Edgar Filing: COLUMBIA BANKING SYSTEM INC

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Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2011.

¨	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 0-20288

COLUMBIA BANKING SYSTEM, INC.

(Exact name of issuer as specified in its charter)


Washington		91-1422237
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

1301 “A” Street Tacoma, Washington		98402-2156
(Address of principal executive offices)		(Zip Code)

(253) 305-1900

(Issuer’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

The number of shares of common stock outstanding at July 31, 2011 was 39,496,663.

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		Page
PART I — FINANCIAL INFORMATION

Item 1.	Financial Statements (unaudited)

	Consolidated Condensed Statements of Income - three and six months ended June 30, 2011 and 2010		1

	Consolidated Condensed Balance Sheets – June 30, 2011 and December 31, 2010		2

	Consolidated Condensed Statements of Changes in Shareholders’ Equity - three and six months ended June 30, 2011 and 2010		3

	Consolidated Condensed Statements of Cash Flows - three and six months ended June 30, 2011 and 2010		4

	Notes to Unaudited Consolidated Condensed Financial Statements		5

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		28

Item 3.	Quantitative and Qualitative Disclosures about Market Risk		47

Item 4.	Controls and Procedures		47

PART II — OTHER INFORMATION

Item 1.	Legal Proceedings		48

Item 1A.	Risk Factors		48

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		54

Item 3.	Defaults Upon Senior Securities		54

Item 4.	[Removed and Reserved]		54

Item 5.	Other Information		54

Item 6.	Exhibits		55

	Signatures		56

PART I - FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

CONSOLIDATED CONDENSED STATEMENTS OF INCOME

Columbia Banking System, Inc.

(Unaudited)


	Three Months Ended June 30,						Six Months Ended June 30,
*(in thousands except per share)*	2011			2010			2011			2010
*Interest Income*
Loans	$	44,362		$	38,940		$	91,791		$	75,887
Taxable securities		6,247			4,708			10,664			9,453
Tax-exempt securities		2,516			2,290			4,983			4,736
Federal funds sold and deposits in banks		184			210			482			359

Total interest income		53,309			46,148			107,920			90,435

*Interest Expense*
Deposits		2,848			4,334			5,927			9,275
Federal Home Loan Bank advances		714			710			1,408			1,415
Long-term obligations		253			254			504			503
Other borrowings		119			118			257			236

Total interest expense		3,934			5,416			8,096			11,429


*Net Interest Income*		49,375			40,732			99,824			79,006
Provision for loan and lease losses		2,150			13,500			2,150			28,500
Provision for losses on covered loans		2,301			0			1,879			0

Net interest income after provision for loan and lease losses		44,924			27,232			95,795			50,506

*Noninterest Income (Loss)*
Service charges and other fees		6,467			6,442			12,755			11,866
Gain on bank acquisitions		0			0			0			9,818
Merchant services fees		1,808			1,913			3,441			3,652
Gain on sale of investment securities, net		0			0			0			58
Bank owned life insurance		528			516			1,033			1,020
Change in FDIC loss sharing asset		(6,419	)		3,399			(21,193	)		3,399
Other		1,158			967			2,087			1,897

Total noninterest income (loss)		3,542			13,237			(1,877	)		31,710

*Noninterest Expense*
Compensation and employee benefits		19,459			17,497			38,380			34,483
Occupancy		4,388			4,307			8,785			8,276
Merchant processing		905			1,227			1,788			2,327
Advertising and promotion		1,012			785			1,913			1,623
Data processing and communications		1,913			2,567			3,837			4,446
Legal and professional fees		1,498			1,477			2,911			2,975
Taxes, licenses and fees		907			688			1,772			1,252
Regulatory premiums		1,279			1,462			2,979			2,918
Net cost of operation of other real estate owned		214			(672	)		(228	)		640
Amortization of intangibles		955			1,055			1,939			1,842
FDIC clawback liability		448			0			2,148			0
Other		4,186			4,352			8,286			7,860

Total noninterest expense		37,164			34,745			74,510			68,642


Income before income taxes		11,302			5,724			19,408			13,574
Income tax provision		2,670			668			4,997			602


*Net Income*	$	8,632		$	5,056		$	14,411		$	12,972


Net Income Applicable to Common Shareholders	$	8,632		$	3,946		$	14,411		$	10,755


Earnings per common share
Basic	$	0.22		$	0.11		$	0.37		$	0.34
Diluted	$	0.22		$	0.11		$	0.36		$	0.34
Dividends paid per common share	$	0.05		$	0.01		$	0.08		$	0.02
Weighted average number of common shares outstanding		39,107			34,829			39,073			31,376
Weighted average number of diluted common shares outstanding		39,166			35,077			39,159			31,607

See accompanying notes to unaudited consolidated condensed financial statements.

CONSOLIDATED CONDENSED BALANCE SHEETS

Columbia Banking System, Inc.

(Unaudited)


*(in thousands)*					June 30, 2011		December 31, 2010
ASSETS
Cash and due from banks					$	89,926	$	55,492
Interest-earning deposits with banks						179,573		458,638

Total cash and cash equivalents						269,499		514,130
Securities available for sale at fair value (amortized cost of $956,125 and $743,928, respectively)						989,768		763,866
Federal Home Loan Bank stock at cost						18,791		17,908
Loans held for sale						655		754
Loans, excluding covered loans, net of deferred loan fees of ($3,454) and ($3,490), respectively						1,987,474		1,915,754
Less: allowance for loan and lease losses						54,057		60,993

Loans, excluding covered loans, net						1,933,417		1,854,761
Covered loans, net of allowance for loan losses of ($7,948) and ($6,055), respectively						607,310		517,061

Total loans, net						2,540,727		2,371,822
FDIC loss sharing asset						206,238		205,991
Interest receivable						14,010		11,164
Premises and equipment, net						99,439		93,108
Other real estate owned ($24,239 and $14,443 covered by FDIC loss share, respectively)						46,979		45,434
Goodwill						119,343		109,639
Core deposit intangible, net						18,602		18,696
Other assets						105,092		103,851

Total Assets					$	4,429,143	$	4,256,363

LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits:
Noninterest-bearing					$	923,031	$	895,671
Interest-bearing						2,552,136		2,431,598

Total deposits						3,475,167		3,327,269
Federal Home Loan Bank advances						120,681		119,405
Securities sold under agreements to repurchase						25,000		25,000
Other borrowings						0		642
Long-term subordinated debt						25,768		25,735
Other liabilities						54,847		51,434

Total liabilities						3,701,463		3,549,485
Commitments and contingent liabilities
Shareholders’ equity:

	June 30, 2011		December 31, 2010
Common Stock (no par value)
Authorized shares		63,033		63,033
Issued and outstanding		39,475		39,338		578,046		576,905
Retained earnings						128,949		117,692
Accumulated other comprehensive income						20,685		12,281

Total shareholders’ equity						727,680		706,878

Total Liabilities and Shareholders’ Equity					$	4,429,143	$	4,256,363

See accompanying notes to unaudited consolidated condensed financial statements.

CONSOLIDATED CONDENSED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

Columbia Banking System, Inc.

(Unaudited)


	Preferred Stock				Common Stock						Retained Earnings			Accumulated Other Comprehensive Income			Total Shareholders’ Equity
*(in thousands)*	Number of Shares		Amount		Number of Shares			Amount			Retained Earnings			Accumulated Other Comprehensive Income			Total Shareholders’ Equity
Balance at January 1, 2010		77	$	74,301		28,129		$	348,706		$	93,316		$	11,816		$	528,139
Comprehensive income:
Net income												12,972						12,972
Other comprehensive income, net of tax:
Net unrealized gain from securities, net of reclassification adjustments															7,128			7,128
Net change in cash flow hedging instruments															(727	)		(727	)
Net pension plan liability adjustment															37			37

Other comprehensive income																		6,438

Comprehensive income																		19,410

Accretion of preferred stock discount				294								(294	)					0
Issuance of common stock, net of offering costs						11,040			229,129									229,129
Issuance of common stock - stock option and other plans						42			521									521
Issuance of common stock - restricted stock awards, net of cancelled awards						93			705									705
Tax benefit deficiency associated with share-based compensation									(12	)								(12	)
Preferred dividends												(1,922	)					(1,922	)
Cash dividends paid on common stock												(675	)					(675	)

Balance at June 30, 2010		77	$	74,595		39,304		$	579,049		$	103,397		$	18,254		$	775,295


Balance at January 1, 2011		0	$	0		39,338		$	576,905		$	117,692		$	12,281		$	706,878
Comprehensive income:
Net income												14,411						14,411
Other comprehensive income, net of tax:
Net unrealized gain from securities, net of reclassification adjustments															8,780			8,780
Net change in cash flow hedging instruments															(143	)		(143	)
Net pension plan liability adjustment															(233	)		(233	)

Other comprehensive income																		8,404

Comprehensive income																		22,815

Issuance of common stock - stock option and other plans						25			410									410
Issuance of common stock - restricted stock awards, net of cancelled awards						114			763									763
Repurchase of shares						(2	)		(32	)								(32	)
Cash dividends paid on common stock												(3,154	)					(3,154	)

Balance at June 30, 2011		0	$	0		39,475		$	578,046		$	128,949		$	20,685		$	727,680

See accompanying notes to unaudited consolidated condensed financial statements.

