328,968

 
104,664

Non-covered loans and leases
14,830,345

 
7,354,403

Allowance for non-covered loan and lease losses
(97,995
)
 
(85,314
)
Net non-covered loans and leases
14,732,350

 
7,269,089

Covered loans, net of allowance of $8,500 and $9,771
297,610

 
363,992

Restricted equity securities
122,194

 
30,685

Premises and equipment, net
310,407

 
177,680

Goodwill
1,779,732

 
764,305

Other intangible assets, net
62,938

 
12,378

Residential mortgage servicing rights, at fair value
114,192

 
47,765

Non-covered other real estate owned
26,172

 
21,833

Covered other real estate owned
1,810

 
2,102

FDIC indemnification asset
11,293

 
23,174

Bank owned life insurance
292,714

 
96,938

Deferred tax asset, net
259,993

 
16,627

Other assets
257,528

 
111,958

Total assets
$
22,042,229

 
$
11,636,112

LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
Deposits
 
 
 
Noninterest bearing
$
4,363,710

 
$
2,436,477

Interest bearing
11,959,290

 
6,681,183

Total deposits
16,323,000

 
9,117,660

Securities sold under agreements to repurchase
315,025

 
224,882

Term debt
1,057,915

 
251,494

Junior subordinated debentures, at fair value
246,077

 
87,274

Junior subordinated debentures, at amortized cost
101,737

 
101,899

Other liabilities
269,415

 
125,477

Total liabilities
18,313,169

 
9,908,686

COMMITMENTS AND CONTINGENCIES (NOTE 10)

 

SHAREHOLDERS' EQUITY
 
 
 
Common stock, no par value, shares authorized: 400,000,000 in 2014 and 200,000,000 in 2013; issued and outstanding: 217,190,721 in 2014 and 111,973,203 in 2013
3,512,507

 
1,514,485

Retained earnings
204,109

 
217,917

Accumulated other comprehensive income (loss)
12,444

 
(4,976
)
Total shareholders' equity
3,729,060

 
1,727,426

Total liabilities and shareholders' equity
$
22,042,229

 
$
11,636,112


See notes to condensed consolidated financial statements

3
Table of Contents

UMPQUA HOLDINGS CORPORATION AND SUBSIDIARIES 
CONDENSED CONSOLIDATED STATEMENTS OF INCOME 
(UNAUDITED) 

(in thousands, except per share amounts)
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
INTEREST INCOME
 
 
 
 
 
 
 
Interest and fees on non-covered loans and leases
$
193,061

 
$
78,434

 
$
284,329

 
$
156,979

Interest and fees on covered loans and leases
15,931

 
14,750

 
28,649

 
29,330

Interest and dividends on investment securities:
 
 
 
 
 
 
 
Taxable
12,699

 
8,103

 
21,990

 
16,747

Exempt from federal income tax
2,609

 
2,237

 
4,721

 
4,525

Dividends
128

 
90

 
178

 
114

Interest on temporary investments and interest bearing deposits
539

 
401

 
980

 
653

Total interest income
224,967

 
104,015

 
340,847

 
208,348

INTEREST EXPENSE
 
 
 
 
 
 
 
Interest on deposits
6,075

 
5,864

 
9,923

 
11,742

Interest on securities sold under agreement to repurchase
203

 
33

 
244

 
64

Interest on term debt
3,364

 
2,305

 
5,637

 
4,578

Interest on junior subordinated debentures
3,066

 
1,920

 
4,946

 
3,882

Total interest expense
12,708

 
10,122

 
20,750

 
20,266

Net interest income
212,259

 
93,893

 
320,097

 
188,082

PROVISION FOR NON-COVERED LOAN AND LEASE LOSSES 
15,399

 
2,993

 
20,799

 
9,981

RECAPTURE OF PROVISION FOR COVERED LOAN LOSSES
(703
)
 
(3,072
)
 
(132
)
 
(2,840
)
Net interest income after provision for loan and lease losses
197,563

 
93,972

 
299,430

 
180,941

NON-INTEREST INCOME
 
 
 
 
 
 
 
Service charges on deposit accounts
15,371

 
7,478

 
23,138

 
14,470

Brokerage commissions and fees
4,566

 
3,662

 
8,291

 
7,298

Residential mortgage banking revenue, net
24,341

 
24,289

 
34,780

 
47,857

Gain on investment securities, net
976

 
8

 
976

 
15

Loss on junior subordinated debentures carried at fair value
(1,369
)
 
(547
)
 
(1,911
)
 
(1,089
)
Change in FDIC indemnification asset
(5,601
)
 
(8,294
)
 
(10,441
)
 
(13,367
)
BOLI income
1,967

 
910

 
2,703

 
1,670

Other income
4,278

 
6,991

 
10,000

 
11,658

Total non-interest income
44,529

 
34,497

 
67,536

 
68,512

NON-INTEREST EXPENSE
 
 
 
 
 
 
 
Salaries and employee benefits
95,560

 
52,067

 
148,776

 
103,572

Net occupancy and equipment
28,746

 
15,059

 
45,247

 
29,794

Communications
4,166

 
2,827

 
7,068

 
6,030

Marketing
1,157

 
1,296

 
2,162

 
2,157

Services
12,402

 
6,001

 
18,391

 
11,894

FDIC assessments
2,575

 
1,672

 
4,438

 
3,323

Net loss (gain) on non-covered other real estate owned
178

 
(146
)
 
160

 
(276
)
Net loss (gain) on covered other real estate owned
80

 
(62
)
 
34

 
222

Intangible amortization
2,808

 
1,205

 
4,002

 
2,409

Merger related expenses
57,531

 
810

 
63,514

 
2,341

Other expenses
8,928

 
7,202

 
16,857

 
12,227

Total non-interest expense
214,131

 
87,931

 
310,649

 
173,693

Income before provision for income taxes
27,961

 
40,538

 
56,317

 
75,760

Provision for income taxes
10,740

 
14,285

 
20,332

 
26,146

Net income
$
17,221

 
$
26,253

 
$
35,985

 
$
49,614



4
Table of Contents



UMPQUA HOLDINGS CORPORATION AND SUBSIDIARIES 
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Continued) 
(UNAUDITED) 

(in thousands, except per share amounts)
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Net income
$
17,221

