UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2015
Commission File Number 1-31565
NEW YORK COMMUNITY BANCORP, INC.
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
615 Merrick Avenue, Westbury, New York 11590
(Address of principal executive offices)
(Registrant’s telephone number, including area code) (516) 683-4100
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 (3§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. Large Accelerated Filer X 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 No X
484,943,308
Number of shares of common stock outstanding at
November 5, 2015
Quarter Ended September 30, 2015
INDEX
Part I.
Item 1.
Item 2.
Item 3.
Item 4.
Part II.
Item 1A.
Item 5.
Item 6.
Signatures
Exhibits
CONSOLIDATED STATEMENTS OF CONDITION
(in thousands, except share data)
Assets:
Cash and cash equivalents
Securities:
Available-for-sale ($10,752 and $11,436 pledged, respectively)
Held-to-maturity ($4,503,995 and $4,584,886 pledged, respectively) (fair value of $6,812,774 and $7,085,971, respectively)
Total securities
Non-covered loans held for sale
Non-covered loans held for investment, net of deferred loan fees and costs
Less: Allowance for losses on non-covered loans
Non-covered loans held for investment, net
Covered loans
Less: Allowance for losses on covered loans
Covered loans, net
Total loans, net
Federal Home Loan Bank stock, at cost
Premises and equipment, net
FDIC loss share receivable
Goodwill
Core deposit intangibles, net
Mortgage servicing rights
Bank-owned life insurance
Other real estate owned (includes $29,113 and $32,048, respectively, covered by loss sharing agreements)
Other assets
Total assets
Liabilities and Stockholders’ Equity:
Deposits:
NOW and money market accounts
Savings accounts
Certificates of deposit
Non-interest-bearing accounts
Total deposits
Borrowed funds:
Wholesale borrowings:
Federal Home Loan Bank advances
Repurchase agreements
Fed funds purchased
Total wholesale borrowings
Junior subordinated debentures
Total borrowed funds
Other liabilities
Total liabilities
Stockholders’ equity:
Preferred stock at par $0.01 (5,000,000 shares authorized; none issued)
Common stock at par $0.01 (600,000,000 shares authorized; 444,343,024 and 442,659,460 shares issued, and 444,319,494 and 442,587,190 shares outstanding, respectively)
Paid-in capital in excess of par
Retained earnings
Treasury stock, at cost (23,530 and 72,270 shares, respectively)
Accumulated other comprehensive loss, net of tax:
Net unrealized gain on securities available for sale, net of tax of $1,130 and $2,022, respectively
Net unrealized loss on the non-credit portion of other-than-temporary impairment (“OTTI”) losses on securities, net of tax of $3,411 and $3,444, respectively
Net unrealized loss on pension and post-retirement obligations, net of tax of $33,480 and $36,118, respectively
Total accumulated other comprehensive loss, net of tax
Total stockholders’ equity
Total liabilities and stockholders’ equity
See accompanying notes to the consolidated financial statements.
1
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(in thousands, except per share data)
(unaudited)
Interest Income:
Mortgage and other loans
Securities and money market investments
Total interest income
Interest Expense:
Borrowed funds
Total interest expense
Net interest income
Recovery of losses on non-covered loans
Recovery of losses on covered loans
Net interest income after recoveries of loan losses
Non-Interest Income:
Mortgage banking income
Fee income
Net gain on sales of securities
FDIC indemnification expense
Gain on Visa shares sold
Other income
Total non-interest income
Non-Interest Expense:
Operating expenses:
Compensation and benefits
Occupancy and equipment
General and administrative
Total operating expenses
Amortization of core deposit intangibles
Total non-interest expense
Income before income taxes
Income tax expense
Net income
Other comprehensive income, net of tax:
Change in net unrealized gain/loss on securities available for sale, net of tax of $759; $292; $892; and $3,696, respectively
Change in the non-credit portion of OTTI losses recognized in other comprehensive income, net of tax of $11; $110; $33; and $132, respectively
Change in pension and post-retirement obligations, net of tax of $879; $357; $2,638; and $1,070, respectively
Less: Reclassification adjustment for sales of available-for-sale securities, net of tax of $73 and $2,146, respectively
Total other comprehensive income, net of tax
Total comprehensive income, net of tax
Basic earnings per share
Diluted earnings per share
2
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
Common Stock (Par Value: $0.01):
Balance at beginning of year
Shares issued for restricted stock awards (1,683,564 shares)
Balance at end of period
Paid-in Capital in Excess of Par:
Shares issued for restricted stock awards, net of forfeitures
Compensation expense related to restricted stock awards
Tax effect of stock plans
Retained Earnings:
Dividends paid on common stock ($0.75 per share)
Treasury Stock:
Purchase of common stock (447,037 shares)
Shares issued for restricted stock awards (495,777 shares)
Accumulated Other Comprehensive Loss, net of tax:
Other comprehensive income, net of tax
3
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Cash Flows from Operating Activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Recovery of loan losses
Depreciation and amortization
Amortization of discounts and premiums, net
Gain on sales of loans
Stock plan-related compensation
Deferred tax (benefit) expense
Changes in assets and liabilities:
Decrease in other assets
Increase in other liabilities
Origination of loans held for sale
Proceeds from sales of loans originated for sale
Net cash provided by operating activities
Cash Flows from Investing Activities:
Proceeds from repayment of securities held to maturity
Proceeds from repayment of securities available for sale
Proceeds from sales of securities held to maturity
Proceeds from sales of securities available for sale
Purchase of securities held to maturity
Purchase of securities available for sale
Proceeds from sale of Visa shares
Net (purchase) redemption of Federal Home Loan Bank stock
Net increase in loans
Proceeds from sales of loans
Purchase of premises and equipment, net
Net cash used in investing activities
Cash Flows from Financing Activities:
Net (decrease) increase in deposits
Net decrease in short-term borrowed funds
Net increase (decrease) in long-term borrowed funds
Cash dividends paid on common stock
Treasury stock purchases
Net cash received from stock option exercises
Net cash provided by financing activities
Net increase in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
Supplemental information:
Cash paid for interest
Cash paid for income taxes
Non-cash investing and financing activities:
Transfers to other real estate owned from loans
Transfer of loans from held for investment to held for sale
Transfer of loans from held for sale to held for investment
Shares issued for restricted stock awards
4
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Organization and Basis of Presentation
Organization
Formerly known as Queens County Bancorp, Inc., New York Community Bancorp, Inc. (on a stand-alone basis, the “Parent Company” or, collectively with its subsidiaries, the “Company”) was organized under Delaware law on July 20, 1993 and is the holding company for New York Community Bank and New York Commercial Bank (hereinafter referred to as the “Community Bank” and the “Commercial Bank,” respectively, and collectively as the “Banks”). In addition, for the purpose of these Consolidated Financial Statements, the “Community Bank” and the “Commercial Bank” refer not only to the respective banks but also to their respective subsidiaries.
The Community Bank is the primary banking subsidiary of the Company. Founded on April 14, 1859 and formerly known as Queens County Savings Bank, the Community Bank converted from a state-chartered mutual savings bank to the capital stock form of ownership on November 23, 1993, at which date the Company issued its initial offering of common stock (par value: $0.01 per share) at a price of $25.00 per share. The Commercial Bank was established on December 30, 2005.
Reflecting nine stock splits between September 30, 1994 and February 17, 2004, the Company’s initial offering price adjusts to $0.93 per share. All share and per share data presented in this report reflect the impact of the stock splits.
The Company changed its name to New York Community Bancorp, Inc. on November 21, 2000 in anticipation of completing the first of eight business combinations that expanded its footprint well beyond Queens County to encompass all five boroughs of New York City, Long Island, and Westchester County in New York, and seven counties in the northern and central parts of New Jersey. The Company expanded beyond this region to south Florida, northeast Ohio, and central Arizona through its FDIC-assisted acquisition of certain assets and its assumption of certain liabilities of AmTrust Bank (“AmTrust”) in December 2009, and extended its Arizona franchise through its FDIC-assisted acquisition of certain assets and its assumption of certain liabilities of Desert Hills Bank (“Desert Hills”) in March 2010. On June 28, 2012, the Company completed its 11th transaction when it assumed certain deposits of Aurora Bank FSB.
Reflecting its growth through acquisitions, the Community Bank currently operates 239 branches, four of which operate directly under the Community Bank name. The remaining 235 Community Bank branches operate through seven divisional banks: Queens County Savings Bank, Roslyn Savings Bank, Richmond County Savings Bank, and Roosevelt Savings Bank in New York; Garden State Community Bank in New Jersey; AmTrust Bank in Florida and Arizona; and Ohio Savings Bank in Ohio.
The Commercial Bank currently operates 30 branches in Manhattan, Queens, Brooklyn, Westchester County, and Long Island (all in New York), including 18 branches that operate under the name “Atlantic Bank.”
On September 17, 2015, the Company submitted an application to the FDIC and the New York State Department of Financial Services (the “NYSDFS”) requesting approval to merge the Commercial Bank with and into the Community Bank. The merger of the Company’s two bank subsidiaries is not expected to impact either bank’s customers or employees, given that all of their respective branches operate on the same systems and, with few exceptions, offer the same products and services.
Basis of Presentation
The following is a description of the significant accounting and reporting policies that the Company and its wholly-owned subsidiaries follow in preparing and presenting their consolidated financial statements, which conform to U.S. generally accepted accounting principles (“GAAP”) and to general practices within the banking industry. The preparation of financial statements in conformity with GAAP requires the Company to make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Estimates that are particularly susceptible to change in the near term are used in connection with the determination of the allowances for loan losses; the valuation of mortgage servicing rights (“MSRs”); the evaluation of goodwill for impairment; the evaluation of other-than-temporary impairment (“OTTI”) on securities; and the evaluation of the need for a valuation allowance on the Company’s deferred tax assets.
The accompanying consolidated financial statements include the accounts of the Company and other entities in which the Company has a controlling financial interest. All inter-company accounts and transactions are eliminated in consolidation. The Company currently has certain unconsolidated subsidiaries in the form of wholly-owned statutory business trusts, which were formed to issue guaranteed capital debentures (“capital securities”). Please see Note 7, “Borrowed Funds,” for additional information regarding these trusts.
5
Note 2. Computation of Earnings per Share
Basic earnings per share (“EPS”) is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted EPS is computed using the same method as basic EPS, however, the computation reflects the potential dilution that would occur if outstanding in-the-money stock options were exercised and converted into common stock.
Unvested stock-based compensation awards containing non-forfeitable rights to dividends are considered participating securities, and therefore are included in the two-class method for calculating EPS. Under the two-class method, all earnings (distributed and undistributed) are allocated to common shares and participating securities based on their respective rights to receive dividends. The Company grants restricted stock to certain employees under its stock-based compensation plans. Recipients receive cash dividends during the vesting periods of these awards, including on the unvested portion of such awards. Since these dividends are non-forfeitable, the unvested awards are considered participating securities and therefore have earnings allocated to them.
The following table presents the Company’s computation of basic and diluted EPS for the periods indicated:
Less: Dividends paid on and earnings allocated to participating securities
Earnings applicable to common stock
Weighted average common shares outstanding
Basic earnings per common share
Potential dilutive common shares (1)
Total shares for diluted earnings per share computation
Diluted earnings per common share and common share equivalents
Note 3. Reclassifications Out of Accumulated Other Comprehensive Loss (“AOCL”)
Details about
Accumulated Other Comprehensive Loss
Affected Line Item in the
Consolidated Statement of Income
and Comprehensive Income
Amortization of defined benefit pension plan items:
Past service liability
Included in the computation of net periodic (credit) expense (2)
Actuarial losses
Total reclassifications for the period
6
Note 4. Securities
The following table summarizes the Company’s portfolio of securities available for sale at September 30, 2015:
Mortgage-Related Securities:
GSE(1) certificates
Total mortgage-related securities
Other Securities:
Municipal bonds
Capital trust notes
Preferred stock
Mutual funds and common stock (2)
Total other securities
Total securities available for sale
The following table summarizes the Company’s portfolio of securities available for sale at December 31, 2014:
GSE certificates
Mutual funds and common stock
7
The following tables summarize the Company’s portfolio of securities held to maturity at September 30, 2015 and December 31, 2014:
GSE CMOs
GSE debentures
Corporate bonds
Total securities held to maturity (1)
At September 30, 2015 and December 31, 2014, respectively, the Company had $538.5 million and $515.3 million of Federal Home Loan Bank (“FHLB”) stock, at cost, primarily consisting of stock in the FHLB-New York (the “FHLB-NY”). The Company is required to maintain an investment in FHLB-NY stock in order to have access to the funding it provides.
The following table summarizes the gross proceeds, gross realized gains, and gross realized losses from the sale of available-for-sale securities during the nine months ended September 30, 2015 and 2014:
Gross proceeds
Gross realized gains
Gross realized losses
In addition, during the nine months ended September 30, 2015, the Company sold held-to-maturity securities with gross proceeds of $19.7 million and gross realized gains of $543,000, all of which were securities on which the Company had collected a substantial portion (at least 85%) of the initial principal balance. No comparable sales occurred in the first nine months of 2014.
8
In the following table, the beginning balance represents the credit loss component for debt securities on which OTTI occurred prior to January 1, 2015. For credit-impaired debt securities, OTTI recognized in earnings after that date is presented as an addition in two components, based upon whether the current period is the first time a debt security was credit-impaired (initial credit impairment) or is not the first time a debt security was credit-impaired (subsequent credit impairment).
Beginning credit loss amount as of December 31, 2014
Add: Initial other-than-temporary credit losses
Subsequent other-than-temporary credit losses
Amount previously recognized in AOCL
Less: Realized losses for securities sold
Securities intended or required to be sold
Increases in expected cash flows on debt securities
Ending credit loss amount as of September 30, 2015
9
The following table summarizes the carrying amounts and estimated fair values of held-to-maturity mortgage-backed securities and debt securities, and the amortized costs and estimated fair values of available-for-sale securities, at September 30, 2015, by contractual maturity.
Held-to-Maturity Securities:
Due within one year
Due from one to five years
Due from five to ten years
Due after ten years
Total securities held to maturity
Available-for-Sale Securities: (3)
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The following table presents held-to-maturity securities and available-for-sale securities having a continuous unrealized loss position for less than twelve months and for twelve months or longer as of September 30, 2015:
At September 30, 2015
Temporarily Impaired Held-to-Maturity Mortgage-Backed Securities and Debt Securities:
Total temporarily impaired held-to-maturity mortgage-backed securities and debt securities
Temporarily Impaired Available-for-Sale Securities:
Equity securities
Total temporarily impaired available-for-sale securities
11
The following table presents held-to-maturity securities and available-for-sale securities having a continuous unrealized loss position for less than twelve months and for twelve months or longer as of December 31, 2014:
12
An OTTI loss on impaired securities must be fully recognized in earnings if an investor has the intent to sell the debt security, or if it is more likely than not that the investor will be required to sell the debt security before recovery of its amortized cost. However, even if an investor does not expect to sell a debt security, it must evaluate the expected cash flows to be received and determine if a credit loss has occurred. In the event that a credit loss occurs, only the amount of impairment associated with the credit loss is recognized in earnings. Amounts relating to factors other than credit losses are recorded in AOCL. Financial Accounting Standards Board (“FASB”) guidance also requires additional disclosures regarding the calculation of credit losses, as well as factors considered by the investor in reaching a conclusion that an investment is not other-than-temporarily impaired.
Securities in unrealized loss positions are analyzed as part of the Company’s ongoing assessment of OTTI. When the Company intends to sell such securities, the Company recognizes an impairment loss equal to the full difference between the amortized cost basis and the fair value of those securities. When the Company does not intend to sell equity or debt securities in an unrealized loss position, potential OTTI is considered based on a variety of factors, including the length of time and extent to which the fair value has been less than the cost; adverse conditions specifically related to the industry, the geographic area, or financial condition of the issuer, or the underlying collateral of a security; the payment structure of the security; changes to the rating of the security by a rating agency; the volatility of the fair value changes; and changes in fair value of the security after the balance sheet date. For debt securities, the Company estimates cash flows over the remaining life of the underlying collateral to assess whether credit losses exist and, where applicable, to determine if any adverse changes in cash flows have occurred. The Company’s cash flow estimates take into account expectations of relevant market and economic data as of the end of the reporting period. As of September 30, 2015, the Company did not intend to sell its securities with an unrealized loss position, and it was more likely than not that the Company would not be required to sell these securities before recovery of their amortized cost basis. The Company believes that the securities with an unrealized loss position were not other-than-temporarily impaired as of September 30, 2015.
Other factors considered in determining whether or not an impairment is temporary include the severity of the impairment; the cause of the impairment; the near-term prospects of the issuer; and the forecasted recovery period using current estimates of volatility in market interest rates (including liquidity and risk premiums).
Management’s assertion regarding its intent not to sell, or that it is not more likely than not that the Company will be required to sell a security before its anticipated recovery, is based on a number of factors, including a quantitative estimate of the expected recovery period (which may extend to maturity), and management’s intended strategy with respect to the identified security or portfolio. If management does have the intent to sell, or believes it is more likely than not that the Company will be required to sell the security before its anticipated recovery, the unrealized loss is charged directly to earnings in the Consolidated Statement of Income and Comprehensive Income.
The unrealized losses on the Company’s GSE mortgage-related securities, GSE municipal bonds, and GSE debentures at September 30, 2015 were primarily caused by movements in market interest rates and spread volatility, rather than credit risk. It is expected that these securities will not be settled at a price that is less than the amortized cost of the Company’s investment. Because the Company does not have the intent to sell the investments, and it is not more likely than not that the Company will be required to sell them before the anticipated recovery of fair value, which may be at maturity, the Company did not consider these investments to be other than temporarily impaired at September 30, 2015.
The Company reviews quarterly financial information related to its investments in municipal bonds and capital trust notes, as well as other information that is released by each of the issuers of such bonds and notes, to determine their continued creditworthiness. The contractual terms of these investments do not permit settling the securities at prices that are less than the amortized costs of the investments; therefore, the Company expects that these investments will not be settled at prices that are less than their amortized costs. The Company continues to monitor these investments and currently estimates that the present value of expected cash flows is not less than the amortized cost of the securities. Because the Company does not have the intent to sell the investments, and it is not more likely than not that the Company will be required to sell them before the anticipated recovery of fair value, which may be at maturity, it did not consider these investments to be other than temporarily impaired at September 30, 2015. It is possible that these securities will perform worse than is currently expected, which could lead to adverse changes in cash flows from these securities and potential OTTI losses in the future. Future events that could trigger material unrecoverable declines in the fair values of the Company’s investments, and thus result in potential OTTI losses, include, but are not limited to, government intervention; deteriorating asset quality and credit metrics; significantly higher levels of default and loan loss provisions; losses in value on the underlying collateral; deteriorating credit enhancement; net operating losses; and illiquidity in the financial markets.
At September 30, 2015, the Company’s equity securities portfolio consisted of perpetual preferred stock, common stock, and mutual funds. The Company considers a decline in the fair value of available-for-sale equity securities to be other than temporary if the Company does not expect to recover the entire amortized cost basis of the security. The unrealized losses on the Company’s equity securities at September 30, 2015, were primarily caused by market volatility. The Company evaluated
13
the near-term prospects of a recovery of fair value for this security, together with the severity and duration of impairment to date. Based on this evaluation, and its ability and intent to hold this investment for a reasonably sufficient period of time to realize a near-term forecasted recovery of fair value, the Company did not consider this investment to be other than temporarily impaired at September 30, 2015. Nonetheless, it is possible that this equity security will perform worse than is currently expected, which could lead to adverse changes in its fair value, or the failure of the security to fully recover in value as presently forecasted by management. This potentially would cause the Company to record an OTTI loss in a future period. Events that could trigger a material decline in the fair value of these securities include, but are not limited to, deterioration in the equity markets; a decline in the quality of the loan portfolio of the issuer in which the Company has invested; and the recording of higher loan loss provisions and net operating losses by such issuer.
The investment securities designated as having a continuous loss position for twelve months or more at September 30, 2015 consisted of seven agency debt securities, five capital trust notes, and three agency mortgage-backed securities. At December 31, 2014, the investment securities designated as having a continuous loss position for twelve months or more consisted of 16 agency mortgage-backed securities, 17 GSE debt securities, three GSE CMOs, five capital trust notes, two GSE municipal bonds, and one preferred stock security. At September 30, 2015 and December 31, 2014, the combined market value of the respective securities represented unrealized losses of $21.9 million and $51.6 million. At September 30, 2015, the fair value of securities having a continuous loss position for twelve months or more was 1.7% below the collective amortized cost of $1.3 billion. At December 31, 2014, the fair value of such securities was 1.9% below the collective amortized cost of $2.7 billion.
Note 5. Loans
The following table sets forth the composition of the loan portfolio at September 30, 2015 and December 31, 2014:
Non-Covered Loans Held for Investment:
Mortgage Loans:
Multi-family
Commercial real estate
Acquisition, development, and construction
One-to-four family
Total mortgage loans held for investment
Other Loans:
Commercial and industrial
Lease financing, net of unearned income of $31,708 and $18,913
Total commercial and industrial loans
Purchased credit-impaired loans (1)
Other
Total other loans held for investment
Total non-covered loans held for investment
Net deferred loan origination costs
Allowance for losses on non-covered loans
Allowance for losses on covered loans
Loans held for sale
14
Non-Covered Loans
Non-Covered Loans Held for Investment
The majority of the loans the Company originates for investment are multi-family loans, most of which are collateralized by non-luxury apartment buildings in New York City that are rent-regulated and feature below-market rents. In addition, the Company originates commercial real estate (“CRE”) loans, most of which are collateralized by properties located in New York City and on Long Island.
The Company also originates acquisition, development, and construction (“ADC”) loans, and commercial and industrial (“C&I”) loans, for investment. ADC loans are primarily originated for multi-family and residential tract projects in New York City and on Long Island. C&I loans consist of asset-based loans, equipment loans and leases, and dealer floor-plan loans (together, “specialty finance loans and leases”) that are made to nationally recognized borrowers throughout the U.S.; and “other” C&I loans that primarily are made to small and mid-size businesses in Metro New York. “Other” C&I loans are typically made for working capital, business expansion, and the purchase of machinery and equipment.
Payments on multi-family and CRE loans generally depend on the income produced by the underlying properties which, in turn, depends on their successful operation and management. Accordingly, the ability of the Company’s borrowers to repay these loans may be impacted by adverse conditions in the local real estate market and the local economy. While the Company generally requires that such loans be qualified on the basis of the collateral property’s current cash flows, appraised value, and debt service coverage ratio, among other factors, there can be no assurance that its underwriting policies will protect the Company from credit-related losses or delinquencies.
ADC loans typically involve a higher degree of credit risk than loans secured by improved or owner-occupied real estate. Accordingly, borrowers are required to provide a guarantee of repayment and completion, and loan proceeds are disbursed as construction progresses, as certified by in-house or third-party engineers. The risk of loss on an ADC loan is largely dependent upon the accuracy of the initial appraisal of the property’s value upon completion of construction or development; the developer’s experience; the estimated cost of construction, including interest; and the estimated time to complete and/or sell or lease such property. The Company seeks to minimize these risks by maintaining conservative lending policies and rigorous underwriting standards. However, if the estimate of value proves to be inaccurate, the cost of completion is greater than expected, or the length of time to complete and/or sell or lease the collateral property is greater than anticipated (based, for example, on a downturn in the local economy or real estate market), the property could have a value upon completion that is insufficient to assure full repayment of the loan. This could have a material adverse effect on the quality of the ADC loan portfolio, and could result in losses or delinquencies.
To minimize the risk involved in specialty finance lending and leasing, the Company participates in syndicated loans that are brought to it, and equipment loans and leases that are assigned to it, by a select group of nationally recognized sources who have had long-term relationships with its experienced lending officers. Specialty finance loans and leases generally are made to large corporate obligors, many of which are publicly traded, carry investment grade or near-investment grade ratings, and participate in stable industries nationwide. Furthermore, each of these credits is secured with a perfected first security interest or outright ownership in the underlying collateral, and structured as senior debt or as a non-cancelable lease. To further minimize the risk involved in specialty finance lending and leasing, each transaction is re-underwritten. In addition, outside counsel is retained to conduct a further review of the underlying documentation.
To minimize the risks involved in other C&I lending, the Company underwrites such loans on the basis of the cash flows produced by the business; requires that such loans be collateralized by various business assets, including inventory, equipment, and accounts receivable, among others; and requires personal guarantees. However, the capacity of a borrower to repay such a C&I loan is substantially dependent on the degree to which the business is successful. In addition, the collateral underlying such loans may depreciate over time, may not be conducive to appraisal, or may fluctuate in value, based upon the results of operations of the business.
Included in non-covered loans held for investment at September 30, 2015 and December 31, 2014 were loans to non-officer directors of $126.6 million and $129.5 million, respectively.
Non-covered purchased credit-impaired (“PCI”) loans, which had a carrying value of $13.0 million and an unpaid principal balance of $14.8 million at September 30, 2015, are loans that had been covered under an FDIC loss sharing agreement that expired in March 2015 and that now are included in non-covered loans. Such loans continue to be accounted for under Accounting Standards Codification (“ASC”) 310-30 and are initially measured at fair value, which includes estimated future credit losses expected to be incurred over the lives of the loans. Under ASC 310-30, purchasers are permitted to aggregate acquired loans into one or more pools, provided that the loans have common risk characteristics. A pool is then accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows.
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Non-Covered Loans Held for Sale
The mortgage banking operation of the Community Bank was established in January 2010 to originate, aggregate, and service one-to-four family loans. Community banks, credit unions, mortgage companies, and mortgage brokers use its proprietary web-accessible mortgage banking platform to originate and close one-to-four family loans throughout the U.S. These loans are generally sold to GSEs, servicing retained. To a much lesser extent, the Community Bank uses its mortgage banking platform to originate jumbo loans which it typically sells to other financial institutions. Such loans have not represented, nor are they expected to represent, a material portion of the held-for-sale loans originated by the Community Bank. In addition, the Community Bank services mortgage loans for various third parties, primarily including GSEs. The unpaid principal balance of loans serviced for others was $23.9 billion and $22.4 billion at September 30, 2015 and December 31, 2014, respectively.
