10-Q
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 March 31, 2013

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  x    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  x    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  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the last practicable date:

As of April 17, 2013 there were 15,148,304 common shares outstanding, with no par value, of the registrant.

 

 

 


Table of Contents

HERITAGE FINANCIAL CORPORATION

FORM 10-Q

INDEX

FORWARD LOOKING STATEMENT

 

         Page  

PART I.

 

Financial Information

  

Item 1.

 

Condensed Consolidated Financial Statements (Unaudited):

  
 

Condensed Consolidated Statements of Financial Condition as of March 31, 2013 and December 31, 2012

     4   
 

Condensed Consolidated Statements of Income for the Three Months Ended March 31, 2013 and 2012

     5   
 

Condensed Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2013 and 2012

     6   
 

Condensed Consolidated Statements of Stockholders’ Equity for the Three Months Ended March 31, 2013

     7   
 

Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2013 and 2012

     8   
 

Notes to Condensed Consolidated Financial Statements

     10   

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     50   

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

     60   

Item 4.

 

Controls and Procedures

     60   

PART II.

 

Other Information

  

Item 1.

 

Legal Proceedings

     61   

Item 1A.

 

Risk Factors

     61   

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

     61   

Item 3.

 

Defaults Upon Senior Securities

     62   

Item 4.

 

Mine Safety Disclosures

     62   

Item 5.

 

Other Information

     62   

Item 6.

 

Exhibits

     63   
 

Signatures

     65   
 

Certifications

  

 

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Forward Looking Statements

“Safe Harbor” statement under the Private Securities Litigation Reform Act of 1995: This 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 the Northwest Commercial Bank, Cowlitz Bank and Pierce Commercial Bank transactions, 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 the 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 impacted 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 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 Federal Reserve and of our bank subsidiaries by the Federal Deposit Insurance Corporation (the “FDIC”), the Washington State Department of Financial Institutions, Division of Banks (the “Washington DFI”) or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our reserve for loan losses, write-down assets, 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 as a result of Basel III; our ability to control operating costs and expenses; the impact of the Dodd-Frank Act and implementing the 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 statement 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; 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.

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 the remainder of 2013 and beyond 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 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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ITEM 1. HERITAGE FINANCIAL CORPORATION

HERITAGE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Dollars in thousands)

(Unaudited)

 

     March 31, 2013     December 31, 2012  
A S S E T S     

Cash on hand and in banks

   $ 34,129      $ 37,180   

Interest earning deposits

     112,105        69,906   
  

 

 

   

 

 

 

Cash and cash equivalents

     146,234        107,086   

Investment securities available for sale

     147,148        144,293   

Investment securities held to maturity (fair value of $11,808 and $11,010)

     10,933        10,099   

Loans held for sale

     729        1,676   

Originated loans receivable, net

     887,111        874,485   

Less: Allowance for loan losses

     (17,912     (19,125
  

 

 

   

 

 

 

Originated loans receivable, net of allowance for loan losses

     869,199        855,360   

Purchased covered loans receivable, net of allowance for loan losses of ($4,710 and $4,352)

     81,375        83,978   

Purchased non-covered loans receivable, net of allowance for loan losses of ($4,925 and $5,117)

     104,916        59,006   
  

 

 

   

 

 

 

Total loans receivable, net

     1,055,490        998,344   

Federal Deposit Insurance Corporation (“FDIC”) indemnification asset

     5,353        7,100   

Other real estate owned ($367 and $260 covered by FDIC loss share, respectively)

     5,263        5,666   

Premises and equipment, net

     25,962        24,755   

Federal Home Loan Bank (“FHLB”) stock, at cost

     5,533        5,495   

Accrued interest receivable

     4,721        4,821   

Prepaid expenses and other assets

     8,846        8,288   

Deferred income taxes, net

     16,729        13,819   

Other intangible assets, net

     1,127        1,086   

Goodwill

     13,012        13,012   
  

 

 

   

 

 

 

Total assets

   $ 1,447,080      $ 1,345,540   
  

 

 

   

 

 

 
L I A B I L I T I E S A N D S T O C K H O L D E R S’ E Q U I T Y     

Deposits

   $ 1,225,112      $ 1,117,971   

Securities sold under agreement to repurchase

     12,029        16,021   

Accrued expenses and other liabilities

     9,431        12,610   
  

 

 

   

 

 

 

Total liabilities

     1,246,572        1,146,602   
  

 

 

   

 

 

 

Stockholders’ equity:

    

Preferred stock, no par value, 2,500,000 shares authorized; no shares issued and outstanding at March 31, 2013 and December 31, 2012

     —         —    

Common stock, no par value, 50,000,000 shares authorized; 15,148,304 and 15,117,980 shares issued and outstanding at March 31, 2012 and December 31, 2012, respectively

     122,054        121,832   

Retained earnings

     77,038        75,362   

Accumulated other comprehensive income, net

     1,416        1,744   
  

 

 

   

 

 

 

Total stockholders’ equity

     200,508        198,938   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 1,447,080      $ 1,345,540   
  

 

 

   

 

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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HERITAGE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(Dollars in thousands, except for per share amounts)

(Unaudited)

 

     Three Months Ended March 31,  
     2013     2012  

Interest income:

    

Interest and fees on loans

   $ 16,719      $ 17,018   

Taxable interest on investment securities

     373        652   

Nontaxable interest on investment securities

     335        256   

Interest on interest earning deposits

     57        63   
  

 

 

   

 

 

 

Total interest income

     17,484        17,989   
  

 

 

   

 

 

 

Interest expense:

    

Deposits

     937        1,277   

Other borrowings

     9        18   
  

 

 

   

 

 

 

Total interest expense

     946        1,295   
  

 

 

   

 

 

 

Net interest income

     16,538        16,694   

Provision for loan losses on originated loans

     495        —     

Provision for loan losses on purchased loans

     363        (109
  

 

 

   

 

 

 

Net interest income after provision for loan losses

     15,680        16,803   
  

 

 

   

 

 

 

Noninterest income:

    

Bargain purchase gain on bank acquisition

     399        —     

Service charges and other fees

     1,353        1,326   

Merchant Visa income, net

     172        170   

Change in FDIC indemnification asset

     (267     (176

Other income

     625        588   
  

 

 

   

 

 

 

Total noninterest income

     2,282        1,908   
  

 

 

   

 

 

 

Noninterest expense:

    

Impairment loss on investment securities, net

     2        36   

Compensation and employee benefits

     7,589        7,198   

Occupancy and equipment

     1,920        1,785   

Data processing

     1,136        591   

Marketing

     326        403   

Professional services

     1,030        554   

State and local taxes

     279        310   

Federal deposit insurance premium

     233        275   

Other real estate owned, net

     (104     256   

Other expense

     1,308        1,190   
  

 

 

   

 

 

 

Total noninterest expense

     13,719        12,598   
  

 

 

   

 

 

 

Income before income taxes

     4,243        6,113   

Income tax expense

     1,358        1,943   
  

 

 

   

 

 

 

Net income

   $ 2,885      $ 4,170   
  

 

 

   

 

 

 

Basic earnings per common share

   $ 0.19      $ 0.27   

Diluted earnings per common share

   $ 0.19      $ 0.27   

Dividends declared per common share

   $ 0.08      $ 0.06   

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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HERITAGE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Dollars in thousands)

(Unaudited)

 

     Three Months Ended
March 31,
 

Comprehensive Income

   2013     2012  

Net income

   $ 2,885      $ 4,170   

Change in fair value of securities available for sale, net of tax of $(184) and $(176)

     (342     (327

Accretion of other-than-temporary impairment on securities held to maturity, net of tax of $7 and $14

     14        26   
  

 

 

   

 

 

 

Other comprehensive loss

   $ (328   $ (301
  

 

 

   

 

 

 

Comprehensive income

   $ 2,558      $ 3,869   
  

 

 

   

 

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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HERITAGE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY FOR THE THREE MONTHS ENDED

MARCH 31, 2013

(Dollars and shares in thousands, except for per share amounts)

(Unaudited)

 

     Number of
common
shares
    Common
stock
    Retained
earnings
    Accumulated
other
comprehensive
income, net
    Total
stock
holders’
equity
 