 
$
26,253

 
$
35,985

 
$
49,614

Dividends and undistributed earnings allocated to participating securities
83

 
197

 
196

 
380

Net earnings available to common shareholders
$
17,138

 
$
26,056

 
$
35,789

 
$
49,234

Earnings per common share:
 
 
 
 
 
 
 
Basic
$0.09
 
$0.23
 
$0.23
 
$0.44
Diluted
$0.09
 
$0.23
 
$0.23
 
$0.44
Weighted average number of common shares outstanding:
 
 
 
 
 
 
 
Basic
196,312

 
111,954

 
154,473

 
111,946

Diluted
197,638

 
112,145

 
155,276

 
112,133


See notes to condensed consolidated financial statements

5
Table of Contents

UMPQUA HOLDINGS CORPORATION AND SUBSIDIARIES 
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME  
(UNAUDITED) 
 
(in thousands)
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Net income
$
17,221

 
$
26,253

 
$
35,985

 
$
49,614

Available for sale securities:
 
 
 
 
 
 
 
Unrealized gains (losses) arising during the period
21,936

 
(36,793
)
 
29,914

 
(41,220
)
Reclassification adjustment for net gains realized in earnings (net of tax expense of $375 and $3 for the three months ended June 30, 2014 and 2013, respectively, and net of tax expense of $375 thousand and $6 for the six months ended June 30, 2014 and 2013, respectively)
(585
)
 
(5
)
 
(585
)
 
(9
)
Income tax (expense) benefit related to unrealized gains (losses)
(8,775
)
 
14,717

 
(11,966
)
 
16,488

Net change in unrealized gains (losses)
12,576

 
(22,081
)
 
17,363

 
(24,741
)
Held to maturity securities:
 
 
 
 
 
 
 
Accretion of unrealized losses related to factors other than credit to investment securities held to maturity (net of tax benefit of $31 and $10 for the three months ended June 30, 2014 and 2013, respectively, and net of tax benefit of $37 and $21 for the six months ended June 30, 2014 and 2013, respectively)
47

 
14

 
57

 
32

Net change in unrealized losses related to factors other than credit
47

 
14

 
57

 
32

Other comprehensive income (loss), net of tax
12,623

 
(22,067
)
 
17,420

 
(24,709
)
Comprehensive income
$
29,844

 
$
4,186

 
$
53,405

 
$
24,905


See notes to condensed consolidated financial statements

6
Table of Contents

UMPQUA HOLDINGS CORPORATION AND SUBSIDIARIES 
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY  
(UNAUDITED)   

(in thousands, except shares)
 
 
 
 
 
 
Accumulated
 
 
 
 
 
 
 
Other
 
 
 
Common Stock
 
Retained
 
Comprehensive
 
 
 
Shares
 
Amount
 
Earnings
 
Income (Loss)
 
Total
BALANCE AT JANUARY 1, 2013
111,889,959

 
$
1,512,400

 
$
187,293

 
$
24,346

 
$
1,724,039

Net income
 
 
 
 
98,361

 
 
 
98,361

Other comprehensive loss, net of tax
 
 
 
 
 
 
(29,322
)
 
(29,322
)
Comprehensive income
 
 
 
 
 
 
 
 
$
69,039

Stock-based compensation
 
 
5,017

 
 
 
 
 
5,017

Stock repurchased and retired
(584,677
)
 
(9,360
)
 
 
 
 
 
(9,360
)
Issuances of common stock under stock plans
 
 
 
 
 
 
 
 
 
and related net tax benefit
667,921

 
6,428

 
 
 
 
 
6,428

Cash dividends on common stock ($0.60 per share)
 
 
 
 
(67,737
)
 
 
 
(67,737
)
Balance at December 31, 2013
111,973,203

 
$
1,514,485

 
$
217,917

 
$
(4,976
)
 
$
1,727,426

 
 
 
 
 
 
 
 
 
 
BALANCE AT JANUARY 1, 2014
111,973,203

 
$
1,514,485

 
$
217,917

 
$
(4,976
)
 
$
1,727,426

Net income
 
 
 
 
35,985

 
 
 
35,985

Other comprehensive income, net of tax
 
 
 
 
 
 
17,420

 
17,420

Comprehensive income
 
 
 
 
 
 
 
 
$
53,405

Stock issued in connection with merger (1)
104,385,087

 
1,989,030

 
 
 
 
 
1,989,030

Stock-based compensation
 
 
8,682

 
 
 
 
 
8,682

Stock repurchased and retired
(371,236
)
 
(6,617
)
 
 
 
 
 
(6,617
)
Issuances of common stock under stock plans
 
 
 
 
 
 
 
 
 
and related net tax benefit
1,203,667

 
6,927

 
 
 
 
 
6,927

Cash dividends on common stock ($0.30 per share)
 
 
 
 
(49,793
)
 
 
 
(49,793
)
Balance at June 30, 2014
217,190,721

 
$
3,512,507

 
$
204,109

 
$
12,444

 
$
3,729,060


(1) The amount of common stock issued in connection with the merger is net of $784,000 of issuance costs.


See notes to condensed consolidated financial statements

7
Table of Contents

UMPQUA HOLDINGS CORPORATION AND SUBSIDIARIES 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS 
(UNAUDITED) 
 (in thousands)
 
Six Months Ended
 
June 30,
 
2014
 
2013
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
35,985

 
$
49,614

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Amortization of investment premiums, net
9,163

 
20,486

Gain on sale of investment securities, net
(976
)
 
(15
)
Loss (gain) on sale of non-covered other real estate owned
44

 
(713
)
Loss (gain) on sale of covered other real estate owned
34

 
(457
)
Valuation adjustment on non-covered other real estate owned
115

 
437

Valuation adjustment on covered other real estate owned
—

 
679

Provision for non-covered loan and lease losses
20,799

 
9,981

Recapture of provision for covered loan losses
(132
)
 
(2,840
)
Proceeds from bank owned life insurance
187

 
1,173

Change in cash surrender value of bank owned life insurance
(2,717
)
 
(2,801
)
Change in FDIC indemnification asset
10,441

 
13,367

Depreciation, amortization and accretion
47,300

 
8,921

Increase in residential mortgage servicing rights
(7,770
)
 
(11,110
)
Change in residential mortgage servicing rights carried at fair value
4,113

 
346

Change in junior subordinated debentures carried at fair value
2,631

 
1,078

Stock-based compensation
8,682

 
2,222

Net decrease (increase) in trading account assets
1,036

 
(116
)
Gain on sale of loans
(27,833
)
 