Asset Quality
The following table presents information regarding the quality of the Company’s non-covered loans held for investment (excluding non-covered PCI loans) at September 30, 2015:
Commercial and industrial(2)
Total
The following table presents information regarding the quality of the Company’s non-covered loans held for investment at December 31, 2014:
Commercial and industrial(1)
16
The following table summarizes the Company’s portfolio of non-covered loans held for investment, excluding non-covered PCI loans, by credit quality indicator at September 30, 2015:
Credit Quality Indicator:
Pass
Special mention
Substandard
Doubtful
The following table summarizes the Company’s portfolio of non-covered loans held for investment by credit quality indicator at December 31, 2014:
The preceding classifications are the most current available and generally have been updated within the last twelve months. In addition, they follow regulatory guidelines and can generally be described as follows: pass loans are of satisfactory quality; special mention loans have a potential weakness or risk that may result in the deterioration of future repayment; substandard loans are inadequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged (these loans have a well-defined weakness and there is a distinct possibility that the Company will sustain some loss); and doubtful loans, based on existing circumstances, have weaknesses that make collection or liquidation in full highly questionable and improbable. In addition, one-to-four family loans are classified based on the duration of the delinquency.
Troubled Debt Restructurings
The Company is required to account for certain held-for-investment loan modifications and restructurings as troubled debt restructurings (“TDRs”). In general, a modification or restructuring of a loan constitutes a TDR if the Company grants a concession to a borrower experiencing financial difficulty. A loan modified as a TDR generally is placed on non-accrual status until the Company determines that future collection of principal and interest is reasonably assured, which requires, among other things, that the borrower demonstrate performance according to the restructured terms for a period of at least six consecutive months.
In an effort to proactively manage delinquent loans, the Company has selectively extended to certain borrowers concessions such as rate reductions, extension of maturity dates, and forbearance agreements. As of September 30, 2015, loans on which concessions were made with respect to rate reductions and/or extension of maturity dates amounted to $21.2 million; loans on which forbearance agreements were reached amounted to $5.3 million.
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The following table presents information regarding the Company’s TDRs as of September 30, 2015 and December 31, 2014:
Loan Category:
The eligibility of a borrower for work-out concessions of any nature depends upon the facts and circumstances of each transaction, which may change from period to period, and involves judgment by Company personnel regarding the likelihood that the concession will result in the maximum recovery for the Company.
The financial effects of the Company’s TDRs for the nine months ended September 30, 2015 are summarized as follows:
In the nine months ended September 30, 2014, the Company classified one multi-family loan in the amount of $316,000, one CRE loan in the amount of $2.1 million, one ADC loan in the amount of $935,000, and one C&I loan in the amount of $499,000 as non-accrual TDRs. While other concessions were granted to the borrowers, the interest rates on the loans were maintained. As a result, these TDRs did not have a financial impact on the Company’s results of operations during the current nine-month period.
At September 30, 2015 and 2014, none of the loans that had been modified as TDRs during the twelve months ended at those dates were in payment default. A loan is considered to be in payment default once it is 30 days contractually past due under the modified terms.
The Company does not consider a payment to be in default when the loan is in forbearance, or otherwise granted a delay of payment, when the agreement to forebear or allow a delay of payment is part of a modification. Subsequent to the modification, the loan is not considered to be in default until payment is contractually past due in accordance with the modified terms. However, the Company does consider a loan with multiple modifications or forbearance periods to be in default, and would also consider a loan to be in default if it was in bankruptcy or was partially charged off subsequent to modification.
Covered Loans
The following table presents the carrying value of covered loans acquired in the AmTrust and Desert Hills acquisitions as of September 30, 2015:
All other loans
Total covered loans
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The Company refers to certain loans acquired in the AmTrust and Desert Hills transactions as “covered loans” because the Company is being reimbursed for a substantial portion of losses on these loans under the terms of the FDIC loss sharing agreements. Covered loans are accounted for under ASC 310-30 and are initially measured at fair value, which includes estimated future credit losses expected to be incurred over the lives of the loans. Under ASC 310-30, purchasers are permitted to aggregate acquired loans into one or more pools, provided that the loans have common risk characteristics. A pool is then accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows.
At September 30, 2015 and December 31, 2014, the unpaid principal balance of covered loans was $2.6 billion and $2.9 billion, respectively. The carrying value of such loans was $2.1 billion and $2.4 billion, respectively, at the corresponding dates.
At the respective acquisition dates, the Company estimated the fair values of the AmTrust and Desert Hills loan portfolios, which represented the expected cash flows from the portfolios, discounted at market-based rates. In estimating such fair values, the Company: (a) calculated the contractual amount and timing of undiscounted principal and interest payments (the “undiscounted contractual cash flows”); and (b) estimated the expected amount and timing of undiscounted principal and interest payments (the “undiscounted expected cash flows”). The amount by which the undiscounted expected cash flows exceed the estimated fair value (the “accretable yield”) is accreted into interest income over the lives of the loans. The amount by which the undiscounted contractual cash flows exceed the undiscounted expected cash flows is referred to as the “non-accretable difference.” The non-accretable difference represents an estimate of the credit risk in the loan portfolios at the respective acquisition dates.
The accretable yield is affected by changes in interest rate indices for variable rate loans, changes in prepayment assumptions, and changes in expected principal and interest payments over the estimated lives of the loans. Changes in interest rate indices for variable rate loans increase or decrease the amount of interest income expected to be collected, depending on the direction of interest rates. Prepayments affect the estimated lives of covered loans and could change the amount of interest income and principal expected to be collected. Changes in expected principal and interest payments over the estimated lives of covered loans are driven by the credit outlook and by actions that may be taken with borrowers.
On a quarterly basis, the Company evaluates the estimates of the cash flows it expects to collect. Expected future cash flows from interest payments are based on variable rates at the time of the quarterly evaluation. Estimates of expected cash flows that are impacted by changes in interest rate indices for variable rate loans and prepayment assumptions are treated as prospective yield adjustments and included in interest income.
In the nine months ended September 30, 2015, changes in the accretable yield for covered loans were as follows:
Balance at beginning of period
Reclassification to non-accretable difference
Accretion
In the preceding table, the line item “Reclassification to non-accretable difference” includes changes in cash flows that the Company expects to collect due to changes in prepayment assumptions, changes in interest rates on variable rate loans, and changes in loss assumptions. As of the Company’s most recent quarterly evaluation, prepayment assumptions increased, which resulted in a decrease in future expected interest cash flows and, consequently, a decrease in the accretable yield. The effect of this decrease was partially offset by a slight improvement in the underlying credit assumptions coupled with coupon rates on variable rate loans resetting slightly higher, which resulted in an increase in future expected interest cash flows and, consequently, an increase in the accretable yield.
Reflecting the foreclosure of certain loans acquired in the AmTrust and Desert Hills acquisitions, the Company owns certain other real estate owned (“OREO”) that is covered under the Company’s loss sharing agreements with the FDIC (“covered OREO”). Covered OREO was initially recorded at its estimated fair value on the respective dates of acquisition, based on independent appraisals, less the estimated selling costs. Any subsequent write-downs due to declines in fair value have been charged to non-interest expense, and have been partially offset by loss reimbursements under the FDIC loss sharing agreements. Any recoveries of previous write-downs have been credited to non-interest expense and partially offset by the portion of the recovery that was due to the FDIC.
The FDIC loss share receivable represents the present value of the estimated losses to be reimbursed by the FDIC. The estimated losses were based on the same cash flow estimates used in determining the fair value of the covered loans. The FDIC loss share receivable is reduced as losses on covered loans are recognized and as loss sharing payments are received from the
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FDIC. Realized losses in excess of acquisition-date estimates result in an increase in the FDIC loss share receivable. Conversely, if realized losses are lower than the acquisition-date estimates, the FDIC loss share receivable is reduced by amortization to interest income.
The following table presents information regarding the Company’s covered loans that were 90 days or more past due at September 30, 2015 and December 31, 2014:
Covered Loans 90 Days or More Past Due:
Other loans
Total covered loans 90 days or more past due
The following table presents information regarding the Company’s covered loans that were 30 to 89 days past due at September 30, 2015 and December 31, 2014:
Covered Loans 30-89 Days Past Due:
Total covered loans 30-89 days past due
At September 30, 2015, the Company had $38.3 million of covered loans that were 30 to 89 days past due, and covered loans of $142.2 million that were 90 days or more past due but considered to be performing due to the application of the yield accretion method under ASC 310-30. The remaining portion of the Company’s covered loan portfolio totaled $2.0 billion at September 30, 2015 and was considered current at that date. Per ASC 310-30, the Company aggregates credit-impaired loans acquired in the same fiscal quarter into one or more pools, provided that the loans have common risk characteristics. A pool is then accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows.
Loans that may have been classified as non-performing loans by AmTrust or Desert Hills were no longer classified as non-performing by the Company because, at the respective dates of acquisition, the Company believed that it would fully collect the new carrying value of these loans. The new carrying value represents the contractual balance, reduced by the portion that is expected to be uncollectible (i.e., the non-accretable difference) and by an accretable yield (discount) that is recognized as interest income. It is important to note that management’s judgment is required in reclassifying loans subject to ASC 310-30 as performing loans, and such judgment is dependent on having a reasonable expectation about the timing and amount of the cash flows to be collected, even if the loan is contractually past due.
The primary credit quality indicator for covered loans is the expectation of underlying cash flows. In the three months ended September 30, 2015 and 2014, the Company recorded recoveries of losses on covered loans of $8.5 million and $3.9 million, respectively. The respective recoveries were largely due to an increase in expected cash flows in the acquired portfolios of one-to-four family and home equity loans, and were partly offset by FDIC indemnification expense of $6.8 million and $3.2 million, respectively, that was recorded in “Non-interest income” in the respective periods.
Similarly, the Company recovered losses on covered loans of $5.4 million during the nine months ended September 30, 2015, which was largely offset by FDIC indemnification expense of $4.3 million. During the nine months ended September 30, 2014, the Company recovered $18.4 million of losses on covered loans, which was largely offset by FDIC indemnification expense of $14.7 million. The FDIC indemnification expense recorded in the nine months ended September 30, 2015 and 2014 were recorded in “Non-interest income” in the corresponding periods.
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Note 6. Allowances for Loan Losses
The following tables provide information regarding the Company’s allowances for losses on non-covered and covered loans, based upon the method of evaluating loan impairment:
Allowances for Loan Losses at September 30, 2015:
Loans individually evaluated for impairment
Loans collectively evaluated for impairment
Acquired loans with deteriorated credit quality
Allowances for Loan Losses at December 31, 2014:
The following tables provide information regarding loans receivable, based upon the method of evaluating impairment:
Loans Receivable at September 30, 2015:
Loans Receivable at December 31, 2014:
Allowance for Losses on Non-Covered Loans
The following table summarizes activity in the allowance for losses on non-covered loans for the nine months ended September 30, 2015 and 2014:
Balance, beginning of period
Charge-offs
Recoveries
Transfer from the allowance for losses on covered loans (1)
(Recovery of) provision for non-covered loan losses
Balance, end of period
Please see “Critical Accounting Policies” for additional information regarding the Company’s allowance for losses on non-covered loans.
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The following table presents additional information about the Company’s impaired non-covered loans at September 30, 2015:
Impaired loans with no related allowance:
Total impaired loans with no related allowance
Impaired loans with an allowance recorded:
Total impaired loans with an allowance recorded
Total impaired loans:
Total impaired loans
The following table presents additional information about the Company’s impaired non-covered loans at December 31, 2014:
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Allowance for Losses on Covered Loans
Covered loans are reported exclusive of the FDIC loss share receivable. The covered loans acquired in the AmTrust and Desert Hills acquisitions are, and will continue to be, reviewed for collectability based on the expectations of cash flows from these loans. Covered loans have been aggregated into pools of loans with common characteristics. In determining the allowance for losses on covered loans, the Company periodically performs an analysis to estimate the expected cash flows for each of the pools of loans. The Company records a provision for (recovery of) losses on covered loans to the extent that the expected cash flows from a loan pool have decreased or increased since the acquisition date.
Accordingly, if there is a decrease in expected cash flows due to an increase in estimated credit losses (as compared to the estimates made at the respective acquisition dates), the decrease in the present value of expected cash flows is recorded as a provision for covered loan losses charged to earnings, and an allowance for covered loan losses is established. A related credit to non-interest income and an increase in the FDIC loss share receivable is recognized at the same time, and measured based on the applicable loss sharing agreement percentage.
If there is an increase in expected cash flows due to a decrease in estimated credit losses (as compared to the estimates made at the respective acquisition dates), the increase in the present value of expected cash flows is recorded as a recovery of the prior-period impairment charged to earnings, and the allowance for covered loan losses is reduced. A related debit to non-interest income and a decrease in the FDIC loss share receivable is recognized at the same time, and measured based on the applicable loss sharing agreement percentage.
The following table summarizes activity in the allowance for losses on covered loans for the nine months ended September 30, 2015 and 2014:
(Recovery of) losses on covered loans
Transfer to the allowance for losses on non-covered loans (1)
Note 7. Borrowed Funds
The following table summarizes the Company’s borrowed funds at September 30, 2015 and December 31, 2014:
FHLB advances
The following table summarizes the Company’s repurchase agreements accounted for as secured borrowings at September 30, 2015:
GSE debentures and mortgage-related securities
At September 30, 2015 and December 31, 2014, the Company had $358.5 million and $358.4 million, respectively, of outstanding junior subordinated deferrable interest debentures (“junior subordinated debentures”) held by statutory business trusts (the “Trusts”) that issued guaranteed capital securities. Reflecting the adoption of the Basel III capital rules on January 1, 2015, 25% of the capital securities qualified as Tier 1 capital of the Company at September 30, 2015. At December 31, 2014, 100% of the capital securities qualified as Tier 1 capital of the Company.
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The Trusts are accounted for as unconsolidated subsidiaries in accordance with GAAP. The proceeds of each issuance were invested in a series of junior subordinated debentures of the Company and the underlying assets of each statutory business trust are the relevant debentures. The Company has fully and unconditionally guaranteed the obligations under each trust’s capital securities to the extent set forth in a guarantee by the Company to each trust. The Trusts’ capital securities are each subject to mandatory redemption, in whole or in part, upon repayment of the debentures at their stated maturity or earlier redemption.
The following junior subordinated debentures were outstanding at September 30, 2015:
Date of
Original Issue
New York Community Capital Trust V (BONUSESSMUnits)
New York Community Capital Trust X
PennFed Capital Trust III
New York Community Capital Trust XI
Total junior subordinated debentures
Note 8. Mortgage Servicing Rights
The Company had MSRs of $236.2 million and $227.3 million, respectively, at September 30, 2015 and December 31, 2014. The September 30th balance consisted of two classes of MSRs for which the Company separately manages the economic risk: residential MSRs and participation MSRs (i.e., MSRs on loans sold through participations). The December 31st balance consisted entirely of residential MSRs.
Residential MSRs are carried at fair value, with changes in fair value recorded as a component of non-interest income in each period. The Company uses various derivative instruments to mitigate the income statement-effect of changes in fair value due to changes in valuation inputs and assumptions regarding its residential MSRs. The effects of changes in the fair value of the derivatives are recorded in “Non-interest income” in the Consolidated Statements of Income and Comprehensive Income. MSRs do not trade in an active open market with readily observable prices. Accordingly, the Company bases the fair value of its MSRs on the present value of estimated future net servicing income cash flows. The Company estimates future net servicing income cash flows with assumptions that market participants would use to estimate fair value, including estimates of prepayment speeds, discount rates, default rates, refinance rates, servicing costs, escrow account earnings, contractual servicing fee income, and ancillary income. The Company reassesses, and periodically adjusts, the underlying inputs and assumptions to reflect market conditions and assumptions that a market participant would consider in valuing the MSR asset.
The value of residential MSRs at any given time is significantly affected by the mortgage interest rates that are then currently available in the marketplace which, in turn, influence mortgage loan prepayment speeds. During periods of declining interest rates, the value of MSRs generally declines as an increase in mortgage refinancing activity results in an increase in prepayments. Conversely, during periods of rising interest rates, the value of MSRs generally increases as mortgage refinancing activity declines.
Participation MSRs are initially carried at fair value and are subsequently amortized and carried at the lower of their fair value or amortized amount. The amortization is recorded in proportion to, and over the period of, estimated net servicing income. Changes in the carrying value of participation MSRs due to amortization or changes in fair value, if any, are reported in “Other income” in the period during which such changes occur.
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The following tables set forth the changes in the balances of residential MSRs and participation MSRs for the periods indicated:
Carrying value, beginning of period
Additions
Increase (decrease) in fair value:
Due to changes in interest rates and valuation assumptions
Due to other changes (1)
Amortization
Carrying value, end of period
The following table presents the key assumptions used in calculating the fair value of the Company’s residential MSRs at the dates indicated:
Expected Weighted Average Life
Constant Prepayment Speed
Discount Rate
Primary Mortgage Rate to Refinance
Cost to Service (per loan per year):
Current
30-59 days or less delinquent
60-89 days delinquent
90-119 days delinquent
120 days or more delinquent
As indicated in the preceding table, there were no changes in the assumed servicing costs over the nine months ended September 30, 2015. Reflecting the aging of the portfolio and a lower average portfolio note rate, the expected weighted average life increased and, conversely, the constant prepayment speed decreased.
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Note 9. Pension and Other Post-Retirement Benefits
The following tables set forth certain disclosures for the Company’s pension and post-retirement plans for the periods indicated:
Components of net periodic (credit) expense:
Interest cost
Service cost
Expected return on plan assets
Amortization of past service liability
Amortization of net actuarial loss
Net periodic (credit) expense
The Company expects to contribute $1.3 million to its post-retirement plan to pay premiums and claims for the fiscal year ending December 31, 2015. The Company does not expect to make any contributions to its pension plan in 2015.
Note 10. Stock-Based Compensation
At September 30, 2015, the Company had 12,245,112 shares available for grants as options, restricted stock, or other forms of related rights under the New York Community Bancorp, Inc. 2012 Stock Incentive Plan (the “2012 Stock Incentive Plan”), which was approved by the Company’s shareholders at its Annual Meeting on June 7, 2012. Included in this amount were 1,030,673 shares that were transferred from the 2006 Stock Incentive Plan, which was approved by the Company’s shareholders at its Annual Meeting on June 7, 2006 and reapproved at its Annual Meeting on June 2, 2011. The Company granted 2,335,641 shares of restricted stock during the nine months ended September 30, 2015. The shares had an average fair value of $15.83 per share on the date of grant and a vesting period of five years. The nine-month amount includes 34,500 shares that were granted in the third quarter with an average fair value of $18.02 per share on the date of grant. Compensation and benefits expense related to the restricted stock grants is recognized on a straight-line basis over the vesting period, and totaled $22.6 million and $20.7 million, respectively, in the nine months ended September 30, 2015 and 2014, including $8.0 million and $6.8 million, respectively, in the three months ended at those dates.
The following table provides a summary of activity with regard to restricted stock awards in the nine months ended September 30, 2015:
Unvested at beginning of year
Granted
Vested
Cancelled
Unvested at end of period
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As of September 30, 2015, unrecognized compensation cost relating to unvested restricted stock totaled $78.4 million. This amount will be recognized over a remaining weighted average period of 3.2 years.
In addition, the Company had one stock option plan at September 30, 2015: the 2004 Synergy Financial Group Stock Option Plan (the “Stock Option Plan”). All stock options granted under the Stock Option Plan expire 10 years from the date of grant.
The Company uses the modified prospective approach to recognize compensation costs related to share-based payments at fair value on the date of grant, and recognizes such costs in the financial statements over the vesting period during which the employee provides service in exchange for the award. As there were no unvested options at any time during the nine months ended September 30, 2015 or the year ended December 31, 2014, the Company did not record any compensation and benefits expense relating to stock options during those periods.
To satisfy the exercise of options, the Company either issues new shares of common stock or uses common stock held in Treasury. In the event that Treasury stock is used, the difference between the average cost of Treasury shares and the exercise price is recorded as an adjustment to retained earnings or paid-in capital on the date of exercise. At September 30, 2015, there were 2,400 stock options outstanding. There were no shares available for future issuance under the Stock Option Plan at that date.
The status of the Stock Option Plan at September 30, 2015, and the changes that occurred during the nine months ended at that date, are summarized below:
Stock options outstanding, beginning of year
Exercised
Expired/forfeited
Stock options outstanding, end of period
Options exercisable, end of period
The intrinsic value of stock options outstanding and exercisable at September 30, 2015 was $3,000. There were no options exercised during the nine months ended September 30, 2015. The intrinsic value of options exercised during the nine months ended September 30, 2014 was $132,000.
Note 11. Fair Value Measurements
GAAP sets forth a definition of fair value, establishes a consistent framework for measuring fair value, and requires disclosure for each major asset and liability category measured at fair value on either a recurring or non-recurring basis. GAAP also clarifies that fair value is an “exit” price, representing the amount that would be received when selling an asset, or paid when transferring a liability, in an orderly transaction between market participants. Fair value is thus a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, GAAP establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:
A financial instrument’s categorization within this valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
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The following tables present assets and liabilities that were measured at fair value on a recurring basis as of September 30, 2015 and December 31, 2014, and that were included in the Company’s Consolidated Statements of Condition at those dates:
Mortgage-Related Securities Available for Sale:
Other Securities Available for Sale:
Other Assets:
Interest rate lock commitments
Derivative assets-other (2)
Liabilities:
Derivative liabilities
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The Company reviews and updates the fair value hierarchy classifications for its assets on a quarterly basis. Changes from one quarter to the next that are related to the observability of inputs for a fair value measurement may result in a reclassification from one hierarchy level to another.
A description of the methods and significant assumptions utilized in estimating the fair values of available-for-sale securities follows:
Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities include highly liquid government securities, exchange-traded securities, and derivatives.
If quoted market prices are not available for a specific security, then fair values are estimated by using pricing models. These pricing models primarily use market-based or independently sourced market parameters as inputs, including, but not limited to, yield curves, interest rates, equity or debt prices, and credit spreads. In addition to observable market information, models incorporate transaction details such as maturity and cash flow assumptions. Securities valued in this manner would generally be classified within Level 2 of the valuation hierarchy, and primarily include such instruments as mortgage-related and corporate debt securities.
In certain cases where there is limited activity or less transparency around inputs to a valuation, securities are classified within Level 3 of the valuation hierarchy. In valuing capital trust notes, which may include pooled trust preferred securities, collateralized debt obligations (“CDOs”), and certain single-issue capital trust notes, the determination of fair value may require benchmarking to similar instruments or analyzing default and recovery rates. Therefore, capital trust notes are valued using a model based on the specific collateral composition and cash flow structure of the securities. Key inputs to the model consist of market spread data for each credit rating, collateral type, and other relevant contractual features. In instances where quoted price information is available, the price is considered when arriving at a security’s fair value. Where there is limited activity or less transparency around the inputs to the valuation of preferred stock, the valuation is based on a discounted cash flow model.
Periodically, the Company uses fair values supplied by independent pricing services to corroborate the fair values derived from the pricing models. In addition, the Company reviews the fair values supplied by independent pricing services, as well as their underlying pricing methodologies, for reasonableness. The Company challenges pricing services’ valuations that appear to be unusual or unexpected.
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The Company carries loans held for sale originated by the Residential Mortgage Banking segment at fair value. The fair value of loans held for sale is primarily based on quoted market prices for securities backed by similar types of loans. Changes in the fair value of these assets are largely driven by changes in interest rates subsequent to loan funding, and changes in the fair value of servicing associated with the mortgage loans held for sale. Loans held for sale are classified within Level 2 of the valuation hierarchy.
MSRs do not trade in an active open market with readily observable prices. The Company bases the fair value of its MSRs on the present value of estimated future net servicing income cash flows, utilizing an internal valuation model. The Company estimates future net servicing income cash flows with assumptions that market participants would use to estimate fair value, including estimates of prepayment speeds, discount rates, default rates, refinance rates, servicing costs, escrow account earnings, contractual servicing fee income, and ancillary income. The Company reassesses and periodically adjusts the underlying inputs and assumptions to reflect market conditions and assumptions that a market participant would consider in valuing the MSR asset. MSR fair value measurements use significant unobservable inputs and, accordingly, are classified within Level 3.
Exchange-traded derivatives that are valued using quoted prices are classified within Level 1 of the valuation hierarchy. The majority of the Company’s derivative positions are valued using internally developed models that use readily observable market parameters as their basis. These are parameters that are actively quoted and can be validated by external sources, including industry pricing services. Where the types of derivative products have been in existence for some time, the Company uses models that are widely accepted in the financial services industry. These models reflect the contractual terms of the derivatives, including the period to maturity, and market-based parameters such as interest rates, volatility, and the credit quality of the counterparty. Furthermore, many of these models do not contain a high level of subjectivity, as the methodologies used in the models do not require significant judgment, and inputs to the models are readily observable from actively quoted markets, as is the case for “plain vanilla” interest rate swaps and option contracts. Such instruments are generally classified within Level 2 of the valuation hierarchy. Derivatives that are valued based on models with significant unobservable market parameters, and that are normally traded less actively, have trade activity that is one-way, and/or are traded in less-developed markets, are classified within Level 3 of the valuation hierarchy.
The fair values of interest rate lock commitments (“IRLCs”) for residential mortgage loans that the Company intends to sell are based on internally developed models. The key model inputs primarily include the sum of the value of the forward commitment based on the loans’ expected settlement dates and the projected values of the MSRs, loan level price adjustment factors, and historical IRLC closing ratios. The closing ratio is computed by the Company’s mortgage banking operation and is periodically reviewed by management for reasonableness. Such derivatives are classified as Level 3.
