Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 2015
or
o Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from to
Commission File Number 001-34582
NORTHWEST BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
Maryland
27-0950358
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
100 Liberty Street, Warren, Pennsylvania
16365
(Address of principal executive offices)
(Zip Code)
(814) 726-2140
(Registrant’s telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
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 definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer x
Accelerated Filer o
Non-Accelerated Filer o
Smaller reporting company o
Indicate by check mark whether the registrant is a Shell Company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
Common Stock ($0.01 par value) 94,613,110 shares outstanding as of July 31, 2015
INDEX
PAGE
PART I
FINANCIAL INFORMATION
Item 1.
Financial Statements
Consolidated Statements of Financial Condition as of June 30, 2015 and December 31, 2014 (Unaudited)
1
Consolidated Statements of Income for the quarter and six months ended June 30, 2015 and 2014 (Unaudited)
2
Consolidated Statements of Comprehensive Income for the quarter and six months ended June 30, 2015 and 2014 (Unaudited)
3
Consolidated Statements of Changes in Shareholders’ Equity for the quarter ended June 30, 2015 and 2014 (Unaudited)
4
Consolidated Statements of Changes in Shareholders’ Equity for the six months ended June 30, 2015 and 2014 (Unaudited)
5
Consolidated Statements of Cash Flows for the six months ended June 30, 2015 and 2014 (Unaudited)
6
Notes to Consolidated Financial Statements (Unaudited)
8
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
49
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
66
Item 4.
Controls and Procedures
68
PART II
OTHER INFORMATION
Legal Proceedings
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
69
Mine Safety Disclosures
Item 5.
Other information
Item 6.
Exhibits
Signature
70
Certifications
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (Unaudited)
(in thousands, except share data)
June 30,
December 31,
2015
2014
Assets
Cash and due from banks
$
84,000
87,401
Interest-earning deposits in other financial institutions
208,311
152,671
Federal funds sold and other short-term investments
637
634
Marketable securities available-for-sale (amortized cost of $854,147 and $906,702)
861,157
912,371
Marketable securities held-to-maturity (fair value of $62,957 and $106,292)
61,464
103,695
Total cash and investments
1,215,569
1,256,772
Personal Banking:
Residential mortgage loans
2,597,170
2,521,456
Home equity loans
1,055,829
1,066,131
Other consumer loans
252,391
242,744
Total Personal Banking
3,905,390
3,830,331
Business Banking:
Commercial real estate loans
1,859,743
1,801,184
Commercial loans
359,524
358,376
Total Business Banking
2,219,267
2,159,560
Total loans
6,124,657
5,989,891
Allowance for loan losses
(59,057
)
(67,518
Total loans, net
6,065,600
5,922,373
Federal Home Loan Bank stock, at cost
38,066
33,293
Accrued interest receivable
18,682
18,623
Real estate owned, net
13,864
16,759
Premises and equipment, net
142,302
143,909
Bank owned life insurance
146,283
144,362
Goodwill
175,498
175,323
Other intangible assets
2,759
3,033
Other assets
45,887
60,586
Total assets
7,864,510
7,775,033
Liabilities and Shareholders’ equity
Liabilities:
Noninterest-bearing checking deposits
962,347
891,248
Interest-bearing checking deposits
928,417
874,623
Money market deposit accounts
1,143,199
1,179,070
Savings deposits
1,262,991
1,209,287
Time deposits
1,397,528
1,478,314
Total deposits
5,694,482
5,632,542
Borrowed funds
899,056
888,109
Junior subordinated deferrable interest debentures held by trusts that issued guaranteed capital debt securities
103,094
Advances by borrowers for taxes and insurance
41,763
30,507
Accrued interest payable
1,302
936
Other liabilities
56,463
57,198
Total liabilities
6,796,160
6,712,386
Shareholders’ equity:
Preferred stock, $0.01 par value: 50,000,000 authorized, no shares issued
—
Common stock, $0.01 par value: 500,000,000 shares authorized, 94,740,749 and 94,721,453 shares issued, respectively
947
Paid-in capital
624,321
626,134
Retained earnings