(47,116
)
Change in loans held for sale carried at fair value
(12,594
)
 
16,801

Origination of loans held for sale
(855,951
)
 
(1,000,688
)
Proceeds from sales of loans held for sale
810,613

 
1,174,397

Excess tax benefits from the exercise of stock options
(1,719
)
 
(49
)
Change in other assets and liabilities:
 
 
 
Net (increase) decrease in other assets
(29,137
)
 
29,545

Net increase (decrease) in other liabilities
37,487

 
(20,189
)
Net cash provided by operating activities
49,801

 
242,953

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Purchases of investment securities available for sale
(346,844
)
 
(51,191
)
Proceeds from investment securities available for sale
943,104

 
530,898

Proceeds from investment securities held to maturity
365

 
914

Redemption of restricted equity securities
2,755

 
1,331

Net non-covered loan and lease originations
(524,212
)
 
(160,345
)
Net covered loan paydowns
36,438

 
47,744

Proceeds from sales of non-covered loans
159,439

 
53,264

Proceeds from insurance settlement on loss of property
—

 
575

Proceeds from disposals of furniture and equipment
52

 
139

Purchases of premises and equipment
(22,656
)
 
(16,514
)
Net (payments) proceeds (to) from FDIC indemnification asset
(2,376
)
 
3,065

Proceeds from sales of non-covered other real estate owned
7,000

 
11,210

Proceeds from sales of covered other real estate owned
298

 
8,126

Net cash paid in divestiture
(130,627
)
 
—

Cash acquired in merger, net of cash consideration paid
116,867

 
—

Net cash provided by investing activities
$
239,603

 
$
429,216

 
 
 
 

8
Table of Contents

UMPQUA HOLDINGS CORPORATION AND SUBSIDIARIES 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) 
(UNAUDITED) 
 
(in thousands)
 
Six Months Ended
 
June 30,
 
2014
 
2013
CASH FLOWS FROM FINANCING ACTIVITIES:
 

 
 

Net increase (decrease) in deposit liabilities
$
335,788

 
$
(422,723
)
Net (decrease) increase in securities sold under agreements to repurchase
(494,603
)
 
39,372

Repayment of term debt
(47,004
)
 
—

Repayment of junior subordinated debentures
—

 
(8,764
)
Dividends paid on common stock
(33,883
)
 
(16,931
)
Excess tax benefits from stock based compensation
1,719

 
49

Proceeds from stock options exercised
5,193

 
846

Retirement of common stock
(6,617
)
 
(2,811
)
Net cash used by financing activities
(239,407
)
 
(410,962
)
Net increase in cash and cash equivalents
49,997

 
261,207

Cash and cash equivalents, beginning of period
790,423

 
543,787

Cash and cash equivalents, end of period
$
840,420

 
$
804,994

 
 
 
 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 

 
 

Cash paid during the period for:
 

 
 

Interest
$
21,957

 
$
21,825

Income taxes
$
6,486

 
$
13,100

SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
 
 
 
Change in unrealized gains (losses) on investment securities available for sale, net of taxes
$
17,363

 
$
(24,741
)
Change in unrealized losses on investment securities held to maturity related to factors other than credit, net of taxes
$
57

 
$
32

Cash dividend declared on common stock and payable after period-end
$
32,674

 
$
16,907

Transfer of non-covered loans to non-covered other real estate owned
$
3,358

 
$
7,032

Transfer of covered loans to covered other real estate owned
$
40

 
$
2,554

Transfer of covered loans to non-covered loans
$
2,053

 
$
10,560

Transfer from FDIC indemnification asset to due from FDIC and other
$
1,440

 
$
3,168

Receivable from sales of covered other real estate owned
$
—

 
$
1,096

Acquisitions:
 
 
 
Assets acquired, including goodwill of $1,015,427
$
9,879,425

 
$
—

Liabilities assumed
$
8,762,385

 
$
—



See notes to condensed consolidated financial statements
 

9
Table of Contents

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1 – Summary of Significant Accounting Policies 
 
The accounting and financial reporting policies of Umpqua Holdings Corporation conform to accounting principles generally accepted in the United States of America. The accompanying interim condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries.  All material inter-company balances and transactions have been eliminated. The condensed consolidated financial statements have not been audited. A more detailed description of our accounting policies is included in the 2013 Annual Report filed on Form 10-K. These interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes contained in the 2013 Annual Report filed on Form 10-K. All references in this report to "Umpqua," "we," "our," "us," the "Company" or similar references mean Umpqua Holdings Corporation and its successors, and include our consolidated subsidiaries where the context so requires. References to "Bank" refer to our subsidiary Umpqua Bank, an Oregon state-chartered commercial bank, and references to "Umpqua Investments" refer to our subsidiary Umpqua Investments, Inc., a registered broker-dealer and investment adviser. The Bank also has a wholly-owned subsidiary, Financial Pacific Leasing Inc., a commercial equipment leasing company.
 
In preparing these condensed consolidated financial statements, the Company has evaluated events and transactions subsequent to June 30, 2014 for potential recognition or disclosure. In management's opinion, all accounting adjustments necessary to accurately reflect the financial position and results of operations on the accompanying financial statements have been made. These adjustments include normal and recurring accruals considered necessary for a fair and accurate presentation. The results for interim periods are not necessarily indicative of results for the full year or any other interim period.  Certain reclassifications of prior period amounts have been made to conform to current classifications.

 
Note 2 – Business Combinations 
 
Sterling Financial Corporation
As of the close of business on April 18, 2014, the Company completed its merger with Sterling Financial Corporation, a Washington corporation ("Sterling").  The results of Sterling's operations are included in the Company's financial results beginning April 19, 2014 and the combined company's banking operations are operating under the Umpqua Bank name and brand.

The structure of the transaction was as follows:
•
Sterling merged with and into the Company (the "Merger" or the "Sterling merger") with the Company as the surviving corporation in the Merger;
•
Immediately following the Merger, Sterling's wholly owned banking subsidiary, Sterling Savings Bank merged with and into the Bank (the "Bank Merger"), with the Bank as the surviving bank in the Bank Merger;
•
Holders of shares of common stock of Sterling had the right to receive 1.671 shares of the Company's common stock and $2.18 in cash for each share of Sterling common stock;
•
Each outstanding warrant issued by Sterling converted into a warrant exercisable for 1.671 shares of the Company's common stock and $2.18 in cash for each warrant when exercised;
•
Each outstanding option to purchase a share of Sterling common stock converted into an option to purchase 1.7896 shares of Company's common stock, subject to vesting conditions; and
•
Each outstanding restricted stock unit in respect of Sterling common stock converted into a restricted stock unit in respect of 1.7896 shares the Company common stock, subject to vesting conditions.