While the Company believes its valuation methods are appropriate and consistent with those of other market participants, the use of different methodologies or assumptions to determine the fair values of certain financial instruments could result in different estimates of fair values at a reporting date.
Fair Value Option
Loans Held for Sale
The Company has elected the fair value option for its loans held for sale. At September 30, 2015, the Company’s loans held for sale consisted of one-to-four family mortgage loans, none of which was 90 days or more past due. Management believes that the mortgage banking business operates on a short-term cycle. Therefore, in order to reflect the most relevant valuations for the key components of this business, and to reduce timing differences in amounts recognized in earnings, the Company has elected to record loans held for sale at fair value to match the recognition of IRLCs, MSRs, and derivatives, all of which are recorded at fair value in earnings. Fair value is based on independent quoted market prices of mortgage-backed securities comprised of loans with similar features to those of the Company’s loans held for sale, where available, and adjusted as necessary for such items as servicing value, guaranty fee premiums, and credit spread adjustments.
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The following table reflects the difference between the fair value carrying amount of loans held for sale for which the Company has elected the fair value option, and the unpaid principal balance:
Gains and Losses Included in Income for Assets Where the Fair Value Option Has Been Elected
The assets accounted for under the fair value option are initially measured at fair value. Gains and losses from the initial measurement and subsequent changes in fair value are recognized in earnings.
The following table presents the changes in fair value related to initial measurement, and the subsequent changes in fair value included in earnings, for loans held for sale and MSRs for the periods indicated:
Total (loss) gain
The Company has determined that there is no instrument-specific credit risk related to its loans held for sale, due to the short duration of such assets.
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Changes in Level 3 Fair Value Measurements
The following tables present, for the nine months ended September 30, 2015 and 2014, a roll-forward of the balance sheet amounts (including changes in fair value) for financial instruments classified in Level 3 of the valuation hierarchy:
Available-for-sale capital securities
The Company’s policy is to recognize transfers in and out of Levels 1, 2, and 3 as of the end of the reporting period. During the nine months ended September 30, 2015, the Company transferred certain mutual funds to Level 2 from Level 1 as a result of decreased observable market activity for these securities. There were no gains or losses recognized as a result of the transfer of securities during the nine months ended September 30, 2015. There were no transfers in or out of Levels 1, 2, or 3 during the nine months ended September 30, 2014.
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For Level 3 assets and liabilities measured at fair value on a recurring basis as of September 30, 2015, the significant unobservable inputs used in the fair value measurements were as follows:
Significant Unobservable Inputs
Weighted Average Constant Prepayment Rate (1)
Weighted Average Discount Rate
Weighted Average Closing Ratio
The significant unobservable inputs used in the fair value measurement of the Company’s MSRs are the weighted average constant prepayment rate and the weighted average discount rate. Significant increases or decreases in either of those inputs in isolation could result in significantly lower or higher fair value measurements. Although the constant prepayment rate and the discount rate are not directly interrelated, they generally move in opposite directions.
The significant unobservable input used in the fair value measurement of the Company’s IRLCs is the closing ratio, which represents the percentage of loans currently in an interest rate lock position that management estimates will ultimately close. Generally, the fair value of an IRLC is positive if the prevailing interest rate is lower than the IRLC rate, and the fair value of an IRLC is negative if the prevailing interest rate is higher than the IRLC rate. Therefore, an increase in the closing ratio (i.e., a higher percentage of loans estimated to close) will result in the fair value of the IRLC increasing if in a gain position, or decreasing if in a loss position. The closing ratio is largely dependent on the stage of processing that a loan is currently in, and the change in prevailing interest rates from the time of the interest rate lock.
Assets Measured at Fair Value on a Non-Recurring Basis
Certain assets are measured at fair value on a non-recurring basis. Such instruments are subject to fair value adjustments under certain circumstances (e.g., when there is evidence of impairment). The following tables present assets and liabilities that were measured at fair value on a non-recurring basis as of September 30, 2015 and December 31, 2014, and that were included in the Company’s Consolidated Statements of Condition at those dates:
Certain impaired loans (1)
Other assets (2)
The fair values of collateral-dependent impaired loans are determined using various valuation techniques, including consideration of appraised values and other pertinent real estate market data.
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Other Fair Value Disclosures
FASB guidance requires the disclosure of fair value information about the Company’s on- and off-balance sheet financial instruments. When available, quoted market prices are used as the measure of fair value. In cases where quoted market prices are not available, fair values are based on present-value estimates or other valuation techniques. Such fair values are significantly affected by the assumptions used, the timing of future cash flows, and the discount rate.
Because assumptions are inherently subjective in nature, estimated fair values cannot be substantiated by comparison to independent market quotes. Furthermore, in many cases, the estimated fair values provided would not necessarily be realized in an immediate sale or settlement of such instruments.
The following tables summarize the carrying values, estimated fair values, and fair value measurement levels of financial instruments that were not carried at fair value on the Company’s Consolidated Statements of Condition at September 30, 2015 and December 31, 2014:
Financial Assets:
Securities held to maturity
FHLB stock(1)
Loans, net
Financial Liabilities:
Deposits
The methods and significant assumptions used to estimate fair values for the Company’s financial instruments follow:
Cash and Cash Equivalents
Cash and cash equivalents include cash and due from banks and fed funds sold. The estimated fair values of cash and cash equivalents are assumed to equal their carrying values, as these financial instruments are either due on demand or have short-term maturities.
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Securities
If quoted market prices are not available for a specific security, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flows. These pricing models primarily use market-based or independently sourced market parameters as inputs, including, but not limited to, yield curves, interest rates, equity or debt prices, and credit spreads. In addition to observable market information, pricing models also incorporate transaction details such as maturity and cash flow assumptions.
Federal Home Loan Bank Stock
Ownership in equity securities of the FHLB is restricted and there is no established market for their resale. The carrying amount approximates the fair value.
Loans
The loan portfolio is segregated into various components for valuation purposes in order to group loans based on their significant financial characteristics, such as loan type (mortgage or other) and payment status (performing or non-performing). The estimated fair values of mortgage and other loans are computed by discounting the anticipated cash flows from the respective portfolios. The discount rates reflect current market rates for loans with similar terms to borrowers of similar credit quality. The estimated fair values of non-performing mortgage and other loans are based on recent collateral appraisals.
The methods used to estimate the fair values of loans are extremely sensitive to the assumptions and estimates used. While management has attempted to use assumptions and estimates that best reflect the Company’s loan portfolio and current market conditions, a greater degree of subjectivity is inherent in these values than in those determined in active markets. Accordingly, readers are cautioned in using this information for purposes of evaluating the financial condition and/or value of the Company in and of itself or in comparison with any other company.
Mortgage Servicing Rights
MSRs do not trade in an active market with readily observable prices. Accordingly, the Company utilizes a valuation model that calculates the present value of estimated future cash flows. The model incorporates various assumptions, including estimates of prepayment speeds, discount rates, refinance rates, servicing costs, and ancillary income. The Company reassesses and periodically adjusts the underlying inputs and assumptions to reflect current market conditions and assumptions that a market participant would consider in valuing the MSR asset.
Derivative Financial Instruments
For exchange-traded futures and exchange-traded options, fair value is based on observable quoted market prices in an active market. For forward commitments to buy and sell loans and mortgage-backed securities, fair value is based on observable market prices for similar loans and securities in an active market. The fair value of IRLCs for one-to-four family mortgage loans that the Company intends to sell is based on internally developed models. The key model inputs primarily include the sum of the value of the forward commitment based on the loans’ expected settlement dates, the value of MSRs arrived at by an independent MSR broker, government agency price adjustment factors, and historical IRLC fall-out factors.
The fair values of deposit liabilities with no stated maturity (i.e., NOW and money market accounts, savings accounts, and non-interest-bearing accounts) are equal to the carrying amounts payable on demand. The fair values of certificates of deposit represent contractual cash flows, discounted using interest rates currently offered on deposits with similar characteristics and remaining maturities. These estimated fair values do not include the intangible value of core deposit relationships, which comprise a significant portion of the Company’s deposit base.
Borrowed Funds
The estimated fair value of borrowed funds is based either on bid quotations received from securities dealers or the discounted value of contractual cash flows with interest rates currently in effect for borrowed funds with similar maturities and structures.
Off-Balance Sheet Financial Instruments
The fair values of commitments to extend credit and unadvanced lines of credit are estimated based on an analysis of the interest rates and fees currently charged to enter into similar transactions, considering the remaining terms of the commitments and the creditworthiness of the potential borrowers. The estimated fair values of such off-balance sheet financial instruments were insignificant at September 30, 2015 and December 31, 2014.
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Note 12. Derivative Financial Instruments
The Company’s derivative financial instruments consist of financial forward and futures contracts, IRLCs, and options. These derivatives relate to mortgage banking operations, MSRs, and other risk management activities, and seek to mitigate or reduce the Company’s exposure to losses from adverse changes in interest rates. These activities will vary in scope based on the level and volatility of interest rates, the type of assets held, and other changing market conditions.
In accordance with the applicable accounting guidance, the Company takes into account the impact of collateral and master netting agreements that allow it to settle all derivative contracts held with a single counterparty on a net basis, and to offset the net derivative position with the related collateral when recognizing derivative assets and liabilities. As a result, the Company’s Statements of Financial Condition could reflect derivative contracts with negative fair values that are included in derivative assets, and contracts with positive fair values that are included in derivative liabilities.
The Company held derivatives with a notional amount of $2.5 billion at September 30, 2015. Changes in the fair value of these derivatives are reflected in current-period earnings. None of these derivatives are designated as hedges for accounting purposes.
The Company uses various financial instruments, including derivatives, in connection with its strategies to reduce pricing risk resulting from changes in interest rates. Derivative instruments may include IRLCs entered into with borrowers or correspondents/brokers to acquire agency-conforming fixed and adjustable rate residential mortgage loans that will be held for sale, as well as Treasury options and Eurodollar futures.
The Company enters into forward contracts to sell fixed rate mortgage-backed securities to protect against changes in the prices of agency-conforming fixed rate loans held for sale. Forward contracts are entered into with securities dealers in an amount related to the portion of IRLCs that is expected to close. The value of these forward sales contracts moves inversely with the value of the loans in response to changes in interest rates.
To manage the price risk associated with fixed-rate non-conforming mortgage loans, the Company generally enters into forward contracts on mortgage-backed securities or forward commitments to sell loans to approved investors. Short positions in Eurodollar futures contracts are used to manage price risk on adjustable rate mortgage loans held for sale.
The Company also purchases put and call options to manage the risk associated with variations in the amount of IRLCs that ultimately close.
The following table sets forth information regarding the Company’s derivative financial instruments at September 30, 2015:
Treasury options
Treasury futures
Eurodollar futures
Forward commitments to sell loans/mortgage-backed securities
Forward commitments to buy loans/mortgage-backed securities
Total derivatives
In addition, the Company mitigates a portion of the risk associated with changes in the value of MSRs. The general strategy for mitigating this risk is to purchase derivative instruments, the value of which changes in the opposite direction of interest rates, thus partially offsetting changes in the value of our servicing assets, which tends to move in the same direction as interest rates. Accordingly, the Company purchases Eurodollar futures and call options on Treasury securities, and enters into forward contracts to purchase mortgage-backed securities.
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The following table sets forth the effect of derivative instruments on the Consolidated Statements of Income and Comprehensive Income for the periods indicated:
Treasury and Eurodollar futures
Forward commitments to buy/sell loans/mortgage-backed securities
Total gain/(loss)
The Company has in place an enforceable master netting arrangement with every counterparty. All master netting arrangements include rights to offset associated with the Company’s recognized derivative assets, derivative liabilities, and cash collateral received and pledged. Accordingly, the Company, where appropriate, offsets all derivative asset and liability positions with the cash collateral received and pledged.
The following tables present the effect of the master netting arrangements on the presentation of the derivative assets in the Consolidated Statements of Condition as of the dates indicated:
Derivatives
The following tables present the effect the master netting arrangements had on the presentation of the derivative liabilities in the Consolidated Statements of Condition as of the dates indicated:
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Note 13. Segment Reporting
The Company’s operations are divided into two reportable business segments: Banking Operations and Residential Mortgage Banking. These operating segments have been identified based on the Company’s organizational structure. The segments require unique technology and marketing strategies, and offer different products and services. While the Company is managed as an integrated organization, individual executive managers are held accountable for the operations of these business segments.
The Company measures and presents information for internal reporting purposes in a variety of ways. The internal reporting system presently used by management in the planning and measurement of operating activities, and to which most managers are held accountable, is based on organizational structure.
The management accounting process uses various estimates and allocation methodologies to measure the performance of the operating segments. To determine financial performance for each segment, the Company allocates capital, funding charges and credits, certain non-interest expenses, and income tax provisions to each segment, as applicable. Allocation methodologies are subject to periodic adjustment as the internal management accounting system is revised and/or as business or product lines within the segments change. In addition, because the development and application of these methodologies is a dynamic process, the financial results presented may be periodically revised.
The Company seeks to maximize shareholder value by, among other means, optimizing the return on stockholders’ equity and managing risk. Capital is assigned to each segment, the combination of which is equivalent to the Company’s consolidated total, on an economic basis, using management’s assessment of the inherent risks associated with the segment. Capital allocations are made to cover the following risk categories: credit risk, liquidity risk, interest rate risk, option risk, basis risk, market risk, and operational risk.
The Company allocates expenses to the reportable segments based on various factors, including the volume and amount of loans produced and the number of full-time equivalent employees. Income taxes are allocated to the various segments based on taxable income and statutory rates applicable to the segment.
Banking Operations Segment
The Banking Operations segment serves consumers and businesses by offering and servicing a variety of loan and deposit products and other financial services.
Residential Mortgage Banking Segment
The Residential Mortgage Banking segment originates, aggregates, sells, and services one-to-four family mortgage loans. Mortgage loan products consist primarily of agency-conforming fixed- and adjustable-rate loans and, to a lesser extent, jumbo hybrid loans, for the purpose of purchasing or refinancing one-to-four family homes. The Residential Mortgage Banking segment earns interest on loans held in the warehouse and non-interest income from the origination and servicing of loans. It also recognizes gains or losses on the sale of such loans.
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The following table provides a summary of the Company’s segment results for the three months ended September 30, 2015, on an internally managed accounting basis:
Non-interest income:
Third party(1)
Inter-segment
Non-interest expense(2)
Income before income tax expense
Net income (loss)
Identifiable segment assets (period-end)
The following table provides a summary of the Company’s segment results for the nine months ended September 30, 2015, on an internally managed accounting basis:
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The following table provides a summary of the Company’s segment results for the three months ended September 30, 2014, on an internally managed accounting basis:
Third party (1)
Non-interest expense (2)
The following table provides a summary of the Company’s segment results for the nine months ended September 30, 2014, on an internally managed accounting basis:
Note 14. Impact of Recent Accounting Pronouncements
In June 2014, the FASB issued Accounting Standards Update (“ASU”) No. 2014-11, “Transfers and Servicing (Topic 860)—Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures.” The amendments in ASU No. 2014-11 require that repurchase-to-maturity transactions be accounted for as secured borrowings consistent with the accounting for other repurchase agreements. In addition, the amendments require separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty (a repurchase financing), which will result in secured borrowing accounting for the repurchase agreement. The amendments require an entity to disclose information about transfers accounted for as sales in transactions that are economically similar to repurchase agreements, in which the transferor retains substantially all of the exposure to the economic return on the transferred financial asset throughout the term of the transaction. In addition, the amendments require disclosure of the types of collateral pledged in repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions, and the tenor of those transactions. The accounting changes in ASU No. 2014-11 are effective for the first interim or annual period beginning after December 15, 2014. The disclosure for certain transactions accounted for as sales is required to be presented for interim and annual periods beginning after December 15, 2014, and the disclosure for repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions accounted for as secured borrowings is required to be presented for annual periods beginning after December 15, 2014, and for interim periods beginning after March 15, 2015. The adoption of ASU No. 2014-11 did not have a material effect on the Company’s consolidated statement of condition or results of operations.
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In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606).” The amendments in ASU No. 2014-09 create Topic 606, “Revenue from Contracts with Customers,” and supersede the revenue recognition requirements in Topic 605, “Revenue Recognition,” including most industry-specific revenue recognition guidance throughout the Industry Topics of the Codification. In addition, the amendments supersede the cost guidance in Subtopic 605-35, “Revenue Recognition—Construction-Type and Production-Type Contracts,” and create new Subtopic 340-40, “Other Assets and Deferred Costs—Contracts with Customers.” In summary, the core principle of Topic 606 is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU No. 2014-09 is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. Early application is not permitted. The Company is in the process of evaluating the effects the adoption of ASU No. 2014-09 may have on its consolidated statement of condition or results of operations.
In January 2014, the FASB issued ASU No. 2014-01, “Investments – Equity Method and Joint Ventures (Topic 323), Accounting for Investments in Qualified Affordable Housing Projects.” The amendments in ASU No. 2014-01 provide guidance on accounting for investments by a reporting entity in flow-through limited liability entities that manage or invest in affordable housing projects that qualify for low-income housing tax credits. The amendments permit reporting entities 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. ASU No. 2014-01 is effective for annual periods, and interim reporting periods within those annual periods, beginning after December 15, 2014, with early adoption permitted; it should be applied retrospectively to all periods presented. The adoption of ASU No. 2014-01 on January 1, 2014 did not have a material effect on the Company’s consolidated statement of condition or results of operations.
In January 2014, the FASB issued ASU No. 2014-04, “Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40), Reclassification of Residential Real Estate-Collateralized Consumer Mortgage Loans upon Foreclosure.” The amendments in ASU No. 2014-04 clarify when an in-substance repossession or foreclosure occurs, i.e., when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan receivable should be derecognized and the real estate property recognized. ASU No. 2014-04 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. The adoption of ASU No. 2014-04 on January 1, 2015 did not have a material effect on the Company’s consolidated statement of condition or results of operations.
Note 15. Subsequent Events
Proposed Merger with Astoria Financial Corporation
On October 28, 2015, we entered into an Agreement and Plan of Merger with Astoria Financial Corporation (“Astoria Financial”), which had total assets of $15.1 billion, total deposits of $9.0 billion, and 87 banking offices in Nassau, Suffolk, and Westchester Counties, and Queens, Brooklyn, and Manhattan, at September 30, 2015.
Pending receipt of the necessary regulatory and shareholder approvals, the effectiveness of the registration statement on Form S-4 for the common stock to be issued in the merger, and the completion of certain additional customary closing conditions, the merger is currently expected to close in the fourth quarter of 2016. Subject to the terms of, and conditions set forth in, the Agreement and Plan of Merger, Astoria Financial will merge with and into the Company, and Astoria Bank will merge with and into New York Community Bank.
Shareholders of Astoria Financial will receive one share of New York Community Bancorp and a cash payment of $0.50 per share for each share of Astoria Financial held on the closing date of the merger.
Balance Sheet Repositioning
On October 29, 2015, we announced plans to reposition our balance sheet in the fourth quarter of 2015 by prepaying approximately $10 billion of our wholesale borrowings. While the prepayment is expected to result in a one-time after-tax prepayment charge of approximately $614.0 million, it also is expected to reduce our average cost of interest-bearing liabilities and interest expense beginning in next year’s first quarter, and to result in ongoing margin expansion and earnings growth from that point.
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Follow-On Offering of Common Stock
On November 4, 2015, we announced the completion of an underwritten follow-on common stock offering that had been announced and priced on October 29, 2015. The Company offered 40,625,000 shares of its common stock at a price to the public of $16.00 per share, and received net proceeds of $630.5 million after deducting underwriting discounts and commissions.
A substantial portion of the net proceeds from the offering were used to make a capital contribution to New York Community Bank, with the remainder being set aside for general corporate purposes, including the payment of dividends. The offering raised an amount at least equal to that of the after-tax charge we expect to incur in the current fourth quarter related to the aforementioned prepayment of wholesale borrowings.
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MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
For the purpose of this discussion and analysis, the words “we,” “us,” “our,” and the “Company” are used to refer to New York Community Bancorp, Inc. and our consolidated subsidiaries, including New York Community Bank (the “Community Bank”) and New York Commercial Bank (the “Commercial Bank”) (collectively, the “Banks”).
Forward-Looking Statements and Associated Risk Factors
This report, like many written and oral communications presented by New York Community Bancorp, Inc. and our authorized officers, may contain certain forward-looking statements regarding our prospective performance and strategies within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and are including this statement for purposes of said safe harbor provisions.
Forward-looking statements, which are based on certain assumptions, and describe our future plans, strategies, and expectations, are generally identified by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” “plan,” or future or conditional verbs such as “will,” “would,” “should,” “could,” “may,” or other similar expressions. Although we believe that our plans, intentions, and expectations as reflected in these forward-looking statements are reasonable, we can give no assurance that these plans, intentions, or expectations will be achieved or realized.
Our ability to predict results or the actual effects of our plans and strategies are inherently uncertain. Accordingly, actual results, performance, or achievements could differ materially from those contemplated, expressed, or implied, by the forward-looking statements contained in this report. Important factors that could cause actual results to differ materially from our forward-looking statements are set forth in Item 1A, “Risk Factors,” in our 2014 Annual Report on Form 10-K, and in our other reports filed with the SEC, including this Quarterly Report on Form 10-Q.
There are a number of factors, many of which are beyond our control, that could cause actual conditions, events, or results to differ significantly from those described in the forward-looking statements. These factors include, but are not limited to:
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Additionally, the timing and occurrence or non-occurrence of events may be subject to circumstances beyond our control.
It should be noted that we routinely evaluate opportunities to expand through acquisitions and frequently conduct due diligence activities in connection with such opportunities. As a result, acquisition discussions and, in some cases, negotiations, may take place at any time, and acquisitions involving cash or our debt or equity securities may occur.
You should not place undue reliance on these forward-looking statements, which reflect our expectations only as of the date of this report. We do not assume any obligation to revise or update forward-looking statements except as may be required by law.
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RECONCILIATIONS OF STOCKHOLDERS’ EQUITY AND TANGIBLE STOCKHOLDERS’ EQUITY;
TOTAL ASSETS AND TANGIBLE ASSETS; AND THE RELATED MEASURES
Although tangible stockholders’ equity and tangible assets are not measures that are calculated in accordance with U.S. generally accepted accounting principles (“GAAP”), management uses these non-GAAP measures in their analysis of our performance. We believe that these non-GAAP measures are important indications of our ability to grow both organically and through business combinations and, with respect to tangible stockholders’ equity, our ability to pay dividends and to engage in various capital management strategies.
We calculate tangible stockholders’ equity by subtracting from stockholders’ equity the sum of our goodwill and core deposit intangibles (“CDI”), and calculate tangible assets by subtracting the same sum from our total assets. To calculate our ratio of tangible stockholders’ equity to tangible assets, we divide our tangible stockholders’ equity by our tangible assets.
Tangible stockholders’ equity, tangible assets, and the related financial measures should not be considered in isolation or as a substitute for stockholders’ equity or any other measure prepared in accordance with GAAP. Moreover, the manner in which we calculate these non-GAAP financial measures may differ from that of other companies reporting non-GAAP financial measures with similar names.
Reconciliations of our stockholders’ equity and tangible stockholders’ equity; our total assets and tangible assets; and the related financial measures at September 30, 2015 and December 31, 2014 follow:
Stockholders’ Equity
Less: Goodwill
Core deposit intangibles
Tangible stockholders’ equity
Total Assets
Tangible assets
Stockholders’ equity to total assets
Tangible stockholders’ equity to tangible assets
Executive Summary
New York Community Bancorp, Inc. is the holding company for New York Community Bank (the “Community Bank”), with 239 branches in Metro New York, New Jersey, Ohio, Florida, and Arizona; and New York Commercial Bank (the “Commercial Bank”), with 30 branches in Metro New York. With assets of $49.0 billion at September 30, 2015, we rank among the 25 largest U.S. bank holding companies and, with deposits of $28.3 billion at that date, we also rank among its 25 largest depositories.
Both of our banks are New York State-chartered and both are subject to regulation by the FDIC, the Consumer Financial Protection Bureau, and the New York State Department of Financial Services (the “NYSDFS”). In addition, the holding company is subject to regulation by the Board of Governors of the Federal Reserve System (the “FRB”), and to the requirements of the New York Stock Exchange, where shares of our common stock are traded under the symbol “NYCB”.
On September 17, 2015, we submitted an application to the FDIC and the NYSDFS requesting their approval to merge the Commercial Bank with and into the Community Bank. The merger of our bank subsidiaries is not expected to impact either bank’s customers or employees, given that all of our branches operate on the same systems and, with few exceptions, offer the same products and services.
As a publicly traded company, our mission is to provide our shareholders with a solid return on their investment by producing a strong financial performance, maintaining a solid capital position, and engaging in corporate strategies that enhance the value of their shares. In support of this mission, we maintain a consistent business model, as described below:
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The merits of this time-tested business model are reflected in the following achievements:
On October 29, 2015, we announced a series of strategic actions, including:
While the prepayment charge will adversely impact our fourth quarter and full-year 2015 earnings, as stated, the combination of all four strategies is expected to result in both earnings and capital growth in 2016 and 2017.
Third Quarter 2015 Performance
In the third quarter of 2015, we generated net income of $114.7 million, as compared to $123.7 million in the trailing quarter and $120.3 million in the third quarter of 2014. Our earnings were equivalent to $0.26 per diluted share in the current third quarter, as compared to $0.28 and $0.27 per diluted share, respectively, in the earlier periods.
Among the external factors that tend to influence our performance, the interest rate environment is key. Just as short-term interest rates affect the cost of our deposits and that of the funds we borrow, market interest rates affect the yields on the loans we produce for investment and the securities in which we invest.
