Annual Statements Open main menu

UMPQUA HOLDINGS CORP - Quarter Report: 2014 March (Form 10-Q)


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, 2014
 
or
[  ]
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
for the transition period from                                        to                                       .
 
Commission File Number: 001-34624 
 
Umpqua Holdings Corporation 
 
(Exact Name of Registrant as Specified in Its Charter)
OREGON 
93-1261319 
(State or Other Jurisdiction
(I.R.S. Employer Identification Number)
of Incorporation or Organization)
 
 
One SW Columbia Street, Suite 1200 
Portland, Oregon 97258 
(Address of Principal Executive Offices)(Zip Code) 
 
(503) 727-4100 
(Registrant’s Telephone Number, Including Area Code) 
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
[X]   Yes   [  ]   No 
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 
[X]   Yes   [  ]   No 
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
[X]   Large accelerated filer   [    ]   Accelerated filer   [    ]   Non-accelerated filer   [  ]   Smaller reporting company 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
[  ]   Yes   [X]   No 
 
Indicate the number of shares outstanding for each of the issuer’s classes of common stock, as of the latest practical date:
 
Common stock, no par value: 216,936,489 shares outstanding as of April 30, 2014


Table of Contents

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

2

Table of Contents

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

UMPQUA HOLDINGS CORPORATION AND SUBSIDIARIES 
CONDENSED CONSOLIDATED BALANCE SHEETS 
(UNAUDITED) 
(in thousands, except shares)
 
 
 
 
March 31,
 
December 31,
 
2014
 
2013
ASSETS
 
 
 
Cash and due from banks
$
196,963

 
$
178,685

Interest bearing deposits
887,620

 
611,224

Temporary investments
525

 
514

Total cash and cash equivalents
1,085,108

 
790,423

Investment securities
 
 
 
Trading, at fair value
4,498

 
5,958

Available for sale, at fair value
1,701,730

 
1,790,978

Held to maturity, at amortized cost
5,465

 
5,563

Loans held for sale, at fair value
73,106

 
104,664

Non-covered loans and leases
7,411,108

 
7,354,403

Allowance for non-covered loan and lease losses
(86,709
)
 
(85,314
)
Net non-covered loans and leases
7,324,399

 
7,269,089

Covered loans, net of allowance of $10,320 and $9,771
342,263

 
363,992

Restricted equity securities
29,948

 
30,685

Premises and equipment, net
180,199

 
177,680

Goodwill and other intangible assets, net
775,488

 
776,683

Mortgage servicing rights, at fair value
49,220

 
47,765

Non-covered other real estate owned
22,034

 
21,833

Covered other real estate owned
1,746

 
2,102

FDIC indemnification asset
18,362

 
23,174

Bank owned life insurance
97,589

 
96,938

Deferred tax asset, net
11,393

 
16,627

Other assets
116,178

 
111,958

Total assets
$
11,838,726

 
$
11,636,112

LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
Deposits
 
 
 
Noninterest bearing
$
2,465,606

 
$
2,436,477

Interest bearing
6,807,977

 
6,681,183

Total deposits
9,273,583

 
9,117,660

Securities sold under agreements to repurchase
262,483

 
224,882

Term debt
250,964

 
251,494

Junior subordinated debentures, at fair value
87,800

 
87,274

Junior subordinated debentures, at amortized cost
101,818

 
101,899

Other liabilities
127,602

 
125,477

Total liabilities
10,104,250

 
9,908,686

COMMITMENTS AND CONTINGENCIES (NOTE 10)

 

SHAREHOLDERS' EQUITY
 
 
 
Common stock, no par value, shares authorized: 400,000,000 in 2014 and 200,000,000 in 2013; issued and outstanding: 112,319,525 in 2014 and 111,973,203 in 2013
1,514,969

 
1,514,485

Retained earnings
219,686

 
217,917

Accumulated other comprehensive loss
(179
)
 
(4,976
)
Total shareholders' equity
1,734,476

 
1,727,426

Total liabilities and shareholders' equity
$
11,838,726

 
$
11,636,112


See notes to condensed consolidated financial statements

3

Table of Contents

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

(in thousands, except per share amounts)
 
Three months ended
 
March 31,
 
2014
 
2013
INTEREST INCOME
 
 
 
Interest and fees on non-covered loans and leases
$
91,268

 
$
78,545

Interest and fees on covered loans and leases
12,718

 
14,580

Interest and dividends on investment securities:
 
 
 
Taxable
9,291

 
8,644

Exempt from federal income tax
2,112

 
2,288

Dividends
50

 
24

Interest on temporary investments and interest bearing deposits
441

 
252

Total interest income
115,880

 
104,333

INTEREST EXPENSE
 
 
 
Interest on deposits
3,848

 
5,878

Interest on securities sold under agreement to repurchase and federal funds purchased
41

 
31

Interest on term debt
2,273

 
2,273

Interest on junior subordinated debentures
1,880

 
1,962

Total interest expense
8,042

 
10,144

Net interest income
107,838

 
94,189

PROVISION FOR NON-COVERED LOAN AND LEASE LOSSES 
5,400

 
6,988

PROVISION FOR COVERED LOAN LOSSES
571

 
232

Net interest income after provision for loan and lease losses
101,867

 
86,969

NON-INTEREST INCOME
 
 
 
Service charges on deposit accounts
7,767

 
6,992

Brokerage commissions and fees
3,725

 
3,636

Mortgage banking revenue, net
10,439

 
23,568

Gain on investment securities, net

 
7

Loss on junior subordinated debentures carried at fair value
(542
)
 
(542
)
Change in FDIC indemnification asset
(4,840
)
 
(5,073
)
Other income
6,458

 
5,427

Total non-interest income
23,007

 
34,015

NON-INTEREST EXPENSE
 
 
 
Salaries and employee benefits
53,218

 
51,505

Net occupancy and equipment
16,501

 
14,735

Communications
2,902

 
3,203

Marketing
1,005

 
861

Services
5,990

 
5,893

Supplies
896

 
718

FDIC assessments
1,863

 
1,651

Net gain on non-covered other real estate owned
(18
)
 
(130
)
Net (gain) loss on covered other real estate owned
(46
)
 
284

Intangible amortization
1,194

 
1,204

Merger related expenses
5,983

 
1,531

Other expenses
7,030

 
4,307

Total non-interest expense
96,518

 
85,762

Income before provision for income taxes
28,356

 
35,222

Provision for income taxes
9,592

 
11,861

Net income
$
18,764

 
$
23,361



4

Table of Contents



UMPQUA HOLDINGS CORPORATION AND SUBSIDIARIES 
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Continued) 
(UNAUDITED) 
 
(in thousands, except per share amounts)
 
Three months ended
 
March 31,
 
2014
 
2013
Net income
$
18,764

 
$
23,361

Dividends and undistributed earnings allocated to participating securities
113

 
183

Net earnings available to common shareholders
$
18,651

 
$
23,178

Earnings per common share:
 
 
 
Basic
$0.17
 
$0.21
Diluted
$0.17
 
$0.21
Weighted average number of common shares outstanding:
 
 
 
Basic
112,170

 
111,937

Diluted
112,367

 
112,118


See notes to condensed consolidated financial statements

5

Table of Contents

UMPQUA HOLDINGS CORPORATION AND SUBSIDIARIES 
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME  
(UNAUDITED) 
 
(in thousands)
 
Three months ended
 
March 31,
 
2014
 
2013
Net income
$
18,764

 
$
23,361

Available for sale securities:
 
 
 
Unrealized gains (losses) arising during the period
7,979

 
(4,425
)
Reclassification adjustment for net gains realized in earnings (net of tax expense of $3 for the three months ended March 31, 2013)

 
(4
)
Income tax (expense) benefit related to unrealized losses
(3,192
)
 
1,770

Net change in unrealized gains (losses)
4,787

 
(2,659
)
Held to maturity securities:
 
 
 
Accretion of unrealized losses related to factors other than credit to investment securities held to maturity (net of tax benefit of $6 and $12 for the three months ended March 31, 2014 and 2013, respectively)
10

 
17

Net change in unrealized losses related to factors other than credit
10

 
17

Other comprehensive income (loss), net of tax
4,797

 
(2,642
)
Comprehensive income
$
23,561

 
$
20,719


See notes to condensed consolidated financial statements

6

Table of Contents

UMPQUA HOLDINGS CORPORATION AND SUBSIDIARIES 
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY  
(UNAUDITED)   
 
(in thousands, except shares)
 
 
 
 
 
 
 
Accumulated
 
 
 
 
 
 
 
Other
 
 
 
Common Stock
 
Retained
 
Comprehensive
 
 
 
Shares
 
Amount
 
Earnings
 
Income (Loss)
 
Total
BALANCE AT JANUARY 1, 2013
111,889,959

 
$
1,512,400

 
$
187,293

 
$
24,346

 
$
1,724,039

Net income
 
 
 
 
98,361

 
 
 
98,361

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

Stock-based compensation
 
 
5,017

 
 
 
 
 
5,017

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

 
6,428

 
 
 
 
 
6,428

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

 
$
1,514,485

 
$
217,917

 
$
(4,976
)
 
$
1,727,426

 
 
 
 
 
 
 
 
 
 
BALANCE AT JANUARY 1, 2014
111,973,203

 
$
1,514,485

 
$
217,917

 
$
(4,976
)
 
$
1,727,426

Net income
 
 
 
 
18,764

 
 
 
18,764

Other comprehensive income, net of tax
 
 
 
 
 
 
4,797

 
4,797

Comprehensive income
 
 
 
 
 
 
 
 
$
23,561

Stock-based compensation
 
 
1,534

 
 
 
 
 
1,534

Stock repurchased and retired
(256,894
)
 
(4,614
)
 
 
 
 
 
(4,614
)
Issuances of common stock under stock plans
 
 
 
 
 
 
 
 
 
and related net tax benefit
603,216

 
3,564

 
 
 
 
 
3,564

Cash dividends on common stock ($0.15 per share)
 
 
 
 
(16,995
)
 
 
 
(16,995
)
Balance at March 31, 2014
112,319,525

 
$
1,514,969

 
$
219,686

 
$
(179
)
 
$
1,734,476


See notes to condensed consolidated financial statements

7

Table of Contents

UMPQUA HOLDINGS CORPORATION AND SUBSIDIARIES 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS 
(UNAUDITED) 
 (in thousands)
 
Three months ended
 
March 31,
 
2014
 
2013
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
18,764

 
$
23,361

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Amortization of investment premiums, net
4,000

 
11,042

Gain on sale of investment securities, net

 
(7
)
Gain on sale of non-covered other real estate owned
(117
)
 
(499
)
Gain on sale of covered other real estate owned
(46
)
 
(270
)
Valuation adjustment on non-covered other real estate owned
99

 
369

Valuation adjustment on covered other real estate owned

 
554

Provision for non-covered loan and lease losses
5,400

 
6,988

Provision for covered loan losses
571

 
232

Proceeds from bank owned life insurance
187

 
1,173

Change in cash surrender value of bank owned life insurance
(838
)
 
(1,980
)
Change in FDIC indemnification asset
4,840

 
5,073

Depreciation, amortization and accretion
4,280

 
4,497

Increase in mortgage servicing rights
(2,408
)
 
(6,403
)
Change in mortgage servicing rights carried at fair value
953

 
1,734

Change in junior subordinated debentures carried at fair value
526

 
535

Stock-based compensation
1,534

 
1,185

Net decrease in trading account assets
1,460

 
564

Gain on sale of loans
(9,684
)
 
(28,484
)
Change in loans held for sale carried at fair value
(324
)
 
10,798

Origination of loans held for sale
(213,060
)
 
(471,175
)
Proceeds from sales of loans held for sale
254,109

 
675,150

Excess tax benefits from the exercise of stock options
(892
)
 
(27
)
Change in other assets and liabilities:
 
 
 
Net (increase) decrease in other assets
(791
)
 
14,337

Net increase (decrease) in other liabilities
2,077

 
(14,007
)
Net cash provided by operating activities
70,640

 
234,740

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Purchases of investment securities available for sale

 
(51,191
)
Proceeds from investment securities available for sale
93,176

 
264,313

Proceeds from investment securities held to maturity
167

 
402

Redemption of restricted equity securities
737

 
660

Net non-covered loan and lease originations
(80,709
)
 
(3,363
)
Net covered loan paydowns
19,378

 
17,346

Proceeds from sales of non-covered loans
22,272

 
17,515

Proceeds from disposals of furniture and equipment
30

 
112

Purchases of premises and equipment
(8,162
)
 
(5,166
)
Net (payments) proceeds from FDIC indemnification asset
(812
)
 
1,710

Proceeds from sales of non-covered other real estate owned
1,512

 
4,284

Proceeds from sales of covered other real estate owned
402

 
3,935

Net cash provided by investing activities
$
47,991

 
$
250,557


8

Table of Contents

UMPQUA HOLDINGS CORPORATION AND SUBSIDIARIES 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) 
(UNAUDITED) 
 
(in thousands)
 
Three months ended
 
March 31,
 
2014
 
2013
CASH FLOWS FROM FINANCING ACTIVITIES:
 

 
 

Net increase (decrease) in deposit liabilities
$
155,999

 
$
(307,500
)
Net increase in securities sold under agreements to repurchase
37,601

 
5,735

Repayment of junior subordinated debentures

 
(8,764
)
Dividends paid on common stock
(16,936
)
 

Excess tax benefits from stock based compensation
892

 
27

Proceeds from stock options exercised
3,112

 
34

Retirement of common stock
(4,614
)
 
(428
)
Net cash provided (used) by financing activities
176,054

 
(310,896
)
Net increase in cash and cash equivalents
294,685

 
174,401

Cash and cash equivalents, beginning of period
790,423

 
543,787

Cash and cash equivalents, end of period
$
1,085,108

 
$
718,188

 
 
 
 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 

 
 

Cash paid during the period for:
 

 
 

Interest
$
9,032

 
$
11,181

Income taxes
$
1,456

 
$
1,100

SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
 
 
 
Change in unrealized losses (gains) on investment securities available for sale, net of taxes
$
4,787

 
$
(2,659
)
Change in unrealized losses on investment securities held to maturity
 

 
 

related to factors other than credit, net of taxes
$
10

 
$
17

Cash dividend declared on common stock and payable after period-end
$
16,947

 
$
11,288

Transfer of non-covered loans to non-covered other real estate owned
$
1,878

 
$
5,689

Transfer of covered loans to covered other real estate owned
$

 
$
1,741

Transfer of covered loans to non-covered loans
$
1,780

 
$
7,899

Transfer (to) from FDIC indemnification asset (from) to due from FDIC and other
$
(28
)
 
$
1,679

Receivable from sales of covered other real estate owned
$
185

 
$



See notes to condensed consolidated financial statements
 

9

Table of Contents

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1 – Summary of Significant Accounting Policies 
 
The accounting and financial reporting policies of Umpqua Holdings Corporation (referred to in this report as “we”, “our” or “the Company”) conform to accounting principles generally accepted in the United States of America. The accompanying interim consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries.  All material inter-company balances and transactions have been eliminated. The consolidated financial statements have not been audited. A more detailed description of our accounting policies is included in the 2013 Annual Report filed on Form 10-K. These interim condensed consolidated financial statements should be read in conjunction with the financial statements and related notes contained in the 2013 Annual Report filed on Form 10-K. References to "Bank" refer to our subsidiary Umpqua Bank, an Oregon state-chartered commercial bank, and references to "Umpqua Investments" refer to our subsidiary Umpqua Investments, Inc., a registered broker-dealer and investment adviser. The Bank also has a wholly-owned subsidiary, Financial Pacific Leasing Inc., a commercial equipment leasing company.
 
In preparing these financial statements, the Company has evaluated events and transactions subsequent to March 31, 2014 for potential recognition or disclosure. In management’s opinion, all accounting adjustments necessary to accurately reflect the financial position and results of operations on the accompanying financial statements have been made. These adjustments include normal and recurring accruals considered necessary for a fair and accurate presentation. The results for interim periods are not necessarily indicative of results for the full year or any other interim period.  Certain reclassifications of prior period amounts have been made to conform to current classifications.

 
Note 2 – Business Combinations 
 
Sterling Financial Corporation
As of the close of business on April 18, 2014, the Company completed its merger with Sterling Financial Corporation, a Washington corporation ("Sterling").  The results of Sterling's operations will be included in the Company's financial results beginning April 19, 2014 and the combined company's banking operations will operate under the Umpqua Bank name and brand. As of December 31, 2013, Sterling had total assets of $10.3 billion, $7.3 billion in loans, and $7.1 billion in deposits.

The structure of the transaction is as follows:
Sterling merged with and into the Company (the "Merger") with the Company as the surviving corporation in the Merger;
Immediately following the Merger, Sterling's wholly owned subsidiary, Sterling Savings Bank merged with and into the Bank (the "Bank Merger"), with the Bank as the surviving bank in the Bank Merger;
Holders of shares of common stock of Sterling have the right to receive 1.671 shares of the Company's common stock and $2.18 in cash for each share of Sterling common stock;
Holders of outstanding warrants of Sterling, which represent the right to purchase a corresponding share of common stock of Sterling, have the right to receive 1.671 shares of the Company's common stock and $2.18 in cash for each warrant when exercised;
Holders of outstanding options to purchase shares of Sterling common stock converted into 1.7896 options to purchase the Company's common stock, subject to vesting conditions;
Holders of outstanding restricted stock units of Sterling common stock converted into 1.7896 restricted stock units of the Company, subject to vesting conditions;

Aggregate consideration for the Merger is estimated at $2.1 billion and includes the following:
Cash of $136.2 million
Common stock issued of $1.9 billion;
Warrants issued of $52.8 million;
Restricted stock units and stock options of $8.8 million.

The primary reason for the Merger is to continue the Company's growth strategy, including expanding our geographic footprint in markets throughout the West Coast. Six stores are expected to be divested to Banner Bank in the second quarter of 2014. The Company expects to repay securities sold under agreements to repurchase acquired of $500.0 million, funded through the sale of acquired investment securities in the second quarter of 2014.

The Merger will be accounted for using the purchase acquisition method of accounting and, accordingly, assets acquired, liabilities assumed and consideration exchanged will be recorded at fair value as of the acquisition date. Preliminary fair values for all assets and liabilities are not reported herein as the Company is still in the process of determining the preliminary fair

10

Table of Contents

values. The Company expects to disclose preliminary assets acquired and liabilities assumed, including fair value adjustments, as well as supplemental pro forma information, in the Company's June 30, 2014 Form 10-Q. Goodwill will not be deductible for income tax purposes as the merger is accounted for as a tax-free exchange for tax purposes.

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

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

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

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

The operations of FinPac are included in our operating results from July 1, 2013, and added revenue of $15.7 million, non-interest expense of $3.9 million , and net income of $4.2 million net of tax, for the three months ended March 31, 2014. FinPac's results of operations prior to the acquisition are not included in our operating results. There are no merger related expenses for the three months ended March 31, 2014.

A summary of the net assets acquired and the estimated fair value adjustments of FinPac are presented below:
(in thousands)
 
FinPac
 
July 1, 2013
Cost basis net assets
$
61,446

Cash payment paid
(156,110
)
Fair value adjustments:
 
Non-covered loans and leases, net
6,881

Other intangible assets
(8,516
)
Other assets
(1,650
)
Term debt
(400
)
Other liabilities
1,572

Goodwill
$
(96,777
)

11

Table of Contents


The statement of assets acquired and liabilities assumed at their fair values of FinPac are presented below.
(in thousands)
 
FinPac
 
July 1, 2013
Assets Acquired:
 
Cash and equivalents
$
6,452

Non-covered loans and leases, net
264,336

Premises and equipment
491

Goodwill
96,777

Other assets
8,015

 Total assets acquired
$
376,071

 
 
Liabilities Assumed:
 
Term debt
211,204

Other liabilities
8,757

 Total liabilities assumed
219,961

 Net assets acquired
$
156,110


Non-covered leases acquired from FinPac that are not subject to the requirements of FASB ASC 310-30 Loans and Debt Securities Acquired with Deteriorated Credit Quality ("ASC 310-30") are presented below at acquisition:
(in thousands)
 
FinPac
 
July 1, 2013
Contractually required payments
$
350,403

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


The following table presents unaudited pro forma results of operations for the three months ended March 31, 2013 as if the acquisition of FinPac had occurred on January 1, 2013. The proforma results have been prepared for comparative purposes only and are not necessarily indicative of the results that would have been obtained had the acquisitions actually occurred on January 1, 2013.




12

Table of Contents

(in thousands, except per share data)
 
Three months ended March 31, 2013
 
 
 
Pro Forma
 
Pro Forma
 
Company
FinPac (a)
Adjustments
 
Combined
Net interest income
$
94,189

$
12,547

$
(1,224
)
 (b)
$
105,512

Provision for non-covered loan and lease losses
6,988

2,577


(c)
9,565

Provision for covered loan losses
232



 
232

Non-interest income
34,015

790


 
34,805

Non-interest expense
85,762

3,832

(203
)
(d)
89,391

  Income before provision for income taxes
35,222

6,928

(1,021
)
 
41,129

Provision for income taxes
11,861

2,716

(357
)
 (e)
14,220

  Net income
23,361

4,212

(664
)
 
26,909

Dividends and undistributed earnings allocated to participating securities
183


28

 
211

Net earnings available to common shareholders
$
23,178

$
4,212

$
(692
)
 
$
26,698

Earnings per share:
 
 
 
 
 
      Basic
$
0.21

 
 
 
$
0.24

      Diluted
$
0.21

 
 
 
$
0.24

Average shares outstanding:
 
 
 
 
 
      Basic
111,937

 
 
 
111,937

      Diluted
112,118

 
 
 
112,118


(a) FinPac amounts represent results from January 1, 2013 to March 31, 2013.
(b) Adjustment of interest income from loans and leases due to the estimated loss of income from the write-off of FinPac's loan mark (related to a prior acquisition) and the amortization of the new interest rate mark and the accretion of the acquisition accounting adjustment relating to the credit mark. The amortization period will be the contractual lives of the loans and leases, which is approximately four years, and will be amortized into income using the effective yield method.
(c) As acquired loans and leases are recorded at fair value, Umpqua would expect a reduction in the historical provision for loan and leases losses from FinPac; however, no adjustment to the historical amount of FinPac provision for loan and lease losses is reflected.
(d) Adjustment to reflect additional compensation expense related to restricted stock granted to FinPac management and the removal of FinPac director compensation and travel fees, and FinPac management fees of the Financial Pacific Holdings, LLC entity which was not acquired.
(e) Income tax effect of pro forma adjustments at 35%.

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

March 31, 2014

13

Table of Contents

(in thousands)
 
Amortized
 
Unrealized
 
Unrealized
 
Fair
 
Cost
 
Gains
 
Losses
 
Value
AVAILABLE FOR SALE:
 
 
 
 
 
 
 
U.S. Treasury and agencies
$
242

 
$
20

 
$
(1
)
 
$
261

Obligations of states and political subdivisions
222,195

 
8,781

 
(1,297
)
 
229,679

Residential mortgage-backed securities and
 
 
 
 
 
 
 
collateralized mortgage obligations
1,477,553

 
14,077

 
(21,814
)
 
1,469,816

Investments in mutual funds and
 
 
 
 
 
 
 
other equity securities
1,959

 
15

 

 
1,974

 
$
1,701,949

 
$
22,893

 
$
(23,112
)
 
$
1,701,730

HELD TO MATURITY:
 
 
 
 
 
 
 
Residential mortgage-backed securities and
 
 
 
 
 
 
 
collateralized mortgage obligations
$
5,465

 
$
333

 
$
(8
)
 
$
5,790

 
$
5,465

 
$
333

 
$
(8
)
 
$
5,790


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

 
$
20

 
$
(1
)
 
$
268

Obligations of states and political subdivisions
229,969

 
7,811

 
(2,575
)
 
235,205

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

 
15,359

 
(28,819
)
 
1,553,541

Investments in mutual funds and
 
 
 
 
 
 
 
other equity securities
1,959

 
5

 

 
1,964

 
$
1,799,178

 
$
23,195

 
$
(31,395
)
 
$
1,790,978

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

 
330

 
(19
)
 
5,874

 
$
5,563

 
$
330

 
$
(19
)
 
$
5,874

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

14

Table of Contents

March 31, 2014
(in thousands)
 
Less than 12 Months
 
12 Months or Longer
 
Total
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Value
 
Losses
 
Value
 
Losses
 
Value
 
Losses
AVAILABLE FOR SALE:
 

 
 

 
 

 
 

 
 

 
 

U.S. Treasury and agencies
$

 
$

 
$
25

 
$
1

 
$
25

 
$
1

Obligations of states and political subdivisions
38,975

 
1,165

 
1,767

 
132

 
40,742

 
1,297

Residential mortgage-backed securities and
 
 
 
 
 
 
 
 
 
 
 
collateralized mortgage obligations
412,636

 
9,553

 
284,346

 
12,261

 
696,982

 
21,814

Total temporarily impaired securities
$
451,611

 
$
10,718

 
$
286,138

 
$
12,394

 
$
737,749

 
$
23,112

HELD TO MATURITY:
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage-backed securities and
 
 
 
 
 
 
 
 
 
 
 
collateralized mortgage obligations
$
169

 
$
8

 
$

 
$

 
$
169

 
$
8

Total temporarily impaired securities
$
169

 
$
8

 
$

 
$

 
$
169

 
$
8


Unrealized losses on the impaired held to maturity collateralized mortgage obligations include the unrealized losses related to factors other than credit that are included in other comprehensive income. 
 
December 31, 2013
(in thousands)
 
Less than 12 Months
 
12 Months or Longer
 
Total
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Value
 
Losses
 
Value
 
Losses
 
Value
 
Losses
AVAILABLE FOR SALE:
 

 
 

 
 

 
 

 
 

 
 

U.S. Treasury and agencies
$

 
$

 
$
32

 
$
1

 
$
32

 
$
1

Obligations of states and political subdivisions
48,342

 
2,575

 

 

 
48,342

 
2,575

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

 
15,951

 
249,695

 
12,868

 
725,677

 
28,819

Total temporarily impaired securities
$
524,324

 
$
18,526

 
$
249,727

 
$
12,869

 
$
774,051

 
$
31,395

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

 
$
19

 
$

 
$

 
$
156

 
$
19

Total temporarily impaired securities
$
156

 
$
19

 
$

 
$

 
$
156

 
$
19

 
The unrealized losses on investments in U.S. Treasury and agency securities were caused by interest rate increases subsequent to the purchase of these securities. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than par. Because the Bank does not intend to sell the securities in this class and it is not likely that the Bank will be required to sell these securities before recovery of their amortized cost basis, which may include holding each security until contractual maturity, the unrealized losses on these investments are not considered other-than-temporarily impaired ("OTTI"). 
 
The unrealized losses on obligations of political subdivisions were caused by changes in market interest rates or the widening of market spreads subsequent to the initial purchase of these securities. Management monitors published credit ratings of these securities and no adverse ratings changes have occurred since the date of purchase of obligations of political subdivisions which are in an unrealized loss position as of March 31, 2014. Because the decline in fair value is attributable to changes in interest rates or widening market spreads and not credit quality, and because the Bank does not intend to sell the securities in this class and it is not likely that the Bank will be required to sell these securities before recovery of their amortized cost basis, which may include holding each security until maturity, the unrealized losses on these investments are not considered OTTI. 
 
All of the available for sale residential mortgage-backed securities and collateralized mortgage obligations portfolio in an unrealized loss position at March 31, 2014 are issued or guaranteed by governmental agencies. The unrealized losses on

15

Table of Contents

residential mortgage-backed securities and collateralized mortgage obligations were caused by changes in market interest rates or the widening of market spreads subsequent to the initial purchase of these securities, and not concerns regarding the underlying credit of the issuers or the underlying collateral. It is expected that these securities will not be settled at a price less than the amortized cost of each investment. Because the decline in fair value is attributable to changes in interest rates or widening market spreads and not credit quality, and because the Bank does not intend to sell the securities in this class and it is not likely that the Bank will be required to sell these securities before recovery of their amortized cost basis, which may include holding each security until contractual maturity, these investments are not considered OTTI. 

We review investment securities on an ongoing basis for the presence of OTTI or permanent impairment, taking into consideration current market conditions, fair value in relationship to cost, extent and nature of the change in fair value, issuer rating changes and trends, whether we intend to sell a security or if it is likely that we will be required to sell the security before recovery of our amortized cost basis of the investment, which may be maturity, and other factors.  For debt securities, if we intend to sell the security or it is likely that we will be required to sell the security before recovering its cost basis, the entire impairment loss would be recognized in earnings as an OTTI. If we do not intend to sell the security and it is not likely that we will be required to sell the security but we do not expect to recover the entire amortized cost basis of the security, only the portion of the impairment loss representing credit losses would be recognized in earnings. The credit loss on a security is measured as the difference between the amortized cost basis and the present value of the cash flows expected to be collected. Projected cash flows are discounted by the original or current effective interest rate depending on the nature of the security being measured for potential OTTI.  The remaining impairment related to all other factors, the difference between the present value of the cash flows expected to be collected and fair value, is recognized as a charge to other comprehensive income (“OCI”). Impairment losses related to all other factors are presented as separate categories within OCI. For investment securities held to maturity, this amount is accreted over the remaining life of the debt security prospectively based on the amount and timing of future estimated cash flows.  The accretion of the OTTI amount recorded in OCI will increase the carrying value of the investment, and would not affect earnings.  If there is an indication of additional credit losses the security is re-evaluated according to the procedures described above. 
  
The following table presents the maturities of investment securities at March 31, 2014
 
(in thousands)
 
Available For Sale
 
Held To Maturity
 
Amortized
 
Fair
 
Amortized
 
Fair
 
Cost
 
Value
 
Cost
 
Value
AMOUNTS MATURING IN:
 
 
 
 
 
 
 
Three months or less
$
9,295

 
$
9,337

 
$

 
$

Over three months through twelve months
61,111

 
62,068

 
291

 
309

After one year through five years
960,569

 
975,746

 
279

 
487

After five years through ten years
614,744

 
597,870

 
427

 
485

After ten years
54,271

 
54,735

 
4,468

 
4,509

Other investment securities
1,959

 
1,974

 

 

 
$
1,701,949

 
$
1,701,730

 
$
5,465

 
$
5,790

 
The amortized cost and fair value of collateralized mortgage obligations and mortgage-backed securities are presented by expected average life, rather than contractual maturity, in the preceding table. Expected maturities may differ from contractual maturities because borrowers have the right to prepay underlying loans without prepayment penalties. 
 
There were gross realized gains on the sale of securities available for sale of none and $7,000 for the three months ended March 31, 2014 and 2013. 

The following table presents, as of March 31, 2014, investment securities which were pledged to secure borrowings, public deposits, and repurchase agreements as permitted or required by law: 
 

16

Table of Contents

(in thousands)
 
Amortized
 
Fair
 
Cost
 
Value
To Federal Home Loan Bank to secure borrowings
$
8,783

 
$
9,089

To state and local governments to secure public deposits
933,911

 
928,206

Other securities pledged principally to secure repurchase agreements
347,901

 
342,649

Total pledged securities
$
1,290,595

 
$
1,279,944

 
 
  
Note 4 – Non-Covered Loans and Leases  
 
The following table presents the major types of non-covered loans and leases, net of deferred costs, net of $4.7 million and net of deferred fees, net of $495,000, recorded on the balance sheet as of March 31, 2014 and December 31, 2013, respectively: 
 
(in thousands)
 
March 31,
 
December 31,
 
2014
 
2013
Commercial real estate
 
 
 
Non-owner occupied term, net
$
2,311,952

 
$
2,328,260

Owner occupied term, net
1,282,482

 
1,259,583

Multifamily, net
400,927

 
403,537

Construction & development, net
229,262

 
245,231

Residential development, net
89,510

 
88,413

Commercial
 
 
 
Term, net
735,004

 
770,845

LOC & other, net
1,005,800

 
987,360

Leases and equipment finance, net
388,418

 
361,591

Residential
 
 
 
Mortgage, net
651,042

 
597,201

Home equity loans & lines, net
268,497

 
264,269

Consumer & other, net
48,214

 
48,113

Total loans and leases, net of deferred fees and costs
7,411,108

 
7,354,403

 
As of March 31, 2014, loans totaling $5.4 billion were pledged to secure borrowings and available lines of credit.

At March 31, 2014 and December 31, 2013, non-covered loans accounted for under ASC 310-30 were $23.1 million and $21.9 million, respectively.

Note 5 – Allowance for Non-Covered Loan and Lease Loss and Credit Quality 
 
The Bank has a management Allowance for Loan and Lease Losses (“ALLL”) Committee, which is responsible for, among other things, regularly reviewing the ALLL methodology, including loss factors, and ensuring that it is designed and applied in accordance with generally accepted accounting principles. The ALLL Committee reviews and approves loans and leases recommended for impaired status.  The ALLL Committee also approves removing loans from impaired status.  The Bank's Audit and Compliance Committee provides board oversight of the ALLL process and reviews and approves the ALLL methodology on a quarterly basis. 
 
Our methodology for assessing the appropriateness of the ALLL consists of three key elements, which includes 1) the formula allowance; 2) the specific allowance; and 3) the unallocated allowance. By incorporating these factors into a single allowance requirement analysis, all risk-based activities within the loan portfolio are simultaneously considered. 

Formula Allowance 
The Bank performs regular credit reviews of the loan and lease portfolio to determine the credit quality and adherence to underwriting standards. When loans and leases are originated, they are assigned a risk rating that is reassessed periodically

17

Table of Contents

during the term of the loan or lease through the credit review process.  The Bank's risk rating methodology assigns risk ratings ranging from 1 to 10, where a higher rating represents higher risk. The 10 risk rating categories are a primary factor in determining an appropriate amount for the formula allowance. 
 
The formula allowance is calculated by applying risk factors to various segments of pools of outstanding loans and leases. Risk factors are assigned to each portfolio segment based on management’s evaluation of the losses inherent within each segment. Segments or regions with greater risk of loss will therefore be assigned a higher risk factor. 
 
Base risk The portfolio is segmented into loan categories, and these categories are assigned a Base Risk factor based on an evaluation of the loss inherent within each segment. 
 
Extra risk – Additional risk factors provide for an additional allocation of ALLL based on the loan and lease risk rating system and loan delinquency, and reflect the increased level of inherent losses associated with more adversely classified loans and leases. 
 
Changes to risk factors – Risk factors are assigned at origination and may be changed periodically based on management’s evaluation of the following factors: loss experience; changes in the level of non-performing loans and leases; regulatory exam results; changes in the level of adversely classified loans and leases (positive or negative); improvement or deterioration in local economic conditions; and any other factors deemed relevant. 
 
Specific Allowance 
Regular credit reviews of the portfolio also identify loans that are considered potentially impaired. Potentially impaired loans are referred to the ALLL Committee which reviews and approves designated loans as impaired. A loan is considered impaired, when based on current information and events, we determine that we will probably not be able to collect all amounts due according to the loan contract, including scheduled interest payments. When we identify a loan as impaired, we measure the impairment using discounted cash flows, except when the sole remaining source of the repayment for the loan is the liquidation of the collateral. In these cases, we use the current fair value of the collateral, less selling costs, instead of discounted cash flows. If we determine that the value of the impaired loan is less than the recorded investment in the loan, we either recognize an impairment reserve as a specific allowance to be provided for in the allowance for loan and lease losses or charge-off the impaired balance on collateral dependent loans if it is determined that such amount represents a confirmed loss.  Loans determined to be impaired with a specific allowance are excluded from the formula allowance so as not to double-count the loss exposure. The non-accrual impaired loans as of period end have already been partially charged-off to their estimated net realizable value, and are expected to be resolved over the coming quarters with no additional material loss, absent further decline in market prices. 
 
The combination of the formula allowance component and the specific allowance component represents the allocated allowance for loan and lease losses. 
 