10
Table of Contents

A summary of the consideration paid, the assets acquired and liabilities assumed in the Merger are presented below:
(in thousands)
 
 
 
Sterling
 
April 18, 2014
Fair value of consideration to Sterling shareholders:
 
 
  Cash paid
 
$
136,200

  Liability recorded for warrants' cash payment per share
 
6,453

  Fair value of common shares issued
 
1,939,497

  Fair value of warrants, common stock options, and restricted stock exchanged
 
50,317

  Total consideration
 
2,132,467

Fair value of assets acquired:
 
 
  Cash and cash equivalents
$
253,067

 
  Investment securities
1,378,300

 
  Loans held for sale
215,208

 
  Non-covered loans and leases
7,122,989

 
  Premises and equipment
124,881

 
  Residential mortgage servicing rights
62,770

 
  Other intangible assets
54,562

 
  Non-covered other real estate owned
8,140

 
  Bank owned life insurance
193,246

 
  Deferred tax asset
295,371

 
  Accrued interest receivable
23,553

 
  Other assets
147,338

 
  Total assets acquired
9,879,425

 
Fair value of liabilities assumed:
 
 
  Deposits
7,086,052

 
  Securities sold under agreements to repurchase
584,746

 
  Term debt
854,737

 
  Junior subordinated debentures
156,171

 
  Other liabilities
80,679

 
  Total liabilities assumed
$
8,762,385

 
  Net assets acquired
 
1,117,040

  Preliminary goodwill
 
$
1,015,427


Amounts recorded are preliminary estimates of fair value. The primary reason for the Merger was to continue the Company's growth strategy, including expanding our geographic footprint in markets throughout the West Coast. All of the goodwill recorded has been attributed to the Community Banking segment and reporting unit. None of the goodwill will be deductible for income tax purposes.

Subsequent to acquisition, the Company repaid securities sold under agreements to repurchase acquired of $500.0 million, funded through the sale of acquired investment securities in the second quarter of 2014. On June 20, 2014, the Company completed the required divestiture of six stores acquired in the Merger to another financial institution. The divestiture of the six stores included $211.5 million of deposits and $88.3 million of loans. The assets were sold at a discount of $7.0 million, which was recorded by Sterling prior to the merger.

As of April 18, 2014, the unpaid principal balance on purchased non-impaired loans was $7.0 billion. The fair value of the purchased non-impaired loans was $6.7 billion, resulting in a discount of $230.5 million being recorded on these loans.


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The following table presents the acquired purchased impaired loans as of the acquisition date:
(in thousands)
 
Purchase impaired
Contractually required principal payments
 
$
604,136

Nonaccretable difference
 
(95,614
)
Cash flows expected to be collected
 
508,522

Accretable yield
 
(110,757
)
Fair value of purchased non-covered impaired loans
 
$
397,765


The operations of Sterling are included in our operating results beginning on April 19, 2014, and contributed the following net interest income, provision for loan losses, non-interest income and expense, income tax benefit, and net income for the three and six months ended June 30, 2014.
(in thousands)
 
Sterling Stand-alone
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30, 2014
 
June 30, 2014
Net interest income
 
$
101,254

 
$
101,254

Provision for loan losses
 
7,735

 
7,735

Non-interest income
 
22,302

 
22,302

Non-interest expense, excluding merger expense
 
65,132

 
65,132

Merger expense
 
57,531

 
57,531

Income tax benefit
 
1,101

 
1,101

  Net loss
 
$
(5,741
)
 
$
(5,741
)

The following table provides a breakout of Merger related expense for the three and six months ended June 30, 2014.
(in thousands)
 
 
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30, 2014
 
June 30, 2014
Personnel
 
$
15,075

 
$
15,488

Legal and professional
 
8,752

 
13,924

Charitable contributions
 
10,000

 
10,000

Investment banking fees
 
9,573

 
9,573

Contract termination
 
8,853

 
8,853

Communication
 
1,839

 
2,011

Other
 
3,439

 
3,665

  Total Merger related expense
 
$
57,531

 
$
63,514



12
Table of Contents

The following table presents unaudited pro forma results of operations for the three and six months ended June 30, 2014 and 2013, as if the Sterling merger had occurred on January 1, 2013. The pro forma results have been prepared for comparative purposes only and are not necessarily indicative of the results that would have been obtained had the acquisition actually occurred on January 1, 2013. The pro forma results include the impact of certain purchase accounting adjustments including accretion of loan discount, intangible assets amortization and deposit and borrowing premium accretion. These purchase accounting adjustments increased pro forma net income by $2.8 million and $20.4 million for the three months ended June 30, 2014 and 2013, respectively, and $23.4 million and $42.5 million for the six months ended June 30, 2014 and 2013, respectively.

(in thousands, except per share data)
 
 
 
 
 
 
 
 
 
Pro Forma
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2014
 
2013
 
2014
 
2013
 
Net interest income
$
234,503

 
$
214,107

 
$
458,792

 
$
427,140

(1), (2) 
Provision for non-covered loan and lease losses
15,399

 
2,993

 
20,799

 
9,981

 
Recapture of provision for covered loan losses
(703
)
 
(3,072
)
 
(132
)
 
(2,840
)
 
Non-interest income
48,785

 
71,567

 
94,107

 
138,718

(3), (4), (5) 
Non-interest expense
175,480

 
241,906

 
349,705

 
419,915

(6), (7) 
  Income before provision for income taxes
93,112

 
43,847

 
182,527

 
138,802

 
Provision for income taxes
36,637

 
12,822

 
68,905

 
45,039

 
  Net income
56,475

 
31,025

 
113,622

 
93,763

 
Dividends and undistributed earnings allocated to participating securities
83

 
197

 
196

 
380

 
Net earnings available to common shareholders
$
56,392

 
$
30,828

 
$
113,426

 
$
93,383

 
Earnings per share:
 
 
 
 
 
 
 