487,150
481,577
Unallocated common stock of employee stock ownership plan
(21,485
(21,641
Accumulated other comprehensive loss
(22,583
(24,370
Total shareholders’ equity
1,068,350
1,062,647
Total liabilities and shareholders’ equity
See accompanying notes to unaudited consolidated financial statements
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(in thousands, except per share data)
Quarter ended
Six months ended
Interest income:
Loans receivable
70,985
70,726
141,696
140,048
Mortgage-backed securities
2,058
2,666
4,292
5,459
Taxable investment securities
1,604
1,711
4,052
3,067
Tax-free investment securities
1,143
1,598
2,491
3,253
Interest-earning deposits
180
286
319
486
Total interest income
75,970
76,987
152,850
152,313
Interest expense:
Deposits
5,691
6,421
11,457
12,911
8,101
7,793
16,234
15,507
Total interest expense
13,792
14,214
27,691
28,418
Net interest income
62,178
62,773
125,159
123,895
Provision for loan losses
1,050
8,285
1,950
15,770
Net interest income after provision for loan losses
61,128
54,488
123,209
108,125
Noninterest income:
Gain on sale of investments
566
349
661
3,697
Service charges and fees
9,228
9,042
17,887
17,450
Trust and other financial services income
3,094
3,055
5,870
6,102
Insurance commission income
2,210
2,237
4,638
4,801
Loss on real estate owned, net
(541
(562
(1,587
(697
Income from bank owned life insurance
1,008
1,921
2,051
Mortgage banking income
218
265
458
514
Other operating income
742
991
1,890
Total noninterest income
16,525
16,427
31,150
35,808
Noninterest expense:
Compensation and employee benefits
28,920
28,543
56,815
56,515
Premises and occupancy costs
5,899
5,740
12,166
12,297
Office operations
3,508
3,868
7,188
7,625
Processing expenses
7,392
6,639
14,597
13,228
Marketing expenses
3,190
2,931
5,166
4,568
Federal deposit insurance premiums
1,286
1,338
2,633
2,635
Professional services
1,652
1,775
3,444
3,837
Amortization of other intangible assets
269
331
537
662
Real estate owned expense
459
1,206
1,098
Acquisition expense
467
814
Other expenses
2,038
2,182
4,280
4,504
Total noninterest expense
55,135
53,806
108,846
106,969
Income before income taxes
22,518
17,109
45,513
36,964
Federal and state income taxes
7,213
4,435
14,038
9,679
Net income
15,305
12,674
31,475
27,285
Basic earnings per share
0.17
0.14
0.34
0.30
Diluted earnings per share
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(in thousands)
Net Income
Other comprehensive income net of tax:
Net unrealized holding gains/ (losses) on marketable securities:
Unrealized holding gains/ (losses) net of tax of $1,139, $(1,997), $(746) and $(5,576), respectively
(1,788
3,123
1,164
8,719
Reclassification adjustment for gains included in net income, net of tax of $179, $130, $222 and $1,348 respectively
(279
(204
(347
(2,108
Net unrealized holding gains on marketable securities
(2,067
2,919
817
6,611
Change in fair value of interest rate swaps, net of tax of $(263), $(53), $(287) and $(188), respectively
488
98
532
Defined benefit plan:
Reclassification adjustment for prior period service costs included in net income, net of tax of $(140), $74, $(280) and $149, respectively
219
(138
438
(276
Other comprehensive income/ (loss)
(1,360
2,879
1,787
6,684
Total comprehensive income
13,945
15,553
33,262
33,969
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)
(dollars in thousands, expect share data)
Accumulated
Other
Unallocated
Total
Common Stock
Paid-in
Retained
Comprehensive
common stock
Shareholders’
Quarter ended June 30, 2014
Shares
Amount
Capital
Earnings
Income/ (loss)
of ESOP
Equity
Beginning balance at March 31, 2014
94,464,430
945
622,758
562,933
(8,095
(22,632
1,155,909
Comprehensive income:
Other comprehensive income, net of tax of $(1,846)
Exercise of stock options
212,635
2,167
2,169
Stock compensation expense
272,630
1,288
432
1,722
Dividends paid ($1.13 per share)
(104,569
Ending balance at June 30, 2014
94,949,695
949
626,213
471,038
(5,216
(22,200
1,070,784
Quarter ended June 30, 2015
Beginning balance at March 31, 2015
94,553,350
946
624,584
484,774
(21,223
(21,565
1,067,516
Other comprehensive loss, net of tax of $915
Total comprehensive income/ (loss)
60,849
632
Stock-based compensation expense, including tax benefit of $6