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

Columbia Banking System, Inc.

(Unaudited)


	Six Months Ended June 30,
*(in thousands)*	2011			2010
Cash Flows From Operating Activities
Net Income	$	14,411		$	12,972
Adjustments to reconcile net income to net cash provided by operating activities
Provision for loan and lease losses and losses on covered loans		4,029			28,500
Stock-based compensation expense		763			705
Depreciation, amortization and accretion		6,900			6,084
Net realized gain on FDIC assisted bank acquisitions		0			(9,818	)
Net realized gain on sale of securities		0			(58	)
Net realized gain on sale of other assets		(3	)		(14	)
Net realized gain on sale of other real estate owned		(5,455	)		(1,644	)
Gain on termination of cash flow hedging instruments		(222	)		(1,128	)
Write-down on other real estate owned		4,559			1,793
Deferred income tax benefit		0			142
Net change in:
FDIC loss-sharing asset, net of cash received		20,139			(16,340	)
Loans held for sale		99			0
Interest receivable		(1,940	)		469
Interest payable		(1	)		(459	)
Other assets		1,287			5,651
Other liabilities		(2,045	)		11,327

Net cash provided by operating activities		42,521			38,182
Cash Flows From Investing Activities
Loans originated and acquired, net of principal collected		(27,829	)		97,279
Purchases of:
Securities available for sale		(269,966	)		(64,054	)
Premises and equipment		(2,388	)		(1,054	)
Proceeds from:
FDIC reimbursement on loss-sharing asset		44,892			0
Sales of securities available for sale		0			69,328
Principal repayments and maturities of securities available for sale		60,247			42,790
Disposal of premises and equipment		20			60
Sales of covered other real estate owned		11,081			9,347
Sales of other real estate and other personal property owned		7,874			3,190
Capital improvements on other real estate properties		(468	)		(579	)
Decrease in Small Business Administration secured borrowings		(642	)		0
Net cash acquired in business combinations		39,010			145,534

Net cash (used in) provided by investing activities		(138,169	)		301,841
Cash Flows From Financing Activities
Net decrease in deposits		(134,906	)		(345,080	)
Proceeds from:
Issuance of common stock		0			229,129
Exercise of stock options		410			509
Federal Home Loan Bank advances		100			0
Federal Reserve Bank borrowings		100			0
Payment for:
Repayment of Federal Home Loan Bank advances		(11,401	)		(30,197	)
Repayment of Federal Reserve Bank borrowings		(100	)		0
Preferred stock dividends		0			(1,922	)
Common stock dividends		(3,154	)		(675	)
Repurchase of common stock		(32	)		0
Net decrease in other borrowings		0			87

Net cash used in financing activities		(148,983	)		(148,149	)
(Decrease) Increase in cash and cash equivalents		(244,631	)		191,874
Cash and cash equivalents at beginning of period		514,130			305,074

Cash and cash equivalents at end of period	$	269,499		$	496,948

Supplemental Information:
Cash paid during the year for:
Cash paid for interest	$	8,097		$	11,888

Non-cash investing activities
Assets acquired in FDIC assisted acquisitions (excluding cash and cash equivalents)	$	257,104		$	1,075,166
Liabilities assumed in FDIC assisted acquisitions	$	296,114		$	1,210,882
Loans transferred to other real estate owned	$	8,240		$	15,019

See accompanying notes to unaudited consolidated condensed financial statements.

NOTES TO UNAUDITED CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

Columbia Banking System, Inc.

1. Basis of Presentation and Significant Accounting Policies

Basis of Presentation

The interim unaudited consolidated condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for condensed interim financial information and with instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain financial information and footnotes have been omitted or condensed. The consolidated condensed financial statements include the accounts of the Company, and its wholly owned banking subsidiary Columbia Bank (the “Bank”). All intercompany transactions and accounts have been eliminated in consolidation. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair statement of the results for the interim periods presented have been included. The results of operations for the six months ended June 30, 2011 are not necessarily indicative of results to be anticipated for the year ending December 31, 2011. The accompanying interim unaudited consolidated condensed financial statements should be read in conjunction with the financial statements and related notes contained in the Company’s 2010 Annual Report on Form 10-K.

Significant Accounting Policies

The significant accounting policies used in preparation of our consolidated financial statements are disclosed in our 2010 Annual Report on Form 10-K. There have not been any changes in our significant accounting policies compared to those contained in our 2010 10-K disclosure for the year ended December 31, 2010.

2. Accounting Pronouncements Recently Issued

In April 2011, the Financial Accounting Standards Board (“the FASB”) issued Accounting Standards Update (“ASU”) 2011-02, A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring (Topic 310). ASU 2011-02 clarifies the criteria for a restructuring to be classified as a Troubled Debt Restructuring. The effective date of ASU 2011-02 will be the first interim or annual period beginning after June 15, 2011 and should be applied retrospectively to the beginning of the annual period of adoption. The Company is evaluating the impact this ASU will have on its financial condition and results of operations.

In April 2011, the FASB issued ASU 2011-03, Reconsideration of Effective Control for Repurchase Agreements (Topic 860). ASU 2011-03 attempts to improve the accounting for repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before maturity. The effective date of ASU 2011-03 will be the first interim or annual period beginning after December 15, 2011 and should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. The Company is evaluating the impact this ASU will have on its financial condition and results of operations.

In May 2011, the FASB issued ASU 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. Generally Accepted Accounting Principles (“GAAP”) and International Financial Reporting Standards (“IFRS”) (Topic 820). ASU 2011-04 developed common requirements between GAAP and IFRS for measuring fair value and for disclosing information about fair value measurements. The effective date of ASU 2011-04 will be during interim or annual period beginning after December 15, 2011 and should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. The Company is evaluating the impact this ASU will have on its financial condition and results of operations.

In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income (Topic 220). ASU 2011-05 attempts to improve the comparability, consistency, and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income. The effective date of ASU 2011-05 will be the first interim or fiscal period beginning after December 15, 2011 and should be applied retrospectively. Early adoption is permitted. The Company will apply the disclosure requirements of ASU 2011-05 for its first interim period beginning after December 15, 2011.

3. Earnings per Common Share

Basic Earnings per Share (“EPS”) is computed by dividing income applicable to common shareholders by the weighted average number of common shares outstanding for the period. Common shares outstanding include common stock and vested restricted stock awards where recipients have satisfied the vesting terms. Diluted EPS reflects the assumed conversion of all dilutive securities, applying the treasury stock method. The Company calculates earnings per share using the two-class method as described in the Earnings per Share topic of the FASB Accounting Standards Codification (“ASC”). The following table sets forth the computation of basic and diluted earnings per share for the three and six months ended June 30, 2011 and 2010:


	Three Months Ended June 30,						Six Months Ended June 30,
*(in thousands except per share)*	2011			2010			2011			2010
Basic EPS:
Net income	$	8,632		$	5,056		$	14,411		$	12,972
Less: Preferred dividends and accretion of issuance discount for preferred stock		0			(1,110	)		0			(2,217	)

Net income applicable to common shareholders	$	8,632		$	3,946		$	14,411		$	10,755
Less: Earnings allocated to participating securities		(82	)		(38	)		(135	)		(109	)

Earnings allocated to common shareholders	$	8,550		$	3,908		$	14,276		$	10,646

Weighted average common shares outstanding		39,107			34,829			39,073			31,376
Basic earnings per common share	$	0.22		$	0.11		$	0.37		$	0.34