Balance at December 31, 2012

     15,118      $ 121,832      $ 75,362      $ 1,744      $ 198,938   

Restricted stock awards issued, net of forfeitures

     36        —         —         —         —     

Stock option compensation expense

     —         22        —         —         22   

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

     2        20        —         —         20   

Restricted stock compensation expense

     —         251        —         —         251   

Excess tax benefits from restricted stock

     —         47        —         —         47   

Common stock repurchased and retired

     (8     (118     —         —         (118

Net income

     —         —         2,885        —         2,885   

Other comprehensive loss, net of tax

     —         —         —         (328     (328

Cash dividends declared on common stock ($0.08 per share)

     —         —         (1,209     —         (1,209
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at March 31, 2013

     15,148      $ 122,054      $ 77,038      $ 1,416      $ 200,508   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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HERITAGE FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

For the three months ended March 31, 2013 and 2012

(Dollars in thousands)

(Unaudited)

 

     Three Months Ended
March 31,
 
     2013     2012  

Cash flows from operating activities:

    

Net income

   $ 2,885      $ 4,170   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and amortization

     1,292        878   

Changes in net deferred loan fees (costs), net of amortization

     148        (55

Provision for loan losses

     858        (109

Net change in accrued interest receivable, prepaid expenses and other assets, accrued expenses and other liabilities

     (1,622     (431

Recognition of compensation related to ESOP shares and share based payment

     251        226   

Stock option compensation expense

     22        42   

Tax provision realized from stock options exercised, share based payment and dividends on unallocated ESOP shares

     (47     (46

Amortization of intangible assets

     115        107   

Deferred income tax

     139        34   

Bargain purchase gain on bank acquisition

     (399     —     

Impairment loss on investment of securities

     2        36   

Origination of loans held for sale

     (4,143     (3,260

Gain on sale of loans

     (81     (63

Proceeds from sale of loans

     5,171        4,033   

Valuation adjustment on other real estate owned

     (107     331   

(Gain) loss on other real estate owned, net

     (172     12   

Loss on sale of premises and equipment, net

     —          1   
  

 

 

   

 

 

 

Net cash provided by operating activities

     4,312        5,906   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Loans originated, net of principal payments

     (6,393     9,448   

Maturities of investment securities available for sale

     16,109        10,803   

Maturities of investment securities held to maturity

     338        389   

Purchase of investment securities available for sale

     (17,490     (10,344

Purchase of investment securities held to maturity

     (1,157     —     

Purchase of premises and equipment

     (1,527     (498

Proceeds from sales of other real estate owned

     2,711        101   

Proceeds from redemption of FHLB stock

     50        —     

Net cash received from acquisitions

     748        —     
  

 

 

   

 

 

 

Net cash (used in) provided by investing activities

     (6,611     9,899   
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Net increase in deposits

     46,699        3,493   

Common stock cash dividends paid

     (1,209     (927

Net decrease in securities sold under agreement to repurchase

     (3,992     (2,305

Proceeds from exercise of stock options

     20        —     

Tax provision realized from stock options exercised, share based payment and dividends on unallocated ESOP shares

     47        46   

Repurchase of common stock

     (118     (114
  

 

 

   

 

 

 

Net cash provided by financing activities

     41,447        193   
  

 

 

   

 

 

 

Net increase in cash and cash equivalents

     39,148        15,998   

Cash and cash equivalents at beginning of period

     107,086        123,759   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 146,234      $ 139,757   
  

 

 

   

 

 

 

 

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     2013     2012  

Supplemental disclosures of cash flow information:

    

Cash paid for interest

   $ 952      $ 1,337   

Cash paid for income taxes

     2,612        650   

Seller-financed sale of other real estate owned

     250        —     

Loans transferred to other real estate owned

     —          4,309   

Assets acquired (liabilities assumed) in acquisitions:

    

Investment securities available for sale

     2,753        —     

Purchased non-covered loans receivable

     51,509        —     

Other real estate owned

     2,279        —     

Premises and equipment, net

     214        —     

FHLB stock

     88        —     

Accrued interest receivable

     232        —     

Prepaid expenses and other assets

     1,175        —     

Deferred income taxes, net

     2,873        —     

Core deposit intangible

     156        —     

Deposits

     (60,442     —     

Accrued expenses and other liabilities

     (1,186     —     

See accompanying Notes to Condensed Consolidated Financial Statements.

 

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HERITAGE FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three Months Ended March 31, 2013 and 2012

(Unaudited)

 

(1) Description of Business and Basis of Presentation

(a) Description of Business

Heritage Financial Corporation (the “Company”) is a bank holding company 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 subsidiaries: Heritage Bank and Central Valley Bank (the “Banks”). The Banks are Washington-chartered commercial banks and their deposits are insured by the FDIC under the Deposit Insurance Fund (“DIF”). Heritage Bank conducts business from its main office in Olympia, Washington and its twenty-seven branch offices located in western Washington and the greater Portland, Oregon area. Central Valley Bank conducts business from its main office in Toppenish, Washington and its five branch offices located in Yakima and Kittitas counties of Washington State.

The Company’s business consists primarily of lending and deposit relationships with small businesses and their owners in its market areas and attracting deposits from the general public. The Company also makes real estate construction and land development loans and consumer loans and originates for sale or investment purposes first mortgage loans on residential properties located in western and central Washington State and the greater Portland, Oregon area.

Effective July 30, 2010, Heritage Bank entered into a definitive agreement with the FDIC, pursuant to which Heritage Bank acquired certain assets and assumed certain liabilities of Cowlitz Bank, a Washington state-chartered bank headquartered in Longview, Washington (the “Cowlitz Acquisition”). The Cowlitz Acquisition included nine branches of Cowlitz Bank, including its division Bay Bank, which opened as branches of Heritage Bank as of August 2, 2010. It also included the Trust Services Division of Cowlitz Bank. Effective November 5, 2010, Heritage Bank entered into a definitive agreement with the FDIC, pursuant to which Heritage Bank acquired certain assets and assumed certain liabilities of Pierce Commercial Bank, a Washington state-chartered bank headquartered in Tacoma, Washington (the “Pierce Commercial Acquisition”). The Pierce Commercial Acquisition included one branch, which opened as a branch of Heritage Bank as of November 8, 2010.

On September 14, 2012, the Company announced that it had entered into a definitive agreement along with its financial institution subsidiary, Heritage Bank, to acquire Northwest Commercial Bank (“NCB”) a full service commercial bank headquartered in Lakewood, Washington (the “NCB Acquisition”). NCB operated two branch locations in Washington State. The transaction closed on January 9, 2013, and NCB was merged with and into Heritage Bank. See Note 2, “Business Combination.”

The Cowlitz Acquisition, Pierce Commercial Acquisition and NCB Acquisition are collectively referred to as the “Cowlitz, Pierce and NCB Acquisitions.”

On March 11, 2013, the Company announced it had entered into a definitive agreement to acquire Valley Community Bancshares, Inc., headquartered in Puyallup, Washington. The transaction is subject to customary closing conditions, including the receipt of regulatory approvals, and is expected to be completed in the third quarter of 2013. See Note 14, “Proposed Mergers and Acquisitions.”

On April 8, 2013, the Company announced the proposed merger of its wholly-owned bank subsidiaries, with Central Valley Bank merging with and into Heritage Bank. Following the merger, Central Valley Bank will be operated as Heritage Bank dba Central Valley Bank. The merger is expected to be completed in the second quarter of 2013. See Note 14, “Proposed Mergers and Acquisitions.”

(b) Basis of Presentation

The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with Generally Accepted Accounting Principles (“GAAP”), for interim financial information, 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. These Condensed Consolidated Financial Statements should be read with our December 31, 2012 audited Consolidated Financial Statements and the accompanying Notes included in our Annual Report on Form 10-K (“Form 10-K”). In our opinion, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the three

 

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months ended March 31, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013. In preparing the Condensed Consolidated Financial Statements, we are required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses. Actual results could differ from those estimates. Estimates related to the allowance for loan losses, other than temporary impairments in the fair value of investment securities, expected cash flows of purchased 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.

Certain prior period amounts have been reclassified to conform to the current year’s presentation. Reclassifications had no effect on prior period net income or stockholders’ equity.

(c) Significant Accounting Policies

The significant accounting policies used in preparation of our Condensed Consolidated Financial Statements are disclosed in our 2012 Annual Form 10-K. There have not been any material changes in our significant accounting policies compared to those contained in our Form 10-K disclosure for the year ended December 31, 2012.

(d) Recently Issued Accounting Pronouncements

Financial Accounting Standards Board (“FASB”) Accounting Standards Updated (“ASU”) 2011-11, Disclosures about Offsetting Assets and Liabilities, was issued in December 2011 to require an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. The adoption of the Update did not have a material effect on the Company’s Condensed Consolidated Financial Statements at the date of adoption.