306,350
1,316
80
1,399
Share repurchases
(179,800
(2
(2,211
(2,213
Dividends paid ($0.14 per share)
(12,929
Ending balance at June 30, 2015
94,740,749
Six months ended June 30, 2014
Beginning balance at December 31, 2013
94,243,713
943
619,678
569,547
(11,900
(23,083
1,155,185
Other comprehensive income, net of tax of $(4,267)
433,352
4,459
4,463
Stock-based compensation expense
2,076
883
2,961
Dividends paid ($1.36 per share)
(125,794
Six months ended June 30, 2015
Beginning balance at December 31, 2014
94,721,453
Other comprehensive income, net of tax of $(1,091)
210,746
2,065
2,067
2,120
156
2,279
(497,800
(5
(5,998
(6,003
Dividends paid ($0.28 per share)
(25,902
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
OPERATING ACTIVITIES:
Adjustments to reconcile net income to net cash provided by operating activities:
Net gain on sale of assets
(311
(3,874
Net depreciation, amortization and accretion
2,571
4,937
Decrease in other assets
11,233
4,661
Increase/ (decrease) in other liabilities
1,169
(3,531
Net amortization on marketable securities
173
210
Noncash write-down of real estate owned
1,927
1,381
Origination of loans held for sale
(221
(758
Proceeds from sale of loans held for sale
224
1,023
Noncash compensation expense related to stock benefit plans
Net cash provided by operating activities
52,469
50,065
INVESTING ACTIVITIES:
Purchase of marketable securities available-for-sale
(59,980
(22,805
Proceeds from maturities and principal reductions of marketable securities held-to-maturity
42,409
7,205
Proceeds from maturities and principal reductions of marketable securities available-for-sale
111,630
70,071
Proceeds from sale of marketable securities available-for-sale
1,214
6,048
Loan originations
(996,253
(939,594
Proceeds from loan maturities and principal reductions
850,823
842,751
Purchase of Federal Home Loan Bank stock
(4,773
(271
Proceeds from sale of real estate owned
5,704
Sale of real estate owned for investment, net
304
Purchase of premises and equipment
(5,172
(5,034
Acquistions, net of cash received
(438
(2,792
Net cash used in investing activities
(54,532
(38,413
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (continued)
FINANCING ACTIVITIES:
Increase in deposits, net
61,940
105,043
Proceeds from long-term borrowings
85,000
Repayments of long-term borrowings
(50,026
(27
Net decrease in short-term borrowings
(24,027
(12,283
Increase in advances by borrowers for taxes and insurance
11,256
11,008
Cash dividends paid
(125,793
Purchase of common stock for retirement
Proceeds from stock options exercised
Net provided by/ (used in) financing activities
54,305
(17,589
Net increase/ (decrease) in cash and cash equivalents
52,242
(5,937
Cash and cash equivalents at beginning of period
240,706
391,905
Cash and cash equivalents at end of period
292,948
385,968
Cash and cash equivalents:
97,467
287,867
Total cash and cash equivalents
Cash paid during the period for:
Interest on deposits and borrowings (including interest credited to deposit accounts of $10,508 and $11,608, respectively)
27,325
28,490
Income taxes
4,823
14,872
Business acquistions:
Fair value of assets acquired
2,798
Cash paid
Liabilities assumed
Non-cash activities:
Loans foreclosures and repossessions
5,012
3,707
Sale of real estate owned financed by the Company
174
330
7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - Unaudited
(1) Basis of Presentation and Informational Disclosures
Northwest Bancshares, Inc. (the “Company”) or (“NWBI”), a Maryland corporation headquartered in Warren, Pennsylvania, is a savings and loan holding company regulated by the Board of Governors of the Federal Reserve System. The Company was incorporated to be the successor to Northwest Bancorp, Inc. upon the completion of the mutual-to-stock conversion of Northwest Bancorp, MHC in December 2009. The primary activity of the Company is the ownership of all of the issued and outstanding common stock of Northwest Bank, a Pennsylvania-chartered savings bank (“Northwest”). Northwest is regulated by the FDIC and the Pennsylvania Department of Banking. At June 30, 2015, Northwest operated 161 community-banking offices throughout Pennsylvania, western New York, eastern Ohio and Maryland.