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The following table summarizes the high, low, and average five- and ten-year Constant Maturity Treasury rates (“CMT”) in the three months ended September 30, 2015, June 30, 2015, and September 30, 2014:
High
Low
Average
In addition, residential mortgage interest rates impact the volume of one-to-four family mortgage loans we originate in any given quarter, in view of their impact on new home purchases and refinancing activity. Accordingly, when residential mortgage interest rates are low, refinancing activity typically increases; as residential mortgage interest rates begin to rise, the refinancing of one-to-four family mortgage loans typically declines. In the three months ended September 30, 2015, residential mortgage interest rates fell 15 basis points on a linked-quarter basis, and were ten basis points lower than the level in the third quarter of 2014. The volume of one-to-four family loans originated for sale fell $434.1 million sequentially to $960.7 million in the current third quarter, but rose $125.9 million year-over-year. Income from originations fell $3.0 million sequentially to $7.5 million and rose $917,000 year-over-year. The sequential decline was attributable to the narrowing of gain-on-sale margins and a drop in refinancing activity.
The impact of market interest rates on our multi-family and commercial real estate lending is far less overt than the impact on our production of one-to-four family mortgage loans. Because our multi-family and commercial real estate (“CRE”) loans generate prepayment penalty income when they repay, the impact of repayment activity can be especially meaningful. In the third quarter of 2015, prepayment penalty income totaled $23.1 million, reflecting sequential and year-over-year declines of $3.7 million and $2.3 million, respectively.
Largely reflecting the sequential decline in prepayment penalty income, our net interest income fell $5.7 million sequentially to $279.4 million in the current third quarter and our net interest margin dropped eight basis points to 2.56%. Year-over-year, our net interest income fell $9.6 million, while our net interest margin fell 13 basis points. In addition to the decrease in prepayment penalty income, the reduction in our net interest income and margin reflect the replenishment of our portfolio with lower-yielding loans.
Also less overt, but nonetheless having an impact on our operations, has been the significant increase in regulation and supervision required under the Dodd-Frank Act. With assets of $41.2 billion at December 31, 2010, and a fundamental focus on growth through acquisition, we began in 2011 to prepare for the possibility of exceeding the threshold for classification as a D-SIB as such term is defined by the Dodd-Frank Act. Since then, we have invested significant human, technological, and financial resources into our enterprise risk management program, while also strengthening our corporate governance policies, procedures, and practices.
A bank is designated a D-SIB when its total consolidated assets average more than $50 billion over the four most recent quarters, and in the third quarter of 2014, we began taking steps to manage our assets below that amount. In the first nine months of 2015, our assets rose $486.3 million to $49.0 billion, despite our production of $9.0 billion of loans held for investment, including $2.8 billion in the third quarter of the year. The limited asset growth we achieved largely reflects the sale of multi-family and CRE loans through participations, as well as the high level of refinancing activity. In the nine months ended September 30, 2015, we sold $1.5 billion of multi-family and CRE loans through participations, including $510.3 million of CRE loans in the last three months.
Although we expect to continue selling loans through participations, we expect to cross the D-SIB threshold in the second quarter of 2016. While the organic growth of our balance sheet is expected to bring the average of our total consolidated assets somewhat above $50 billion, the Astoria Financial merger is expected to increase our average total consolidated assets substantially. At September 30, 2015, Astoria Financial had total assets of $15.1 billion, while our assets were $49.0 billion at that date. In addition, Astoria Financial had deposits of $9.0 billion at the end of the current third quarter, and 87 branches in six of our local markets: Nassau, Suffolk, and Westchester Counties, and Brooklyn, Manhattan, and Queens.
On July 20, 2015, A&P, which owns and operates Pathmark, Waldbaums, and other supermarket chains in Metro New York and New Jersey, announced that it had filed for bankruptcy protection and plans to close or sell certain of its stores. Of our 32 in-store branches located in supermarkets impacted by the A&P filing, three have closed and six are currently pending closure. The remaining supermarkets are being marketed to prospective buyers and we are actively engaged in dialog with the prospective new store owners.
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Given that our in-store branches are generally located within a short distance of one or more of our traditional branches, we do not expect the closing or sale of these locations to have a material impact on our financial condition or results of operations.
Non-performing non-covered assets totaled $78.8 million at the end of September, a $60.1 million decrease from the balance at December 31, 2014. The reduction was attributable to a $21.7 million decline in non-performing non-covered loans to $55.2 million, together with a $38.4 million decrease in other real estate owned (“OREO”) to $23.6 million at September 30, 2015. The latter decline was largely due to the sale of a multi-family property in the amount of $41.6 million, which generated a second-quarter pre-tax gain of $7.8 million.
Non-performing non-covered loans represented 0.16% of total non-covered loans at the end of September, the lowest such measure we’ve reported since the second quarter of 2008. Similarly, non-performing non-covered assets represented 0.17% of total non-covered assets, the lowest such measure we’ve reported since the third quarter of 2008.
While the quality of our assets generally reflects the nature of our primary lending niche and the benefit of conservative underwriting, it also reflects economic conditions and the direction of property values in the markets where our held-for-investment loans are produced.
The following table presents the unemployment rates for the United States and our key deposit markets in the months ended September 30, 2015, June 30, 2015, and September 30, 2014. Unemployment declined year-over-year in each of our markets, and, with the exception of Arizona, declined sequentially as well.
Unemployment rate:
United States
New York City
Arizona
Florida
New Jersey
New York
Ohio
(Source: U.S. Department of Labor)
Yet another key economic indicator is the Consumer Price Index (the “CPI”), which measures the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. The following table shows the change in the CPI for the twelve months ended at each of the indicated dates:
Change in prices:
Given the impact that home prices have on residential mortgage lending, we believe the S&P/Case-Shiller Home Price Index is an important economic indicator for the Company. According to this index, home prices rose 4.7% across the U.S. in the twelve months ended August 2015 as compared to 4.5% and 4.8%, respectively, in the twelve months ended June 2015 and September 2014.
In addition, the volume of new home sales nationwide was at a seasonally adjusted annual rate of 468,000 in September 2015, according to estimates set forth in a U.S. Commerce Department report issued on October 26, 2015. The September 2015 rate was 11.5% lower than the rate reported in August 2015 and 2.0% above the rate reported in September 2014.
Yet another pertinent economic indicator is the residential rental vacancy rate in New York, as reported by the U.S. Department of Commerce, and the office vacancy rate in Manhattan, as reported by a leading commercial real estate broker, Jones Lang LaSalle. These measures are important in view of the fact that 78.4% of our multi-family loans and 87.3% of our CRE loans are secured by properties in New York, with Manhattan accounting for 32.1% and 53.2% of our multi-family and CRE loans, respectively. As reflected in the following table, residential rental vacancy rates increased linked-quarter and year-over-year, while office vacancy rates in Manhattan declined during the same time periods.
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Residential rental vacancy rates:
Manhattan office vacancy rate:
In addition, the Consumer Confidence Index® moved up to 103.0 in September 2015 from 99.8 in June 2015, and from 89.0 in September 2014. An index level of 90 or more is considered indicative of a strong economy.
Recent Events
Dividend Declaration
On October 20, 2015, the Board of Directors declared a quarterly cash dividend of $0.25 per share, payable on November 18, 2015 to shareholders of record at the close of business on November 6, 2015.
On October 28, 2015, we entered into an Agreement and Plan of Merger with Astoria Financial, which had total assets of $15.1 billion, total deposits of $9.0 billion, and 87 banking offices in Nassau, Suffolk, and Westchester Counties, and Queens, Brooklyn, and Manhattan, at September 30, 2015.
Expected Change in Dividend Payments
We generally pay quarterly dividends on our common stock depending on our financial results, determinations by our Board of Directors, and certain regulatory requirements. Due to the prepayment charge to be incurred in the fourth quarter of this year in connection with the aforementioned balance sheet repositioning, any dividends to be paid by the Company over the next four quarters will require regulatory clearance.
Based upon an anticipated dividend payout ratio of 50% upon completion of the merger, the Company has decided, going forward, to re-allocate $0.08 per share from its traditional dividend payment to support its future growth and capital strength. Accordingly, our expected dividend will be $0.17 per share, subject to Board and regulatory approval, beginning in the first quarter of 2016.
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Critical Accounting Policies
We consider certain accounting policies to be critically important to the portrayal of our financial condition and results of operations, since they require management to make complex or subjective judgments, some of which may relate to matters that are inherently uncertain. The inherent sensitivity of our consolidated financial statements to these critical accounting policies, and the judgments, estimates, and assumptions used therein, could have a material impact on our financial condition or results of operations.
We have identified the following to be critical accounting policies: the determination of the allowances for loan losses; the valuation of mortgage servicing rights (“MSRs”); the determination of whether an impairment of securities is other than temporary; the determination of the amount, if any, of goodwill impairment; and the determination of the valuation allowance for deferred tax assets.
The judgments used by management in applying these critical accounting policies may be influenced by adverse changes in the economic environment, which may result in changes to future financial results.
Allowances for Loan Losses
The allowance for losses on non-covered loans represents our estimate of probable and estimable losses inherent in the non-covered loan portfolio as of the date of the balance sheet. Losses on non-covered loans are charged against, and recoveries of losses on non-covered loans are credited back to, the allowance for losses on non-covered loans.
Although non-covered loans are held by either the Community Bank or the Commercial Bank, and a separate loan loss allowance is established for each, the total of the two allowances is available to cover all losses incurred. In addition, except as otherwise noted in the following discussion, the process for establishing the allowance for losses on non-covered loans is largely the same for each of the Community Bank and the Commercial Bank.
The methodology used for the allocation of the allowance for non-covered loan losses at September 30, 2015, December 31, 2014, and September 30, 2014 was also generally comparable, whereby the Community Bank and the Commercial Bank segregated their loss factors (used for both criticized and non-criticized loans) into a component that was primarily based on historical loss rates and a component that was primarily based on other qualitative factors that were probable to affect loan collectability. In determining the respective allowances for non-covered loan losses, management considers the Community Bank’s and the Commercial Bank’s current business strategies and credit processes, including compliance with applicable regulatory guidelines and with guidelines approved by the respective Boards of Directors with regard to credit limitations, loan approvals, underwriting criteria, and loan workout procedures.
The allowance for losses on non-covered loans is established based on our evaluation of incurred losses in our portfolio in accordance with GAAP, and is comprised of both specific valuation allowances and general valuation allowances.
Specific valuation allowances are established based on management’s analyses of individual loans that are considered impaired. If a non-covered loan is deemed to be impaired, management measures the extent of the impairment and establishes a specific valuation allowance for that amount. A non-covered loan is classified as “impaired” when, based on current balance, information, and/or events, it is probable that we will be unable to collect both the principal and interest due under the contractual terms of the loan agreement. Smaller-balance homogenous loans and loans carried at the lower of cost or fair value are evaluated for impairment on a collective, rather than individual, basis. Loans for which the terms have been modified, resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings (“TDRs”) and classified as impaired.
We generally measure impairment on an individual loan and determine the extent to which a specific valuation allowance is necessary by comparing the loan’s outstanding balance to either the fair value of the collateral, less the estimated cost to sell, or the present value of expected cash flows, discounted at the loan’s effective interest rate. Generally, when the fair value of the collateral, net of the estimated cost to sell, or the present value of the expected cash flows, is less than the recorded investment in the loan, any shortfall is promptly charged off.
We also follow a process to assign general valuation allowances to non-covered loan categories. General valuation allowances are established by applying our loan loss provisioning methodology, and reflect the inherent risk in outstanding held-for-investment loans. This loan loss provisioning methodology considers various factors in determining the appropriate quantified risk factors to use to determine the general valuation allowances. The factors assessed begin with the historical loan loss experience for each major loan category. Our allowance for loan losses methodology also considers an estimate of the historical loss emergence period (which is the period of time between the event that triggers a loss and the confirmation and/or charge-off of that loss) for each loan portfolio segment.
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The allocation methodology consists of the following components: (1) First, we determine an allowance for loan losses based on a quantitative loss factor for loans evaluated collectively for impairment. This quantitative loss factor is based primarily on historical loss rates, after considering loan type, historical loss and delinquency experience, and loss emergence periods. (2) The quantitative loss factors applied in the methodology are periodically re-evaluated and adjusted to reflect changes in historical loss levels, loss emergence periods, or other risks. (3) Lastly, we allocate an allowance for loan losses to qualitative loss factors. These qualitative loss factors are designed to account for losses that may not be provided for by the quantitative loss component due to other factors evaluated by management which, include, but are not limited to:
By considering the factors discussed above, we determine an allowance for loan losses that is applied to each significant loan portfolio segment to determine the total allowance for loan losses.
In the first quarter of 2015, we changed the historical loss period we use to determine the allowance for loan losses on non-covered loans from a rolling 16-quarter look-back period to a rolling 24-quarter look-back period, as we believe this to be a more appropriate reflection of the Company’s historical loss experience. This change has not had a significant effect on the allowance for losses on non-covered loans, nor is it expected to do so for the foreseeable future.
The process of establishing the allowance for losses on non-covered loans also involves:
In order to determine their overall adequacy, each of the respective non-covered loan loss allowances is reviewed quarterly by management and the Board of Directors of the Community Bank or the Commercial Bank, as applicable.
We charge off loans, or portions of loans, in the period that such loans, or portions thereof, are deemed uncollectible. The collectability of individual loans is determined through an assessment of the financial condition and repayment capacity of the borrower and/or through an estimate of the fair value of any underlying collateral. For non-real estate-related consumer credits, the following past-due time periods determine when charge-offs are typically recorded: (1) Closed-end credits are charged off in the quarter that the loan becomes 120 days past due; (2) Open-end credits are charged off in the quarter that the loan becomes 180 days past due; and (3) Both closed-end and open-end credits are typically charged off in the quarter that the credit is 60 days past the date we received notification that the borrower has filed for bankruptcy.
The level of future additions to the respective non-covered loan loss allowances is based on many factors, including certain factors that are beyond management’s control, such as changes in economic and local market conditions, including
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declines in real estate values, and increases in vacancy rates and unemployment. Management uses the best available information to recognize losses on loans or to make additions to the loan loss allowances; however, the Community Bank and/or the Commercial Bank may be required to take certain charge-offs and/or recognize further additions to their loan loss allowances, based on the judgment of regulatory agencies with regard to information provided to them during their examinations of the Banks.
An allowance for unfunded commitments is maintained separate from the allowances for non-covered loan losses and is included in “Other liabilities” in the consolidated statements of condition.
We account for certain of the loans acquired in the AmTrust Bank (“AmTrust”) and Desert Hills Bank (“Desert Hills”) acquisitions (our “covered loans”) based on expected cash flows, in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 310-30, “Loans and Debt Securities Acquired with Deteriorated Credit Quality” (“ASC 310-30”). In accordance with ASC 310-30, we maintain the integrity of a pool of multiple loans accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows.
Covered loans are reported exclusive of the FDIC loss share receivable. The covered loans acquired in the AmTrust and Desert Hills acquisitions are, and will continue to be, reviewed for collectability based on the expectations of cash flows from these loans. Covered loans have been aggregated into pools of loans with common characteristics. In determining the allowance for losses on covered loans, we periodically perform an analysis to estimate the expected cash flows for each of the loan pools. A provision for losses on covered loans is recorded to the extent that the expected cash flows from a loan pool have decreased for credit-related items since the acquisition date. Accordingly, during the loss share recovery period, if there is a decrease in expected cash flows due to an increase in estimated credit losses as compared to the estimates made at the respective acquisition dates, the decrease in the present value of expected cash flows will be recorded as a provision for covered loan losses charged to earnings, and the allowance for covered loan losses will be increased. During the loss share recovery period, a related credit to non-interest income and an increase in the FDIC loss share receivable will be recognized at the same time, and will be measured based on the applicable loss sharing agreement percentage.
Please see Note 6, “Allowances for Loan Losses” for a further discussion of our allowance for losses on covered loans, as well as additional information about our allowance for losses on non-covered loans.
We recognize the right to service mortgage loans for others as a separate asset referred to as “mortgage servicing rights,” or “MSRs.” MSRs are generally recognized when loans are sold whole or in part (as a “participation”), and servicing is retained by us. Both of the Company’s two classes of MSRs, residential and participation, are initially recorded at fair value. While residential MSRs continue to be carried at fair value, participation MSRs are subsequently amortized and carried at the lower of their fair value or amortized amount. The amortization is recorded in proportion to, and over the period of, estimated net servicing income.
We base the fair value of our MSRs on the present value of estimated future net servicing income cash flows, utilizing an internal valuation model. The model we utilize is based on assumptions that market participants would use to estimate fair value, including estimates of prepayment speeds, discount rates, default rates, refinance rates, servicing costs, escrow account earnings, contractual servicing fee income, and ancillary income. We reassess, and periodically adjust, these underlying inputs and assumptions to reflect market conditions and changes in the assumptions that a market participant would consider in valuing MSRs.
Changes in the fair value of MSRs occur primarily in connection with the collection/realization of expected cash flows, as well as changes in the valuation inputs and assumptions. Changes in the fair value of residential MSRs are reported in “Mortgage banking income” in the period during which such changes occur. Changes in the value of participation MSRs are reported in “Other income” in the period during which such changes occur.
Investment Securities
The securities portfolio primarily consists of mortgage-related securities and, to a lesser extent, debt and equity (together, “other”) securities. Securities that are classified as “available for sale” are carried at their estimated fair value, with any unrealized gains or losses, net of taxes, reported as accumulated other comprehensive income or loss in stockholders’ equity. Securities that we have the intent and ability to hold to maturity are classified as “held to maturity” and carried at amortized cost, less the non-credit portion of other-than-temporary impairment (“OTTI”) recorded in accumulated other comprehensive loss, net of tax (“AOCL”).
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The fair values of our securities, and particularly our fixed-rate securities, are affected by changes in market interest rates and credit spreads. In general, as interest rates rise and/or credit spreads widen, the fair value of fixed-rate securities will decline; as interest rates fall and/or credit spreads tighten, the fair value of fixed-rate securities will rise. We regularly conduct a review and evaluation of our securities portfolio to determine if the decline in the fair value of any security below its carrying amount is other than temporary. If we deem any decline in value to be other than temporary, the security is written down to its current fair value, creating a new cost basis, and the resultant loss (other than the OTTI on debt securities attributable to non-credit factors) is charged against earnings and recorded in “Non-interest income.” Our assessment of a decline in fair value includes judgment as to the financial position and future prospects of the entity that issued the investment security, as well as a review of the security’s underlying collateral. Broad changes in the overall market or interest rate environment generally will not lead to a write-down.
In accordance with OTTI accounting guidance, unless we have the intent to sell, or it is more likely than not that we may be required to sell a security before recovery, OTTI is recognized as a realized loss in earnings to the extent that the decline in fair value is credit-related. If there is a decline in fair value of a security below its carrying amount and we have the intent to sell it, or it is more likely than not that we may be required to sell the security before recovery, the entire amount of the decline in fair value is charged to earnings.
Goodwill Impairment
Goodwill is presumed to have an indefinite useful life and is tested for impairment, rather than amortized, at the reporting unit level, at least once a year. We performed our annual goodwill impairment test as of December 31, 2014 and found no indication of goodwill impairment at that date.
Goodwill would be tested in less than one year’s time if there were a “triggering event.” There were no triggering events identified during the nine months ended September 30, 2015.
The goodwill impairment analysis is a two-step test. However, a company can, under Accounting Standards Update (“ASU”) No. 2011-08, “Testing Goodwill for Impairment,” first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. Under this amendment, an entity would not be required to calculate the fair value of a reporting unit unless the entity determined, based on a qualitative assessment, that it was more likely than not that its fair value was less than its carrying amount. The Company did not elect to perform a qualitative assessment in 2014. The first step (“Step 1”) is used to identify potential impairment, and involves comparing each reporting segment’s estimated fair value to its carrying amount, including goodwill. If the estimated fair value of a reporting segment exceeds its carrying amount, goodwill is not considered to be impaired. If the carrying amount exceeds the estimated fair value, there is an indication of potential impairment and the second step (“Step 2”) is performed to measure the amount.
Step 2 involves calculating an implied fair value of goodwill for each reporting segment for which impairment was indicated in Step 1. The implied fair value of goodwill is determined in a manner similar to the amount of goodwill calculated in a business combination, i.e., by measuring the excess of the estimated fair value of the reporting segment, as determined in Step 1, over the aggregate estimated fair values of the individual assets, liabilities, and identifiable intangibles, as if the reporting segment were being acquired in a business combination at the impairment test date. If the implied fair value of goodwill exceeds the carrying amount of goodwill assigned to the reporting segment, there is no impairment. If the carrying amount of goodwill assigned to a reporting segment exceeds the implied fair value of the goodwill, an impairment charge is recorded for the excess. An impairment loss cannot exceed the carrying amount of goodwill assigned to a reporting segment, and the loss establishes a new basis in the goodwill. Subsequent reversal of goodwill impairment losses is not permitted.
Quoted market prices in active markets are the best evidence of fair value and are used as the basis for measurement, when available. Other acceptable valuation methods include present-value measurements based on multiples of earnings or revenues, or similar performance measures. Differences in the identification of reporting units and in valuation techniques could result in materially different evaluations of impairment.
For the purpose of goodwill impairment testing, management has determined that the Company has two reporting units: Banking Operations and Residential Mortgage Banking. All of our recorded goodwill has resulted from prior acquisitions and, accordingly, is attributed to Banking Operations. There is no goodwill associated with Residential Mortgage Banking, as this unit was acquired in our FDIC-assisted AmTrust acquisition, which resulted in a bargain purchase gain. In order to perform our annual goodwill impairment test, we determined the carrying value of the Banking Operations unit to be the carrying value of the Company and compared it to the fair value of the Company.
Income Taxes
In estimating income taxes, management assesses the relative merits and risks of the tax treatment of transactions, taking into account statutory, judicial, and regulatory guidance in the context of our tax position. In this process, management also
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relies on tax opinions, recent audits, and historical experience. Although we use the best available information to record income taxes, underlying estimates and assumptions can change over time as a result of unanticipated events or circumstances such as changes in tax laws and judicial guidance influencing our overall or transaction-specific tax position.
We recognize deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and the carryforward of certain tax attributes such as net operating losses. A valuation allowance is maintained for deferred tax assets that we estimate are more likely than not to be unrealizable, based on available evidence at the time the estimate is made. In assessing the need for a valuation allowance, we estimate future taxable income, considering the prudence and feasibility of tax planning strategies and the realizability of tax loss carryforwards. Valuation allowances related to deferred tax assets can be affected by changes to tax laws, statutory tax rates, and future taxable income levels. In the event we were to determine that we would not be able to realize all or a portion of our net deferred tax assets in the future, we would reduce such amounts through a charge to income tax expense in the period in which that determination was made. Conversely, if we were to determine that we would be able to realize our deferred tax assets in the future in excess of the net carrying amounts, we would decrease the recorded valuation allowance through a decrease in income tax expense in the period in which that determination was made. Subsequently recognized tax benefits associated with valuation allowances recorded in a business combination would be recorded as an adjustment to goodwill.
On March 31, 2014, tax legislation was enacted that changed the manner in which financial institutions and their affiliates are taxed in New York State. The most significant changes affecting the Company are summarized below:
While most of the provisions of this legislation are effective for fiscal years beginning in 2015, the statutory tax rate will not be reduced until 2016. It is expected that this law will result in a modest reduction in our current income tax expense. The amount of the impact on our future tax expense will be affected by any changes in our operations, structure, or profitability.
In April 2015, new legislation was enacted that changed the tax laws of New York City that are applicable to the Company in a manner similar to the changes that were made to the New York State laws described above. These changes were also effective January 1, 2015. However, the New York City laws differ from the New York State laws in certain ways including by:
Since the law was enacted in April, the impact of the New York City tax legislation was first reflected in our earnings for the three months ended June 30, 2015. The legislation resulted in a one-time reduction in deferred tax expense of approximately $1.4 million in the second quarter, and a modest increase in the ongoing tax expense of the Company. The amount of the impact on our future tax expense will be affected by any changes in our operations, structure, or profitability.
Balance Sheet Summary
At September 30, 2015, loans, net represented $36.5 billion, or 74.4%, of total assets, an $844.9 million increase from the balance at December 31, 2014. Included in the September 30th amount were covered loans, net of $2.1 billion; non-covered loans held for investment, net of $34.0 billion; and non-covered loans held for sale of $380.6 million, as more fully discussed below.
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“Covered loans” refers to certain loans we acquired in our FDIC-assisted AmTrust and Desert Hills transactions, and are referred to as such because they are covered by loss sharing agreements with the FDIC. At September 30, 2015, covered loans represented $2.1 billion, or 5.8%, of the total loan balance, a $271.7 million decrease from the balance at December 31, 2014. In addition to repayments, the reduction reflects $13.0 million of non-residential loans acquired in the Desert Hills transaction that are no longer covered by our FDIC loss sharing agreements, in accordance with their terms. These loans are classified as “purchased credit-impaired” (“PCI”) loans and are included in the balance of non-covered “Other loans” at September 30, 2015.
One-to-four family loans represented $2.0 billion of total covered loans at the end of September, with all other loan types (primarily consisting of home equity lines of credit, or “HELOCs”) representing $155.4 million, combined.
Covered one-to-four family loans include both fixed and adjustable rate loans. At September 30, 2015, $1.5 billion, or 69.4%, of our covered loans were adjustable rate loans, with a weighted average interest rate of 3.36%. The remainder of the covered loan portfolio at that date consisted of fixed rate loans. The interest rates on the adjustable rate loans in the covered loan portfolio are indexed to the one-year LIBOR or the one-year Treasury rate, plus a spread in the range of 2% to 5%, subject to certain caps.
The AmTrust and Desert Hills loss sharing agreements each require the FDIC to reimburse us for 80% of losses up to a specified threshold, and for 95% of losses beyond that threshold, with respect to covered one-to-four family loans and covered OREO.