 
      Basic
$
0.26

 
$
0.14

 
$
0.52

 
$
0.43

 
      Diluted
$
0.26

 
$
0.14

 
$
0.52

 
$
0.43

 
Average shares outstanding:
 
 
 
 
 
 
 
 
      Basic
216,960

 
216,040

 
216,700

 
215,992

 
      Diluted
220,531

 
218,476

 
219,748

 
218,424

 

(1) Includes $5.1 million and $33.6 million of incremental loan discount accretion for the three months ended June 30, 2014 and 2013, respectively and $31.9 million and $69.8 million for the six months ended June 30, 2014 and 2013, respectively.
(2) Includes a reduction of interest expense of $1.0 million and $5.6 million related to deposit and borrowing premiums amortization for the three months ended June 30, 2014 and 2013, respectively and $5.9 million and $11.4 million for the six months ended June 30, 2014 and 2013, respectively.
(3) Includes a reduction of service charges on deposit of $288,000 and $1.4 million as a result of passing the $10 billion asset threshold for the three months ended June 30, 2014 and 2013, respectively and $1.7 million and $2.9 million for the six months ended June 30, 2014 and 2013, respectively.
(4) Includes a loss on junior subordinated debentures carried at fair value of $190,000 and $966,000 for the three months ended June 30, 2014 and 2013, respectively and $837,000 and $1.9 million for six months ended June 30, 2014 and 2013, respectively.
(5) The six months ended June 30, 2014 includes the reversal of the $7.0 million loss on the sale of the six stores.
(6) Includes $347,000 and $2.0 million of incremental core deposit intangible amortization for the three months ended June 30, 2014 and 2013, respectively and $2.1 million and $4.1 million for the six months ended June 30, 2014 and 2013, respectively.
(7) The three and six months ended June 30, 2014 were adjusted to exclude $70.7 million and $79.4 million of merger expenses, respectively, the three and six months ended June 2013 were adjusted to include these charges.

Financial Pacific Holding Corp.
On July 1, 2013, the Bank acquired Financial Pacific Holding Corp. ("FPHC") based in Federal Way, Washington, and its subsidiary, Financial Pacific Leasing, Inc. ("FinPac Leasing"), and its subsidiaries, Financial Pacific Funding, Inc. ("FPF"), Financial Pacific Funding II, Inc. ("FPF II") and Financial Pacific Funding III, Inc. ("FPF III"). As part of the same transaction,

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the Company acquired two related entities, FPC Leasing Corporation ("FPC") and Financial Pacific Reinsurance Co., Ltd. ("FPR"). FPHC, FinPac Leasing, FPF, FPF II, FPF III, FPC and FPR are collectively referred to herein as "FinPac." FinPac provides business-essential commercial equipment leases to various industries throughout the United States and Canada. It originates leases through its brokers, lessors, and direct marketing programs. The results of FinPac's operations are included in the consolidated financial statements as of July 1, 2013.

The aggregate consideration for the FinPac purchase was $158.0 million. Of that amount, $156.1 million was distributed in cash, and $1.9 million was exchanged for restricted shares of the Company stock. The restricted shares were issued from the Company's 2013 Incentive Plan pursuant to employment agreements between the Company's and certain executives of FinPac, vest over a period of either two or three years, and will be recognized over that time period within the salaries and employee benefits line item on the Consolidated Statements of Income. The structure of the transaction was as follows:

•
The Bank acquired all of the outstanding stock of FPHC, a shell holding company, which is the sole shareholder of FinPac Leasing, the primary operating subsidiary of FinPac that engages in equipment leasing and financing activities. FinPac Leasing is also the sole shareholder of FPF, FPF II and FPF III, which are bankruptcy-remote entities that formerly served as lien holder for certain leases. FPF, FPF II and FPF III have no assets or current business activities and are in the process of dissolution. Upon the dissolution of FPHC, the Bank will hold all of the outstanding stock of FinPac Leasing.
•
The Company acquired all of the outstanding stock of FPC, a Canadian leasing subsidiary, and FPR, a corporation organized in the Turks & Caicos Islands that reinsures a portion of the liability risk of each insurance policy that is issued by a third party insurance company on leased equipment when the lessee fails to meet its contractual obligations under the lease or financing agreement to obtain insurance on the leased equipment.

A summary of consideration paid, the assets acquired and liabilities assumed at their fair values in the acquisition of FinPac are presented below.
(in thousands)
 
 
 
FinPac
 
July 1, 2013
Fair value of consideration:
 
 
          Cash
 
$
156,110

Fair value of assets acquired:
 
 
Cash and equivalents
$
6,452

 
Non-covered loans and leases, net
264,336

 
Premises and equipment
491

 
Other assets
8,015

 
 Total assets acquired
279,294

 
Fair value of liabilities assumed:
 
 
Term debt
211,204

 
Other liabilities
8,757

 
 Total liabilities assumed
$
219,961

 
 Net assets acquired
 
59,333

 Goodwill
 
$
96,777


The acquisition provides diversification, and a scalable platform that is consistent with expansion initiatives that the Bank has completed over the last three years, including growth in the business banking, agricultural lending and home builder lending groups. The transaction leverages excess capital of the Company and deploys excess liquidity into significantly higher yielding assets, provides growth and diversification, and is anticipated to increase profitability. There is no tax deductible goodwill or other intangibles.

The operations of FinPac are included in our operating results from July 1, 2013, and added revenue of $15.9 million, non-interest expense of $3.7 million , and net income of $3.9 million net of tax, for the three months ended June 30, 2014. For the six months ended June 30, 2014, FinPac added revenue of $31.5 million, non-interest expense of $7.6 million, and net income of $8.2 million, net of tax. FinPac's results of operations prior to the acquisition are not included in our operating results. There

14
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are no FinPac merger related expenses for the three and six months ended June 30, 2014. FinPac merger related expenses were $654,000 and $796,000 for the three and six months ended June 30, 2013.

Non-covered leases acquired from FinPac are presented below as of acquisition date:
(in thousands)
FinPac
 
July 1, 2013
Contractually required payments
$
350,403

Purchase adjustment for credit
$
(20,520
)
Balance of non-covered impaired leases, net
$
264,336


The following table presents unaudited pro forma results of operations for the three and six months ended June 30, 2013 as if the acquisition of FinPac had occurred on January 1, 2013. The proforma results have been prepared for comparative purposes only and are not necessarily indicative of the results that would have been obtained had the acquisition actually occurred on January 1, 2013. The pro forma results include the impact of certain purchase accounting adjustments which reduced pro forma earnings available to common shareholders by $820,000 and $1.5 million for the three and six months ended June 30, 2013, respectively.