FASB ASU 2012-06, Business Combinations (Topic 805): Subsequent Accounting for an Indemnification Asset Recognized at the Acquisition Date as a Result of a Government-Assisted Acquisition of a Financial Institution, was issued in October 2012. The objective of the Update is to address the diversity in practice about how to interpret the terms “on the same basis” and “contractual limitations” when subsequently measuring an indemnification asset. This Update is effective for fiscal years and interim periods beginning on or after December 15, 2012. Early adoption was permitted, and adoption should be applied prospectively to indemnification assets existing as of the date of adoption. The adoption of this Update did not have a material effect on the Company’s Condensed Consolidated Financial Statements at the date of adoption as the Company previously accounted for its indemnification asset in a manner consistent with the Update.

FASB ASU 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, was issued in February 2013. The Update requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component and to present either on the face of the statement where net income is presented, or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income, but only if the amount reclassified is required to be reclassified to net income in its entirety in the same reporting period. The amendments are effective for annual and interim reporting periods beginning on or after December 15, 2012. The adoption of this Update did not have a material effect on the Company’s Condensed Consolidated Financial Statements. The additional disclosures are included in Note 7, “Accumulated Other Comprehensive Income.”

 

(2) Business Combination

On September 14, 2012, the Company announced that it had entered into a definitive agreement along with its financial institution subsidiary, Heritage Bank, to acquire NCB headquartered in Lakewood, Washington. NCB was a full service commercial bank that operated two branch locations in Washington State. The transaction closed on January 9, 2013, and NCB was merged with and into Heritage Bank.

Pursuant to the agreement, the Company provided cash consideration of $3.0 million, or $5.50 per NCB share, which was paid out on January 9, 2013. Additionally, the NCB shareholders have the ability to potentially receive additional consideration based on an earn-out structure from the sale of an asset included in “other real estate owned.” The estimated additional consideration as of January 9, 2013 is approximately $533,000, or $0.99 per NCB share, and is included in “accrued expenses and other liabilities.” Prior to the closing of the transaction, NCB redeemed its outstanding preferred stock of approximately $2.0 million issued to the U.S. Department of Treasury in connection with its participation in the Troubled Asset Relief Program Capital Purchase Plan.

 

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The acquisition of the net assets constitutes a business acquisition as defined by FASB Accounting Standards Codification (“ASC”) 805, Business Combinations. The Business Combinations topic establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired and the liabilities assumed. Accordingly, the estimated fair values of the acquired assets, including the identifiable intangible assets, and the assumed liabilities in the acquisition were measured and recorded as of the acquisition date. A description of the methods used to determine the fair values of the significant assets and liabilities of the acquisition is included in Note 1, “Description of Business and Basis of Presentation” and Note 13, “Fair Value Measurements.”

A statement of the fair value of the assets acquired and liabilities assumed in the NCB Acquisition was as follows:

 

     Northwest Commercial Bank
January 9, 2013
 
     (In thousands)  

Assets

  

Cash on hand and in banks

   $ 2,463   

Interest earning deposits

     1,252   

Investment securities available for sale

     2,753   

Purchased non-covered loans receivable

     51,509   

Other real estate owned

     2,279   

Premises and equipment

     214   

FHLB stock

     88   

Accrued interest receivable

     232   

Core deposit intangible

     156   

Prepaid expenses and other assets

     1,175   

Deferred income taxes, net

     2,873   
  

 

 

 

Total assets acquired

   $ 64,994   
  

 

 

 

Liabilities

  

Deposits

   $ 60,442   

Accrued expenses and other liabilities

     1,186   
  

 

 

 

Total liabilities assumed

     61,628   
  

 

 

 

Net assets acquired

   $ 3,366   
  

 

 

 

The cost basis of net assets transferred to Heritage Bank was $6.1 million. A bargain purchase gain of $399,000 was recognized by the Company in the Condensed Consolidated Statement of Income for the three months ended March 31, 2013. A summary of the net assets purchased and the estimated fair value adjustments and resulting bargain purchase gain recognized from the NCB Acquisition was as follows:

 

     Northwest  Commercial
Bank
January 9, 2013
 
     (In thousands)  

Cost basis of net assets on acquisition date

   $ 6,113   

Cash consideration paid

     (2,967

Fair value adjustments:

  

Interest earning deposits

     7   

Investment securities

     (2

Purchased non-covered loans, net

     (3,299

Other real estate owned

     (1,301

Premises and equipment

     (69

Core deposit intangible

     156   

Prepaid expenses and other assets

     (479

Deferred income tax, net

     2,873   

Certificates of deposit

     (11

Accrued expenses and other liabilities

     (622
  

 

 

 

Bargain purchase gain recognized from the acquisition

   $ 399   
  

 

 

 

 

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The bargain purchase gain represents the excess of the estimated fair value of the net assets acquired and liabilities assumed over the value of the consideration paid. The bargain purchase gain was influenced significantly by the net deferred tax asset acquired in the NCB Acquisition. NCB had significant net operating losses and as a result of its estimate of whether or not it was more likely than not that the net deferred tax asset would be realized, had recorded a full valuation allowance on the net deferred tax asset. The Company, however, has reviewed the net deferred tax asset and determined it is more likely than not that the net deferred tax asset would be realized by the Company.

The operating results of the Company for the three months ended March 31, 2013 include the operating results produced by the net assets acquired from the NCB Acquisition for the period from January 10, 2013 to March 31, 2013. The Company has considered the requirement of FASB ASC 805 related to the contribution of the NCB Acquisition to the Company’s results of operations. The table below presents only the significant results for the acquired business from acquisition date to March 31, 2013.

 

     Northwest Commercial  Bank
January 10, 2013 to
March 31, 2013
 
     (In thousands)  

Interest income: Interest and fees on loans (1)

   $ 565   

Interest income: Interest and fees on loans (2)

     1,096   

Interest expense: Deposits

     (76

Noninterest income:

     438   

Noninterest expense:

     (1,028
  

 

 

 

Net effect, pre-tax

   $ 995   
  

 

 

 

 

(1) Includes the contractual interest income on the purchased other loans.
(2) Includes the accretion of the purchased impaired loans and the amortization of the discount on the purchased other loans.

The Company also considered the pro forma requirements of FASB ASC 805 and deemed it not necessary to provide pro forma financial statements as required under the standard as the NCB Acquisition was not material to the Company. The Company believes that the historical NCB operating results are not of enough significance to be meaningful to the Company’s results of operations.

There were no acquisitions completed by the Company during the year ended December 31, 2012.

 

(3) Loans Receivable

The Company originates loans in the ordinary course of business. These loans are identified as “originated” loans. Disclosures related to the Company’s recorded investment in originated loans receivable generally exclude accrued interest receivable and net deferred loan origination fees and costs because they are insignificant. The Company has also acquired loans through FDIC-assisted and open bank transactions. Loans acquired in a business acquisition are designated as “purchased” loans. The Company refers to the purchased loans subject to the FDIC shared-loss agreements as “covered” loans, and those loans without a shared-loss agreement are referred to as “non-covered” 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 ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. These loans are identified as “purchased impaired” 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. These loans are identified as “purchased other” loans.

 

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(a) Loan Origination/Risk Management

The Company originates loans in one of the four segments of the total loan portfolio: commercial business, real estate construction and land development, one-to-four family residential, 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 external loan reviews and validates the credit risk assessment on a periodic basis. Results of these reviews are presented to management. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Company’s policies and procedures.

A discussion of the risk characteristics of each portfolio segment is as follows:

Commercial Business:

There are three significant classes of loans in the commercial portfolio segment, including 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.

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 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.

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. The Company generally sells most single-family loans in the secondary market. Management determines to what extent the Company will retain or sell these loans and other fixed rate mortgages in order to control the Banks’ interest rate sensitivity position, growth and liquidity.

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 a variable rate 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 regards 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

 

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Table of Contents

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 sensitive to interest rate changes, governmental 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 is developed to ensure a qualifying primary and secondary source of repayment. Underwriting standards for home equity loans are heavily 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 the consumer loans are relatively small amounts spread across many individual borrowers which minimizes the credit risk. Additionally, trend reports are reviewed by management on a regular basis.