Geographical Analysis of the Covered Loan Portfolio
The following table presents a geographical analysis of our covered loan portfolio at September 30, 2015:
California
Massachusetts
Michigan
Illinois
Maryland
Nevada
All other states
Non-covered loans held for investment, net represented $34.0 billion, or 93.2%, of total loans, net at the end of September, a $1.1 billion increase from the balance at December 31, 2014. In addition to multi-family loans and CRE loans, the held-for-investment portfolio includes substantially smaller balances of one-to-four family loans; acquisition, development, and construction (“ADC”) loans; and other loans, with specialty finance loans and leases and other commercial and industrial (“C&I”) loans comprising the bulk of the “Other loan” portfolio.
We originated $9.0 billion of non-covered loans held for investment in the first nine months of 2015, including $2.8 billion in the third quarter of this year. However, the growth of the portfolio was largely tempered by the sale of multi-family and CRE loans through participations, in addition to property sales and refinancing activity. Sales of multi-family and CRE loans through participations totaled $1.5 billion in the first nine months of this year, including $510.3 million of CRE loans sold in the third quarter, in connection with our aforementioned strategy of managing our assets below the current D-SIB threshold.
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The following table presents information about the loans held for investment we originated in the three months ended September 30, 2015, June 30, 2015, and September 30, 2014 and in the nine months ended September 30, 2015 and 2014:
Mortgage Loans Originated for Investment:
Total mortgage loans originated for investment
Other Loans Originated for Investment:
Specialty finance
Other commercial and industrial
Total other loans originated for investment
Total loans originated for investment
The individual held-for-investment loan portfolios are discussed below.
Multi-Family Loans
Multi-family loans are our principal asset. The loans we produce are primarily secured by non-luxury, residential apartment buildings in New York City that are rent-regulated and feature below-market rents—a market we refer to as our “primary lending niche.” Consistent with our emphasis on this niche, multi-family loan originations represented $6.4 billion, or 71.9%, of the held-for-investment loans we produced in the current nine-month period, exceeding the year-earlier nine-month’s production by $731.0 million. Included in the current nine-month amount were third-quarter originations of $2.2 billion, reflecting a linked-quarter decrease of $402.7 million and a year-over-year increase of $532.7 million.
At September 30, 2015, multi-family loans represented $24.6 billion, or 72.2%, of total non-covered loans held for investment, an $881.8 million increase from the June 30th balance and an $803.7 million increase from the balance at December 31, 2014. While we sold $863.2 million of multi-family loans in the first nine months of this year through participations, the impact was substantially tempered by the high volume of multi-family loans we produced. At September 30, 2015, the average multi-family loan had a principal balance of $5.1 million, as compared to $4.9 million and $5.0 million, respectively, at June 30, 2015 and December 31, 2014.
The vast majority of our multi-family loans are made to long-term owners of buildings with apartments that are subject to rent regulation and feature below-market rents. Our borrowers typically use the funds we provide to make building-wide improvements and renovations to certain apartments, as a result of which they are able to increase the rents their tenants pay. In doing so, the borrower creates increased cash flows to borrow against in future years. We also make loans to building owners seeking to expand their real estate holdings with the purchase of additional properties.
In addition to underwriting multi-family loans on the basis of the buildings’ income and condition, we consider the borrowers’ credit history, profitability, and building management expertise. Borrowers are required to present evidence of their ability to repay the loan from the buildings’ current rent rolls, their financial statements, and related documents.
While a small percentage of our multi-family loans are ten-year fixed rate credits, the vast majority of our multi-family loans feature a term of ten or twelve years, with a fixed rate of interest for the first five or seven years of the loan, and an alternative rate of interest in years six through ten or eight through twelve. The rate charged in the first five or seven years is generally based on intermediate-term interest rates plus a spread. During the remaining years, the loan resets to an annually adjustable rate that is tied to the prime rate of interest, plus a spread. Alternately, the borrower may opt for a fixed rate that is tied to the five-year fixed advance rate of the Federal Home Loan Bank (the “FHLB”) of New York (the “FHLB-NY”), plus a spread. The fixed-rate option also requires the payment of one percentage point of the then-outstanding loan balance. In either case, the minimum rate at repricing is equivalent to the rate in the initial five- or seven-year term.
As the rent roll increases, the typical property owner seeks to refinance the mortgage, and generally does so before the loan reprices in year six or eight. At September 30, 2015 and December 31, 2014, the weighted average life of the multi-family loan portfolio was 2.7 years and 3.0 years, respectively.
Multi-family loans that refinance within the first five or seven years are typically subject to an established prepayment penalty schedule. Depending on the remaining term of the loan at the time of prepayment, the penalties normally range from five percentage points to one percentage point of the then-current loan balance. If a loan extends past the fifth or seventh year and the borrower selects the fixed rate option, the prepayment penalties typically reset to a range of five points to one point
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over years six through ten or eight through twelve. For example, a ten-year multi-family loan that prepays in year three would generally be expected to pay a prepayment penalty equal to three percentage points of the remaining principal balance. A twelve-year multi-family loan that prepays in year one or two would generally be expected to pay a penalty equal to five percentage points.
Prepayment penalties are recorded as interest income and are therefore reflected in the average yields on our loans and assets, our interest rate spread and net interest margin, and the level of net interest income we record. No assumptions are involved in the recognition of prepayment penalty income, as such income is only recorded when cash is received.
Our emphasis on multi-family loans is driven by several factors, including their structure, which reduces our exposure to interest rate volatility. Another factor driving our focus on multi-family lending has been the comparative quality of the loans we produce. Reflecting the nature of the buildings securing our loans, our underwriting standards, and the generally conservative loan-to-value ratios (“LTVs”) our multi-family loans feature at origination, a relatively small percentage of the multi-family loans that have transitioned to non-performing status have actually resulted in losses, even when the credit cycle has taken a downward turn.
We primarily underwrite our multi-family loans based on the current cash flows produced by the collateral property, with a reliance on the “income” approach to appraising the properties, rather than the “sales” approach. The sales approach is subject to fluctuations in the real estate market, as well as general economic conditions, and is therefore likely to be more risky in the event of a downward credit cycle turn. We also consider a variety of other factors, including the physical condition of the underlying property; the net operating income of the mortgaged premises prior to debt service and depreciation; the debt service coverage ratio (“DSCR”), which is the ratio of the property’s net operating income to its debt service; and the ratio of the loan amount to the appraised value of the property (i.e., the LTV). The multi-family loans we are originating today generally represent no more than 75% of the lower of the appraised value or the sales price of the underlying property and typically feature an amortization period of 30 years, in some cases with an initial interest-only period. In addition to typically requiring a minimum DSCR of 120% on multi-family buildings, we obtain a security interest in the personal property located on the premises, and an assignment of rents and leases.
Accordingly, while our multi-family lending niche has not been immune to downturns in the credit cycle, we continue to believe that the multi-family loans we produce involve less credit risk than certain other types of loans. In general, buildings that are subject to rent regulation have tended to be stable, with occupancy levels remaining more or less constant over time. Because the rents are typically below market and the buildings securing our loans are generally maintained in good condition, they have been more likely to retain their tenants in adverse economic times. In addition, we underwrite our multi-family loans on the basis of the current cash flows generated by the underlying properties, and generally exclude any short-term property tax exemptions and abatement benefits the property owners receive.
Commercial Real Estate Loans
In the nine months ended September 30, 2015, CRE loans represented $1.3 billion, or 15.1%, of the loans we originated for investment, a $105.8 million increase from the volume produced in the year-earlier nine months. Included in the current nine-month amount were third-quarter originations of $254.0 million, reflecting a $230.2 million decrease from the trailing-quarter volume and a year-over-year decrease of $180.2 million.
At September 30, 2015, CRE loans represented $7.6 billion, or 22.4%, of loans held for investment, reflecting a three-month decrease of $440.7 million and a nine-month increase of $8.7 million. At September 30, 2015, the average CRE loan had a principal balance of $5.2 million, as compared to $5.4 million and $5.0 million, respectively, at June 30, 2015 and December 31, 2014.
In support of our short-term focus on limiting the growth of our assets, we sold $632.7 million of CRE loans through participations in the nine months ended September 30, 2015, including $510.3 million in the three months ended at that date.
The CRE loans we produce are secured by income-producing properties such as office buildings, retail centers, mixed-use buildings, and multi-tenanted light industrial properties. The pricing of our CRE loans is similar to the pricing of our multi-family credits. While a small percentage of our CRE loans feature ten-year fixed-rate terms, they primarily feature a fixed rate of interest for the first five or seven years of the loan that is generally based on intermediate-term interest rates plus a spread. During years six through ten or eight through twelve, the loan resets to an annually adjustable rate that is tied to the prime rate of interest, plus a spread. Alternately, the borrower may opt for a fixed rate that is tied to the five-year fixed advance rate of the FHLB-NY plus a spread. The fixed-rate option also requires the payment of an amount equal to one percentage point of the then-outstanding loan balance. In either case, the minimum rate at repricing is equivalent to the rate in the initial five- or seven-year term.
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Prepayment penalties apply to our CRE loans, as they do our multi-family credits. Depending on the remaining term of the loan at the time of prepayment, the penalties normally range from five percentage points to one percentage point of the then-current loan balance. If a loan extends past the fifth or seventh year and the borrower selects the fixed rate option, the prepayment penalties typically reset to a range of five points to one point over years six through ten or eight through twelve. Our CRE loans tend to refinance within three to four years of origination; the weighted average life of the CRE portfolio was 3.0 years at September 30, 2015, as compared to 3.1 years and 3.2 years at June 30, 2015 and December 31, 2014, respectively.
The repayment of loans secured by commercial real estate is often dependent on the successful operation and management of the underlying properties. To minimize our credit risk, we originate CRE loans in adherence with conservative underwriting standards, and require that such loans qualify on the basis of the property’s current income stream and DSCR. The approval of a loan also depends on the borrower’s credit history, profitability, and expertise in property management, and typically requires a minimum DSCR of 130% and a maximum LTV of 65%. In addition, the origination of CRE loans typically requires a security interest in the fixtures, equipment, and other personal property of the borrower and an assignment of the rents and leases.
One-to-Four Family Loans
Consistent with our short-term focus on containing the growth of our assets, originations of one-to-four family loans for investment declined $254.7 million year-over-year to $8.4 million in the nine months ended September 30, 2015. Included in the latter amount were third-quarter originations of $2.4 million, down $90.6 million from the volume produced in the year-earlier three months. Reflecting the decline in production, in addition to repayments and sales, the balance of one-to-four family loans held for investment fell $36.6 million from the balance at the end of December to $102.3 million at the current third quarter-end.
Acquisition, Development, and Construction Loans
ADC loans represented $294.8 million, or 0.86%, of total loans held for investment at the end of the third quarter as compared to $258.1 million at December 31st. The nine-month rise was largely due to an increase in production, with originations of ADC loans rising $62.5 million year-over-year to $141.9 million in the current nine-month period. Included in the current nine-month amount were third-quarter ADC loan originations of $27.6 million, reflecting a year-over-year increase of $20.7 million.
Because ADC loans are generally considered to have a higher degree of credit risk, especially during a downturn in the credit cycle, borrowers are required to provide a guarantee of repayment and completion. In the nine months ended September 30, 2015 and 2014, we recovered losses against guarantees of $204,000 and $124,000, respectively; in the three months ended at those dates, we recovered losses against guarantees of $29,000 and $44,000, respectively.
Other Loans
Other loans represented $1.4 billion, or 4.3%, of total loans held for investment at the end of September, and were up $308.1 million from the balance at December 31st. Specialty finance loans and leases accounted for $776.8 million of the September 30th balance, reflecting a nine-month rise of $143.9 million, while other C&I loans represented $633.4 million, reflecting a $157.1 million increase. The latter increase reflects the transfer of certain other C&I loans in the amount of $153.6 million from “held for sale” to “held for investment” in the first three months of this year.
In the nine months ended September 30, 2015, we originated $733.1 million of specialty finance loans and leases, reflecting a $181.0 million increase from the year-earlier amount. Originations of other C&I loans totaled $280.7 million in the current nine-month period, reflecting a year-over-year decline of $159.7 million.
The remainder of the “other loan” portfolio includes non-covered PCI loans, home equity loans, and HELOCs, as well as consumer loans.
Specialty Finance Loans and Leases
Our specialty finance subsidiary is based in Foxboro, Massachusetts, and staffed by a group of industry veterans with expertise in originating and underwriting senior secured debt and equipment loans and leases. The subsidiary participates in syndicated loans that are brought to us, and equipment loans and leases that are assigned to us, by a select group of nationally recognized sources, and generally are made to large corporate obligors, many of which are publicly traded, carry investment grade or near-investment grade ratings, and participate in stable industries nationwide.
The loans and leases we fund fall into three distinct categories: asset-based lending, dealer floor-plan lending, and equipment loan and lease financing. Each of these credits is secured with a perfected first security interest or outright ownership in the underlying collateral, and structured as senior debt or as a non-cancelable lease. The pricing of our asset-based and dealer floor-plan loans are at floating rates predominately tied to LIBOR, while our equipment financing credits are at fixed rates at a spread over treasuries.
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Other Commercial and Industrial Loans
In contrast to the loans produced by our specialty finance subsidiary, the other C&I loans we produce are primarily made to small and mid-size businesses in the five boroughs of New York City and on Long Island. The other C&I loans we produce are tailored to meet the specific needs of our borrowers, and include term loans, revolving lines of credit, and, to a lesser extent, loans that are partly guaranteed by the Small Business Administration. A broad range of other C&I loans, both collateralized and unsecured, are made available to businesses for working capital (including inventory and accounts receivable), business expansion, the purchase of machinery and equipment, and other general corporate needs. In determining the term and structure of other C&I loans, several factors are considered, including the purpose, the collateral, and the anticipated sources of repayment. Other C&I loans are typically secured by business assets and personal guarantees of the borrower, and include financial covenants to monitor the borrower’s financial stability.
The interest rates on our other C&I loans can be fixed or floating, with floating rate loans being tied to prime or some other market index, plus an applicable spread. Our floating rate loans may or may not feature a floor rate of interest. The decision to require a floor on other C&I loans depends on the level of competition we face for such loans from other institutions, the direction of market interest rates, and the profitability of our relationship with the borrower.
Lending Authority
The loans we originate for investment are subject to federal and state laws and regulations, and are underwritten in accordance with loan underwriting policies and procedures approved by the Mortgage Committee, the Credit Committee, and the respective Boards of Directors.
In accordance with the Banks’ policies, all loans are reviewed by the Mortgage Committee or the Credit Committee, as applicable, and all loans of $10.0 million or more are reported to the respective Boards of Directors. At September 30, 2015, our largest loan was in the amount of $262.5 million; the interest rate on the credit was 3.7% at that date. The loan was originated by the Community Bank on June 28, 2013 to the owner of a commercial office building located in Manhattan and, as of the date of this report, has been current since the origination date.
Geographical Analysis of the Portfolio of Non-Covered Loans Held for Investment
The following table presents a geographical analysis of the multi-family and CRE loans in our held-for-investment loan portfolio at September 30, 2015:
New York City:
Manhattan
Brooklyn
Bronx
Queens
Staten Island
Total New York City
Long Island
Other New York State
At September 30, 2015, the largest concentration of one-to-four family loans held for investment was located in New York State, with a total of $30.7 million; the largest concentration of ADC loans held for investment was located in New York City, with a total of $222.4 million. The majority of our other loans held for investment were secured by properties and/or businesses located in Metro New York.
At September 30, 2015, non-covered loans held for sale totaled $380.6 million, an $81.1 million increase from the June 30th balance and a $1.2 million increase from the balance at December 31, 2014. Reflecting the transfer of other C&I loans in the amount of $153.6 million from “held-for-sale” to “held-for-investment” in the current year’s first quarter, all of our held-for-sale loans were one-to-four family loans at March 31, June 30, and September 30, 2015.
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In the nine months ended September 30, 2015, the volume of one-to-four family loans originated for sale totaled $3.8 billion, exceeding the year-earlier volume by $1.6 billion, or 73.7%. Included in the current nine-month amount were third-quarter originations of $960.7 million, reflecting a linked-quarter decrease of $434.1 million and a $125.9 million increase year-over-year. While the linked-quarter decline was largely due to a nationwide decline in refinancing volumes, the year-over-year increase is indicative of the rise, albeit small, in residential mortgage interest rates.
Most of our one-to-four family loans are produced or acquired by our mortgage banking operation, which operates as a mortgage aggregator via a group of approximately 900 clients—community banks, credit unions, mortgage companies, and mortgage brokers—the vast majority of which utilize our proprietary web-accessible mortgage banking platform to originate full-documentation, prime credit one-to-four family loans throughout the United States.
The vast majority of the held-for-sale loans we produce are agency-conforming loans sold to GSEs. To a much lesser extent, we utilize our mortgage banking platform to originate fixed-rate jumbo loans for sale to other financial institutions. Of the loans we originated for sale in the first nine months of 2015, all but $314.0 million, or 8.2%, were agency-conforming. The latter amount consisted of non-conforming jumbo loans.
Both the agency-conforming and non-conforming (i.e., jumbo) one-to-four family loans we originate for sale require that we make certain representations and warranties with regard to the underwriting, documentation, and legal/regulatory compliance, and we may be required to repurchase a loan or loans if it is found that a breach of the representations and warranties has occurred. In such case, we would be exposed to any subsequent credit loss on the mortgage loans that might or might not be realized in the future.
As governed by our agreements with the GSEs and other third parties to whom we sell loans, the representations and warranties we make relate to several factors, including, but not limited to, the ownership of the loan; the validity of the lien securing the loan; the absence of delinquent taxes or liens against the property securing the loan as of its closing date; the process used to select the loan for inclusion in a transaction; and the loan’s compliance with any applicable criteria, including underwriting standards, loan program guidelines, and compliance with applicable federal, state, and local laws.
We record a liability for estimated losses relating to these representations and warranties, which is included in “Other liabilities” in the accompanying Consolidated Statements of Condition. The related expense is recorded in “Mortgage banking income” in the accompanying Consolidated Statements of Income and Comprehensive Income. At September 30, 2015 and 2014, the respective liabilities for estimated possible future losses relating to these representations and warranties were $8.2 million and $8.4 million. The methodology used to estimate the liability for representations and warranties is a function of the representations and warranties given and considers a variety of factors, including, but not limited to, actual default experience, estimated future defaults, historical loan repurchase rates and the frequency and potential severity of defaults, probability that a repurchase request will be received, and the probability that a loan will be required to be repurchased.
Representation and Warranty Reserve
The following table sets forth the activity in our representation and warranty reserve during the periods indicated:
Repurchase losses
Because the level of mortgage loan repurchase losses is dependent on economic factors, investor demand strategies, and other external conditions that may change over the lives of the underlying loans, the level of the liability for mortgage loan repurchase losses is difficult to estimate and requires considerable management judgment. However, we believe that the amount and range of reasonably possible losses in excess of our reserve would not be material to our operations or to our financial condition or results of operations.
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Indemnified and Repurchased Loans Outstanding
The following table sets forth our activity with regard to repurchased loans and the loans we indemnified for GSEs during the periods indicated:
New indemnifications
New repurchases
Transfer to other real estate owned
Principal payoffs
Principal payments
Balance, end of period (1)
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Repurchase and Indemnification Request Activity
The following table sets forth our repurchase and indemnification requests during the periods indicated:
New repurchase requests (2)
Successful rebuttal/rescission
New indemnifications (3)
Loan repurchases
Balance, end of period (4)
Please see “Asset and Liability Management and the Management of Interest Rate Risk” later in this report for a discussion of the strategies we employ to mitigate the interest rate risk associated with our production of one-to-four family loans for sale.
Outstanding Loan Commitments
At September 30, 2015, we had outstanding loan commitments of $3.5 billion, reflecting a $925.5 million increase from the level at December 31st. Commitments to originate loans held for investment represented $3.0 billion of the September 30th total, and commitments to originate loans held for sale represented the remaining $470.4 million. At December 31, 2014, the respective commitments were $2.1 billion and $494.6 million.
Multi-family and CRE loans together represented $1.8 billion of held-for-investment loan commitments at the end of September, while one-to-four family, ADC, and other loans represented $5.4 million, $324.0 million, and $921.1 million, respectively. Included in the latter amount were commitments to originate specialty finance loans and leases of $483.4 million and commitments to originate other C&I loans of $401.1 million.
In addition to loan commitments, we had commitments to issue financial stand-by, performance stand-by, and commercial letters of credit totaling $252.1 million at September 30, 2015, as compared to $201.0 million at December 31, 2014. The fees we collect in connection with the issuance of letters of credit are included in “Fee income” in the Consolidated Statements of Income and Comprehensive Income.
Non-Covered Loans Held for Investment (Excluding PCI Loans) and Non-Covered Other Real Estate Owned
Non-performing non-covered assets fell $60.1 million, or 43.2%, from the December 31st balance to $78.8 million at September 30, 2015. The reduction was attributable to a $21.7 million, or 28.2%, decline in non-performing non-covered loans to $55.2 million and a $38.4 million, or 61.9%, decline in OREO to $23.6 million.
The nine-month decline in OREO was largely due to the sale of a single multi-family building in the amount of $41.6 million that was completed in the second quarter of this year. The sale resulted in a gain of $7.8 million, which is included in “Other non-interest income” in the Consolidated Statements of Income for the three months ended June 30, 2015 and the nine months ended September 30, 2015.
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Reflecting the aforementioned reductions, non-performing non-covered loans represented 0.16% and 0.23%, respectively, of total non-covered loans at September 30, 2015 and December 31, 2014; non-performing non-covered assets represented 0.17% and 0.30% of total non-covered assets at the corresponding dates.
The following table sets forth the changes in non-performing non-covered loans over the nine months ended September 30, 2015:
Balance at December 31, 2014
New non-accrual
Transferred to other real estate owned
Loan payoffs, including dispositions and principal pay-downs
Restored to performing status
Balance at September 30, 2015
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The following table presents our non-performing loans by loan type and the changes in the respective balances from December 31, 2014 to September 30, 2015:
Non-Performing Non-Covered Loans:
Non-accrual non-covered mortgage loans:
Total non-accrual non-covered mortgage loans
Other non-accrual non-covered loans
Total non-performing non-covered loans
A loan generally is classified as a “non-accrual” loan when it is 90 days or more past due or when we no longer expect to collect all amounts due according to the contractual terms of the loan agreement. When a loan is placed on non-accrual status, we cease the accrual of interest owed, and previously accrued interest is reversed and charged against interest income. At September 30, 2015 and December 31, 2014, all of our non-performing loans were non-accrual loans. A loan is generally returned to accrual status when the loan is current and we have reasonable assurance that the loan will be fully collectible.
We monitor non-accrual loans both within and beyond our primary lending area in the same manner. Monitoring loans generally involves inspecting and re-appraising the collateral properties; holding discussions with the principals and managing agents of the borrowing entities and/or retained legal counsel, as applicable; requesting financial, operating, and rent roll information; confirming that hazard insurance is in place or force-placing such insurance; monitoring tax payment status and advancing funds as needed; and appointing a receiver, whenever possible, to collect rents, manage the operations, provide information, and maintain the collateral properties.
It is our policy to order updated appraisals for all non-performing loans, irrespective of loan type, that are collateralized by multi-family buildings, CRE properties, or land, in the event that such a loan is 90 days or more past due, and if the most recent appraisal on file for the property is more than one year old. Appraisals are ordered annually until such time as the loan becomes performing and is returned to accrual status. It is not our policy to obtain updated appraisals for performing loans. However, appraisals may be ordered for performing loans when a borrower requests an increase in the loan amount, a modification in loan terms, or an extension of a maturing loan. We do not analyze current LTVs on a portfolio-wide basis.
Non-performing loans are reviewed regularly by management and reported on a monthly basis to the Mortgage Committee of the Community Bank, the Credit Committee of the Commercial Bank, and the Boards of Directors of the respective Banks. In accordance with our charge-off policy, collateral-dependent non-performing loans are written down to their current appraised values, less certain transaction costs. Workout specialists from our Loan Workout Unit actively pursue borrowers who are delinquent in repaying their loans in an effort to collect payment. In addition, outside counsel with experience in foreclosure proceedings are retained to institute such action with regard to such borrowers.
Properties that are acquired through foreclosure are classified as OREO. Upon acquisition, the excess of the remaining loan balance over the asset’s fair value, less the costs to sell, is charged off against the allowance for loan losses. We generally obtain an appraisal and environmental assessment of properties classified as OREO before foreclosure, and re-appraise the properties on an as-needed basis, and not less than annually, until they are sold. We dispose of such properties as quickly and prudently as possible, given current market conditions and the property’s condition.
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The following table presents our loans 30 to 89 days past due by loan type and the changes in the respective balances from December 31, 2014 to September 30, 2015:
Non-Covered Loans 30-89 Days Past Due:
Total non-covered loans 30-89 days past due
To mitigate the potential for credit losses, we underwrite our loans in accordance with credit standards that we consider to be prudent. In the case of multi-family and CRE loans, we look first at the consistency of the cash flows being generated by the property to determine its economic value using the “income approach”, and then at the market value of the property that collateralizes the loan. The amount of the loan is then based on the lower of the two values, with the economic value more typically used.
The condition of the collateral property is another critical factor. Multi-family buildings and CRE properties are inspected from rooftop to basement as a prerequisite to approval, with a member of the Mortgage or Credit Committee participating in inspections on multi-family loans to be originated in excess of $7.5 million, and a member of the Mortgage or Credit Committee participating in inspections on CRE loans to be originated in excess of $4.0 million. Furthermore, independent appraisers, whose appraisals are carefully reviewed by our experienced in-house appraisal officers and staff, perform appraisals on collateral properties. In many cases, a second independent appraisal review is performed.
