HFWA-2015.06.30 10Q
Table of Contents


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, 2015
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 0-29480 
 
HERITAGE FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter) 
 
 
 
Washington
 
91-1857900
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
201 Fifth Avenue SW, Olympia, WA
 
98501
(Address of principal executive offices)
 
(Zip Code)
(360) 943-1500
(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.    Yes  ý    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).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a 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.
 
Large accelerated filer
¨
  
Accelerated filer
x
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  ¨    No  ý
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the last practicable date:
As of July 30, 2015 there were 29,954,942 shares of the registrant's common stock, no par value per share, outstanding.



Table of Contents


HERITAGE FINANCIAL CORPORATION
FORM 10-Q
INDEX
June 30, 2015
 
 
Page
 
 
 
 
Part I.
Item 1.
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
Part II.
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 
 
CERTIFICATIONS
 




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FORWARD LOOKING STATEMENTS:

“Safe Harbor” statement under the Private Securities Litigation Reform Act of 1995: This Quarterly Report on Form 10-Q ("Form 10-Q") contains forward-looking statements that are subject to risks and uncertainties, including, but not limited to: our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we have acquired, including those from the Cowlitz Bank, Pierce Commercial Bank, Northwest Commercial Bank, Valley Community Bancshares and Washington Banking Company transactions described in this Form 10-Q, or may in the future acquire, into our operations and our ability to realize related revenue synergies and cost savings within expected time frames or at all, and any goodwill charges related thereto and costs or difficulties relating to integration matters, including but not limited to customer and employee retention, which might be greater than expected; the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in our allowance for loan losses and provision for loan losses that may be effected by deterioration in the housing and commercial real estate markets, which may lead to increased losses and non-performing assets in our loan portfolio, and may result in our allowance for loan losses no longer being adequate to cover actual losses, and require us to increase our allowance for loan losses; changes in general economic conditions, either nationally or in our market areas; changes in the levels of general interest rates, and the relative differences between short and long term interest rates, deposit interest rates, our net interest margin and funding sources; risks related to acquiring assets in or entering markets in which we have not previously operated and may not be familiar; fluctuations in the demand for loans, the number of unsold homes and other properties and fluctuations in real estate values in our market areas; results of examinations of us by the Board of Governors of the Federal Reserve System and of our bank subsidiary by the Federal Deposit Insurance Corporation ("FDIC"), the Washington State Department of Financial Institutions, Division of Banks or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our allowance for loan losses, write-down assets, or change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings; legislative or regulatory changes that adversely affect our business including changes in regulatory policies and principles, or the interpretation of regulatory capital or other rules including as a result of Basel III; our ability to control operating costs and expenses; the impact of the Wall Street Reform and Consumer Protection Act and the implementing regulations; further increases in premiums for deposit insurance; the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation; difficulties in reducing risk associated with the loans on our Condensed Consolidated Statements of Financial Condition; staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges; failure or security breach of computer systems on which we depend; our ability to retain key members of our senior management team; costs and effects of litigation, including settlements and judgments; our ability to implement our expansion strategy of pursuing acquisitions and de novo branching; increased competitive pressures among financial service companies; changes in consumer spending, borrowing and savings habits; the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions; adverse changes in the securities markets; inability of key third-party providers to perform their obligations to us; changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; and other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and other risks detailed from time to time in our filings with the Securities and Exchange Commission including our Annual Report on Form 10-K for the year ended December 31, 2014.
The Company cautions readers not to place undue reliance on any forward-looking statements. Moreover, you should treat these statements as speaking only as of the date they are made and based only on information then actually known to the Company. The Company does not undertake and specifically disclaims any obligation to revise any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. These risks could cause our actual results for future periods to differ materially from those expressed in any forward-looking statements by, or on behalf of, us, and could negatively affect the Company’s operating results and stock price performance.
As used throughout this report, the terms “we”, “our”, “us”, or the “Company” refer to Heritage Financial Corporation and its consolidated subsidiaries, unless the context otherwise requires.


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PART I.     FINANCIAL INFORMATION

ITEM 1.     FINANCIAL STATEMENTS
HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
June 30, 2015 and December 31, 2014
(Dollars in thousands)
(Unaudited)
 
June 30, 2015
 
December 31, 2014
ASSETS
 
 
 
Cash on hand and in banks
$
62,540


$
74,028

Interest earning deposits
22,772


47,608

Cash and cash equivalents
85,312


121,636

Other interest earning deposits
5,110


10,126

Investment securities available for sale, at fair value
699,122


742,846

Investment securities held to maturity (fair value of $34,494 and $36,874, respectively)
33,587


35,814

Loans held for sale
6,939

 
5,582

Noncovered loans receivable, net
2,239,621

 
2,124,877

Allowance for loan losses on noncovered loans
(22,779
)
 
(22,153
)
Noncovered loans receivable, net of allowance for loan losses
2,216,842

 
2,102,724

Covered loans receivable, net
107,681

 
126,200

Allowance for loan losses on covered loans
(5,499
)
 
(5,576
)
Covered loans receivable, net of allowance for loan losses
102,182

 
120,624

Total loans receivable, net
2,319,024

 
2,223,348

FDIC indemnification asset
388


1,116

Other real estate owned ($2,758 and $1,177 covered by FDIC shared-loss agreements, respectively)
3,017


3,355

Premises and equipment, net
63,968


64,938

Federal Home Loan Bank stock, at cost
4,148


12,188

Bank owned life insurance
60,579

 
35,176

Accrued interest receivable
9,883


9,836

Prepaid expenses and other assets
60,383


61,871

Other intangible assets, net
9,835


10,889

Goodwill
119,029


119,029

Total assets
$
3,480,324


$
3,457,750

LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
Deposits
$
2,946,487

 
$
2,906,331

Junior subordinated debentures
19,278

 
19,082

Securities sold under agreement to repurchase
20,589

 
32,181

Accrued expenses and other liabilities
34,842

 
45,650

Total liabilities
3,021,196

 
3,003,244

Stockholders’ equity:
 
 
 
Preferred stock, no par value, 2,500,000 shares authorized; no shares issued and outstanding at June 30, 2015 and December 31, 2014

 

Common stock, no par value, 50,000,000 shares authorized; 29,954,936 and 30,259,838 shares issued and outstanding at June 30, 2015 and December 31, 2014, respectively
358,365

 
364,741

Retained earnings
98,565

 
86,387

Accumulated other comprehensive income, net
2,198

 
3,378

Total stockholders’ equity
459,128

 
454,506

Total liabilities and stockholders’ equity
$
3,480,324

 
$
3,457,750

See accompanying Notes to Condensed Consolidated Financial Statements.