Unallocated Allowance 
The Bank may also maintain an unallocated allowance amount to provide for other credit losses inherent in a loan and lease portfolio that may not have been contemplated in the credit loss factors. This unallocated amount generally comprises less than 5% of the allowance, but may be maintained at higher levels during times of deteriorating economic conditions characterized by falling real estate values. The unallocated amount is reviewed quarterly with consideration of factors including, but not limited to: 
• Changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere in estimating credit losses; 
• Changes in international, national, regional, and local economic and business conditions and developments that affect the collectability of the portfolio, including the condition of various market segments; 
• Changes in the nature and volume of the portfolio and in the terms of loans and leases; 
• Changes in the experience and ability of lending management and other relevant staff; 
• Changes in the volume and severity of past due loans, the volume of nonaccrual loans and leases, and the volume and severity of adversely classified or graded loans; 
• Changes in the quality of the institution’s loan and lease review system; 
• Changes in the value of underlying collateral for collateral-depending loans; 
• The existence and effect of any concentrations of credit, and changes in the level of such concentrations; and
• The effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the institutions’ existing portfolio. 


18

Table of Contents

These factors are evaluated through a management survey of the Chief Credit Officer, Chief Lending Officer, Senior Credit Officers, Special Assets Manager, and Credit Review Manager. The survey requests responses to evaluate current changes in the nine qualitative factors. This information is then incorporated into our understanding of the reasonableness of the formula factors and our evaluation of the unallocated portion of the ALLL. 
 
Management believes that the ALLL was adequate as of March 31, 2014. There is, however, no assurance that future loan and lease losses will not exceed the levels provided for in the ALLL and could possibly result in additional charges to the provision for loan and lease losses. In addition, bank regulatory authorities, as part of their periodic examination of the Bank, may require additional charges to the provision for loan and lease losses in future periods if warranted as a result of their review. Approximately 74% of our loan and lease portfolio is secured by real estate, and a significant decline in real estate market values may require an increase in the allowance for loan and lease losses. The recent U.S. recession, the housing market downturn, and declining real estate values in our markets have negatively impacted aspects of our loan and lease portfolio. A continued deterioration in our markets may adversely affect our loan and lease portfolio and may lead to additional charges to the provision for loan and lease losses. 
 
The reserve for unfunded commitments (“RUC”) is established to absorb inherent losses associated with our commitment to lend funds, such as with a letter or line of credit. The adequacy of the ALLL and RUC are monitored on a regular basis and are based on management's evaluation of numerous factors. For each portfolio segment, these factors include: 
• The quality of the current loan and lease portfolio; 
• The trend in the loan portfolio's risk ratings; 
• Current economic conditions; 
• Loan and lease concentrations; 
• Loan and lease growth rates; 
• Past-due and non-performing trends; 
• Evaluation of specific loss estimates for all significant problem loans; 
• Historical short (one year), medium (three year), and long-term charge-off rates; 
• Recovery experience; and
• Peer comparison loss rates. 
 
There have been no significant changes to the Bank’s methodology or policies in the periods presented. 
 
Activity in the Non-Covered Allowance for Loan and Lease Losses 
 
The following table summarizes activity related to the allowance for non-covered loan and lease losses by non-covered loan and lease portfolio segment for three months ended March 31, 2014 and 2013
 
(in thousands)
 
Three months ended March 31, 2014
 
Commercial
 
 
 
 
 
Consumer
 
 
 
 
 
Real Estate
 
Commercial
 
Residential
 
& Other
 
Unallocated
 
Total
Balance, beginning of period
$
53,433

 
$
24,191

 
$
6,827

 
$
863

 
$

 
$
85,314

Charge-offs
(1,895
)
 
(3,350
)
 
(132
)
 
(188
)
 

 
(5,565
)
Recoveries
439

 
981

 
47

 
93

 

 
1,560

(Recapture) provision
(130
)
 
4,940

 
449

 
141

 

 
5,400

Balance, end of period
$
51,847

 
$
26,762

 
$
7,191

 
$
909

 
$

 
$
86,709

 
 
 
 
 
 
 
 
 
 
 
 
 
Three months ended March 31, 2013
 
Commercial
 
 
 
 
 
Consumer
 
 
 
 
 
Real Estate
 
Commercial
 
Residential
 
& Other
 
Unallocated
 
Total
Balance, beginning of period
$
54,909

 
$
22,925

 
$
6,925

 
$
632

 
$

 
$
85,391

Charge-offs
(1,454
)
 
(6,174
)
 
(904
)
 
(193
)
 

 
(8,725
)
Recoveries
470

 
367

 
92

 
109

 

 
1,038

Provision
1,170

 
4,543

 
1,106

 
169

 

 
6,988

Balance, end of period
$
55,095

 
$
21,661

 
$
7,219

 
$
717

 
$

 
$
84,692


19

Table of Contents

 
 
 
 
 
 
 
 
 
 
 
 
 
The following table presents the allowance and recorded investment in non-covered loans and leases by portfolio segment and balances individually or collectively evaluated for impairment as of March 31, 2014 and 2013
 
(in thousands)
 
March 31, 2014
 
Commercial
 
 
 
 
 
Consumer
 
 
 
 
 
Real Estate
 
Commercial
 
Residential
 
& Other
 
Unallocated
 
Total
Allowance for non-covered loans and leases:
Collectively evaluated for impairment
$
50,504

 
$
26,747

 
$
7,191

 
$
909

 
$

 
$
85,351

Individually evaluated for impairment
1,343

 
15

 

 

 

 
1,358

Total
$
51,847

 
$
26,762

 
$
7,191

 
$
909

 
$

 
$
86,709

Non-covered loans and leases:
 
 
 
 
 
 
 
 
 
 
 
Collectively evaluated for impairment
$
4,222,943

 
$
2,114,681

 
$
919,539

 
$
48,214

 
 
 
$
7,305,377

Individually evaluated for impairment
91,190

 
14,541

 

 

 
 
 
105,731

Total
$
4,314,133

 
$
2,129,222

 
$
919,539

 
$
48,214

 
 
 
$
7,411,108

 
(in thousands)
 
March 31, 2013
 
Commercial
 
 
 
 
 
Consumer
 
 
 
 
 
Real Estate
 
Commercial
 
Residential
 
& Other
 
Unallocated
 
Total
Allowance for non-covered loans and leases:
Collectively evaluated for impairment
$
53,158

 
$
21,645

 
$
7,219

 
$
717

 
$

 
$
82,739

Individually evaluated for impairment
1,937

 
16

 

 

 

 
1,953

Total
$
55,095

 
$
21,661

 
$
7,219

 
$
717

 
$

 
$
84,692

Non-covered loans and leases:
 
 
 
 
 
 
 
 
 
 
Collectively evaluated for impairment
$
4,071,110

 
$
1,668,522

 
$
748,115

 
$
41,173

 
 
 
$
6,528,920

Individually evaluated for impairment
114,553

 
19,375

 
338

 

 
 
 
134,266

Total
$
4,185,663

 
$
1,687,897

 
$
748,453

 
$
41,173

 
 
 
$
6,663,186

 

The non-covered loan and lease balances are net of deferred loans costs, net of $4.7 million at March 31, 2014 and net of deferred fees, net of $11.6 million at March 31, 2013.  


20

Table of Contents

Summary of Reserve for Unfunded Commitments Activity 

The following table presents a summary of activity in the RUC and unfunded commitments for the three months ended March 31, 2014 and 2013

(in thousands) 
 
Three months ended March 31, 2014
 
Commercial
 
 
 
 
 
Consumer
 
 
 
Real Estate
 
Commercial
 
Residential
 
& Other
 
Total
Balance, beginning of period
$
220

 
$
900

 
$
232

 
$
84

 
$
1,436

Net change to other expense
(26
)
 
(14
)
 
11

 
10

 
(19
)
Balance, end of period
$
194

 
$
886

 
$
243

 
$
94

 
$
1,417

 
 
 
 
 
 
 
 
 
 
 
Three months ended March 31, 2013
 
Commercial
 
 
 
 
 
Consumer
 
 
 
Real Estate
 
Commercial
 
Residential
 
& Other
 
Total
Balance, beginning of period
$
172

 
$
807

 
$
173

 
$
71

 
$
1,223

Net change to other expense
(13
)
 
43

 
9

 
7

 
46

Balance, end of period
$
159

 
$
850

 
$
182

 
$
78

 
$
1,269



 
 
 
 
 
 
 
 
 
 
(in thousands)  
 
Commercial
 
 
 
 
 
Consumer
 
 
 
Real Estate
 
Commercial
 
Residential
 
& Other
 
Total
Unfunded loan and lease commitments:
 
 
 
 
 
 
 
 
 
March 31, 2014
$
213,675

 
$
969,475

 
$
353,498

 
$
59,017

 
$
1,595,665

March 31, 2013
$
183,996

 
$
984,672

 
$
270,510

 
$
54,240

 
$
1,493,418

 
Non-covered loans and leases sold 
 
In the course of managing the loan and lease portfolio, at certain times, management may decide to sell loans and leases.  The following table summarizes loans and leases sold by loan portfolio during the three months ended March 31, 2014 and 2013
 
(In thousands) 
 
Three months ended
 
March 31,
 
2014
 
2013
Commercial real estate
 
 
 
Non-owner occupied term
$
3,193

 
$

Owner occupied term
2,147

 
2,850

Construction & development

 
3,515

Residential development
605

 
23

Commercial
 
 
 
Term
15,996

 
11,127

Residential
 
 
 
Mortgage
331

 

Total
$
22,272

 
$
17,515



21

Table of Contents

Asset Quality and Non-Performing Loans and Leases
 
We manage asset quality and control credit risk through diversification of the non-covered loan and lease portfolio and the application of policies designed to promote sound underwriting and loan and lease monitoring practices. The Bank's Credit Quality Group is charged with monitoring asset quality, establishing credit policies and procedures and enforcing the consistent application of these policies and procedures across the Bank.  Reviews of non-performing, past due non-covered loans and leases and larger credits, designed to identify potential charges to the allowance for loan and lease losses, and to determine the adequacy of the allowance, are conducted on an ongoing basis. These reviews consider such factors as the financial strength of borrowers, the value of the applicable collateral, loan and lease loss experience, estimated loan and lease losses, growth in the loan and lease portfolio, prevailing economic conditions and other factors. 
 
A loan is considered impaired when, based on current information and events, we determine it is probable that we will not be able to collect all amounts due according to the loan contract, including scheduled interest payments. Generally, when non-covered loans are identified as impaired, they are moved to the Special Assets Division. When we identify a loan as impaired, we measure the loan for potential impairment using discounted cash flows, except when the sole remaining source of the repayment for the loan is the liquidation of the collateral.  In these cases, we will use the current fair value of collateral, less selling costs.  The starting point for determining the fair value of collateral is through obtaining external appraisals.  Generally, external appraisals are updated every 12 months.  We obtain appraisals from a pre-approved list of independent, third party, local appraisal firms.  Approval and addition to the list is based on experience, reputation, character, consistency and knowledge of the respective real estate market. At a minimum, it is ascertained that the appraiser is: (a) currently licensed in the state in which the property is located, (b) is experienced in the appraisal of properties similar to the property being appraised, (c) is actively engaged in the appraisal work, (d) has knowledge of current real estate market conditions and financing trends, (e) is reputable, and (f) is not on Freddie Mac’s or the Bank’s Exclusionary List of appraisers and brokers. In certain cases appraisals will be reviewed by our Real Estate Valuation Services Group to ensure the quality of the appraisal and the expertise and independence of the appraiser. Upon receipt and review, an external appraisal is utilized to measure a loan for potential impairment.  Our impairment analysis documents the date of the appraisal used in the analysis, whether the officer preparing the report deems it current, and, if not, allows for internal valuation adjustments with justification.  Typical justified adjustments might include discounts for continued market deterioration subsequent to appraisal date, adjustments for the release of collateral contemplated in the appraisal, or the value of other collateral or consideration not contemplated in the appraisal. An appraisal over one year old in most cases will be considered stale dated and an updated or new appraisal will be required.  Any adjustments from appraised value to net realizable value are detailed and justified in the impairment analysis, which is reviewed and approved by senior credit quality officers and the Bank's ALLL Committee. Although an external appraisal is the primary source to value collateral dependent loans, we may also utilize values obtained through purchase and sale agreements, negotiated short sales, broker price opinions, or the sales price of the note.  These alternative sources of value are used only if deemed to be more representative of value based on updated information regarding collateral resolution. Impairment analyses are updated, reviewed and approved on a quarterly basis at or near the end of each reporting period. Appraisals or other alternative sources of value received subsequent to the reporting period, but prior to our filing of periodic reports, are considered and evaluated to ensure our periodic filings are materially correct and not misleading.  Based on these processes, we do not believe there are significant time lapses for the recognition of additional loan loss provisions or charge-offs from the date they become known.  
 
Loans and leases are classified as non-accrual when collection of principal or interest is doubtful—generally if they are past due as to maturity or payment of principal or interest by 90 days or more—unless such loans are well-secured and in the process of collection. Additionally, all loans that are impaired are considered for non-accrual status. Loans placed on non-accrual will typically remain on non-accrual status until all principal and interest payments are brought current and the prospects for future payments in accordance with the loan agreement appear relatively certain. 

Loans are reported as restructured when the Bank grants a more than insignificant concession(s) to a borrower experiencing financial difficulties that it would not otherwise consider.  Examples of such concessions include a reduction in the loan rate, forgiveness of principal or accrued interest, extending the maturity date or providing a lower interest rate than would be normally available for a transaction of similar risk. As a result of these concessions, restructured loans are impaired as the Bank will not collect all amounts due, both principal and interest, in accordance with the terms of the original loan agreement. Impairment reserves on non-collateral dependent restructured loans are measured by comparing the present value of expected future cash flows on the restructured loans discounted at the interest rate of the original loan agreement to the loan’s carrying value. These impairment reserves are recognized as a specific component to be provided for in the allowance for loan and lease losses. 
 
Loans and leases are reported as past due when installment payments, interest payments, or maturity payments are past due based on contractual terms. All loans determined to be impaired are individually assessed for impairment except for impaired

22

Table of Contents

homogeneous loans which are collectively evaluated for impairment in accordance with FASB ASC 450, Contingencies (“ASC 450”). The specific factors considered in determining that a loan is impaired include borrower financial capacity, current economic, business and market conditions, collection efforts, collateral position and other factors deemed relevant. Generally, impaired loans are placed on non-accrual status and all cash receipts are applied to the principal balance.  Continuation of accrual status and recognition of interest income is generally limited to performing restructured loans. 
 
The Bank has written down impaired, non-accrual loans as of March 31, 2014 to their estimated net realizable value, and expects resolution with no additional material loss, absent a further decline in market prices. 
 
Non-Covered Non-Accrual Loans and Leases and Loans and Leases Past Due  
 
The following table summarizes our non-covered non-accrual loans and leases and loans and leases past due, by loan and lease class, as of March 31, 2014 and December 31, 2013

(in thousands)
 
March 31, 2014
 
Greater than
 
 
 
90 Days and
 
 
 
 
 
 
 
Total non-
 
30 to 59
 
60 to 89
 
Greater
 
 
 
 
 
 
 
covered
 
Days
 
Days
 
and
 
Total
 
Non-
 
Current &
 
Loans
 
Past Due
 
Past Due
 
Accruing
 
Past Due
 
accrual
 
Other (1)
 
and Leases
Commercial real estate
 

 
 

 
 

 
 

 
 

 
 

 
 

Non-owner occupied term, net
$
1,736

 
$
533

 
$
369

 
$
2,638

 
$
15,948

 
$
2,293,366

 
$
2,311,952

Owner occupied term, net
625

 
466

 
36

 
1,127

 
5,449

 
1,275,906

 
1,282,482

Multifamily, net
3,855

 
1,145

 

 
5,000

 
355

 
395,572

 
400,927

Construction & development, net

 

 

 

 

 
229,262

 
229,262

Residential development, net

 

 

 

 
195

 
89,315

 
89,510

Commercial
 
 
 
 
 
 
 
 
 
 
 
 

Term, net
1,427

 
8,832

 

 
10,259

 
11,964

 
712,781

 
735,004

LOC & other, net
423

 
2,023

 

 
2,446

 
1,025

 
1,002,329

 
1,005,800

Leases and equipment finance, net
1,828

 
1,556

 

 
3,384

 
2,948

 
382,086

 
388,418

Residential
 
 
 
 
 
 
 
 
 
 
 
 

Mortgage, net
3,418

 

 
1,503

 
4,921

 

 
646,121

 
651,042

Home equity loans & lines, net
483

 
955

 
287

 
1,725

 

 
266,772

 
268,497

Consumer & other, net
100

 
11

 
74

 
185

 

 
48,029

 
48,214

Total, net of deferred fees and costs
$
13,895

 
$
15,521

 
$
2,269

 
$
31,685

 
$
37,884

 
$
7,341,539

 
$
7,411,108


(1) Other includes non-covered loans accounted for under ASC 310-30.


23

Table of Contents

(in thousands) 
 
December 31, 2013
 
Greater than
 
 
 
90 Days and
 
 
 
 
 
 
 
Total non-
 
30 to 59
 
60 to 89
 
Greater
 
 
 
 
 
 
 
covered
 
Days
 
Days
 
and
 
Total
 
Non-
 
Current &
 
Loans
 
Past Due
 
Past Due
 
Accruing
 
Past Due
 
accrual
 
Other (1)
 
and Leases
Commercial real estate
 

 
 

 
 

 
 

 
 

 
 

 
 

Non-owner occupied term, net
$
3,618

 
$
352

 
$

 
$
3,970

 
$
9,193

 
$
2,315,097

 
$
2,328,260

Owner occupied term, net
1,320

 
340

 
610

 
2,270

 
6,204

 
1,251,109

 
1,259,583

Multifamily, net

 

 

 

 
935

 
402,602

 
403,537

Construction & development, net

 

 

 

 

 
245,231

 
245,231

Residential development, net

 

 

 

 
2,801

 
85,612

 
88,413

Commercial
 
 
 
 
 

 

 
 
 
 
 
 
Term, net
901

 
1,436

 

 
2,337

 
8,723

 
759,785

 
770,845

LOC & other, net
619

 
224

 

 
843

 
1,222

 
985,295

 
987,360

Leases and equipment finance, net
2,202

 
1,706

 
517

 
4,425

 
2,813

 
354,353

 
361,591

Residential
 
 
 
 
 
 

 
 
 
 
 
 
Mortgage, net
1,050

 
342

 
2,070

 
3,462

 

 
593,739

 
597,201

Home equity loans & lines, net
473

 
563

 
160

 
1,196

 

 
263,073

 
264,269

Consumer & other, net
69

 
75

 
73

 
217

 

 
47,896

 
48,113

Total, net of deferred fees and costs
$
10,252

 
$
5,038

 
$
3,430

 
$
18,720

 
$
31,891

 
$
7,303,792

 
$
7,354,403


(1) Other includes non-covered loans accounted for under ASC 310-30.

Non-Covered Impaired Loans 

Loans with no related allowance reported generally represent non-accrual loans. The Bank recognizes the charge-off of impairment reserves on impaired loans in the period it arises for collateral dependent loans.  Therefore, the non-accrual loans as of March 31, 2014 have already been written-down to their estimated net realizable value and are expected to be resolved with no additional material loss, absent further decline in market prices.  The valuation allowance on impaired loans primarily represents the impairment reserves on performing restructured loans, and is measured by comparing the present value of expected future cash flows on the restructured loans discounted at the interest rate of the original loan agreement to the loan’s carrying value. 
 
At March 31, 2014 and December 31, 2013, impaired loans of $67.9 million and $68.8 million, respectively, were classified as accruing restructured loans. The restructurings were granted in response to borrower financial difficulty by providing for a modification of loan repayment terms. The restructured loans on accrual status represent the only impaired loans accruing interest at each respective date.  In order for a restructured loan to be considered for accrual status, the loan’s collateral coverage generally will be greater than or equal to 100% of the loan balance, the loan is current on payments, and the borrower must either prefund an interest reserve or demonstrate the ability to make payments from a verified source of cash flow. The Bank had obligations of $3.8 million to lend additional funds on restructured loans as of March 31, 2014

24

Table of Contents

 
The following table summarizes our non-covered impaired loans by loan class as of March 31, 2014 and December 31, 2013
 
(in thousands)
 
March 31, 2014
 
Unpaid
 
 
 
 
 
Principal
 
Recorded
 
Related
 
Balance
 
Investment
 
Allowance
With no related allowance recorded:
 
 
 
 
 
Commercial real estate
 
 
 
 
 
Non-owner occupied term, net
$
25,814

 
$
24,995

 
$

Owner occupied term, net
5,741

 
5,449

 

Multifamily, net
521

 
355

 

Construction & development, net
9,455

 
8,435

 

Residential development, net
6,684

 
6,684

 

Commercial
 
 
 
 
 
Term, net
19,549

 
11,964

 

LOC & other, net
3,720

 
1,025

 

Residential
 
 
 
 
 
Mortgage, net

 

 

Home equity loans & lines, net

 

 

Consumer & other, net

 

 

With an allowance recorded:
 
 
 
 
 
Commercial real estate
 
 
 
 
 
Non-owner occupied term, net
28,706

 
28,706

 
764

Owner occupied term, net
7,731

 
7,731

 
491

Multifamily, net

 

 

Construction & development, net
1,091

 
1,091

 
5

Residential development, net
7,744

 
7,744

 
83

Commercial
 
 
 
 
 
Term, net
300

 
300

 
11

LOC & other, net
1,252

 
1,252

 
4

Residential
 
 
 
 
 
Mortgage, net

 

 

Home equity loans & lines, net

 

 

Consumer & other, net

 

 

Total:
 
 
 
 
 
Commercial real estate, net
93,487

 
91,190

 
1,343

Commercial, net
24,821

 
14,541

 
15

Residential, net

 

 

Consumer & other, net

 

 

Total, net of deferred fees and costs
$
118,308

 
$
105,731

 
$
1,358

 
 

25

Table of Contents

(in thousands)
 
December 31, 2013
 
Unpaid
 
 
 
 
 
Principal
 
Recorded
 
Related
 
Balance
 
Investment
 
Allowance
With no related allowance recorded:
 
 
 
 
 
Commercial real estate
 
 
 
 
 
Non-owner occupied term, net
$
19,350

 
$
18,285

 
$

Owner occupied term, net
6,674

 
6,204

 

Multifamily, net
1,416

 
935

 

Construction & development, net
9,518

 
8,498

 

Residential development, net
12,347

 
5,776

 

Commercial
 
 
 
 
 
Term, net
22,750

 
8,723

 

LOC & other, net
5,886

 
1,222

 

Residential
 
 
 
 
 
Mortgage, net

 

 

Home equity loans & lines, net

 

 

Consumer & other, net

 

 

With an allowance recorded:
 
 
 
 
 
Commercial real estate
 
 
 
 
 
Non-owner occupied term, net
31,252

 
31,362

 
928

Owner occupied term, net
5,202

 
5,202

 
198

Multifamily, net

 

 

Construction & development, net
1,091

 
1,091

 
11

Residential development, net
10,166

 
11,927

 
648

Commercial
 
 
 
 
 
Term, net

 
300

 
8

LOC & other, net
1,258

 
1,258

 
4

Residential
 
 
 
 
 
Mortgage, net

 

 

Home equity loans & lines, net

 

 

Consumer & other, net

 

 

Total:
 
 
 
 
 
Commercial real estate, net
97,016

 
89,280

 
1,785

Commercial, net
29,894

 
11,503

 
12

Residential, net

 

 

Consumer & other, net

 

 

Total, net of deferred fees and costs
$
126,910

 
$
100,783

 
$
1,797




26

Table of Contents

The following table summarizes our average recorded investment and interest income recognized on impaired non-covered loans by loan class for the three months ended March 31, 2014 and 2013

(in thousands) 
 
Three months ended
 
Three months ended
 
March 31, 2014
 
March 31, 2013
 
Average
 
Interest
 
Average
 
Interest
 
Recorded
 
Income
 
Recorded
 
Income
 
Investment
 
Recognized
 
Investment
 
Recognized
With no related allowance recorded:
 
 
 
 
 
 
 
Commercial real estate
 
 
 
 
 
 
 
Non-owner occupied term, net
$
21,640

 
$

 
$
33,117

 
$

Owner occupied term, net
5,826

 

 
5,676

 

Multifamily, net
645

 

 
886

 

Construction & development, net
8,467

 

 
14,649

 

Residential development, net
6,230

 

 
10,515

 

Commercial
 
 
 
 
 
 
 
Term, net
10,343

 

 
11,795

 

LOC & other, net
1,123

 

 
5,478

 

Residential
 
 
 
 
 
 
 
Mortgage, net

 

 

 

Home equity loans & lines, net

 

 
175

 

Consumer & other, net

 

 
2

 

With an allowance recorded:
 
 
 
 
 
 
 
Commercial real estate
 
 
 
 
 
 
 
Non-owner occupied term, net
30,034

 
349

 
31,811

 
338

Owner occupied term, net
6,467

 
77

 
5,918

 
48

Multifamily, net

 

 

 

Construction & development, net
1,091

 
118

 
1,746

 
149

Residential development, net
9,835

 
159

 
17,069

 
163

Commercial
 
 
 
 
 
 
 
Term, net
300

 
4

 
1,959

 
42

LOC & other, net
1,255

 
13

 
1,033

 
11

Residential
 
 
 
 
 
 
 
Mortgage, net

 

 
145

 

Home equity loans & lines, net

 

 
64

 

Consumer & other, net

 

 

 

Total:
 
 
 
 
 
 
 
Commercial real estate, net
90,235

 
703

 
121,387

 
698

Commercial, net
13,021

 
17

 
20,265

 
53

Residential, net

 

 
384

 

Consumer & other, net

 

 
2

 

Total, net of deferred fees and costs
$
103,256

 
$
720

 
$
142,038

 
$
751


The impaired loans for which these interest income amounts were recognized primarily relate to accruing restructured loans. 
 
Non-Covered Credit Quality Indicators 
 

27

Table of Contents

As previously noted, the Bank's risk rating methodology assigns risk ratings ranging from 1 to 10, where a higher rating represents higher risk.  The Bank differentiates its lending portfolios into homogeneous loans and leases and non-homogeneous loans and leases. The 10 risk rating categories can be generally described by the following groupings for non-homogeneous loans and leases: 
 
Minimal Risk—A minimal risk loan or lease, risk rated 1, is to a borrower of the highest quality. The borrower has an unquestioned ability to produce consistent profits and service all obligations and can absorb severe market disturbances with little or no difficulty. 
 
Low Risk—A low risk loan or lease, risk rated 2, is similar in characteristics to a minimal risk loan.  Margins may be smaller or protective elements may be subject to greater fluctuation. The borrower will have a strong demonstrated ability to produce profits, provide ample debt service coverage and to absorb market disturbances. 
 
Modest Risk—A modest risk loan or lease, risk rated 3, is a desirable loan or lease with excellent sources of repayment and no currently identifiable risk associated with collection. The borrower exhibits a very strong capacity to repay the credit in accordance with the repayment agreement. The borrower may be susceptible to economic cycles, but will have reserves to weather these cycles. 
 
Average Risk—An average risk loan or lease, risk rated 4, is an attractive loan or lease with sound sources of repayment and no material collection or repayment weakness evident. The borrower has an acceptable capacity to pay in accordance with the agreement. The borrower is susceptible to economic cycles and more efficient competition, but should have modest reserves sufficient to survive all but the most severe downturns or major setbacks. 
 
Acceptable Risk—An acceptable risk loan or lease, risk rated 5, is a loan or lease with lower than average, but still acceptable credit risk. These borrowers may have higher leverage, less certain but viable repayment sources, have limited financial reserves and may possess weaknesses that can be adequately mitigated through collateral, structural or credit enhancement. The borrower is susceptible to economic cycles and is less resilient to negative market forces or financial events. Reserves may be insufficient to survive a modest downturn. 

Watch—A watch loan or lease, risk rated 6, is still pass-rated, but represents the lowest level of acceptable risk due to an emerging risk element or declining performance trend. Watch ratings are expected to be temporary, with issues resolved or manifested to the extent that a higher or lower rating would be appropriate. The borrower should have a plausible plan, with reasonable certainty of success, to correct the problems in a short period of time. Borrowers rated watch are characterized by elements of uncertainty, such as: 
Borrower may be experiencing declining operating trends, strained cash flows or less-than anticipated performance. Cash flow should still be adequate to cover debt service, and the negative trends should be identified as being of a short-term or temporary nature. 
The borrower may have experienced a minor, unexpected covenant violation. 
Companies who may be experiencing tight working capital or have a cash cushion deficiency. 
A loan or lease may also be a watch if financial information is late, there is a documentation deficiency, the borrower has experienced unexpected management turnover, or if they face industry issues that, when combined with performance factors create uncertainty in their future ability to perform. 
Delinquent payments, increasing and material overdraft activity, request for bulge and/or out-of-formula advances may be an indicator of inadequate working capital and may suggest a lower rating. 
Failure of the intended repayment source to materialize as expected, or renewal of a loan (other than cash/marketable security secured or lines of credit) without reduction are possible indicators of a watch or worse risk rating. 
 
Special Mention—A special mention loan or lease, risk rated 7, has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or the institutions credit position at some future date. They contain unfavorable characteristics and are generally undesirable. Loans and leases in this category are currently protected but are potentially weak and constitute an undue and unwarranted credit risk, but not to the point of a substandard classification. A special mention loan or lease has potential weaknesses, which if not checked or corrected, weaken the asset or inadequately protect the Bank’s position at some future date. Such weaknesses include: 
Performance is poor or significantly less than expected. There may be a temporary debt-servicing deficiency or inadequate working capital as evidenced by a cash cushion deficiency, but not to the extent that repayment is compromised. Material violation of financial covenants is common. 

28

Table of Contents

Loans or leases with unresolved material issues that significantly cloud the debt service outlook, even though a debt servicing deficiency does not currently exist. 
Modest underperformance or deviation from plan for real estate loans where absorption of rental/sales units is necessary to properly service the debt as structured. Depth of support for interest carry provided by owner/guarantors may mitigate and provide for improved rating. 
This rating may be assigned when a loan officer is unable to supervise the credit properly, an inadequate loan agreement, an inability to control collateral, failure to obtain proper documentation, or any other deviation from prudent lending practices. 
Unlike a substandard credit, there should be a reasonable expectation that these temporary issues will be corrected within the normal course of business, rather than liquidation of assets, and in a reasonable period of time. 
 
Substandard—A substandard asset, risk rated 8, is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified substandard. Loans and leases are classified as substandard when they have unsatisfactory characteristics causing unacceptable levels of risk. A substandard loan or lease normally has one or more well-defined weaknesses that could jeopardize repayment of the debt. The likely need to liquidate assets to correct the problem, rather than repayment from successful operations is the key distinction between special mention and substandard. The following are examples of well-defined weaknesses: 
• Cash flow deficiencies or trends are of a magnitude to jeopardize current and future payments with no immediate relief. A loss is not presently expected, however the outlook is sufficiently uncertain to preclude ruling out the possibility. 
• The borrower has been unable to adjust to prolonged and unfavorable industry or economic trends. 
• Material underperformance or deviation from plan for real estate loans where absorption of rental/sales units is necessary to properly service the debt and risk is not mitigated by willingness and capacity of owner/guarantor to support interest payments. 
• Management character or honesty has become suspect. This includes instances where the borrower has become uncooperative. 
• Due to unprofitable or unsuccessful business operations, some form of restructuring of the business, including liquidation of assets, has become the primary source of loan repayment. Cash flow has deteriorated, or been diverted, to the point that sale of collateral is now the Bank’s primary source of repayment (unless this was the original source of repayment). If the collateral is under the Bank’s control and is cash or other liquid, highly marketable securities and properly margined, then a more appropriate rating might be special mention or watch. 
• The borrower is bankrupt, or for any other reason, future repayment is dependent on court action. 
• There is material, uncorrectable faulty documentation or materially suspect financial information. 

Doubtful—Loans or leases classified as doubtful, risk rated 9, have all the weaknesses inherent in one classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. The possibility of loss is extremely high, but because of certain important and reasonably specific pending factors, which may work towards strengthening of the asset, classification as a loss (and immediate charge-off) is deferred until more exact status may be determined. Pending factors include proposed merger, acquisition, liquidation procedures, capital injection, and perfection of liens on additional collateral and refinancing plans. In certain circumstances, a doubtful rating will be temporary, while the Bank is awaiting an updated collateral valuation. In these cases, once the collateral is valued and appropriate margin applied, the remaining un-collateralized portion will be charged-off. The remaining balance, properly margined, may then be upgraded to substandard, however must remain on non-accrual. 
 
Loss—Loans or leases classified as loss, risk rated 10, are considered un-collectible and of such little value that the continuance as an active Bank asset is not warranted. This rating does not mean that the loan or lease has no recovery or salvage value, but rather that the loan or lease should be charged-off now, even though partial or full recovery may be possible in the future. 
 
Impaired—Loans are classified as impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal and interest when due, in accordance with the terms of the original loan agreement, without unreasonable delay. This generally includes all loans classified as non-accrual and troubled debt restructurings. Impaired loans are risk rated for internal and regulatory rating purposes, but presented separately for clarification. 
 

29

Table of Contents

Homogeneous loans and leases are not risk rated until they are greater than 30 days past due, and risk rating is based primarily on the past due status of the loan or lease.  The risk rating categories can be generally described by the following groupings for commercial and commercial real estate homogeneous loans and leases: 
 
Special Mention—A homogeneous special mention loan or lease, risk rated 7, is 30-59 days past due from the required payment date at month-end. 
 
Substandard—A homogeneous substandard loan or lease, risk rated 8, is 60-89 days past due from the required payment date at month-end. 
 
Doubtful—A homogeneous doubtful loan or lease, risk rated 9, is 90-179 days past due from the required payment date at month-end. 
 
Loss—A homogeneous loss loan or lease, risk rated 10, is 180 days and more past due from the required payment date. These loans are generally charged-off in the month in which the 180 day time period elapses. 
 
The risk rating categories can be generally described by the following groupings for residential and consumer and other homogeneous loans: 
 
Special Mention—A homogeneous retail special mention loan, risk rated 7, is 30-89 days past due from the required payment date at month-end. 
 
Substandard—A homogeneous retail substandard loan, risk rated 8, is an open-end loan 90-180 days past due from the required payment date at month-end or a closed-end loan 90-120 days past due from the required payment date at month-end. 
 
Loss—A homogeneous retail loss loan, risk rated 10, is a closed-end loan that becomes past due 120 cumulative days or an open-end retail loan that becomes past due 180 cumulative days from the contractual due date.   These loans are generally charged-off in the month in which the 120 or 180 day period elapses. 
 