Diluted EPS:
Earnings allocated to common shareholders	$	8,550		$	3,908		$	14,276		$	10,646

Weighted average common shares outstanding		39,107			34,829			39,073			31,376
Dilutive effect of equity awards and warrants		59			248			86			231

Weighted average diluted common shares outstanding		39,166			35,077			39,159			31,607

Diluted earnings per common share	$	0.22		$	0.11		$	0.36		$	0.34


Potentially dilutive share options that were not included in the computation of diluted EPS because to do so would be anti-dilutive.		62			54			54			54

4. Business Combinations

Summit Bank

On May 20, 2011 the Bank acquired certain assets and assumed certain liabilities of Summit Bank from the Federal Deposit Insurance Corporation (“FDIC”) in an FDIC-assisted transaction. As part of the Purchase and Assumption Agreement, the Bank and the FDIC entered into loss-sharing agreements (each, a “loss-sharing agreement” and collectively, the “loss-sharing agreements”), whereby the FDIC will cover a substantial portion of any future losses on loans (and related unfunded commitments), OREO and certain accrued interest on loans for up to 90 days. We refer to the acquired loans and OREO subject to the loss-sharing agreements collectively as “covered assets.” Under the terms of the loss-sharing agreements, the FDIC will absorb 80% of losses and share in 80% of loss recoveries. The loss-sharing provisions of the agreements for commercial and single family residential mortgage loans are in effect for five years and ten years, respectively, from the May 20, 2011 acquisition date and the loss recovery provisions for such loans are in effect for eight years and ten years, respectively, from the acquisition date.

Summit Bank was a full service community bank headquartered in Burlington, Washington that operated three branch locations in Skagit County. We entered into this transaction to assist us with filling in our geographic footprint between Seattle and Bellingham, Washington and to support our recently expanded Bellingham banking team. We believe participating with the FDIC in this assisted transaction was, from an economical standpoint, advantageous to expansion through de novo branching.

The assets acquired and liabilities assumed have been accounted for under the acquisition method of accounting (formerly the purchase method). The assets and liabilities, both tangible and intangible, were recorded at their estimated fair values as of the May 20, 2011 acquisition date. Initial accounting for acquired loans and the related indemnification asset for the Summit Bank acquisition was incomplete as of June 30, 2011. The amounts currently recognized in the financial statements have been determined provisionally as we are completing a fair value analysis of those assets utilizing an income approach. The application of the acquisition method of accounting resulted in the recognition of $3.8 million of goodwill and a core deposit intangible of $509 thousand. The goodwill represents the excess of the estimated fair value of the liabilities assumed over the estimated fair value of the assets acquired and is influenced significantly by the FDIC-assisted transaction process. All of the goodwill and core deposit intangible assets recognized are deductible for income tax purposes.

The operating results of the Company include the operating results produced by the acquired assets and assumed liabilities for the period May 21, 2011 to June 30, 2011. Due primarily to the significant amount of fair value adjustments and the FDIC loss-sharing agreements put in place, historical results of Summit Bank are not meaningful to the Company’s results and thus no pro forma information is presented.

The table below displays the amounts recognized as of the acquisition date for each major class of assets acquired and liabilities assumed:


	May 20, 2011
	*(in thousands)*
Assets
Cash and due from banks	$	1,837
Interest-earning deposits with banks and federal funds sold		14,198
Investment securities		871
Federal Home Loan Bank stock		406
Acquired loans		71,452
Accrued interest receivable		429
Premises and equipment		42
FDIC receivable		6,984
Other real estate owned covered by loss sharing		2,671
Goodwill		3,770
Core deposit intangible		509
FDIC indemnification asset		27,174
Other assets		786

Total assets acquired	$	131,129

Liabilities
Deposits	$	123,279
Federal Home Loan Bank advances		7,772
Accrued interest payable		71
Other liabilities		7

Total liabilities assumed	$	131,129

First Heritage Bank

On May 27, 2011 the Bank acquired certain assets and assumed certain liabilities of First Heritage Bank from the FDIC in an FDIC-assisted transaction. As part of the Purchase and Assumption Agreement, the Bank and the FDIC entered into loss-sharing agreements (each, a “loss-sharing agreement” and collectively, the “loss-sharing agreements”), whereby the FDIC will cover a substantial portion of any future losses on loans (and related unfunded commitments), OREO and certain accrued interest on loans for up to 90 days. We refer to the acquired loans and OREO subject to the loss-sharing agreements collectively as “covered assets.” Under the terms of the loss-sharing agreements, the FDIC will absorb 80% of losses and share in 80% of loss recoveries. The loss-sharing provisions of the agreements for commercial and single family residential mortgage loans are in effect for five years and ten years, respectively, from the May 27, 2011 acquisition date and the loss recovery provisions for such loans are in effect for eight years and ten years, respectively, from the acquisition date.

First Heritage Bank was a full service community bank headquartered in Snohomish, Washington that operated five branch locations in King and Snohomish Counties. We entered into this transaction to assist us with filling in our geographic footprint between Seattle and Bellingham, Washington and to support our recently expanded Bellingham banking team. We believe participating with the FDIC in this assisted transaction was, from an economical standpoint, advantageous to expansion through de novo branching.

The assets acquired and liabilities assumed have been accounted for under the acquisition method of accounting (formerly the purchase method). The assets and liabilities, both tangible and intangible, were recorded at their estimated fair values as of the May 27, 2011 acquisition date. The initial accounting for acquired loan’s and the related indemnification asset for the First Heritage Bank acquisition was incomplete as of June 30, 2011. The amounts currently recognized in the financial statements have been determined provisionally as we are completing a fair value analysis of those assets utilizing an income approach. The application of the acquisition method of accounting resulted in the recognition in $5.9 million of goodwill and a core deposit intangible of $1.3 million. The goodwill represents the excess of the estimated fair value of the liabilities assumed over the estimated fair value of the assets acquired and is influenced significantly by the FDIC-assisted transaction process. All of the goodwill and core deposit intangible assets recognized are deductible for income tax purposes.

The operating results of the Company include the operating results produced by the acquired assets and assumed liabilities for the period May 28, 2011 to June 30, 2011. Due primarily to the significant amount of fair value adjustments and the FDIC loss-sharing agreements put in place, historical results of First Heritage Bank are not meaningful to the Company’s results and thus no pro forma information is presented.

The table below displays the amounts recognized as of the acquisition date for each major class of assets acquired and liabilities assumed:


	May 27, 2011
	*(in thousands)*
Assets
Cash and due from banks	$	4,688
Interest-earning deposits with banks		6,689
Investment securities		5,303
Federal Home Loan Bank stock		477
Acquired loans		81,857
Accrued interest receivable		476
Premises and equipment		5,339
FDIC receivable		4,751
Other real estate owned covered by loss sharing		8,286
Goodwill		5,934
Core deposit intangible		1,337
FDIC indemnification asset		38,104
Other assets		1,743

Total assets acquired	$	164,984

Liabilities
Deposits	$	159,525
Federal Home Loan Bank advances		5,003
Accrued interest payable		421
Other liabilities		35

Total liabilities assumed	$	164,984

5. Securities

The following table summarizes the amortized cost, gross unrealized gains and losses and the resulting fair value of securities available for sale:


*(in thousands)*	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
June 30, 2011:
U.S. government agency and government-sponsored enterprise mortgage-backed securities and collateralized mortgage obligations	$	671,342	$	22,154	($	84	)	$	693,412
State and municipal securities		250,336		12,161		(858	)		261,639
U.S. government agency securities		30,054		224		0			30,278
Other securities		4,393		77		(31	)		4,439

Total	$	956,125	$	34,616	($	973	)	$	989,768


December 31, 2010:
U.S. government agency and government-sponsored enterprise mortgage-backed securities and collateralized mortgage obligations	$	491,530	$	16,139	($	1,027	)	$	506,642
State and municipal securities		249,117		7,247		(2,383	)		253,981
Other securities		3,281		0		(38	)		3,243

Total	$	743,928	$	23,386	($	3,448	)	$	763,866

The scheduled contractual maturities of investment securities available for sale at June 30, 2011 are presented as follows:


	June 30, 2011
	Amortized Cost		Fair Value
	*(in thousands)*
Due within one year	$	29,452	$	29,790
Due after one year through five years		93,873		96,310
Due after five years through ten years		169,886		177,458
Due after ten years		659,633		682,942