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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
For the Three and Six Months Ended June 30, 2015 and 2014
(Dollars in thousands, except per share amounts)
(Unaudited)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2015
 
2014
 
2015
 
2014
INTEREST INCOME:
 
 
 
 
 
 
 
Interest and fees on loans
$
30,554

 
$
27,446

 
$
61,035

 
$
43,897

Taxable interest on investment securities
2,328

 
1,812

 
5,012

 
2,451

Nontaxable interest on investment securities
1,048

 
638

 
2,081

 
1,074

Interest and dividends on other interest earning assets
60

 
127

 
111

 
214

Total interest income
33,990

 
30,023

 
68,239

 
47,636

INTEREST EXPENSE:
 
 
 
 
 
 
 
Deposits
1,309

 
1,297

 
2,626

 
2,151

Junior subordinated debentures
193

 
115

 
432

 
115

Other borrowings
18

 
15

 
37

 
33

Total interest expense
1,520

 
1,427

 
3,095

 
2,299

Net interest income
32,470

 
28,596

 
65,144

 
45,337

Provision for loan losses on noncovered loans
1,189

 
370

 
2,474

 
349

Provision for loan losses on covered loans

 
321

 
(77
)
 
800

Total provision for loan losses
1,189

 
691

 
2,397

 
1,149

Net interest income after provision for loan losses
31,281

 
27,905

 
62,747

 
44,188

NONINTEREST INCOME:
 
 
 
 
 
 
 
Service charges and other fees
3,687

 
2,777

 
6,982

 
4,175

Merchant Visa income, net
194

 
316

 
392

 
561

Change in FDIC indemnification asset
(304
)
 
109

 
(497
)
 
72

Gain on sale of investment securities, net
425

 
87

 
969

 
267

Gain on sale of loans, net
1,282

 
233

 
2,417

 
233

Other income
1,597

 
1,258

 
4,963

 
1,779

Total noninterest income
6,881

 
4,780

 
15,226

 
7,087

NONINTEREST EXPENSE:
 
 
 
 
 
 
 
Compensation and employee benefits
13,842

 
12,779

 
28,067

 
20,790

Occupancy and equipment
3,850

 
2,816

 
7,541

 
5,433

Data processing
1,925

 
4,003

 
3,552

 
4,999

Marketing
1,063

 
496

 
1,696

 
1,001

Professional services
904

 
3,230

 
1,708

 
4,060

State and local taxes
569

 
554

 
1,189

 
803

Impairment loss on investment securities, net

 
37

 

 
45

Federal deposit insurance premium
523

 
460

 
1,038

 
712

Other real estate owned, net
200

 
214

 
859

 
266

Amortization of intangible assets
527

 
489

 
1,054

 
645

Other expense
2,676

 
1,915

 
5,413

 
3,018

Total noninterest expense
26,079

 
26,993

 
52,117

 
41,772

Income before income taxes
12,083

 
5,692

 
25,856

 
9,503

Income tax expense
3,358

 
1,544

 
7,352

 
2,812

Net income
$
8,725

 
$
4,148

 
$
18,504

 
$
6,691

Basic earnings per common share
$
0.29

 
$
0.16

 
$
0.61

 
$
0.32

Diluted earnings per common share
$
0.29

 
$
0.16

 
$
0.61

 
$
0.32

Dividends declared per common share
$
0.11

 
$
0.08

 
$
0.21

 
$
0.16

See accompanying Notes to Condensed Consolidated Financial Statements.


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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the Three and Six Months Ended June 30, 2015 and 2014
(Dollars in thousands)
(Unaudited)

 
Three Months Ended June 30,
 
Six Months Ended 
 June 30,
 
2015
 
2014
 
2015
 
2014
Net income
$
8,725

 
$
4,148

 
$
18,504

 
$
6,691

Change in fair value of securities available for sale, net of tax of $(2,106), $1,089, $(402) and $1,410, respectively
(3,891
)
 
2,022

 
(739
)
 
2,615

Reclassification adjustment of net gain from sale of investment securities included in income, net of tax of $(149), $(30), $(339) and $(93), respectively
(276
)
 
(57
)
 
(630
)
 
(174
)
Accretion of other-than-temporary impairment on investment securities, net of tax of $1, $8, $4 and $16, respectively
3

 
15

 
11

 
30

Reclassification of other-than-temporary impairment on securities from sale of investment securities, net of tax $99, $0, $99, $0
178

 

 
178

 

Other comprehensive (loss) income
(3,986
)
 
1,980

 
(1,180
)
 
2,471

Comprehensive income
$
4,739

 
$
6,128

 
$
17,324

 
$
9,162

See accompanying Notes to Condensed Consolidated Financial Statements.


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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the Six Months Ended June 30, 2015 and 2014
(In thousands, except per share amounts)
(Unaudited)

 
Number of
common
shares
 
Common
stock
 
Retained
earnings
 
Accumulated
other
comprehensive (loss)
income, net
 
Total
stock-
holders’
equity
Balance at December 31, 2013
16,211

 
$
138,659

 
$
78,265

 
$
(1,162
)
 
$
215,762

Restricted and unrestricted stock awards issued, net of forfeitures
6

 

 

 

 

Stock option compensation expense

 
20

 

 

 
20

Exercise of stock options (including excess tax benefits from nonqualified stock options)
38

 
427

 

 

 
427

Restricted stock compensation expense

 
539

 

 

 
539

Excess tax benefits from restricted stock

 
33

 

 

 
33

Common stock repurchased
(17
)
 
(271
)
 

 

 
(271
)
Net income

 

 
6,691

 

 
6,691

Other comprehensive income, net of tax

 

 

 
2,471

 
2,471

Common stock issued in business combination
13,975

 
226,751

 

 

 
226,751

Cash dividends declared on common stock ($0.16 per share)

 

 
(2,594
)
 

 
(2,594
)
Balance at June 30, 2014
30,213

 
$
366,158

 
$
82,362

 
$
1,309

 
$
449,829

 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2014
30,260

 
$
364,741

 
$
86,387

 
$
3,378

 
$
454,506

Restricted and unrestricted stock awards issued, net of forfeitures
116

 

 

 

 

Exercise of stock options (including excess tax benefits from nonqualified stock options)
43

 
541

 

 

 
541

Restricted stock compensation expense

 
716

 

 

 
716

Excess tax benefits from restricted stock

 
90

 

 

 
90

Common stock repurchased
(464
)
 
(7,723
)
 

 

 
(7,723
)
Net income

 

 
18,504

 

 
18,504

Other comprehensive loss, net of tax

 

 

 
(1,180
)
 
(1,180
)
Cash dividends declared on common stock ($0.21 per share)

 

 
(6,326
)
 

 
(6,326
)
Balance at June 30, 2015
29,955

 
$
358,365

 
$
98,565

 
$
2,198

 
$
459,128

See accompanying Notes to Condensed Consolidated Financial Statements.