(in thousands, except per share data)
Pro Forma
 
Three Months Ended
 
Six Months Ended
 
June 30, 2013
 
June 30, 2013
Net interest income
$
105,297

 
$
210,809

Provision for non-covered loan and lease losses
3,688

 
13,253

Recapture of provision for covered loan losses
(3,072
)
 
(2,840
)
Non-interest income
35,019

 
69,824

Non-interest expense
92,403

 
181,794

  Income before provision for income taxes
47,297

 
88,426

Provision for income taxes
16,910

 
31,094

  Net income
30,387

 
57,332

Dividends and undistributed earnings allocated to participating securities
228

 
439

Net earnings available to common shareholders
$
30,159

 
$
56,893

Earnings per share:
 
 
 
      Basic
$
0.27

 
$
0.51

      Diluted
$
0.27

 
$
0.51

Average shares outstanding:
 
 
 
      Basic
111,954

 
111,946

      Diluted
112,145

 
112,133



15
Table of Contents

Note 3 – Investment Securities 
 
The following table presents the amortized costs, unrealized gains, unrealized losses and approximate fair values of investment securities at June 30, 2014 and December 31, 2013: 

 (in thousands)
June 30, 2014
 
Amortized
 
Unrealized
 
Unrealized
 
Fair
 
Cost
 
Gains
 
Losses
 
Value
AVAILABLE FOR SALE:
 
 
 
 
 
 
 
U.S. Treasury and agencies
$
214

 
$
19

 
$
—

 
$
233

Obligations of states and political subdivisions
336,607

 
13,428

 
(1,056
)
 
348,979

Residential mortgage-backed securities and collateralized mortgage obligations
2,229,391

 
22,995

 
(14,645
)
 
2,237,741

Investments in mutual funds and other equity securities
2,016

 
—

 
—

 
2,016

 
$
2,568,228

 
$
36,442

 
$
(15,701
)
 
$
2,588,969

HELD TO MATURITY:
 
 
 
 
 
 
 
Residential mortgage-backed securities and collateralized mortgage obligations
$
5,375

 
$
306

 
$
(42
)
 
$
5,639

Other investment securities
144

 
—

 
—

 
144

 
$
5,519

 
$
306

 
$
(42
)
 
$
5,783


 (in thousands)
December 31, 2013
 
Amortized
 
Unrealized
 
Unrealized
 
Fair
 
Cost
 
Gains
 
Losses
 
Value
AVAILABLE FOR SALE:
 
 
 
 
 
 
 
U.S. Treasury and agencies
$
249

 
$
20

 
$
(1
)
 
$
268

Obligations of states and political subdivisions
229,969

 
7,811

 
(2,575
)
 
235,205

Residential mortgage-backed securities and collateralized mortgage obligations
1,567,001

 
15,359

 
(28,819
)
 
1,553,541

Investments in mutual funds and other equity securities
1,959

 
5

 
—

 
1,964

 
$
1,799,178

 
$
23,195

 
$
(31,395
)
 
$
1,790,978

HELD TO MATURITY:
 
 
 
 
 
 
 
Residential mortgage-backed securities and collateralized mortgage obligations
$
5,563

 
$
330

 
$
(19
)
 
$
5,874

 
$
5,563

 
$
330

 
$
(19
)
 
$
5,874

 
Investment securities that were in an unrealized loss position as of June 30, 2014 and December 31, 2013 are presented in the following tables, based on the length of time individual securities have been in an unrealized loss position. In the opinion of management, these securities are considered only temporarily impaired due to changes in market interest rates or the widening of market spreads subsequent to the initial purchase of the securities, and not due to concerns regarding the underlying credit of the issuers or the underlying collateral. 
 

16
Table of Contents

June 30, 2014
 
 
 
 
 
 
 
 
 
 
 
 (in thousands)
Less than 12 Months
 
12 Months or Longer
 
Total
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Value
 
Losses
 
Value
 
Losses
 
Value
 
Losses
AVAILABLE FOR SALE:
 

 
 

 
 

 
 

 
 

 
 

Obligations of states and political subdivisions
$
7,145

 
$
647

 
$
24,892

 
$
409

 
$
32,037

 
$
1,056

Residential mortgage-backed securities and collateralized mortgage obligations
249,624

 
582

 
557,774

 
14,063

 
807,398

 
14,645

Total temporarily impaired securities
$
256,769

 
$
1,229

 
$
582,666

 
$
14,472

 
$
839,435

 
$
15,701

HELD TO MATURITY:
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage-backed securities and collateralized mortgage obligations
$
210

 
$
42

 
$
—

 
$
—

 
$
210

 
$
42

Total temporarily impaired securities
$
210

 
$
42

 
$
—

 
$
—

 
$
210

 
$
42


Unrealized losses on the impaired held to maturity collateralized mortgage obligations include the unrealized losses related to factors other than credit that are included in other comprehensive income. 

December 31, 2013
 
 
 
 
 
 
 
 
 
 
 
 (in thousands)
Less than 12 Months
 
12 Months or Longer
 
Total
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Value
 
Losses
 
Value
 
Losses
 
Value
 
Losses
AVAILABLE FOR SALE:
 

 
 

 
 

 
 

 
 

 
 

U.S. Treasury and agencies
$
—

 
$
—

 
$
32

 
$
1

 
$
32

 
$
1

Obligations of states and political subdivisions
48,342

 
2,575

 
—

 
—

 
48,342

 
2,575

Residential mortgage-backed securities and collateralized mortgage obligations
475,982

 
15,951

 
249,695

 
12,868

 
725,677

 
28,819

Total temporarily impaired securities
$
524,324

 
$
18,526

 
$
249,727

 
$
12,869

 
$
774,051

 
$
31,395

HELD TO MATURITY:
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage-backed securities and collateralized mortgage obligations
$
156

 
$
19

 
$
—

 
$
—

 
$
156

 
$
19

Total temporarily impaired securities
$
156

 
$
19

 
$
—

 
$
—

 
$
156

 
$
19

 
The unrealized losses on investments in U.S. Treasury and agency securities were caused by interest rate increases subsequent to the purchase of these securities. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than par. Because the Bank does not intend to sell the securities in this class and it is not likely that the Bank will be required to sell these securities before recovery of their amortized cost basis, which may include holding each security until contractual maturity, the unrealized losses on these investments are not considered other-than-temporarily impaired ("OTTI"). 
 