Total investment securities available-for-sale	$	952,844	$	986,500

The following table summarizes the carrying value of securities pledged as collateral at June 30, 2011:


*(in thousands)*	Carrying Amount
Washington and Oregon State public deposits	$	220,540
Federal Home Loan Bank advances		92,418
Federal Reserve Bank borrowings		51,657
Repurchase agreement		27,556
Interest rate contracts		13,336
Other		1,429

Total securities pledged as collateral	$	406,936

The following tables show the gross unrealized losses and fair value of the Company’s investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2011 and December 31, 2010:


June 30, 2011
	Less than 12 Months					12 Months or More					Total
*(in thousands)*	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
U.S. government agency and government-sponsored enterprise mortgage-backed securities and collateralized mortgage obligations	$	26,028	($	83	)	$	347	($	1	)	$	26,375	($	84	)
State and municipal securities		27,944		(636	)		2,829		(222	)		30,773		(858	)
Other securities		0		0			969		(31	)		969		(31	)

Total	$	53,972	($	719	)	$	4,145	($	254	)	$	58,117	($	973	)


December 31, 2010
	Less than 12 Months					12 Months or More					Total
*(in thousands)*	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
U.S. government agency and government-sponsored enterprise mortgage-backed securities and collateralized mortgage obligations	$	86,529	($	1,025	)	$	588	($	2	)	$	87,117	($	1,027	)
State and municipal securities		74,755		(2,099	)		2,792		(284	)		77,547		(2,383	)
Other securities		2,275		(6	)		968		(32	)		3,243		(38	)

Total	$	163,559	($	3,130	)	$	4,348	($	318	)	$	167,907	($	3,448	)

The unrealized losses on the above securities are primarily attributable to increases in market interest rates subsequent to their purchase by the Company. Management does not intend to sell any impaired securities nor does available evidence suggest it is more likely than not that management will be required to sell any impaired securities. The Company’s securities portfolio does not include any private label mortgage backed securities or investments in trust preferred securities. Management believes the nature of securities in the Company’s investment portfolio present a very high probability of collecting all contractual amounts due, as the majority of the securities held are backed by government agencies or government-sponsored enterprises. However, this recovery in value may not occur for some time, perhaps greater than the one-year time horizon or perhaps even at maturity.

6. Noncovered Loans

The following is an analysis of the noncovered loan portfolio by major types of loans (net of deferred loan fees):


*(in thousands)*	June 30, 2011			December 31, 2010
Noncovered loans:
Commercial business	$	836,745		$	795,369
Real Estate:
One-to-four family residential		51,077			49,383
Commercial and five or more family residential properties		843,288			794,329

Total real estate		894,365			843,712
Real estate construction:
One-to-four family residential		52,368			67,961
Commercial and five or more family residential properties		29,886			30,185

Total real estate construction		82,254			98,146
Consumer		177,564			182,017
Less: deferred loan fees		(3,454	)		(3,490	)

Total noncovered loans, net of deferred fees		1,987,474			1,915,754
Less: Allowance for loan and lease losses		(54,057	)		(60,993	)

Total loans, net	$	1,933,417		$	1,854,761


Loans held for sale	$	655		$	754

At June 30, 2011 and December 31, 2010, the Company had no loans to foreign domiciled businesses or foreign countries, or loans related to highly leveraged transactions. Substantially all of the Company’s loans and unfunded commitments are geographically concentrated in its service areas within the states of Washington and Oregon.

The Company and its banking subsidiary have granted loans to officers and directors of the Company and related interests. These loans are made on the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than the normal risk of collectability. The aggregate dollar amount of these loans was $9.8 million and $12.9 million at June 30, 2011 and December 31, 2010, respectively. During the first six months of 2011, advances on related party loans were $3.1 million and repayments totaled $6.2 million.

At June 30, 2011 and December 31, 2010, $366.1 million and $426.6 million of commercial and residential real estate loans were pledged as collateral on Federal Home Loan Bank borrowings.

The following is an analysis of noncovered, nonaccrual loans as of June 30, 2011 and December 31, 2010:


	June 30, 2011				December 31, 2010
*(in thousands)*	Recorded Investment (1) Nonaccrual Loans		Unpaid Principal Balance Nonaccrual Loans		Recorded Investment (1) Nonaccrual Loans		Unpaid Principal Balance Nonaccrual Loans
Commercial Business
Secured	$	11,506	$	17,798	$	32,368	$	44,316
Unsecured		204		814		0		327
Real Estate 1-4 Family
Residential RE Perm		2,748		3,197		2,999		3,353
Real Estate Commercial & Multifamily
Commercial RE Land		3,962		7,382		4,093		6,279
Income Property Multifamily Perm		8,611		10,724		11,716		12,737
Owner Occupied RE Perm		10,256		11,134		7,407		8,990
Construction 1-4 Family
Land & Acquisition		7,823		18,168		11,608		21,344
Residential Construction		2,307		4,593		6,503		11,547
Construction Commercial & Multifamily
Income Property Multifamily Construction		5,977		12,873		7,585		12,916
Owner Occupied RE Construction		0		0		0		0
Consumer		6,076		6,620		5,022		5,192

Total	$	59,470	$	93,303	$	89,301	$	127,001

(1)	Recorded investment includes unpaid principal balance, net of charge-offs, unamortized deferred loan fees or costs, unamortized premiums or discounts and accrued interest.

The following is an analysis of the aged loan portfolio as of June 30, 2011 and December 31, 2010:


*(in thousands)*	Current Loans		30 - 59 Days Past Due		60 - 89 Days Past Due		Greater than 90 Days Past Due		Total Past Due		Nonaccrual Loans		Total Loans
June 30, 2011
Commercial Business
Secured	$	782,661	$	446	$	969	$	0		1,415	$	11,380	$	795,456
Unsecured		40,921		0		59		0		59		310		41,290
Real Estate 1-4 Family
Residential RE Perm		48,331		0		0		0		0		2,746		51,077
Real Estate Commercial & Multifamily
Commercial RE Land		21,525		211		0		0		211		3,957		25,693
Income Property Multifamily Perm		472,606		45		0		0		45		8,601		481,252
Owner Occupied RE Perm		333,095		301		460		0		761		10,252		344,108
Construction 1-4 Family
Land & Acquisition		22,233		0		0		0		0		7,819		30,052
Residential Construction		18,084		1,942		0		0		1,942		2,289		22,315
Construction Commercial & Multifamily
Income Property Multifamily
Construction		2,938		0		0		0		0		5,976		8,914
Owner Occupied RE Construction		13,208		0		0		0		0		0		13,208
Consumer		168,317		663		2,509		0		3,172		6,074		177,563

Total	$	1,923,919	$	3,608	$	3,997	$	0	$	7,605	$	59,404	$	1,990,928


*(in thousands)*	Current Loans		30 - 59 Days Past Due		60 - 89 Days Past Due		Greater than 90 Days Past Due		Total Past Due		Nonaccrual Loans		Total Loans
December 31, 2010
Commercial Business
Secured	$	720,926	$	919	$	692	$	1	$	1,612	$	31,919	$	754,457
Unsecured		40,455		9		0		0		9		448		40,912
Real Estate 1-4 Family
Residential RE Perm		46,167		220		0		0		220		2,996		49,383
Real Estate Commercial & Multifamily
Commercial RE Land		18,979		0		1,752		0		1,752		4,091		24,822
Income Property Multifamily Perm		426,320		1,208		121		0		1,329		10,745		438,394
Owner Occupied RE Perm		318,508		497		3,752		0		4,249		8,356		331,113
Construction 1-4 Family
Land & Acquisition		24,883		214		205		0		419		11,604		36,906
Residential Construction		24,655		0		0		0		0		6,400		31,055
Construction Commercial & Multifamily
Income Property Multifamily
Construction		10,666		0		0		0		0		7,584		18,250
Owner Occupied RE Construction		11,935		0		0		0		0		0		11,935
Consumer		176,005		397		595		0		992		5,020		182,017

Total	$	1,819,499	$	3,464	$	7,117	$	1	$	10,582	$	89,163	$	1,919,244

The following is an analysis of impaired loans as of June 30, 2011 and December 31, 2010:


	Balance of Loans Collectively Measured for Contingency Provision		Balance of Loans Individually Measured for Specific Impairment		Impaired Loans With Recorded Allowance						Impaired Loans Without Recorded Allowance				Average Recorded Investment Impaired Loans (1)		Interest Recognized on Impaired Loans
*(in thousands)*					Recorded Investment (1)		Unpaid Principal Balance		Related Allowance		Recorded Investment (1)		Unpaid Principal Balance		Average Recorded Investment Impaired Loans (1)		Interest Recognized on Impaired Loans
June 30, 2011
Commercial Business
Secured	$	786,252	$	9,204	$	1,593	$	1,592	$	331	$	7,617	$	7,612	$	20,471	$	52
Unsecured		41,189		100		71		71		71		29		29		102		1
Real Estate 1-4 Family
Residential RE Perm		48,652		2,425		0		0		0		2,428		2,425		2,649		0
Real Estate Commercial & Multifamily
Commercial RE Land		21,933		3,760		0		0		0		3,763		3,760		4,567		0
Income Property Multifamily Perm		473,138		8,113		2,340		2,339		301		5,782		5,774		10,330		442
Owner Occupied RE Perm		327,962		16,146		1,466		1,465		286		14,717		14,681		15,431		64
Construction 1-4 Family
Land & Acquisition		22,078		7,974		1,190		1,190		148		6,787		6,784		9,681		138
Residential Construction		20,027		2,289		0		0		0		2,311		2,289		4,158		0
Construction Commercial & Multifamily
Income Property Multifamily Construction		2,939		5,976		0		0		0		5,977		5,976		6,878		0
Owner Occupied RE Construction		13,207		0		0		0		0		0		0		0		0
Consumer		172,409		5,155		106		106		11		5,050		5,049		4,871		1

Total	$	1,929,786	$	61,142	$	6,766	$	6,763	$	1,148	$	54,461	$	54,379	$	79,138	$	698


			Balance of Loans Individually Measured for Specific Impairment		Impaired Loans With Recorded Allowance						Impaired Loans Without Recorded Allowance
*(in thousands)*	Balance of Loans Collectively Measured for Contingency Provision				Recorded Investment (1)		Unpaid Principal Balance		Related Allowance		Recorded Investment (1)		Unpaid Principal Balance
December 31, 2010
Commercial Business
Secured	$	724,665	$	29,793	$	2,717	$	2,758	$	600	$	27,081	$	26,913
Unsecured		40,808		104		75		75		75		29		30
Real Estate 1-4 Family
Residential RE Perm		46,728		2,655		0		0		0		2,658		2,949
Real Estate Commercial & Multifamily
Commercial RE Land		20,959		3,863		3,062		5,225		0		804		826
Income Property Multifamily Perm		427,799		10,595		3,094		3,139		59		10,292		12,253
Owner Occupied RE Perm		317,010		14,103		0		0		0		14,152		17,099
Construction 1-4 Family
Land & Acquisition		25,362		11,543		533		549		3		11,013		20,718
Residential Construction		24,655		6,400		915		1,723		62		5,585		9,824
Construction Commercial & Multifamily
Income Property Multifamily Construction		10,666		7,584		6,792		10,515		175		792		2,401
Owner Occupied RE Construction		11,935		0		0		0		0		0		0
Consumer		177,484		4,533		0		0		0		4,533		4,691

Total	$	1,828,071	$	91,173	$	17,188	$	23,984	$	974	$	76,939	$	97,704

(1)	Recorded investment includes unpaid principal balance, net of charge-offs, unamortized deferred loan fees or costs, unamortized premiums or discounts and accrued interest.

7. Allowance for Loan and Lease Losses and Unfunded Commitments and Letters of Credit

We maintain an allowance for loan and lease losses (“ALLL”) to absorb losses inherent in the loan portfolio. The size of the ALLL is determined through quarterly assessments of the probable estimated losses in the loan portfolio. Our methodology for making such assessments and determining the adequacy of the ALLL includes the following key elements:

General valuation allowance consistent with the Contingencies topic of the FASB ASC.

Classified loss reserves on specific relationships. Specific allowances for identified problem loans are determined in accordance with the Receivables topic of the FASB ASC.

The unallocated allowance provides for other factors inherent in our loan portfolio that may not have been contemplated in the general and specific components of the allowance. This unallocated amount generally comprises less than 5% of the allowance. The unallocated amount is reviewed quarterly based on trends in credit losses, the results of credit reviews and overall economic trends.

The general valuation allowance is systematically calculated quarterly using quantitative and qualitative information about specific loan classes. The minimum required level in which an entity develops a systematic methodology to determine its allowance for loan and lease losses is at the segment level. However, the Company’s systematic methodology in determining its allowance for loan and lease losses is prepared at the class level, which is more detailed than the segment level. The quantitative information uses historical losses from a specific loan class and incorporates the loan’s risk rating migration from origination to the point of loss. A loan’s risk rating is primarily determined based upon the borrower’s ability to fulfill its debt obligation from a cash flow perspective. In the event there is financial deterioration of the borrower, the borrower’s other sources of income or repayment are also considered, including recent appraisal values for collateral dependent loans. The qualitative information takes into account general economic and business conditions affecting our market place, seasoning of the loan portfolio, duration of the business cycle, etc. to ensure our methodologies reflect the current economic environment and other factors as using historical loss information exclusively may not give an accurate estimate of inherent losses within the Company’s loan portfolio.

The specific valuation allowance is a reserve for each loan determined to be impaired and the value of the impaired loan is less than its recorded investment. The Company measures the impairment based on the discounted expected future cash flows, observable market price, or the fair value of the collateral less selling costs if the loan is collateral dependant or if foreclosure is probable. The specific reserve for each loan is equal to the difference between the recorded investment in the loan and its determined impairment value.

The ALLL is increased by provisions for loan and lease losses (“provision”) charged to expense, and is reduced by loans charged off, net of recoveries. While the Company’s management believes the best information available is used to determine the ALLL, changes in market conditions could result in adjustments to the ALLL, affecting net income, if circumstances differ from the assumptions used in determining the ALLL.

We have used the same methodology for ALLL calculations during the three and six months ended June 30, 2011 and 2010. Adjustments to the percentages of the ALLL allocated to loan categories are made based on trends with respect to delinquencies and problem loans within each pool of loans. The Company reviews the ALLL quantitative and qualitative methodology on a quarterly basis and makes adjustments when appropriate. The Company continues to strive towards maintaining a conservative approach to credit quality and will continue to prudently add to our ALLL as necessary in order to maintain adequate reserves. The Company carefully monitors the loan portfolio and continues to emphasize the importance of credit quality while continuously strengthening loan monitoring systems and controls.

The following table shows a detailed analysis of the allowance for loan and lease losses for noncovered loans as of the three and six months ended June 30, 2011:


*(in thousands)*	Beginning Balance		Charge-offs			Recoveries		Provision			Ending Balance		Specific Reserve		General Allocation
Three months ended June 30, 2011
Commercial Business
Secured	$	22,307	($	834	)	$	233	$	614		$	22,320	$	330	$	21,990
Unsecured		618		0			359		(404	)		573		72		501
Real Estate 1-4 Family
Residential RE Perm		1,100		(216	)		0		(37	)		847		0		847
Real Estate Commercial & Multifamily
Commercial RE Land		555		(656	)		0		995			894		0		894
Income Property Multifamily Perm		12,297		(275	)		13		2,674			14,709		301		14,408
Owner Occupied RE Perm		10,412		(623	)		0		(3,310	)		6,479		286		6,193
Construction 1-4 Family
Land & Acquisition		3,295		(410	)		700		(733	)		2,852		148		2,704
Residential Construction		2,118		(395	)		0		(19	)		1,704		0		1,704
Construction Commercial & Multifamily
Income Property Multifamily Construction		127		(1,078	)		0		994			43		0		43
Owner Occupied RE Construction		68		0			0		(34	)		34		0		34
Consumer		2,418		(271	)		45		556			2,748		161		2,587
Unallocated		0		0			0		854			854		0		854