Originated loans receivable at March 31, 2013 and December 31, 2012 consisted of the following portfolio segments and classes:

 

     March 31, 2013     December 31,
2012
 
     (In thousands)  

Commercial business:

    

Commercial and industrial

   $ 269,174      $ 277,240   

Owner-occupied commercial real estate

     193,518        188,494   

Non-owner occupied commercial real estate

     285,963        265,835   
  

 

 

   

 

 

 

Total commercial business

     748,655        731,569   

One-to-four family residential

     39,111        38,848   

Real estate construction and land development:

    

One-to-four family residential

     23,003        25,175   

Five or more family residential and commercial properties

     50,658        52,075   
  

 

 

   

 

 

 

Total real estate construction and land development

     73,661        77,250   

Consumer

     27,928        28,914   
  

 

 

   

 

 

 

Gross originated loans receivable

     889,355        876,581   

Net deferred loan fees

     (2,244     (2,096
  

 

 

   

 

 

 

Originated loans receivable, net

     887,111        874,485   

Allowance for loan losses

     (17,912     (19,125
  

 

 

   

 

 

 

Originated loans receivable, net of allowance for loan losses

   $ 869,199      $ 855,360   
  

 

 

   

 

 

 

The recorded investment of purchased covered loans receivable at March 31, 2013 and December 31, 2012 consisted of the following portfolio segments and classes:

 

     March 31, 2013     December 31,
2012
 
     (In thousands)  

Commercial business:

    

Commercial and industrial

   $ 21,058      $ 25,781   

Owner-occupied commercial real estate

     33,609        34,796   

Non-owner occupied commercial real estate

     17,168        13,028   
  

 

 

   

 

 

 

Total commercial business

     71,835        73,605   

One-to-four family residential

     5,012        5,027   

Real estate construction and land development:

    

One-to-four family residential

     4,505        4,433   

Five or more family residential and commercial properties

     —          —     
  

 

 

   

 

 

 

Total real estate construction and land development

     4,505        4,433   

Consumer

     4,733        5,265   
  

 

 

   

 

 

 

Gross purchased covered loans receivable

     86,085        88,330   

Allowance for loan losses

     (4,710     (4,352
  

 

 

   

 

 

 

Purchased covered loans receivable, net

   $ 81,375      $ 83,978   
  

 

 

   

 

 

 

 

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Table of Contents

The March 31, 2013 and December 31, 2012 gross recorded investment balance of purchased impaired covered loans accounted for under FASB ASC 310-30 was $57.4 million and $59.0 million, respectively. The gross recorded investment balance of purchased other covered loans was $28.6 million and $29.3 million at March 31, 2013 and December 31, 2012, respectively. At both March 31, 2013 and December 31, 2012, the recorded investment balance of purchased covered loans which are no longer covered under the FDIC loss-sharing agreements was $3.5 million.

Funds advanced on the purchased covered loans subsequent to acquisition, identified as “subsequent advances,” are included in the purchased covered loan balances as these subsequent advances are covered under the loss-sharing agreements. These subsequent advances are not accounted for under FASB ASC 310-30. The total balance of subsequent advances on the purchased covered loans was $7.7 million and $6.9 million as of March 31, 2013 and December 31, 2012, respectively.

The recorded investment of purchased non-covered loans receivable at March 31, 2013 and December 31, 2012 consisted of the following portfolio segments and classes:

 

     March 31, 2013     December 31,
2012
 
     (In thousands)  

Commercial business:

    

Commercial and industrial

   $ 39,971      $ 24,763   

Owner-occupied commercial real estate

     26,670        13,211   

Non-owner occupied commercial real estate

     23,287        11,019   
  

 

 

   

 

 

 

Total commercial business

     89,928        48,993   

One-to-four family residential

     3,769        3,040   

Real estate construction and land development:

    

One-to-four family residential

     715        513   

Five or more family residential and commercial properties

     3,277        864   
  

 

 

   

 

 

 

Total real estate construction and land development

     3,992        1,377   

Consumer

     12,152        10,713   
  

 

 

   

 

 

 

Gross purchased non-covered loans receivable

     109,841        64,123   

Allowance for loan losses

     (4,925     (5,117
  

 

 

   

 

 

 

Purchased non-covered loans receivable, net

   $ 104,916      $ 59,006   
  

 

 

   

 

 

 

The loans purchased in the NCB Acquisition on January 9, 2013 are included in the purchased non-covered loans receivable balances shown above as of March 31, 2013. The estimated fair value of the purchased non-covered loans totaled $51.5 million at the acquisition date. The gross recorded investment balance of the NCB purchased impaired loans and the NCB purchased other loans was $4.8 million and $44.3 million at March 31, 2013, respectively.

The March 31, 2013 and December 31, 2012 gross recorded investment balance of purchased impaired non-covered loans accounted for under FASB ASC 310-30 was $44.6 million and $42.0 million, respectively. The recorded investment balance of purchased other non-covered loans was $65.3 million and $22.1 million at March 31, 2013 and December 31, 2012, respectively.

(b) Concentrations of Credit

Most of the Company’s lending activity occurs within the State of Washington, and to a lesser extent the State of Oregon. The primary market areas include Thurston, Pierce, King, Mason, Cowlitz and Clark counties in Washington and Multnomah County in Oregon, as well as other markets. The majority of the Company’s loan portfolio consists of commercial and industrial, non-owner occupied commercial real estate, and owner occupied commercial real estate. As of March 31, 2013 and December 31, 2012, there were no concentrations of loans related to any single industry in excess of 10% of total loans.

 

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Table of Contents

(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 9, and a “W”. A description of the general characteristics of the risk grades is as follows:

 

   

Grades 0 to 5: These grades are considered “pass grade” and includes 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 “W”: This grade is considered “pass grade” and includes loans on management’s “watch list” and 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 6: 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 be modest and likely illiquid. The loan is at risk of further decline unless active measures are taken to correct the situation.

 

   

Grade 7: This grade includes “Substandard” loans in accordance with regulatory guidelines, for which 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 8: This grade includes “Doubtful” loans in accordance with regulatory guidelines, and the Company has determined these loans to have excessive 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.

 

   

Grade 9: 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.

Loan grades for all commercial business loans and real estate construction and land development loans are established at the origination of the loan. One-to-four family residential loans and consumer loans (“non-commercial loans”) are not graded as a 0 to 9 at origination date as these loans are determined to be “pass graded” loans. These non-commercial loans may subsequently require a 0-9 risk grade if the credit department has evaluated the credit and determined it necessary to classify the loan. 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 inherent losses in the portfolios, but to a lesser extent than the other loan grades. These pass graded loans may also have a zero percent loss based on historical experience and current market trends. 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, however, is greater than Watch grade 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.

 

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The following tables present the balance of the originated loans receivable by credit quality indicator as of March 31, 2013 and December 31, 2012.

 

     March 31, 2013  
     Pass      OAEM      Substandard      Doubtful      Total  
     (In thousands)  

Commercial business:

              

Commercial and industrial

   $ 245,894       $ 2,712       $ 19,361       $ 1,207       $ 269,174   

Owner-occupied commercial real estate

     187,033         2,487         3,998         —           193,518   

Non-owner occupied commercial real estate

     276,550         4,083         5,330         —           285,963   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial business

     709,477         9,282         28,689         1,207         748,655   

One-to-four family residential

     37,537         692         882         —           39,111   

Real estate construction and land development:

              

One-to-four family residential

     14,819         1,783         6,401         —           23,003   

Five or more family residential and commercial properties

     47,393         —           3,265         —           50,658   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total real estate construction and land development

     62,212         1,783         9,666         —           73,661   

Consumer

     27,796         81         51         —           27,928   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross originated loans

   $ 837,022       $ 11,838       $ 39,288       $ 1,207       $ 889,355   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2012  
     Pass      OAEM      Substandard      Doubtful      Total  
     (In thousands)  

Commercial business:

              

Commercial and industrial

   $ 254,593       $ 3,908       $ 18,157       $ 582       $ 277,240   

Owner-occupied commercial real estate

     181,630         2,658         4,206         —           188,494   

Non-owner occupied commercial real estate

     256,077         4,132         5,257         369         265,835   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial business

     692,300         10,698         27,620         951         731,569   

One-to-four family residential

     37,239         920         689         —           38,848   

Real estate construction and land development:

              

One-to-four family residential

     16,446         1,795         6,934         —           25,175   

Five or more family residential and commercial properties

     48,718         —           3,357         —           52,075   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total real estate construction and land development

     65,164         1,795         10,291         —           77,250   

Consumer

     28,748         —           156         10         28,914   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross originated loans

   $ 823,451       $ 13,413       $ 38,756       $ 961       $ 876,581   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The tables above include $30.2 million and $27.5 million of originated impaired loans as of March 31, 2013 and December 31, 2012, respectively, as detailed in the impaired loans section below. These impaired loans have been individually reviewed for probable losses and have specific valuation allowance, as necessary. The tables above also include potential problem loans. Potential problem loans are those loans 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. Potential problem originated loans as of March 31, 2013 and December 31, 2012 were $25.1 million and $28.3 million, respectively. The balance of potential problem originated loans guaranteed by a governmental agency was $2.5 million and $3.2 million as of March 31, 2013 and December 31, 2012, respectively. This guarantee reduces the Company’s credit exposure.