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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Months Ended June 30, 2015 and 2014
(Dollars in thousands)
(Unaudited)
 
Six Months Ended June 30,
 
2015
 
2014
Cash flows from operating activities:
 
 
 
Net income
$
18,504

 
$
6,691

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
6,670

 
4,829

Changes in net deferred loan fees, net of amortization
(1,001
)
 
(393
)
Provision for loan losses
2,397

 
1,149

Net change in accrued interest receivable, FDIC indemnification asset, prepaid expenses and other assets, accrued expenses and other liabilities
(7,672
)
 
(3,176
)
Restricted and unrestricted stock compensation expense
716

 
539

Stock option compensation expense

 
20

Excess tax benefits from stock options and restricted and unrestricted stock
(90
)
 
(33
)
Amortization of intangible assets
1,054

 
645

Gain on sale of investment securities, net
(969
)
 
(267
)
Impairment loss on investment of securities, net

 
45

Origination of loans held for sale
(66,257
)
 
(12,592
)
Gain on sale of loans, net
(2,417
)
 
(233
)
Proceeds from sale of loans held for sale
67,317

 
9,329

Earnings on bank owned life insurance
(403
)
 
(95
)
Valuation adjustment on other real estate owned
415

 

Loss (gain) on sale of other real estate owned, net
97

 
(65
)
Loss on sale or write-off of furniture, equipment and leasehold improvements

 
421

Net cash provided by operating activities
18,361

 
6,814

Cash flows from investing activities:
 
 
 
Loans originated, net of principal payments
(98,885
)
 
4,969

Maturities of other interest earning deposits
4,986

 
1,494

Maturities of investment securities available for sale
56,700

 
17,916

Maturities of investment securities held to maturity
1,235

 
521

Purchase of investment securities available for sale
(81,755
)
 
(206,075
)
Purchase of investment securities held to maturity

 
(3,313
)
Purchase of premises and equipment
(979
)
 
(1,978
)
Proceeds from sales of other real estate owned
1,639

 
3,857

Proceeds from sales of investment securities available for sale
64,432

 
157,987

Proceeds from redemption of FHLB stock
8,040

 
258

Purchase of bank owned life insurance
(25,000
)
 

Investment in new market tax credit partnership

 
(25,000
)
Investment in low-income housing tax credit partnership
(244
)
 

Net cash received from acquisitions

 
31,591

Net cash (used in) provided by investing activities
(69,831
)
 
(17,773
)

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Six Months Ended June 30,
 
2015
 
2014
Cash flows from financing activities:
 
 
 
Net increase in deposits
40,156

 
33,459

Common stock cash dividends paid
(6,326
)
 
(2,594
)
Net decrease in securities sold under agreement to repurchase
(11,592
)
 
(3,970
)
Proceeds from exercise of stock options
541

 
427

Excess tax benefits from stock options and restricted and unrestricted stock
90

 
33

Repurchase of common stock
(7,723
)
 
(271
)
Net cash (used in) provided by financing activities
15,146

 
27,084

Net (decrease) increase in cash and cash equivalents
(36,324
)
 
16,125

Cash and cash equivalents at beginning of period
121,636

 
130,400

Cash and cash equivalents at end of period
$
85,312

 
$
146,525

 
 
 
 
Supplemental disclosures of cash flow information:
 
 
 
Cash paid for interest
$
2,923

 
$
1,848

Cash paid for income taxes
9,805

 
7,000

 
 
 
 
Supplemental non-cash disclosures of cash flow information:
 
 
 
Transfers of loans receivable to other real estate owned
$
1,813

 
$
218

Common stock issued for business combinations

 
226,751

Assets acquired (liabilities assumed) in acquisitions:
 
 
 
Investment securities available for sale

 
458,312

Loans held for sale

 
3,923

Noncovered loans receivable

 
893,824

Covered loans receivable

 
109,693

Other real estate owned

 
7,121

Premises and equipment

 
31,776

Federal Home Loan Bank stock

 
7,064

FDIC indemnification asset

 
7,047

Accrued interest receivable

 
4,943

Bank owned life insurance

 
32,519

Prepaid expenses and other assets

 
14,942

Other intangible assets

 
11,194

Deposits

 
(1,433,894
)
Junior subordinated debentures

 
(18,937
)
Accrued expenses and other liabilities

 
(23,551
)
See accompanying Notes to Condensed Consolidated Financial Statements.

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HERITAGE FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Three and Six Months Ended June 30, 2015 and 2014
(Unaudited)

(1)
Description of Business, Basis of Presentation, Significant Accounting Policies and Recently Issued Accounting Pronouncements
(a) Description of Business
Heritage Financial Corporation ("Heritage" or the “Company”) is a bank holding company that was incorporated in the State of Washington in August 1997. The Company is primarily engaged in the business of planning, directing and coordinating the business activities of its wholly-owned subsidiary, Heritage Bank (the “Bank”). The Bank is a Washington-chartered commercial bank and its deposits are insured by the FDIC under the Deposit Insurance Fund. The Bank is headquartered in Olympia, Washington and conducts business from its 67 branch offices located throughout Washington State and the greater Portland, Oregon area. The Bank’s business consists primarily of commercial lending and deposit relationships with small businesses and their owners in its market areas and attracting deposits from the general public. The Bank also makes real estate construction and land development loans and consumer loans and originates first mortgage loans on residential properties primarily located in its market area.
The Company has expanded its footprint through mergers and acquisitions. The largest of these transactions was the strategic merger with Washington Banking Company (“Washington Banking”) and its wholly owned subsidiary bank, Whidbey Island Bank ("Whidbey"). Effective May 1, 2014, Washington Banking merged with and into Heritage and Whidbey merged with and into Heritage Bank and this transaction is referred to herein as the "Washington Banking Merger". In connection with the Washington Banking Merger, Heritage also acquired as a subsidiary the Washington Banking Master Trust, a Delaware statutory business trust. Pursuant to the merger agreement, Heritage assumed the performance and observance of the covenants to be performed by Washington Banking under an indenture relating to $25.0 million in trust preferred securities issued in 2007 and the due and punctual payment of the principal of and premium and interest on such trust preferred securities. For additional information, see Note 9, Junior Subordinated Debentures.
(b) Basis of Presentation
The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with the accounting principles generally accepted in the United States (“GAAP”) for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. It is recommended that these unaudited Condensed Consolidated Financial Statements and accompanying Notes be read with the audited Consolidated Financial Statements and the accompanying Notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2014 (“2014 Annual Form 10-K”). In management's opinion, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three and six months ended June 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015. In preparing the unaudited Condensed Consolidated Financial Statements, management is required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and disclosures. Estimates related to the allowance for loan losses, other than temporary impairments in the fair value of investment securities, expected cash flows of purchased credit impaired loans and related indemnification asset, fair value measurements, stock-based compensation, impairment of goodwill and other intangible assets and income taxes are particularly subject to change. Management believes that the judgments, estimates and assumptions used in the preparation of the financial statements are appropriate based on the facts and circumstances at the time. Actual results, however, could differ from those estimates.
Certain prior period amounts have been reclassified to conform to the current period’s presentation. Reclassifications had no effect on prior periods' net income or stockholders’ equity.
(c) Significant Accounting Policies
The significant accounting policies used in preparation of the Company's Condensed Consolidated Financial Statements are disclosed in the 2014 Annual Form 10-K. There have not been any material changes in the Company's significant accounting policies from those contained in the 2014 Annual Form 10-K.