Total	$	55,315	($	4,758	)	$	1,350	$	2,150		$	54,057	$	1,298	$	52,759


*(in thousands)*	Beginning Balance		Charge-offs			Recoveries		Provision			Ending Balance		Specific Reserve		General Allocation
Six months ended June 30, 2011
Commercial Business
Secured	$	21,811	($	4,121	)	$	329	$	4,301		$	22,320	$	330	$	21,990
Unsecured		738		(84	)		368		(449	)		573		72		501
Real Estate 1-4 Family
Residential RE Perm		1,100		(664	)		0		411			847		0		847
Real Estate Commercial & Multifamily
Commercial RE Land		634		(656	)		0		916			894		0		894
Income Property Multifamily Perm		15,210		(640	)		55		84			14,709		301		14,408
Owner Occupied RE Perm		9,692		(623	)		31		(2,621	)		6,479		286		6,193
Construction 1-4 Family
Land & Acquisition		3,769		(1,178	)		1,768		(1,507	)		2,852		148		2,704
Residential Construction		2,292		(1,054	)		36		430			1,704		0		1,704
Construction Commercial & Multifamily
Income Property Multifamily Construction		274		(1,565	)		0		1,334			43		0		43
Owner Occupied RE Construction		70		0			0		(36	)		34		0		34
Consumer		2,120		(1,196	)		108		1,716			2,748		161		2,587
Unallocated		3,283		0			0		(2,429	)		854		0		854

Total	$	60,993	($	11,781	)	$	2,695	$	2,150		$	54,057	$	1,298	$	52,759

The three and six months changes as of June 30, 2011 and 2010 are summarized as follows:


	Three Months Ended June 30,			Six Months Ended June 30,			Three Months Ended June 30,			Six Months Ended June 30,
*(in thousands)*	2011			2011			2010			2010
Beginning balance	$	55,315		$	60,993		$	56,981		$	53,478
Provision charged to expense		2,150			2,150			13,500			28,500
Loans charged off		(4,758	)		(11,781	)		(11,073	)		(23,926	)
Recoveries		1,350			2,695			340			1,696

Ending balance	$	54,057		$	54,057		$	59,748		$	59,748

Changes in the allowance for unfunded commitments and letters of credit are summarized as follows:


	Three Months Ended June 30,					Six Months Ended June 30,
*(in thousands)*	2011			2010		2011		2010
Beginning balance	$	1,660		$	815	$	1,165	$	775
Net changes in the allowance for unfunded commitments and letters of credit		(200	)		0		295		40

Ending balance	$	1,460		$	815	$	1,460	$	815

Risk Elements

The extension of credit in the form of loans to individuals and businesses is one of our principal commerce activities. Our policies and applicable laws and regulations require risk analysis as well as ongoing portfolio and credit management. We manage our credit risk through lending limit constraints, credit review, approval policies and extensive, ongoing internal monitoring. We also manage credit risk through diversification of the loan portfolio by type of loan, type of industry, type of borrower and by limiting the aggregation of debt to a single borrower.

The monitoring process for the loan portfolio includes periodic reviews of individual loans with risk ratings assigned to each loan. Based on the analysis, loans are given a risk rating of 1-10 based on the following criteria:

ratings of 1-3 indicate minimal to low credit risk,

ratings of 4-5 indicate an average to above average credit risk with adequate repayment capacity when prolonged periods of adversity do not exist,

ratings of 6-7 indicate potential weaknesses and higher credit risk requiring greater attention by bank personnel and management to help prevent further deterioration,

rating of 8 indicates a loss is possible if loan weaknesses are not corrected,

rating of 9 indicates loss is highly probable; however, the amount of loss has not yet been determined,

and a rating of 10 indicates the loan is uncollectable, and when identified is charged-off.

Loans with a risk rating of 1-6 are considered Pass loans and loans with risk ratings of 7, 8, 9 and 10 are considered Special Mention, Substandard, Doubtful and Loss, respectively. Loans with a risk rating of Substandard or worse are reported as classified loans in our allowance for loan and lease losses analysis. We review these loans to assess the ability of our borrowers to service all interest and principal obligations and, as a result, the risk rating may be adjusted accordingly. Risk ratings are reviewed and updated whenever appropriate, with more periodic reviews as the risk and dollar value of loss on the loan increases. In the event full collection of principal and interest is not reasonably assured, the loan is appropriately downgraded and, if warranted, placed on non-accrual status even though the loan may be current as to principal and interest payments. Additionally, we assess whether an impairment of a loan warrants specific reserves or a write-down of the loan.

The following is an analysis of the credit quality of our noncovered loan portfolio as of June 30, 2011 and December 31, 2010:


	June 30, 2011				December 31, 2010
*(dollars in thousands)*	Weighted- Average Risk Rating		Recorded Investment Noncovered Loans (1)		Weighted- Average Risk Rating		Recorded Investment Noncovered Loans (1)
Commercial Business
Secured		4.94	$	799,676		4.96	$	757,372
Unsecured		4.27		41,568		4.23		41,175
Real Estate 1-4 Family
Residential RE Perm		4.94		51,259		4.96		49,436
Real Estate Commercial & Multifamily
Commercial RE Land		5.79		25,899		5.75		24,956
Income Property Multifamily Perm		5.05		483,465		5.07		406,711
Owner Occupied RE Perm		5.12		345,811		5.12		366,284
Construction 1-4 Family
Land & Acquisition		6.66		30,164		6.79		37,054
Residential Construction		6.49		22,529		6.63		31,293
Construction Commercial & Multifamily
Income Property Multifamily Construction		5.94		8,932		6.38		18,296
Owner Occupied RE Construction		4.81		13,266		4.93		11,990
Consumer		4.39		178,560		4.31		182,624

Total recorded investment of noncovered loans			$	2,001,129			$	1,927,191

(1)	Recorded investment includes unpaid principal balance, net of charge-offs, unamortized deferred loan fees or costs, unamortized premiums or discounts and accrued interest.

8. Covered Assets and FDIC Loss-sharing Asset

Covered Assets

Covered assets consist of loans and OREO acquired in FDIC assisted acquisitions during 2010 and 2011, for which the Bank entered into loss-sharing agreements, whereby the FDIC will cover a substantial portion of any future losses on loans (and related unfunded loan commitments), OREO and certain accrued interest on loans. Under the terms of the loss-sharing agreements, the FDIC will absorb 80% of losses and share in 80% of loss recoveries up to specified amounts and, with respect to loss-sharing agreements for two acquisitions completed in 2010, will absorb 95% of losses and share in 95% of loss recoveries thereafter. The loss-sharing provisions of the agreements for commercial and single-family mortgage loans are in effect for five and ten years, respectively, from the acquisition dates and the loss recovery provisions are in effect for eight and ten years, respectively, from the acquisition dates.

Ten years and forty-five days after the acquisition dates, the Bank shall pay to the FDIC a clawback in the event the losses from the acquisitions fail to reach stated levels. This clawback shall be in the amount of 50% of the excess, if any, of 20% of the stated threshold amounts, less the sum of 25% of the asset premium (discount), 20% or 25% of the cumulative loss-sharing payments (depending on the particular agreement), and the cumulative servicing amount. As of June 30, 2011, the net present value of the Bank’s estimated clawback liability is $2.1 million, which is included in other liabilities on the consolidated condensed financial statements.

The following is an analysis of our covered loans, net of related allowance for losses on covered loans as of June 30, 2011 and December 31, 2010:

		$241,391		$241,391		$241,391
*(dollars in thousands)*	Covered Loans June 30, 2011		Weighted- Average Risk Rating		Allowance for Loan Losses
Commercial Business	$	241,391		5.82	$	3,156
Real Estate 1-4 Family		84,568		4.68		508
Real Estate Commercial & Multifamily		365,099		5.72		3,861
Construction 1-4 Family		57,638		7.44		0
Construction Commercial & Multifamily		32,203		6.65		382
Consumer		65,936		4.60		41

Subtotal of covered loans		846,835			$	7,948

Less:
Valuation discount resulting from acquisition accounting		231,577
Allowance for loan losses		7,948

Covered loans, net of allowance for loan losses	$	607,310


*(dollars in thousands)*	Covered Loans December 31, 2010		Weighted- Average Risk Rating		Allowance for Loan Losses
Commercial Business	$	165,255		5.74	$	2,903
Real Estate 1-4 Family		68,700		4.77		1,013
Real Estate Commercial & Multifamily		341,063		5.70		821
Construction 1-4 Family		39,754		7.29		98
Construction Commercial & Multifamily		41,624		6.79		469
Consumer		58,337		4.49		751

Subtotal of covered loans		714,733			$	6,055

Less:
Valuation discount resulting from acquisition accounting		191,617
Allowance for loan losses		6,055

Covered loans, net of allowance for loan losses	$	517,061

Acquired loans are accounted for under ASC 310-30 and initially measured at fair value based on expected future cash flows over the life of the loans or market-based information for comparable loans. Management monitors and estimates expected future cash flows of acquired loans on a quarterly basis. Acquired loans are also subject to the Company’s internal and external credit review and are risk rated using the same criteria as loans originated by the Company. However, risk ratings are not a clear indicator of losses on acquired loans as a majority of the losses are recoverable from the FDIC under the loss-sharing agreements.