The following tables present the recorded invested balance of the purchased other loans receivable by credit quality indicator as of March 31, 2013 and December 31, 2012.

 

     March 31, 2013  
     Pass      OAEM      Substandard      Doubtful      Total  
     (In thousands)  

Commercial business:

              

Commercial and industrial

   $ 27,170       $ 496       $ 14       $  —         $ 27,680   

Owner-occupied commercial real estate

     35,395         2,380         332         —           38,107   

Non-owner occupied commercial real estate

     13,767         728         970         —           15,465   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

18


Table of Contents
     March 31, 2013  
     Pass      OAEM      Substandard      Doubtful      Total  
     (In thousands)  

Total commercial business

     76,332         3,604         1,316         —           81,252   

One-to-four family residential

     765         550         —           —           1,315   

Real estate construction and land development:

              

One-to-four family residential

     —           —           —           —           —     

Five or more family residential and commercial properties

     1,745         —           —           —           1,745   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total real estate construction and land development

     1,745         —           —           —           1,745   

Consumer

     9,130         186         248         32         9,596   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross purchased other loans

   $ 87,972       $ 4,340       $ 1,564       $ 32       $ 93,908   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2012  
     Pass      OAEM      Substandard      Doubtful      Total  
     (In thousands)  

Commercial business:

              

Commercial and industrial

   $ 11,393       $ 496       $ 92       $  —         $ 11,981   

Owner-occupied commercial real estate

     23,685         2,390         335         —           26,410   

Non-owner occupied commercial real estate

     3,108         732         973         —           4,813   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial business

     38,186         3,618         1,400         —           43,204   

One-to-four family residential

     770         553         61         —           1,384   

Real estate construction and land development:

              

One-to-four family residential

     —           —           —           —           —     

Five or more family residential and commercial properties

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total real estate construction and land development

     —           —           —           —           —     

Consumer

     6,385         2         346         32         6,765   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross purchased other loans

   $ 45,341       $ 4,173       $ 1,807       $ 32       $ 51,353   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The tables above include $2.0 million and $2.2 million of purchased other impaired loans as of March 31, 2013 and December 31, 2012, respectively, as detailed in the impaired loans section below. These purchased other impaired loans have been individually reviewed for potential losses and have a specific valuation allowance, as necessary.

 

(d) Nonaccrual loans

Originated nonaccrual loans, segregated by segments and classes of loans, were as follows as of March 31, 2013 and December 31, 2012:

 

     March 31,
2013(1)
     December 31,
2012(1)
 
     (In thousands)  

Commercial business:

     

Commercial and industrial

   $ 5,863       $ 4,560   

Owner-occupied commercial real estate

     975         563   

Non-owner occupied commercial real estate

     89         369   
  

 

 

    

 

 

 

Total commercial business

     6,927         5,492   

One-to-four family residential

     586         389   

Real estate construction and land development:

     

One-to-four family residential

     2,820         3,063   

Five or more family residential and commercial properties

     3,265         3,357   
  

 

 

    

 

 

 

Total real estate construction and land development

     6,085         6,420   

Consumer

     47         157   
  

 

 

    

 

 

 

Gross originated nonaccrual loans

   $ 13,645       $ 12,458   
  

 

 

    

 

 

 

 

(1) $1.8 million and $1.2 million of nonaccrual originated loans were guaranteed by governmental agencies at March 31, 2013 and December 31, 2012, respectively.

 

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Table of Contents

The recorded investment balance of purchased other nonaccrual loans, segregated by segments and classes of loans, were as follows as of March 31, 2013 and December 31, 2012:

 

     March 31,
2013(1)
     December 31,
2012(1)
 
     (In thousands)  

Commercial business:

     

Owner-occupied commercial real estate

   $ 136       $ 139   

Non-owner occupied commercial real estate

     437         437   
  

 

 

    

 

 

 

Total commercial business

     573         576   

One-to-four family residential

     —          61   

Consumer

     39         163   
  

 

 

    

 

 

 

Gross purchased other nonaccrual loans

   $ 612       $ 800   
  

 

 

    

 

 

 

 

(1) $39,000 of purchased other nonaccrual loans were covered by the FDIC shared-loss agreements at both March 31, 2013 and December 31, 2012.

 

20


Table of Contents
(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. The balances of originated past due loans, segregated by segments and classes of loans, as of March 31, 2013 and December 31, 2012 were as follows:

 

     March 31, 2013  
     30-89 Days      90 Days or
Greater
     Total Past Due      Current      Total      90 Days or More
and Still
Accruing
 
     (In thousands)  

Commercial business:

                 

Commercial and industrial

   $ 1,214       $ 2,871       $ 4,085       $ 265,089       $ 269,174       $ —     

Owner-occupied commercial real estate

     832         681         1,513         192,005         193,518         —     

Non-owner occupied commercial real estate

     —           89         89         285,874         285,963         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial business

     2,046         3,641         5,687         742,968         748,655         —     

One-to-four family residential

     —           225         225         38,886         39,111         —     

Real estate construction and land development:

                 

One-to-four family residential

     607         2,820         3,427         19,576         23,003         —     

Five or more family residential and commercial properties

     265        3,000         3,265         47,393         50,658         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total real estate construction and land development

     872         5,820         6,692         66,969         73,661         —     

Consumer

     86         47         133         27,795         27,928         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross originated loans

   $ 3,004       $ 9,733       $ 12,737       $ 876,618       $ 889,355       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2012  
     30-89 Days      90 Days or
Greater
     Total Past Due      Current      Total      90 Days or More
and Still
Accruing
 
     (In thousands)  

Commercial business:

                 

Commercial and industrial

   $ 2,768       $ 2,014       $ 4,782       $ 272,458       $ 277,240       $ 25   

Owner-occupied commercial real estate

     920         112         1,032         187,462         188,494         —     

Non-owner occupied commercial real estate

     92         369         461         265,374         265,835         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial business

     3,780         2,495         6,275         725,294         731,569         25   

One-to-four family residential

     239         375         614         38,234         38,848         —     

Real estate construction and land development:

                 

One-to-four family residential

     847         3,242         4,089         21,086         25,175         179   

Five or more family residential and commercial properties

     —           3,018         3,018         49,057         52,075         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total real estate construction and land development

     847         6,260         7,107         70,143         77,250         179   

Consumer

     68         146         214         28,700         28,914         10   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross originated loans

   $ 4,934       $ 9,276       $ 14,210       $ 862,371       $ 876,581       $ 214   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

The balances of purchased other past due loans, segregated by segments and classes of loans, as of March 31, 2013 and December 31, 2012 are as follows:

 

     March 31, 2013  
     30-89 Days      90 Days or
Greater
     Total Past Due      Current      Total      90 Days or More
and Still
Accruing
 
     (In thousands)  

Commercial business:

                 

Commercial and industrial

   $ 279      $ —         $ 279       $ 27,401       $ 27,680       $ —     

Owner-occupied commercial real estate

     —           —           —           38,107         38,107         —     

Non-owner occupied commercial real estate

     —           437         437         15,028         15,465         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial business

     279         437         716         80,536         81,252         —     

One-to-four family residential

     —           —           —           1,315         1,315         —     

Real estate construction and land development:

                 

One-to-four family residential

     —           —           —           —           —           —     

Five or more family residential and commercial properties

     —           —           —           1,745         1,745         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total real estate construction and land development

     —           —           —           1,745         1,745         —     

Consumer

     20         32         52         9,544         9,596         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross purchased other loans

   $ 299       $ 469       $ 768       $ 93,140       $ 93,908       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2012  
     30-89 Days      90 Days or
Greater
     Total Past Due      Current      Total      90 Days or More
and Still
Accruing
 
     (In thousands)  

Commercial business:

                 

Commercial and industrial

   $ —         $ —         $ —         $ 11,981       $ 11,981       $ —     

Owner-occupied commercial real estate

     662         —           662         25,748         26,410         —     

Non-owner occupied commercial real estate

     —           437         437         4,376         4,813         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial business

     662         437         1,099         42,105         43,204         —     

One-to-four family residential

     —           61         61         1,323         1,384         —     

Real estate construction and land development:

                 

One-to-four family residential

     —           —           —           —           —           —     

Five or more family residential and commercial properties

     —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total real estate construction and land development

     —           —           —           —           —           —     

Consumer

     75         216         291         6,474         6,765         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross purchased other loans

   $ 737       $ 714       $ 1,451       $ 49,902       $ 51,353       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

 

22


Table of Contents
(f) Impaired loans

Originated impaired loans (including restructured loans) at March 31, 2013 and December 31, 2012 are set forth in the following tables.