The accompanying unaudited consolidated financial statements include the accounts of the Company and its subsidiary, Northwest, and Northwest’s subsidiaries Northwest Settlement Agency, LLC, Northwest Consumer Discount Company, Northwest Financial Services, Inc., Northwest Advisors, Inc., Northwest Capital Group, Inc., Allegheny Services, Inc., Great Northwest Corporation, Boetger & Associates, Inc. and The Bert Company. The unaudited consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information or footnotes required for complete annual financial statements. In the opinion of management, all adjustments necessary for the fair presentation of the Company’s financial position and results of operations have been included. The consolidated statements have been prepared using the accounting policies described in the financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014 updated, as required, for any new pronouncements or changes.
Certain items previously reported have been reclassified to conform with the current year’s reporting format.
The results of operations for the quarter and six months ended June 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015, or any other period.
Stock-Based Compensation
On May 20, 2015, we awarded employees 600,570 stock options and directors 64,800 stock options with an exercise price of $12.37 and grant date fair value of $1.14 per stock option. On May 20, 2015, we also awarded employees 282,050 restricted common shares and directors 24,300 restricted common shares with a grant date fair value of $12.31. Awarded stock options and common shares vest over a ten-year period with the first vesting occurring on the grant date. Stock-based compensation expense of $1.4 million and $1.7 million for the quarters ended June 30, 2015 and 2014, respectively, and $2.3 million and $3.0 million for the six months ended June 30, 2015 and 2014, respectively, was recognized in compensation expense relating to our stock benefit plans. At June 30, 2015 there was compensation expense of $4.8 million to be recognized for awarded but unvested stock options and $16.3 million for unvested common shares.
Income Taxes- Uncertain Tax Positions
Accounting standards prescribe a comprehensive model for how a company should recognize, measure, present and disclose in its financial statements uncertain tax positions that the company has taken or expects to take on a tax return. A tax benefit from an uncertain position may be recognized only if it is “more likely than not” that the position is sustainable, based on its technical merits. The tax benefit of a qualifying position is the largest amount of tax benefit that is greater than 50% likely of being realized
upon ultimate settlement with a taxing authority having full knowledge of all relevant information. At June 30, 2015 we had no liability for unrecognized tax benefits.
We recognize interest accrued related to: (1) unrecognized tax benefits in federal and state income taxes and (2) refund claims in other operating income. We recognize penalties (if any) in federal and state income taxes. There is no amount accrued for the payment of interest or penalties at June 30, 2015. We are subject to audit by the Internal Revenue Service and any state in which we conduct business for the tax periods ended December 31, 2013, 2012 and 2011. We are currently under audit by the state of New York for the tax periods ended December 31, 2013, 2012 and 2011.