Draws on acquired loans, advanced subsequent to the loan acquisition date, are accounted for under ASC 450-20 and those amounts are also subject to the Company’s internal and external credit review. An allowance for loan losses is estimated in a similar manner as the originated loan portfolio, and a provision for loan losses is charged to earnings as necessary.

During the six months ended June 30, 2011, the Company recorded a provision expense for losses on covered loans of $1.9 million. Of this amount, $2.3 million was impairment expense calculated in accordance with ASC 310-30 and $462 thousand was a negative provision to adjust the allowance for loss calculated under ASC 450-20 for draws on acquired loans. The impact to earnings of the $1.9 million of provision expense for covered loans was partially offset through noninterest income by a $1.5 million increase in the FDIC loss-sharing asset.

The following table shows the changes in accretable yield for acquired loans for three and six months ended June 30, 2011. Due to the provisional measurement of loans acquired from Summit Bank and First Heritage Bank acquisitions, the table below does not include accretable yield arising from those two acquisitions:


*(in thousands)*	Three months ended June 30, 2011			Six months ended June 30, 2011
Balance at beginning of period	$	217,351		$	256,572
Accretion		(15,458	)		(36,761	)
Cash receipts, disposals and change in cash flows		52,629			34,711

Balance at end of period	$	254,522		$	254,522

The excess of cash flows expected to be collected over the initial fair value of acquired loans is referred to as the accretable yield and is accreted into interest income over the estimated life of the acquired loans using the effective yield method. Other adjustments to the accretable yield include changes in the estimated remaining life of the acquired loans, changes in expected cash flows and changes of indices for acquired loans with variable interest rates.

The following table sets forth activity in covered OREO at carrying value for the three and six months ended June 30, 2011:


*(in thousands)*	Three Months Ended June 30, 2011			Six Months Ended June 30, 2011
Covered OREO:
Balance, beginning of period	$	13,527		$	14,443
Established through acquisitions		10,896			10,896
Transfers in, net of write-downs ($23 and $441, respectively)		1,668			5,092
OREO improvements		0			0
Additional OREO write-downs		(99	)		(113	)
Proceeds from sale of OREO property		(4,122	)		(11,081	)
Gain on sale of OREO		2,369			5,002

Total covered OREO, end of period	$	24,239		$	24,239

The covered OREO is covered by loss-sharing agreements with the FDIC in which the FDIC will assume 80% of additional write-downs and losses on covered OREO sales, or 95%, if applicable, of additional write-downs and losses on covered OREO sales if the minimum loss share thresholds are met.

FDIC Loss-sharing Asset

The FDIC loss-sharing asset as of June 30, 2011 is comprised of a $199.3 million FDIC indemnification asset and a $6.9 million FDIC receivable. The indemnification is the present value of the cash flows the Company expects to collect from the FDIC under the loss-sharing agreements and the FDIC receivable represents 80% of reimbursable amounts from the FDIC that have not yet been received.


	Three months ended June 30,						Six months ended June 30,
*(in thousands)*	2011			2010			2011			2010
Balance at beginning of period	$	193,053		$	210,405		$	205,991		$	0
Adjustments not reflected in income
Established through acquistions		65,278			0			65,278			210,405
Cash received from the FDIC		(44,892	)		0			(44,892	)		0
FDIC share of additional estimated losses		991			13,947			2,295			13,947
Other		(1,773	)		(1,006	)		(1,241	)		(1,006	)
Adjustments reflected in income
(Amortization) accretion		(6,638	)		3,952			(15,641	)		3,952
Loan loss provision		1,841			0			1,503			0
Other		(1,622	)		(553	)		(7,055	)		(553	)

Balance at end of period	$	206,238		$	226,745		$	206,238		$	226,745

9. Changes in Noncovered Other Real Estate Owned

The following table sets forth activity in noncovered OREO for the period:


*(in thousands)*	Three Months Ended June 30, 2011			Six Months Ended June 30, 2011
Noncovered OREO:
Balance, beginning of period	$	26,081		$	30,991
Transfers in, net of write-downs ($18 and $108, respectively)		1,106			3,148
OREO improvements		217			468
Additional OREO write-downs		(2,536	)		(4,446	)
Proceeds from sale of OREO property		(2,502	)		(7,874	)
Gain on sale of OREO		373			452

Total noncovered OREO, end of period	$	22,739		$	22,739

10. Goodwill and Intangible Assets

In accordance with the Intangibles – Goodwill and Other topic of the FASB ASC, goodwill is not amortized but is reviewed for potential impairment at the reporting unit level during the third quarter on an annual basis and between annual tests in certain circumstances such as material adverse changes in legal, business, regulatory and economic factors. An impairment loss is recorded to the extent that the carrying amount of goodwill exceeds its implied fair value. The Company completed its annual goodwill impairment test during the third quarter of 2010 and determined the fair value of the Company’s single reporting unit exceeded its carrying value.

The core deposit intangible (“CDI”) is evaluated for impairment if events and circumstances indicate a possible impairment. The CDI is amortized on an accelerated basis over an estimated life of approximately 10 years.

The following table sets forth activity for goodwill and intangible assets for the period:


	Three Months Ended June 30,						Six Months Ended June 30,
*(in thousands)*	2011			2010			2011			2010
Total goodwill, beginning of period	$	109,639		$	109,639		$	109,639		$	95,519
Established through acquisitions		9,704			0			9,704			14,120

Total goodwill, end of period		119,343			109,639			119,343			109,639

Gross core deposit intangible balance, beginning of period		26,651			26,651			26,651			8,896
Accumulated amortization, beginning of period		(8,939	)		(4,820	)		(7,955	)		(4,033	)

Core deposit intangible, net, beginning of period		17,712			21,831			18,696			4,863
Established through acquisitions		1,846			0			1,846			17,755
CDI current period amortization		(956	)		(1,055	)		(1,940	)		(1,842	)

Total core deposit intangible, end of period		18,602			20,776			18,602			20,776

Total goodwill and intangible assets, end of period	$	137,945		$	130,415		$	137,945		$	130,415

The following table provides the estimated future amortization expense of core deposit intangibles for the remaining six months ending December 31, 2011 and the succeeding four years:


*(in thousands)*	Amount
Year ending December 31,
2011	$	2,053
2012		3,760
2013		3,352
2014		2,856
2015		2,176

11. Shareholders’ Equity

Common Stock. On February 3, 2011, the Company declared a quarterly cash dividend of $0.03 per share, payable on March 3, 2011 to shareholders of record as of the close of business on February 17, 2011. On April 27, 2011 the Company declared a quarterly cash dividend of $0.05 per share, payable on May 25, 2011 to shareholders of record at the close of business May 11, 2011. The payment of cash dividends is subject to Federal regulatory requirements for capital levels and other restrictions. In addition, the cash dividends paid by Columbia Bank to the Company are subject to both Federal and State regulatory requirements. Subsequent to quarter end, on July 28, 2011 the Company declared a quarterly cash dividend of $0.06 per share, payable on August 24, 2011 to shareholders of record at the close of business August 10, 2011.