 

     March 31, 2013  
     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

   $ 9,360       $ 3,915       $ 13,275       $ 15,244       $ 1,747   

Owner-occupied commercial real estate

     1,394         1,057         2,451         2,621         431   

Non-owner occupied commercial real estate

     2,734         4,200         6,934         6,934         1,360   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial business

     13,488         9,172         22,660         24,799         3,538   

One-to-four family residential

     676         586         1,262         1,272         75   

Real estate construction and land development:

              

One-to-four family residential

     650         2,350         3,000         4,173         661   

Five or more family residential and commercial properties

     265        3,000         3,265         3,379         643   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total real estate construction and land development

     915         5,350         6,265         7,552         1,304   

Consumer

     47         —           47         47         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross originated loans

   $ 15,126       $ 15,108       $ 30,234       $ 33,670       $ 4,917   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2012  
     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

   $ 7,797       $ 2,643       $ 10,440       $ 10,741       $ 858   

Owner-occupied commercial real estate

     633         1,418         2,051         2,134         509   

Non-owner occupied commercial real estate

     3,031         4,226         7,257         7,257         1,386   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial business

     11,461         8,287         19,748         20,132         2,753   

One-to-four family residential

     422         389         811         811         46   

Real estate construction and land development:

              

One-to-four family residential

     700         2,724         3,424         4,597         792   

Five or more family residential and commercial properties

     —           3,357         3,357         3,397         658   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total real estate construction and land development

     700         6,081         6,781         7,994         1,450   

Consumer

     47         110         157         157         110   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross originated loans

   $ 12,630       $ 14,867       $ 27,497       $ 29,094       $ 4,359   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

23


Table of Contents

The Company had governmental guarantees of $3.0 million and $1.9 million related to the impaired originated loan balances at March 31, 2013 and December 31, 2012, respectively.

The average recorded investment of originated impaired loans (including restructured loans) for the three months ended March 31, 2013 and March 31, 2012 are set forth in the following table.

 

     Three Months Ended March 31,  
     2013      2012  
     (In thousands)  

Commercial business:

     

Commercial and industrial

   $ 11,858       $ 11,093   

Owner-occupied commercial real estate

     2,251         2,440   

Non-owner occupied commercial real estate

     7,095         7,900   
  

 

 

    

 

 

 

Total commercial business

     21,204         21,433   

One-to-four family residential

     1,036         993   

Real estate construction and land development:

     

One-to-four family residential

     3,213         5,159   

Five or more family residential and commercial properties

     3,310         7,230   
  

 

 

    

 

 

 

Total real estate construction and land development

     6,523         12,389   

Consumer

     102         178   
  

 

 

    

 

 

 

Gross originated impaired loans

   $ 28,865       $ 34,993   
  

 

 

    

 

 

 

Purchased other loans become impaired when classified as nonaccrual or when modified, resulting in troubled debt restructure. Purchased other impaired loans (including restructured loans) at March 31, 2013 and December 31, 2012 are set forth in the following tables.

 

     March 31, 2013  
     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

   $ 334       $ 104       $ 438       $ 437       $ 13   

Owner-occupied commercial real estate

     —           136         136         132         7   

Non-owner occupied commercial real estate

     437         533         970         924         15   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial business

     771         773         1,544         1,493         35   

One-to-four family residential

     —           463         463         434         41   

Consumer

     —           39         39         48         41   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross purchased other impaired loans

   $ 771       $ 1,275       $ 2,046       $ 1,975       $ 117   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

24


Table of Contents
     December 31, 2012  
     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

   $ 330       $ 106       $ 436       $ 434       $ 14   

Owner-occupied commercial real estate

     —           139         139         135         7   

Non-owner occupied commercial real estate

     437         536         973         926         18   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial business

     767         781         1,548         1,495         39   

One-to-four family residential

     —           527         527         489         105   

Consumer

     —           163         163         173         157   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross purchased other impaired loans

   $ 767       $ 1,471       $ 2,238       $ 2,157       $ 301   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

 

25


Table of Contents

The average recorded investment of purchased other impaired loans (including restructured loans) for three months ended March 31, 2013 and March 31, 2012 are set forth in the following table.

 

     Three Months Ended
March 31,
 
     2013      2012  
     (In thousands)  

Commercial business:

     

Commercial and industrial

   $ 437      $ 70   

Owner-occupied commercial real estate

     138        —     

Non-owner occupied commercial real estate

     972        218   
  

 

 

    

 

 

 

Total commercial business

     1,547         288   

One-to-four family residential

     495         —     

Consumer

     101         445   
  

 

 

    

 

 

 

Gross purchased other impaired loans

   $ 2,143       $ 733   
  

 

 

    

 

 

 

For the three months ended March 31, 2013 and March 31, 2012 no interest income was recognized subsequent to a loan’s classification as impaired.

(g) Troubled Debt Restructured Loans

A troubled debt restructured loan (“TDR”) is a restructuring in which the Banks, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to the borrower that it would not otherwise consider. TDRs are considered impaired and are separately measured for impairment under FASB ASC 310-10-35, whether on accrual or nonaccrual status.

The recorded investment balance and related allowance for loan losses of accruing and non-accruing TDRs as of March 31, 2013 and December 31, 2012 are as follows:

 

     March 31, 2013      December 31, 2012  
     Accruing
TDRs
     Non-Accruing
TDRs
     Accruing
TDRs
     Non-Accruing
TDRs
 
     (In thousands)  

Originated TDRs

   $ 16,588       $ 8,948       $ 15,039       $ 9,311   

Allowance for loan losses on originated TDRs

     2,871         1,871         2,131         1,994   

Purchased other TDRs

     1,434         7         1,437         7   

Allowance for loan losses on purchased other TDRs

     69         1         76         2   

The unfunded commitment to borrowers related to originated TDRs was $2.2 million and $1.5 million as of March 31, 2013 and December 31, 2012, respectively. There were no unfunded commitments to borrowers related to the purchased other TDRs as of March 31, 2013 and December 31, 2012.

Originated loans that were modified as TDRs during the three months ended March 31, 2013 and March 31, 2012 are set forth in the following table:

 

     Three Months Ended March 31,  
     2013      2012  
     Number of
Contracts
(1)
     Outstanding
Principal Balance
(1)(2)
     Number of
Contracts
(1)
     Outstanding
Principal
Balance (1)(2)
 
     (Dollars in thousands)  

Commercial business:

           

Commercial and industrial

     11       $ 4,224         9       $ 1,800   

Owner-occupied commercial real estate

     —           —           2         561   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial business

     11         4,224         11         2,361   

One-to-four family residential

     1         257         —           —     

Real estate construction and land development:

           

One-to-four family residential

     1         180         3         578   

Five or more family residential and commercial properties

     —           —           1         384   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

26


Table of Contents
     Three Months Ended March 31,  
     2013      2012  
     Number of
Contracts
(1)
     Outstanding
Principal Balance
(1)(2)
     Number of
Contracts
(1)
     Outstanding
Principal
Balance (1)(2)
 
     (Dollars in thousands)  

Total real estate construction and land development

     1         180         4         962   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total originated TDRs

     13       $ 4,661         15       $ 3,323   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Number of contracts and outstanding principal balance represent loans which have balances as of period end dates as certain loans may have been paid-down or charged-off during the three months ended March 31, 2013 and March 31, 2012.
(2) Includes subsequent payments after modifications and reflects the balance as of the end of the period. The Banks’ initial recorded investments in the loans did not change as a result of the modifications as the Banks did not forgive any principal or interest balance as part of the modifications.