The following table summarizes our internal risk rating by loan and lease class for the non-covered loan and lease portfolio as of March 31, 2014 and December 31, 2013
 
(in thousands)  
 
March 31, 2014
 
Pass/Watch
 
Special Mention
 
Substandard
 
Doubtful
 
Loss
 
Impaired
 
Total
Commercial real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-owner occupied term, net
$
2,068,165

 
$
95,323

 
$
94,763

 
$

 
$

 
$
53,701

 
$
2,311,952

Owner occupied term, net
1,206,791

 
28,483

 
34,028

 

 

 
13,180

 
1,282,482

Multifamily, net
385,668

 
4,280

 
10,624

 

 

 
355

 
400,927

Construction & development, net
212,460

 
3,957

 
3,319

 

 

 
9,526

 
229,262

Residential development, net
72,328

 
1,008

 
1,746

 

 

 
14,428

 
89,510

Commercial
 
 
 
 
 
 
 
 
 
 
 
 
 
Term, net
692,529

 
12,513

 
17,698

 

 

 
12,264

 
735,004

LOC & other, net
963,039

 
26,891

 
13,593

 

 

 
2,277

 
1,005,800

Leases and equipment finance, net
382,086

 
1,800

 
1,584

 
2,480

 
468

 

 
388,418

Residential
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage, net
646,095

 
3,430

 
354

 

 
1,163

 

 
651,042

Home equity loans & lines, net
266,768

 
1,441

 
65

 

 
223

 

 
268,497

Consumer & other, net
48,028

 
111

 
15

 

 
60

 

 
48,214

Total, net of deferred fees and costs
$
6,943,957

 
$
179,237

 
$
177,789

 
$
2,480

 
$
1,914

 
$
105,731

 
$
7,411,108



30

Table of Contents

(in thousands)
 
December 31, 2013
 
Pass/Watch
 
Special Mention
 
Substandard
 
Doubtful
 
Loss
 
Impaired
 
Total
Commercial real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-owner occupied term, net
$
2,073,366

 
$
108,263

 
$
96,984

 
$

 
$

 
$
49,647

 
$
2,328,260

Owner occupied term, net
1,182,865

 
27,615

 
37,524

 
173

 

 
11,406

 
1,259,583

Multifamily, net
385,335

 
5,574

 
11,693

 

 

 
935

 
403,537

Construction & development, net
230,262

 
2,054

 
3,326

 

 

 
9,589

 
245,231

Residential development, net
67,019

 
1,836

 
1,855

 

 

 
17,703

 
88,413

Commercial
 
 
 
 
 
 
 
 
 
 
 
 
 
Term, net
718,778

 
23,393

 
19,651

 

 

 
9,023

 
770,845

LOC & other, net
951,109

 
24,197

 
9,574

 

 

 
2,480

 
987,360

Leases and equipment finance, net
351,971

 
4,585

 
1,706

 
2,996

 
333

 

 
361,591

Residential
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage, net
593,723

 
1,405

 
743

 

 
1,330

 

 
597,201

Home equity loans & lines, net
263,070

 
1,038

 
25

 

 
136

 

 
264,269

Consumer & other, net
47,895

 
144

 
33

 

 
41

 

 
48,113

Total, net of deferred fees and costs
$
6,865,393

 
$
200,104

 
$
183,114

 
$
3,169

 
$
1,840

 
$
100,783

 
$
7,354,403

 
The percentage of non-covered impaired loans classified as watch, special mention, and substandard was 6.4%, 2.9%, and 90.6%, respectively, as of March 31, 2014. The percentage of non-covered impaired loans classified as watch, special mention, and substandard was 6.4%, 3.7%, and 89.9%, respectively, as of December 31, 2013
 
Troubled Debt Restructurings 
 
At March 31, 2014 and December 31, 2013, impaired loans of $67.9 million and $68.8 million, respectively, were classified as accruing restructured loans. The restructurings were granted in response to borrower financial difficulty, and generally provide for a temporary modification of loan repayment terms. The restructured loans on accrual status represent the only impaired loans accruing interest. In order for a restructured loan to be considered for accrual status, the loan’s collateral coverage generally will be greater than or equal to 100% of the loan balance, the loan is current on payments, and the borrower must either prefund an interest reserve or demonstrate the ability to make payments from a verified source of cash flow. Impaired restructured loans carry a specific allowance and the allowance on impaired restructured loans is calculated consistently across the portfolios. 

There were $3.8 million of available commitments for troubled debt restructurings outstanding as of March 31, 2014 and none as of December 31, 2013
 

31

Table of Contents

The following tables present troubled debt restructurings by accrual versus non-accrual status and by loan class as of March 31, 2014 and December 31, 2013

(in thousands) 
 
March 31, 2014
 
Accrual
 
Non-Accrual
 
Total
 
Status
 
Status
 
Modifications
Commercial real estate
 
 
 
 
 
Non-owner occupied term, net
$
34,684

 
$

 
$
34,684

Owner occupied term, net
7,731

 

 
7,731

Multifamily, net

 

 

Construction & development, net
9,527

 

 
9,527

Residential development, net
14,232

 

 
14,232

Commercial
 
 
 
 
 
Term, net

 
2,740

 
2,740

LOC & other, net
1,252

 

 
1,252

Residential
 
 
 
 
 
Mortgage, net
471

 

 
471

Home equity loans & lines, net

 

 

Consumer & other, net

 

 

Total, net of deferred fees and costs
$
67,897

 
$
2,740

 
$
70,637

 
(in thousands)
 
December 31, 2013
 
Accrual
 
Non-Accrual
 
Total
 
Status
 
Status
 
Modifications
Commercial real estate
 
 
 
 
 
Non-owner occupied term, net
$
37,366

 
$

 
$
37,366

Owner occupied term, net
5,202

 

 
5,202

Multifamily, net

 

 

Construction & development, net
9,590

 

 
9,590

Residential development, net
14,902

 
2,196

 
17,098

Commercial
 
 
 
 
 
Term, net

 
2,603

 
2,603

LOC & other, net
1,258

 

 
1,258

Residential
 
 
 
 
 
Mortgage, net
473

 

 
473

Home equity loans & lines, net

 

 

Consumer & other, net

 

 

Total, net of deferred fees and costs
$
68,791

 
$
4,799

 
$
73,590


The Bank’s policy is that loans placed on non-accrual will typically remain on non-accrual status until all principal and interest payments are brought current and the prospect for future payment in accordance with the loan agreement appears relatively certain.  The Bank’s policy generally refers to six months of payment performance as sufficient to warrant a return to accrual status. 
 
The types of modifications offered can generally be described in the following categories: 
 
Rate Modification—A modification in which the interest rate is modified. 
 

32

Table of Contents

Term Modification —A modification in which the maturity date, timing of payments, or frequency of payments is changed. 
 
Interest Only Modification—A modification in which the loan is converted to interest only payments for a period of time. 
 
Payment Modification—A modification in which the payment amount is changed, other than an interest only modification described above. 
 
Combination Modification—Any other type of modification, including the use of multiple types of modifications. 
 
There were no new non-covered restructured loans during the three months ended March 31, 2014. The following table presents newly non-covered restructured loans that occurred during the three months ended March 31, 2013
 
(in thousands)
 
Three months ended March 31, 2013
 
Rate
 
Term
 
Interest Only
 
Payment
 
Combination
 
Total
 
Modifications
 
Modifications
 
Modifications
 
Modifications
 
Modifications
 
Modifications
Commercial real estate
 
 
 
 
 
 
 
 
 
 
 
Non-owner occupied term, net
$

 
$

 
$
4,291

 
$

 
$

 
$
4,291

Owner occupied term, net

 

 

 

 

 

Multifamily, net

 

 

 

 

 

Construction & development, net

 

 

 

 

 

Residential development, net

 

 

 

 

 

Commercial
 
 
 
 
 
 
 
 
 
 
 
Term, net

 

 

 

 

 

LOC & other, net

 

 

 

 
452

 
452

Residential
 
 
 
 
 
 
 
 
 
 
 
Mortgage

 

 

 

 
289

 
289

Home equity loans & lines

 

 

 

 

 

Consumer & other

 

 

 

 

 

Total, net of deferred fees and costs
$

 
$

 
$
4,291

 
$

 
$
741

 
$
5,032

 
 
 
 
 
 
 
 
 
 
 
 
  
For the periods presented in the tables above, the outstanding recorded investment was the same pre and post modification. 
 
There were no financing receivables modified as troubled debt restructurings within the previous 12 months for which there was a payment default during the three months ended March 31, 2014 and 2013.

Note 6 – Covered Assets and Indemnification Asset 
 
Covered Loans 
Loans acquired in a FDIC-assisted acquisition that are subject to a loss-share agreement are referred to as “covered loans” and reported separately in our statements of financial condition. Covered loans are reported exclusive of the cash flow reimbursements expected from the FDIC. 
 
Acquired loans are valued as of acquisition date in accordance with ASC 805. Loans purchased with evidence of credit deterioration since origination for which it is probable that all contractually required payments will not be collected are accounted for under FASB ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (“ASC 310-30”).  Because of the significant fair value discounts associated with the acquired portfolios, the concentration of real estate related loans (to finance or secured by real estate collateral) and the decline in real estate values in the regions serviced, and after considering the underwriting standards of the acquired originating bank, the Company elected to account for all acquired loans under ASC 310-30.  Under ASC 805 and ASC 310-30, loans are to be recorded at fair value at acquisition date, factoring in credit losses expected to be incurred over the life of the loan. Accordingly, an allowance for loan losses is not

33

Table of Contents

carried over or recorded as of the acquisition date.  We have aggregated the acquired loans into various loan pools based on multiple layers of common risk characteristics for the purpose of determining their respective fair values as of their acquisition dates, and for applying the subsequent recognition and measurement provisions for income accretion and impairment testing. 
 
The covered loans acquired are, and will continue to be, subject to the Company’s internal and external credit review and monitoring. To the extent there is experienced or projected credit deterioration on the acquired loan pools subsequent to amounts estimated at the previous remeasurement date, this deterioration will be measured, and a provision for credit losses will be charged to earnings. Additionally, provision for credit losses will be recorded on advances on covered loans subsequent to acquisition date in a manner consistent with the allowance for non-covered loan and lease losses. These provisions will be mostly offset by an increase to the FDIC indemnification asset through the life of the loss sharing agreement, which is recognized in non-interest income. 
 
Covered Loans 
 
The following table presents the major types of covered loans as of March 31, 2014 and December 31, 2013
 
(in thousands) 
 
 
March 31, 2014
 
Evergreen
 
Rainier
 
Nevada Security
 
Total
Commercial real estate
 
 
 
 
 
 
 
Non-owner occupied term, net
$
30,251

 
$
113,584

 
$
55,983

 
$
199,818

Owner occupied term, net
18,532

 
14,778

 
16,177

 
49,487

Multifamily, net
1,973

 
18,508

 
7,081

 
27,562

Construction & development, net
1,511

 

 
1,935

 
3,446

Residential development, net
1,856

 

 
5,357

 
7,213

Commercial
 
 
 
 
 
 
 
Term, net
2,161

 
740

 
7,908

 
10,809

LOC & other, net
2,373

 
4,930

 
2,148

 
9,451

Residential
 
 
 
 
 
 
 
Mortgage, net
3,058

 
16,983

 
1,762

 
21,803

Home equity loans & lines, net
2,706

 
14,366

 
1,922

 
18,994

Consumer & other, net
938

 
3,062

 

 
4,000

Total, net of deferred fees and costs
$
65,359

 
$
186,951

 
$
100,273

 
$
352,583

Allowance for covered loans
 
 
 
 
 
 
(10,320
)
Total
 
 
 
 
 
 
$
342,263

 

34

Table of Contents

 
December 31, 2013
 
Evergreen
 
Rainier
 
Nevada Security
 
Total
Commercial real estate
 
 
 
 
 
 
 
Non-owner occupied term, net
$
29,019

 
$
117,076

 
$
60,807

 
$
206,902

Owner occupied term, net
18,582

 
14,711

 
16,524

 
49,817

Multifamily, net
7,626

 
22,210

 
7,835

 
37,671

Construction & development, net
1,506

 

 
1,949

 
3,455

Residential development, net
1,861

 

 
5,425

 
7,286

Commercial
 
 
 
 
 
 
 
Term, net
5,651

 
768

 
9,300

 
15,719

LOC & other, net
2,664

 
1,934

 
2,100

 
6,698

Residential
 
 
 
 
 
 
 
Mortgage, net
3,075

 
17,468

 
1,773

 
22,316

Home equity loans & lines, net
2,820

 
14,782

 
2,035

 
19,637

Consumer & other, net
954

 
3,308

 

 
4,262

Total, net of deferred fees and costs
$
73,758

 
$
192,257

 
$
107,748

 
$
373,763

Allowance for covered loans
 
 
 
 
 
 
(9,771
)
Total
 
 
 
 
 
 
$
363,992


The outstanding contractual unpaid principal balance, excluding purchase accounting adjustments, at March 31, 2014 was $82.1 million, $217.0 million and $133.0 million, for Evergreen, Rainier, and Nevada Security, respectively, as compared to $93.8 million, $224.1 million and $144.5 million, for Evergreen, Rainier, and Nevada Security, respectively, at December 31, 2013
 
In estimating the fair value of the covered loans at the acquisition date, we (a) calculated the contractual amount and timing of undiscounted principal and interest payments and (b) estimated the amount and timing of undiscounted expected principal and interest payments. The difference between these two amounts represents the nonaccretable difference. 
 
On the acquisition date, the amount by which the undiscounted expected cash flows exceed the estimated fair value of the acquired loans 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 loans. 
 
The following table presents the changes in the accretable yield for the three months ended March 31, 2014 and 2013 for each respective acquired loan portfolio:  
 

35

Table of Contents

(in thousands)
 
Three months ended March 31, 2014
 
Evergreen
 
Rainier
 
Nevada Security
 
Total
Balance, beginning of period
$
20,063

 
$
71,789

 
$
34,632

 
$
126,484

Accretion to interest income
(3,637
)
 
(4,281
)
 
(4,464
)
 
(12,382
)
Disposals
(1,240
)
 
(987
)
 
(1,630
)
 
(3,857
)
Reclassifications from nonaccretable difference
974

 
1,402

 
2,953

 
5,329

Balance, end of period
$
16,160

 
$
67,923

 
$
31,491

 
$
115,574

 
 
 
 
 
 
 
 
 
Three months ended March 31, 2013
 
Evergreen
 
Rainier
 
Nevada Security
 
Total
Balance, beginning of period
$
34,567

 
$
102,468

 
$
46,353

 
$
183,388

Accretion to interest income
(4,139
)
 
(5,864
)
 
(4,194
)
 
(14,197
)
Disposals
(236
)
 
(1,363
)
 
(1,331
)
 
(2,930
)
Reclassifications from nonaccretable difference
1,412

 
142

 
1,805

 
3,359

Balance, end of period
$
31,604

 
$
95,383

 
$
42,633

 
$
169,620

 
 
 
 
 
 
 
 
Allowance for Covered Loan Losses 
 
The following table summarizes activity related to the allowance for covered loan losses by covered loan portfolio segment for the three months ended March 31, 2014 and 2013
 
(in thousands)  
 
Three months ended March 31, 2014
 
Commercial
 
 
 
 
 
Consumer
 
 
 
Real Estate
 
Commercial
 
Residential
 
& Other
 
Total
Balance, beginning of period
$
6,105

 
$
2,837

 
$
660

 
$
169

 
$
9,771

Charge-offs
(346
)
 
(169
)
 
(118
)
 
(36
)
 
(669
)
Recoveries
391

 
121

 
115

 
20

 
647

Provision (recapture)
(79
)
 
680

 
(25
)
 
(5
)
 
571

Balance, end of period
$
6,071

 
$
3,469

 
$
632

 
$
148

 
$
10,320

 
 
 
 
 
 
 
 
 
 
 
Three months ended March 31, 2013
 
Commercial
 
 
 
 
 
Consumer
 
 
 
Real Estate
 
Commercial
 
Residential
 
& Other
 
Total
Balance, beginning of period
$
12,129

 
$
4,980

 
$
804

 
$
362

 
$
18,275

Charge-offs
(261
)
 
(328
)
 
(50
)
 
(178
)
 
(817
)
Recoveries
295

 
164

 
37

 
35

 
531

Provision (recapture)
211

 
51

 
(106
)
 
76

 
232

Balance, end of period
$
12,374

 
$
4,867

 
$
685

 
$
295

 
$
18,221



36

Table of Contents

 
 
 
 
 
 
 
 
 
 
The following table presents the allowance and recorded investment in covered loans by portfolio segment as of March 31, 2014 and 2013
 
(in thousands)  
 
March 31, 2014
 
Commercial
 
 
 
 
 
Consumer
 
 
 
Real Estate
 
Commercial
 
Residential
 
& Other
 
Total
Allowance for covered loans:
 
 
 
 
 
 
 
 
 
Loans acquired with deteriorated credit quality (1)
$
5,962

 
$
3,216

 
$
581

 
$
98

 
$
9,857

Collectively evaluated for impairment (2)
109

 
253

 
51

 
50

 
463

Total
$
6,071

 
$
3,469

 
$
632

 
$
148

 
$
10,320

Covered loans:
 
 
 
 
 
 
 
 
 
Loans acquired with deteriorated credit quality (1)
$
286,507

 
$
10,807

 
$
35,775

 
$
1,577

 
$
334,666

Collectively evaluated for impairment (2)
1,019

 
9,453

 
5,022

 
2,423

 
17,917

Total
$
287,526

 
$
20,260

 
$
40,797

 
$
4,000

 
$
352,583

 
 
March 31, 2013
 
Commercial
 
 
 
 
 
Consumer
 
 
 
Real Estate
 
Commercial
 
Residential
 
& Other
 
Total
Allowance for covered loans:
 
 
 
 
 
 
 
 
 
Loans acquired with deteriorated credit quality (1)
$
11,985

 
$
4,529

 
$
636

 
$
249

 
$
17,399

Collectively evaluated for impairment (2)
389

 
338

 
49

 
46

 
822

Total
$
12,374

 
$
4,867

 
$
685

 
$
295

 
$
18,221

Covered loans:
 
 
 
 
 
 
 
 
 
Loans acquired with deteriorated credit quality (1)
$
363,158

 
$
18,213

 
$
42,652

 
$
2,484

 
$
426,507

Collectively evaluated for impairment (2)
2,940

 
12,942

 
4,966

 
2,505

 
23,353

Total
$
366,098

 
$
31,155

 
$
47,618

 
$
4,989

 
$
449,860

 
(1) In accordance with ASC 310-30, the valuation allowance is netted against the carrying value of the covered loan balance.

(2) The allowance on covered loan losses includes an allowance on covered loan advances on acquired loans subsequent to acquisition.
 
The valuation allowance on covered loans was reduced by recaptured provision of $400,000 for the three months ended March 31, 2014, and $1.7 million for the three months ended March 31, 2013
 
Covered Credit Quality Indicators 
 
Covered loans are risk rated in a manner consistent with non-covered loans. As previously noted, the Bank’s risk rating methodology assigns risk ratings ranging from 1 to 10, where a higher rating represents higher risk.  The 10 risk rating groupings are described fully in Note 5. The following table includes loans acquired with deteriorated credit quality accounted for under ASC 310-30, and advances made subsequent to acquisition on covered loans.
 

37

Table of Contents

The following table summarizes our internal risk rating grouping by covered loans, net as of March 31, 2014 and December 31, 2013
 
(in thousands) 
 
 
March 31, 2014
 
 
 
Special
 
 
 
 
 
 
 
 
 
Pass/Watch
 
Mention
 
Substandard
 
Doubtful
 
Loss
 
Total
Commercial real estate
 
 
 
 
 
 
 
 
 
 
 
Non-owner occupied term, net
$
131,647

 
$
21,814

 
$
43,606

 
$

 
$

 
$
197,067

Owner occupied term, net
32,077

 
3,232

 
12,927

 
211

 

 
48,447

Multifamily, net
16,092

 
1,174

 
9,813

 

 

 
27,079

Construction & development, net
1,123

 

 
1,656

 

 

 
2,779

Residential development, net
482

 
222

 
5,317

 
62

 

 
6,083

Commercial
 
 
 
 
 
 
 
 
 
 
 
Term, net
3,710

 
915

 
2,981

 
255

 

 
7,861

LOC & other, net
7,321

 
209

 
1,399

 

 

 
8,929

Residential
 
 
 
 
 
 
 
 
 
 
 
Mortgage, net
21,664

 

 

 

 

 
21,664

Home equity loans & lines, net
18,405

 

 
97

 

 

 
18,502

Consumer & other, net
3,852

 

 

 

 

 
3,852

Total, net of deferred fees and costs
$
236,373

 
$
27,566

 
$
77,796

 
$
528

 
$

 
$
342,263


 
December 31, 2013
 
 
 
Special
 
 
 
 
 
 
 
 
 
Pass/Watch
 
Mention
 
Substandard
 
Doubtful
 
Loss
 
Total
Commercial real estate
 
 
 
 
 
 
 
 
 
 
 
Non-owner occupied term, net
$
133,452

 
$
26,321

 
$
44,279

 
$

 
$

 
$
204,052

Owner occupied term, net
30,119

 
3,370

 
14,971

 
213

 

 
48,673

Multifamily, net
24,213

 
2,563

 
10,409

 

 

 
37,185

Construction & development, net
1,117

 

 
1,686

 

 

 
2,803

Residential development, net
492

 
224

 
5,541

 
54

 

 
6,311

Commercial
 
 
 
 
 
 
 
 
 
 
 
Term, net
3,753

 
3,141

 
6,128

 
258

 

 
13,280

LOC & other, net
4,630

 
991

 
681

 

 

 
6,302

Residential
 
 
 
 
 
 
 
 
 
 
 
Mortgage, net
22,175

 

 

 

 

 
22,175

Home equity loans & lines, net
19,043

 

 
76

 

 

 
19,119

Consumer & other, net
4,092

 

 

 

 

 
4,092

Total, net of deferred fees and costs
$
243,086

 
$
36,610

 
$
83,771

 
$
525

 
$

 
$
363,992

 
Covered Other Real Estate Owned 
 
All other real estate owned (“OREO”) acquired in FDIC-assisted acquisitions that are subject to an FDIC loss-share agreement are referred to as “covered OREO” and reported separately in our statements of financial position. Covered OREO is reported exclusive of expected reimbursement cash flows from the FDIC. Foreclosed covered loan collateral is transferred into covered OREO at the collateral’s net realizable value, less selling costs. 
 
Covered OREO was initially recorded at its estimated fair value on the acquisition date based on similar market comparable valuations less estimated selling costs. Subsequent to acquisition, loan collateral transferred to OREO is at its net realizable

38

Table of Contents

value. Any subsequent valuation adjustments due to declines in fair value will be charged to non-interest expense, and will be mostly offset by non-interest income representing the corresponding increase to the FDIC indemnification asset for the offsetting loss reimbursement amount. Any recoveries of previous valuation adjustments will be credited to non-interest expense with a corresponding charge to non-interest income for the portion of the recovery that is due to the FDIC. 
 
The following table summarizes the activity related to the covered OREO for the three months ended March 31, 2014 and 2013
 
(in thousands)  
 
Three months ended
 
March 31,
 
2014
 
2013
Balance, beginning of period
$
2,102

 
$
10,374

Additions to covered OREO

 
1,741

Dispositions of covered OREO
(356
)
 
(3,665
)
Valuation adjustments in the period

 
(554
)
Balance, end of period
$
1,746

 
$
7,896


FDIC Indemnification Asset 
 
The Company has elected to account for amounts receivable under the loss-share agreement as an indemnification asset in accordance with FASB ASC 805, Business Combinations. The FDIC indemnification asset is initially recorded at fair value, based on the discounted value of expected future cash flows under the loss-share agreement. The difference between the present value and the undiscounted cash flows the Company expects to collect from the FDIC will be accreted into non-interest income over the life of the FDIC indemnification asset. 
 
Subsequent to initial recognition, the FDIC indemnification asset is reviewed quarterly and adjusted for any changes in expected cash flows based on recent performance and expectations for future performance of the covered assets. These adjustments are measured on the same basis as the related covered loans and covered OREO. Any increases in cash flow of the covered assets over those expected will reduce the FDIC indemnification asset and any decreases in cash flow of the covered assets under those expected will increase the FDIC indemnification asset. Increases and decreases to the FDIC indemnification asset are recorded as adjustments to non-interest income. The resulting carrying value of the indemnification asset represents the amounts recoverable from the FDIC for future expected losses, and the amounts due from the FDIC for claims related to covered losses the Company have incurred less amounts due back to the FDIC relating to shared recoveries. 
 
The following table summarizes the activity related to the FDIC indemnification asset for each respective acquired portfolio for the three months ended March 31, 2014 and 2013

(in thousands) 
 
Three months ended March 31, 2014
 
Evergreen
 
Rainier
 
Nevada Security
 
Total
Balance, beginning of period
$
5,209

 
$
8,016

 
$
9,949

 
$
23,174

Change in FDIC indemnification asset
(1,704
)
 
(1,410
)
 
(1,726
)
 
(4,840
)
Transfers to due from FDIC and other
58

 
(24
)
 
(6
)
 
28

Balance, end of period
$
3,563

 
$
6,582

 
$
8,217

 
$
18,362

 
 
 
 
 
 
 
 
 
Three months ended March 31, 2013
 
Evergreen
 
Rainier
 
Nevada Security
 
Total
Balance, beginning of period
$
14,876

 
$
15,110

 
$
22,812

 
$
52,798

Change in FDIC indemnification asset
(1,238
)
 
(1,568
)
 
(2,267
)
 
(5,073
)
Transfers to due from FDIC and other
(473
)
 
(513
)
 
(693
)
 
(1,679
)
Balance, end of period
$
13,165

 
$
13,029

 
$
19,852

 
$
46,046

 
 
 
 
 
 
 
 

39

Table of Contents

 
Note 7 – Mortgage Servicing Rights 
 
The following table presents the changes in the Company’s mortgage servicing rights (“MSR”) for the three months ended March 31, 2014 and 2013

(in thousands) 
 
Three months ended
 
March 31,
 
2014
 
2013
Balance, beginning of period
$
47,765

 
$
27,428

Additions for new MSR capitalized
2,408

 
6,403

Changes in fair value:
 
 
 
 Due to changes in model inputs or assumptions(1)
(1,087
)
 
(1,525
)
 Other(2)
134

 
(209
)
Balance, end of period
$
49,220

 
$
32,097

 
(1)
Principally reflects changes in discount rates and prepayment speed assumptions, which are primarily affected by changes in interest rates. 
(2)
Represents changes due to collection/realization of expected cash flows over time. 
 
Information related to our serviced loan portfolio as of March 31, 2014 and December 31, 2013 is as follows: 
 
(dollars in thousands)
 
March 31, 2014
 
December 31, 2013
Balance of loans serviced for others
$
4,496,662

 
$
4,362,499

MSR as a percentage of serviced loans
1.09
%
 
1.09
%
 
The amount of contractually specified servicing fees, late fees and ancillary fees earned, recorded in mortgage banking revenue on the Condensed Consolidated Statements of Income, was $3.0 million for the three months ended March 31, 2014, as compared to $2.2 million for the three months ended March 31, 2013
 
Key assumptions used in measuring the fair value of MSR as of March 31, 2014 and December 31, 2013 are as follows: 
 
 
March 31, 2014
 
December 31, 2013
Constant prepayment rate
13.59
%
 
12.74
%
Discount rate
8.70
%
 
8.69
%
Weighted average life (years)
5.7

 
6.0

 
  

A sensitivity analysis of the current fair value to changes in discount and prepayment speed assumptions as of March 31, 2014 and December 31, 2013 is as follows:
 
March 31, 2014
 
December 31, 2013
Constant prepayment rate
 
 
 
Effect on fair value of a 10% adverse change
$
(2,338
)
 
$
(2,255
)
Effect on fair value of a 20% adverse change
$
(4,479
)
 
$
(4,323
)
 
 
 
 
Discount rate
 
 
 
Effect on fair value of a 100 basis point adverse change
$
(1,817
)
 
$
(1,832
)
Effect on fair value of a 200 basis point adverse change
$
(3,503
)
 
$
(3,534
)


40

Table of Contents

The sensitivity analysis presents the hypothetical effect on fair value of the MSR. The effect of such hypothetical change in assumptions generally cannot be extrapolated because the relationship of the change in an assumption to the change in fair value is not linear. Additionally, in the analysis, the impact of an adverse change in one assumption is calculated independent of any impact on other assumptions. In reality, changes in one assumption may change another assumption.

Note 8 – OREO 
 
The following table presents the changes in non-covered OREO for the three months ended March 31, 2014 and 2013
 
(in thousands)
 
Three months ended
 
March 31,
 
2014
 
2013
Balance, beginning of period
$
21,833

 
$
17,138

Additions to OREO
1,878

 
5,689

Dispositions of OREO
(1,578
)
 
(3,785
)
Valuation adjustments in the period
(99
)
 
(369
)
Balance, end of period
$
22,034

 
$
18,673


Note 9 – Junior Subordinated Debentures 
 
Following is information about the Company’s wholly-owned trusts (“Trusts”) as of March 31, 2014
 
(dollars in thousands)
 
 
 
Issued
 
Carrying
 
 
 
Effective
 
 
 
 
Trust Name
Issue Date
 
Amount
 
Value (1)
 
Rate (2)
 
Rate (3)
 
Maturity Date
 
Redemption Date
AT FAIR VALUE:
 
 
 
 
 
 
 
 
 
 
 
 
 
Umpqua Statutory Trust II
October 2002
 
$
20,619

 
$
14,865

 
Floating (4)
 
4.97%
 
October 2032
 
October 2007
Umpqua Statutory Trust III
October 2002
 
30,928

 
22,499

 
Floating (5)
 
5.07%
 
November 2032
 
November 2007
Umpqua Statutory Trust IV
December 2003
 
10,310

 
7,019

 
Floating (6)
 
4.54%
 
January 2034
 
January 2009
Umpqua Statutory Trust V
December 2003
 
10,310

 
6,998

 
Floating (6)
 
4.54%
 
March 2034
 
March 2009
Umpqua Master Trust I
August 2007
 
41,238

 
22,887

 
Floating (7)
 
2.85%
 
September 2037
 
September 2012
Umpqua Master Trust IB
September 2007
 
20,619

 
13,532

 
Floating (8)
 
4.55%
 
December 2037
 
December 2012
 
 
 
134,024

 
87,800

 
 
 
 
 
 
 
 
AT AMORTIZED COST:
 
 
 
 
 
 
 
 
 
 
 
 
 
HB Capital Trust I
March 2000
 
5,310

 
6,203

 
10.875%
 
8.41%
 
March 2030
 
March 2010
Humboldt Bancorp Statutory Trust I
February 2001
 
5,155

 
5,809

 
10.200%
 
8.38%
 
February 2031
 
February 2011
Humboldt Bancorp Statutory Trust II
December 2001
 
10,310

 
11,257

 
Floating (9)
 
3.03%
 
December 2031
 
December 2006
Humboldt Bancorp Statutory Trust III
September 2003
 
27,836

 
30,313

 
Floating (10)
 
2.49%
 
September 2033
 
September 2008
CIB Capital Trust
November 2002
 
10,310

 
11,120

 
Floating (5)
 
3.02%
 
November 2032
 
November 2007
Western Sierra Statutory Trust I
July 2001
 
6,186

 
6,186

 
Floating (11)
 
3.82%
 
July 2031
 
July 2006
Western Sierra Statutory Trust II
December 2001
 
10,310

 
10,310

 
Floating (9)
 
3.83%
 
December 2031
 
December 2006
Western Sierra Statutory Trust III
September 2003
 
10,310

 
10,310

 
Floating (12)
 
3.14%
 
September 2033
 
September 2008
Western Sierra Statutory Trust IV
September 2003
 
10,310

 
10,310

 
Floating (12)
 
3.14%
 
September 2033
 
September 2008
 
 
 
96,037

 
101,818

 
 
 
 
 
 
 
 
 
Total
 
$
230,061

 
$
189,618

 
 
 
 
 
 
 
 
 

41

Table of Contents

(1)
Includes purchase accounting adjustments, net of accumulated amortization, for junior subordinated debentures assumed in connection with previous mergers as well as fair value adjustments related to trusts recorded at fair value. 
(2)
Contractual interest rate of junior subordinated debentures. 
(3)
Effective interest rate based upon the carrying value as of March 31, 2014
(4)
Rate based on LIBOR plus 3.35%, adjusted quarterly. 
(5)
Rate based on LIBOR plus 3.45%, adjusted quarterly. 
(6)
Rate based on LIBOR plus 2.85%, adjusted quarterly. 
(7)
Rate based on LIBOR plus 1.35%, adjusted quarterly. 
(8)
Rate based on LIBOR plus 2.75%, adjusted quarterly. 
(9)
Rate based on LIBOR plus 3.60%, adjusted quarterly.
(10)
 Rate based on LIBOR plus 2.95%, adjusted quarterly. 
(11)
 Rate based on LIBOR plus 3.58%, adjusted quarterly. 
(12)
 Rate based on LIBOR plus 2.90%, adjusted quarterly. 
 
The Trusts are reflected as junior subordinated debentures in the Condensed Consolidated Balance Sheets.  The common stock issued by the Trusts is recorded in other assets in the Condensed Consolidated Balance Sheets, and totaled $6.9 million at March 31, 2014 and December 31, 2013

On January 1, 2007, the Company selected the fair value measurement option for certain pre-existing junior subordinated debentures (the Umpqua Statutory Trusts). The remaining junior subordinated debentures as of the adoption date were acquired through business combinations and were measured at fair value at the time of acquisition. In 2007, the Company issued two series of trust preferred securities and elected to measure each instrument at fair value. Accounting for the junior subordinated debentures originally issued by the Company at fair value enables us to more closely align our financial performance with the economic value of those liabilities. Additionally, we believe it improves our ability to manage the market and interest rate risks associated with the junior subordinated debentures. The junior subordinated debentures measured at fair value and amortized cost are presented as separate line items on the balance sheet. The ending carrying (fair) value of the junior subordinated debentures measured at fair value represents the estimated amount that would be paid to transfer these liabilities in an orderly transaction amongst market participants under current market conditions as of the measurement date. 
 
The significant inputs utilized in the estimation of fair value of these instruments are the credit risk adjusted spread and three month LIBOR.  The credit risk adjusted spread represents the nonperformance risk of the liability, contemplating the inherent risk of the obligation.  Generally, an increase in the credit risk adjusted spread and/or a decrease in the three month LIBOR will result in positive fair value adjustments.  Conversely, a decrease in the credit risk adjusted spread and/or an increase in the three month LIBOR will result in negative fair value adjustments. 
 
Through the first quarter of 2010 we obtained valuations from a third-party pricing service to assist with the estimation and determination of fair value of these liabilities. In these valuations, the credit risk adjusted interest spread for potential new issuances through the primary market and implied spreads of these instruments when traded as assets on the secondary market, were estimated to be significantly higher than the contractual spread of our junior subordinated debentures measured at fair value. The difference between these spreads has resulted in the cumulative gain in fair value, reducing the carrying value of these instruments as reported on our Consolidated Balance Sheets. In July 2010, the Dodd-Frank Wall Street Reform and consumer Protection Act (the "Dodd-Frank Act") was signed into law which, among other things, limits the ability of certain bank holding companies to treat trust preferred security debt issuances as Tier 1 capital. This law may require many banks to raise new Tier 1 capital and has effectively closed the trust-preferred securities markets from offering new issuances in the future. As a result of this legislation, our third-party pricing service noted that they were no longer able to provide reliable fair value estimates related to these liabilities given the absence of observable or comparable transactions in the market place in recent history or as anticipated into the future. 
 
Due to inactivity in the junior subordinated debenture market and the inability to obtain observable quotes of our, or similar, junior subordinated debenture liabilities or the related trust preferred securities when traded as assets, we utilize an income approach valuation technique to determine the fair value of these liabilities using our estimation of market discount rate assumptions. The Company monitors activity in the trust preferred and related markets, to the extent available, changes related to the current and anticipated future interest rate environment, and considers our entity-specific creditworthiness, to validate the reasonableness of the credit risk adjusted spread and effective yield utilized in our discounted cash flow model.  Regarding the activity in and condition of the junior subordinated debt market, we noted no observable changes in the current period as it relates to companies comparable to our size and condition, in either the primary or secondary markets.  Relating to the interest rate environment, we considered the change in slope and shape of the forward LIBOR swap curve in the current period, the effects of which did not result in a significant change in the fair value of these liabilities. 
 

42

Table of Contents

The Company’s specific credit risk is implicit in the credit risk adjusted spread used to determine the fair value of our junior subordinated debentures. As our Company is not specifically rated by any credit agency, it is difficult to specifically attribute changes in our estimate of the applicable credit risk adjusted spread to specific changes in our own creditworthiness versus changes in the market’s required return from similar companies. As a result, these considerations must be largely based off of qualitative considerations as we do not have a credit rating and we do not regularly issue senior or subordinated debt that would provide us an independent measure of the changes in how the market quantifies our perceived default risk. 