In addition, we work with a select group of mortgage brokers who are familiar with our credit standards and whose track record with our lending officers is typically greater than ten years. Furthermore, in New York City, where the majority of the buildings securing our multi-family loans are located, the rents that tenants may be charged on certain apartments are typically restricted under certain rent-control or rent-stabilization laws. As a result, the rents that tenants pay for such apartments are generally lower than current market rents. Buildings with a preponderance of such rent-regulated apartments are less likely to experience vacancies in times of economic adversity.
To further manage our credit risk, our lending policies limit the amount of credit granted to any one borrower, and typically require minimum DSCRs of 120% for multi-family loans and 130% for CRE loans. Although we typically will lend up to 75% of the appraised value on multi-family buildings and up to 65% on commercial properties, the average LTVs of such credits at origination were below those levels at September 30, 2015. Exceptions to these LTV limitations are reviewed on a case-by-case basis.
The repayment of loans secured by commercial real estate is often dependent on the successful operation and management of the underlying properties. To minimize our credit risk, we originate CRE loans in adherence with conservative underwriting standards, and require that such loans qualify on the basis of the property’s current income stream and DSCR. The approval of a loan also depends on the borrower’s credit history, profitability, and expertise in property management.
Although the reasons for a loan to default will vary from credit to credit, our multi-family and CRE loans, in particular, typically have not resulted in significant losses. Such loans are generally originated at conservative LTVs and DSCRs, as previously stated. Furthermore, in the case of multi-family loans, the cash flows generated by the properties are generally below-market and have significant value.
With regard to ADC loans, we typically lend up to 75% of the estimated as-completed market value of multi-family and residential tract projects; however, in the case of home construction loans to individuals, the limit is 80%. With respect to commercial construction loans, which are not our primary focus, we typically lend up to 65% of the estimated as-completed market value of the property. Credit risk is also managed through the loan disbursement process. Loan proceeds are disbursed periodically in increments as construction progresses, and as warranted by inspection reports provided to us by our own lending officers and/or consulting engineers.
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Furthermore, our loan portfolio has been structured to manage our exposure to both credit and interest rate risk. The vast majority of the loans in our portfolio are intermediate-term credits, with multi-family and CRE loans typically repaying or refinancing within three to four years of origination. In addition, our multi-family loans are largely secured by buildings with rent-regulated apartments that tend to maintain a high level of occupancy, regardless of economic conditions in our marketplace.
To minimize the risk involved in specialty finance lending and leasing, our specialty finance subsidiary participates in syndicated loans that are brought to us, and equipment loans and leases that are assigned to us, by a select group of nationally recognized sources who have had long-term relationships with our experienced lending officers. Our specialty finance loans and leases generally are made to large corporate obligors, many of which are publicly traded, carry investment grade or near-investment grade ratings, and participate in stable industries nationwide.
In a credit downturn, the ability of these borrowers to generate cash flows may be diminished, and their ability to repay their obligations may deteriorate. Accordingly, each of our credits is secured with a perfected first security interest or outright ownership in the underlying collateral, and structured as senior debt or as a non-cancellable lease. To further minimize the risk involved in specialty finance lending and leasing, we re-underwrite each transaction. In addition, we retain outside counsel to conduct a further review of the underlying documentation.
Other C&I loans are typically underwritten on the basis of the cash flows produced by the borrower’s business, and are generally collateralized by various business assets, including, but not limited to, inventory, equipment, and accounts receivable. As a result, the capacity of the borrower to repay is substantially dependent on the degree to which the business is successful. Furthermore, the collateral underlying the loan may depreciate over time, may not be conducive to appraisal, and may fluctuate in value, based upon the operating results of the business. Accordingly, personal guarantees are also a normal requirement for other C&I loans.
The procedures we follow with respect to delinquent loans are generally consistent across all categories, with late charges assessed, and notices mailed to the borrower, at specified dates. We attempt to reach the borrower by telephone to ascertain the reasons for delinquency and the prospects for repayment. When contact is made with a borrower at any time prior to foreclosure or recovery against collateral property, we attempt to obtain full payment, and will consider a repayment schedule to avoid taking such action. Delinquencies are addressed by our Loan Workout Unit and every effort is made to collect rather than initiate foreclosure proceedings.
Fair values for all multi-family buildings, CRE properties, and land are determined based on the appraised value. If an appraisal is more than one year old and the loan is classified as either non-performing or as an accruing TDR, then an updated appraisal is required to determine fair value. Estimated disposition costs are deducted from the fair value of the property to determine estimated net realizable value. In the instance of an outdated appraisal on an impaired loan, we adjust the original appraisal by using a third-party index value to determine the extent of impairment until an updated appraisal is received.
While we strive to originate loans that will perform fully, adverse economic and market conditions, among other factors, can adversely impact a borrower’s ability to repay. Reflecting the improving economy, the nature of our primary lending niche, and our conservative underwriting standards, we recorded a net recovery of $7.0 million in the nine months ended September 30, 2015, as compared to net charge-offs of $2.2 million in the first nine months of last year. Included in the current nine-month amount was a third-quarter net recovery of $5.2 million; in the year-earlier third quarter, no recovery was recorded, nor was any provision for non-covered loan losses set aside.
Reflecting the net recovery recorded in the first nine months of this year, and the recovery of $512,000 from the allowance for non-covered loan losses, the allowance for losses on non-covered loans rose to $146.0 million at the end of September from $139.9 million at December 31, 2014. The September 30th balance represented 0.42% of total non-covered loans and 259.74% of non-performing non-covered loans at that date.
Based upon all relevant and available information as of September 30, 2015, management believes that the allowance for losses on non-covered loans was appropriate at that date.
Historically, our level of charge-offs has been relatively low in adverse credit cycles, even when the volume of non-performing loans has increased. This distinction has largely been due to the nature of our primary lending niche (multi-family loans collateralized by non-luxury apartment buildings in New York City that are rent-regulated and feature below-market rents), and to our conservative underwriting practices that require, among other things, low LTVs.
Reflecting the strength of the underlying collateral for these loans and the collateral structure, a relatively small percentage of our non-performing multi-family loans have resulted in losses over time. Low LTVs provide a greater likelihood of full recovery and reduce the possibility of incurring a severe loss on a credit. Furthermore, in many cases, low LTVs result
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in our having fewer loans with a potential for the borrower to “walk away” from the property. Although borrowers may default on loan payments, they have a greater incentive to protect their equity in the collateral property and to return their loans to performing status.
Given that our CRE loans are underwritten in accordance with underwriting standards that are similar to those that apply to our multi-family credits, an increase in non-performing CRE loans historically has not resulted in a corresponding increase in losses on such loans.
In addition, one-to-four family loans, ADC loans, and other loans represented 0.30%, 0.86%, and 4.3%, respectively, of total non-covered loans held for investment at September 30, 2015, and 11.2%, 0.18%, and 0.53%, respectively, of one-to-four family, ADC, and other loans were non-performing at that date.
In view of these factors, we do not believe that our level of non-performing non-covered loans will result in a comparable level of loan losses, and will not necessarily require an increase in the allowance for non-covered loan losses in any given period.
The following table presents information about our five largest non-performing loans at September 30, 2015, all of which are non-covered held-for-investment loans:
Type of Loan
Origination Date
Origination Balance
Full Commitment Balance(1)
Associated Allowance
Non-Accrual Date
Origination LTV
Current LTV
Last Appraisal
The following is a description of the five loans identified in the preceding table. It should be noted that no allocation for the non-covered loan loss allowance was needed for any of these loans, as determined by using the fair value of collateral method defined in ASC 310-10 and -35.
No. 1 – The borrower is an owner of real estate and is based in New Jersey. The loan is collateralized by a multi-family complex with 314 residential units and four retail stores in Atlantic City, New Jersey.
No. 2 – The borrower is an owner of real estate and is based in New York. These loans are collateralized by an 87,500-square foot commercial building in Bethpage, New York.
No. 3 – The borrower is an owner of real estate and is based in New Jersey. This loan is collateralized by a 33,040-square foot medical/professional office building in Raritan, New Jersey.
No. 4 – The borrower is an owner of real estate and is based in Connecticut. This loan is collateralized by three multi-family buildings with a total of 34 residential units in New Haven, Connecticut.
No. 5 – The borrower is an owner of real estate and is based in New Jersey. This loan is collateralized by a 23,791-square foot retail building in Somerset, New Jersey.
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The following tables present the number and amount of non-performing multi-family and CRE loans by originating bank at September 30, 2015 and December 31, 2014:
As of September 30, 2015
(dollars in thousands)
New York Community Bank
New York Commercial Bank
Total for New York Community Bancorp
As of December 31, 2014
In an effort to proactively manage delinquent loans, we have selectively extended to certain borrowers such concessions as rate reductions and extensions of maturity dates, as well as forbearance agreements, when such borrowers have exhibited financial difficulty. In accordance with GAAP, we are required to account for such loan modifications or restructurings as TDRs.
The eligibility of a borrower for work-out concessions of any nature depends upon the facts and circumstances of each transaction, which may change from period to period, and involve management’s judgment regarding the likelihood that the concession will result in the maximum recovery for the Company.
Loans modified as TDRs are placed on non-accrual status until we determine that future collection of principal and interest is reasonably assured. This generally requires that the borrower demonstrate performance according to the restructured terms for at least six consecutive months. At September 30, 2015, loans on which concessions were made with respect to rate reductions and/or extension of maturity dates totaled $21.2 million; loans in connection with which forbearance agreements were reached totaled $5.3 million at that date.
Based on the number of loans performing in accordance with their revised terms, our success rates for restructured multi-family and CRE loans were 86% and 92%, respectively, at September 30, 2015; in addition, our success rate was 100% for all other loan types at that date.
Analysis of Troubled Debt Restructurings
The following table presents information regarding our TDRs as of September 30, 2015:
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The following table presents information regarding our TDRs as of December 31, 2014:
The following table sets forth the changes in TDRs over the nine months ended September 30, 2015:
New TDRs
Transferred to accruing from non-accrual
On a limited basis, we may provide additional credit to a borrower after a loan has been placed on non-accrual status or modified as a TDR if, in management’s judgment, the value of the property after the additional loan funding is greater than the initial value of the property plus the additional loan funding amount. During the nine months ended September 30, 2015, no such additions were made. Furthermore, the terms of our restructured loans typically would not restrict us from cancelling outstanding commitments for other credit facilities to a borrower in the event of non-payment of a restructured loan.
Except for the non-accrual loans and TDRs disclosed in this filing, we did not have any potential problem loans at the end of the current third quarter that would have caused management to have serious doubts as to the ability of a borrower to comply with present loan repayment terms and that would have resulted in such disclosure if that were the case.
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Asset Quality Analysis (Excluding Covered Loans, Covered OREO, Non-Covered PCI Loans, and Non-Covered Loans Held for Sale)
The following table presents information regarding our consolidated allowance for losses on non-covered loans, our non-performing non-covered assets, and our non-covered loans 30 to 89 days past due at September 30, 2015 and December 31, 2014. Covered loans and non-covered PCI loans are considered to be performing due to the application of the yield accretion method, as discussed elsewhere in this report. Therefore, covered loans and non-covered PCI loans are not reflected in the amounts or ratios provided in this table.
Allowance for Losses on Non-Covered Loans:
Charge-offs:
Total charge-offs
Net recoveries (charge-offs)
Non-Performing Non-Covered Assets:
Total non-performing non-covered loans (1)
Non-covered other real estate owned (2)
Total non-performing non-covered assets
Asset Quality Measures:
Non-performing non-covered loans to total non-covered loans
Non-performing non-covered assets to total non-covered assets
Allowance for losses on non-covered loans to non-performing non-covered loans
Allowance for losses on non-covered loans to total non-covered loans
Net (recovery) charge-offs during the period to average loans outstanding during the period (3)
Total non-covered loans 30-89 days past due (5)
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Covered Loans and Covered Other Real Estate Owned
The credit risk associated with the assets acquired in our AmTrust transaction in December 2009 and our Desert Hills transaction in March 2010 has been substantially mitigated by our loss sharing agreements with the FDIC. Under the terms of the loss sharing agreements, the FDIC agreed to reimburse us for 80% of losses (and share in 80% of any recoveries) up to a specified threshold with respect to the loans and OREO acquired in the transactions, and to reimburse us for 95% of any losses (and share in 95% of any recoveries) with respect to the acquired assets beyond that threshold. The loss sharing (and reimbursement) agreements applicable to one-to-four family mortgage loans and HELOCs are effective for a ten-year period from the date of acquisition. Under the loss sharing agreements applicable to all other covered loans and OREO, the FDIC reimbursed us for losses for a five-year period from the date of acquisition which has since expired; the period for sharing in recoveries on all other covered loans and OREO extends for a period of eight years from the acquisition date.
We consider our covered loans to be performing due to the application of the yield accretion method underASC 310-30, which allows us to aggregate credit-impaired loans acquired in the same fiscal quarter into one or more pools, provided that the loans have common risk characteristics. A pool is then accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows. Accordingly, loans that may have been classified as non-performing loans by AmTrust or Desert Hills were no longer classified as non-performing at the respective dates of acquisition because we believed at that time that we would fully collect the new carrying value of those loans. The new carrying value represents the contractual balance, reduced by the portion expected to be uncollectible (referred to as the “non-accretable difference”) and by an accretable yield (discount) that is recognized as interest income. It is important to note that management’s judgment is required in reclassifying loans subject to ASC 310-30 as performing loans, and is dependent on having a reasonable expectation about the timing and amount of the cash flows to be collected, even if a loan is contractually past due.
In connection with the AmTrust and Desert Hills loss sharing agreements, we established FDIC loss share receivables of $740.0 million and $69.6 million, respectively, which were the acquisition date fair values of the respective loss sharing agreements (i.e., the expected reimbursements from the FDIC over the terms of the agreements). The loss share receivables increase if the losses increase, and decrease if the losses fall short of the expected amounts. Increases in estimated reimbursements are recognized in income in the same period that they are identified and that the allowance for losses on the related covered loans is recognized.
In the nine months ended September 30, 2015 and 2014, respectively, we recorded FDIC indemnification expense of $4.3 million and $14.7 million in “Non-interest income” in connection with recoveries of $5.4 million and $18.4 million, respectively, from the allowance for losses on covered loans. The respective recoveries were recorded to reflect our expectation that the cash flows generated by certain pools of covered loans would increase as a result of an improvement in credit quality.
Decreases in estimated reimbursements from the FDIC, if any, are recognized in income prospectively over the life of the related covered loans (or, if shorter, over the remaining term of the loss sharing agreement). Related additions to the accretable yield on covered loans will be recognized in income prospectively over the lives of the loans. Gains and recoveries on covered assets will offset losses, or be paid to the FDIC at the applicable loss share percentage at the time of recovery.
The loss share receivables may also increase due to accretion, or decrease due to amortization. In the nine months ended September 30, 2015 and 2014, we recorded amortization of $37.6 million and $28.8 million, respectively, including amortization of $11.3 million and $11.2 million in the three months ended at the respective dates. Accretion of the FDIC loss share receivable relates to the difference between the discounted, versus the undiscounted, expected cash flows of covered loans subject to the FDIC loss sharing agreements. Amortization occurs when the expected cash flows from the covered loan portfolio improve, thus reducing the amounts receivable from the FDIC. These cash flows are discounted to reflect the uncertainty of the timing and receipt of the loss sharing reimbursements from the FDIC. In the three and nine months ended September 30, 2015, we received FDIC reimbursements of $8.9 million and $19.2 million, respectively, as compared to $8.2 million and $30.7 million, respectively, in the year-earlier three- and nine-month periods.
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Asset Quality Analysis (Including Covered Loans, Covered OREO, and Non-Covered PCI Loans)
The following table presents information regarding our non-performing assets and loans past due at September 30, 2015 and December 31, 2014, including covered loans and covered OREO (collectively, “covered assets”), and non-covered PCI loans:
Covered Loans and Non-Covered PCI Loans 90 Days or More Past Due:
Total covered loans and non-covered PCI loans 90 days or more past due
Covered other real estate owned
Total covered assets and non-covered PCI loans
Total Non-Performing Assets:
Non-performing loans:
Total non-performing loans
Other real estate owned
Total non-performing assets
Asset Quality Ratios (including the allowance for losses on covered loans and non-covered PCI loans):
Total non-performing loans to total loans
Total non-performing assets to total assets
Allowance for loan losses to total non-performing loans
Allowance for loan losses to total loans
Covered Loans and Non-Covered PCI Loans 30-89 Days Past Due:
Total covered loans and non-covered PCI loans 30-89 days past due
Total Loans 30-89 Days Past Due:
Total loans 30-89 days past due
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Geographical Analysis of Non-Performing Loans (Covered and Non-Covered)
The following table presents a geographical analysis of our non-performing loans at September 30, 2015:
Consistent with our objective of containing the growth of our assets, our securities portfolio declined $336.8 million from the year-end balance to $6.8 billion at September 30, 2015. The September 30th amount represented 13.8% of total assets, while the December 31st balance represented 14.6%. The nine-month decline was largely due to repayments and, to a lesser extent, calls of securities. GSE obligations represented 95.3% of total securities at the end of September, as compared to 95.5% at year-end 2014.
Held-to-maturity securities represented $6.6 billion, or 97.6%, of securities at the end of September, down $325.4 million from the balance at year-end. The fair value of securities held to maturity represented 103.3% of their carrying value at the end of September and 102.4% of their carrying value at December 31st. Mortgage-related securities and other securities accounted for $3.8 billion and $2.8 billion, respectively, of the September 30th balance, as compared to $4.1 billion and $2.8 billion at the end of last year.
GSE obligations represented $6.4 billion of held-to-maturity securities at the end of the third quarter, while capital trust notes, corporate bonds, and municipal obligations represented $65.6 million, $73.6 million, and $77.1 million, respectively. At December 31, 2014, GSE obligations accounted for $6.7 billion of held-to-maturity securities, while capital trust notes and corporate bonds represented $75.6 million and $73.3 million, respectively. The estimated weighted average life of the held-to-maturity securities portfolio was 6.4 years and 7.2 years at the respective period-ends.
Available-for-sale securities represented the remaining $162.3 million, or 2.4%, of total securities at the end of the third quarter, an $11.5 million decrease from the balance at December 31st. Included in the respective balances were mortgage-related securities of $14.3 million and $19.7 million, and other securities of $148.0 million and $154.1 million. The estimated weighted average life of the available-for-sale securities portfolio was 10.1 years and 8.6 years at the corresponding dates.
As members of the FHLB-NY, the Community Bank and the Commercial Bank are required to acquire and hold shares of its capital stock. At September 30, 2015, the Community Bank held $497.9 million of FHLB stock, including $478.9 million of stock in the FHLB-NY and $19.0 million of stock in the FHLB-Cincinnati that was acquired in connection with the AmTrust transaction in December 2009. The Commercial Bank had $40.5 million of FHLB stock at the end of the third quarter, all of which was with the FHLB-NY. All FHLB stock continued to be valued at par, with no impairment required at September 30, 2015.
In the three and nine months ended September 30, 2015, dividends from the FHLB to the Community Bank totaled $4.5 million and $14.7 million, respectively; dividends from the FHLB to the Commercial Bank totaled $406,000 and $1.2 million, respectively, during that time.
Sources of Funds
The Parent Company (i.e., the Company on an unconsolidated basis) has four primary funding sources for the payment of dividends, share repurchases, and other corporate uses: dividends paid to the Company by the Banks; capital raised through the issuance of stock; funding raised through the issuance of debt instruments; and repayments of, and income from, investment securities.
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On a consolidated basis, our funding primarily stems from a combination of the following sources: retail, institutional, municipal, and brokered deposits; borrowed funds, primarily in the form of wholesale borrowings; the cash flows generated through the repayment and sale of loans; and the cash flows generated through the repayment and sale of securities.
Loan repayments and sales totaled $12.0 billion in the first nine months of 2015, as compared to $8.0 billion in the first nine months of the prior year. Included in the respective amounts were third-quarter loan repayments and sales totaling $3.3 billion and $2.9 billion.
In the nine months ended September 30, 2015 and 2014, cash flows from the repayment and sale of securities respectively totaled $617.2 million and $821.7 million, while purchases of securities totaled $276.5 million and $366.3 million in the corresponding periods. Consistent with our business model, the cash flows from loans and securities were primarily deployed into the production of held-for-investment multi-family and CRE loans.
Our ability to retain and attract deposits depends on numerous factors, including customer satisfaction, the rates of interest we pay, the types of products we offer, and the attractiveness of their terms. That said, there have been times that we’ve chosen not to compete actively for deposits, depending on our access to deposits through acquisitions, the availability of lower-cost funding sources, the impact of competition on pricing, and the need to fund our loan demand.
At September 30, 2015, our deposits totaled $28.3 billion, reflecting a $48.6 million decrease from the balance at December 31st. The modest decline was the net effect of a $902.7 million reduction in certificates of deposit (“CDs”) to $5.5 billion and an $854.2 million increase in all other deposits combined. Included in this increase was a $153.0 million rise in NOW and money market accounts to $12.7 billion; a $454.4 million rise in savings accounts to $7.5 billion; and a $246.8 million rise in non-interest-bearing accounts to $2.6 billion over the first nine months of the year. CDs represented 19.5% of total deposits at the end of September, as compared to 22.7% at December 31, 2014.
The bulk of our deposits consist of retail deposits, which declined $151.7 million from the December 31st balance to $21.2 billion at the third quarter-end. Institutional deposits fell $9.5 million during this time to $2.2 billion, while municipal deposits rose $145.3 million to $993.1 million.
Brokered deposits totaled $3.9 million at the end of September, reflecting a $32.8 million decrease from the balance recorded at December 31st. During this time, brokered money market accounts fell $105.5 million to $2.5 billion, while brokered NOW accounts rose $76.3 million to $1.5 billion. In addition, we had no brokered CDs at the end of September, in contrast to brokered CDs of $3.5 million at December 31, 2014. The extent to which we accept brokered deposits depends on various factors, including the availability and pricing of such wholesale funding sources, and the availability and pricing of other sources of funds.
Borrowed funds consist primarily of wholesale borrowings (i.e., FHLB advances, repurchase agreements, and fed funds purchased) and, to a far lesser extent, junior subordinated debentures. In the first nine months of this year, borrowed funds rose $497.3 million to $14.7 billion, representing 30.0% of total assets at September 30, 2015.
Wholesale Borrowings
Wholesale borrowings totaled $14.4 billion and $13.9 billion, respectively, at September 30, 2015 and December 31, 2014, representing 29.3% and 28.6% of total assets at the corresponding dates.
The majority of our wholesale borrowings consist of FHLB advances, which rose $346.1 million to $10.5 billion in the nine months ended September 30, 2015. During this time, the balance of repurchase agreements fell $100.0 million to $3.3 billion, while the balance of fed funds purchased rose $251.0 million to $511.0 million.
Both the Community Bank and the Commercial Bank are members of, and have lines of credit with, the FHLB-NY. Pursuant to blanket collateral agreements with the Banks, our FHLB advances and overnight advances are secured by pledges of certain eligible collateral in the form of loans. In addition to $10.0 billion of FHLB-NY advances, the September 30th balance included $485.3 million of FHLB-Cincinnati advances that were acquired in the AmTrust acquisition.
At September 30, 2015, $5.6 billion of our wholesale borrowings were callable in the next 12 months.
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Junior Subordinated Debentures
Junior subordinated debentures totaled $358.5 million at September 30, 2015, a modest rise from the balance at December 31, 2014.
Asset and Liability Management and the Management of Interest Rate Risk
We manage our assets and liabilities to reduce our exposure to changes in market interest rates. The asset and liability management process has three primary objectives: to evaluate the interest rate risk inherent in certain balance sheet accounts; to determine the appropriate level of risk, given our business strategy, operating environment, capital and liquidity requirements, and performance objectives; and to manage that risk in a manner consistent with guidelines approved by the Boards of Directors of the Company, the Community Bank, and the Commercial Bank.
Market Risk
As a financial institution, we are focused on reducing our exposure to interest rate volatility, which represents our primary market risk. Changes in market interest rates pose the greatest challenge to our financial performance, as such changes can have a significant impact on the level of income and expense recorded on a large portion of our interest-earning assets and interest-bearing liabilities, and on the market value of all interest-earning assets, other than those possessing a short term to maturity. To reduce our exposure to changing rates, the Boards of Directors and management monitor interest rate sensitivity on a regular or as needed basis so that adjustments to the asset and liability mix can be made when deemed appropriate.
The actual duration of held-for-investment mortgage loans and mortgage-related securities can be significantly impacted by changes in prepayment levels and market interest rates. The level of prepayments may be impacted by a variety of factors, including the economy in the region where the underlying mortgages were originated; seasonal factors; demographic variables; and the assumability of the underlying mortgages. However, the largest determinants of prepayments are market interest rates and the availability of refinancing opportunities.
In the first nine months of 2015, we managed our interest rate risk by taking the following actions: (1) We continued to emphasize the origination and retention of intermediate-term assets, primarily in the form of multi-family and CRE loans; (2) We continued the origination of certain C&I loans that feature floating interest rates; (3) We reduced our balance of CDs while increasing our balance of non-interest-bearing deposits; and (4) We repositioned certain of our short-term wholesale borrowings.
In connection with the activities of our mortgage banking operation, we enter into contingent commitments to fund or purchase residential mortgage loans by a specified future date at a stated interest rate and corresponding price. Such commitments, which are generally known as interest rate lock commitments (“IRLCs”), are considered to be financial derivatives and, as such, are carried at fair value.
To mitigate the interest rate risk associated with our IRLCs, we enter into forward commitments to sell mortgage loans or mortgage-backed securities (“MBS”) by a specified future date and at a specified price. These forward-sale agreements are also carried at fair value. Such forward commitments to sell generally obligate us to complete the transaction as agreed, and therefore pose a risk to us if we are not able to deliver the loans or MBS pursuant to the terms of the applicable forward-sale agreement. For example, if we are unable to meet our obligation, we may be required to pay a fee to the counterparty.