Of the 13 loans modified during the three months ended March 31, 2013, five loans with a total outstanding principal balance of $1.9 million were previously reported as TDRs as of December 31, 2012. Of the 15 loans modified during the three months ended March 31, 2012, five loans with a total outstanding principal balance of $1.1 million were previously reported as TDRs as of December 31, 2011. The Banks typically grant shorter extension periods to continually monitor the troubled credits despite the fact that the extended date might not be the date the Banks expect the cash flow. The Company does not consider these modifications a subsequent default of a TDR as new loan terms, specifically maturity dates, were granted. The potential losses related to these loans would have been considered in the period the loan was first reported as a TDR and adjusted, as necessary, in the current periods based on more recent information.

There were no purchased other loans that were modified as TDRs during the three months ended March 31, 2013. There was one commercial and industrial purchased other loan totaling $19,000 that was modified for the first time as a TDR during the three months ended March 31, 2012.

The majority of the Banks’ TDRs are a result of granting extensions to troubled credits which have already been adversely classified. We grant such extensions to reassess the borrower’s financial status and to develop a plan for repayment. Certain modifications with extensions also include interest rate reductions, which is the second most prevalent concession. Certain TDRs were additionally re-amortized over a longer period of time. These modifications would all be considered a concession for a borrower that could not obtain similar financing terms from another source other than from the Banks.

The financial effects of each modification will vary based on the specific restructure. For the majority of the Banks’ TDRs, the loans were interest-only with a balloon payment at maturity. If the interest rate is not adjusted and the terms are consistent with market, the Banks might not experience any loss associated with the restructure. If, however, the restructure involves forbearance agreements or interest rate modifications, the Banks might not collect all the principal and interest based on the original contractual terms. The Banks estimate the necessary allowance for loan losses on TDRs using the same guidance as other impaired loans.

There were no originated or purchased other TDRs that had been modified during the previous twelve months ended that subsequently defaulted during the three months ended March 31, 2013 and March 31, 2012.

(h) Purchased Impaired Loans

As indicated above, the Company purchased impaired loans from the Cowlitz, Pierce and NCB Acquisitions which are accounted for under FASB ASC 310-30.

 

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Table of Contents

The following tables reflect the outstanding balance at March 31, 2013 and December 31, 2012 of the purchased impaired loans by acquisition:

 

     Cowlitz Bank  
     March 31,
2013
     December 31,
2012
 
     (In thousands)  

Commercial business:

     

Commercial and industrial

   $ 16,685       $ 21,624   

Owner-occupied commercial real estate

     16,461         17,157   

Non-owner occupied commercial real estate

     16,495         12,908   
  

 

 

    

 

 

 

Total commercial business

     49,641         51,689   

One-to-four family residential

     4,232         4,262   

Real estate construction and land development:

     

One-to-four family residential

     6,082         6,122   

Five or more family residential and commercial properties

     —           —     
  

 

 

    

 

 

 

Total real estate construction and land development

     6,082         6,122   

Consumer

     2,946         3,533   
  

 

 

    

 

 

 

Gross purchased impaired covered loans

   $ 62,901       $ 65,606   
  

 

 

    

 

 

 

The total balance of subsequent advances on the purchased impaired covered loans was $4.6 million and $3.8 million as of March 31, 2013 and December 31, 2012, respectively. Heritage Bank has the option to modify certain purchased covered loans which may terminate the FDIC loss-share coverage on those modified loans. At both March 31, 2013 and December 31, 2012, the recorded investment balance of purchased impaired covered loans which are no longer covered under the FDIC loss-sharing agreements was $1.7 million. Heritage Bank continues to report these loans in the covered portfolio as they are in a pool and they continue to be accounted for under FASB ASC 310-30. The FDIC indemnification asset has been properly adjusted to reflect the change in the loan status.

 

     Pierce Commercial Bank  
     March 31, 2013      December 31, 2012  
     (In thousands)  

Commercial business:

     

Commercial and industrial

   $ 20,298       $ 21,953   

Owner-occupied commercial real estate

     5,389         5,748   

Non-owner occupied commercial real estate

     7,478         7,802   
  

 

 

    

 

 

 

Total commercial business

     33,165         35,503   

One-to-four family residential

     4,139         3,303   

Real estate construction and land development:

     

One-to-four family residential

     3,207         3,375   

Five or more family residential and commercial properties

     819         820   
  

 

 

    

 

 

 

Total real estate construction and land development

     4,026         4,195   

Consumer

     2,988         4,393   
  

 

 

    

 

 

 

Gross purchased impaired non-covered loans

   $ 44,318       $ 47,394   
  

 

 

    

 

 

 

 

     Northwest
Commercial Bank
 
     March 31, 2013 (1)  
     (In thousands)  

Commercial business:

  

Commercial and industrial

   $ 1,828   

Owner-occupied commercial real estate

     1,738   

Non-owner occupied commercial real estate

     2,346   
  

 

 

 

Total commercial business

     5,912   

One-to-four family residential

     —     

Real estate construction and land development:

  

One-to-four family residential

     —     

Five or more family residential and commercial properties

     994   
  

 

 

 

Total real estate construction and land development

     994   

Consumer

     88   
  

 

 

 

Gross purchased impaired non-covered loans

   $ 6,994   
  

 

 

 

 

(1) The NCB Acquisition was effective January 9, 2013

 

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Table of Contents

On the acquisition date, the amount by which the undiscounted expected cash flows of the purchased impaired loans exceed the estimate fair value of the loan is the “accretable yield”. The accretable yield is then measured at each financial reporting date and represents the difference between the remaining undiscounted expected cash flows and the current carrying value of the purchased impaired loan.

The following table summarizes the accretable yield on the purchased impaired loans resulting from the Cowlitz, Pierce and NCB Acquisitions for the three months ended March 31, 2013 and 2012. As the NCB Acquisition was as of January 9, 2013, there are no three months ended March 31, 2012 balances.

 

     Three Months Ended March 31, 2013  
     Cowlitz Bank     Pierce
Commercial
Bank
    Northwest
Commercial
Bank
 
     (In thousands)  

Balance at the beginning of period (1)

   $ 14,286      $ 7,352      $ 713   

Accretion

     (1,354     (1,282     (116

Disposals and other

     945        2,822        —     

Change in accretable yield

     231        28        —     
  

 

 

   

 

 

   

 

 

 

Balance at the end of period

   $ 14,108      $ 8,920      $ 597   
  

 

 

   

 

 

   

 

 

 

 

(1) For the NCB Acquisition, the balance at the beginning of the period represents the balance acquired at January 9, 2013. The contractual cash flows were $8.1 million and the expected cash flows were $5.6 million, resulting in a non-accretable difference of $2.5 million. As the fair value of these purchased impaired loans was $4.9 million, this provides an accretable yield of $713,000.

 

     Three Months Ended
March 31, 2012
 
     Cowlitz
Bank
    Pierce
Commercial
Bank
 
     (In thousands)  

Balance at the beginning of period

   $ 19,912      $ 14,638   

Accretion

     (1,916     (1,571

Disposals and other

     (239     (519

Change in accretable yield

     67        —     
  

 

 

   

 

 

 

Balance at the end of period

   $ 17,824      $ 12,548   
  

 

 

   

 

 

 

 

(4) Allowance for Loan Losses

The allowance for loan losses is maintained at a level deemed appropriate by management to adequately provide for known and inherent risks in the loan portfolio. A summary of the changes in the originated loans’ allowance for loan losses for the three months ended March 31, 2013 and March 31, 2012 are as follows:

 

     Three Months Ended
March 31,
 
     2013     2012  
     (In thousands)  

Balance at the beginning of period

   $ 19,125      $ 22,317   

Loans charged off

     (1,827     (1,334

Recoveries of loans previously charged off

     119        1,580   

Provision charged to operations

     495        —     
  

 

 

   

 

 

 

Balance at the end of period

   $ 17,912      $ 22,563   
  

 

 

   

 

 

 

 

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Table of Contents

A summary of the changes in the purchased covered and purchased non-covered loans’ allowance for loan losses for the three months ended March 31, 2013 and March 31, 2012 are as follows:

 

     Three Months Ended March 31,  
     2013     2012  
     Purchased
Covered
     Purchased
Non-
covered
    Purchased
Covered
    Purchased
Non-
covered
 
     (In thousands)  

Balance at the beginning of period

   $ 4,352       $ 5,117      $ 3,963      $ 4,635   

Loans charged off

     —           (197     (33     (224

Recoveries of loans charged off

     —           —          —          —     

Provisions charged to operations

     358         5        181        (290
  

 

 

    

 

 

   

 

 

   

 

 

 

Balance at the end of period

   $ 4,710       $ 4,925      $ 4,111      $ 4,121   
  

 

 

    

 

 

   

 

 

   

 

 

 

The purchased loans acquired in the Cowlitz, Pierce and NCB Acquisitions are subject to the Company’s internal and external credit review. If and when credit deterioration occurs subsequent to the acquisition dates, a provision for loan losses will be charged to earnings for the full amount without regard to the FDIC loss-sharing agreement for the covered loan balances. The portion of the estimated loss reimbursable from the FDIC is recorded in noninterest income and increases the FDIC indemnification asset.