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(d) Recently Issued Accounting Pronouncements
Financial Accounting Standards Board ("FASB") Accounting Standards Update ("ASU" or "Update") 2014-09, Revenue from Contracts with Customers, was issued in May 2014. Under this Update, FASB created a new Topic 606 which is in response to a joint initiative of FASB and the International Accounting Standards Board to clarify the principles for recognizing revenue and to develop a common revenue standard for U.S. GAAP and international financial reporting standards that would:
Remove inconsistencies and weaknesses in revenue requirements.
Provide a more robust framework for addressing revenue issues.
Improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets.
Provide more useful information to users of financial statements through improved disclosure requirements.
Simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer.
The Update is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. Early application is not permitted. The Company is currently evaluating the impact that this Update will have on its Condensed Consolidated Financial Statements.
FASB ASU 2014-11, Transfers and Servicing: Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures, was issued in June 2014. This Update aligns the accounting for repurchase-to-maturity transactions and repurchase agreements executed as a repurchase financing with the accounting for other typical repurchase agreements, such as secured borrowings. The guidance eliminates sale accounting and supersedes the guidance under which a transfer of a financial asset and a contemporaneous repurchase financing could be accounted for on a combined basis as a forward agreement. The Update requires new and expanded disclosures that are effective for interim or annual reporting periods beginning after December 15, 2014, with certain requirements applicable for periods beginning after March 31, 2015. The adoption of this Update did not have a material impact on the Company's Condensed Consolidated Financial Statements.

(2)
Investment Securities
The Company’s investment policy is designed primarily to provide and maintain liquidity, generate a favorable return on assets without incurring undue interest rate and credit risk, and complement the Bank’s lending activities. Securities are classified as either available for sale or held to maturity when acquired.
(a) Securities by Type and Maturity
The amortized cost, gross unrealized gains, gross unrealized losses and fair values of investment securities available for sale at the dates indicated were as follows:
 
Securities Available for Sale
 
June 30, 2015
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
(In thousands)
U.S. Treasury and U.S. Government-sponsored agencies
$
26,339

 
$
113

 
$
(6
)
 
$
26,446

Municipal securities
172,837

 
2,246

 
(873
)
 
174,210

Mortgage backed securities and collateralized mortgage obligations-residential:
 
 
 
 
 
 
 
U.S. Government-sponsored agencies
488,356

 
3,199

 
(1,285
)
 
490,270

Corporate obligations
6,243

 

 
(12
)
 
6,231

Mutual funds and other equities
1,956

 
9

 

 
1,965

Total
$
695,731

 
$
5,567

 
$
(2,176
)
 
$
699,122


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Securities Available for Sale
 
December 31, 2014
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
(In thousands)
U.S. Treasury and U.S. Government-sponsored agencies
$
21,414

 
$
44

 
$
(31
)
 
$
21,427

Municipal securities
170,082

 
3,139

 
(184
)
 
173,037

Mortgage backed securities and collateralized mortgage obligations-residential:
 
 
 
 
 
 
 
U.S. Government agencies
539,859

 
4,015

 
(1,475
)
 
542,399

Corporate obligations
4,034

 

 
(24
)
 
4,010

Mutual funds and other equities
1,956

 
17

 

 
1,973

Total
$
737,345

 
$
7,215

 
$
(1,714
)
 
$
742,846


The amortized cost, gross unrecognized gains, gross unrecognized losses and fair values of investment securities held to maturity at the dates indicated were as follows:
 
Securities Held to Maturity
 
June 30, 2015
 
Amortized
Cost
 
Gross
Unrecognized
Gains
 
Gross
Unrecognized
Losses
 
Fair
Value
 
(In thousands)
U.S. Treasury and U.S. Government-sponsored agencies
$
1,582

 
$
158

 
$

 
$
1,740

Municipal securities
21,927

 
553

 
(24
)
 
22,456

Mortgage backed securities and collateralized mortgage obligations-residential:
 
 
 
 
 
 
 
U.S. Government-sponsored agencies
10,078

 
313

 
(93
)
 
10,298

Private residential collateralized mortgage obligations

 

 

 

Total
$
33,587

 
$
1,024

 
$
(117
)
 
$
34,494

 
Securities Held to Maturity
 
December 31, 2014
 
Amortized
Cost
 
Gross
Unrecognized
Gains
 
Gross
Unrecognized
Losses
 
Fair
Value
 
(In thousands)
U.S. Treasury and U.S. Government-sponsored agencies
$
1,591

 
$
167

 
$

 
$
1,758

Municipal securities
22,486

 
643

 
(11
)
 
23,118

Mortgage backed securities and collateralized mortgage obligations-residential:
 
 
 
 
 
 
 
U.S. Government-sponsored agencies
10,866

 
364

 
(74
)
 
11,156

Private residential collateralized mortgage obligations
871

 
75

 
(104
)
 
842

Total
$
35,814

 
$
1,249

 
$
(189
)
 
$
36,874

There were no securities classified as trading at June 30, 2015 or December 31, 2014.