On a quarterly basis we assess entity-specific qualitative considerations that if not mitigated or represents a material change from the prior reporting period may result in a change to the perceived creditworthiness and ultimately the estimated credit risk adjusted spread utilized to value these liabilities.  Entity-specific considerations that positively impact our creditworthiness include: our strong capital position resulting from our successful public stock offerings in 2009 and 2010 that offers us flexibility to pursue business opportunities such as mergers and  acquisitions, or expand our footprint and product offerings; having significant levels of on and off-balance sheet liquidity; being profitable (after excluding the one-time goodwill impairment charge recognized in 2009); and, having an experienced management team.  However, these positive considerations are mitigated by significant risks and uncertainties that impact our creditworthiness and ability to maintain capital adequacy in the future. Specific risks and concerns include: given our concentration of loans secured by real estate in our loan portfolio, a continued and sustained deterioration of the real estate market may result in declines in the value of the underlying collateral and increased delinquencies that could result in an increase of charge-offs; despite recent improvement, our credit quality metrics remain negatively elevated since 2007 relative to historical standards; the continuation of current economic downturn that has been particularly severe in our primary markets could adversely affect our business; recent increased regulation facing our industry, such as the Emergency Economic Stabilization Act of 2008, the American Recovery and Reinvestment Act of 2009 and the Dodd-Frank Act, will increase the cost of compliance and restrict our ability to conduct business consistent with historical practices, require that we hold additional capital and could negatively impact profitability; we have a significant amount of goodwill and other intangible assets that dilute our available tangible common equity; and the carrying value of certain material, recently recorded assets on our balance sheet, such as the FDIC loss-sharing indemnification asset, are highly reliant on management estimates, such as the timing or amount of losses that are estimated to be covered, and the assumed continued compliance with the provisions of the applicable loss-share agreement. To the extent assumptions ultimately prove incorrect or should we consciously forego or unknowingly violate the guidelines of the agreement, an impairment of the asset may result which would reduce capital. 
 
Additionally, the Company periodically utilizes an external valuation firm to determine or validate the reasonableness of the assessments of inputs and factors that ultimately determines the estimated fair value of these liabilities. The extent we involve or engage these external third parties correlates to management’s assessment of the current subordinated debt market, how the current environment and market compares to the preceding quarter, and perceived changes in the Company’s own creditworthiness during the quarter.  In periods of potential significant valuation changes and at year-end reporting periods we typically engage third parties to perform a full independent valuation of these liabilities.  For periods where management has assessed the market and other factors impacting the underlying valuation assumptions of these liabilities, and has determined significant changes to the valuation of these liabilities in the current period are remote, the scope of the valuation specialist’s review is limited to a review the reasonableness of management’s assessment of inputs.  Based on the procedures and methodology as described above, the Company has determined that the underlying inputs and assumptions have not materially changed since that last third-party independent valuation prepared in the fourth quarter of 2013.
 
Absent changes to the significant inputs utilized in the discounted cash flow model used to measure the fair value of these instruments at each reporting period, the cumulative discount for each junior subordinated debenture will reverse over time, ultimately returning the carrying values of these instruments to their notional values at their expected redemption dates, in a manner similar to the effective yield method as if these instruments were accounted for under the amortized cost method.  This will result in recognizing losses on junior subordinated debentures carried at fair value on a quarterly basis within non-interest income.  For the three months ended March 31, 2014 and March 31, 2013, we recorded losses of $542,000, resulting from the change in fair value of the junior subordinated debentures recorded at fair value. Observable activity in the junior subordinated debenture and related markets in future periods may change the effective rate used to discount these liabilities, and could result in additional fair value adjustments (gains or losses on junior subordinated debentures measured at fair value) outside the expected periodic change in fair value had the fair value assumptions remained unchanged. 
 
On July 2, 2013, the federal banking regulators approved the final proposed rules that revise the regulatory capital rules to incorporate certain revisions by the Basel Committee on Banking Supervision to the Basel capital framework ("Basel III"). Under the final rule, consistent with Section 171 of the Dodd-Frank Act, bank holding companies with less than $15 billion assets as of December 31, 2009 will be grandfathered and may continue to include these instruments in Tier 1 capital, subject to certain restrictions. However, if an institution grows above $15 billion as a result of an acquisition (as is the result of the the recently closed merger with Sterling), the combined trust preferred issuances must be phased out of Tier 1 and into Tier 2

43

Table of Contents

capital (75% in 2015 and 100% in 2016). It is possible the Company may accelerate redemption of the existing junior subordinated debentures.  This could result in adjustments to the fair value of these instruments including the acceleration of losses on junior subordinated debentures carried at fair value within non-interest income. The Company currently does not intend to redeem junior subordinated debentures in order to support regulatory total capital levels. At March 31, 2014, the Company's restricted core capital elements were 18.6% of total core capital, net of goodwill and any associated deferred tax liability.

Note 10 – Commitments and Contingencies 
 
Lease Commitments — As of March 31, 2014, the Bank leased 155 sites under non-cancelable operating leases. The leases contain various provisions for increases in rental rates, based either on changes in the published Consumer Price Index or a predetermined escalation schedule. Substantially all of the leases provide the Company with the option to extend the lease term one or more times following expiration of the initial term. 
 
Rent expense for the three months ended March 31, 2014 was $5.0 million and for the three months ended March 31, 2013 was $4.7 million. Rent expense was partially offset by rent income for the three months ended March 31, 2014 of $177,000 and for the three months ended March 31, 2013 of $255,000.
 
Financial Instruments with Off-Balance-Sheet Risk — The Company's financial statements do not reflect various commitments and contingent liabilities that arise in the normal course of the Bank's business and involve elements of credit, liquidity, and interest rate risk. 
 
The following table presents a summary of the Bank's commitments and contingent liabilities: 
 
(in thousands)
 
As of March 31, 2014
Commitments to extend credit
$
1,566,413

Commitments to extend overdrafts
$
179,360

Forward sales commitments
$
146,405

Commitments to originate loans held for sale
$
112,039

Standby letters of credit
$
52,736

 
The Bank is a party to financial instruments with off-balance-sheet credit risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit and financial guarantees. Those instruments involve elements of credit and interest-rate risk similar to the risk involved in on-balance sheet items recognized in the Condensed Consolidated Balance Sheets. The contract or notional amounts of those instruments reflect the extent of the Bank's involvement in particular classes of financial instruments. 
 
The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit, and financial guarantees written, is represented by the contractual notional amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. 
 
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any covenant or condition established in the applicable contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. While most standby letters of credit are not utilized, a significant portion of such utilization is on an immediate payment basis. The Bank evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if it is deemed necessary by the Bank upon extension of credit, is based on management's credit evaluation of the counterparty. Collateral varies but may include cash, accounts receivable, inventory, premises and equipment and income-producing commercial properties. 
 
Standby letters of credit and financial guarantees written are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. These guarantees are primarily issued to support public and private borrowing arrangements, including international trade finance, commercial paper, bond financing and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank holds cash, marketable securities, or real estate as collateral supporting those commitments for which collateral is deemed

44

Table of Contents

necessary. The Bank was not required to perform on any financial guarantees and there were no recoveries during the three months ended March 31, 2014.  The Bank was not required to perform on any financial guarantees and incurred $79,000 losses in connection with standby letters of credit during the three months ended March 31, 2013. At March 31, 2014, approximately $36.0 million of standby letters of credit expire within one year, and $16.7 million expire thereafter. Upon issuance, the Bank recognizes a liability equivalent to the amount of fees received from the customer for these standby letter of credit commitments. Fees are recognized ratably over the term of the standby letter of credit. The estimated fair value of guarantees associated with standby letters of credit was $119,000 as of March 31, 2014

Mortgage loans sold to investors may be sold with servicing rights retained, for which the Bank makes only standard legal representations and warranties as to meeting certain underwriting and collateral documentation standards. In the past two years, the Bank has had to repurchase fewer than 20 loans due to deficiencies in underwriting or loan documentation and has not realized significant losses related to these repurchases. Management believes that any liabilities that may result from such recourse provisions are not significant. 
 
Legal Proceedings—The Bank owns 468,659 shares of Class B common stock of Visa Inc. which are convertible into Class A common stock at a conversion ratio of 0.4206 per Class A share. As of March 31, 2014, the value of the Class A shares was $215.86 per share. Utilizing the conversion ratio, the value of unredeemed Class A equivalent shares owned by the Bank was $42.5 million as of March 31, 2014, and has not been reflected in the accompanying financial statements. The shares of Visa Inc. Class B common stock are restricted and may not be transferred. Visa member banks are required to fund an escrow account to cover settlements, resolution of pending litigation and related claims. If the funds in the escrow account are insufficient to settle all the covered litigation, Visa Inc. may sell additional Class A shares and use the proceeds to settle litigation, thereby reducing the conversion ratio.  If funds remain in the escrow account after all litigation is settled, the Class B conversion ratio will be increased to reflect that surplus. 
 
On July 13, 2012, Visa Inc. announced that it had entered into a memorandum of understanding obligating it to enter into a settlement agreement to resolve the multi-district interchange litigation brought by the class plaintiffs in the matter styled In re Payment Card Interchange Fee and Merchant Discount Antitrust Litigation, Case No. 5-MD-1720 (JG) (JO) pending in the U.S. District Court for the Eastern District of New York. The claims originally were brought by a class of U.S. retailers in 2005. The settlement was approved by the Court on December 13, 2013. However, the decision of the Court which granted approval to settlement is currently being appealed. Visa’s share of the settlement to be paid is estimated to be approximately $4.4 billion. However, certain trade associations and merchants are actively opposing the proposed settlement and it is unknown when or if the proposed settlement will be approved.  A fairness hearing was held on September 12, 2013 to determine if the settlement will be finally approved. It is not known when the Court will issue an order related to the motion for final approval of the settlement. The effect of this proposed settlement on the value of the Bank’s Class B common stock is unknown at this time. 
 
In the ordinary course of business, various claims and lawsuits are brought by and against the Company and its subsidiaries, including the Bank and Umpqua Investments. In the opinion of management, there is no pending or threatened proceeding in which an adverse decision could result in a material adverse change in the Company's consolidated financial condition or results of operations. 
 
Concentrations of Credit Risk— The Bank grants real estate mortgage, real estate construction, commercial, agricultural and installment loans and leases to customers throughout Oregon, Washington, California, and Nevada. In management’s judgment, a concentration exists in real estate-related loans, which represented approximately 74% of the Bank’s non-covered loan and lease portfolio at both March 31, 2014 and December 31, 2013.  Commercial real estate concentrations are managed to assure wide geographic and business diversity. Although management believes such concentrations have no more than the normal risk of collectability, a substantial decline in the economy in general, material increases in interest rates, changes in tax policies, tightening credit or refinancing markets, or a decline in real estate values in the Bank's primary market areas in particular, could have an adverse impact on the repayment of these loans.  Personal and business incomes, proceeds from the sale of real property, or proceeds from refinancing, represent the primary sources of repayment for a majority of these loans. 
 
The Bank recognizes the credit risks inherent in dealing with other depository institutions. Accordingly, to prevent excessive exposure to any single correspondent, the Bank has established general standards for selecting correspondent banks as well as internal limits for allowable exposure to any single correspondent. In addition, the Bank has an investment policy that sets forth limitations that apply to all investments with respect to credit rating and concentrations with an issuer.
  
Note 11 – Derivatives 
 
The Bank may use derivatives to hedge the risk of changes in the fair values of interest rate lock commitments, residential mortgage loans held for sale, and mortgage servicing rights. None of the Company’s derivatives are designated as hedging

45

Table of Contents

instruments.  Rather, they are accounted for as free-standing derivatives, or economic hedges, with changes in the fair value of the derivatives reported in income. The Company primarily utilizes forward interest rate contracts in its derivative risk management strategy. 

The Bank enters into forward delivery contracts to sell residential mortgage loans or mortgage-backed securities to broker/dealers at specific prices and dates in order to hedge the interest rate risk in its portfolio of mortgage loans held for sale and its residential mortgage loan commitments.  Credit risk associated with forward contracts is limited to the replacement cost of those forward contracts in a gain position.  There were no counterparty default losses on forward contracts in the three months ended March 31, 2014 and 2013.  Market risk with respect to forward contracts arises principally from changes in the value of contractual positions due to changes in interest rates. The Bank limits its exposure to market risk by monitoring differences between commitments to customers and forward contracts with broker/dealers. In the event the Company has forward delivery contract commitments in excess of available mortgage loans, the Company completes the transaction by either paying or receiving a fee to or from the broker/dealer equal to the increase or decrease in the market value of the forward contract. At March 31, 2014, the Bank had commitments to originate mortgage loans held for sale totaling $112.0 million and forward sales commitments of $146.4 million
 
The Bank’s mortgage banking derivative instruments do not have specific credit risk-related contingent features.  The forward sales commitments do have contingent features that may require transferring collateral to the broker/dealers upon their request. However, this amount would be limited to the net unsecured loss exposure at such point in time and would not materially affect the Company’s liquidity or results of operations. 
 
The Bank executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies.  Those interest rate swaps are simultaneously hedged by offsetting the interest rate swaps that the Bank executes with a third party, such that the Bank minimizes its net risk exposure. As of March 31, 2014, the Bank had 270 interest rate swaps with an aggregate notional amount of $1.4 billion related to this program. 
 
In connection with the interest rate swap program with commercial customers, the Bank has agreements with its derivative counterparties that contain a provision where if the Bank defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the Bank could also be declared in default on its derivative obligations. The Bank also has agreements with its derivative counterparties that contain a provision where if the Bank fails to maintain its status as a well/adequately capitalized institution, then the counterparty could terminate the derivative positions and the Bank would be required to settle its obligations under the agreements. Similarly, the Bank could be required to settle its obligations under certain of its agreements if specific regulatory events occur, such as if the Bank were issued a prompt corrective action directive or a cease and desist order, or if certain regulatory ratios fall below specified levels. If the Bank had breached any of these provisions at March 31, 2014, it could have been required to settle its obligations under the agreements at the termination value.
 
As of March 31, 2014, the termination value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements was $16.3 million.  The Bank has collateral posting requirements for initial or variation margins with its clearing members and clearing houses and has been required to post collateral against its obligations under these agreements of $26.5 million and $13.0 million as of March 31, 2014 and December 31, 2013, respectively. 
 
The fair value of the interest rate swaps is determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts).  The variable cash payments (or receipts) are based on the expectation of future interest rates (forward curves) derived from observed market interest rate curves. In addition, to comply with the provisions of ASC 820, the Bank incorporates credit valuation adjustments (“CVA”) to appropriately reflect nonperformance risk in the fair value measurements of its derivatives. The CVA is calculated by determining the total expected exposure of the derivatives (which incorporates both the current and potential future exposure) and then applying the counterparties’ credit spreads to the exposure. For derivatives with two-way exposure, specifically, the Bank’s interest rate swaps, the counterparty’s credit spread is applied to the Bank’s exposure to the counterparty, and the Bank’s own credit spread is applied to the counterparty’s exposure to the Bank, and the net CVA is reflected in the Bank’s derivative valuations. The total expected exposure of a derivative is derived using market-observable inputs, such as yield curves and volatilities. For the Bank’s own credit spread and for counterparties having publicly available credit information, the credit spreads over LIBOR used in the calculations represent implied credit default swap spreads obtained from a third party credit data provider. For counterparties without publicly available credit information, which are primarily commercial banking customers, the credit spreads over LIBOR used in the calculations are estimated by the Bank based on current market conditions, including consideration of current borrowing spreads for similar customers and transactions, review of existing collateralization or other credit enhancements, and changes in credit sector and entity-specific

46

Table of Contents

credit information. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Bank has considered the impact of netting and any applicable credit enhancements.  Effective January 1, 2012, the Company made an accounting policy election to use the exception commonly referred to as the “portfolio exception” with respect to measuring counterparty credit risk for its interest rate swap derivative instruments that are subject to master netting agreements with commercial banking customers that are hedged with offsetting interest rate swaps with third parties.

As of January 1, 2013, the Bank changed its valuation methodology for interest rate swap derivatives to discount cash flows based on Overnight Index Swap (“OIS”) rates. Fully collateralized trades are discounted using OIS with no additional economic adjustments to arrive at fair value. Uncollateralized or partially-collateralized trades are also discounted at OIS, but include appropriate economic adjustments for funding costs (e.g., a LIBOR-OIS basis adjustment to approximate uncollateralized cost of funds) and credit risk. The Company is making the changes to better align its inputs, assumptions, and pricing methodologies with those used in its principal market by most dealers and major market participants. The changes in valuation methodology are applied prospectively as a change in accounting estimate and are immaterial to the Company's financial statements.

As of March 31, 2014, the net CVA increased the settlement values of the Bank’s net derivative assets by $299,000. During the three months ended March 31, 2014, the Bank recognized a loss of $1.2 million and during the three months ended March 31, 2013, the Bank recognized a gain of $16,000 related to credit valuation adjustments on nonhedge derivative instruments, which is included in noninterest income. Various factors impact changes in the CVA over time, including changes in the credit spreads of the parties to the contracts, as well as changes in market rates and volatilities, which affect the total expected exposure of the derivative instruments. 
 
The following tables summarize the types of derivatives, separately by assets and liabilities, their locations on the Condensed Consolidated Balance Sheets, and the fair values of such derivatives as of March 31, 2014 and December 31, 2013
 
(in thousands)
 
 
 
 
Asset Derivatives
 
Liability Derivatives
Derivatives not designated
 
Balance Sheet
 
March 31,
 
December 31,
 
March 31,
 
December 31,
as hedging instrument
 
Location
 
2014
 
2013
 
2014
 
2013
Interest rate lock commitments
 
Other assets/Other liabilities
 
$
1,394

 
$
706

 
$

 
$

Interest rate forward sales commitments
 
Other assets/Other liabilities
 
330

 
1,250

 
72

 
6

Interest rate swaps
 
Other assets/Other liabilities
 
15,988

 
15,965

 
15,612

 
14,556

Total
 
 
 
$
17,712

 
$
17,921

 
$
15,684

 
$
14,562

 
The following table summarizes the types of derivatives, their locations within the Condensed Consolidated Statements of Income, and the gains (losses) recorded during the three months ended March 31, 2014 and 2013
 
(in thousands)
 
 
 
Three months ended
Derivatives not designated
 
Income Statement
March 31,
as hedging instrument
 
Location
2014
 
2013
Interest rate lock commitments
 
Mortgage banking revenue
$
688

 
$
2,467

Interest rate forward sales commitments
 
Mortgage banking revenue
(2,648
)
 
2,631

Interest rate swaps
 
Other income
(1,214
)
 
16

Total
 
 
$
(3,174
)
 
$
5,114

 

47

Table of Contents

The following table summarizes the offsetting derivatives assets that have a right of offset as of March 31, 2014 and December 31, 2013:

(in thousands)
 
 
 
 
 
 
 
 
Gross Amounts Not Offset in the Statement of Financial Position
 
 
 
 
Gross Amounts of Recognized Assets/Liabilities
 
Gross Amounts Offset in the Statement of Financial Position
 
Net Amounts of Assets/Liabilities presented in the Statement of Financial Position
 
Financial Instruments
 
Collateral Posted
 
Net Amount
March 31, 2014
 
 
 
 
 
 
 
 
 
 
 
 
Derivative Assets
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
 
$
15,988

 
$

 
$
15,988

 
$
(4,930
)
 
$
(6,550
)
 
$
4,508

Derivative Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
 
$
15,612

 
$

 
$
15,612

 
$
(4,930
)
 
$
(10,682
)
 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2013
 
 
 
 
 
 
 
 
 
 
 
 
Derivative Assets
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
 
$
15,965

 
$

 
$
15,965

 
$
(4,852
)
 
$
(2,207
)
 
$
8,906

Derivative Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
 
$
14,556

 
$

 
$
14,556

 
$
(4,852
)
 
$
(9,704
)
 
$


Note 12 – Shareholders’ Equity, Stock Compensation, and Share Repurchase Plan

At a special meeting on February 25, 2014, the Company's shareholders approved an amendment to the Company's articles of incorporation, effective on April 18, 2014 at the close of the Sterling merger, increasing the number of authorized shares of common stock to 400,000,000.

Stock-Based Compensation 
 
The compensation cost related to stock options, restricted stock and restricted stock units (included in salaries and employee benefits) was $1.5 million for the three months ended March 31, 2014, as compared to $1.2 million for the three months ended March 31, 2013. The total income tax benefit recognized related to stock-based compensation was $614,000 for the three months ended March 31, 2014 as compared to $474,000 for the three months ended March 31, 2013
 
The following table summarizes information about stock option activity for the three months ended March 31, 2014

(in thousands, except per share data)
 
Three months ended March 31, 2014
 
 
 
 
 
Weighted-Avg
 
 
 
Options
 
Weighted-Avg
 
Remaining Contractual
 
Aggregate
 
Outstanding
 
Exercise Price
 
Term (Years)
 
Intrinsic Value
Balance, beginning of period
981

 
$
16.17

 
 
 
 
Exercised
(222
)
 
$
11.77

 
 
 
 
Forfeited/expired

 
$

 
 
 
 
Balance, end of period
759

 
$
17.45

 
3.7
 
$
2,818

Options exercisable, end of period
662

 
$
18.21

 
3.3
 
$
2,200

 
The total intrinsic value (which is the amount by which the stock price exceeded the exercise price on the date of exercise) of options exercised during the three months ended March 31, 2014 was $1.4 million, as compared to the three months ended March 31, 2013 of $7,000.

48

Table of Contents


During the three months ended March 31, 2014, the amount of cash received from the exercise of stock options was $897,000, as compared to the three months ended March 31, 2013 of $22,000. Total consideration was $2.6 million for the three months ended March 31, 2014, as compared to the three months ended March 31, 2013 of $33,000.
 
The fair value of each option grant is estimated as of the grant date using the Black-Scholes option-pricing model.  There were no stock options granted in the three months ended March 31, 2014 and 2013. 
 
 
The Company grants restricted stock periodically for the benefit of employees and directors. Restricted shares issued prior to 2011 generally vest on an annual basis over five years. Restricted shares issued since 2011 generally vest over a three year period, subject to time or time plus performance vesting conditions.  The following table summarizes information about nonvested restricted share activity for the three months ended March 31, 2014
 
(in thousands, except per share data)
 
Three months ended March 31, 2014
 
Restricted
 
Weighted
 
Shares
 
Average Grant
 
Outstanding
 
Date Fair Value
Balance, beginning of period
992

 
$
12.79

Granted
317

 
$
17.31

Released
(311
)
 
$
11.86

Forfeited/expired
(7
)
 
$
14.28

Balance, end of period
991

 
$
14.51


The total fair value of restricted shares vested and released during the three months ended March 31, 2014 was $5.5 million as compared to the three months ended March 31, 2013 of $1.3 million
 
The Company granted restricted stock units as a part of the 2007 Long Term Incentive Plan for the benefit of certain executive officers.  Restricted stock unit grants are subject to performance-based vesting as well as other approved vesting conditions.  The total number of restricted stock units granted represents the maximum number of restricted stock units eligible to vest based upon the performance and service conditions set forth in the grant agreements.  There were 70,000 restricted stock units vested and released and none forfeited during the three months ended March 31, 2014. There are 20,000 restricted stock units with a weighted average grant date fair value of $10.39 that remain outstanding at March 31, 2014.
 
As of March 31, 2014, there was $497,000 of total unrecognized compensation cost related to nonvested stock options which is expected to be recognized over a weighted-average period of 1.4 years.  As of March 31, 2014, there was $9.8 million of total unrecognized compensation cost related to nonvested restricted stock which is expected to be recognized over a weighted-average period of 1.9 years. As of March 31, 2014, there was $57,000 of total unrecognized compensation cost related to nonvested restricted stock units which is expected to be recognized over a weighted-average period of 0.8 years, assuming expected performance conditions are met. 
 
For the three months ended March 31, 2014, the Company received income tax benefits of $3.3 million, as compared to the three months ended March 31, 2013 of $517,000 related to the exercise of non-qualified employee stock options, disqualifying dispositions on the exercise of incentive stock options, the vesting of restricted shares and the vesting of restricted stock units. In the three months ended March 31, 2014, the Company had net excess tax benefit (tax benefit resulting from tax deductions greater than the compensation cost recognized) of $1.1 million, compared to $10,000 for the three months ended March 31, 2013.  Only gross excess tax benefits are classified as financing cash flows.

At the annual meeting on April 16, 2013, shareholders approved the Company's 2013 Incentive Plan (the “2013 Plan”), which, among other things, authorizes the issuance of equity awards to directors and employees and reserves 4,000,000 shares of the Company's common stock for issuance under the plan. With the adoption of the 2013 Plan, no additional awards will be issued from the 2003 Stock Incentive Plan or the 2007 Long Term Incentive Plan.


49

Table of Contents

Note 13 – Income Taxes 
 
The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction, as well as the Oregon and California state jurisdictions.  Additionally, as a result of the FinPac acquisition, the Company will now be subject to filings in the majority of states and in Canada. The Company is no longer subject to U.S. federal or other state tax authority examinations for years before 2011, except in California for years before 2005 and for Canadian tax authority examinations for years before 2012.  During 2013, the Internal Revenue Service concluded an examination of the Company’s U.S. income tax returns through 2010.  The results of these examinations had no significant impact on the Company’s financial statements. 
 
The Company had gross unrecognized tax benefits relating to California tax incentives of $602,000 recorded as of March 31, 2014.  If recognized, the unrecognized tax benefit would reduce the 2014 annual effective tax rate by 0.5%.  During the three months ended March 31, 2014, the Company accrued $6,000 of interest relating to its liability for unrecognized tax benefits.  Interest on unrecognized tax benefits is reported by the Company as a component of tax expense.  As of March 31, 2014, the accrued interest related to unrecognized tax benefits was $198,000.
  
Note 14 – Earnings Per Common Share  
 
Nonvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents are participating securities and are included in the computation of earnings per share pursuant to the two-class method.  The two-class method is an earnings allocation formula that determines earnings per share for each class of common stock and participating security according to dividends declared (or accumulated) and participation rights in undistributed earnings. Certain of the Company’s nonvested restricted stock awards qualify as participating securities. 
 
Net earnings is allocated between the common stock and participating securities pursuant to the two-class method.  Basic earnings per common share is computed by dividing net earnings available to common shareholders by the weighted average number of common shares outstanding during the period, excluding participating nonvested restricted shares. 
 
Diluted earnings per common share is computed in a similar manner, except that first the denominator is increased to include the number of additional common shares that would have been outstanding if potentially dilutive common shares, excluding the participating securities, were issued using the treasury stock method. For all periods presented, stock options, certain restricted stock awards and restricted stock units are the only potentially dilutive non-participating instruments issued by the Company.  Next, we determine and include in diluted earnings per common share calculation the more dilutive effect of the participating securities using the treasury stock method or the two-class method. Undistributed losses are not allocated to the nonvested share-based payment awards (the participating securities) under the two-class method as the holders are not contractually obligated to share in the losses of the Company. 
 
The following is a computation of basic and diluted earnings per common share for the three months ended March 31, 2014 and 2013
 
(in thousands, except per share data)

50

Table of Contents

 
Three months ended
 
March 31,
 
2014
 
2013
NUMERATORS:
 
 
 
Net income
$
18,764

 
$
23,361

Less:
 
 
 
Dividends and undistributed earnings allocated to participating securities (1)
113

 
183

Net earnings available to common shareholders
$
18,651

 
$
23,178

DENOMINATORS:
 
 
 
Weighted average number of common shares outstanding - basic
112,170

 
111,937

Effect of potentially dilutive common shares (2)
197

 
181

Weighted average number of common shares outstanding - diluted
112,367

 
112,118

EARNINGS PER COMMON SHARE:
 
 
 
Basic
$
0.17

 
$
0.21

Diluted
$
0.17

 
$
0.21

 
(1)
Represents dividends paid and undistributed earnings allocated to nonvested restricted stock awards. 
(2)
Represents the effect of the assumed exercise of stock options, vesting of non-participating restricted shares, and vesting of restricted stock units, based on the treasury stock method. 

The following table presents the weighted average outstanding securities that were not included in the computation of diluted earnings per common share because their effect would be anti-dilutive for the three months ended March 31, 2014 and 2013
 
(in thousands)
 
Three months ended
 
March 31,
 
2014
 
2013
Stock options
336

 
1,069

 
Note 15 – Segment Information 
 
The Company operates three primary segments: Community Banking, Home Lending and Wealth Management. The Community Banking segment's principal business focus is the offering of loan and deposit products to business and retail customers in its primary market areas. As of March 31, 2014, the Community Banking segment operated 204 locations throughout Oregon, California, Washington, and Nevada.  
 
The Home Lending segment, which operates as a division of the Bank, originates, sells and services residential mortgage loans.  
 
The Wealth Management segment consists of the operations of Umpqua Investments, which offers a full range of retail brokerage services and products to its clients who consist primarily of individual investors, and Umpqua Private Bank, which serves high net worth individuals with liquid investable assets and provides customized financial solutions and offerings. The Company accounts for intercompany fees and services between Umpqua Investments and the Bank at estimated fair value according to regulatory requirements for services provided.  Intercompany items relate primarily to management services, referral fees and deposit rebates. 
  
Summarized financial information concerning the Company's reportable segments and the reconciliation to the consolidated financial results is shown in the following tables: 
 

51

Table of Contents

Segment Information 
 
 
(in thousands)
 
Three months ended March 31, 2014
 
Community
 
Wealth
 
Home
 
 
 
Banking
 
Management
 
Lending
 
Consolidated
Interest income
$
106,603

 
$
3,553

 
$
5,724

 
$
115,880

Interest expense
7,315

 
173

 
554

 
8,042

Net interest income
99,288

 
3,380

 
5,170

 
107,838

Provision for non-covered loan and lease losses
5,400

 

 

 
5,400

Provision for covered loan losses
571

 

 

 
571

Non-interest income
8,522

 
3,965

 
10,520

 
23,007

Non-interest expense
84,540

 
4,794

 
7,184

 
96,518

Income before income taxes
17,299

 
2,551

 
8,506

 
28,356

Provision for income taxes
5,170

 
1,020

 
3,402

 
9,592

Net income
12,129

 
1,531

 
5,104

 
18,764

Dividends and undistributed earnings allocated
 
 
 
 
 
 
 
to participating securities
113

 

 

 
113

Net earnings available to common shareholders
$
12,016

 
$
1,531

 
$
5,104

 
$
18,651


(in thousands)
 
Three months ended March 31, 2013
 
Community
 
Wealth
 
Home
 
 
 
Banking
 
Management
 
Lending
 
Consolidated
Interest income
$
95,011

 
$
3,724

 
$
5,598

 
$
104,333

Interest expense
9,281

 
190

 
673

 
10,144

Net interest income
85,730

 
3,534

 
4,925

 
94,189

Provision for non-covered loan and lease losses
6,988

 

 

 
6,988

Provision for covered loan losses
232

 

 

 
232

Non-interest income
6,496

 
3,790

 
23,729

 
34,015

Non-interest expense
71,458

 
4,002

 
10,302

 
85,762

Income before income taxes
13,548

 
3,322

 
18,352

 
35,222

Provision for income taxes
3,191

 
1,329

 
7,341

 
11,861

Net income
10,357

 
1,993

 
11,011

 
23,361

Dividends and undistributed earnings allocated
 
 
 
 
 
 
 
to participating securities
183

 

 

 
183

Net earnings available to common shareholders
$
10,174

 
$
1,993

 
$
11,011

 
$
23,178


(in thousands)
 
March 31, 2014
 
Community
 
Wealth
 
Home
 
 
 
Banking
 
Management
 
Lending
 
Consolidated
Total assets
$
10,993,095

 
$
139,008

 
$
706,623

 
$
11,838,726

Total loans and leases (covered and non-covered)
$
7,049,228

 
$
122,883

 
$
581,260

 
$
7,753,371

Total deposits
$
8,883,658

 
$
356,787

 
$
33,138

 
$
9,273,583



52

Table of Contents

(in thousands)
 
December 31, 2013
 
Community
 
Wealth
 
Home
 
 
 
Banking
 
Management
 
Lending
 
Consolidated
Total assets
$
10,822,990

 
$
126,060

 
$
687,062

 
$
11,636,112

Total loans and leases (covered and non-covered)
$
7,076,279

 
$
110,087

 
$
532,029

 
$
7,718,395

Total deposits
$
8,734,175

 
$
356,784

 
$
26,701

 
$
9,117,660

   
Note 16 – Fair Value Measurement 
 
The following table presents estimated fair values of the Company’s financial instruments as of March 31, 2014 and December 31, 2013, whether or not recognized or recorded at fair value in the Condensed Consolidated Balance Sheets
 
(in thousands)
 
March 31, 2014
 
December 31, 2013
 
Carrying
 
Fair
 
Carrying
 
Fair
 
Value
 
Value
 
Value
 
Value
FINANCIAL ASSETS:
 
 
 
 
 
 
 
Cash and cash equivalents
$
1,085,108

 
$
1,085,108

 
$
790,423

 
$
790,423

Trading securities
4,498

 
4,498

 
5,958

 
5,958

Securities available for sale
1,701,730

 
1,701,730

 
1,790,978

 
1,790,978

Securities held to maturity
5,465

 
5,790

 
5,563

 
5,874

Loans held for sale, at fair value
73,106

 
73,106

 
104,664

 
104,664

Non-covered loans and leases, net
7,324,399

 
7,310,441

 
7,269,089

 
7,250,596

Covered loans, net
342,263

 
383,114

 
363,992

 
409,555

Restricted equity securities
29,948

 
29,948

 
30,685

 
30,685

Mortgage servicing rights
49,220

 
49,220

 
47,765

 
47,765

Bank owned life insurance assets
97,589

 
97,589

 
96,938

 
96,938

FDIC indemnification asset
18,362

 
4,363

 
23,174

 
6,001

Derivatives
17,712

 
17,712

 
17,921

 
17,921

Visa Class B common stock

 
40,422

 

 
41,700

FINANCIAL LIABILITIES:
 
 
 
 
 
 
 
Deposits
$
9,273,583

 
$
9,280,543

 
$
9,117,660

 
$
9,125,832

Securities sold under agreements to repurchase
262,483

 
262,483

 
224,882

 
224,882

Term debt
250,964

 
273,750

 
251,494

 
270,004

Junior subordinated debentures, at fair value
87,800

 
87,800

 
87,274

 
87,274

Junior subordinated debentures, at amortized cost
101,818

 
72,440

 
101,899

 
72,009

Derivatives
15,684

 
15,684

 
14,562

 
14,562

 


53

Table of Contents

Fair Value of Assets and Liabilities Not Measured at Fair Value 

The following table presents information about the level in the fair value hierarchy for the Company’s assets and liabilities that are not measured at fair value as of March 31, 2014 and December 31, 2013
 
(in thousands)
 
March 31, 2014
Description
Total
 
Level 1
 
Level 2
 
Level 3
ASSETS
 
 
 
 
 
 
 
Cash and cash equivalents
$
1,085,108

 
$
1,085,108

 
$

 
$

Securities held to maturity
4,498

 

 

 
4,498

Non-covered loans and leases, net
7,310,441

 

 

 
7,310,441

Covered loans, net
383,114

 

 

 
383,114

Restricted equity securities
29,948

 
29,948

 

 

Bank owned life insurance assets
97,589

 
97,589

 

 

FDIC indemnification asset
4,363

 

 

 
4,363

Visa Class B common stock
40,422

 

 

 
40,422

LIABILITIES
 
 
 
 
 
 
 
Deposits
 
 
 
 
 
 
 
Non-maturity deposits
$
7,752,846

 
$
7,752,846

 
$

 
$

Deposits with stated maturities
1,527,697

 

 
1,527,697

 

Securities sold under agreements to repurchase
262,483

 

 
262,483

 

Term debt
273,750

 

 
273,750

 

Junior subordinated debentures, at amortized cost
72,440

 

 

 
72,440


(in thousands)
 
December 31, 2013
Description
Total
 
Level 1
 
Level 2
 
Level 3
ASSETS
 
 
 
 
 
 
 
Cash and cash equivalents
$
790,423

 
$
790,423

 
$

 
$

Securities held to maturity
5,958

 

 

 
5,958

Non-covered loans and leases, net
7,250,596

 

 

 
7,250,596

Covered loans, net
409,555

 

 

 
409,555

Restricted equity securities
30,685

 
30,685

 

 

Bank owned life insurance assets
96,938

 
96,938

 

 

FDIC indemnification asset
6,001

 

 

 
6,001

Visa Class B common stock
41,700

 

 

 
41,700

LIABILITIES
 
 
 
 
 
 
 
Deposits
 
 
 
 
 
 
 
Non-maturity deposits
$
7,580,192

 
$
7,580,192

 
$

 
$

Deposits with stated maturities
1,545,640

 

 
1,545,640

 

Securities sold under agreements to repurchase
224,882

 

 
224,882

 

Term debt
270,004

 

 
270,004

 

Junior subordinated debentures, at amortized cost
72,009

 

 

 
72,009







54

Table of Contents

Fair Value of Assets and Liabilities Measured on a Recurring Basis 
 
The following tables present information about the Company’s assets and liabilities measured at fair value on a recurring basis as of March 31, 2014 and December 31, 2013
 
(in thousands)
 
March 31, 2014
Description
Total
 
Level 1
 
Level 2
 
Level 3
Trading securities
 
 
 
 
 
 
 
Obligations of states and political subdivisions
$
401

 
$

 
$
401

 
$

Equity securities
4,002

 
4,002

 

 

Other investments securities(1)
95

 

 
95

 

Available for sale securities
 
 
 
 
 
 
 
U.S. Treasury and agencies
261

 

 
261

 

Obligations of states and political subdivisions
229,679

 

 
229,679

 

Residential mortgage-backed securities and
 
 
 
 
 
 
 
 collateralized mortgage obligations
1,469,816

 

 
1,469,816

 

Other debt securities

 

 

 

Investments in mutual funds and other equity securities
1,974

 

 
1,974

 

Loans held for sale, at fair value
73,106

 
 
 
73,106

 
 
Mortgage servicing rights, at fair value
49,220

 

 

 
49,220

Derivatives
 
 
 
 
 
 
 
Interest rate lock commitments
1,394

 

 

 
1,394

Interest rate forward sales commitments
330

 

 
330

 

Interest rate swaps
15,988

 

 
15,988

 

Total assets measured at fair value
$
1,846,266

 
$
4,002

 
$
1,791,650

 
$
50,614

Junior subordinated debentures, at fair value
$
87,800

 
$

 
$

 
$
87,800

Derivatives
 
 
 
 
 
 
 
Interest rate lock commitments

 

 

 

Interest rate forward sales commitments
72

 

 
72

 

Interest rate swaps
15,612

 

 
15,612

 

Total liabilities measured at fair value
$
103,484

 
$

 
$
15,684

 
$
87,800


55

Table of Contents

(in thousands)
 
December 31, 2013
Description
Total
 
Level 1
 
Level 2
 
Level 3
Trading securities
 
 
 
 
 
 
 
Obligations of states and political subdivisions
$
2,366

 
$

 
$
2,366

 
$

Equity securities
3,498

 
3,498

 

 

Other investments securities(1)
94

 

 
94

 

Available for sale securities
 
 
 
 
 
 
 
U.S. Treasury and agencies
268

 

 
268

 

Obligations of states and political subdivisions
235,205

 

 
235,205

 

Residential mortgage-backed securities and
 
 
 
 
 
 
 
collateralized mortgage obligations
1,553,541

 

 
1,553,541

 

Other debt securities

 

 

 

Investments in mutual funds and other equity securities
1,964

 

 
1,964

 

Loans held for sale, at fair value
104,664

 
 
 
104,664

 
 
Mortgage servicing rights, at fair value
47,765

 

 

 
47,765

Derivatives
 
 
 
 
 
 
 
Interest rate lock commitments
706

 

 

 
706

Interest rate forward sales commitments
1,250

 

 
1,250

 

Interest rate swaps
15,965

 

 
15,965

 

Total assets measured at fair value
$
1,967,286

 
$
3,498

 
$
1,915,317

 
$
48,471

Junior subordinated debentures, at fair value
$
87,274

 
$

 
$

 
$
87,274

Derivatives
 
 
 
 
 
 
 
Interest rate lock commitments

 

 

 

Interest rate forward sales commitments
6

 

 
6

 

Interest rate swaps
14,556

 

 
14,556

 

Total liabilities measured at fair value
$
101,836

 
$

 
$
14,562

 
$
87,274

 
(1)
Principally represents U.S. Treasury and agencies or residential mortgage-backed securities issued or guaranteed by governmental agencies. 
 