 

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Table of Contents

The following table details activity in the allowance for loan losses disaggregated on the basis of the Company’s impairment method as of and for the three months ended March 31, 2013:

 

    Commercial
and
industrial
    Owner-
occupied
commercial
real estate
    Non-owner
occupied
commercial
real estate
    One-to-four
family
residential
    Real estate
construction
and land
development:
one-to-four
family
residential
    Real estate
construction
and land
development:
five or more
family
residential
and
commercial
properties
    Consumer     Unallocated     Total  
    (In thousands)  

Allowance for loan losses for the three months ended March 31, 2013:

                 

December 31, 2012

  $ 9,912      $ 4,021      $ 5,369      $ 1,221      $ 3,131      $ 2,309      $ 1,761      $ 870      $ 28,594   

Charge-offs

    (1,637     —          —          (52     —          (83     (252     —          (2,024

Recoveries

    110        —          —          —          —          —          9        —          119   

Provisions for / (Reallocation of) allowance

    2,459        (180     (94     37        (476     (891     (23     26        858   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

March 31, 2013

  $ 10,844      $ 3,841      $ 5,275      $ 1,206      $ 2,655      $ 1,335      $ 1,495      $ 896      $ 27,547   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan losses as of March 31, 2013 allocated to:

                 

Originated loans individually evaluated for impairment

  $ 1,747      $ 431      $ 1,360      $ 75      $ 661      $ 643      $      $     $ 4,917   

Originated loans collectively evaluated for impairment

    5,616        1,885        2,067        565        816        570        580        896        12,995   

Purchased other covered loans individually evaluated for impairment

    3        —          —          41        —          —          41        —          85   

Purchased other covered loans collectively evaluated for impairment

    39        29        —          16        —          —          6        —          90   

Purchased other non-covered loans individually evaluated for impairment

    10        7        15        —          —          —          —          —          32   

Purchased other non-covered loans collectively evaluated for impairment

    30        28        9        27        —          —          52        —          146   

Purchased impaired covered loans collectively evaluated for impairment

    855        1,072        1,418        243        823        —          124        —          4,535   

Purchased impaired non-covered loans collectively evaluated for impairment

    2,544        389        406        239        355        122        692        —          4,747   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

March 31, 2013

  $ 10,844      $ 3,841      $ 5,275      $ 1,206      $ 2,655      $ 1,335      $ 1,495      $ 896      $ 27,547   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

The following table details the recorded investment balance of the loan receivables disaggregated on the basis of the Company’s impairment method as of March 31, 2013:

 

     Commercial
and
industrial
     Owner-
occupied
commercial
real estate
     Non-owner
occupied
commercial
real estate
     One-to-four
family
residential
     Real estate
construction
and land
development:
one-to-four
family
residential
     Real estate
construction
and land
development:
five or more
family
residential
and
commercial
properties
     Consumer      Total  
     (In thousands)  

Originated loans individually evaluated for impairment

   $ 13,275       $ 2,451       $ 6,934       $ 1,262       $ 3,000       $ 3,265       $ 47       $ 30,234   

Originated loans collectively evaluated for impairment

     255,899         191,067         279,029         37,849         20,003         47,393         27,881         859,121   

Purchased other covered loans individually evaluated for impairment

     56         —           —           463         —           —           39         558   

Purchased other covered loans collectively evaluated for impairment

     7,059         17,799         383         852         —           —           1,990         28,083   

Purchased other non-covered loans individually evaluated for impairment

     382         136         970         —           —           —           —           1,488   

Purchased other non-covered loans collectively evaluated for impairment

     20,183         20,172         14,112         —           —           1,745        7,567         63,779   

Purchased impaired covered loans collectively evaluated for impairment

     13,943         15,810         16,785         3,697         4,505         —           2,704         57,444   

Purchased impaired non-covered loans collectively evaluated for impairment

     19,406         6,362         8,205         3,769         715         1,532         4,585         44,574   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total gross loans receivable as of March 31, 2013

   $ 330,203       $ 253,797       $ 326,418       $ 47,892       $ 28,223       $ 53,935       $ 44,813       $ 1,085,281   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

The following table details the balance in the allowance for loan losses disaggregated on the basis of the Company’s impairment method for the three months ended March 31, 2012 and as of December 31, 2012:

 

    Commercial
and
industrial
    Owner-
occupied
commercial
real estate
    Non-owner
occupied
commercial
real estate
    One-to-four
family
residential
    Real estate
construction
and land
development:
one-to-four
family
residential
    Real estate
construction
and land
development:
five or more
family
residential
and
commercial
properties
    Consumer     Unallocated     Total  
    (In thousands)  

Allowance for loan losses for the three months ended March 31, 2012:

                 

December 31, 2011

  $ 11,805      $ 2,979      $ 4,394      $ 794      $ 4,823      $ 3,800      $ 1,410      $ 910      $ 30,915   

Charge-offs

    (489     —          —          (42     (371     (445     (244     —          (1,591

Recoveries

    1,428        —          11       —          125        —          16        —          1,580   

Provisions for (Reallocation of) allowance

    (1,049     689        19        105        (538     322        278        65        (109
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

March 31, 2012

  $ 11,695      $ 3,668      $ 4,424      $ 857      $ 4,039      $ 3,677      $ 1,460      $ 975      $ 30,795   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan losses as of December 31, 2012 allocated to:

                 

Originated loans individually evaluated for impairment

  $ 858      $ 509      $ 1,386      $ 46      $ 792      $ 658      $ 110      $ —        $ 4,359   

Originated loans collectively evaluated for impairment

    5,372        2,054        2,375        591        1,339        1,527        638        870        14,766   

Purchased other covered loans individually evaluated for impairment

    4        —          —          44        —          —          33        —          81   

Purchased other covered loans collectively evaluated for impairment

    38        29        —          23        —          —          4        —          94   

Purchased other non-covered loans individually evaluated for impairment

    10        7        18        61        —          —          124        —          220   

Purchased other non-covered loans collectively evaluated for impairment

    30        40        16        5        —          —          14        —          105   

Purchased impaired covered loans collectively evaluated for impairment

    1,034        989        1,164        210        639        —          141        —          4,177   

Purchased impaired non-covered loans collectively evaluated for impairment

    2,566        393        410        241        361        124        697        —          4,792   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

December 31, 2012

  $ 9,912      $ 4,021      $ 5,369      $ 1,221      $ 3,131      $ 2,309      $ 1,761      $ 870      $ 28,594   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

The following table details the recorded investment balance of the loan receivables disaggregated on the basis of the Company’s impairment method for the year ended December 31, 2012:

 

     Commercial
and
industrial
     Owner-
occupied
commercial
real estate
     Non-owner
occupied
commercial
real estate
     One-to-four
family
residential
     Real estate
construction
and land
development:
one-to-four
family
residential
     Real estate
construction
and land
development:
five or more
family
residential
and
commercial
properties
     Consumer      Total  
     (In thousands)  

Originated loans individually evaluated for impairment

   $ 10,440       $ 2,051       $ 7,257       $ 811       $ 3,424       $ 3,357       $ 157       $ 27,497   

Originated loans collectively evaluated for impairment

     266,800         186,443         258,578         38,037         21,751         48,718         28,757         849,084   

Purchased other covered loans individually evaluated for impairment

     51         —           —           466         —           —           38         555   

Purchased other covered loans collectively evaluated for impairment

     7,232         18,347         384         857         —           —           1,911         28,731   

Purchased other non-covered loans individually evaluated for impairment

     385         139         973         61         —           —           125         1,683   

Purchased other non-covered loans collectively evaluated for impairment

     4,313         7,924         3,456         —           —           —           4,691         20,384   

Purchased impaired covered loans collectively evaluated for impairment

     18,498         16,449         12,644         3,704         4,433         —           3,316         59,044   

Purchased impaired non-covered loans collectively evaluated for impairment

     20,065         5,148         6,590         2,979         513         864         5,897         42,056