12. Comprehensive Income

The components of comprehensive income are as follows:


	Three Months Ended June 30,
*(in thousands)*	2011			2010
Net income as reported	$	8,632		$	5,056
Unrealized gain from securities:
Net unrealized holding gain from available for sale securities arising during the period, net of tax of ($3,641) and ($1,907)		6,467			3,610
Reclassification adjustment of net gain from sale of available for sale securities included in income, net of tax of $0 and $0		0			0

Net unrealized gain from securities, net of reclassification adjustment		6,467			3,610
Cash flow hedging instruments:
Reclassification adjustment of net gain included in income, net of tax of $0 and $137		0			(248	)

Net change in cash flow hedging instruments		0			(248	)
Pension plan liability adjustment:
Net unrealized gain from unfunded defined benefit plan liability arising during the period, net of tax of $0 and $0		0			0
Less: amortization of unrecognized net actuarial loss included in net periodic pension cost, net of tax of ($8) and $(4)		14			7

Pension plan liability adjustment, net		14			7

Total comprehensive income	$	15,113		$	8,425


	Six Months Ended June 30,
*(in thousands)*	2011			2010
Net income as reported	$	14,411		$	12,972
Unrealized gain from securities:
Net unrealized holding gain from available for sale securities arising during the period, net of tax of ($4,925) and ($3,943)		8,780			7,166
Reclassification adjustment of net gain from sale of available for sale securities included in income, net of tax of $0 and $20		0			(38	)

Net unrealized gain from securities, net of reclassification adjustment		8,780			7,128
Cash flow hedging instruments:
Reclassification adjustment of net gain included in income, net of tax of $79 and $401		(143	)		(727	)

Net change in cash flow hedging instruments		(143	)		(727	)
Pension plan liability adjustment:
Net unrealized gain from unfunded defined benefit plan liability arising during the period, net of tax of $154 and $(12)		(261	)		23
Less: amortization of unrecognized net actuarial loss included in net periodic pension cost, net of tax of $(16) and $(8)		28			14

Pension plan liability adjustment, net		(233	)		37

Total comprehensive income	$	22,815		$	19,410

13. Fair Value Accounting and Measurement

The Fair Value Measurements and Disclosures topic of the FASB ASC defines fair value, establishes a consistent framework for measuring fair value and expands disclosure requirements about fair value. We hold fixed and variable rate interest-bearing securities, investments in marketable equity securities and certain other financial instruments, which are carried at fair value. Fair value is determined based upon quoted prices when available or through the use of alternative approaches, such as matrix or model pricing, when market quotes are not readily accessible or available.

The valuation techniques are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our own market assumptions. These two types of inputs create the following fair value hierarchy:

Level 1 – Quoted prices for identical instruments in active markets that are accessible at the measurement date.

Level 2 – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model derived valuations whose inputs are observable or whose significant value drivers are observable.

Level 3 – Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable.

Fair values are determined as follows:

Securities at fair value are priced using matrix pricing based on the securities’ relationship to other benchmark quoted prices, and under the provisions of the Fair Value Measurements and Disclosures topic of the FASB ASC are considered a Level 2 input method.

Interest rate contract positions are valued in models, which use as their basis, readily observable market parameters and are classified within level 2 of the valuation hierarchy.

The following table sets forth the Company’s financial assets and liabilities that were accounted for at fair value on a recurring basis at June 30, 2011 by level within the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement:


	Fair value at June 30, 2011		Fair Value Measurements at Reporting Date Using
(in thousands)	Fair value at June 30, 2011		Level 1		Level 2		Level 3
Assets
Securities available for sale
U.S. government agency	$	30,278	$	0	$	30,278	$	0
U.S. government agency and sponsored enterprise mortgage-back securities and collateralized mortgage obligations		693,412		0		693,412		0
State and municipal debt securities		261,639		0		261,639		0
Other securities		4,439		0		4,439		0

Total securities available for sale	$	989,768	$	0	$	989,768	$	0
Other assets (Interest rate contracts)	$	10,476	$	0	$	10,476	$	0
Liabilities
Other liabilities (Interest rate contracts)	$	10,476	$	0	$	10,476	$	0

Certain assets and liabilities are measured at fair value on a nonrecurring basis after initial recognition such as loans measured for impairment and OREO. The following methods were used to estimate the fair value of each such class of financial instrument:

Impaired loans—A loan is considered to be impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due (both interest and principal) according to the contractual terms of the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, a loan’s observable market price, or the fair market value of the collateral if the loan is collateral-dependent loan. Generally, the Company utilizes the fair market value of the collateral to measure impairment.

Other real estate owned—OREO is real property that the Bank has taken ownership of in partial or full satisfaction of a loan or loans. OREO is recorded at the lower of the carrying amount of the loan or fair value less estimated costs to sell. This amount becomes the property’s new basis. Any write-downs based on the property fair value less estimated cost to sell at the date of acquisition are charged to the allowance for loan and lease losses. Management periodically reviews OREO in an effort to ensure the property is carried at the lower of its new basis or fair value, net of estimated costs to sell. Any write-downs subsequent to acquisition are charged to earnings.

The following table presents information about the Company’s assets 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 at the reporting date.


	Fair value at June 30, 2011		Fair Value Measurements at Reporting Date Using						Losses During the Three Months Ended June 30, 2011		Losses During the Six Months Ended June 30, 2010
(in thousands)	Fair value at June 30, 2011		Level 1		Level 2		Level 3
Impaired loans	$	13,924	$	0	$	0	$	13,924	$	411	$	5,320
Non-covered OREO		6,846		0		0		6,846		1,313		3,314

	$	20,770	$	0	$	0	$	20,770	$	1,724	$	8,634

The losses on impaired loans disclosed above represent the amount of the specific reserve and/or charge-offs during the period applicable to loans held at period end. The amount of the specific reserve is included in the allowance for loan and lease losses. The losses on non-covered OREO disclosed above represent the writedowns taken at foreclosure that were charged to the allowance for loan and lease losses, as well as subsequent writedowns from updated appraisals that were charged to earnings.

14. Fair Value of Financial Instruments

Because broadly traded markets do not exist for most of the Company’s financial instruments, the fair value calculations attempt to incorporate the effect of current market conditions at a specific time. These determinations are subjective in nature, involve uncertainties and matters of significant judgment and do not include tax ramifications; therefore, the results cannot be determined with precision, substantiated by comparison to independent markets and may not be realized in an actual sale or immediate settlement of the instruments. There may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results. For all of these reasons, the aggregation of the fair value calculations presented herein do not represent, and should not be construed to represent, the underlying value of the Company.

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

Cash and due from banks and interest-earning deposits with banks—The fair value of financial instruments that are short-term or reprice frequently and that have little or no risk are considered to have a fair value that approximates carrying value.

Securities available for sale—Securities at fair value are priced using matrix pricing based on the securities’ relationship to other benchmark quoted prices.

Federal Home Loan Bank stock—The fair value is based upon the par value of the stock which equates to its carrying value.

Loans—Loans are not recorded at fair value on a recurring basis. Nonrecurring fair value adjustments are periodically recorded on impaired loans that are measured for impairment based on the fair value of collateral. For most performing loans, fair value is estimated using expected duration and lending rates that would have been offered on June 30, 2011 for loans which mirror the attributes of the loans with similar rate structures and average maturities. Commercial loans and construction loans, which are variable rate and short-term are reflected with fair values equal to carrying value. The fair values resulting from these calculations are reduced by an amount representing the change in estimated fair value attributable to changes in borrowers’ credit quality since the loans were originated. For nonperforming loans, fair value is estimated by applying a valuation discount based upon loan sales data from the FDIC.

FDIC loss-sharing asset —The FDIC loss-sharing asset is considered to have a fair value that approximates carrying value.

Interest rate contracts—Interest rate swap positions are valued in models, which use as their basis, readily observable market parameters.

Deposits—For deposits with no contractual maturity, the fair value is equal to the carrying value. The fair value of fixed maturity deposits is based on discounted cash flows using the difference between the deposit rate and current market rates for deposits of similar remaining maturities.

FHLB and FRB borrowings—The fair value of Federal Home Loan Bank of Seattle (the “FHLB”) advances and Federal Reserve Bank of San Francisco (the “FRB”) borrowings are estimated based on discounting the future cash flows using the market rate currently offered.

Repurchase Agreements—The fair value of securities sold under agreement to repurchase are estimated based on discounting the future cash flows using the market rate currently offered.

Long-term subordinated debt—The fair value of long-term subordinated debt are estimated based on discounting the future cash flows using an estimated market rate.

Other Financial Instruments—The majority of our commitments to extend credit and standby letters of credit carry current market interest rates if converted to loans, as such, carrying value is assumed to equal fair value.

The following table summarizes carrying amounts and estimated fair values of selected financial instruments as well as assumptions used by the Company in estimating fair value:


	June 30, 2011				December 31, 2010
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
			*(in thousands)*
Assets
Cash and due from banks	$	89,926	$	89,926	$	55,492	$	55,492
Interest-earning deposits with banks		179,573		179,573		458,638		458,638
Securities available for sale		989,768		989,768		763,866		763,866
FHLB stock		18,791		18,791		17,908		17,908
Loans held for sale		655		655		754		754
Loans		2,540,727		2,806,335		2,371,822		2,525,113
FDIC loss-sharing asset		206,238		206,238

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company