The following methods were used to estimate the fair value of each class of financial instrument above: 
 
Cash and Cash Equivalents—For short-term instruments, including cash and due from banks, and interest bearing deposits with banks, the carrying amount is a reasonable estimate of fair value. 
 
Securities— Fair values for investment securities are based on quoted market prices when available or through the use of alternative approaches, such as matrix or model pricing, or broker indicative bids, when market quotes are not readily accessible or available. 
 
Loans Held for Sale— Fair value is determined based on quoted secondary market prices for similar loans, including the implicit fair value of embedded servicing rights.
 
Non-covered Loans and Leases - Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type, including commercial, real estate and consumer loans. Each loan category is further segregated by fixed and adjustable rate loans. The fair value of loans is calculated by discounting expected cash flows at rates which similar loans are currently being made. These amounts are discounted further by embedded probable losses expected to be realized in the portfolio.
 
Covered Loans – Covered loans are initially measured at their estimated fair value on their date of acquisition as described in Note 6. Subsequent to acquisition, the fair value of covered loans is measured using the same methodology as that of non-covered loans. 

56

Table of Contents

 
Restricted Equity Securities – The carrying value of restricted equity securities approximates fair value as the shares can only be redeemed by the issuing institution at par. 

Mortgage Servicing Rights - The fair value of mortgage servicing rights is estimated using a discounted cash flow model.  Assumptions used include market discount rates, anticipated prepayment speeds, delinquency and foreclosure rates, and ancillary fee income net of servicing costs. This model is periodically validated by an independent external model validation group. The model assumptions and the MSR fair value estimates are also compared to observable trades of similar portfolios as well as to MSR broker valuations and industry surveys, as available. Management believes the significant inputs utilized are indicative of those that would be used by market participants. 
 
Bank Owned Life Insurance Assets – Fair values of insurance policies owned are based on the insurance contract’s cash surrender value. 
 
FDIC Indemnification Asset - The FDIC indemnification asset is calculated as the expected future cash flows under the loss-share agreement discounted by a rate reflective of the creditworthiness of the FDIC as would be required from the market. 
 
Visa Class B Common Stock - The fair value of Visa Class B common stock is estimated by applying a 5% discount to the value of the unredeemed Class A equivalent shares.  The discount primarily represents the risk related to the further potential reduction of the conversion ratio between Class B and Class A shares and a liquidity risk premium. 
 
Deposits—The fair value of deposits with no stated maturity, such as non-interest bearing deposits, savings and interest checking accounts, and money market accounts, is equal to the amount payable on demand. The fair value of certificates of deposit is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities. 
 
Securities Sold under Agreements to Repurchase and Federal Funds Purchased - For short-term instruments, including securities sold under agreements to repurchase and federal funds purchased, the carrying amount is a reasonable estimate of fair value. 
 
Term Debt—The fair value of medium term notes is calculated based on the discounted value of the contractual cash flows using current rates at which such borrowings can currently be obtained. 
 
Junior Subordinated Debentures - The fair value of junior subordinated debentures is estimated using an income approach valuation technique.  The ending carrying (fair) value of the junior subordinated debentures measured at fair value represents the estimated amount that would be paid to transfer these liabilities in an orderly transaction amongst market participants.  Due to credit concerns in the capital markets and inactivity in the trust preferred markets that have limited the observability of market spreads, we have classified this as a Level 3 fair value measure.  For further discussion of the valuation technique and inputs, see Note 9. 
 
Derivative Instruments - The fair value of the interest rate lock commitments and forward sales commitments are estimated using quoted or published market prices for similar instruments, adjusted for factors such as pull-through rate assumptions based on historical information, where appropriate.  The pull-through rate assumptions are considered Level 3 valuation inputs and are significant to the interest rate lock commitment valuation; as such, the interest rate lock commitment derivatives are classified as Level 3. The fair value of the interest rate swaps is determined using a discounted cash flow technique incorporating credit valuation adjustments to reflect nonperformance risk in the measurement of fair value. Although the Bank has determined that the majority of the inputs used to value its interest rate swap derivatives fall within Level 2 of the fair value hierarchy, the CVA associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of March 31, 2014, the Bank has assessed the significance of the impact of the CVA on the overall valuation of its interest rate swap positions and has determined that the CVA are not significant to the overall valuation of its interest rate swap derivatives. As a result, the Bank has classified its interest rate swap derivative valuations in Level 2 of the fair value hierarchy.   
 

57

Table of Contents

Assets and Liabilities Measured at Fair Value Using Significant Unobservable Inputs (Level 3) 
 
The following table provides a description of the valuation technique, unobservable input, and qualitative information about the unobservable inputs for the Company’s assets and liabilities classified as Level 3 and measured at fair value on a recurring basis at March 31, 2014
 
(in thousands)
Financial Instrument
Valuation Technique
Unobservable Input
Weighted Average (Range)
Mortgage servicing rights
Discounted cash flow
 
 
 
 
Constant Prepayment Rate
13.59%
 
 
Discount Rate
8.7%
Interest rate lock commitment
Internal Pricing Model
 
 
 
 
Pull-through rate
76.4%
Junior subordinated debentures
Discounted cash flow
 
 
 
 
Credit Spread
6.53%

Generally, any significant increases in the constant prepayment rate and discount rate utilized in the fair value measurement of the mortgage servicing rights will result in negative fair value adjustments (and a decrease in the fair value measurement). Conversely, a decrease in the constant prepayment rate and discount rate will result in a positive fair value adjustment (and increase in the fair value measurement).

An increase in the pull-through rate utilized in the fair value measurement of the interest rate lock commitment derivative will result in positive fair value adjustments (and an increase in the fair value measurement.) Conversely, a decrease in the pull-through rate will result in a negative fair value adjustment (and a decrease in the fair value measurement.)
 
Management believes that the credit risk adjusted spread utilized in the fair value measurement of the junior subordinated debentures carried at fair value is indicative of the nonperformance risk premium a willing market participant would require under current market conditions, that is, the inactive market. Management attributes the change in fair value of the junior subordinated debentures during the period to market changes in the nonperformance expectations and pricing of this type of debt, and not as a result of changes to our entity-specific credit risk. The widening of the credit risk adjusted spread above the Company’s contractual spreads has primarily contributed to the positive fair value adjustments.  Future contractions in the credit risk adjusted spread relative to the spread currently utilized to measure the Company’s junior subordinated debentures at fair value as of March 31, 2014, or the passage of time, will result in negative fair value adjustments.  Generally, an increase in the credit risk adjusted spread and/or a decrease in the three month LIBOR swap curve will result in positive fair value adjustments (and decrease the fair value measurement).  Conversely, a decrease in the credit risk adjusted spread and/or an increase in the three month LIBOR swap curve will result in negative fair value adjustments (and increase the fair value measurement). 
 

58

Table of Contents

The following table provides a reconciliation of assets and liabilities measured at fair value using significant unobservable inputs (Level 3) on a recurring basis during the three months ended March 31, 2014 and 2013
 
(in thousands)
Three months ended March 31,
Beginning
Balance
 
Change
included in
earnings
 
Purchases and issuances
 
Sales and settlements
 
Ending
Balance
 
Net change in
unrealized gains
or (losses) relating
to items held at
end of period
2014
 
 
 
 
 
 
 
 
 
 
 
Mortgage servicing rights
$
47,765

 
$
(953
)
 
$
2,408

 
$

 
$
49,220

 
$
(394
)
Interest rate lock commitment
706

 
(706
)
 
4,634

 
(3,240
)
 
1,394

 
1,394

Junior subordinated debentures
87,274

 
1,490

 

 
(964
)
 
87,800

 
1,490

 
 
 
 
 
 
 
 
 
 
 
 
2013
 
 
 
 
 
 
 
 
 
 
 
Mortgage servicing rights
$
27,428

 
$
(1,734
)
 
$
6,403

 
$

 
$
32,097

 
$
(512
)
Interest rate lock commitment
1,478

 
(1,478
)
 
17,425

 
(13,479
)
 
3,946

 
2,467

Junior subordinated debentures
85,081

 
1,511

 

 
(976
)
 
85,616

 
1,511

 
 
 
 
 
 
 
 
 
 
 
 
Losses on mortgage servicing rights carried at fair value are recorded in mortgage banking revenue within other non-interest income. Gains (losses) on interest rate lock commitments carried at fair value are recorded in mortgage banking revenue within other non-interest income. Gains (losses) on junior subordinated debentures carried at fair value are recorded within other non-interest income.  The contractual interest expense on the junior subordinated debentures is recorded on an accrual basis as interest on junior subordinated debentures within interest expense. Settlements related to the junior subordinated debentures represent the payment of accrued interest that is embedded in the fair value of these liabilities. 

Additionally, from time to time, certain assets are measured at fair value on a nonrecurring basis.  These adjustments to fair value generally result from the application of lower-of-cost-or-market accounting or write-downs of individual assets due to impairment. 
 
Fair Value of Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis 
 
The following table presents information about the Company’s assets and liabilities measured at fair value on a nonrecurring basis for which a nonrecurring change in fair value has been recorded during the reporting period.  The amounts disclosed below represent the fair values at the time the nonrecurring fair value measurements were made, and not necessarily the fair value as of the dates reported upon. 
 
(in thousands)
 
March 31, 2014
 
Total
 
Level 1
 
Level 2
 
Level 3
Non-covered loans and leases
$
12,470

 
$

 
$

 
$
12,470

Non-covered other real estate owned
563

 

 

 
563

Covered other real estate owned

 

 

 

 
$
13,033

 
$

 
$

 
$
13,033


(in thousands) 
 
December 31, 2013
 
Total
 
Level 1
 
Level 2
 
Level 3
Non-covered loans and leases
$
20,421

 
$

 
$

 
$
20,421

Non-covered other real estate owned
1,986

 

 

 
1,986

Covered other real estate owned
2,770

 

 

 
2,770

 
$
25,177

 
$

 
$

 
$
25,177


59

Table of Contents


The following table presents the losses resulting from nonrecurring fair value adjustments for the three months ended March 31, 2014 and 2013
 
(in thousands)
 
Three months ended
 
March 31,
 
2014
 
2013
Non-covered loans and leases
$
2,585

 
$
8,279

Non-covered other real estate owned
99

 
369

Covered other real estate owned

 
554

Total loss from nonrecurring measurements
$
2,684

 
$
9,202


The non-covered loans and leases amount above represents impaired, collateral dependent loans that have been adjusted to fair value.  When we identify a collateral dependent loan as impaired, we measure the impairment using the current fair value of the collateral, less selling costs.  Depending on the characteristics of a loan, the fair value of collateral is generally estimated by obtaining external appraisals.  If we determine that the value of the impaired loan is less than the recorded investment in the loan, we recognize this impairment and adjust the carrying value of the loan to fair value through the allowance for loan and lease losses.  The loss represents charge-offs or impairments on collateral dependent loans for fair value adjustments based on the fair value of collateral.
 
The non-covered and covered other real estate owned amount above represents impaired real estate that has been adjusted to fair value.  Non-covered other real estate owned represents real estate which the Bank has taken control of in partial or full satisfaction of loans. At the time of foreclosure, other real estate owned is recorded at the lower of the carrying amount of the loan or fair value less costs to sell, which becomes the property's new basis. Any write-downs based on the asset's fair value at the date of acquisition are charged to the allowance for loan and lease losses. After foreclosure, management periodically performs valuations such that the real estate is carried at the lower of its new cost basis or fair value, net of estimated costs to sell. Fair value adjustments on other real estate owned are recognized within net loss on real estate owned. The loss represents impairments on non-covered other real estate owned for fair value adjustments based on the fair value of the real estate. 
 
Fair Value Option
The following table presents the difference between the aggregate fair value and the aggregate unpaid principal balance of loans held for sale accounted for under the fair value option as of March 31, 2014 and December 31, 2013:

(in thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
March 31, 2014
 
December 31, 2013
 
 
 
 
 
Fair Value
 
 
 
 
 
Fair Value
 
 
 
Aggregate
 
Less Aggregate
 
 
 
Aggregate
 
Less Aggregate
 
 
 
Unpaid
 
Unpaid
 
 
 
Unpaid
 
Unpaid
 
Fair
 
 Principal
 
Principal
 
Fair
 
Principal
 
Principal
 
Value
 
Balance
 
Balance
 
Value
 
Balance
 
Balance
  Loans held for sale
$
73,106

 
$
69,913

 
$
3,193

 
$
104,664

 
$
101,795

 
$
2,869


Loans held for sale accounted for under the fair value option are measured initially at fair value with subsequent changes in fair value recognized in earnings. Gains and losses from such changes in fair value are reported as a component of mortgage banking revenue, net in the Consolidated Statements of Income. For the three months ended March 31, 2014 the Company recorded a net increase of $324,000 and for the three months ended March 31, 2013, the Company recorded a net decrease of $10.8 million, respectively, representing the change in fair value reflected in earnings.

There were no nonaccrual mortgage loans held for sale or mortgage loans held for sale 90 days or more past due and still accruing interest as of March 31, 2014 and December 31, 2013, respectively.


60

Table of Contents

Item 2.         Management’s Discussion and Analysis of Financial Condition and Results of Operations 
 
Forward-Looking Statements 
 
This Report contains certain forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which are intended to be covered by the safe harbor for “forward-looking statements” provided by the Private Securities Litigation Reform Act of 1995. These statements may include statements that expressly or implicitly predict future results, performance or events. Statements other than statements of historical fact are forward-looking statements. You can find many of these statements by looking for words such as “anticipates,” “expects,” “believes,” “estimates” and “intends” and words or phrases of similar meaning. We make forward-looking statements regarding projected sources of funds, use of proceeds, availability of acquisition and growth opportunities, dividends, adequacy of our allowance for loan and lease losses, reserve for unfunded commitments and provision for loan and lease losses, performance of troubled debt restructurings, our commercial real estate portfolio and subsequent charge-offs, our covered loan portfolio and the FDIC indemnification asset, the benefits of the FinPac acquisition, cost of interest bearing deposits and pricing strategy, anticipated repayment of securities sold under agreements to repurchase acquired and sale of investment securities acquired in the Merger with Sterling, valuation and the potential redemption of junior subordinated debentures, the divestiture of certain stores to Banner Bank in connection with the Merger with Sterling and the integration of Sterling following the Merger. Forward-looking statements involve substantial risks and uncertainties, many of which are difficult to predict and are generally beyond our control. There are many factors that could cause actual results to differ materially from those contemplated by these forward-looking statements. Risks and uncertainties include those set forth in our filings with the Securities and Exchange Commission (the "SEC") and the following factors that might cause actual results to differ materially from those presented: 
our ability to attract new deposits and loans and leases; 
demand for financial services in our market areas; 
competitive market pricing factors; 
deterioration in economic conditions that could result in increased loan and lease losses; 
risks associated with concentrations in real estate related loans; 
market interest rate volatility; 
compression of our net interest margin; 
stability of funding sources and continued availability of borrowings; 
changes in legal or regulatory requirements or the results of regulatory examinations that could restrict growth; 
our ability to recruit and retain key management and staff; 
availability of, and competition for acquisition opportunities; 
risks associated with merger and acquisition integration; 
significant decline in the market value of the Company that could result in an impairment of goodwill; 
our ability to raise capital or incur debt on reasonable terms; 
regulatory limits on the Bank’s ability to pay dividends to the Company; 
the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) and related rules and regulations on the Company’s business operations and competitiveness, including the impact of executive compensation restrictions, which may affect the Company’s ability to retain and recruit executives in competition with firms in other industries who do not operate under those restrictions;
the impact of the Dodd-Frank Act on the Company’s interest expense, FDIC deposit insurance assessments, regulatory compliance expenses, and interchange fee revenue, which includes a  maximum permissible interchange fee that an issuer may receive for an electronic debit transaction, resulting in a decrease in interchange revenue on an average transaction; and 
the impact of “Basel III” capital rules that could require the Company to adjust the fair value, including the acceleration of losses, of the trust preferred securities.
benefits from the Merger may not be fully realized or may take longer to realize than expected, including as a result of changes in general economic and market conditions, interest rates, monetary policy, laws and regulations and their enforcement, and the degree of competition in the geographic and business areas in which we operate;

61

Table of Contents

Sterling’s business may not be integrated into Umpqua’s successfully, or such integration may take longer to accomplish than expected;
the anticipated growth opportunities and cost savings from the Merger may not be fully realized or may take longer to realize than expected;
operating costs, customer losses and business disruption following the Merger, including adverse developments in relationships with employees, may be greater than expected; and
management's time and effort will be diverted to the resolution of Merger-related issues.
There are many factors that could cause actual results to differ materially from those contemplated by these forward-looking statements. Forward-looking statements are made as of the date of this Form 10-Q. We do not intend to update these forward-looking statements. Readers should consider any forward-looking statements in light of this explanation, and we caution readers about relying on forward-looking statements.
  
General 
Umpqua Holdings Corporation (referred to in this report as “we,” “our,” “Umpqua,” and “the Company”), an Oregon corporation, is a financial holding company with two principal operating subsidiaries, Umpqua Bank (the “Bank”) and Umpqua Investments, Inc. (“Umpqua Investments”).   

Headquartered in Roseburg, Oregon, the Bank is considered one of the most innovative community banks in the United States and has implemented a variety of retail marketing strategies to increase revenue and differentiate the company from its competition. The Bank combines a high touch customer experience with the sophisticated products and expertise of a commercial bank. The Bank provides a wide range of banking, wealth management, mortgage and other financial services to corporate, institutional and individual customers. The Bank also owns Financial Pacific Leasing, a commercial equipment leasing company.

Along with its subsidiaries, the Company is subject to the regulations of state and federal agencies and undergoes periodic examinations by these regulatory agencies.  
 
Umpqua Investments is a registered broker-dealer and investment advisor with offices in Portland, Lake Oswego, and Medford, Oregon, and Santa Rosa, California, and also offers products and services through certain Bank stores. The firm is one of the oldest investment companies in the Northwest and is actively engaged in the communities it serves. Umpqua Investments offers a full range of investment products and services including: stocks, fixed income securities (municipal, corporate, and government bonds, certificates of deposit, and money market instruments), mutual funds, annuities, options, retirement planning, money management services and life insurance.
  
Executive Overview 
 
Significant items for the three months ended March 31, 2014 were as follows: 
 
Net earnings available to common shareholders per diluted common share were $0.17 for the three months ended March 31, 2014, as compared to $0.21 for the three months ended March 31, 2013.  Operating income per diluted common share, defined as earnings available to common shareholders before net gains or losses on junior subordinated debentures carried at fair value, net of tax and merger related expenses, net of tax, divided by the same diluted share total used in determining diluted earnings per common share, were $0.21 for the three months ended March 31, 2014, as compared to operating income per diluted common share of $0.22 for the three months ended March 31, 2013.  Operating income per diluted share is considered a “non-GAAP” financial measure.  More information regarding this measurement and reconciliation to the comparable GAAP measurement is provided under the heading Results of Operations - Overview below. 
 
Net interest margin, on a tax equivalent basis was 4.28% for the three months ended March 31, 2014, compared to 3.77% for the three months ended March 31, 2013.  The increase in net interest margin for the three months ended March 31, 2014 is attributable to an increase in loan and lease yields, an increase in investment yields, the increase in average non-covered loans outstanding, the decrease in the cost of interest bearing deposits, and the decline in average interest bearing liabilities, partially offset by the decrease in average covered loan balances and the increase in average interest bearing cash. Excluding the impact of loan disposal gains from the covered loan portfolio and interest and fee reversals on non-accrual loans, our adjusted net interest margin was 4.12% for the three months ended March 31, 2014, as compared to adjusted net interest margin of 3.69% for the three months ended March 31,

62

Table of Contents

2013. Adjusted net interest margin is considered a “non-GAAP” financial measure. More information regarding this measurement and reconciliation to the comparable GAAP measurement is provided under the heading Results of Operations - Overview below. 

The provision for non-covered loan and lease losses was $5.4 million for the three months ended March 31, 2014, as compared to the $7.0 million recognized for the three months ended March 31, 2013. This decrease resulted primarily from a decrease in net charge-offs as a result of continued reduction of non-performing loans, partially offset by an increase in provision related to growth in the FinPac portfolio.

Mortgage banking revenue was $10.4 million for the three months ended March 31, 2014, compared to $23.6 million for the three months ended March 31, 2013.  Closed mortgage volume decreased 42% in the three months ended March 31, 2014, compared to the prior year same period, due to lower refinancing activity, partially offset by increased purchase activity, as a result of increasing interest rates.
 
Total gross non-covered loans and leases were $7.4 billion as of March 31, 2014, an increase of $56.7 million, or 0.8%, as compared to December 31, 2013.  This increase is attributable to growth in the residential mortgage, lease financing, owner occupied commercial real estate and commercial lines of credit portfolios.
 
Total deposits were $9.3 billion as of March 31, 2014, an increase of $155.9 million, or 1.7%, as compared to December 31, 2013.  The increase was concentrated in money market, savings, and non-interest bearing demand accounts, partially offset by lower interest bearing demand and certificate of deposit balances.
 
Total consolidated assets were $11.8 billion as of March 31, 2014, compared to $11.6 billion at December 31, 2013.  

Non-covered, non-performing assets increased to $62.2 million, or 0.53% of total assets, as of March 31, 2014, as compared to $57.2 million, or 0.49% of total assets, as of December 31, 2013.  Non-covered, non-performing loans decreased to $40.2 million, or 0.54% of total non-covered loans, as of March 31, 2014, as compared to $35.3 million, or 0.48% of total non-covered loans as of December 31, 2013.  Non-accrual loans have been written-down to their estimated net realizable values. 
 
Net charge-offs on non-covered loans were $4.0 million for the three months ended March 31, 2014, or 0.22% of average non-covered loans and leases (annualized), as compared to net charge-offs of $7.7 million, or 0.47% of average non-covered loans and leases (annualized), for the three months ended March 31, 2013.  

Total risk based capital was 14.7% as of March 31, 2014, consistent with December 31, 2013.
 
Cash dividends declared in the first quarter of 2014 were $0.15 per common share, compared to cash dividends declared in the first quarter of 2013 of $0.10 per common share.  

Summary of Critical Accounting Policies 
 
Our significant accounting policies are described in Note 1 to the Consolidated Financial Statements for the year ended December 31, 2013 included in the Form 10-K filed with the SEC on February 14, 2014. Not all of these critical accounting policies require management to make difficult, subjective or complex judgments or estimates. Management believes that the following policies would be considered critical under the SEC's definition. 
 
Allowance for Loan and Lease Losses and Reserve for Unfunded Commitments 
 
The Bank performs regular credit reviews of the loan and lease portfolio to determine the credit quality and adherence to underwriting standards. When loans and leases are originated, they are assigned a risk rating that is reassessed periodically during the term of the loan through the credit review process.  The Bank’s risk rating methodology assigns risk ratings ranging from 1 to 10, where a higher rating represents higher risk. The 10 risk rating categories are a primary factor in determining an appropriate amount for the allowance for loan and lease losses. The Bank has a management Allowance for Loan and Lease Losses (“ALLL”) Committee, which is responsible for, among other things, regularly reviewing the ALLL methodology, including loss factors, and ensuring that it is designed and applied in accordance with generally accepted accounting principles. The ALLL Committee reviews and approves loans and leases recommended for impaired status.  The ALLL Committee also approves removing loans and leases from impaired status.  The Bank's Audit and Compliance Committee provides board oversight of the ALLL process and reviews and approves the ALLL methodology on a quarterly basis. 


63

Table of Contents

Each risk rating is assessed an inherent credit loss factor that determines the amount of the allowance for loan and lease losses provided for that group of loans and leases with similar risk rating. Credit loss factors may vary by region based on management's belief that there may ultimately be different credit loss rates experienced in each region.  
 
Regular credit reviews of the portfolio also identify loans that are considered potentially impaired. Potentially impaired loans are referred to the ALLL Committee which reviews and approves designated loans as impaired. A loan is considered impaired when based on current information and events, we determine that we will probably not be able to collect all amounts due according to the loan contract, including scheduled interest payments. When we identify a loan as impaired, we measure the impairment using discounted cash flows, except when the sole remaining source of the repayment for the loan is the liquidation of the collateral. In these cases, we use the current fair value of the collateral, less selling costs, instead of discounted cash flows. If we determine that the value of the impaired loan is less than the recorded investment in the loan, we either recognize an impairment reserve as a specific component to be provided for in the allowance for loan and lease losses or charge-off the impaired balance on collateral dependent loans if it is determined that such amount represents a confirmed loss.  The combination of the risk rating-based allowance component and the impairment reserve allowance component lead to an allocated allowance for loan and lease losses.  
 
The Bank may also maintain an unallocated allowance amount to provide for other credit losses inherent in a loan and lease portfolio that may not have been contemplated in the credit loss factors. This unallocated amount generally comprises less than 5% of the allowance, but may be maintained at higher levels during times of economic conditions characterized by falling real estate values. The unallocated amount is reviewed periodically based on trends in credit losses, the results of credit reviews and overall economic trends.
 
The reserve for unfunded commitments (“RUC”) is established to absorb inherent losses associated with our commitment to lend funds, such as with a letter or line of credit. The adequacy of the ALLL and RUC are monitored on a regular basis and are based on management's evaluation of numerous factors. These factors include the quality of the current loan portfolio; the trend in the loan portfolio's risk ratings; current economic conditions; loan concentrations; loan growth rates; past-due and non-performing trends; evaluation of specific loss estimates for all significant problem loans; historical charge-off and recovery experience; and other pertinent information.  
 
Management believes that the ALLL was adequate as of March 31, 2014. There is, however, no assurance that future loan losses will not exceed the levels provided for in the ALLL and could possibly result in additional charges to the provision for loan and lease losses. In addition, bank regulatory authorities, as part of their periodic examination of the Bank, may require additional charges to the provision for loan and lease losses in future periods if warranted as a result of their review. Approximately 74% of our loan portfolio is secured by real estate, and a significant decline in real estate market values may require an increase in the allowance for loan and lease losses.  
 
Covered Loans and FDIC Indemnification Asset 
 
Loans acquired in an FDIC-assisted acquisition that are subject to a loss-share agreement are referred to as “covered loans” and reported separately in our statements of financial condition. Acquired loans were aggregated into pools based on individually evaluated common risk characteristics and aggregate expected cash flows were estimated for each pool. A pool is accounted for as a single asset with a single interest rate, cumulative loss rate and cash flow expectation. The cash flows expected to be received over the life of the pool were estimated by management with the assistance of a third party valuation specialist. These cash flows were input into a FASB ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (“ASC 310-30”), compliant accounting loan system which calculates the carrying values of the pools and underlying loans, book yields, effective interest income and impairment, if any, based on actual and projected events. Default rates, loss severity, and prepayment speeds assumptions are periodically reassessed and updated within the accounting model to update our expectation of future cash flows. The excess of the cash flows expected to be collected over a pool’s carrying value is considered to be the accretable yield and is recognized as interest income over the estimated life of the loan or pool using the effective yield method. The accretable yield may change due to changes in the timing and amounts of expected cash flows.
 
The Company has elected to account for amounts receivable under the loss-share agreement as an indemnification asset in accordance with FASB ASC 805, Business Combinations (“ASC 805”). The FDIC indemnification asset is initially recorded at fair value, based on the discounted value of expected future cash flows under the loss-share agreement. The difference between the carrying value and the undiscounted cash flows the Company expects to collect from the FDIC will be accreted or amortized into non-interest income over the life of the FDIC indemnification asset, which is maintained at the loan pool level. 
 
Mortgage Servicing Rights (“MSR”) 
 

64

Table of Contents

The Company determines its classes of servicing assets based on the asset type being serviced along with the methods used to manage the risk inherent in the servicing assets, which includes the market inputs used to value the servicing assets. The Company measures its residential mortgage servicing assets at fair value and reports changes in fair value through earnings.  Fair value adjustments encompass market-driven valuation changes and the runoff in value that occurs from the passage of time, which are separately reported. Under the fair value method, the MSR is carried on the balance sheet at fair value and the changes in fair value are reported in earnings under the caption mortgage banking revenue in the period in which the change occurs. 
 
Retained mortgage servicing rights are measured at fair values as of the date of sale. We use quoted market prices when available. Subsequent fair value measurements are determined using a discounted cash flow model. In order to determine the fair value of the MSR, the present value of expected future cash flows is estimated. Assumptions used include market discount rates, anticipated prepayment speeds, delinquency and foreclosure rates, and ancillary fee income net of servicing costs. This model is periodically validated by an independent external model validation group. The model assumptions and the MSR fair value estimates are also compared to observable trades of similar portfolios as well as to MSR broker valuations and industry surveys, as available. 
 
The expected life of the loan can vary from management's estimates due to prepayments by borrowers, especially when rates fall. Prepayments in excess of management's estimates would negatively impact the recorded value of the mortgage servicing rights. The value of the mortgage servicing rights is also dependent upon the discount rate used in the model, which we base on current market rates. Management reviews this rate on an ongoing basis based on current market rates. A significant increase in the discount rate would reduce the value of mortgage servicing rights. Additional information is included in Note 7 of the Notes to Consolidated Financial Statements

Valuation of Goodwill and Intangible Assets 
 
At March 31, 2014, we had $775.5 million in goodwill and other intangible assets as a result of business combinations. Goodwill and other intangible assets with indefinite lives are not amortized but instead are periodically tested for impairment. Management performs an impairment analysis for the intangible assets with indefinite lives on an annual basis as of December 31.  Additionally, goodwill and other intangible assets with indefinite lives are evaluated on an interim basis when events or circumstance indicate impairment potentially exists.  The impairment analysis requires management to make subjective judgments. Events and factors that may significantly affect the estimates include, among others, competitive forces, customer behaviors and attrition, changes in revenue growth trends, cost structures, technology, changes in discount rates and specific industry and market conditions. There can be no assurance that changes in circumstances, estimates or assumption may result in additional impairment of all, or some portion of, goodwill. 
 
Stock-based Compensation 
 
In accordance with FASB ASC 718, Stock Compensation, we recognize expense in the income statement for the grant-date fair value of stock options and other equity-based forms of compensation issued to employees over the employees’ requisite service period (generally the vesting period). The requisite service period may be subject to performance conditions. The fair value of each grant is estimated as of the grant date using the Black-Scholes option-pricing model or a Monte Carlo simulation pricing model. Management assumptions utilized at the time of grant impact the fair value of the option calculated under the pricing model, and ultimately, the expense that will be recognized over the life of the option. Additional information is included in Note 12 of the Notes to Consolidated Financial Statements
 
Fair Value 
 
FASB ASC 820, Fair Value Measurements and Disclosures, establishes a hierarchical disclosure framework associated with the level of pricing observability utilized in measuring financial instruments at fair value. The degree of judgment utilized in measuring the fair value of financial instruments generally correlates to the level of pricing observability. Financial instruments with readily available active quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of pricing observability and a lesser degree of judgment utilized in measuring fair value. Conversely, financial instruments rarely traded or not quoted will generally have little or no pricing observability and a higher degree of judgment utilized in measuring fair value. Pricing observability is impacted by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established and the characteristics specific to the transaction. See Note 16 of the Notes to Consolidated Financial Statements for additional information about the level of pricing transparency associated with financial instruments carried at fair value.
  
Recent Accounting Pronouncements 

65

Table of Contents

 
In July 2013, the FASB issued ASU No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. ASU No. 2013-11 requires an entity to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except to the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. No new recurring disclosures are required. The amendments are effective for annual and interim reporting periods beginning on or after December 15, 2013 and are to be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. The adoption of ASU No. 2013-11 did not have a material impact on the Company's consolidated financial statements.
In January 2014, the FASB issued ASU No. 2014-01, Accounting for Investments in Qualified Affordable Housing Projects. ASU 2014-04 permit an entity to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognize the net investment performance in the income statement as a component of income tax expense (benefit). The amendments are effective for annual and interim reporting periods beginning on or after December 15, 2014 and should be applied prospectively. The Company is currently reviewing the requirements of ASU No. 2014-01, but does not expect the ASU to have a material impact on the Company's consolidated financial statements.

In January 2014, the FASB issued ASU No. 2014-04, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon foreclosure. ASU 2014-04 clarifies that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The amendments are effective for annual and interim reporting periods beginning on or after December 15, 2014 and can be applied with a modified retrospective transition method or prospectively. The adoption of ASU No. 2014-04 is not expected to have a material impact on the Company's consolidated financial statements.