The unrealized losses on obligations of political subdivisions were caused by changes in market interest rates or the widening of market spreads subsequent to the initial purchase of these securities. Management monitors published credit ratings of these securities and no adverse ratings changes have occurred since the date of purchase of obligations of political subdivisions which are in an unrealized loss position as of June 30, 2014. Because the decline in fair value is attributable to changes in interest rates or widening market spreads and not credit quality, and because the Bank does not intend to sell the securities in this class and it is not likely that the Bank will be required to sell these securities before recovery of their amortized cost basis, which may include holding each security until maturity, the unrealized losses on these investments are not considered OTTI. 
 
All of the available for sale residential mortgage-backed securities and collateralized mortgage obligations portfolio in an unrealized loss position at June 30, 2014 are issued or guaranteed by governmental agencies. The unrealized losses on residential mortgage-backed securities and collateralized mortgage obligations were caused by changes in market interest rates or the widening of market spreads subsequent to the initial purchase of these securities, and not concerns regarding the underlying credit of the issuers or the underlying collateral. It is expected that these securities will not be settled at a price less than the amortized cost of each investment. Because the decline in fair value is attributable to changes in interest rates or widening market spreads and not credit quality, and because the Bank does not intend to sell the securities in this class and it is

17
Table of Contents

not likely that the Bank will be required to sell these securities before recovery of their amortized cost basis, which may include holding each security until contractual maturity, these investments are not considered OTTI. 

The following table presents the maturities of investment securities at June 30, 2014: 
 
 (in thousands)
Available For Sale
 
Held To Maturity
 
Amortized
 
Fair
 
Amortized
 
Fair
 
Cost
 
Value
 
Cost
 
Value
AMOUNTS MATURING IN:
 
 
 
 
 
 
 
Three months or less
$
11,267

 
$
11,314

 
$
—

 
$
—

Over three months through twelve months
40,413

 
40,990

 
5

 
5

After one year through five years
1,522,689

 
1,548,906

 
27

 
28

After five years through ten years
887,929

 
879,608

 
29

 
31

After ten years
103,914

 
106,135

 
5,314

 
5,575

Other investment securities
2,016

 
2,016

 
144

 
144

 
$
2,568,228

 
$
2,588,969

 
$
5,519

 
$
5,783

 
The amortized cost and fair value of collateralized mortgage obligations and mortgage-backed securities are presented by expected average life, rather than contractual maturity, in the preceding table. Expected maturities may differ from contractual maturities because borrowers have the right to prepay underlying loans without prepayment penalties. The following table presents the gross realized gains and gross realized losses on the sale of securities available for sale for the three and six months ended June 30, 2014 and 2013:

(in thousands)
Three Months Ended
 
June 30, 2014
 
June 30, 2013
 
Gains
 
Losses
 
Gains
 
Losses
Obligations of states and political subdivisions
$
3

 
$
1

 
$
—

 
$
1

Residential mortgage-backed securities and collateralized mortgage obligations
974

 
—

 
—

 
—

Other debt securities
—

 
—

 
9

 
—

 
$
977

 
$
1

 
$
9

 
$
1

 
 
 
 
 
 
 
 
 
Six Months Ended
 
June 30, 2014
 
June 30, 2013
 
Gains
 
Losses
 
Gains
 
Losses
Obligations of states and political subdivisions
$
3

 
$
1

 
$
7

 
$
1

Residential mortgage-backed securities and collateralized mortgage obligations
974

 
—

 
—

 
—

Other debt securities
—

 
—

 
9

 
—

 
$
977

 
$
1

 
$
16

 
$
1



18
Table of Contents

The following table presents, as of June 30, 2014, investment securities which were pledged to secure borrowings, public deposits, and repurchase agreements as permitted or required by law: 
 (in thousands)
Amortized
 
Fair
 
Cost
 
Value
To Federal Home Loan Bank to secure borrowings
$
8,290

 
$
8,634

To state and local governments to secure public deposits
1,674,935

 
1,687,353

Other securities pledged principally to secure repurchase agreements
460,240

 
459,421

Total pledged securities
$
2,143,465

 
$
2,155,408


 
 
Note 4 – Non-Covered Loans and Leases  
 
The following table presents the major types of non-covered loans and leases, net as of June 30, 2014 and December 31, 2013, respectively: 
(in thousands)
June 30,
 
December 31,
 
2014
 
2013
Commercial real estate
 
 
 
 
Non-owner occupied term, net
$
3,348,029

 
$
2,328,260

 
Owner occupied term, net
2,666,128

 
1,259,583

 
Multifamily, net
2,482,995

 
403,537

 
Construction & development, net
261,767

 
245,231

 
Residential development, net
91,690

 
88,413

 
Commercial


 
 
 
Term, net
1,104,206

 
770,845

 
LOC & other, net
1,322,167

 
987,360

 
Leases and equipment finance, net
463,784

 
361,591

 
Residential


 
 
 
Mortgage, net
1,958,597

 
597,201

 
Home equity loans & lines, net
799,171

 
264,269

 
Consumer & other, net
331,811

 
48,113

 
Total loans and leases, net of deferred fees and costs
$
14,830,345

 
$
7,354,403

 
 
The non-covered loan balances are net of net deferred loan costs of $13.5 million as of June 30, 2014 and net of net deferred loan fees of $495,000 at December 31, 2013. Net non-covered loans include discounts on acquired loans of $287.4 million and $3.3 million as of June 30, 2014 and December 31, 2013, respectively. As of June 30, 2014, non-covered loans totaling $8.6 billion were pledged to secure borrowings and available lines of credit.

Purchased loans and leases are recorded at their fair value at the acquisition date. Credit discounts are included in the determination of fair value; therefore, an allowance for loan and lease losses is not recorded at the acquisition date. Acquired loans are evaluated upon acquisition and classified as either purchased impaired or purchased non-impaired. Purchased impaired loans reflect credit deterioration since origination such that it is probable at acquisition that the Company will be unable to collect all contractually required payments. The outstanding contractual unpaid principal balance of non-covered purchased impaired loans, excluding purchase accounting adjustments, was $511.2 million and $35.1 million at June 30, 2014 and December 31, 2013, respectively. The carrying balance of non-covered purchased impaired loans was $402.5 million and $21.9 million at June 30, 2014 and December 31, 2013, respectively.