Recent Accounting Pronouncements
In May 2014 the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers”. This guidance supersedes the revenue recognition requirements in Topic 605, Revenue Recognition, and most industry-specific guidance. The core principle of this guidance requires an entity to recognize revenue upon 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 and provides five steps to be analyzed to accomplish the core principle. This guidance is effective retrospectively for annual reporting periods beginning after December 15, 2017, including interim periods within those years and early adoption is not permitted. We are currently evaluating the impact this standard will have on our results of operations and financial position.
In June 2014 the FASB issued ASU 2014-12, “Compensation—Stock Compensation”. This guidance requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. Specifically, if the performance target becomes probable of being achieved before the end of the requisite service period, the remaining unrecognized compensation cost should be recognized prospectively over the remaining requisite service period. Further, the total amount of compensation cost recognized during and after the requisite service period should reflect the number of awards that are expected to vest and should be adjusted to reflect those awards that ultimately vest. This guidance is effective for annual periods beginning after December 15, 2015, including interim periods within those years and early adoption is permitted. We do not expect that this standard will have a material impact on our results of operations or financial position.
In February 2015 the FASB issued ASU 2015-02, “Consolidation”. This guidance amends existing standards regarding the evaluation of certain legal entities and their consolidation in the financial statements. The amendments modify the evaluation of whether limited partnerships and similar legal entities are variable interest entities or voting interest entities and eliminate the presumption that a general partner should consolidate a limited partnership. The amendments also affect the consolidation analysis of reporting entities that are involved with variable interest entities and provide a scope exception from consolidation guidance for reporting entities with interests in legal entities that are required to comply with or operate in accordance with requirements that are similar to those in Rule 2a-7 of the Investment Company Act of 1940 for registered money market funds. This guidance is effective for annual periods beginning after December 15, 2015, including interim periods within those years and early adoption is permitted. We do not expect that this standard will have a material impact on our results of operations or financial position.
9
(2) Business Segments
We operate in two reportable business segments: Community Banking and Consumer Finance. The Community Banking segment provides services traditionally offered by full-service community banks, including business and personal deposit accounts and business and personal loans, as well as insurance, brokerage and investment management and trust services. The Consumer Finance segment, which is comprised of Northwest Consumer Discount Company, a subsidiary of Northwest, operates 51 offices in Pennsylvania and offers personal installment loans for a variety of consumer and real estate products. This activity is funded primarily through an intercompany borrowing relationship with Allegheny Services, Inc., a subsidiary of Northwest. Net income is the primary measure used by management to measure segment performance. The following tables provide financial information for these reportable segments. The “All Other” column represents the parent company and elimination entries necessary to reconcile to the consolidated amounts presented in the financial statements.
At or for the quarter ended:
Community
Consumer
June 30, 2015 ($ in 000’s)
Banking
Finance
All other (1)
Consolidated
External interest income
71,273
4,492
205
Intersegment interest income
582
(582
Interest expense
12,781
429
850
200
Noninterest income
16,080
411
34
Noninterest expense
51,682
3,081
372
Income tax expense (benefit)
7,183
434
(404
15,439
606
(740
7,740,273
108,348
15,889
June 30, 2014 ($ in 000’s)
72,061
4,706
220
591
(591
13,148
475
7,500
785
15,932
482
13
50,540
2,948
318
4,489
358
(412
12,907
506
(739
7,772,277
105,909
22,442
7,900,628
(1) Eliminations consist of intercompany loans, interest income and interest expense.