12

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The amortized cost and fair value of securities at June 30, 2015, by contractual maturity, are set forth below. Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
 
Securities Available for Sale
 
Securities Held to Maturity
 
Amortized
Cost
 
Fair Value
 
Amortized
Cost
 
Fair Value
 
(In thousands)
Due in one year or less
$
3,543

 
$
3,555

 
$
3,005

 
$
3,019

Due after one year through three years
32,677

 
32,854

 
3,749

 
3,779

Due after three years through five years
34,919

 
35,246

 
6,911

 
7,211

Due after five years through ten years
148,604

 
149,692

 
16,745

 
17,331

Due after ten years
474,032

 
475,810

 
3,177

 
3,154

Investment securities with no stated maturities
1,956

 
1,965

 

 

Total
$
695,731

 
$
699,122

 
$
33,587

 
$
34,494

(b) Unrealized Losses and Other-Than-Temporary Impairments
Available for sale investment securities with unrealized losses as of June 30, 2015 and December 31, 2014 were as follows:
 
Securities Available for Sale
 
June 30, 2015
 
Less than 12 Months
 
12 Months or
Longer
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
(In thousands)
U.S. Treasury and U.S. Government-sponsored agencies
$
4,584

 
$
(6
)
 
$

 
$

 
$
4,584

 
$
(6
)
Municipal securities
$
54,568

 
$
(855
)
 
$
1,460

 
$
(18
)
 
$
56,028

 
$
(873
)
Mortgage backed securities and collateralized mortgage obligations-residential:
 
 
 
 
 
 
 
 
 
 
 
U.S. Government-sponsored agencies
104,716

 
(569
)
 
49,465

 
(716
)
 
154,181

 
(1,285
)
Corporate obligations
6,231

 
(12
)
 

 

 
6,231

 
(12
)
Total
$
170,099

 
$
(1,442
)
 
$
50,925

 
$
(734
)
 
$
221,024

 
$
(2,176
)

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Securities Available for Sale
 
December 31, 2014
 
Less than 12 Months
 
12 Months or
Longer
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
(In thousands)
U.S. Treasury and U.S. Government-sponsored agencies
$
3,567

 
$
(31
)
 
$

 
$

 
$
3,567

 
$
(31
)
Municipal securities
25,176

 
(184
)
 

 

 
25,176

 
(184
)
Mortgage backed securities and collateralized mortgage obligations-residential:
 
 
 
 
 
 
 
 
 
 
 
U.S. Government-sponsored agencies
182,970

 
(1,475
)
 

 

 
182,970

 
(1,475
)
Corporate obligations
2,119

 
(24
)
 

 

 
2,119

 
(24
)
Total
$
213,832

 
$
(1,714
)
 
$

 
$

 
$
213,832

 
$
(1,714
)

Held to maturity investment securities with unrecognized losses as of June 30, 2015 and December 31, 2014 were as follows:
 
Securities Held to Maturity
 
June 30, 2015
 
Less than 12
Months
 
12 Months or
Longer
 
Total
 
Fair
Value
 
Unrecognized
Losses
 
Fair
Value
 
Unrecognized
Losses
 
Fair
Value
 
Unrecognized
Losses
 
(In thousands)
Municipal securities
$
1,094

 
$
(24
)
 
$

 
$

 
$
1,094

 
$
(24
)
Mortgage backed securities and collateralized mortgage obligations-residential:
 
 
 
 
 
 
 
 
 
 
 
U.S. Government-sponsored agencies

 

 
2,009

 
(93
)
 
2,009

 
(93
)
Total
$
1,094

 
$
(24
)
 
$
2,009

 
$
(93
)
 
$
3,103

 
$
(117
)

 
Securities Held to Maturity
 
December 31, 2014
 
Less than 12
Months
 
12 Months or
Longer
 
Total
 
Fair
Value
 
Unrecognized
Losses
 
Fair
Value
 
Unrecognized
Losses
 
Fair
Value
 
Unrecognized
Losses
 
(In thousands)
Municipal securities
$
2,196

 
$
(11
)
 
$

 
$

 
$
2,196

 
$
(11
)
Mortgage backed securities and collateralized mortgage obligations-residential:
 
 
 
 
 
 
 
 
 
 
 
U.S. Government-sponsored agencies
2,553

 
(74
)
 

 

 
2,553

 
(74
)
Private residential collateralized mortgage obligations
558

 
(104
)
 

 

 
558

 
(104
)
Total
$
5,307

 
$
(189
)
 
$

 
$

 
$
5,307

 
$
(189
)

14

Table of Contents


The Company has evaluated these securities and has determined that, other than certain private residential collateralized mortgage obligations discussed below, the decline in their value is temporary. The unrealized losses are primarily due to increases in market interest rates and larger spreads in the market for mortgage-related products. The fair value of these securities is expected to recover as the securities approach their maturity date and/or as the pricing spreads narrow on mortgage-related securities. The Company has the ability and intent to hold the investments until recovery of the market value which may be the maturity date of the securities.
During the three months ended June 30, 2015, the Company sold its entire portfolio of private residential collateralized mortgage obligations with a carrying value of $829,000, all of which were classified as held-to-maturity. Since acquisition these securities had been downgraded below the Company's acceptable investment grades. As of result of these downgrades and the effects of Basel III on the risk-weighting of sub-investment grade securities, the Company's intent to hold these securities changed and management elected to divest of its interest in the downgraded securities. The Company recorded a realized loss of $125,000 on this sale. The Company's intent and ability to hold the remaining held-to-maturity securities was not impacted by this sale.
Prior to the sale of the securities noted above, to analyze the unrealized losses, the Company estimated expected future cash flows of the private residential collateralized mortgage obligations by estimating the expected future cash flows of the underlying collateral and applying those collateral cash flows, together with any credit enhancements such as subordinated interests owned by third parties, to the security. The expected future cash flows of the underlying collateral are determined using the remaining contractual cash flows adjusted for future expected credit losses (which considers current delinquencies and nonperforming assets, future expected default rates and collateral value by vintage and geographic region) and prepayments. The expected cash flows of the security are then discounted at the interest rate used to recognize interest income on the security to arrive at a present value amount. The average prepayment rate and average discount rate used in the valuation of the present value as of June 30, 2014 were 6.0% and 9.4%, respectively.
For the six months ended June 30, 2015, there were no private residential collateralized mortgage obligations determined to be other-than-temporarily impaired and the Company recorded no unrealized losses for the six months ended June 30, 2015 in earnings or other comprehensive income. In comparison, for the six months ended June 30, 2014, there were four private residential collateralized mortgage obligations determined to be other-than-temporarily impaired. All unrealized losses for the three and six months ended June 30, 2014 were deemed to be credit related, and the Company recorded the impairment in earnings.
The following table summarizes activity for the six months ended June 30, 2014 related to the amount of impairments on held to maturity securities:
 
Life-to-Date Gross Other-Than-Temporary Impairments
 
Life-to-Date Other-Than-Temporary Impairments Included in Other Comprehensive Income
 
Life-to-Date Net
Other-Than-Temporary Impairments Included in Earnings
 
(In thousands)
December 31, 2013
$
2,603

 
$
1,152

 
$
1,451

Subsequent impairments
45

 

 
45

June 30, 2014
$
2,648

 
$
1,152

 
$
1,496


(c) Pledged Securities

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The following table summarizes the amortized cost and fair value of available for sale and held to maturity securities that are pledged as collateral for the following obligations at June 30, 2015 and December 31, 2014:
 
June 30, 2015
 
December 31, 2014
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
 
(In thousands)
Washington and Oregon state to secure public deposits
$
195,548

 
$
197,810

 
$
150,507

 
$
153,785

Federal Reserve Bank of San Francisco and FHLB to secure borrowing arrangements
512

 
513

 
4,430

 
4,460

Repurchase agreements
31,612

 
31,801

 
43,676

 
44,457

Other securities pledged
15,073

 
15,162

 
14,828

 
14,922

Total
$
242,745

 
$
245,286

 
$
213,441

 
$
217,624


At June 30, 2015 and December 31, 2014, the total carrying value of pledged securities was $245.0 million and $216.7 million, respectively.