When we retain the servicing on the loans we sell, we capitalize an MSR asset. Residential MSRs are recorded at fair value, with changes in fair value recorded as a component of non-interest income. We estimate the fair value of the MSR asset based upon a number of factors, including current and expected loan prepayment rates, economic conditions, and market forecasts, as well as relevant characteristics of the associated underlying loans. Generally, when market interest rates decline, loan prepayments increase as customers refinance their existing mortgages to take advantage of more favorable interest rate terms. When a mortgage prepays, or when loans are expected to prepay earlier than originally expected, a portion of the anticipated cash flows associated with servicing these loans is terminated or reduced, which can result in a reduction in the fair value of the capitalized MSRs and a corresponding reduction in earnings.
To mitigate the prepayment risk inherent in residential MSRs, we could sell the servicing of the loans we produce, and thus minimize the potential for earnings volatility. Instead, we have opted to mitigate such risk by investing in exchange-traded derivative financial instruments that are expected to experience opposite and partially offsetting changes in fair value as related to the value of our residential MSRs.
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Interest Rate Sensitivity Analysis
The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are “interest rate sensitive” and by monitoring a bank’s interest rate sensitivity “gap.” An asset or liability is said to be interest rate sensitive within a specific time frame if it will mature or reprice within that period of time. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time frame and the amount of interest-bearing liabilities maturing or repricing within that same period of time.
In a rising interest rate environment, an institution with a negative gap would generally be expected, absent the effects of other factors, to experience a greater increase in the cost of its interest-bearing liabilities than it would in the yield on its interest-earning assets, thus producing a decline in its net interest income. Conversely, in a declining rate environment, an institution with a negative gap would generally be expected to experience a lesser reduction in the yield on its interest-earning assets than it would in the cost of its interest-bearing liabilities, thus producing an increase in its net interest income.
In a rising interest rate environment, an institution with a positive gap would generally be expected to experience a greater increase in the yield on its interest-earning assets than it would in the cost of its interest-bearing liabilities, thus producing an increase in its net interest income. Conversely, in a declining rate environment, an institution with a positive gap would generally be expected to experience a lesser reduction in the cost of its interest-bearing liabilities than it would in the yield on its interest-earning assets, thus producing a decline in its net interest income.
At September 30, 2015, our one-year gap was a negative 12.51%, as compared to a negative 15.92% at December 31, 2014. The 341-basis point change was primarily due to an increase in deposits repricing in one year, the benefit of which was partially offset by a decrease in borrowings repricing in the same time, coupled with an increase in securities projected to be called.
The table on the following page sets forth the amounts of interest-earning assets and interest-bearing liabilities outstanding at September 30, 2015 which, based on certain assumptions stemming from our historical experience, are expected to reprice or mature in each of the future time periods shown. Except as stated below, the amounts of assets and liabilities shown as repricing or maturing during a particular time period were determined in accordance with the earlier of (1) the term to repricing, or (2) the contractual terms of the asset or liability.
The table provides an approximation of the projected repricing of assets and liabilities at September 30, 2015 on the basis of contractual maturities, anticipated prepayments, and scheduled rate adjustments within a three-month period and subsequent selected time intervals. For residential mortgage-related securities, prepayment rates are forecasted at a weighted average constant prepayment rate (“CPR”) of 18% per annum; for multi-family and CRE loans, prepayment rates are forecasted at weighted average CPRs of 25% and 20% per annum, respectively. Borrowed funds were not assumed to prepay. Savings, NOW, and money market accounts were assumed to decay based on a comprehensive statistical analysis that incorporated our historical deposit experience. Based on the results of this analysis, savings accounts were assumed to decay at a rate of 59% for the first five years and 41% for years six through ten. NOW accounts were assumed to decay at a rate of 74% for the first five years and 26% for years six through ten. This comprehensive statistical analysis incorporated updated deposit data and modeling assumptions, and resulted in no decay rates beyond ten years. The change in the decay assumptions was made due to the prolonged low interest rate environment and the uncertainty regarding future depositor behavior. Including those accounts having specified repricing dates, money market accounts were assumed to decay at a rate of 82% for the first five years and 18% for years six through ten.
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INTEREST-EARNING ASSETS:
Mortgage and other loans (1)
Mortgage-related securities (2)(3)
Other securities and money market investments (2)
Total interest-earning assets
INTEREST-BEARING LIABILITIES:
Total interest-bearing liabilities
Interest rate sensitivity gap per period (4)
Cumulative interest rate sensitivity gap
Cumulative interest rate sensitivity gap as a percentage of total assets
Cumulative net interest-earning assets as a percentage of net interest-bearing liabilities
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Prepayment and deposit decay rates can have a significant impact on our estimated gap. While we believe our assumptions to be reasonable, there can be no assurance that the assumed prepayment and decay rates will approximate actual future loan and securities prepayments and deposit withdrawal activity.
To validate our prepayment assumptions for our multi-family and CRE loan portfolios, we perform a monthly analysis, during which we review our historical prepayment rates and compare them to our projected prepayment rates. We continually review the actual prepayment rates to ensure that our projections are as accurate as possible, since prepayments on these types of loans are not as closely correlated to changes in interest rates as prepayments on one-to-four family loans would be. In addition, we review the call provisions in our borrowings and investment portfolios and, on a monthly basis, compare the actual calls to our projected calls to ensure that our projections are reasonable.
As of September 30, 2015, the impact of a 100-basis point decline in market interest rates would have increased our projected prepayment rates by a constant prepayment rate of 2.09% per annum. Conversely, the impact of a 100-basis point increase in market interest rates would have decreased our projected prepayment rates by a constant prepayment rate of 2.15% per annum.
Certain shortcomings are inherent in the method of analysis presented in the preceding Interest Rate Sensitivity Analysis. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. The interest rates on certain types of assets and liabilities may fluctuate in advance of the market, while interest rates on other types may lag behind changes in market interest rates. Additionally, certain assets, such as adjustable-rate loans, have features that restrict changes in interest rates both on a short-term basis and over the life of the asset. Furthermore, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate from those assumed in calculating the table. Also, the ability of some borrowers to repay their adjustable-rate loans may be adversely impacted by an increase in market interest rates.
Interest rate sensitivity is also monitored through the use of a model that generates estimates of the change in our net portfolio value (“NPV”) over a range of interest rate scenarios. NPV is defined as the net present value of expected cash flows from assets, liabilities, and off-balance sheet contracts. The NPV ratio, under any interest rate scenario, is defined as the NPV in that scenario divided by the market value of assets in the same scenario. The model assumes estimated loan prepayment rates, reinvestment rates, and deposit decay rates similar to those utilized in formulating the preceding Interest Rate Sensitivity Analysis.
Based on the information and assumptions in effect at September 30, 2015, the following table reflects the estimated percentage change in our NPV, assuming the changes in interest rates noted:
Change in Interest Rates
(in basis points)(1)
Estimated Percentage Change in
Net Portfolio Value
+100
+200
The net changes in NPV presented in the preceding table are within the parameters approved by the Boards of Directors of the Company and the Banks.
As with the Interest Rate Sensitivity Analysis, certain shortcomings are inherent in the methodology used in the preceding interest rate risk measurements. Modeling changes in NPV requires that certain assumptions be made which may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the NPV Analysis presented above assumes that the composition of our interest rate sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured, and also assumes that a particular change in interest rates is reflected uniformly across the yield curve, regardless of the duration to maturity or repricing of specific assets and liabilities. Furthermore, the model does not take into account the benefit of any strategic actions we may take to further reduce our exposure to interest rate risk. Accordingly, while the NPV Analysis provides an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to, and do not, provide a precise forecast of the effect of changes in market interest rates on our net interest income, and may very well differ from actual results.
We also utilize an internal net interest income simulation to manage our sensitivity to interest rate risk. The simulation incorporates various market-based assumptions regarding the impact of changing interest rates on future levels of our financial assets and liabilities. The assumptions used in the net interest income simulation are inherently uncertain. Actual results may differ significantly from those presented in the following table, due to the frequency, timing, and magnitude of changes in interest rates; changes in spreads between maturity and repricing categories; and prepayments, among other factors, coupled with any actions taken to counter the effects of any such changes.
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Based on the information and assumptions in effect at September 30, 2015, the following table reflects the estimated percentage change in future net interest income for the next twelve months, assuming the changes in interest rates noted:
Future changes in our mix of assets and liabilities may result in greater changes to our gap, NPV, and/or net interest income simulation.
In the event that our interest rate sensitivity gap analysis or net interest income simulation were to indicate a variance in our NPV in excess of our internal policy limits, we would undertake the following actions to ensure that appropriate remedial measures were put in place:
Where temporary changes in market conditions or volume levels result in significant increases in risk, strategies may involve reducing open positions or employing synthetic hedging techniques to more immediately reduce risk exposure. Where variance from policy tolerances is triggered by more fundamental imbalances in the risk profiles of core loan and deposit products, a remedial strategy may involve restoring balance through natural hedges to the extent possible before employing synthetic hedging techniques. Other strategies might include:
In connection with our net interest income simulation modeling, we also evaluate the impact of changes in the slope of the yield curve. At September 30, 2015, our analysis indicated that an immediate flattening of the yield curve would be expected to result in a 7.17% decrease in net interest income over the next four quarters; conversely, an immediate steepening of the yield curve would be expected to result in a 3.41% increase in net interest income over such time.
Liquidity
We manage our liquidity to ensure that cash flows are sufficient to support our operations, and to compensate for any temporary mismatches between sources and uses of funds caused by variable loan and deposit demand.
We monitor our liquidity daily to ensure that sufficient funds are available to meet our financial obligations. Our most liquid assets are cash and cash equivalents, which totaled $585.8 million and $564.2 million, respectively, at September 30, 2015 and December 31, 2014. As in the past, our portfolios of loans and securities provided liquidity in the current nine-month period, with cash flows from the repayment and sale of loans totaling $12.0 billion and cash flows from the repayment and sale of securities totaling $617.2 million.
Additional liquidity stems from the retail, institutional, and municipal deposits we gather and from our use of wholesale funding sources, including brokered deposits and wholesale borrowings. We also have access to the Banks’ approved lines of
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credit with various counterparties, including the FHLB-NY. The availability of these wholesale funding sources is generally based on the available amount of mortgage loan collateral under a blanket lien we have pledged to the respective institutions and, to a lesser extent, the available amount of securities that may be pledged to collateralize our borrowings. At September 30, 2015, our available borrowing capacity with the FHLB-NY was $7.4 billion. In addition, the Community Bank and the Commercial Bank had $14.3 million in available-for-sale securities, combined, at that date.
Furthermore, both the Community Bank and the Commercial Bank have agreements with the Federal Reserve Bank of New York (the “FRB-NY”) that enable them to access the discount window as a further means of enhancing their liquidity if need be. In connection with their agreements, the Banks have pledged certain loans and securities to collateralize any funds they may borrow. At September 30, 2015, the maximum amount the Community Bank could borrow from the FRB-NY was $1.0 billion; the maximum amount the Commercial Bank could borrow from the FRB-NY was $152.4 million. There were no borrowings against either of the respective lines of credit at that date.
Our primary investing activity is loan production. In the first nine months of 2015, the volume of loans originated for investment was $9.0 billion. During this time, the net cash used in investing activities totaled $363.2 million. Our operating activities provided net cash of $273.6 million in the current nine-month period, while our financing activities provided net cash of $111.3 million.
CDs due to mature in one year or less from September 30, 2015 totaled $4.6 billion, representing 83.1% of total CDs at that date. Our ability to retain these CDs and to attract new deposits depends on numerous factors, including customer satisfaction, the rates of interest we pay on our deposits, the types of products we offer, and the attractiveness of their terms. However, there are times when we may choose not to compete for such deposits, depending on the availability of lower-cost funding, the competitiveness of the market and its impact on pricing, and our need for such deposits to fund loan demand, as previously discussed.
The Company (the “Parent Company”) is a separate legal entity from each of the Banks and must provide for its own liquidity. In addition to operating expenses and any share repurchases, the Parent Company is responsible for paying any dividends declared to our shareholders. As a Delaware corporation, the Parent Company is able to pay dividends either from surplus or, in case there is no surplus, from net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year. Due to the prepayment charge to be incurred in the fourth quarter of this year in connection with the aforementioned balance sheet repositioning, any dividends to be paid by the Company over the next four quarters will require regulatory clearance.
The Parent Company’s ability to pay dividends may depend, in part, upon the dividends it receives from the Banks. The ability of the Community Bank and the Commercial Bank to pay dividends and other capital distributions to the Parent Company is generally limited by New York State banking law and regulations, and by certain regulations of the FDIC. In addition, the Superintendent of the New York State Department of Financial Services (the “Superintendent”), the FDIC, and the Federal Reserve, for reasons of safety and soundness, may prohibit the payment of dividends that are otherwise permissible by regulations.
Under New York State Banking Law, a New York State-chartered stock-form savings bank or commercial bank may declare and pay dividends out of its net profits, unless there is an impairment of capital. However, the approval of the Superintendent is required if the total of all dividends declared in a calendar year would exceed the total of a bank’s net profits for that year, combined with its retained net profits for the preceding two years. In the nine months ended September 30, 2015, the Banks paid dividends totaling $335.0 million to the Parent Company, leaving $187.0 million they could dividend to the Parent Company without regulatory approval at that date. If either of the Banks were to apply to the Superintendent for approval to make a dividend or capital distribution in excess of the dividend amounts permitted under the regulations, there can be no assurance that such application would be approved. Additional sources of liquidity available to the Parent Company at September 30, 2015 included $108.3 million in cash and cash equivalents and $2.0 million of available-for-sale securities.
We use various financial instruments, including derivatives, in connection with our strategies to mitigate or reduce our exposure to losses from adverse changes in interest rates. Our derivative financial instruments consist of financial forward and futures contracts, IRLCs, swaps, and options, and relate to our mortgage banking operation, residential MSRs, and other risk management activities. These activities will vary in scope based on the level and volatility of interest rates, the types of assets held, and other changing market conditions. At September 30, 2015, we held derivative financial instruments with a notional value of $2.5 billion. (Please see Note 12, “Derivative Financial Instruments,” for a further discussion of our use of such financial instruments.)
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Capital Position
Stockholders’ equity rose $45.0 million from the December 31, 2014 balance to $5.8 billion at September 30, 2015. The September 30th balance represented 11.88% of total assets and a book value per share of $13.11, while the December 31, 2014 balance represented 11.91% of total assets and a book value per share of $13.06.
We calculate book value per share by dividing the amount of stockholders’ equity at the end of a period by the number of shares outstanding at the same date. At September 30, 2015 and December 31, 2014, we had outstanding shares of 444,319,494 and 442,587,190, respectively.
Tangible stockholders’ equity rose $49.2 million in the first nine months of this year to $3.4 billion, after the distribution of quarterly cash dividends totaling $332.8 million. The September 30th balance represented 7.27% of tangible assets and a tangible book value per share of $7.62. At December 31, 2014, tangible stockholders equity represented 7.24% of tangible assets and a book value per share of $7.54.
We calculate tangible stockholders’ equity by subtracting the amount of goodwill and CDI recorded at the end of a period from the amount of stockholders’ equity recorded at the same date. At both September 30, 2015 and December 31, 2014, we recorded goodwill of $2.4 billion; we recorded CDI, net of $3.7 million and $7.9 million, respectively, at the corresponding dates. (Please see the discussion and reconciliations of stockholders’ equity and tangible stockholders’ equity, total assets and tangible assets, and the related financial measures that appear earlier in this report.)
Both stockholders’ equity and tangible stockholders’ equity include AOCL. AOCL declined $2.3 million from the balance at the end of December to $53.4 million at September 30, 2015. The modest decline was largely the net effect of a $3.6 million decrease in pension and post-retirement obligations, net of tax, to $49.7 million and a $1.4 million decline in the net unrealized gain on securities available for sale, net of tax, to $1.6 million. The respective declines occurred in tandem with a modest decline in the net unrealized loss on the non-credit portion of OTTI losses, net of tax, to $5.3 million.
At September 30, 2015, our capital measures continued to exceed the minimum federal requirements for a bank holding company, which reflect the new capital rules under Basel III that took effect on January 1st of this year. The following table sets forth our Common Equity Tier 1, Tier 1 risk-based, total risk-based, and leverage capital amounts and ratios on a consolidated basis, as well as the respective minimum regulatory capital requirements, at that date:
Regulatory Capital Analysis (the Company)
Total capital
Minimum for capital adequacy purposes
Excess
The impact of the new Basel III capital rules is primarily reflected in the Tier 1 capital of the Company. In accordance with these rules, which call for the phase-out of trust preferred securities as Tier 1 capital, only 25% of our trust preferred securities were included in Tier 1 capital at September 30, 2015. Based on the balance of the Company’s trust preferred securities at that date, the phase-out of 75% of our trust preferred securities reduced our Tier 1 capital by $259.3 million, our leverage capital ratio by 56 basis points, and our Tier 1 to risk-weighted assets ratio by 80 basis points at quarter-end. The Tier 1 and total capital to risk-weighted assets ratios were also negatively impacted by changes in the calculation of risk-weighted assets under Basel III.
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As reflected in the following tables, the capital ratios for the Community Bank and the Commercial Bank also continued to exceed the minimum regulatory capital levels required at September 30, 2015, in accordance with the new rules under Basel III:
Regulatory Capital Analysis (New York Community Bank)
Regulatory Capital Analysis (New York Commercial Bank)
As of September 30, 2015, the Community Bank and the Commercial Bank also exceeded the minimum capital requirements to be categorized as “well capitalized.” To be categorized as well capitalized, a bank must maintain a minimum Common Equity Tier 1 ratio of 6.50%; a minimum Tier 1 risk-based capital ratio of 8.00%; a minimum total risk-based capital ratio of 10.00%; and a minimum leverage capital ratio of 5.00%.
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EARNINGS SUMMARY FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2015
We generated earnings of $114.7 million in the current third quarter, as compared to $123.7 million and $120.3 million, respectively, in the trailing and year-earlier three months. The respective amounts were equivalent to $0.26, $0.28, and $0.27 per diluted share.
Net Interest Income
Net interest income is our primary source of income. Its level is a function of the average balance of our interest-earning assets, the average balance of our interest-bearing liabilities, and the spread between the yield on such assets and the cost of such liabilities. These factors are influenced by both the pricing and mix of our interest-earning assets and our interest-bearing liabilities which, in turn, are impacted by various external factors, including the local economy, competition for loans and deposits, the monetary policy of the Federal Open Market Committee of the Federal Reserve Board of Governors (the “FOMC”), and market interest rates.
The cost of our deposits and borrowed funds is largely based on short-term rates of interest, the level of which is partially impacted by the actions of the FOMC. The FOMC reduces, maintains, or increases the target fed funds rate (the rate at which banks borrow funds overnight from one another) as it deems necessary. The target fed funds rate has been maintained at a range of zero to 0.25% since the fourth quarter of 2008.
While the target fed funds rate generally impacts the cost of our short-term borrowings and deposits, the yields on our held-for-investment loans and other interest-earning assets are typically impacted by intermediate-term market interest rates. In the third quarter of 2015, the average five-year CMT was 1.56%, as compared to 1.53% and 1.70%, respectively, in the trailing and year-earlier three months. The average ten-year CMT was 2.22% in the current third quarter, as compared to 2.16% and 2.50%, respectively, in the corresponding periods.
Net interest income is also influenced by the level of prepayment penalty income generated, primarily in connection with the prepayment of our multi-family and CRE loans. Since prepayment penalty income is recorded as interest income, an increase or decrease in its level will also be reflected in the average yields on our loans and interest-earning assets, and therefore in our interest rate spread and net interest margin.
In the three months ended September 30, 2015, we generated net interest income of $279.4 million, a $5.7 million reduction from the trailing-quarter level and $9.6 million reduction year-over-year. The linked-quarter decline was the net effect of a $5.1 million reduction in interest income to $416.6 million and a $615,000 rise in interest expense to $137.1 million. The year-over-year decline in net interest income was the net effect of a $10.5 million reduction in interest income and a $904,000 reduction in interest expense.
Our net interest margin also declined in the current third quarter, to 2.56%. In the three months ended June 30, 2015, our margin was 2.64%, i.e., eight basis points higher; in the three months ended September 30, 2014, our margin was 13 basis points higher, at 2.69%.
The following factors contributed to the sequential decline in our net interest income and margin:
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The following factors contributed to the year-over-year declines in our net interest income and margin:
It should be noted that the level of prepayment penalty income recorded in any given period depends on the volume of loans that refinance or prepay during that time. Such activity is largely dependent on such external factors as current market conditions, including real estate values, and the perceived or actual direction of market interest rates. In addition, while a decline in market interest rates may trigger an increase in refinancing and, therefore, prepayment penalty income, so too may an increase in market interest rates. It is not unusual for borrowers to lock in lower interest rates when they expect, or see, that market interest rates are rising rather than risk refinancing later at a still higher interest rate.
Furthermore, the level of prepayment penalty income recorded when a loan prepays is a function of the remaining principal balance, as well as the number of years remaining on the loan. The number of years dictates the number of prepayment penalty points that are charged on the remaining principal balance, based on a sliding scale of five percentage points to one, as discussed under “Multi-Family Loans” and “Commercial Real Estate Loans” earlier in this report.
The following tables set forth certain information regarding our average balance sheet for the quarters indicated, including the average yields on our interest-earning assets and the average costs of our interest-bearing liabilities. Average yields are calculated by dividing the interest income produced by the average balance of interest-earning assets. Average costs are calculated by dividing the interest expense produced by the average balance of interest-bearing liabilities. The average balances for the quarters are derived from average balances that are calculated daily. The average yields and costs include fees, as well as premiums and discounts (including mark-to-market adjustments from acquisitions), that are considered adjustments to such average yields and costs.
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Net Interest Income Analysis (Linked-Quarter Comparison)
Interest-earning assets:
Mortgage and other loans, net (1)
Securities and money market investments (2)(3)
Non-interest-earning assets
Interest-bearing deposits:
Total interest-bearing deposits
Non-interest-bearing deposits
Stockholders’ equity
Net interest income/interest rate spread
Net interest margin
Ratio of interest-earning assets to interest-bearing liabilities
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Net Interest Income Analysis (Year-Over-Year Comparison)
(Recoveries of) Provisions for Loan Losses
(Recovery of) Provision for Losses on Non-Covered Loans
The provision for losses on non-covered loans is based on the methodology used by management in calculating the allowance for losses on such loans. Reflecting this methodology, which is discussed in detail under “Critical Accounting Policies,” and the net recoveries recorded in the quarter, the Company recovered $512,000 from the allowance for non-covered loan losses in the three months ended September 30, 2015. In the second quarter of this year, the Company recorded a recovery of $1.9 million; there was no recovery of, or provision for, non-covered loan losses recorded in the third quarter of 2014.
(Recovery of) Provision for Losses on Covered Loans
A provision for losses on covered loans is recorded when we have reason to believe that the cash flows from certain loans acquired in our FDIC-assisted transactions will fall short of our expectations, due to a decline in their credit quality. Conversely, when we have reason to believe that the cash flows from certain loan portfolios acquired in our FDIC-assisted transactions will exceed our expectations due to an improvement in credit quality, we reverse the previously established covered loan loss allowance by recording a recovery.
Reflecting an increase in the cash flows expected from certain pools of acquired loans covered by FDIC loss-sharing agreements, the Company recovered $8.5 million from the allowance for covered loan losses in the three months ended September 30, 2015, as compared to recovering $3.9 million in the three months ended September 30, 2014. In contrast, the Company recorded a $2.2 million provision for covered loan losses in the trailing quarter, reflecting a decline in the cash flows expected from certain pools of covered loans during that time.
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Because our FDIC loss sharing agreements call for the FDIC to reimburse us for a portion of our losses on covered loans—and for the FDIC to share in any recoveries of such losses—we record FDIC indemnification income in “Non-interest income” in the same period that a provision for covered loan losses is recorded, and we record FDIC indemnification expense in “Non-interest income” in the same period that a recovery occurs. While the recoveries recorded in the three months ended September 30, 2015 and 2014 were largely offset by FDIC indemnification expense of $6.8 million and $3.2 million, respectively, the trailing-quarter provision was largely offset by FDIC indemnification income of $1.8 million, as further discussed below.
For additional information about our recoveries of (provisions for) loan losses, please see the discussion of the respective loan loss allowances under “Critical Accounting Policies” and the discussion of “Asset Quality” that appear earlier in this report.
Non-Interest Income
We generate non-interest income through a variety of sources, including—among others—mortgage banking income (which consists of income from the origination of one-to-four family loans for sale and income from the servicing of these and other one-to-four family loans); fee income (in the form of retail deposit fees and charges on loans); income from our investment in bank-owned life insurance (“BOLI”); gains on the sale of securities; and revenues produced through the sale of third-party investment products and those produced through our wholly-owned subsidiary, Peter B. Cannell & Co., Inc. (“PBC”), an investment advisory firm.
Non-interest income totaled $37.6 million in the current third quarter, reflecting a linked-quarter reduction of $24.3 million and a year-over-over reduction of $3.7 million.
The linked-quarter decline was largely due to three distinct factors, including the $8.6 million difference between the FDIC indemnification expense recorded in the current third quarter and the FDIC indemnification income recorded in the trailing three months, as noted above.
In addition, mortgage banking income fell $8.5 million sequentially, to $7.5 million, partly reflecting a $3.0 million decline in income from originations to $7.5 million as gain-on-sale margins narrowed and refinancing activity declined. The remainder of the sequential decline in mortgage banking income was attributable to the $5.5 million difference between the servicing income recorded in the second quarter and the servicing loss recorded in the third quarter of this year. Reflecting a decline in hedge effectiveness, the Company recorded a $50,000 servicing loss in the three months ended September 30, 2015, as compared to servicing income of $5.4 million in the trailing three-month period. Excluding the net impact of hedging in the respective quarters, servicing income rose 3.8% sequentially.