10
At or for the six months ended:
143,604
8,822
424
1,157
(1,157
25,669
865
1,100
30,406
681
63
102,122
6,034
690
14,218
609
(789
32,058
853
(1,436
142,405
9,365
543
1,197
(1,197
26,317
904
14,350
1,420
32,689
770
2,349
100,402
5,869
698
9,002
684
(7
26,220
965
100
11
(3) Investment securities and impairment of investment securities
The following table shows the portfolio of investment securities available-for-sale at June 30, 2015 (in thousands):
Gross
unrealized
Amortized
holding
Fair
cost
gains
losses
value
Debt issued by the U.S. government and agencies:
Due in one year or less
21
Debt issued by government sponsored enterprises:
500
508
Due after one year through five years
320,553
466
(1,035
319,984
Due after five years through ten years
24,500
(28
24,472
Equity securities
1,417
515
1,932
Municipal securities:
1,085
1,088
6,733
118
6,851
4,651
113
4,764
Due after ten years
48,627
1,651
(32
50,246
Corporate debt issues:
17,002
2,324
(396
18,930
Residential mortgage-backed securities:
Fixed rate pass-through
65,398
2,693
(321
67,770
Variable rate pass-through
60,275
3,182
(8
63,449
Fixed rate non-agency CMOs
2,793
320
3,113
Fixed rate agency CMOs
201,346
579
(3,684
198,241
Variable rate agency CMOs
99,246
578
(36
99,788
Total residential mortgage-backed securities
429,058
7,352
(4,049
432,361
Total marketable securities available-for-sale
854,147
12,550
(5,540
12
The following table shows the portfolio of investment securities available-for-sale at December 31, 2014 (in thousands):
25
310,172
287
(2,672
307,787
25,746
25,718
2,591
682
(116
3,157
810
15
825
7,878
132
8,010
6,965
115
7,080
51,839
2,391
54,230
18,267
2,579
(419
20,427
72,852
3,149
(124
75,877
66,140
3,466
69,598
3,162
246
3,408
226,413
685
(5,331
221,767
113,842
657
(37
114,462
482,409
8,203
(5,500
485,112
906,702
14,404
(8,735
The following table shows the portfolio of investment securities held-to-maturity at June 30, 2015 (in thousands):
4,641
36
4,677
25,831
544
26,375
7,292
408
7,700
3,927
96
4,023
18,762
392
19,154
1,011
17
1,028
30,992
913
31,905
Total marketable securities held-to-maturity
1,493
62,957
The following table shows the portfolio of investment securities held-to-maturity at December 31, 2014 (in thousands):
10,207
141
10,348
56,545
1,314
57,859
8,236
477
8,713
4,273
122
4,395
23,382
531
23,913
1,052
1,064
36,943
1,142
38,085
2,597
106,292
The following table shows the fair value of and gross unrealized losses on investment securities, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position at June 30, 2015 (in thousands):
Less than 12 months
12 months or more
Unrealized
Fair value
loss
U.S. government and agencies
101,837
(340
125,031
(723
226,868
(1,063
Municipal securities
750
Corporate issues
2,028
Residential mortgage- backed securities - agency
18,148
(73
166,264
(3,976
184,412
Total temporarily impaired securities
120,735
(445
293,323
(5,095
414,058
14
The following table shows the fair value of and gross unrealized losses on investment securities, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position at December 31, 2014 (in thousands):
28,878
(67
244,828
(2,633
273,706
(2,700
Corporate debt issues
2,003
20,832
(79
195,505
(5,421
216,337
50,216
(262
442,336
(8,473
492,552
We review our investment portfolio on a quarterly basis for indications of impairment. This review includes analyzing the length of time and the extent to which amortized costs have exceeded fair values, the financial condition and near-term prospects of the issuer, including any specific events which may influence the operations of the issuer, and the intent to hold the investments for a period of time sufficient to allow for a recovery in value. Certain investments are evaluated using our best estimate of future cash flows. If the estimate of cash flows indicates that an adverse change has occurred, other-than-temporary impairment is recognized for the amount of the unrealized loss that was deemed credit related.
Credit related other-than-temporary impairment on all debt securities is recognized in earnings while noncredit related other-than-temporary impairment on available-for-sale debt securities, not expected to be sold, is recognized in other comprehensive income.
The table below shows a cumulative roll forward of credit losses recognized in earnings for debt securities held and not intended to be sold for the quarter ended (in thousands):
Beginning balance at April 1, (1)
8,865
10,334
Credit losses on debt securities for which other-than-temporary impairment was not previously recognized
Reduction for losses realized during the quarter
(16
(170
Reduction for securities called realized during the quarter
(360
Additional credit losses on debt securities for which other-than-temporary impairment was previously recognized
Ending balance at June 30,
8,489
10,164
(1) – The beginning balance represents credit losses included in other-than-temporary impairment charges recognized on debt securities in prior periods.