(3)
Noncovered Loans Receivable
The Company originates loans in the ordinary course of business and has also acquired loans through FDIC-assisted and open bank transactions. Loans that are not covered by FDIC shared-loss agreements are referred to as "noncovered loans." Disclosures related to the Company’s recorded investment in noncovered loans receivable generally exclude accrued interest receivable and net deferred loan origination fees and costs because they are insignificant.
Loans acquired in a business combination may be further classified as “purchased” loans. Loans purchased with evidence of credit deterioration since origination for which it is probable that not all contractually required payments will be collected are accounted for under FASB Accounting Standards Codification ("ASC") 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. These loans are identified as “purchased credit impaired” ("PCI") loans. Loans purchased that are not accounted for under FASB ASC 310-30 are accounted for under FASB ASC 310-20, Receivables—Nonrefundable Fees and Other Costs and are referred to as "non-PCI" loans.
(a) Loan Origination/Risk Management
The Company categorizes loans in one of the four segments of the total loan portfolio: commercial business, one-to-four family residential, real estate construction and land development and consumer. Within these segments are classes of loans to which management monitors and assesses credit risk in the loan portfolios. The Company has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies, and nonperforming and potential problem loans. The Company also conducts internal loan reviews and validates the credit risk assessment on a periodic basis and presents the results of these reviews to management. The loan review process complements and reinforces the risk identification and assessment decisions made by loan officers and credit personnel, as well as the Company’s policies and procedures.
A discussion of the risk characteristics of each loan portfolio segment is as follows:
Commercial Business:
There are three significant classes of loans in the commercial portfolio segment: commercial and industrial loans, owner-occupied commercial real estate and non-owner occupied commercial real estate. The owner and non-owner occupied commercial real estate are both considered commercial real estate loans. As the commercial and industrial loans carry different risk characteristics than the commercial real estate loans, they are discussed separately below.
Commercial and industrial. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may include a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

16

Table of Contents


Commercial real estate. The Company originates commercial real estate loans within its primary market areas. These loans are subject to underwriting standards and processes similar to commercial and industrial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate involves more risk than other classes of loans in that the lending typically involves higher loan principal amounts, and payments on loans secured by real estate properties are dependent on successful operation and management of the properties. Repayment of these loans may be more adversely affected by conditions in the real estate market or the economy. Owner-occupied commercial real estate loans are generally of lower credit risk than non-owner occupied commercial real estate loans as the borrowers' businesses are likely dependent on the properties.
One-to-Four Family Residential:
The majority of the Company’s one-to-four family residential loans are secured by single-family residences located in its primary market areas. The Company’s underwriting standards require that single-family portfolio loans generally are owner-occupied and do not exceed 80% of the lower of appraised value at origination or cost of the underlying collateral. Terms of maturity typically range from 15 to 30 years. Historically, the Company sold most single-family loans in the secondary market and retained a smaller portion in its loan portfolio. From the second quarter of 2013 until May 1, 2014, the Company only originated single-family loans for its loan portfolio. As a result of the Washington Banking Merger, since May 1, 2014 the Company is originating and selling a majority of its single-family mortgages.
Real Estate Construction and Land Development:
The Company originates construction loans for one-to-four family residential and for five or more family residential and commercial properties. The one-to-four family residential construction loans generally include construction of custom homes whereby the home buyer is the borrower. The Company also provides financing to builders for the construction of pre-sold homes and, in selected cases, to builders for the construction of speculative residential property. Substantially all construction loans are short-term in nature and priced with variable rates of interest. Construction lending can involve a higher level of risk than other types of lending because funds are advanced partially based upon the value of the project, which is uncertain prior to the project’s completion. Because of the uncertainties inherent in estimating construction costs as well as the market value of a completed project and the effects of governmental regulation of real property, the Company’s estimates with regard to the total funds required to complete a project and the related loan-to-value ratio may vary from actual results. As a result, construction loans often involve the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project and the ability of the borrower to sell or lease the property or refinance the indebtedness. If the Company’s estimate of the value of a project at completion proves to be overstated, it may have inadequate security for repayment of the loan and may incur a loss if the borrower does not repay the loan. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being dependent upon successful completion of the construction project, interest rate changes, government regulation of real property, general economic conditions and the availability of long-term financing.
Consumer:
The Company originates consumer loans and lines of credit that are both secured and unsecured. The underwriting process for these loans ensures a qualifying primary and secondary source of repayment. Underwriting standards for home equity loans are significantly influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage of 80%, collection remedies, the number of such loans a borrower can have at one time and documentation requirements. To monitor and manage consumer loan risk, policies and procedures are developed and modified, as needed. The majority of consumer loans are for relatively small amounts disbursed among many individual borrowers which reduces the credit risk for this type of loan. To further reduce the risk, trend reports are reviewed by management on a regular basis.
As a result of the Washington Banking Merger, the Company is originating indirect consumer loans. These loans are for new and used automobile and recreational vehicles that are originated indirectly by selected dealers located in the Company's market areas. The Company has limited its purchase of indirect loans primarily to dealerships that are established and well known in their market areas and to applicants that are not classified as sub-prime.

17

Table of Contents


Noncovered loans receivable at June 30, 2015 and December 31, 2014 consisted of the following portfolio segments and classes:
 
June 30, 2015
 
December 31, 2014
 
(In thousands)
Commercial business:
 
 
 
Commercial and industrial
$
551,989

 
$
551,343

Owner-occupied commercial real estate
565,721

 
535,742

Non-owner occupied commercial real estate
676,872

 
616,757

Total commercial business
1,794,582

 
1,703,842

One-to-four family residential
67,083

 
63,540

Real estate construction and land development:
 
 
 
One-to-four family residential
41,693

 
46,749

Five or more family residential and commercial properties
66,024

 
61,360

Total real estate construction and land development
107,717

 
108,109

Consumer
270,175

 
250,323

Gross noncovered loans receivable
2,239,557

 
2,125,814

Net deferred loan fees
64

 
(937
)
Noncovered loans receivable, net
2,239,621

 
2,124,877

Allowance for loan losses
(22,779
)
 
(22,153
)
Noncovered loans receivable, net of allowance for loan losses
$
2,216,842