19
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The following table presents the changes in the accretable yield for purchased impaired loans for the three and six months ended June 30, 2014 and 2013:
(in thousands)
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
 
2014
 
2013
 
2014
 
2013
Balance, beginning of period
 
$
1,053

 
$
667

 
$
1,140

 
$
770

Additions
 
110,757

 
—

 
110,757

 
—

Accretion to interest income
 
(5,990
)
 
(73
)
 
(6,077
)
 
(151
)
Disposals
 
(315
)
 
(424
)
 
(315
)
 
(449
)
Reclassifications from nonaccretable difference
 
—

 
—

 
—

 
—

Balance, end of period
 
$
105,505

 
$
170

 
$
105,505

 
$
170


Note 5 – Allowance for Non-Covered Loan and Lease Loss and Credit Quality 
 
The Bank's methodology for assessing the appropriateness of the Allowance for Loan and Lease Loss "ALLL" consists of three key elements, which includes 1) the formula allowance; 2) the specific allowance; and 3) the unallocated allowance. By incorporating these factors into a single allowance requirement analysis, all risk-based activities within the loan and lease portfolios are simultaneously considered. 

Formula Allowance 
When loans and leases are originated, they are assigned a risk rating that is reassessed periodically during the term of the loan or lease through the credit review process.  The Bank's risk rating methodology assigns risk ratings ranging from 1 to 10, where a higher rating represents higher risk. The 10 risk rating categories are a primary factor in determining an appropriate amount for the formula allowance. 
 
The formula allowance is calculated by applying risk factors to various segments of pools of outstanding loans and leases. Risk factors are assigned to each portfolio segment based on management's evaluation of the losses inherent within each segment. Segments or regions with greater risk of loss will therefore be assigned a higher risk factor. 
 
Base risk – The portfolio is segmented into loan categories, and these categories are assigned a Base risk factor based on an evaluation of the loss inherent within each segment. 
 
Extra risk – Additional risk factors provide for an additional allocation of ALLL based on the loan and lease risk rating system and loan delinquency, and reflect the increased level of inherent losses associated with more adversely classified loans and leases. 

Risk factors may be changed periodically based on management's evaluation of the following factors: loss experience; changes in the level of non-performing loans and leases; regulatory exam results; changes in the level of adversely classified loans and leases; improvement or deterioration in local economic conditions; and any other factors deemed relevant.
 
Specific Allowance 
Regular credit reviews of the portfolio identify loans that are considered potentially impaired. Potentially impaired loans are referred to the ALLL Committee which reviews and approves designated loans as impaired. A loan is considered impaired, when based on current information and events, we determine that we will probably not be able to collect all amounts due according to the loan contract, including scheduled interest payments. When we identify a loan as impaired, we measure the impairment using discounted cash flows, except when the sole remaining source of the repayment for the loan is the liquidation of the collateral. In these cases, we use the current fair value of the collateral, less selling costs, instead of discounted cash flows. If we determine that the value of the impaired loan is less than the recorded investment in the loan, we either recognize an impairment reserve as a specific allowance to be provided for in the allowance for loan and lease losses or charge-off the impaired balance on collateral-dependent loans if it is determined that such amount represents a confirmed loss.  Loans determined to be impaired with a specific allowance are excluded from the formula allowance so as not to double-count the loss exposure. The non-accrual impaired loans as of period end have already been partially charged-off to their estimated net realizable value, and are expected to be resolved over the coming quarters with no additional material loss, absent further decline in market prices. 
 

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Table of Contents

The combination of the formula allowance component and the specific allowance component represents the allocated allowance for loan and lease losses. 
 
Unallocated Allowance 
The Bank may also maintain an unallocated allowance amount to provide for other credit losses inherent in a loan and lease portfolio that may not have been contemplated in the credit loss factors. This unallocated amount generally comprises less than 5% of the allowance, but may be maintained at higher levels during times of deteriorating economic conditions characterized by falling real estate values. The unallocated amount is reviewed quarterly based on trends in credit losses, the results of credit reviews, overall economic trends and other qualitative factors.

Management believes that the ALLL was adequate as of June 30, 2014. There is, however, no assurance that future loan and lease losses will not exceed the levels provided for in the ALLL and could possibly result in additional charges to the provision for loan and lease losses.
 
The reserve for unfunded commitments ("RUC") is established to absorb inherent losses associated with our commitment to lend funds, such as with a letter or line of credit. The adequacy of the ALLL and RUC are monitored on a regular basis and are based on management's evaluation of numerous factors. These factors include the quality of the current loan portfolio; the trend in the loan portfolio's risk ratings; current economic conditions; loan concentrations; loan growth rates; past-due and non-performing trends; evaluation of specific loss estimates for all significant problem loans; historical charge-off and recovery experience; and other pertinent information.
 
There have been no significant changes to the Bank's ALLL methodology or policies in the periods presented. 
 
Activity in the Non-Covered Allowance for Loan and Lease Losses 
 
The following table summarizes activity related to the allowance for non-covered loan and lease losses by non-covered loan and lease portfolio segment for three and six months ended June 30, 2014 and 2013: 
 
(in thousands)
Three Months Ended June 30, 2014
 
Commercial
 
 
 
 
 
Consumer
 
 
 
Real Estate
 
Commercial
 
Residential
 
& Other
 
Total
Balance, beginning of period
$
51,847

 
$
26,762

 
$
7,191

 
$
909

 
$
86,709

Charge-offs
(629
)
 
(4,418
)
 
(449
)
 
(318
)
 
(5,814
)
Recoveries
532

 
979

 
120

 
70

 
1,701

Provision
208

 
9,264

 
4,541

 
1,386

 
15,399

Balance, end of period
$
51,958

 
$
32,587

 
$
11,403

 
$
2,047

 
$
97,995

 
 
 
 
 
 
 
 
 
 
 
Three Months Ended June 30, 2013
 
Commercial
 
 
 
 
 
Consumer
 
 
 
Real Estate
 
Commercial
 
Residential
 
& Other
 
Total
Balance, beginning of period
$
55,095

 
$
21,661

 
$
7,219

 
$
717