The table below shows a cumulative roll forward of credit losses recognized in earnings for debt securities held and not intended to be sold for the six months ended (in thousands):
Beginning balance at January 1, (1)
8,894
10,342
Reduction for losses realized during the six months
(45
(178
Reduction for securities called realized during the six months
(4) Loans receivable
The following table shows a summary of our loans receivable at June 30, 2015 and December 31, 2014 (in thousands):
2,597,204
2,526,240
3,905,424
3,835,115
Commercial real estate
1,986,613
1,874,944
368,417
419,525
2,355,030
2,294,469
Total loans receivable, gross
6,260,454
6,129,584
Deferred loan costs
10,251
6,095
Undisbursed loan proceeds:
(10,285
(10,879
(126,870
(73,760
(8,893
(61,149
Total loans receivable, net
16
The following table provides information related to the allowance for loan losses by portfolio segment and by class of financing receivable for the quarter ended June 30, 2015 (in thousands):
Balance June 30, 2015
Current period provision
Charge-offs
Recoveries
Balance March 31, 2015
Residental mortgage loans
4,892
76
(278
5,077
3,445
(187
(542
131
4,043
6,244
1,865
(1,759
303
5,835
14,581
1,754
(2,579
451
14,955
30,163
(1,558
(3,439
1,908
33,252
14,313
4,832
(6,356
724
15,113
44,476
3,274
(9,795
2,632
48,365
Unallocated (1)
(3,978
3,978
59,057
(12,374
3,083
67,298
(1) – Due to enhancements in our allowance for loan losses process we allocated the previously unallocated allowance using both qualitative and quantitative factors.
The following table provides information related to the allowance for loan losses by portfolio segment and by class of financing receivable for the quarter ended June 30, 2014 (in thousands):
Balance June 30, 2014
Balance March 31, 2014
7,767
(883
41
7,467
6,516
72
(593
79
6,958
5,626
1,495
(1,450
301
5,280
19,909
2,709
(2,926
421
19,705
35,081
364
(2,578
1,086
36,209
12,106
5,017
(9,516
436
16,169
47,187
5,381
(12,094
1,522
52,378
4,346
195
4,151
71,442
(15,020
1,943
76,234
The following table provides information related to the allowance for loan losses by portfolio segment and by class of financing receivable for the six months ended June 30, 2015 (in thousands):
Balance December 31, 2014
(206
(613
130
5,581
(400
(884
179
4,550
3,135
(3,699
6,118
2,529
(5,196
999
16,249
(1,316
(4,552
2,642
33,389
5,102
(7,080
2,776
13,515
3,786
(11,632
5,418
46,904
(4,365
4,365
(16,828
6,417
67,518
(1) - Due to enhancements in our allowance for loan losses process we allocated the previously unallocated allowance using both qualitative and quantitative factors.
The following table provides information related to the allowance for loan losses by portfolio segment and by class of financing receivable for the six months ended June 30, 2014 (in thousands):
Balance December 31, 2013
1,177
(1,342
57
7,875
109
(965
127
7,245
2,679
(3,166
626
5,487
3,965
(5,473
20,607
1,685
(3,510
1,707
35,199
10,436
(10,286
1,076
10,880
12,121
(13,796
2,783
46,079
(316
4,662
(19,269
3,593
71,348
18
The following table provides information related to the loan portfolio by portfolio segment and by class of financing receivable at June 30, 2015 (in thousands):
Recorded investment in loans receivable
Recorded investment in loans on nonaccrual (1)
Recorded investment in loans past due 90 days or more and still accruing
TDRs
Allowance related to TDRs
Additional commitments to customers with loans classified as TDRs
18,977
6,340
6,482
2,588
276
2,638
28,097
8,928
1,284
22,640
37,028
1,718
7,259
10,228
787
29,899
47,256
2,505
1,024
57,996
385
56,184
3,789
(1) Includes $15.4 million of nonaccrual TDRs.