The sequential decline in non-interest income also reflects a $6.8 million drop in “other” other income to $10.9 million in the three months ended September 30, 2015. While the current third-quarter amount included gains on the sale of loans of $7.0 million, the trailing-quarter amount included gains on the sale of loans of $8.8 million, as well as the aforementioned $7.8 million gain on the sale of a multi-family property that had been classified as OREO.
The year-over-year decline in non-interest income was far more modest than the linked-quarter reduction, as a $9.4 million increase in “other” other income offset the impact of a $9.1 million reduction in mortgage banking income, and tempered the impact of the $3.7 million increase in FDIC indemnification expense. The year-over-year rise in “other” other non-interest income was primarily due to a $7.0 million gain on the sale of CRE loans through participations; the decline in mortgage banking income was primarily due to the difference between the $50,000 servicing loss recorded in the current third quarter and the $10.0 million of servicing income recorded in the year-earlier three months. The impact of the year-over-year decline in servicing income was tempered by a $917,000 rise in income from originations.
It should be noted that the amount of mortgage banking income we record in any given quarter is likely to vary, and therefore is difficult to predict. The mortgage banking income we record depends in large part on the volume of loans originated which, in turn, depends on a variety of factors, including changes in market interest rates and economic conditions, competition, refinancing activity, and loan demand.
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The following table presents all the components of non-interest income for the three months ended September 30, 2015, June 30, 2015, and September 30, 2014:
Non-Interest Income Analysis
BOLI income
FDIC indemnification (expense) income
Other income:
Peter B. Cannell & Co., Inc.
Third-party investment product sales
Total other income
Non-Interest Expense
Non-interest expense has two primary components: operating expenses, which include compensation and benefits, occupancy and equipment, and general and administrative (“G&A”) expenses; and the amortization of the CDI stemming from certain of our business combinations prior to 2009.
In the three months ended September 30, 2015, we recorded non-interest expense of $147.3 million, reflecting a $4.6 million decrease from the trailing-quarter level and a $2.1 million increase year-over-year.
Operating expenses declined to $146.0 million in the current third quarter from $150.6 million in the second quarter of this year. The sequential decline was driven by a $5.7 million reduction in G&A expense to $35.9 million, which more than offset the impact of a $1.1 million increase in compensation and benefits expense to $84.2 million and an even more modest rise in occupancy and equipment expense to $26.0 million. The sequential decline in G&A expense was primarily driven by a $3.1 million reduction in franchise taxes and a $2.6 million decrease in FDIC deposit insurance premiums to $9.2 million.
Year-over-year, operating expenses rose $2.9 million, as the benefit of a $5.6 million decline in G&A expense was exceeded by the impact of a $6.1 million increase in compensation and benefits expense, together with a $2.4 million rise in occupancy and equipment expense. The year-over-year decline in G&A expense was primarily due to the same factors that drove the sequential reduction; the year-over-year rise in compensation and benefits expense was largely due to normal salary increases and an increase in medical benefits expense.
Income Tax Expense
Income tax expense declined $7.0 million sequentially and $4.8 million year-over-year to $64.0 million in the three months ended September 30, 2015. The respective declines were primarily due to pre-tax income, which fell $16.0 million and $10.3 million, respectively, from the levels recorded in the trailing and year-earlier quarters to $178.7 million in the current three-month period. In addition, the effective tax rate was 35.83% in the current third quarter, as compared to 36.48% and 36.39%, respectively, in the three months ended June 30, 2015 and September 30, 2014.
EARNINGS SUMMARY FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2015
In the first nine months of 2015 and 2014, we generated earnings of $357.7 million and $354.2 million, respectively, with both amounts being equivalent to $0.80 per diluted share.
Net interest income totaled $857.3 million in the current nine-month period, a $606,000 increase from the year-earlier amount. While interest income rose $6.8 million year-over-year to $1.3 billion, the benefit was largely offset by the impact of a $6.2 million increase in interest expense to $409.8 million. Our net interest margin, meanwhile, declined to 2.63% in the current nine-month period from 2.69% in the year-earlier nine months.
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The following factors contributed to the year-over-year increase in net interest income and the year-over-year decline in net interest margin:
The following table sets forth certain information regarding our average balance sheet for the nine-month periods indicated, including the average yields on our interest-earning assets and the average costs of our interest-bearing liabilities. Average yields are calculated by dividing the interest income produced by the average balance of interest-earning assets. Average costs are calculated by dividing the interest expense produced by the average balance of interest-bearing liabilities. The average balances for the nine-month periods are derived from average balances that are calculated daily. The average yields and costs include fees, as well as premiums and discounts (including mark-to-market adjustments from acquisitions), that are considered adjustments to such average yields and costs.
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Recoveries of (Provisions for) Loan Losses
Recovery of (Provision for) Losses on Non-Covered Loans
Reflecting the methodology used by management to calculate the allowance for non-covered loan losses, we recovered $3.3 million from said allowance in the nine months ended September 30, 2015. No losses on non-covered loans were recovered or provided for in the nine months ended September 30, 2014.
Recovery of (Provision for) Losses on Covered Loans
In the first nine months of 2015 and 2014, we recovered $5.4 million and $18.4 million, respectively, from the allowance for covered loan losses, reflecting an increase in expected cash flows from certain pools of covered loans as their credit quality improved. In connection with the respective recoveries, we recorded FDIC indemnification expense of $4.3 million and $14.7 million in “Non-interest income” in the corresponding periods.
In contrast to the marked decline in non-interest income in the current third quarter, non-interest income rose $20.6 million year-over-year to $151.7 million in the nine months ended September 30, 2015.
The increase was primarily driven by a $24.0 million increase in “other” other income to $36.4 million which included the aforementioned $7.8 million gain on the sale of an OREO property in the second quarter, and gains of $21.7 million on the sale of multi-family and CRE loans through participations in the first nine months of this year.
The increase in non-interest income was somewhat tempered by a $4.4 million decline in net securities gains to $943,000 and by a $4.7 million decline in mortgage banking income to $41.8 million. While income from originations rose $18.3 million
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year-over-year, to $33.6 million, the benefit was exceeded by the impact of a $22.9 million reduction in servicing income to $8.2 million, as the benefit of the servicing income recorded in the first six months of this year was exceeded by the impact of the third-quarter servicing loss. Furthermore, we recorded a $3.9 million gain on Visa shares sold in the first nine months of 2014; no comparable gain was recorded in the first nine months of this year.
The following table presents the components of non-interest income for the nine months ended September 30, 2015 and 2014:
BOLI
Net gain on sale of securities
Non-interest expense rose $16.7 million year-over-year to $456.1 million in the current nine-month period, the net effect of an $18.9 million increase in operating expenses to $451.9 million and a $2.2 million decline in the amortization of CDI to $4.2 million.
While G&A expense fell $10.1 million year-over-year, to $120.2 million, the benefit was exceeded by the impact of a $25.8 million rise in compensation and benefits expense to $254.5 million. In addition, occupancy and equipment expense rose $3.2 million year-over-year to $77.2 million.
In addition to severance expenses of $4.0 million incurred in the first quarter, the increase in compensation and benefits expense was primarily driven by higher pension expenses, higher payroll taxes, and salary increases that took effect at the beginning of the year. The reduction in G&A expense was largely due to a $3.1 million decline in franchise taxes, in addition to lower FDIC deposit insurance premiums and a reduction in expenses related to the management and disposition of OREO.
Income tax expense fell $8.7 million year-over-year to $204.0 million in the nine months ended September 30, 2015, while the effective tax rate fell to 36.32% from 37.51%.
In addition to a $5.2 million decline in pre-tax income to $561.6 million, the year-over-year reduction in income tax expense was largely due to a one-time deferred tax benefit of $1.4 million in connection with the enactment of new tax laws by the City of New York in the current year’s second quarter, and a one-time deferred tax charge of $4.5 million in connection with the enactment of new tax laws by the State of New York in the first quarter of 2014.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Quantitative and qualitative disclosures about the Company’s market risk were presented on pages 90-94 of our 2014 Annual Report on Form 10-K, filed with the U.S. Securities and Exchange Commission (the “SEC”) on March 2, 2015. Subsequent changes in the Company’s market risk profile and interest rate sensitivity are detailed in the discussion entitled “Asset and Liability Management and the Management of Interest Rate Risk” earlier in this quarterly report.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15(b), as adopted by the Securities and Exchange Commission (the “SEC”) under the Securities Exchange Act of 1934 (the “Exchange Act”). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the period.
Disclosure controls and procedures are the controls and other procedures that are designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
(b) Changes in Internal Control over Financial Reporting
There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
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PART II – OTHER INFORMATION
Item 1. Legal Proceedings
The Company is involved in various legal actions arising in the ordinary course of its business. All such actions, in the aggregate, involve amounts that are believed by management to be immaterial to the financial condition and results of operations of the Company.
Item 1A. Risk Factors
In addition to the other information set forth in this report, and the risk factors discussed in Part I, “Item 1A. Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014, there are several additional risk factors in connection with the Company’s proposed merger with Astoria Financial Corporation and its fourth quarter 2015 balance sheet repositioning. These additional risk factors are described below:
Risks Related to the Common Stock
The price of our common stock may fluctuate.
The market price of our common stock could be subject to significant fluctuations due to changes in sentiment in the market regarding our operations or business prospects, including market sentiment regarding our entry into the merger agreement. These risks may be affected by:
Furthermore, given recent and ongoing volatile market and economic conditions, the market price of our common stock may continue to be subject to further significant market fluctuations. While the U.S. and other governments continue efforts to restore confidence in financial markets and promote economic growth, we cannot assure you that continued or further market and economic turmoil will not occur in the near or long term, which would negatively affect our business, financial condition, and results of operations, as well as the price and trading volume volatility of our common stock.
We will issue additional shares if the Astoria Financial merger is completed and there may be future sales or other dilution of our equity that may adversely affect the market price of our common stock.
Based on the number of shares of Astoria Financial common stock outstanding as of October 26, 2015, we expect to issue approximately 101 million shares of common stock based on the closing price on October 28, 2015 if the proposed merger with Astoria Financial is completed.
Except as required by the underwriters in connection with the October 2015 common stock offering discussed in the section entitled “Underwriting” in the prospectus supplement dated October 29, 2015, we are not restricted from issuing additional common stock, preferred stock, and any securities that are convertible into or exchangeable for, or that represent the right to receive, common stock. Any issuance of additional common stock will dilute the ownership interest of existing common stockholders. Further, the market price of our common stock could decline in the future as a result of future offerings by us of our common stock, preferred stock, or securities convertible into or exchangeable for, or that represent the right to receive, common stock, or the perception that such offers or sales could occur.
Our common stock is equity and is subordinate to our existing and future indebtedness and preferred stock.
Shares of our common stock are equity interests and do not constitute indebtedness. As such, shares of our common stock rank junior to all indebtedness of, and other non-equity claims on, the Company with respect to assets available to satisfy claims. Additionally, holders of our common stock are subject to the prior dividend and liquidation rights of the holders of any series of preferred stock we may issue.
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Various factors could make a takeover attempt of the Company more difficult to achieve.
Certain provisions of our amended and restated certificate of incorporation and amended and restated bylaws, in addition to certain federal banking laws and regulations, could make it more difficult for a third party to acquire the Company without the consent of our Board of Directors, even if doing so were perceived to be beneficial to our stockholders. These provisions also make it more difficult to remove our current Board of Directors or management or to appoint new directors, and also regulate the timing and content of stockholder proposals and nominations, and qualification for service on our Board of Directors. In addition, we have entered into employment agreements with certain executive officers and directors that would require payments to be made to them in the event that their employment was terminated following a change in control of the Company or the Banks. These payments may have the effect of increasing the costs of acquiring the Company. The combination of these provisions could effectively inhibit a non-negotiated merger or other business combination, which could adversely impact the market price of our common stock.
If we defer payments on our trust preferred capital debt securities or are in default under the related indentures, we will be prohibited from making distributions on our common stock.
The terms of our outstanding trust preferred capital debt securities prohibit us from declaring or paying any dividends or distributions on our capital stock, including our common stock, or purchasing, acquiring, or making a liquidation payment on such stock, if an event of default has occurred and is continuing under the applicable indenture, we are in default with respect to a guarantee payment under the guarantee of the related trust preferred securities, or we have given notice of our election to defer interest payments but the related deferral period has not yet commenced or a deferral period is continuing. In addition, without notice to, or consent from, the holders of our common stock, we may issue additional series of trust preferred capital debt securities with similar terms or enter into other financing agreements that limit our ability to purchase or pay dividends or distributions on our common stock.
Risks Related to the Proposed Merger and the Balance Sheet Repositioning
The market price of shares of our common stock after the merger may be affected by factors different from those affecting the shares currently.
Upon completion of the merger, each share of Astoria Financial common stock will be converted into the right to receive one share of Company common stock and $0.50 in cash, and holders of Astoria Financial common stock will become holders of Company common stock. The Company’s business differs in important respects from that of Astoria Financial and, accordingly, the results of operations of the combined company and the market price of Company common stock after the completion of the merger may be affected by factors different from those currently affecting the independent results of operations of each of the Company and Astoria Financial .
The success of the merger and our integration of the acquired branches will depend on a number of uncertain factors.
The success of the merger will depend on a number of factors, including, without limitation:
Integrating the Acquired Branches will be an operation of substantial size and expense, and may be affected by general market and economic conditions or government actions affecting the financial industry generally. Integration efforts will also likely divert our management’s attention and resources. No assurance can be given that we will be able to integrate the Acquired Branches successfully, and the integration process could result in the loss of key employees, the disruption of ongoing business, or inconsistencies in standards, controls, procedures, and policies that adversely affect our ability to maintain relationships with clients, customers, depositors, and employees or to achieve the anticipated benefits of the merger. We may also encounter unexpected difficulties or costs during the integration that could adversely affect our earnings and financial condition, perhaps materially. Additionally, no assurance can be given that the operation of the Acquired Branches will not adversely affect our existing profitability, that we will be able to achieve results in the future similar to those achieved by our existing banking business, or that we will be able to manage any growth resulting from the merger effectively.
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There can be no assurance that we will be able to complete the balance sheet repositioning on the terms currently contemplated or at all.
We intend to complete the balance sheet repositioning in the current fourth quarter, however, these actions, which require numerous individual steps, may take longer than anticipated or result in greater costs than currently contemplated. If we are unable to complete all or a portion of the balance sheet repositioning, we would not get the benefit of the after-tax savings or other advantages created by the repositioning.
In connection with the merger, we will assume Astoria Financial’s outstanding debt obligations and preferred stock, and our level of indebtedness following the completion of the merger could adversely affect our ability to raise additional capital and to meet our obligations under our existing indebtedness.
In connection with the merger, we will assume $250.0 million of Astoria Financial’s outstanding indebtedness and Astoria Financial’s obligations related to its outstanding preferred stock. Our existing debt, together with any future incurrence of additional indebtedness, and assumption of Astoria Financial’s outstanding securities could have important consequences for our creditors and our shareholders. For example, it could:
Following completion of the merger, the holders of our issued and outstanding shares of preferred stock, which we will assume from Astoria Financial, as well as any shares of preferred stock that we may issue in the future, would receive, upon our voluntary or involuntary liquidation, dissolution, or winding up, before any payment is made to holders of our common stock, their liquidation preferences as well as any accrued and unpaid distributions. These payments would reduce the remaining amount of our assets, if any, available for distribution to holders of our common stock.
Termination of the merger agreement could negatively impact the Company.
If the merger agreement is terminated, there may be various consequences. For example, the Company’s businesses may have been impacted adversely by the failure to pursue other beneficial opportunities due to the focus of management on the merger, without realizing any of the anticipated benefits of completing the merger. Additionally, if the merger agreement is terminated, the market price of the Company’s common stock could decline to the extent that the market prices since the announcement of the merger reflect a market assumption that the merger will be completed. If the merger agreement is terminated under certain circumstances, Astoria Financial or the Company may be required to pay to the other party a termination fee equal to $69.5 million.
The Company will be subject to business uncertainties while the merger is pending.
Uncertainty about the effect of the merger on employees and customers may have an adverse effect on the Company. These uncertainties may impair the Company’s ability to attract, retain, and motivate key personnel until the merger is completed, and could cause customers and others that deal with the Company to seek to change existing business relationships with the Company. Retention of certain employees by the Company may be challenging while the merger is pending, as certain employees may experience uncertainty about their future roles with the Company. If key employees depart because of issues relating to the uncertainty and difficulty of integration or a desire not to remain with the Company, the Company’s business could be harmed.
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If the merger is not completed, the Company will have incurred substantial expenses without realizing the expected benefits of the merger.
The Company has incurred and will incur substantial expenses in connection with the negotiation and completion of the transactions contemplated by the merger agreement, as well as the costs and expenses related to the offering of shares of its common stock and all filing and other fees paid to the SEC in connection with the offering. If the merger is not completed, the Company would have to recognize these expenses without realizing the expected benefits of the merger.
Regulatory approvals may not be received, may take longer than expected, or may impose conditions that are not presently anticipated or that could have an adverse effect on the combined company following the merger.
Before the merger and the bank merger may be completed, the Company must obtain approvals from the Federal Reserve, the FDIC, and the NYSDFS. Other approvals, waivers, or consents from regulators may also be required. In determining whether to grant these approvals the regulators consider a variety of factors, including the regulatory standing of each party. An adverse development in either party’s regulatory standing or these factors could result in an inability to obtain approval or delay their receipt. These regulators may impose conditions on the completion of the merger of the holding companies or the banks, or require changes to the terms of these mergers. Such conditions or changes could have the effect of delaying or preventing completion of the mergers or imposing additional costs on or limiting the revenues of the combined company following the mergers, any of which might have an adverse effect on the combined company following the merger.
The processing time for obtaining regulatory approvals for bank mergers, particularly for larger institutions, has increased since the financial crisis. Specifically, the Dodd-Frank Act requires bank regulators to consider financial stability concerns when evaluating a proposed bank merger. We are only aware of one other transaction since the enactment of the Dodd-Frank Act that caused the surviving entity to cross the $50 billion in total consolidated assets threshold.
In a recent approval order, the Federal Reserve has stated that if material weaknesses are identified by examiners before a banking organization applies to engage in expansionary activity, the Federal Reserve will not in the future allow the application to remain pending while the banking organization addresses its weaknesses. The Federal Reserve explained that, in the future, if issues arise during processing of an application, a banking organization will withdraw its application pending resolution of any supervisory concerns. Accordingly, if there is an adverse development in either party’s regulatory standing we may be required to withdraw the application for approval of the proposed merger.
If the merger is successfully completed, our total consolidated assets following the completion of the merger will be over $50 billion and we will be subject to stricter prudential standards required by the Dodd-Frank Act for large bank holding companies.
Pursuant to the current requirements of the Dodd-Frank Act, a bank holding company whose total consolidated assets average more than $50 billion over the four most recent quarters is determined to be a “systemically important financial institution”, or a SIFI, and therefore is subject to stricter prudential standards, primarily including capital requirements, liquidity requirements, risk-management requirements, capital stress test requirements, dividend limits, and early remediation regimes. The Dodd-Frank Act permits, but does not require, the Federal Reserve to apply heightened prudential standards in a number of other areas, including short-term debt limits and enhanced public disclosure.
Following the closing of the proposed merger, based on current definitions and requirements for a SIFI, we will become subject to the enhanced regulatory standards applicable to bank holding companies at the end of the quarter in which the proposed merger closes, including but not limited to submitting an annual capital plan, undergoing an annual supervisory capital stress test and two company-run capital stress tests, enhanced requirements for liquidity risk management and overall risk management, liquidity buffer and liquidity stress testing requirements, submitting a resolution plan, implementation of an enhanced compliance program under the Volcker Rule, and payment of additional Federal Reserve assessments. As a SIFI, we would be required to participate in the annual Comprehensive Capital Assessment and Review, and we would be subjected to heightened supervisory expectations in a range of other areas, including enterprise-wide compliance risk management, corporate governance, recovery and resolution planning, and management of core business lines. Other Dodd-Frank Act requirements applicable to SIFIs that have not yet been implemented in final regulations could apply to us in the future, including single counterparty credit limits, early remediation requirements, and limits on payment of incentive-based executive compensation. The date on which we must comply with each SIFI requirement will vary, depending on the terms of the particular regulation and timing of the closing of the proposed merger with Astoria Financial.
If the merger is successfully completed, we will be subject to the modified Liquidity Coverage Ratio applicable to bank holding companies with $50 billion or more in total consolidated assets.
On September 3, 2014, the Federal Reserve and other banking regulators adopted final rules implementing a U.S. version of the Basel Committee’s Liquidity Coverage Ratio (the “LCR”) requirement. The LCR requirement, including the modified
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version applicable to certain bank holding companies with $50 billion or more in total consolidated assets, requires a banking organization to maintain an amount of unencumbered “high-quality liquid assets” to be at least equal to the amount of its total net cash outflows over a 30-day stress period. Only specific classes of assets qualify under the rule as high-quality assets (the numerator of the LCR), with riskier classes of assets subject to haircuts and caps. The total net cash outflow amount (the denominator of the LCR) is determined under the rule by applying outflow and inflow rates that reflect certain standardized assumptions against the balances of the banking organization’s funding sources, obligations, transactions, and assets over a 30-day stress period. Inflows that can be included to offset outflows are limited to 75% of outflows (which effectively means that banking organizations must hold high-quality liquid assets equal to 25% of outflows even if outflows perfectly match inflows over the stress period).
The initial compliance date for the modified LCR will be January 2016, with the requirement fully phased-in by January 2017. Although we are not currently subject to the modified LCR requirements, were we to have average total consolidated assets over the four most recent quarters in excess of $50 billion, we would have to comply with the requirements of the modified LCR beginning on the first day of the first quarter after which we exceed that threshold. The modified LCR is a minimum requirement, and the Federal Reserve can impose additional liquidity requirements as a supervisory matter.
This Form 10-Q contains limited financial information on which to evaluate the merger.
This Form 10-Q does not contain Astoria Financial’s financial information or pro forma combined financial information about the Company and Astoria Financial after giving effect to the merger. The financial condition of the combined company following the merger will impact the price of our common stock after 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.
The Company and Astoria Financial have operated and, until the completion of the merger, will continue to operate, independently. The success of the merger, including anticipated benefits and cost savings, will depend, in part, on the Company’s ability to successfully combine and integrate the businesses of the Company and Astoria Financial 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 the Company’s ability to successfully conduct its business, which could have an adverse effect on the Company’s financial results and the value of its common stock. If the Company experiences difficulties with the integration process and attendant systems conversion, 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 cause the Company and/or Astoria Financial to lose customers or cause customers to remove their accounts from the Company and/or Astoria Financial and move their business to competing financial institutions. Integration efforts between the two companies will also divert management’s attention and resources. These integration matters could have an adverse effect on each of Astoria Financial and the Company during this transition period and for an undetermined period after completion of the merger on the combined company. In addition, the actual cost savings of the merger could be less than anticipated.
Holders of Company common stock will have a reduced ownership and voting interest in the combined company after the merger and will exercise less influence over management.
We expect to issue approximately 101 million shares of common stock if the proposed merger with Astoria Financial is completed. Consequently, our shareholders before the merger, as a group, will exercise less influence over the management and policies of the combined company than they currently may have over the management and policies of the Company.
Lawsuits that may be filed against Astoria Financial and the Company could result in an injunction preventing the completion of the merger or a judgment resulting in the payment of damages.
The outcome of any such litigation is uncertain. If the cases are not resolved, these lawsuits could prevent or delay completion of the merger and result in substantial costs to the Company, including any costs associated with the indemnification of directors and officers. Plaintiffs may file additional lawsuits against the Company, Astoria Financial, and/or the directors and officers of either company in connection with the merger. The defense or settlement of any lawsuit or claim that remains unresolved at the time the merger is completed may adversely affect the Company’s business, financial condition, results of operations, and cash flows.
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The risks described above, in the 2014 Annual Report on Form 10-K, and in the prospectus supplement dated October 29, 2015 are not the only risks that the Company faces. Additional risks and uncertainties not currently known to the Company, or that the Company currently deems to be immaterial, also may have a material adverse impact on the Company’s business, financial condition, or results of operations.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Shares Repurchased Pursuant to the Company’s Stock-Based Incentive Plans
Participants in the Company’s stock-based incentive plans may have shares of common stock withheld to fulfill the income tax obligations that arise in connection with their exercise of stock options and the vesting of their stock awards. Shares that are withheld for this purpose are repurchased pursuant to the terms of the applicable stock-based incentive plan, rather than pursuant to the share repurchase program authorized by the Board of Directors, described below.
During the three months ended September 30, 2015, the Company allocated $317,000 toward the repurchase of shares of its common stock pursuant to the terms of its stock-based incentive plans, as indicated in the following table:
(dollars in thousands, except per share data)
Third Quarter 2015
July 1 – July 30
August 1 – August 31
September 1 – September 30
Total shares repurchased
Shares Repurchased Pursuant to the Board of Directors’ Share Repurchase Authorization
On April 20, 2004, the Board of Directors authorized the repurchase of up to five million shares of the Company’s common stock. Of this amount, 1,659,816 shares were still available for repurchase at September 30, 2015. Under said authorization, shares may be repurchased on the open market or in privately negotiated transactions. No shares have been repurchased under this authorization since August 2006.
Shares that are repurchased pursuant to the Board of Directors’ authorization, and those that are repurchased pursuant to the Company’s stock-based incentive plans, are held in our Treasury account and may be used for various corporate purposes, including, but not limited to, merger transactions and the vesting of restricted stock awards.
Item 3. Defaults upon Senior Securities
Not applicable.
Item 4. Mine Safety Disclosures
Item 5. Other Information
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Item 6. Exhibits
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SIGNATURES
Pursuant to the requirements 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.
Joseph R. Ficalora
President, Chief Executive Officer,
and Director
Thomas R. Cangemi
Senior Executive Vice President
and Chief Financial Officer
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