Results of Operations
 
Overview 
 
For the three months ended March 31, 2014, net earnings available to common shareholders were $18.7 million, or $0.17 per diluted common share, as compared to net earnings available to common shareholders of $23.2 million, or $0.21 per diluted common share for the three months ended March 31, 2013.  The decrease in net earnings for the three months ended March 31, 2014 compared to the same period of the prior year was principally attributable to decreased non-interest income and increased non-interest expense, partially offset by increased net interest income and decreased provision for loan and lease losses.
  
Umpqua recognizes gains or losses on our junior subordinated debentures carried at fair value resulting from the estimated market credit risk adjusted spread and changes in interest rates that do not directly correlate with the Company’s operating performance.  Also, Umpqua incurs significant expenses related to the completion and integration of mergers and acquisitions. Additionally, we may recognize goodwill impairment losses that have no direct effect on the Company’s or the Bank’s cash balances, liquidity, or regulatory capital ratios. Lastly, Umpqua may recognize one-time bargain purchase gains on certain FDIC-assisted acquisitions that are not reflective of Umpqua's on-going earnings power.  Accordingly, management believes that our operating results are best measured on a comparative basis excluding the impact of gains or losses on junior subordinated debentures measured at fair value, net of tax, merger-related expenses, net of tax, and other charges related to business combinations such as goodwill impairment charges or bargain purchase gains, net of tax. We define operating earnings as earnings available to common shareholders before gains or losses on junior subordinated debentures carried at fair value, net of tax, bargain purchase gains on acquisitions, net of tax, merger related expenses, net of tax, and goodwill impairment, and we calculate operating earnings per diluted share by dividing operating earnings by the same diluted share total used in determining diluted earnings per common share. 

66

Table of Contents

 
The following table provides the reconciliation of earnings available to common shareholders (GAAP) to operating earnings (non-GAAP), and earnings per diluted common share (GAAP) to operating earnings per diluted share (non-GAAP) for the three months ended March 31, 2014 and 2013:   
 
Reconciliation of Net Earnings Available to Common Shareholders to Operating Earnings   
(in thousands, except per share data)
 
Three months ended
 
March 31,
 
2014
 
2013
Net earnings available to common shareholders
$
18,651

 
$
23,178

Adjustments:
 
 
 
Net loss on junior subordinated debentures carried at fair value, net of tax
325

 
325

Merger-related expenses, net of tax
5,073

 
919

Operating earnings
$
24,049

 
$
24,422

Per diluted share:
 
 
 
Net earnings available to common shareholders
$
0.17

 
$
0.21

Adjustments:
 
 
 
Net loss on junior subordinated debentures carried at fair value, net of tax

 

Merger-related expenses, net of tax
0.04

 
0.01

Operating earnings
$
0.21

 
$
0.22


Management believes adjusted net interest income and adjusted net interest margin are useful financial measures because they enable investors to evaluate the underlying growth or compression in these values excluding interest income adjustments related to credit quality.  Management uses these measures to evaluate adjusted net interest income operating results exclusive of credit costs, in order to monitor our effectiveness in growing higher interest yielding assets and managing our cost of interest bearing liabilities over time. Adjusted net interest income is calculated as net interest income, adjusting tax exempt interest income to its taxable equivalent, adding back interest and fee reversals related to new non-accrual loans during the period, and deducting the interest income gains recognized from loan disposition activities within covered loan pools.  Adjusted net interest margin is calculated by dividing annualized adjusted net interest income by a period’s average interest earning assets. Adjusted net interest income and adjusted net interest margin are considered “non-GAAP” financial measures. Although we believe the presentation of non-GAAP financial measures provides a better indication of our operating performance, readers of this report are urged to review the GAAP results as presented in the Financial Statements (unaudited) in Item 1. 
 
The following table presents a reconciliation of net interest income to adjusted net interest income and net interest margin to adjusted net interest margin for the three months ended March 31, 2014 and 2013:   
 
Reconciliation of Net Interest Income to Adjusted Net Interest Income and Net Interest Margin to Adjusted Net Interest Margin 
 

67

Table of Contents

(in thousands, except per share data)
 
Three months ended
 
March 31,
 
2014
 
2013
Net interest income - tax equivalent basis (1)
$
108,930

 
$
95,360

Adjustments:
 
 
 
Interest and fee reversals on non-accrual loans
122

 
1,085

Covered loan disposal gains
(4,259
)
 
(3,154
)
Adjusted net interest income - tax equivalent basis (1)
$
104,793

 
$
93,291

Average interest earning assets
$
10,310,116

 
$
10,250,643

Net interest margin - consolidated (1)
4.28
%
 
3.77
%
Adjusted net interest margin - consolidated (1)
4.12
%
 
3.69
%
 
(1)
Tax-exempt income has been adjusted to a tax equivalent basis at a 35% tax rate. The amount of such adjustment was an addition to recorded income of approximately $1.1 million and $1.2 million for the three months ended March 31, 2014 and 2013, respectively.
 
The following table presents the returns on average assets, average common shareholders' equity and average tangible common shareholders' equity for the three months ended March 31, 2014 and 2013. For each of the periods presented, the table includes the calculated ratios based on reported net earnings available to common shareholders and operating income as shown in the table above. Our return on average common shareholders' equity is negatively impacted as the result of capital required to support goodwill. To the extent this performance metric is used to compare our performance with other financial institutions that do not have merger and acquisition-related intangible assets, we believe it beneficial to also consider the return on average tangible common shareholders' equity. The return on average tangible common shareholders' equity is calculated by dividing net earnings available to common shareholders by average shareholders' common equity less average goodwill and intangible assets, net (excluding MSRs). The return on average tangible common shareholders' equity is considered a non-GAAP financial measure and should be viewed in conjunction with the return on average common shareholders' equity.  
 
Return on Average Assets, Common Shareholders' Equity and Tangible Common Shareholders' Equity 

(dollars in thousands) 
 
 
 
Three months ended
 
March 31,
 
2014
 
2013
Returns on average assets:
 
 
 
Net earnings available to common shareholders
0.65
%
 
0.82
%
Operating earnings
0.84
%
 
0.86
%
Returns on average common shareholders' equity:
 
 
 
Net earnings available to common shareholders
4.35
%
 
5.43
%
Operating earnings
5.61
%
 
5.72
%
Returns on average tangible common shareholders' equity:
 
 
 
Net earnings available to common shareholders
7.86
%
 
8.99
%
Operating earnings
10.13
%
 
9.47
%
Calculation of average common tangible shareholders' equity:
 
 
 
Average common shareholders' equity
$
1,738,680

 
$
1,730,538

Less: average goodwill and other intangible assets, net
(776,006
)
 
(684,631
)
Average tangible common shareholders' equity
$
962,674

 
$
1,045,907


Additionally, management believes tangible common equity and the tangible common equity ratio are meaningful measures of capital adequacy. Umpqua believes the exclusion of certain intangible assets in the computation of tangible common equity and

68

Table of Contents

tangible common equity ratio provides a meaningful base for period-to-period and company-to-company comparisons, which management believes will assist investors in analyzing the operating results and capital of the Company.  Tangible common equity is calculated as total shareholders' equity less goodwill and other intangible assets, net (excluding MSRs).  In addition, tangible assets are total assets less goodwill and other intangible assets, net (excluding MSRs).  The tangible common equity ratio is calculated as tangible common shareholders’ equity divided by tangible assets. The tangible common equity and tangible common equity ratio is considered a non-GAAP financial measure and should be viewed in conjunction with the total shareholders’ equity and the total shareholders’ equity ratio. The following table provides a reconciliation of ending shareholders’ equity (GAAP) to ending tangible common equity (non-GAAP), and ending assets (GAAP) to ending tangible assets (non-GAAP) as of March 31, 2014 and December 31, 2013
 
Reconciliations of Total Shareholders' Equity to Tangible Common Shareholders' Equity and Total Assets to Tangible Assets 

(dollars in thousands) 
 
 
March 31,
 
December 31,
 
2014
 
2013
Total shareholders' equity
$
1,734,476

 
$
1,727,426

Subtract:
 
 
 
Goodwill and other intangible assets, net
775,488

 
776,683

Tangible common shareholders' equity
$
958,988

 
$
950,743

Total assets
$
11,838,726

 
$
11,636,112

Subtract:
 
 
 
Goodwill and other intangible assets, net
775,488

 
776,683

Tangible assets
$
11,063,238

 
$
10,859,429

Tangible common equity ratio
8.67
%
 
8.75
%
 
Non-GAAP financial measures have inherent limitations, are not required to be uniformly applied, and are not audited.  Although we believe these non-GAAP financial measure are frequently used by stakeholders in the evaluation of a company, they have limitations as analytical tools, and should not be considered in isolation or as a substitute for analyses of results as reported under GAAP.
  
Net Interest Income 
 
Net interest income is the largest source of our operating income. Net interest income for the three months ended March 31, 2014 was $107.8 million, an increase of $13.6 million or 14.5% compared to the same period in 2013. The results for the three months ended March 31, 2014 as compared to the same period in 2013 are attributable to an increase in average non-covered loans and leases, a decrease in average interest-bearing liabilities and an increase in net interest margin, partially offset by a decrease in outstanding average covered loans and investment securities. 

The net interest margin (net interest income as a percentage of average interest-earning assets) on a fully tax equivalent basis was 4.28% for the three months ended March 31, 2014, an increase of 51 basis points as compared to the same period in 2013.  The increase in net interest margin for the three months ended March 31, 2014 as compared to the same period in the prior year primarily resulted from an increase in loan and investment yields, the increase in average non-covered loans outstanding, the decrease in the cost of interest bearing deposits, and the decline in average interest bearing liabilities, partially offset by the decrease in average covered loans balances and the increase in average interest bearing cash.

Loan disposal related activities within the covered loan portfolio, either through loans being paid off in full or transferred to other real estate owned (“OREO”), result in gains within covered loan interest income to the extent assets received in satisfaction of debt (such as cash or the net realizable value of OREO received) exceeds the allocated carrying value of the loan disposed of from the pool.  Loan disposal activities contributed $4.3 million of interest income for the three months ended March 31, 2014 compared to $3.2 million of interest income during the three months ended March 31, 2013
 
Net interest income for the three months ended March 31, 2014 was negatively impacted by the $122,000 reversal of interest and fee income on non-covered, non-accrual loans, as compared to the $1.1 million reversal of interest and fee income during the three months ended March 31, 2013.  Excluding the impact of covered loan disposal gains and interest and fee income

69

Table of Contents

reversals on non-covered, non-accrual loans, tax equivalent net interest margin would have been 4.12% for the three months ended March 31, 2014 and 3.69% for the three months ended March 31, 2013
 
Adding to the increase in net interest margin in the current quarter as compared to the same period of the prior year is the continued reduction of the cost of interest-bearing liabilities, specifically interest-bearing deposits.  The total cost of interest-bearing deposits for the three months ended March 31, 2014 was 0.23%, representing an 11 basis point decrease compared to the three months ended March 31, 2013
 
Our net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, as well as changes in the yields earned on interest-earning assets and rates paid on deposits and borrowed funds. The following table presents condensed average balance sheet information, together with interest income and yields on average interest-earning assets, and interest expense and rates paid on average interest-bearing liabilities for the three months ended March 31, 2014 and 2013


70

Table of Contents

Average Rates and Balances  
(dollars in thousands) 
 
 
Three months ended
 
Three months ended
 
March 31, 2014
 
March 31, 2013
 
 
 
Interest
 
Average 
 
 
 
Interest
 
Average 
 
Average
 
Income or
 
Yields or
 
Average
 
Income or
 
Yields or
 
Balance
 
Expense
 
Rates
 
Balance
 
Expense
 
Rates
INTEREST-EARNING ASSETS:
 
 
 
 
 
 
 
 
 
 
 
Non-covered loans and leases (1)
$
7,461,789

 
$
91,268

 
4.96
%
 
$
6,843,785

 
$
78,545

 
4.65
%
Covered loans, net
347,984

 
12,718

 
14.82
%
 
459,952

 
14,580

 
12.86
%
Taxable securities
1,562,849

 
9,341

 
2.39
%
 
2,303,159

 
8,668

 
1.51
%
Non-taxable securities (2)
231,520

 
3,204

 
5.54
%
 
260,335

 
3,459

 
5.32
%
Temporary investments and interest-bearing deposits
705,974

 
441

 
0.25
%
 
383,412

 
252

 
0.27
%
Total interest earning assets
10,310,116

 
116,972

 
4.60
%
 
10,250,643

 
105,504

 
4.17
%
Allowance for non-covered loan and lease losses
(86,918
)
 
 
 
 
 
(84,705
)
 
 
 
 
Other assets
1,415,159

 
 
 
 
 
1,330,906

 
 
 
 
Total assets
$
11,638,357

 
 
 
 
 
$
11,496,844

 
 
 
 
INTEREST-BEARING LIABILITIES:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing checking and savings accounts
$
5,179,485

 
$
1,194

 
0.09
%
 
$
4,963,484

 
$
1,296

 
0.11
%
Time deposits
1,516,544

 
2,654

 
0.71
%
 
1,973,748

 
4,582

 
0.94
%
Federal funds purchased and repurchase agreements
240,521

 
41

 
0.07
%
 
132,570

 
31

 
0.09
%
Term debt
251,189

 
2,273

 
3.67
%
 
253,306

 
2,273

 
3.64
%
Junior subordinated debentures
189,041

 
1,880

 
4.03
%
 
192,641

 
1,962

 
4.13
%
Total interest-bearing liabilities
7,376,780

 
8,042

 
0.44
%
 
7,515,749

 
10,144

 
0.55
%
Non-interest-bearing deposits
2,414,001

 
 
 
 
 
2,155,110

 
 
 
 
Other liabilities
108,896

 
 
 
 
 
95,447

 
 
 
 
Total liabilities
9,899,677

 
 
 
 
 
9,766,306

 
 
 
 
Common equity
1,738,680

 
 
 
 
 
1,730,538

 
 
 
 
Total liabilities and shareholders' equity
$
11,638,357

 
 
 
 
 
$
11,496,844

 
 
 
 
NET INTEREST INCOME
 
 
$
108,930

 
 
 
 
 
$
95,360

 
 
NET INTEREST SPREAD
 
 
 
 
4.16
%
 
 
 
 
 
3.62
%
AVERAGE YIELD ON EARNING ASSETS  (1), (2)
 
 
 
 
4.60
%
 
 
 
 
 
4.17
%
INTEREST EXPENSE TO EARNING ASSETS
 
 
 
 
0.32
%
 
 
 
 
 
0.40
%
NET INTEREST INCOME TO EARNING ASSETS OR NET INTEREST MARGIN (1), (2)
 
 
 
 
4.28
%
 
 
 
 
 
3.77
%
 
(1)
Non-covered non-accrual loans, leases, and mortgage loans held for sale are included in the average balance.   
(2)
Tax-exempt income has been adjusted to a tax equivalent basis at a 35% tax rate. The amount of such adjustment was an addition to recorded income of approximately $1.1 million and $1.2 million for the three months ended March 31, 2014 and 2013, respectively. 
 
 
 
 
 
 
 
 
 
 
 
 
 


71

Table of Contents

The following table sets forth a summary of the changes in tax equivalent net interest income due to changes in average asset and liability balances (volume) and changes in average rates (rate) for the three months ended March 31, 2014 as compared to the same periods in 2013. Changes in tax equivalent interest income and expense, which are not attributable specifically to either volume or rate, are allocated proportionately between both variances. 

Rate/Volume Analysis  
(in thousands)
 
Three months ended March 31,
 
2014 compared to 2013
 
Increase (decrease) in interest income
 
and expense due to changes in
 
Volume
 
Rate
 
Total
INTEREST-EARNING ASSETS:
 
 
 
 
 
Non-covered loans and leases
$
7,363

 
$
5,360

 
$
12,723

Covered loans
(3,882
)
 
2,020

 
(1,862
)
Taxable securities
(3,365
)
 
4,038

 
673

Non-taxable securities (1)
(395
)
 
140

 
(255
)
Temporary investments and interest bearing deposits
202

 
(13
)
 
189

     Total (1)
(77
)
 
11,545

 
11,468

INTEREST-BEARING LIABILITIES:
 
 
 
 
 
Interest bearing checking and savings accounts
55

 
(157
)
 
(102
)
Time deposits
(934
)
 
(994
)
 
(1,928
)
Repurchase agreements and federal funds
20

 
(10
)
 
10

Term debt
(19
)
 
19

 

Junior subordinated debentures
(37
)
 
(45
)
 
(82
)
Total
(915
)
 
(1,187
)
 
(2,102
)
Net increase in net interest income (1)
$
838

 
$
12,732

 
$
13,570

 
(1)
Tax exempt income has been adjusted to a tax equivalent basis at a 35% tax rate. 
 
 
 
 
 
 
 
Provision for Loan and Lease Losses 
 
The provision for non-covered loan and lease losses was $5.4 million for the three months ended March 31, 2014, as compared to $7.0 million for the same period in 2013.  As an annualized percentage of average outstanding non-covered loans and leases, the provision for loan and lease losses recorded for the three months ended March 31, 2014 was 0.30% as compared to 0.43% in the same period in 2013
 
The decrease in the provision for loan and lease losses in the three months ended March 31, 2014 as compared to the same period in 2013 was principally attributable to a decrease in net charge-offs as a result of the overall stabilization of the non-covered loan and lease portfolio, partially offset by an increase in provision related to growth in the FinPac portfolio. 
 
The Company recognizes the charge-off of impairment reserves on impaired loans in the period they arise for collateral dependent loans.  Therefore, the non-covered, non-accrual loans of $37.9 million as of March 31, 2014 have already been written-down to their estimated fair value, less estimated costs to sell, and are expected to be resolved with no additional material loss, absent further decline in market prices. Depending on the characteristics of a loan, the fair value of collateral is estimated by obtaining external appraisals. 
 
The provision for non-covered loan and lease losses is based on management's evaluation of inherent risks in the loan portfolio and a corresponding analysis of the allowance for non-covered loan and lease losses. Additional discussion on loan quality and the allowance for non-covered loan and lease losses is provided under the heading Asset Quality and Non-Performing Assets below.  
 

72

Table of Contents

The provision for covered loan losses was $571,000 for the three months ended March 31, 2014, as compared to the provision for covered loan losses of $232,000 for the same period in 2013.  This change is primarily due to deterioration of identified loans and the corresponding impact to the pool, offset by recapture of provision resulting from improvements in the amount and the timing of expected cash flows on the acquired loans compared to those previously estimated, and charge-offs of unpaid principal balance, as measured on a pool basis.  Provisions for covered loans are recognized subsequent to acquisition to the extent it is probable we will be unable to collect all cash flows expected at acquisition plus additional cash flows expected to be collected arising from changes in estimates after acquisition, considering both the timing and amount of those expected cash flows.  Provisions may be required when determined losses of unpaid principal incurred exceed previous loss expectations to-date, or future cash flows previously expected to be collectible are no longer probable of collection.  Provisions for covered loan losses, including amounts advanced subsequent to acquisition, are not reflected in the allowance for non-covered loan losses, rather as a valuation allowance netted against the carrying value of the covered loan balance accounted for under ASC 310-30, in accordance with applicable guidance.
  
Non-Interest Income 
 
Non-interest income for the three months ended March 31, 2014 was $23.0 million, a decrease of $11.0 million, or 32.4%, as compared to the same period in 2013. The following table presents the key components of non-interest income for the three months ended March 31, 2014 and 2013
 
Non-Interest Income 
 
(in thousands)
 
Three months ended
 
March 31,
 
 
 
 
 
Change
 
Change
 
2014
 
2013
 
Amount
 
Percent
Service charges on deposit accounts
$
7,767

 
$
6,992

 
$
775

 
11
 %
Brokerage commissions and fees
3,725

 
3,636

 
89

 
2
 %
Mortgage banking revenue, net
10,439

 
23,568

 
(13,129
)
 
(56
)%
Gain on investment securities, net

 
7

 
(7
)
 
(100
)%
Loss on junior subordinated debentures carried at fair value
(542
)
 
(542
)
 

 
 %
Change in FDIC indemnification asset
(4,840
)
 
(5,073
)
 
233

 
(5
)%
Other income
6,458

 
5,427

 
1,031

 
19
 %
Total
$
23,007

 
$
34,015

 
$
(11,008
)
 
(32
)%
 
The increase in deposit service charges in the three months ended March 31, 2014 compared to the same period in 2013 was primarily the result of expanded business and consumer checking account products. 

Mortgage banking revenue decreased for the three months ended March 31, 2014 due to a decrease in refinancing activity, partially offset by an increase in purchase activity, due to increased mortgage interest rates compared to the same period of the prior year. Closed mortgage volume for the three months ended March 31, 2014 was $293.2 million and represented a decrease of 42.4% compared to the same period of the prior year.   
 
For the three months ended March 31, 2014 and 2013, we recorded losses of $542,000, in the change of fair value on the junior subordinated debentures recorded at fair value.  Additional information on the junior subordinated debentures carried at fair value is included in Note 9 of the Notes to Condensed Consolidated Financial Statements and under the heading Junior Subordinated Debentures.   
 
The change in FDIC indemnification asset represents a change in cash flows expected to be recoverable under the loss-share agreements entered into with the FDIC in connection with FDIC-assisted acquisitions. 
 
Other income for the three months ended March 31, 2014 compared to the same period in the prior year increased $1.0 million primarily due to FinPac operations of $858,000.
  
Non-Interest Expense 

73

Table of Contents

 
Non-interest expense for the three months ended March 31, 2014 was $96.5 million, an increase of $10.8 million, or 12.5%, as compared to the same period in 2013.  The following table presents the key elements of non-interest expense for the three months ended March 31, 2014 and 2013
 
Non-Interest Expense 
 
(in thousands)
 
Three months ended
 
March 31,
 
 
 
 
 
Change
 
Change
 
2014
 
2013
 
Amount
 
Percent
Salaries and employee benefits
$
53,218

 
$
51,505

 
$
1,713

 
3
 %
Net occupancy and equipment
16,501

 
14,735

 
1,766

 
12
 %
Communications
2,902

 
3,203

 
(301
)
 
(9
)%
Marketing
1,005

 
861

 
144

 
17
 %
Services
5,990

 
5,893

 
97

 
2
 %
Supplies
896

 
718

 
178

 
25
 %
FDIC assessments
1,863

 
1,651

 
212

 
13
 %
Net gain on non-covered other real estate owned
(18
)
 
(130
)
 
112

 
(86
)%
Net (gain) loss on covered other real estate owned
(46
)
 
284

 
(330
)
 
(116
)%
Intangible amortization
1,194

 
1,204

 
(10
)
 
(1
)%
Merger related expenses
5,983

 
1,531

 
4,452

 
291
 %
Other expenses
7,030

 
4,307

 
2,723

 
63
 %
Total
$
96,518

 
$
85,762

 
$
10,756

 
13
 %

Salaries and employee benefits costs increased $1.7 million in the three months ended March 31, 2014, as compared to the same period prior year, which primarily related to an additional 128 employees with the FinPac acquisition (since the July 1, 2013 acquisition date), partially offset by a decrease in full-time equivalent employees in our Home Lending segment due to a decrease in mortgage loan production.
 
Net occupancy and equipment expense increased $1.8 million for the three months ended March 31, 2014, as compared to the same period in the prior year as a result of the addition of three stores, compared to the same period prior year, as well as $439,000 in occupancy and equipment cost related to FinPac subsequent to acquisition.

FDIC assessments increased for the three months ended March 31, 2014 as compared to the same period of the prior year, primarily as a result of an increase in the assessment base, partially offset by a decrease in the assessment rate.

In the three months ended March 31, 2014, the Company recognized a net gain (which includes gains on sale and valuation adjustments) on non-covered other real estate owned ("OREO") properties of $18,000, as compared to a net gain (which includes loss on sale and valuation adjustments) on non-covered OREO properties of $130,000 in the same period a year ago. Included within the results for the three months ended March 31, 2014, the Company recognized a net gain (which includes gains on sale and valuation adjustments) on covered OREO properties of $46,000 as compared to net losses (which includes gains on sale and valuation adjustments) on covered OREO properties of $284,000 in the same period a year ago. This is primarily the result of improving real estate values, allowing for better realization of market values of existing OREO properties.

We incur significant expenses in connection with the completion and integration of bank acquisitions that are not capitalizable.  The merger-related expenses incurred in 2014 relate to the merger with Sterling. The merger related expense in 2013 related to the acquisition of Circle in the fourth quarter of 2012, the acquisition of FinPac on July 1, 2013, and merger activities related to the merger with Sterling. The classification of expenses as merger-related is done in accordance with the provisions of a written policy approved by our Board of Directors.  
 

74

Table of Contents

Other expenses increased by $2.7 million for the three months ended March 31, 2014 as compared to the same period in the prior year primarily as a result of an increase due to FinPac operations and an FDIC loss sharing claw back liability expense recorded due to better than expected performance of the Evergreen FDIC-assisted acquisition.
  
Income Taxes 
 
The Company's consolidated effective tax rate as a percentage of pre-tax income for the three months ended March 31, 2014 was 33.8%, as compared to 33.7% for the three months ended March 31, 2013. The effective tax rates differed from the federal statutory rate of 35% and the apportioned state rate of 5.9% (net of the federal tax benefit) principally because of the relative amount of income earned in each state jurisdiction, non-taxable income arising from bank-owned life insurance, income on tax-exempt investment securities, nondeductible merger expenses and tax credits arising from low income housing investments.
  
FINANCIAL CONDITION 
 
Investment Securities 
 
Trading securities consist of securities held in inventory by Umpqua Investments for sale to its clients and securities invested in trust for the benefit of certain executives or former employees of acquired institutions as required by agreements. Trading securities were $4.5 million at March 31, 2014, as compared to $6.0 million at December 31, 2013. The change is primarily attributable to a decrease in Umpqua Investments’ inventory of trading securities. 
 
Investment securities available for sale were $1.7 billion as of March 31, 2014, as compared to $1.8 billion at December 31, 2013.  Paydowns of $93.2 million and amortization of net purchase price premiums of $4.0 million were partially offset by an increase in fair value of investments securities available for sale of $8.0 million.

Investment securities held to maturity were $5.5 million as of March 31, 2014, as compared to holdings of $5.6 million at December 31, 2013. The change primarily related to paydowns and maturities of investment securities held to maturity of $167,000
 
The following table presents the available for sale and held to maturity investment securities portfolio by major type as of March 31, 2014 and December 31, 2013
 
Investment Securities Composition  
 
 
(dollars in thousands)
 
Investment Securities Available for Sale
 
March 31, 2014
 
December 31, 2013
 
Fair Value
 
%
 
Fair Value
 
%
U.S. Treasury and agencies
$
261

 
%
 
$
268

 
%
Obligations of states and political subdivisions
229,679

 
14
%
 
235,205

 
13
%
Residential mortgage-backed securities and collateralized mortgage obligations
1,469,816

 
86
%
 
1,553,541

 
87
%
Investments in mutual funds and other equity securities
1,974

 
%
 
1,964

 
%
Total
$
1,701,730

 
100
%
 
$
1,790,978

 
100
%
 
Investment Securities Held to Maturity
 
March 31, 2014
 
December 31, 2013
 
Amortized
 
 
 
Amortized
 
 
 
Cost
 
%
 
Cost
 
%
Residential mortgage-backed securities and collateralized mortgage obligations
$
5,465

 
100
%
 
$
5,563

 
100
%
Total
$
5,465

 
100
%
 
$
5,563

 
100
%
 
 
We review investment securities on an ongoing basis for the presence of other-than-temporary impairment (“OTTI”), taking into consideration current market conditions, fair value in relationship to cost, extent and nature of the change in fair value,

75

Table of Contents

issuer rating changes and trends, whether we intend to sell a security or if it is likely that we will be required to sell the security before recovery of our amortized cost basis of the investment, which may be maturity, and other factors.   
 
For debt securities, if we intend to sell the security or it is likely that we will be required to sell the security before recovering its cost basis, the entire impairment loss would be recognized in earnings as an OTTI. If we do not intend to sell the security and it is not likely that we will be required to sell the security but we do not expect to recover the entire amortized cost basis of the security, only the portion of the impairment loss representing credit losses would be recognized in earnings. The credit loss on a security is measured as the difference between the amortized cost basis and the present value of the cash flows expected to be collected. Projected cash flows are discounted by the original or current effective interest rate depending on the nature of the security being measured for potential OTTI.   
 
The remaining impairment related to all other factors, the difference between the present value of the cash flows expected to be collected and fair value, is recognized as a charge to other comprehensive income (“OCI”). Impairment losses related to all other factors are presented as separate categories within OCI.  For investment securities held to maturity, this amount is accreted over the remaining life of the debt security prospectively based on the amount and timing of future estimated cash flows. The accretion of the OTTI amount recorded in OCI will increase the carrying value of the investment, and would not affect earnings. If there is an indication of additional credit losses the security is reevaluated according to the procedures described above. 

Gross unrealized losses in the available for sale investment portfolio was $23.1 million at March 31, 2014.  This consisted primarily of unrealized losses on residential mortgage-backed securities and collateralized mortgage obligations of $21.8 million.  The unrealized losses were primarily caused by interest rate increases subsequent to the purchase of the securities, and not credit quality.  In the opinion of management, these securities are considered only temporarily impaired due to changes in market interest rates or the widening of market spreads subsequent to the initial purchase of the securities, and not due to concerns regarding the underlying credit of the issuers or the underlying collateral. Additional information about the investment portfolio is provided in Note 3 of the Notes to Condensed Consolidated Financial Statements.

Restricted Equity Securities 
 
Restricted equity securities were $29.9 million at March 31, 2014 and $30.7 million at December 31, 2013.  The decrease of $737,000 is attributable to stock redemptions by the Federal Home Loan Banks (“FHLB”) of San Francisco and Seattle during the period.  Of the $29.9 million at March 31, 2014, $28.7 million represent the Bank’s investment in the FHLBs of Seattle and San Francisco.  The remaining restricted equity securities represent investments in Pacific Coast Bankers’ Bancshares stock. FHLB stock is carried at par and does not have a readily determinable fair value. Ownership of FHLB stock is restricted to the FHLB and member institutions, and can only be purchased and redeemed at par.   
 
In September 2012, the FHLB of Seattle was notified by the Federal Housing Finance Agency (“Finance Agency”) that it is now classified as “adequately capitalized” as compared to the prior classification of “undercapitalized.” Under Finance Agency regulations, the FHLB of Seattle may repurchase excess capital stock under certain conditions; however it may not redeem stock or pay a dividend without Finance Agency approval. The Company has determined there is not an other-than-temporary impairment on the FHLB stock investment as of March 31, 2014.
  
Loans and Leases
 
Non-Covered Loans and Leases, net 
 
Total non-covered loans and leases outstanding at March 31, 2014 were $7.4 billion, an increase of $56.7 million as compared to year-end 2013. This increase is principally attributable to net loan and lease originations of $80.7 million and covered loans transferred to non-covered loans and leases of $1.8 million, partially offset by non-covered loans sold of $22.3 million, charge-offs of $5.6 million, and transfers to other real estate owned of $1.9 million during the period. The following table presents the concentration distribution of our non-covered loan and lease portfolio at March 31, 2014 and December 31, 2013.     
 

76

Table of Contents

Non-Covered Loan and Lease Concentrations 

(dollars in thousands)
 
March 31, 2014
 
December 31, 2013
 
Amount
 
Percentage
 
Amount
 
Percentage
Commercial real estate
 
 
 
 
 
 
 
Non-owner occupied term, net
$
2,311,952

 
31.2
%
 
$
2,328,260

 
31.7
%
Owner occupied term, net
1,282,482

 
17.3
%
 
1,259,583

 
17.1
%
Multifamily, net
400,927

 
5.4
%
 
403,537

 
5.5
%
Construction & development, net
229,262

 
3.1
%
 
245,231

 
3.3
%
Residential development, net
89,510

 
1.2
%
 
88,413

 
1.2
%
Commercial
 
 
 
 
 
 
 
Term, net
735,004

 
9.9
%
 
770,845

 
10.5
%
LOC & other, net
1,005,800

 
13.6
%
 
987,360

 
13.4
%
Leases and equipment finance, net
388,418

 
5.2
%
 
361,591

 
4.9
%
Residential
 
 
 
 
 
 
 
Mortgage, net
651,042

 
8.8
%
 
597,201

 
8.1
%
Home equity loans & lines, net
268,497

 
3.6
%
 
264,269

 
3.6
%
Consumer & other, net
48,214

 
0.7
%
 
48,113

 
0.7
%
Total, net of deferred fees and costs
$
7,411,108

 
100.0
%
 
$
7,354,403

 
100.0
%

Covered Loans, net
 
Total covered loans outstanding at March 31, 2014 were $342.3 million, a decrease of $21.7 million as compared to year-end 2013. This decrease was principally attributable to net loan paydowns and maturities of $19.4 million and transfers of covered loans to non-covered loans and leases of $1.8 million. The following table presents the concentration distribution of our covered loan portfolio at March 31, 2014 and December 31, 2013.   
 

77

Table of Contents

Covered Loan Concentrations 

(dollars in thousands)  
 
March 31, 2014
 
December 31, 2013
 
Amount
 
Percentage
 
Amount
 
Percentage
Commercial real estate
 
 
 
 
 
 
 
Non-owner occupied term, net
$
199,818

 
56.7
%
 
$
206,902

 
55.4
%
Owner occupied term, net
49,487

 
14.0
%
 
49,817

 
13.3
%
Multifamily, net
27,562

 
7.8
%
 
37,671

 
10.1
%
Construction & development, net
3,446

 
1.0
%
 
3,455

 
0.9
%
Residential development, net
7,213

 
2.0
%
 
7,286

 
1.9
%
Commercial
 
 
 
 
 
 
 
Term, net
10,809

 
3.1
%
 
15,719

 
4.2
%
LOC & other, net
9,451

 
2.7
%
 
6,698

 
1.8
%
Residential
 
 
 
 
 
 
 
Mortgage, net
21,803

 
6.2
%
 
22,316

 
6.0
%
Home equity loans & lines, net
18,994

 
5.4
%
 
19,637

 
5.3
%
Consumer & other, net
4,000

 
1.1
%
 
4,262

 
1.1
%
Total, net of deferred fees and costs
352,583

 
100.0
%
 
373,763

 
100.0
%
Allowance for covered loans
(10,320
)
 
 
 
(9,771
)
 
 
Total
$
342,263

 
 
 
$
363,992

 
 
  
The covered loans are subject to loss-sharing agreements with the FDIC. Under the terms of the Evergreen Bank acquisition loss-sharing agreement, the FDIC will cover a substantial portion of any future losses on loans, related unfunded loan commitments, OREO and accrued interest on loans for up to 90 days. The FDIC will absorb 80% of losses and share in 80% of loss recoveries on the first $90.0 million on covered assets and absorb 95% of losses and share in 95% of loss recoveries exceeding $90.0 million, except for the Bank will incur losses up to $30.2 million before the loss-sharing will commence. As of March 31, 2014, losses have exceeded $30.2 million. The loss-sharing arrangements for non-single family residential and single family residential loans are in effect for 5 years and 10 years, respectively, and the loss recovery provisions are in effect for 8 years and 10 years, respectively, from the acquisition dates. 
 
Under the terms of the Rainier Pacific Bank loss-sharing agreement, the FDIC will cover a substantial portion of any future losses on loans, related unfunded loan commitments, OREO and accrued interest on loans for up to 90 days. The FDIC will absorb 80% of losses and share in 80% of loss recoveries on the first $95.0 million of losses on covered assets and absorb 95% of losses and share in 95% of loss recoveries exceeding $95.0 million. The loss-sharing arrangements for non-single family residential and single family residential loans are in effect for 5 years and 10 years, respectively, and the loss recovery provisions are in effect for 8 years and 10 years, respectively, from the acquisition dates. 
 
Under the terms of the Nevada Security Bank loss-sharing agreement, the FDIC will cover a substantial portion of any future losses on loans, related unfunded loan commitments, OREO and accrued interest on loans for up to 90 days. The FDIC will absorb 80% of losses and share in 80% of loss recoveries on all covered assets. The loss-sharing arrangements for non-single family residential and single family residential loans are in effect for 5 years and 10 years, respectively, and the loss recovery provisions are in effect for 8 years and 10 years, respectively, from the acquisition dates.  