 
$
2,102,724

(b) Concentrations of Credit
Most of the Company’s lending activity occurs within Washington State, and to a lesser extent Oregon. The Company’s primary market areas are concentrated along the I-5 corridor from Whatcom County to Clark County in Washington State and Multnomah County in Oregon, as well as other contiguous markets. The Washington Banking Merger allowed the expansion of the Company's market area north of Seattle, Washington to the Canadian border. The majority of the Company’s loan portfolio consists of (in order of balances at June 30, 2015) non-owner occupied commercial real estate, owner-occupied commercial real estate and commercial and industrial. As of June 30, 2015 and December 31, 2014, there were no concentrations of loans related to any single industry in excess of 10% of the Company’s total loans.
(c) Credit Quality Indicators
As part of the on-going monitoring of the credit quality of the Company’s loan portfolio, management tracks certain credit quality indicators including trends related to (i) the risk grade of the loans, (ii) the level of classified loans, (iii) net charge-offs, (iv) nonperforming loans, and (v) the general economic conditions of the United States of America, and specifically the states of Washington and Oregon. The Company utilizes a risk grading matrix to assign a risk grade to each of its loans. Loans are graded on a scale of 0 to 10. A description of the general characteristics of the risk grades is as follows:
Grades 0 to 5: These grades are considered “pass grade” and include loans with negligible to above average but acceptable risk. These borrowers generally have strong to acceptable capital levels and consistent earnings and debt service capacity. Loans with the higher grades within the “pass” category may include borrowers who are experiencing unusual operating difficulties, but have acceptable payment performance to date. Increased monitoring of financials and/or collateral may be appropriate. Loans with this grade show no immediate loss exposure.
Grade 6: This grade includes "Watch" loans and is considered a “pass grade”. The grade is intended to be utilized on a temporary basis for pass grade borrowers where a potentially significant risk-modifying action is anticipated in the near term.
Grade 7: This grade includes “Other Assets Especially Mentioned” (“OAEM”) loans in accordance with regulatory guidelines, and is intended to highlight loans with elevated risks. Loans with this grade show signs of deteriorating profits and capital, and the borrower might not be strong enough to sustain a major setback. The borrower is typically higher than normally leveraged, and outside support might

18

Table of Contents


be modest and likely illiquid. The loan is at risk of further decline unless active measures are taken to correct the situation.
Grade 8: This grade includes “Substandard” loans in accordance with regulatory guidelines, which the Company has determined have a high credit risk. These loans also have well-defined weaknesses which make payment default or principal exposure likely, but not yet certain. The borrower may have shown serious negative trends in financial ratios and performance. Such loans may be dependent upon collateral liquidation, a secondary source of repayment or an event outside of the normal course of business. Loans with this grade can be placed on accrual or nonaccrual status based on the Company’s accrual policy.
Grade 9: This grade includes “Doubtful” loans in accordance with regulatory guidelines, and the Company has determined these loans to have excessive credit risk. Such loans are placed on nonaccrual status and may be dependent upon collateral having a value that is difficult to determine or upon some near-term event which lacks certainty. Additionally, these loans generally have a specific valuation allowance or have been partially charged-off for the amount considered uncollectible.
Grade 10: This grade includes “Loss” loans in accordance with regulatory guidelines, and the Company has determined these loans have the highest risk of loss. Such loans are charged-off or charged-down when payment is acknowledged to be uncertain or when the timing or value of payments cannot be determined. “Loss” is not intended to imply that the loan or some portion of it will never be paid, nor does it in any way imply that there has been a forgiveness of debt.
Numerical loan grades for all commercial business loans and real estate construction and land development loans are established at the origination of the loan. Prior to November 2014, one-to-four family residential loans and consumer loans (“non-commercial loans”) were not numerically graded at origination date as these loans were determined to be “pass graded” loans. A numeric grade was assigned to these non-commercial loans if subsequent to origination, the credit department evaluated the credit and determined it necessary to classify the loan. Subsequent to November 2014, non-commercial loans were designated a loan grade “4” at origination date to reflect a "pass grade". The Bank follows the FDIC’s Uniform Retail Credit Classification and Account Management Policy for subsequent classification in the event of payment delinquencies or default. Loan grades are reviewed on a quarterly basis, or more frequently if necessary, by the credit department. Typically, an individual loan grade will not be changed from the prior period unless there is a specific indication of credit deterioration or improvement. Credit deterioration is evidenced by delinquency, direct communications with the borrower, or other borrower information that becomes known to management. Credit improvements are evidenced by known facts regarding the borrower or the collateral property.
The loan grades relate to the likelihood of losses in that the higher the grade, the greater the loss potential. Loans with a pass grade may have some estimated inherent losses, but to a lesser extent than the other loan grades. The OAEM loan grade is transitory in that the Company is waiting on additional information to determine the likelihood and extent of the potential loss. The likelihood of loss for OAEM graded loans, however, is greater than Watch graded loans because there has been measurable credit deterioration. Loans with a Substandard grade are generally loans for which the Company has individually analyzed for potential impairment. For Doubtful and Loss graded loans, the Company is almost certain of the losses, and the unpaid principal balances are generally charged-off to the realizable value.

19

Table of Contents


The following tables present the balance of the noncovered loans receivable by credit quality indicator as of June 30, 2015 and December 31, 2014.
 
June 30, 2015
 
Pass
 
OAEM
 
Substandard
 
Doubtful
 
Total
 
(In thousands)
Commercial business:
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
522,215

 
$
10,389

 
$
19,073

 
$
312

 
$
551,989

Owner-occupied commercial real estate
545,857

 
8,136

 
11,728

 

 
565,721

Non-owner occupied commercial real estate
641,385

 
19,603

 
15,884

 

 
676,872

Total commercial business
1,709,457

 
38,128

 
46,685

 
312

 
1,794,582

One-to-four family residential
64,953

 

 
2,130

 

 
67,083

Real estate construction and land development:
 
 
 
 
 
 
 
 
 
One-to-four family residential
32,316

 
1,465

 
7,912

 

 
41,693

Five or more family residential and commercial properties
62,048

 

 
3,976

 

 
66,024

Total real estate construction and land development
94,364

 
1,465

 
11,888

 

 
107,717

Consumer
263,731

 

 
6,444

 

 
270,175

Gross noncovered loans
$
2,132,505

 
$
39,593

 
$
67,147

 
$
312

 
$
2,239,557


 
December 31, 2014
 
Pass
 
OAEM
 
Substandard
 
Doubtful
 
Total
 
(In thousands)
Commercial business:
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
509,483

 
$
14,487

 
$
27,049

 
$
324

 
$
551,343

Owner-occupied commercial real estate
496,234

 
22,946

 
16,562

 