Discussion of and tables related to the covered loan segment is provided under the heading Asset Quality and Non-Performing Assets.
  
Asset Quality and Non-Performing Assets 
 
Non-Covered Loans and Leases 
 
Non-covered, non-performing loans and leases, which include non-covered, non-accrual loans and leases and non-covered accruing loans and leases past due 90 days or more, totaled $40.2 million or 0.54% of total non-covered loans and leases as of

78

Table of Contents

March 31, 2014, as compared to $35.3 million, or 0.48% of total non-covered loans and leases, at December 31, 2013. Non-covered, non-performing assets, which include non-covered, non-performing loans and leases and non-covered, foreclosed real estate (OREO), totaled $62.2 million, or 0.53% of total assets as of March 31, 2014 compared with $57.2 million, or 0.49% of total assets as of December 31, 2013.  
 
A loan is considered impaired when, based on current information and events, we determine it is probable that we will not be able to collect all amounts due according to the loan contract, including scheduled interest payments. Generally, when non-covered loans are identified as impaired they are moved to our Special Assets Division. When we identify a loan as impaired, we measure the loan for potential impairment using discount cash flows, except when the sole remaining source of the repayment for the loan is the liquidation of the collateral.  In these cases, we will use the current fair value of collateral, less selling costs.  The starting point for determining the fair value of collateral is through obtaining external appraisals.  Generally, external appraisals are updated every 12 months.  We obtain appraisals from a pre-approved list of independent, third party, local appraisal firms.  Approval and addition to the list is based on experience, reputation, character, consistency and knowledge of the respective real estate market. At a minimum, it is ascertained that the appraiser is: (a) currently licensed in the state in which the property is located, (b) is experienced in the appraisal of properties similar to the property being appraised, (c) is actively engaged in the appraisal work, (d) has knowledge of current real estate market conditions and financing trends, (e) is reputable, and (f) is not on Freddie Mac’s or the Bank’s Exclusionary List of appraisers and brokers. In certain cases appraisals will be reviewed by our Real Estate Valuation Services Group to ensure the quality of the appraisal and the expertise and independence of the appraiser. Upon receipt and review, an external appraisal is utilized to measure a loan for potential impairment.  Our impairment analysis documents the date of the appraisal used in the analysis, whether the officer preparing the report deems it current, and, if not, allows for internal valuation adjustments with justification.  Typical justified adjustments might include discounts for continued market deterioration subsequent to appraisal date, adjustments for the release of collateral contemplated in the appraisal, or the value of other collateral or consideration not contemplated in the appraisal. An appraisal over one year old in most cases will be considered stale dated and an updated or new appraisal will be required.  Any adjustments from appraised value to net realizable value are detailed and justified in the impairment analysis, which is reviewed and approved by senior credit quality officers and the Bank's ALLL Committee. Although an external appraisal is the primary source to value collateral dependent loans, we may also utilize values obtained through purchase and sale agreements, negotiated short sales, broker price opinions, or the sales price of the note.  These alternative sources of value are used only if deemed to be more representative of value based on updated information regarding collateral resolution. Impairment analyses are updated, reviewed and approved on a quarterly basis at or near the end of each reporting period.  Appraisals or other alternative sources of value received subsequent to the reporting period, but prior to our filing of periodic reports, are considered and evaluated to ensure our periodic filings are materially correct and not misleading. Based on these processes, we do not believe there are significant time lapses for the recognition of additional loan loss provisions or charge-offs from the date they become known.  
 
Non-covered loans and leases are classified as non-accrual when collection of principal or interest is doubtful—generally if they are past due as to maturity or payment of principal or interest by 90 days or more—unless such non-covered loans and leases are well-secured and in the process of collection. Additionally, all loans that are impaired are considered for non-accrual status.  Non-covered loans and leases placed on non-accrual will typically remain on non-accrual status until all principal and interest payments are brought current and the prospects for future payments in accordance with the loan agreement appear relatively certain.  
 
Upon acquisition of real estate collateral, typically through the foreclosure process, we promptly begin to market the property for sale. If we do not begin to receive offers or indications of interest we will analyze the price and review market conditions to assess whether a lower price reflects the market value of the property and would enable us to sell the property.  In addition, we update appraisals on other real estate owned property six to 12 months after the most recent appraisal. Increases in valuation adjustments recorded in a period are primarily based on (a) updated appraisals received during the period, or (b) management's authorization to reduce the selling price of the property during the period.  Unless a current appraisal is available, an appraisal will be ordered prior to a loan moving to other real estate owned.  Foreclosed properties held as other real estate owned are recorded at the lower of the recorded investment in the loan or market value of the property less expected selling costs. Non-covered other real estate owned at March 31, 2014 totaled $22.0 million and consisted of 15 properties.   

Non-covered loans are reported as restructured when the Bank grants a more than insignificant concession(s) to a borrower experiencing financial difficulties that it would not otherwise consider.  Examples of such concessions include a reduction in the loan rate, forgiveness of principal or accrued interest, extending the maturity date(s) or providing a lower interest rate than would be normally available for a transaction of similar risk. As a result of these concessions, restructured loans are impaired as the Bank will not collect all amounts due, both principal and interest, in accordance with the terms of the original loan agreement. Impairment reserves on non-collateral dependent restructured loans are measured by comparing the present value of expected future cash flows on the restructured loans discounted at the interest rate of the original loan agreement to the loan’s

79

Table of Contents

carrying value. These impairment reserves are recognized as a specific component to be provided for in the allowance for loan and lease losses. 
 
The Bank has written down impaired, non-covered non-accrual loans as of March 31, 2014 to their estimated net realizable value and expects resolution with no additional material loss, absent further decline in market prices.   
 
The following table summarizes our non-covered non-performing assets and restructured loans as of March 31, 2014 and December 31, 2013:   
 
Non-Covered Non-Performing Assets 
 
(in thousands)
 
March 31,
 
December 31,
 
2014
 
2013
Non-covered loans and leases on non-accrual status
$
37,884

 
$
31,891

Non-covered loans and leases past due 90 days or more and accruing
2,269

 
3,430

Total non-covered non-performing loans and leases
40,153

 
35,321

Non-covered other real estate owned
22,034

 
21,833

Total non-covered non-performing assets
$
62,187

 
$
57,154

Restructured loans (1)
$
67,897

 
$
68,791

Allowance for non-covered loan and lease losses
$
86,709

 
$
85,314

Reserve for unfunded commitments
1,417

 
1,436

Allowance for non-covered credit losses
$
88,126

 
$
86,750

Asset quality ratios:
 
 
 
Non-covered non-performing assets to total assets
0.53
%
 
0.49
%
Non-covered non-performing loans and leases to total non-covered loans and leases
0.54
%
 
0.48
%
Allowance for non-covered loan and leases losses to total non-covered loans and leases
1.17
%
 
1.16
%
Allowance for non-covered credit losses to total non-covered loans and leases
1.19
%
 
1.18
%
Allowance for non-covered credit losses to total non-covered non-performing loans and leases
219
%
 
246
%
  
(1)
Represents accruing restructured non-covered loans performing according to their restructured terms. 
 
The following tables summarize our non-covered non-performing assets by loan type and region as of March 31, 2014 and December 31, 2013
 
Non-Covered Non-Performing Assets by Type and Region 

(in thousands)  
 
March 31, 2014
 
 
 
Northwest
 
Southern
 
Northern
 
Central
 
Greater Bay
 
 
 
Washington
 
Oregon
 
Oregon
 
California
 
California
 
California
 
Total
Loans and leases on non-accrual status:
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-owner occupied term, net
$

 
$
1,722

 
$
10,793

 
$

 
$
731

 
$
2,701

 
$
15,947

Owner occupied term, net

 
145

 

 
1,536

 

 
3,768

 
5,449

Multifamily, net

 

 

 

 

 
355

 
355

Construction & development, net

 

 

 

 

 

 


80

Table of Contents

Residential development, net

 
195

 

 

 

 

 
195

Commercial
 
 
 
 
 
 
 
 
 
 
 
 
 
Term, net

 
782

 

 
179

 
64

 

 
1,025

LOC & other, net
2,083

 
4,831

 
200

 
4,741

 

 
110

 
11,965

Leases and equipment finance, net
2,948

 

 

 

 

 

 
2,948

Residential
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage, net

 

 

 

 

 

 

Home equity loans & lines, net

 

 

 

 

 

 

Consumer & other, net

 

 

 

 

 

 

Total
5,031

 
7,675

 
10,993

 
6,456

 
795

 
6,934

 
37,884

Loans and leases past due 90 days or more and accruing:
 
 
 
 
 
 
 
 
 
 
Commercial real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-owner occupied term, net
$

 
$
369

 
$

 
$

 
$

 
$

 
$
369

Owner occupied term, net

 

 

 
36

 

 

 
36

Multifamily, net

 

 

 

 

 

 

Construction & development, net

 

 

 

 

 

 

Residential development, net

 

 

 

 

 

 

Commercial
 
 
 
 
 
 
 
 
 
 
 
 
 
Term, net

 

 

 

 

 

 

LOC & other, net

 

 

 

 

 

 

Leases and equipment finance, net

 

 

 

 

 

 

Residential
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage, net

 
98

 
44

 
101

 

 
43

 
286

Home equity loans & lines, net

 
1,503

 

 

 

 

 
1,503

Consumer & other, net
19

 
30

 
10

 

 
16

 

 
75

Total
19

 
2,000

 
54

 
137

 
16

 
43

 
2,269

Total non-performing loans and leases
5,050

 
9,675

 
11,047

 
6,593

 
811

 
6,977

 
40,153

Other real estate owned:
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-owner occupied term
$

 
$
11,428

 
$

 
$
150

 
$
64

 
$
513

 
$
12,155

Owner occupied term

 

 
562

 

 
1,741

 

 
2,303

Multifamily

 

 

 

 

 

 

Construction & development
563

 
5,130

 

 

 
163

 

 
5,856

Residential development

 
1,215

 

 

 

 

 
1,215

Commercial
 
 
 
 
 
 
 
 
 
 
 
 
 
Term

 

 

 

 
460

 

 
460

LOC & other

 

 

 

 

 

 

Leases and equipment finance

 

 

 

 

 

 

Residential
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage

 

 
45

 

 

 

 
45

Home equity loans & lines

 

 

 

 

 

 

Consumer & other

 

 

 

 

 

 

Total
563

 
17,773

 
607

 
150

 
2,428

 
513

 
22,034

Total non-performing assets
$
5,613

 
$
27,448

 
$
11,654

 
$
6,743

 
$
3,239

 
$
7,490

 
$
62,187


81

Table of Contents

(in thousands)  
 
December 31, 2013
 
 
 
Northwest
 
Southern
 
Northern
 
Central
 
Greater Bay
 
 
 
Washington
 
Oregon
 
Oregon
 
California
 
California
 
California
 
Total
Loans and leases on non-accrual status:
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-owner occupied term, net
$

 
$
1,065

 
$
3,484

 
$
389

 
$
1,599

 
$
2,656

 
$
9,193

Owner occupied term, net

 
509

 

 
2,093

 

 
3,602

 
6,204

Multifamily, net

 

 

 

 
580

 
355

 
935

Construction & development, net

 

 

 

 

 

 

Residential development, net

 
2,801

 

 

 

 

 
2,801

Commercial
 
 
 
 
 
 
 
 
 
 
 
 
 
Term, net

 
1,040

 

 
182

 

 

 
1,222

LOC & other, net

 
4,620

 
207

 
3,615

 
171

 
110

 
8,723

Leases and equipment finance, net
2,813

 

 

 

 

 

 
2,813

Residential
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage, net

 

 

 

 

 

 

Home equity loans & lines, net

 

 

 

 

 

 

Consumer & other, net

 

 

 

 

 

 

Total
2,813

 
10,035

 
3,691

 
6,279

 
2,350

 
6,723

 
31,891

Loans and leases past due 90 days or more and accruing:
 
 
 
 
 
 
 
 
 
 
Commercial real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-owner occupied term, net
$

 
$

 
$

 
$

 
$

 
$

 
$

Owner occupied term, net

 

 

 
437

 

 
173

 
610

Multifamily, net

 

 

 

 

 

 

Construction & development, net

 

 

 

 

 

 

Residential development, net

 

 

 

 

 

 

Commercial
 
 
 
 
 
 
 
 
 
 
 
 
 
Term, net

 

 

 

 

 

 

LOC & other, net

 

 

 

 

 

 

Leases and equipment finance, net
517

 

 

 

 

 

 
517

Residential
 
 
 
 
 
 
 
 
 
 
 
 

Mortgage, net

 

 
35

 
100

 
25

 

 
160

Home equity loans & lines, net

 
2,070

 

 

 

 

 
2,070

Consumer & other, net
14

 
20

 
25

 
8

 
5

 
1

 
73

Total
531

 
2,090

 
60

 
545

 
30

 
174

 
3,430

Total non-performing loans and leases
3,344

 
12,125

 
3,751

 
6,824

 
2,380

 
6,897

 
35,321

Other real estate owned:
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-owner occupied term
$

 
$
11,428

 
$

 
$
155

 
$
64

 
$

 
$
11,647

Owner occupied term

 
311

 
562

 
219

 
1,905

 

 
2,997

Multifamily

 

 

 

 

 

 

Construction & development
662

 
5,130

 

 

 
163

 

 
5,955


82

Table of Contents

Residential development

 
373

 

 

 

 

 
373

Commercial
 
 
 
 
 
 
 
 
 
 
 
 
 
Term

 

 

 

 
460

 

 
460

LOC & other

 

 

 

 

 

 

Leases and equipment finance

 

 

 

 

 

 

Residential
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage

 

 
45

 

 

 

 
45

Home equity loans & lines

 
356

 

 

 

 

 
356

Consumer & other

 

 

 

 

 

 

Total
662

 
17,598

 
607

 
374

 
2,592

 

 
21,833

Total non-performing assets
$
4,006

 
$
29,723

 
$
4,358

 
$
7,198

 
$
4,972

 
$
6,897

 
$
57,154


The Company has performed, and will continue to perform, extensive reviews of our permanent commercial real estate portfolio, including stress testing.  These reviews were performed on both our non-owner and owner occupied credits. These reviews were completed to verify leasing status, to ensure the accuracy of risk ratings, and to develop proactive action plans with borrowers on projects where debt service coverage has dropped below the Bank’s benchmark.  The stress testing has been performed to determine the effect of rising cap rates, interest rates and vacancy rates, on this portfolio.  Based on our analysis, the Bank believes lending teams are effectively managing the risks in this portfolio. There can be no assurance that any further declines in economic conditions, such as potential increases in retail or office vacancy rates, will exceed the projected assumptions utilized in the stress testing and may result in additional non-covered, non-performing loans in the future.  
 
Non-Covered Restructured Loans 
 
At March 31, 2014 and December 31, 2013, non-covered impaired loans of $67.9 million and $68.8 million were classified as non-covered performing restructured loans, respectively.  The restructurings were granted in response to borrower financial difficulty, and generally provide for a temporary modification of loan repayment terms. The non-covered performing restructured loans on accrual status represent principally the only impaired loans accruing interest at March 31, 2014.  In order for a restructured loan to be considered performing and on accrual status, the loan’s collateral coverage generally will be greater than or equal to 100% of the loan balance, the loan must be current on payments, and the borrower must either prefund an interest reserve or demonstrate the ability to make payments from a verified source of cash flow. The Bank had an obligation to lend additional funds on the restructured loans of $3.8 million as of March 31, 2014
 
Residential Modification Program 
The Bank’s modification program is designed to enable the Bank to work with its customers experiencing financial difficulty to maximize repayment. While the Bank has designed guidelines similar to the government sponsored Home Affordable Refinance Program and Home Affordable Modification Program, the Bank participates in the programs only in the capacity as servicer on behalf of investor loans that have been sold.   

A and B Note Workout Structures 
The Bank performs A note/B note workout structures as a subset of the Bank’s troubled debt restructuring strategy.  The amount of loans restructured using this structure were $3.8 million as of March 31, 2014 and December 31, 2013.     
 
Under an A note/B note workout structure, a new A note is underwritten in accordance with customary troubled debt restructuring underwriting standards and is reasonably assured of full repayment while the corresponding B note is not.  The B note is immediately charged-off upon restructuring. 
 
If the loan was on accrual prior to the troubled debt restructuring being documented with the loan legally bifurcated into an A note fully supporting accrual status and a B note or amount fully contractually forgiven and charged-off, the A note may remain on accrual status.  If the loan was on nonaccrual at the time the troubled debt restructuring was documented with the loan legally bifurcated into an A note fully supporting accrual status and a B note or amount contractually forgiven and fully charged-off, the A note may be returned to accrual status, and risk rated accordingly, after a reasonable period of performance under the troubled debt restructuring terms.  Six months of payment performance is generally required to return these loans to accrual status. 
 

83

Table of Contents

The A note will continue to be classified as a troubled debt restructuring and only may be removed from impaired status in years after the restructuring if (a) the restructuring agreement specifies an interest rate equal to or greater than the rate that the Bank was willing to accept at the time of the restructuring for a new loan with comparable risk and (b) the loan is not impaired based on the terms specified by the restructuring agreement. 
 
The following tables summarize our performing non-covered restructured loans by loan type and region as of March 31, 2014 and December 31, 2013
 
Non-Covered Restructured Loans by Type and Region 

(in thousands)
 
March 31, 2014
 
 
 
Northwest
 
Southern
 
Northern
 
Central
 
Greater Bay
 
 
 
Washington
 
Oregon
 
Oregon
 
California
 
California
 
California
 
Total
Commercial real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-owner occupied term, net
$
13,121

 
$
13,446

 
$
3,863

 
$

 
$
4,254

 
$

 
$
34,684

Owner occupied term, net

 
645

 

 
596

 
6,490

 

 
7,731

Multifamily, net

 

 

 

 

 

 

Construction & development, net

 
8,435

 

 

 
1,092

 

 
9,527

Residential development, net

 
6,685

 

 

 
7,547

 

 
14,232

Commercial


 
 
 
 
 
 
 
 
 
 
 
 
Term, net

 

 

 

 
1,252

 

 
1,252

LOC & other, net

 

 

 

 

 

 

Residential


 
 
 
 
 
 
 
 
 
 
 
 
Mortgage, net

 
471

 

 

 

 

 
471

Home equity loans & lines, net

 

 

 

 

 

 

Consumer & other, net

 

 

 

 

 

 

Total, net of deferred fees and costs
$
13,121

 
$
29,682

 
$
3,863

 
$
596

 
$
20,635

 
$

 
$
67,897

 

84

Table of Contents

(in thousands)
 
December 31, 2013
 
 

 
Northwest
 
Southern
 
Northern
 
Central
 
Greater Bay
 
 

 
Washington
 
Oregon
 
Oregon
 
California
 
California
 
California
 
Total
Commercial real estate
 

 
 

 
 

 
 

 
 

 
 

 
 

Non-owner occupied term, net
$
13,188

 
$
13,492

 
$
3,865

 
$

 
$
6,821

 
$

 
$
37,366

Owner occupied term, net

 
650

 

 
608

 
3,944

 

 
5,202

Multifamily, net

 

 

 

 

 

 

Construction & development, net

 
8,498

 

 

 
1,092

 

 
9,590

Residential development, net

 
6,987

 

 

 
7,915

 

 
14,902

Commercial
 
 
 
 
 
 
 
 
 
 
 
 
 
Term, net

 

 

 

 
1,258

 

 
1,258

LOC & other, net

 

 

 

 

 

 

Residential
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage, net

 
473

 

 

 

 

 
473

Home equity loans & lines, net

 

 

 

 

 

 

Consumer & other, net

 

 

 

 

 

 

Total, net of deferred fees and costs
$
13,188

 
$
30,100

 
$
3,865

 
$
608

 
$
21,030

 
$

 
$
68,791


The following table presents a distribution of our performing non-covered restructured loans by year of maturity, according to the restructured terms, as of March 31, 2014
 
(in thousands) 
Year
Amount
2014
$
43,582

2015
8,990

2016
8,435

2017
2,475

2018
3,944

Thereafter
471

Total
$
67,897

 
The Bank has had varying degrees of success with different types of concessions.  The following table presents the percentage of troubled debt restructurings, by type of concession, that have performed and are expected to perform according to the troubled debt restructuring agreement at March 31, 2014
 
 
March 31, 2014
Rate
99%
Interest Only
100%
Payment
100%
Combination
93%
 
A further decline in the economic conditions in our general market areas or other factors could adversely impact individual borrowers or the loan portfolio in general. Accordingly, there can be no assurance that loans will not become 90 days or more past due, become impaired or placed on non-accrual status, restructured or transferred to other real estate owned in the future. Additional information about the loan portfolio is provided in Note 5 of the Notes to Condensed Consolidated Financial Statements

85

Table of Contents

 
Covered Non-Performing Assets 
 
Covered non-performing assets totaled $1.7 million, or 0.01% of total assets at March 31, 2014, as compared to $2.1 million, or 0.02% of total assets at December 31, 2013. These covered nonperforming assets are subject to shared-loss agreements with the FDIC. The following tables summarize our covered non-performing assets by loan type, as of March 31, 2014 and December 31, 2013
 
(in thousands)
 
March 31, 2014
 
Evergreen
 
Rainier
 
Nevada Security
 
Total
Covered other real estate owned:
 
 
 
 
 
 
 
Commercial real estate
 
 
 
 
 
 
 
Non-owner occupied term
$
234

 
$
55

 
$
72

 
$
361

Owner occupied term

 

 

 

Multifamily

 

 

 

Construction & development
417

 

 
692

 
1,109

Residential development

 

 
97

 
97

Commercial
 
 
 
 
 
 
 
Term

 

 
179

 
179

LOC & other

 

 

 

Residential
 
 
 
 
 
 
 
Mortgage

 

 

 

Home equity loans & lines

 

 

 

Consumer & other

 

 

 

Total
$
651

 
$
55

 
$
1,040

 
$
1,746

(in thousands)
 
December 31, 2013
 
Evergreen
 
Rainier
 
Nevada Security
 
Total
Covered other real estate owned:
 
 
 
 
 
 
 
Commercial real estate
 
 
 
 
 
 
 
Non-owner occupied term
$
234

 
$
55

 
$
72

 
$
361

Owner occupied term

 

 

 

Multifamily

 

 

 

Construction & development
417

 

 
1,048

 
1,465

Residential development

 

 
97

 
97

Commercial
 
 
 
 
 
 
 
Term

 

 
179

 
179

LOC & other

 

 

 

Residential
 
 
 
 
 
 
 
Mortgage

 

 

 

Home equity loans & lines

 

 

 

Consumer & other

 

 

 

Total
$
651

 
$
55

 
$
1,396

 
$
2,102

 
Total Non-Performing Assets 
 
The following tables summarize our total (including covered and non-covered) nonperforming assets at March 31, 2014 and December 31, 2013

86

Table of Contents

 
(dollars in thousands) 
 
March 31,
 
December 31,
 
2014
 
2013
Loans and leases on non-accrual status
$
37,884

 
$
31,891

Loans and leases past due 90 days or more and accruing
2,269

 
3,430

Total non-performing loans and leases
40,153

 
35,321

Other real estate owned
23,780

 
23,935

Total non-performing assets
$
63,933

 
$
59,256

Asset quality ratios:
 
 
 
Total non-performing assets to total assets
0.54
%
 
0.51
%
Total non-performing loans and leases to total loans and leases
0.52
%
 
0.46
%
 
 
  
Allowance for Non-Covered Loan and Lease Losses and Reserve for Unfunded Commitments 
 
The ALLL totaled $86.7 million at March 31, 2014, an increase of $1.4 million from $85.3 million at December 31, 2013.
The following table shows the activity in the ALLL for the three months ended March 31, 2014 and 2013
 
Allowance for Non-Covered Loan and Lease Losses 
 
(in thousands)
 
Three months ended
 
March 31,
 
2014
 
2013
Balance, beginning of period
$
85,314

 
$
85,391

Loans charged-off:
 
 
 
Commercial real estate, net
(1,895
)
 
(1,454
)
Commercial, net
(3,350
)
 
(6,174
)
Residential, net
(132
)
 
(904
)
Consumer & other, net
(188
)
 
(193
)
Total loans charged-off
(5,565
)
 
(8,725
)
Recoveries:
 
 
 
Commercial real estate, net
439

 
470

Commercial, net
981

 
367

Residential, net
47

 
92

Consumer & other, net
93

 
109

Total recoveries
1,560

 
1,038

Net charge-offs
(4,005
)
 
(7,687
)
Provision charged to operations
5,400

 
6,988

Balance, end of period
$
86,709

 
$
84,692

As a percentage of average non-covered loans and leases (annualized):
 
 
 
Net charge-offs
0.22
%
 
0.47
%
Provision for non-covered loan and lease losses
0.30
%
 
0.43
%
Recoveries as a percentage of charge-offs
28.03
%
 
11.90
%

The increase in non-covered allowance for loan and lease losses as of March 31, 2014 compared to the same period of the prior year was primarily the result of growth in our non-covered loan and lease portfolios, partially offset by continued stabilizing credit quality characteristics of the portfolio. Additional discussion on the change in provision for loan and lease losses is

87

Table of Contents

provided under the heading Provision for Loan and Lease Losses above. Classified loans include non-performing loans, as well as performing loans which are risk rated substandard or worse.
 
All impaired loans are individually evaluated for impairment.  If the measurement of each impaired loans' value is less than the recorded investment in the loan, we recognize this impairment and adjust the carrying value of the loan to fair value through the allowance for loan and lease losses.  This can be accomplished by charging-off the impaired portion of the loan or establishing a specific component within the allowance for loan and lease losses.  If in management’s assessment the sources of repayment will not result in a reasonable probability that the carrying value of a loan can be recovered, the amount of a loan’s specific impairment is charged-off against the allowance for loan and lease losses. The Company recognizes the charge-off of impairment reserves on impaired loans in the period they arise for collateral dependent loans.  Impairment reserves on non-collateral dependent restructured loans are measured by comparing the present value of expected future cash flows on the restructured loans discounted at the interest rate of the original loan agreement to the loan’s carrying value. These impairment reserves are recognized as a specific component to be provided for in the allowance for loan and lease losses. 
 
The following table sets forth the allocation of the allowance for non-covered loan and lease losses and percent of loans in each category to total loans and leases (excluding deferred loan fees) as of March 31, 2014 and December 31, 2013

(dollars in thousands) 
 
March 31, 2014
 
December 31, 2013
 
Amount
 
%
 
Amount
 
%
Commercial real estate, net
$
51,847

 
58.2
%
 
$
53,433

 
58.8
%
Commercial, net
26,762

 
28.7
%
 
24,191

 
28.8
%
Residential, net
7,191

 
12.4
%
 
6,827

 
11.7
%
Consumer & other, net
909

 
0.7
%
 
863

 
0.7
%
Unallocated

 
 
 

 
 
Allowance for non-covered loan and lease losses
$
86,709

 
 
 
$
85,314

 
 

At March 31, 2014, the recorded investment in non-covered loans classified as impaired totaled $105.7 million, with a corresponding valuation allowance (included in the allowance for loan and lease losses) of $1.4 million.  The valuation allowance on impaired loans represents the impairment reserves on performing current and former non-covered restructured loans and nonaccrual loans. At December 31, 2013, the total recorded investment in non-covered impaired loans was $100.8 million, with a corresponding valuation allowance (included in the allowance for loan and lease losses) of $1.8 million.  The valuation allowance on impaired loans represents the impairment reserves on performing current and former non-covered restructured loans and nonaccrual loans at December 31, 2013
 
The following table presents a summary of activity in the reserve for unfunded commitments (“RUC”):  
 
Summary of Reserve for Unfunded Commitments Activity 
 
(in thousands)
 
Three months ended
 
March 31,
 
2014
 
2013
Balance, beginning of period
$
1,436

 
$
1,223

Net change to other expense:
 
 
 
Commercial real estate, net
(26
)
 
(13
)
Commercial, net
(14
)
 
43

Residential, net
11

 
9

Consumer & other, net
10

 
7

Total change to other expense
(19
)
 
46

Balance, end of period
$
1,417

 
$
1,269

 

88

Table of Contents

We believe that the ALLL and RUC at March 31, 2014 are sufficient to absorb losses inherent in the loan and lease portfolio and credit commitments outstanding as of that date based on the best information available. This assessment, based in part on historical levels of net charge-offs, loan and lease growth, and a detailed review of the quality of the loan and lease portfolio, involves uncertainty and judgment. Therefore, the adequacy of the ALLL and RUC cannot be determined with precision and may be subject to change in future periods. In addition, bank regulatory authorities, as part of their periodic examination of the Bank, may require additional charges to the provision for loan and lease losses in future periods if warranted as a result of their review.
 
Allowance for Covered Loan Losses 
 
The covered ALLL totaled $10.3 million at March 31, 2014, an increase of $549,000 from the $9.8 million at December 31, 2013. The change in the covered ALLL, as compared to the prior year end results from changes in the amount and the timing of expected cash flows on the acquired loans compared to those previously estimated and charge-offs of unpaid principal balance against previously established allowance, as measured on a pool basis.  The following table summarizes activity related to the allowance for covered loan losses by covered loan portfolio segment for the three months ended March 31, 2014 and 2013, respectively:  
 
Allowance for Covered Loan Losses 
 
(in thousands)
 
Three months ended
 
March 31,
 
2014
 
2013
Balance, beginning of period
$
9,771

 
$
18,275

Loans charged-off:
 
 
 
Commercial real estate, net
(346
)
 
(261
)
Commercial, net
(169
)
 
(328
)
Residential, net
(118
)
 
(50
)
Consumer & other, net
(36
)
 
(178
)
Total loans charged-off
(669
)
 
(817
)
Recoveries:
 
 
 
Commercial real estate, net
391

 
295

Commercial, net
121

 
164

Residential, net
115

 
37

Consumer & other, net
20

 
35

Total recoveries
647

 
531

Net charge-offs
(22
)
 
(286
)
Covered provision charged to operations
571

 
232

Balance, end of period
$
10,320

 
$
18,221

 
 
 
 
As a percentage of average covered loans (annualized):
 
 
 
Net charge-offs
0.03
%
 
0.25
%
Provision for covered loan losses
0.67
%
 
0.20
%

The following table sets forth the allocation of the allowance for covered loan losses and percent of covered loans in each category to total loans as of March 31, 2014 and December 31, 2013
 

89

Table of Contents

(in thousands) 
 
 
March 31, 2014
 
December 31, 2013
 
Amount
 
%
 
Amount
 
%
Commercial real estate, net
$
6,071

 
81.5
%
 
$
6,105

 
81.6
%
Commercial, net
3,469

 
5.8
%
 
2,837

 
6.0
%
Residential, net
632

 
11.6
%
 
660

 
11.3
%
Consumer & other, net
148

 
1.1
%
 
169

 
1.1
%
Allowance for covered loan losses
$
10,320

 
 
 
$
9,771

 
 
 
 
Mortgage Servicing Rights 
 
The following table presents the key elements of our mortgage servicing rights asset for the three months ended March 31, 2014 and 2013, respectively: 
 
Summary of Mortgage Servicing Rights 
 
 
(in thousands)
 
Three months ended
 
March 31,
 
2014
 
2013
Balance, beginning of period
$
47,765

 
$
27,428

Additions for new MSR capitalized
2,408

 
6,403

Changes in fair value:
 
 
 
 Due to changes in model inputs or assumptions(1)
(1,087
)
 
(1,525
)
 Other(2)
134

 
(209
)
Balance, end of period
$
49,220

 
$
32,097

 
(1)
Principally reflects changes in discount rates and prepayment speed assumptions, which are primarily affected by changes in interest rates.
(2)
Represents changes due to collection/realization of expected cash flows over time.

Information related to our serviced loan portfolio as of March 31, 2014 and December 31, 2013 was as follows: 
 
(dollars in thousands)
 
March 31, 2014
 
December 31, 2013
Balance of loans serviced for others
$
4,496,662

 
$
4,362,499

MSR as a percentage of serviced loans
1.09
%
 
1.09
%

Mortgage servicing rights are adjusted to fair value quarterly with the change recorded in mortgage banking revenue.
  
Goodwill and Other Intangible Assets 
 
At March 31, 2014, we had goodwill and other intangible assets of $775.5 million, as compared to $776.7 million at December 31, 2013.  The goodwill recorded in connection with acquisitions represents the excess of the purchase price over the estimated fair value of the net assets acquired.  Goodwill and other intangible assets with indefinite lives are not amortized but instead are periodically tested for impairment.  Management evaluates intangible assets with indefinite lives on an annual basis as of December 31. Additionally, we perform impairment evaluations on an interim basis when events or circumstances indicate impairment potentially exists.  A significant amount of judgment is involved in determining if an indicator of impairment has occurred.  Such indicators may include, among others, a significant decline in our expected future cash flows; a sustained, significant decline in our stock price and market capitalization; a significant adverse change in legal factors or in the business climate; adverse action or assessment by a regulator; and unanticipated competition. 

90

Table of Contents

 
The Company has the option to perform a qualitative assessment before completing the goodwill impairment test two-step process.  The first step compares the fair value of a reporting unit to its carrying value.  If the reporting unit’s fair value is less than its carrying value, the Company would be required to proceed to the second step.  In the second step the Company calculates the implied fair value of the reporting unit’s goodwill. The implied fair value of goodwill is determined in the same manner as goodwill recognized in a business combination.  The estimated fair value of the Company is allocated to all of the Company’s assets and liabilities, including any unrecognized identifiable intangible assets, as if the Company had been acquired in a business combination and the estimated fair value of the reporting unit is the price paid to acquire it.  The allocation process is performed only for purposes of determining the amount of goodwill impairment.  No assets or liabilities are written up or down, nor are any additional unrecognized identifiable intangible assets recorded as a part of this process. Any excess of the estimated purchase price over the fair value of the reporting unit’s net assets represents the implied fair value of goodwill.  If the carrying amount of the goodwill is greater than the implied fair value of that goodwill, an impairment loss would be recognized as a charge to earnings in an amount equal to that excess. The Company performs the first step on an annual basis and in between if certain events or circumstances indicate goodwill may be impaired. No goodwill impairment losses have been recognized in the periods presented. 
 
At March 31, 2014, we had other intangible assets of $11.2 million, as compared to $12.4 million at December 31, 2013.   Intangible assets with definite useful lives are amortized to their estimated residual values over their respective estimated useful lives, and are also reviewed for impairment.  We amortize other intangible assets on an accelerated or straight-line basis over an estimated ten to fifteen year life.  No impairment losses separate from the scheduled amortization have been recognized in the periods presented.
  
Deposits 
 
Total deposits were $9.3 billion at March 31, 2014, an increase of $155.9 million, or 1.7%, as compared to year-end 2013. The increase resulted primarily from increased money market and non-interest bearing demand accounts, offset by a decrease in interest bearing demand accounts.
 