 
535,742

Non-owner occupied commercial real estate
584,262

 
17,643

 
14,852

 

 
616,757

Total commercial business
1,589,979

 
55,076

 
58,463

 
324

 
1,703,842

One-to-four family residential
61,185

 
315

 
2,040

 

 
63,540

Real estate construction and land development:
 
 
 
 
 
 
 
 
 
One-to-four family residential
34,356

 
3,977

 
8,416

 

 
46,749

Five or more family residential and commercial properties
57,025

 

 
4,335

 

 
61,360

Total real estate construction and land development
91,381

 
3,977

 
12,751

 

 
108,109

Consumer
242,836

 

 
7,487

 

 
250,323

Gross noncovered loans
$
1,985,381

 
$
59,368

 
$
80,741

 
$
324

 
$
2,125,814


Noncovered potential problem loans are loans classified as OAEM or worse that are currently accruing interest and are not considered impaired, but which management is monitoring because the financial information of the borrower causes concern as to their ability to meet their loan repayment terms. Noncovered potential problem loans also include PCI loans as these loans continue to accrete loan discounts established at acquisition based on the guidance of ASC 310-30. Noncovered potential problem loans as of June 30, 2015 and December 31, 2014 were $86.2 million and $117.3 million, respectively. The balance of noncovered potential problem loans guaranteed by a governmental agency, which guarantee reduces the Company's credit exposure, was $501,000 and $2.0 million as of June 30, 2015 and December 31, 2014, respectively.

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Table of Contents


(d) Nonaccrual Loans
Nonaccrual noncovered loans, segregated by segments and classes of loans, were as follows as of June 30, 2015 and December 31, 2014:
 
June 30, 2015
 
December 31, 2014
 
(In thousands)
Commercial business:
 
 
 
Commercial and industrial
$
2,533

 
$
3,463

Owner-occupied commercial real estate
1,957

 
1,163

Non-owner occupied commercial real estate

 
93

Total commercial business
4,490

 
4,719

One-to-four family residential

 

Real estate construction and land development:
 
 
 
One-to-four family residential
2,489

 
2,652

Total real estate construction and land development
2,489

 
2,652

Consumer
19

 
139

Gross nonaccrual noncovered loans
$
6,998

 
$
7,510

The Company had $1.7 million and $1.6 million of nonaccrual noncovered loans guaranteed by governmental agencies at June 30, 2015 and December 31, 2014, respectively.
PCI noncovered loans are not included in the nonaccrual loan table above because these loans are accounted for under ASC 310-30, which provides that accretable yield is calculated based on a loan's expected cash flow even if the loan is not performing under its conventional terms.
(e) Past due loans
The Company performs an aging analysis of past due loans using the categories of 30-89 days past due and 90 or more days past due. This policy is consistent with regulatory reporting requirements.

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Table of Contents


The balances of past due noncovered loans, segregated by segments and classes of loans, as of June 30, 2015 and December 31, 2014 were as follows:
 
June 30, 2015
 
30-89 Days
 
90 Days or
Greater
 
Total Past 
Due
 
Current
 
Total
 
90 Days or More
and  Still
Accruing (1)
 
(In thousands)
Commercial business:
 
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
1,194

 
$
1,690

 
$
2,884

 
$
549,105

 
$
551,989

 
$

Owner-occupied commercial real estate
1,944

 
1,087

 
3,031

 
562,690

 
565,721

 

Non-owner occupied commercial real estate
378

 
182

 
560

 
676,312

 
676,872

 

Total commercial business
3,516

 
2,959

 
6,475

 
1,788,107

 
1,794,582

 

One-to-four family residential
41

 

 
41

 
67,042

 
67,083

 

Real estate construction and land development:
 
 
 
 
 
 
 
 
 
 
 
One-to-four family residential
668

 
1,964

 
2,632

 
39,061

 
41,693

 

Five or more family residential and commercial properties

 

 

 
66,024

 
66,024

 

Total real estate construction and land development
668

 
1,964

 
2,632

 
105,085

 
107,717

 

Consumer
1,358

 

 
1,358

 
268,817

 
270,175

 

Gross noncovered loans
$
5,583

 
$
4,923

 
$
10,506

 
$
2,229,051

 
$
2,239,557

 
$

(1) Excludes PCI loans.
 
December 31, 2014
 
30-89 Days
 
90 Days or
Greater
 
Total Past 
Due
 
Current
 
Total
 
90 Days or More
and  Still
Accruing (1)
 
(In thousands)
Commercial business:
 
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
2,503

 
$
1,962

 
$
4,465

 
$
546,878

 
$
551,343

 
$

Owner-occupied commercial real estate
1,038

 
100

 
1,138

 
534,604

 
535,742

 

Non-owner occupied commercial real estate
113

 
75

 
188

 
616,569

 
616,757

 

Total commercial business
3,654

 
2,137

 
5,791

 
1,698,051

 
1,703,842

 

One-to-four family residential
200

 

 
200

 
63,340

 
63,540

 

Real estate construction and land development:
 
 
 
 
 
 
 
 
 
 
 
One-to-four family residential
62

 
2,135

 
2,197

 
44,552

 
46,749

 

Five or more family residential and commercial properties

 
376

 
376

 
60,984

 
61,360

 

Total real estate construction and land development
62

 
2,511

 
2,573

 
105,536

 
108,109

 

Consumer
2,413

 
125

 
2,538

 
247,785

 
250,323

 

Gross noncovered loans
$
6,329

 
$
4,773

 
$
11,102

 
$
2,114,712

 
$
2,125,814

 
$

(1) Excludes PCI loans.


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Table of Contents



(f) Impaired loans

Impaired noncovered loans includes nonaccrual noncovered loans and performing troubled debt restructured noncovered loans ("TDRs"). The table below excludes $624,000, as of June 30, 2015, of certain performing TDR noncovered loans classified as PCI as these loans are recorded at the recorded investment balance and may not have further impairment. The balance of impaired noncovered loans as of June 30, 2015 and December 31, 2014 are set forth in the following tables.
 
June 30, 2015
 
Recorded
Investment With
No Specific
Valuation
Allowance
 
Recorded
Investment With
Specific
Valuation
Allowance
 
Total
Recorded
Investment
 
Unpaid
Contractual
Principal
Balance
 
Related
Specific
Valuation
Allowance
 
(In thousands)
Commercial business:
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
865

 
$
5,860

 
$
6,725

 
$
7,111

 
$
746

Owner-occupied commercial real estate

 
3,214

 
3,214

 
3,232

 
755

Non-owner occupied commercial real estate
3,752

 
5,786

 
9,538

 
9,547

 
943

Total commercial business
4,617

 
14,860

 
19,477

 
19,890

 
2,444

One-to-four family residential

 
241

 
241