The following table presents the deposit balances by major category as of March 31, 2014 and December 31, 2013
 
Deposits 
(dollars in thousands) 
 
 
March 31, 2014
 
December 31, 2013
 
Amount
 
Percentage
 
Amount
 
Percentage
Non-interest bearing
$
2,465,606

 
26
%
 
$
2,436,477

 
26
%
Interest bearing demand
1,182,634

 
13
%
 
1,233,070

 
14
%
Money market
3,526,368

 
38
%
 
3,349,946

 
37
%
Savings
578,238

 
6
%
 
560,699

 
6
%
Time, $100,000 or greater
1,067,946

 
12
%
 
1,065,380

 
12
%
Time, less than $100,000
452,791

 
5
%
 
472,088

 
5
%
Total
$
9,273,583

 
100
%
 
$
9,117,660

 
100
%
 
The following table presents the average deposit and average rate paid on those deposits, by major category, as of the three months ended March 31, 2014 and 2013


91

Table of Contents

(dollars in thousands) 
 
Three months ended
 
March 31,
 
2014
 
2013
 
Average
 
Average
 
Average
 
Average
 
Deposits
 
Rate
 
Deposits
 
Rate
Non-interest bearing
$
2,414,001

 
 
$
2,155,110

 
Interest bearing demand
1,187,428

 
0.07%
 
1,201,224

 
0.10%
Money market
3,422,291

 
0.10%
 
3,272,646

 
0.11%
Savings
569,766

 
0.06%
 
489,614

 
0.06%
Time
1,516,544

 
0.71%
 
1,973,748

 
0.94%
Total
$
9,110,030

 
 
 
$
9,092,342

 
 
 
The Bank has an agreement with Promontory Interfinancial Network LLC (“Promontory”) that makes it possible to provide FDIC deposit insurance to balances in excess of current deposit insurance limits.  Promontory’s Certificate of Deposit Account Registry Service (“CDARS”) uses a deposit-matching program to exchange Bank deposits in excess of the current deposit insurance limits for excess balances at other participating banks, on a dollar-for-dollar basis, that would be fully insured at the Bank.  This product is designed to enhance our ability to attract and retain customers and increase deposits, by providing additional FDIC coverage to customers.  CDARS deposits can be reciprocal or one-way.  All of the Bank’s CDARS deposits are reciprocal.  At March 31, 2014 and December 31, 2013, the Company’s CDARS balances totaled $76.0 million and $66.9 million, respectively.  Of these totals, at March 31, 2014 and December 31, 2013, $74.4 million and $62.2 million, respectively, represented time deposits equal to or greater than $100,000 but were fully insured under current deposit insurance limits. 
 
The Dodd-Frank Act permanently raised the standard maximum federal deposit insurance amount from $100,000 to $250,000 per qualified account.    
Borrowings 
 
At March 31, 2014, the Bank had outstanding $262.5 million of securities sold under agreements to repurchase and no outstanding federal funds purchased balances. The Bank had outstanding term debt of $251.0 million at March 31, 2014. Term debt outstanding as of March 31, 2014 decreased $530,000 since December 31, 2013 as a result of accretion of purchase accounting adjustments. Advances from the FHLB amounted to $245.0 million of the total term debt and are secured by investment securities and loans secured by real estate.  The FHLB advances have fixed interest rates ranging from 4.46% to 4.72% and mature in 2016 and 2017.

Junior Subordinated Debentures 
 
We had junior subordinated debentures with carrying values of $189.6 million and $189.2 million at March 31, 2014 and December 31, 2013, respectively.  
 
At March 31, 2014, approximately $219.6 million, or 95% of the total issued amount, had interest rates that are adjustable on a quarterly basis based on a spread over three month LIBOR.  Interest expense for junior subordinated debentures decreased for the three months ended March 31, 2014, compared to the same period in 2013, primarily resulting from decreases in three month LIBOR.  Although increases in three month LIBOR will increase the interest expense for junior subordinated debentures, we believe that other attributes of our balance sheet will serve to mitigate the impact to net interest income on a consolidated basis.  
 
On January 1, 2007, the Company elected the fair value measurement option for certain pre-existing junior subordinated debentures of $97.9 million (the Umpqua Statutory Trusts).  The remaining junior subordinated debentures as of the adoption date were acquired through business combinations and were measured at fair value at the time of acquisition. In 2007, the Company issued two series of trust preferred securities and elected to measure each instrument at fair value. Accounting for junior subordinated debentures originally issued by the Company at fair value enables us to more closely align our financial performance with the economic value of those liabilities. Additionally, we believe it improves our ability to manage the market and interest rate risks associated with the junior subordinated debentures. The junior subordinated debentures measured at fair value and amortized cost have been presented as separate line items on the balance sheet. The ending carrying (fair) value of

92

Table of Contents

the junior subordinated debentures measured at fair value represents the estimated amount that would be paid to transfer these liabilities in an orderly transaction amongst market participants under current market conditions as of the measurement date. 
 
The significant inputs utilized in the estimation of fair value of these instruments are the credit risk adjusted spread and three month LIBOR.  The credit risk adjusted spread represents the nonperformance risk of the liability, contemplating the inherent risk of the obligation.  Generally, an increase in the credit risk adjusted spread and/or a decrease in the three month LIBOR will result in positive fair value adjustments.  Conversely, a decrease in the credit risk adjusted spread and/or an increase in the three month LIBOR will result in negative fair value adjustments.  
 
Through the first quarter of 2010 we obtained valuations from a third-party pricing service to assist with the estimation and determination of fair value of these liabilities.  In these valuations, the credit risk adjusted interest spread for potential new issuances through the primary market and implied spreads of these instruments when traded as assets on the secondary market, were estimated to be significantly higher than the contractual spread of our junior subordinated debentures measured at fair value.  The difference between these spreads has resulted in the cumulative gain in fair value, reducing the carrying value of these instruments as reported on our Condensed Consolidated Balance Sheets. In July 2010, the Dodd-Frank Act was signed into law which, among other things, limits the ability of certain bank holding companies to treat trust preferred security debt issuances as Tier 1 capital.  This law may require many banks to raise new Tier 1 capital and is expected to effectively close the trust-preferred securities markets from offering new issuances in the future.  As a result of this legislation, our third-party pricing service noted that they were no longer able to provide reliable fair value estimates related to these liabilities given the absence of observable or comparable transactions in the market place in recent history or as anticipated into the future.    
 
Due to inactivity in the junior subordinated debenture market and the inability to obtain observable quotes of our, or similar, junior subordinated debenture liabilities or the related trust preferred securities when traded as assets, we utilize an income approach valuation technique to determine the fair value of these liabilities using our estimation of market discount rate assumptions. The Company monitors activity in the trust preferred and related markets, to the extent available, changes related to the current and anticipated future interest rate environment, and considers our entity-specific creditworthiness, to validate the reasonableness of the credit risk adjusted spread and effective yield utilized in our discounted cash flow model.  Regarding the activity in and condition of the junior subordinated debt market, we noted no observable changes in the current period as it relates to companies comparable to our size and condition, in either the primary or secondary markets.  Relating to the interest rate environment, we considered the change in slope and shape of the forward LIBOR swap curve in the current period, the effects of which did not result in a significant change in the fair value of these liabilities. 
 
The Company’s specific credit risk is implicit in the credit risk adjusted spread used to determine the fair value of our junior subordinated debentures. As our Company is not specifically rated by any credit agency, it is difficult to specifically attribute changes in our estimate of the applicable credit risk adjusted spread to specific changes in our own creditworthiness versus changes in the market’s required return from similar companies. As a result, these considerations must be largely based off of qualitative considerations as we do not have a credit rating and we do not regularly issue senior or subordinated debt that would provide us an independent measure of the changes in how the market quantifies our perceived default risk.   

On a quarterly basis we assess entity-specific qualitative considerations that if not mitigated or represents a material change from the prior reporting period may result in a change to the perceived creditworthiness and ultimately the estimated credit risk adjusted spread utilized to value these liabilities.  Entity-specific considerations that positively impact our creditworthiness include: our strong capital position resulting from our successful public stock offerings in 2009 and 2010, that offers us flexibility to pursue business opportunities such as mergers and  acquisitions, or expand our footprint and product offerings; having significant levels of on and off-balance sheet liquidity; being profitable; and, having an experienced management team.  However, these positive considerations are mitigated by significant risks and uncertainties that impact our creditworthiness and ability to maintain capital adequacy in the future. Specific risks and concerns include: given our concentration of loans secured by real estate in our loan portfolio, a continued and sustained deterioration of the real estate market may result in declines in the value of the underlying collateral and increased delinquencies that could result in an increased of charge-offs; despite recent improvement, our credit quality metrics remain negatively elevated since 2007 relative to historical standards; the continuation of current economic downturn that has been particularly severe in our primary markets could adversely affect our business; recent increased regulation facing our industry, such as the Dodd-Frank Act, will increase the cost of compliance and restrict our ability to conduct business consistent with historical practices, and could negatively impact profitability; we have a significant amount of goodwill and other intangible assets that dilute our available tangible common equity; and the carrying value of certain material, recently recorded assets on our balance sheet, such as the FDIC loss-sharing indemnification asset, are highly reliant on management estimates, such as the timing or amount of losses that are estimated to be covered, and the assumed continued compliance with the provisions of the loss-share agreement. To the extent assumptions ultimately prove incorrect or should we consciously forego or unknowingly violate the guidelines of the agreement, an impairment of the asset may result which would reduce capital.  

93

Table of Contents

 
Additionally, the Company periodically utilizes an external valuation firm to determine or validate the reasonableness of the assessments of inputs and factors that ultimately determines the estimate fair value of these liabilities. The extent we involve or engage these external third parties correlates to management’s assessment of the current subordinate debt market, how the current environment and market compares to the preceding quarter, and perceived changes in the Company’s own creditworthiness during the quarter.  In periods of potential significant valuation changes and at year-end reporting periods we typically engage third parties to perform a full independent valuation of these liabilities.  For periods where management has assessed the market and other factors impacting the underlying valuation assumptions of these liabilities, and has determined significant changes to the valuation of these liabilities in the current period are remote, the scope of the valuation specialist’s review is limited to a review the reasonableness of management’s assessment of inputs.  In the fourth quarter of 2013, the Company engaged an external valuation firm to prepare an independent valuation of our junior subordinated debentures measured at fair value and the results were consistent with the Company’s valuation.  
 
Absent changes to the significant inputs utilized in the discounted cash flow model used to measure the fair value of these instruments at each reporting period, the cumulative discount for each junior subordinated debenture will reverse over time, ultimately returning the carrying values of these instruments to their notional values at their expected redemption dates, in a manner similar to the effective yield method as if these instruments were accounted for under the amortized cost method.   For the three months ended March 31, 2014 and 2013, we recorded losses of $542,000, resulting from the change in fair value of the junior subordinated debentures recorded at fair value.  Observable activity in the junior subordinated debenture and related markets in future periods may change the effective rate used to discount these liabilities, and could result in additional fair value adjustments (gains or losses on junior subordinated debentures measured at fair value) outside the expected periodic change in fair value had the fair value assumptions remained unchanged. 
 
On July 2, 2013, the federal banking regulators approved the final proposed rules that revise the regulatory capital rules to incorporate certain revisions by the Basel Committee on Banking Supervision to the Basel capital framework ("Basel III"). Under the final rule, consistent with Section 171 of the Dodd-Frank Act, bank holding companies with less than $15 billion in assets as of December 31, 2009 will be grandfathered and may continue to include these instruments in Tier 1 capital, subject to certain restrictions. However, if an institution grows above $15 billion as a result of an acquisition (including our closed merger with Sterling), the combined trust preferred issuances must be phased out of Tier 1 and into Tier 2 capital (75% in 2015 and 100% in 2016). It is possible the Company may accelerate redemption of the existing junior subordinated debentures.  This could result in adjustments to the fair value of these instruments including the acceleration of losses on junior subordinated debentures carried at fair value within non-interest income. The Company currently does not intend to redeem the junior subordinated debentures following the Merger in order to support regulatory total capital levels. At March 31, 2014, the Company's restricted core capital elements were 18.6% of total core capital, net of goodwill and any associated deferred tax liability.
 
Additional information regarding junior subordinated debentures measured at fair value is included in Note 16 of the Notes to Condensed Consolidated Financial Statements
 
All of the debentures issued to the Trusts, less the common stock of the Trusts, qualified as Tier 1 capital as of March 31, 2014, under guidance issued by the Board of Governors of the Federal Reserve System. Additional information regarding the terms of the junior subordinated debentures, including maturity/redemption dates, interest rates and the fair value election, is included in Note 9 of the Notes to Condensed Consolidated Financial Statements.

Liquidity and Cash Flow 
 
The principal objective of our liquidity management program is to maintain the Bank's ability to meet the day-to-day cash flow requirements of our customers who either wish to withdraw funds or to draw upon credit facilities to meet their cash needs. 
 
We monitor the sources and uses of funds on a daily basis to maintain an acceptable liquidity position. One of those sources is public deposits. Individual state laws require banks to collateralize public deposits, typically as a percentage of their public deposit balance in excess of FDIC insurance.  Public deposits represent 12.0% of total deposits at March 31, 2014 and 11.0% of total deposits at December 31, 2013. The amount of collateral required varies by state and may also vary by institution within each state, depending on the individual state’s risk assessment of depository institutions. Changes in the pledging requirements for uninsured public deposits may require pledging additional collateral to secure these deposits, drawing on other sources of funds to finance the purchase of assets that would be available to be pledged to satisfy a pledging requirement, or could lead to the withdrawal of certain public deposits from the Bank. In addition to liquidity from core deposits and the repayments and maturities of loans and investment securities, the Bank can utilize established uncommitted federal funds lines of credit, sell securities under agreements to repurchase, borrow on a secured basis from the FHLB or issue brokered certificates of deposit.  

94

Table of Contents

 
The Bank had available lines of credit with the FHLB totaling $2.2 billion at March 31, 2014, subject to certain collateral requirements, namely the amount of pledged loans and investment securities. The Bank had available lines of credit with the Federal Reserve totaling $460.6 million, subject to certain collateral requirements, namely the amount of certain pledged loans. The Bank had uncommitted federal funds line of credit agreements with additional financial institutions totaling $185.0 million at March 31, 2014. Availability of lines is subject to federal funds balances available for loan and continued borrower eligibility. These lines are intended to support short-term liquidity needs, and the agreements may restrict consecutive day usage. 
 
The Company is a separate entity from the Bank and must provide for its own liquidity. Substantially all of the Company's revenues are obtained from dividends declared and paid by the Bank. There were $18.5 million of dividends paid by the Bank to the Company in the three months ended March 31, 2014.  There are statutory and regulatory provisions that could limit the ability of the Bank to pay dividends to the Company. We believe that such restrictions will not have an adverse impact on the ability of the Company to fund its quarterly cash dividend distributions to common shareholders and meet its ongoing cash obligations, which consist principally of debt service on the $230.1 million (issued amount) of outstanding junior subordinated debentures. As of March 31, 2014, the Company did not have any borrowing arrangements of its own. 
 
As disclosed in the Consolidated Statements of Cash Flows, net cash provided by operating activities was $70.6 million during the three months ended March 31, 2014, with the difference between cash provided by operating activities and net income largely consisting of proceeds from the sale of loans held for sale of $254.1 million, offset by originations of loans held for sale of $213.1 million.  This compares to net cash provided by operating activities of $234.7 million during the three months ended March 31, 2013, with the difference between cash provided by operating activities and net income largely consisting of proceeds from the sale of loans held for sale of $675.2 million, partially offset by originations of loans held for sale of $471.2 million.
 
Net cash of $48.0 million provided by investing activities during the three months ended March 31, 2014 consisted principally of proceeds from investment securities available for sale of $93.2 million, proceeds from sale of non-covered loans and leases of $22.3 million, and net covered loan paydowns of $19.4 million, partially offset by $80.7 million of net non-covered loan and lease originations and purchases of premises and equipment of $8.2 million.   This compares to net cash of $250.6 million used by investing activities during the three months ended March 31, 2013, which consisted principally of proceeds from investment securities available for sale of $264.3 million, proceeds from the sale of non-covered loans and leases of $17.5 million, net covered loan paydowns of $17.3 million, proceeds from the sale of non-covered other real estate owned of $4.3 million, and net proceeds from the FDIC indemnification asset of $1.7 million, partially offset by purchases of investment securities available for sale of $51.2 million, purchases of premises and equipment of $5.2 million, and net non-covered loan originations of $3.4 million.
 
Net cash of $176.1 million provided by financing activities during the three months ended March 31, 2014 primarily consisted of $156.0 million increase in net deposits and $37.6 million increase in securities sold under agreements to repurchase, offset by dividends paid on common stock of $16.9 million. This compares to net cash of $310.9 million used by financing activities during the three months ended March 31, 2013, which consisted primarily of $307.5 million decrease in net deposits and repayment of junior subordinated debentures of $8.8 million, partially offset by $5.7 million increase in net securities sold under agreements to repurchase.
 
Although we expect the Bank's and the Company's liquidity positions to remain satisfactory during 2014, it is possible that our deposit growth for 2014 may not be maintained at previous levels due to pricing pressure or, in order to generate deposit growth, our pricing may need to be adjusted in a manner that results in increased interest expense on deposits.
  
Off-balance-Sheet Arrangements 
 
Information regarding Off-Balance-Sheet Arrangements is included in Note 10 of the Notes to Condensed Consolidated Financial Statements.
  
Concentrations of Credit Risk 
Information regarding Concentrations of Credit Risk is included in Note 10 of the Notes to Condensed Consolidated Financial Statements.

Capital Resources 
 

95

Table of Contents

Shareholders' equity at March 31, 2014 was $1.7 billion, an increase of $7.1 million from December 31, 2013. The increase in shareholders' equity during the three months ended March 31, 2014 was principally due to net income of $18.8 million and other comprehensive income, net of tax, of $4.8 million primarily offset by common stock dividends declared of $17.0 million.
 
The following table shows the Company's consolidated and the Bank’s capital adequacy ratios, as calculated under regulatory guidelines, compared to the regulatory minimum capital ratio and the regulatory minimum capital ratio needed to qualify as a “well-capitalized” institution at March 31, 2014 and December 31, 2013
 
(dollars in thousands) 
 
 
 
 
 
 
 
For Capital
 
To be Well
 
Actual
 
Adequacy purposes
 
Capitalized
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
As of March 31, 2014
 
 
 
 
 
 
 
 
 
 
 
Total Capital
 
 
 
 
 
 
 
 
 
 
 
(to Risk Weighted Assets)
 
 
 
 
 
 
 
 
 
 
 
Consolidated
$
1,285,588

 
14.70
%
 
$
699,640

 
8.00
%
 
$
874,550

 
10.00
%
Umpqua Bank
$
1,186,521

 
13.58
%
 
$
698,981

 
8.00
%
 
$
873,727

 
10.00
%
Tier I Capital
 
 
 
 
 
 
 
 
 
 
 
(to Risk Weighted Assets)
 
 
 
 
 
 
 
 
 
 
 
Consolidated
$
1,187,142

 
13.57
%
 
$
349,931

 
4.00
%
 
$
524,897

 
6.00
%
Umpqua Bank
$
1,088,123

 
12.46
%
 
$
349,317

 
4.00
%
 
$
523,976

 
6.00
%
Tier I Capital
 
 
 
 
 
 
 
 
 
 
 
(to Average Assets)
 
 
 
 
 
 
 
 
 
 
 
Consolidated
$
1,187,142

 
10.92
%
 
$
434,851

 
4.00
%
 
$
543,563

 
5.00
%
Umpqua Bank
$
1,088,123

 
10.01
%
 
$
434,814

 
4.00
%
 
$
543,518

 
5.00
%
As of December 31, 2013
 
 
 
 
 
 
 
 
 
 
 
Total Capital
 
 
 
 
 
 
 
 
 
 
 
(to Risk Weighted Assets)
 
 
 
 
 
 
 
 
 
 
 
Consolidated
$
1,278,354

 
14.65
%
 
$
698,077

 
8.00
%
 
$
872,597

 
10.00
%
Umpqua Bank
$
1,177,782

 
13.51
%
 
$
697,428

 
8.00
%
 
$
871,785

 
10.00
%
Tier I Capital
 
 
 
 
 
 
 
 
 
 
 
(to Risk Weighted Assets)
 
 
 
 
 
 
 
 
 
 
 
Consolidated
$
1,181,829

 
13.54
%
 
$
349,137

 
4.00
%
 
$
523,706

 
6.00
%
Umpqua Bank
$
1,081,282

 
12.40
%
 
$
348,801

 
4.00
%
 
$
523,201

 
6.00
%
Tier I Capital
 
 
 
 
 
 
 
 
 
 
 
(to Average Assets)
 
 
 
 
 
 
 
 
 
 
 
Consolidated
$
1,181,829

 
10.89
%
 
$
434,097

 
4.00
%
 
$
542,621

 
5.00
%
Umpqua Bank
$
1,081,282

 
9.97
%
 
$
433,814

 
4.00
%
 
$
542,268

 
5.00
%
 
On July 2, 2013, the federal banking regulators approved the final proposed rules that revise the regulatory capital rules to incorporate certain revisions by the Basel Committee on Banking Supervision to the Basel capital framework ("Basel III"). The phase-in period for the final rules will begin for the Company on January 1, 2015, with full compliance with the final rules entire requirement phased in on January 1, 2019.

The final rules, among other things, include a new common equity Tier 1 capital (“CET1”) to risk-weighted assets ratio, including a capital conservation buffer, which will gradually increase from 4.5% on January 1, 2015 to 7.0% on January 1, 2019. The final rules also raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0% on January 1, 2015 to 8.5% on January 1, 2019, as well as require a minimum leverage ratio of 4.0%.

Under the final rule, consistent with Section 171 of the Dodd-Frank Act, bank holding companies with less than $15 billion assets as of December 31, 2009 will be grandfathered and may continue to include these instruments in Tier 1 capital, subject to

96

Table of Contents

certain restrictions. However, if an institution grows above $15 billion as a result of an acquisition (including our closed merger with Sterling), the combined trust preferred issuances must be phased out of Tier 1 and into Tier 2 capital (75% in 2015 and 100% in 2016). It is possible the Company may accelerate redemption of the existing junior subordinated debentures.  This could result in adjustments to the fair value of these instruments including the acceleration of losses on junior subordinated debentures carried at fair value within non-interest income. The Company currently does not intend to redeem the junior subordinated debentures following the Merger in order to support regulatory total capital levels. At March 31, 2014, the Company's restricted core capital elements were 18.6% of total core capital, net of goodwill and any associated deferred tax liability.

The final rules also provide for a number of adjustments to and deductions from the new CET1, as well as changes to the calculation of risk-weighted assets which is expected to increase the absolute level. Under current capital standards, the effects of accumulated other comprehensive income items included in capital are excluded for the purposes of determining regulatory capital ratios. Under Basel III, the effects of certain accumulated other comprehensive items are not excluded; however, non-advanced approaches banking organizations, including the Company and the Bank, may make a one-time permanent election to continue to exclude these items. The Company and Bank expect to make this election in order to avoid significant variations in the level of capital depending upon the impact of interest rate fluctuations on the fair value of the Company's securities portfolio. In addition, deductions include, for example, the requirement that mortgage servicing rights, deferred tax assets dependent upon future taxable income and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such categories in the aggregate exceed 15% of CET1. Further, deferred tax assets which are related to operating losses and tax credit carry forward (including those acquired in our closed merger with Sterling) are excluded from CET1.

Based on its review and analysis of Basel III, management believes that the Company and the Bank will remain in excess of the "well-capitalized" standards under these new rules.

The Company’s share repurchase plan, which was first approved by the Company's Board of Directors and announced in August 2003, was amended on September 29, 2011 to increase the number of common shares available for repurchase under the plan to 15 million shares.  In April 2013, the repurchase program was extended to run through June 2015. As of March 31, 2014, a total of 12.0 million shares remained available for repurchase. The timing and amount of future repurchases will depend upon the market price for our common stock, securities laws restricting repurchases, asset growth, earnings, and our capital plan.  In addition, our stock plans provide that option and award holders may pay for the exercise price and tax withholdings in part or whole by tendering previously held shares. 
 
The Company’s dividend policy considers, among other things, earnings, regulatory capital levels, the overall payout ratio and expected asset growth to determine the amount of dividends declared, if any, on a quarterly basis. There is no assurance that future cash dividends on common shares will be declared or increased. The following table presents cash dividends declared and dividend payout ratios (dividends declared per common share divided by basic earnings per common share) for the three months ended March 31, 2014 and 2013:   

Cash Dividends and Payout Ratios per Common Share 
 
 
Three months ended
 
March 31,
 
2014
 
2013
Dividend declared per common share
$
0.15

 
$
0.10

Dividend payout ratio
88
%
 
48
%
   
Item 3.             Quantitative and Qualitative Disclosures about Market Risk 
 
Our assessment of market risk as of March 31, 2014 indicates there are no material changes in the quantitative and qualitative disclosures from those in our Annual Report on Form 10-K for the year ended December 31, 2013.
  
Item 4.             Controls and Procedures 
 

97

Table of Contents

Our management, including our Chief Executive Officer, Chief Financial Officer and Principal Accounting Officer, has concluded that our disclosure controls and procedures are effective in timely alerting them to information relating to us that is required to be included in our periodic filings with the Securities and Exchange Commission. The disclosure controls and procedures were last evaluated by management as of March 31, 2014
 
There have been no changes in our internal controls or in other factors that have materially affected or are likely to materially affect our internal controls over financial reporting subsequent to the date of the evaluation.

98

Table of Contents

Part II. OTHER INFORMATION 
Item 1.      Legal Proceedings 
Due to the nature of our business, we are involved in legal proceedings that arise in the ordinary course of our business. While the outcome of these matters is currently not determinable, we do not expect that the ultimate costs to resolve these matters will have a material adverse effect on our consolidated financial position, results of operations or cash flows.
 
In our Form 10-K for the period ending December 31, 2011, we initially reported on a class action lawsuit filed in the U.S. District Court for the Northern District of California against the Bank by Amber Hawthorne relating to overdraft fees and the posting order of point of sale and ACH items.  In March 2014, the parties reached an agreement in principle to settle the case on a class basis, subject to execution of a comprehensive written settlement agreement. Once executed, the settlement agreement will be presented to the court for preliminary approval. Settlement of this matter on the agreed terms will have no material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.

In our Form 10-K for the period ending December 31, 2013, we initially reported on two separate class action lawsuits filed in Spokane County, Washington, Superior Court against the Company and other defendants arising from the proposed Sterling merger. The court consolidated the cases before a single judge for further administration. The consolidated litigation generally alleges that directors of Sterling breached their duties to the Sterling shareholders by approving the Merger, failing to take steps to maximize shareholder value, engaging in a flawed sales process, and agreeing to deal protection provisions in the Merger agreement that are alleged to unduly favor the Company. The Company is alleged to have aided and abetted the alleged breaches of duty. The consolidated litigation also alleges that the disclosures approved by the Sterling board in connection with the Merger and the vote thereon are false and misleading in various respects. As relief, the complaints sought to enjoin the Merger and seek, among other things, damages in an unspecified amount and payment of plaintiffs’ attorneys’ fees and costs. The defendants believe that the lawsuits are without merit. On January 16, 2014, the parties executed a Memorandum of Understanding (the “MOU”) that contains the essential terms of a settlement and dismissal of the consolidated cases. The MOU does not call for the payment of any money damages, but required the defendants to make certain additional disclosures relating to the Merger and to pay the attorney fees, costs, and expenses of plaintiffs' counsel incurred in connection with the action. The agreed additional disclosures were made and included in the joint proxy statement/prospectus filed January 22, 2014. The MOU further provides that if the parties cannot agree on the amount of fees, costs, and expenses to be paid by the defendants to plaintiffs’ counsel, such amount shall be decided by the court. There has been no significant activity in the cases since the MOU was executed.

As set forth below, there are litigation matters pending against Sterling, the defense of which the Company has assumed, as successor in interest by Merger to Sterling.

On December 11, 2009, a putative securities class action complaint, captioned City of Roseville Employees' Retirement System v. Sterling Financial Corp., et al., No. CV 09-00368-EFS, was filed in the United States District Court for the Eastern District of Washington against Sterling and certain of its current and former officers. The Court appointed City of Roseville Employees' Retirement System as lead plaintiff on March 9, 2010. On June 18, 2010, lead plaintiff filed a consolidated complaint alleging that the defendants violated sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 by making false and misleading statements concerning our business and financial results. The consolidated complaint purported to be brought on behalf of a class of persons who purchased or otherwise acquired Sterling's stock during the period from July 23, 2008 to October 15, 2009. The consolidated complaint alleged that defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 by failing to disclose the extent of Sterling's delinquent commercial real estate, construction and land development loans, properly record losses for impaired loans, and properly reserve for loan losses, thereby causing Sterling's stock price to be artificially inflated during the purported class period. Plaintiffs sought unspecified damages and attorneys' fees and costs. On August 30, 2010, Sterling moved to dismiss the Complaint. On March 2, 2011, after complete briefing, the court held a hearing on the motion to dismiss. On August 5, 2013, the court granted the motion to dismiss without prejudice. On October 11, 2013, the lead plaintiff filed an amended consolidated complaint. The amended consolidated complaint names the same defendants, specifies the same class period, alleges the same violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and seeks the same relief. The amended consolidated complaint contains similar allegations of improper disclosure regarding Sterling's lending practices, status of loans and reserving and accounting for loans. On January 24, 2014, Sterling moved to dismiss the amended consolidated complaint. The Company, as successor in interest by Merger to Sterling, believes the lawsuit is without merit and continues to vigorously defend against it. Failure by the Company, as successor in interest by Merger to Sterling, to obtain a favorable resolution of the claims set forth in the complaint could have a material adverse effect on our business, results of operations and financial condition. Currently, a loss resulting from these claims is not considered probable or reasonably estimable in amount.
 

99

Table of Contents

See Note 10 of the Notes to the Condensed Consolidated Financial Statements for a discussion of the Company’s involvement in litigation pertaining to Visa Inc. 

Item 1A.   Risk Factors 
 
In addition to the other information set forth in this report, including the risk factors related to the recently completed merger with Sterling stated below, you should carefully consider the factors discussed under "Part I--Item 1A--Risk Factors" in our Form 10-K for the year ended December 31, 2013.   These factors could materially and adversely affect our business, financial condition, liquidity, results of operations and capital position, and could cause our actual results to differ materially from our historical results or the results contemplated by the forward-looking statements contained in this report.  Except for the updated risk factors described below, there have been no material changes from the risk factors described in our Form 10-K. The information below updates, and should be read in conjunction with, the risk factors and information disclosed in our Form 10-K.

Our Merger with Sterling, given its size and scope, will likely make it difficult for us to engage in traditional M&A transactions in the near term.
The successful integration of our Merger with Sterling is presently our top priority and it will take significant resources over the next 12 to 24 months to accomplish that goal. During this integration phase it is unlikely that we would receive regulatory approval to acquire another bank and our ability to engage in traditional merger and acquisition transactions will be constrained over the near term.

We have a gross deferred tax asset position of $93.1 million at March 31, 2014 and we are required to assess the recoverability of this asset on an ongoing basis.
Deferred tax assets are evaluated on a quarterly basis to determine if they are expected to be recoverable in the future. Our evaluation considers positive and negative evidence to assess whether it is more likely than not that a portion of the asset will not be realized. The risk of a valuation allowance increases if continuing operating losses are incurred. Future negative operating performance or other negative evidence may result in a valuation allowance being recorded against some or all of this amount. A valuation allowance on our deferred tax asset could have a material adverse impact on our capital and results of operations.
The market price of Umpqua common stock after the Merger with Sterling may be affected by factors different from those affecting the shares of Sterling or Umpqua currently.
Upon completion of the Merger with Sterling, holders of Sterling common stock became holders of Umpqua common stock. Umpqua’s business differs in important respects from that of Sterling, and, accordingly, the results of operations of the combined company and the market price of Umpqua common stock may be affected by factors different from those that affected the results of Umpqua’s operations prior to the Merger.
Combining the two companies may be more difficult, costly or time consuming than expected and the anticipated benefits and cost savings of the Merger may not be realized.
Umpqua and Sterling operated independently prior to the completion of the Merger on April 18, 2014. The success of the Merger, including anticipated benefits and cost savings, will depend, in part, on Umpqua’s ability to successfully combine and integrate the businesses of Umpqua and Sterling in a manner that permits growth opportunities and does not materially disrupt the existing customer relations nor result in decreased revenues due to loss of customers. It is possible that the integration process could result in the loss of key employees, the disruption of either company’s ongoing businesses or inconsistencies in standards, controls, procedures and policies that adversely affect the combined company’s ability to maintain relationships with clients, customers, depositors and employees or to achieve the anticipated benefits and cost savings of the merger. The loss of key employees could adversely affect Umpqua’s ability to successfully conduct its business, which could have an adverse effect on Umpqua’s financial results and the value of its common stock. If Umpqua experiences difficulties with the integration process, the anticipated benefits of the merger may not be realized fully or at all, or may take longer to realize than expected. As with any merger of financial institutions, there also may be business disruptions that causes Umpqua to lose customers or cause customers to remove their accounts from Umpqua and move their business to competing financial institutions. Integration efforts between the two companies will also divert management attention and resources. These integration matters could have an adverse effect on Umpqua during this integration period.


100

Table of Contents

Item 2.     Unregistered Sales of Equity Securities and Use of Proceeds  
 
(a)Not applicable  
 
(b)Not applicable 

(c)The following table provides information about repurchases of common stock by the Company during the quarter ended March 31, 2014
 
Period
 
Total number
of Common Shares
Purchased (1)
 
Average Price
Paid per Common Share
 
Total Number of Shares Purchased as Part of Publicly Announced Plan (2)
 
Maximum Number of Remaining Shares that May be Purchased at Period End under the Plan
1/1/14-1/31/14
 
128,686

 
$
18.11

 

 
12,013,429

2/1/14-2/28/14
 
55,026

 
$
16.99

 

 
12,013,429

3/1/14-3/31/14
 
73,182

 
$
18.42

 

 
12,013,429

Total for quarter
 
256,894

 
$
17.96

 

 
 
 
(1)
Common shares repurchased by the Company during the quarter consist of cancellation of 97,261 restricted stock awards and 35,665 restricted stock units to pay withholding taxes.  During the three months ended March 31, 2014, 123,968 common shares were repurchased in connection with option exercises and no shares were repurchased pursuant to the Company’s publicly announced corporate stock repurchase plan described in (2) below.

(2)
The Company’s share repurchase plan, which was first approved by its Board of Directors and announced in August 2003, was amended on September 29, 2011 to increase the number of common shares available for repurchase under the plan to 15 million shares.  The repurchase program was extended in April 2013 to run through June 2015. As of March 31, 2014, a total of 12.0 million shares remained available for repurchase. The timing and amount of future repurchases will depend upon the market price for our common stock, securities laws restricting repurchases, asset growth, earnings, and our capital plan.
  
Item 3.            Defaults upon Senior Securities 
Not applicable 
Item 4.            Mine Safety Disclosures 
Not applicable 
Item 5.            Other Information 
 
(a)
Not applicable 
 
(b)
Not applicable 
Item 6.            Exhibits  
 
The exhibits filed as part of this Report and exhibits incorporated herein by reference to other documents are listed in the Exhibit Index to this Report, which follows the signature page.

101

Table of Contents

SIGNATURES 
 
Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. 
 
 
 
UMPQUA HOLDINGS CORPORATION
 
 
(Registrant) 
 
 
 
Dated
May 7, 2014
/s/ Raymond P. Davis                                                
 
 
President and Chief Executive Officer  
Raymond P. Davis
 
 
 
Dated
May 7, 2014
/s/ Ronald L. Farnsworth
 
 
Ronald L. Farnsworth  
Executive Vice President/ Chief Financial Officer and 
Principal Financial Officer
 
 
 
Dated
May 7, 2014
/s/ Neal T. McLaughlin
 
 
Neal T. McLaughlin                                     
Executive Vice President/Treasurer and 
Principal Accounting Officer

102

Table of Contents

EXHIBIT INDEX (see separate attachment)
Exhibit
 
3.1
Restated Articles of Incorporation, as amended
 
 
3.2
(a) Bylaws, as amended 
 
 
4.1
(b) Specimen Common Stock Certificate
 
 
31.1
Certification of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002
 
 
31.2
Certification of Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002
 
 
31.3
Certification of Principal Accounting Officer under Section 302 of the Sarbanes-Oxley Act of 2002
 
 
32
Certification of Chief Executive Officer, Chief Financial Officer and Principal Accounting Officer pursuant to
 
Section 906 of the Sarbanes-Oxley Act of 2002
 
                                     
 
101.INS XBRL Instance Document * 
101.SCH XBRL Taxonomy Extension Schema Document * 
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document * 
101.DEF XBRL Taxonomy Extension Definition Linkbase Document * 
101.LAB XBRL Taxonomy Extension Label Linkbase Document * 
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document * 
                         
* Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, or Section 18 of the Securities and 
Exchange Act of 1934, as amended and otherwise are not subject to liability under those sections. 
 
(a)     Incorporated by reference to Exhibit 3.2 to Form 8-K filed April 22, 2008
(b)     Incorporated by reference to Exhibit 4 to the Registration Statement on Form S-8 (No. 333-77259) filed April 28, 1999




103