The following table provides information related to the loan portfolio by portfolio segment and by class of financing receivable at December 31, 2014 (in thousands):
21,194
6,574
1,133
9,569
2,412
229
2,820
206
33,583
214
8,986
1,362
38,647
41,917
4,938
449
7,578
10,885
1,095
46,225
52,802
6,033
1,263
63,153
79,808
235
61,788
7,395
(1) Includes $24.5 million of nonaccrual TDRS.
19
The following table provides geographical and delinquency information related to the loan portfolio by portfolio segment and class of financing receivable at June 30, 2015 (in thousands):
Pennsylvania
New York
Ohio
Recorded investment in loans receivable:
2,223,206
165,217
18,379
133,981
56,387
897,285
119,459
8,447
25,732
4,906
232,797
11,103
3,740
1,396
3,355
3,353,288
295,779
30,566
161,109
64,648
973,777
689,043
24,270
115,796
56,857
273,771
53,881
16,717
6,080
9,075
1,247,548
742,924
40,987
121,876
65,932
4,600,836
1,038,703
71,553
282,985
130,580
Percentage of total loans receivable
75.1
%
17.0
1.2
4.6
2.1
100.0
Loans 90 or more days delinquent:
11,498
1,553
58
1,820
1,196
16,125
2,804
766
1,046
4,616
2,082
103
2,199
16,384
2,422
2,866
22,940
10,758
1,243
271
352
12,673
1,845
1,858
12,603
62
14,531
28,987
3,665
134
3,137
1,548
37,471
Percentage of total loans 90 or more days delinquent
77.3
9.8
0.4
8.4
4.1
20
The following table provides geographical and delinquency information related to the loan portfolio by portfolio segment and class of financing receivable at December 31, 2014 (in thousands):
2,151,361
161,445
18,486
134,228
55,936
909,139
115,459
9,087
27,203
5,243
225,088
9,961
3,132
1,328
3,235
3,285,588
286,865
30,705
162,759
64,414
1,013,632
590,934
24,901
114,850
56,867
243,159
83,252
15,826
7,817
8,322
1,256,791
674,186
40,727
122,667
65,189
4,542,379
961,051
71,432
285,426
129,603
75.8
16.0
4.8
2.2
12,282
1,237
710
1,678
1,789
17,696
4,474
35
1,058
6,606
2,388
55
2,450
19,144
2,228
752
2,736
1,892
26,752
8,827
1,072
270
930
11,099
2,659
284
207
325
3,475
11,486
1,356
1,255
14,574
30,630
3,584
3,213
3,147
41,326
74.1
8.7
1.8
7.8
7.6
The following table provides information related to the composition of impaired loans by portfolio segment and by class of financing receivable at and for the six months ended June 30, 2015 (in thousands):
Nonaccrual loans 90 or more days delinquent
Nonaccrual loans less than 90 days delinquent
Loans less than 90 days delinquent reviewed for impairment
TDRs less than 90 days delinquent not included elsewhere
Total impaired loans
Average recorded investment in impaired loans
Interest income recognized on impaired loans
2,852
5,237
24,214
24,895
433
1,866
2,127
8,609
10,097
223
439
2,645
44
5,157
7,364
35,461
37,637
700
9,967
26,960
16,615
66,215
79,416
1,564
5,401
1,736
4,806
13,801
18,232
345
15,368
28,696
21,421
80,016
97,648
1,909
20,525
28,785
115,477
135,285
2,609
The following table provides information related to the composition of impaired loans by portfolio segment and by class of financing receivable at and for the year ended December 31, 2014 (in thousands):
3,498
5,845
27,039
28,227
2,963
1,706
11,275
11,753
485
370
2,383
6,831
7,551
41,134
42,363
1,368
27,548
26,400
12,128
77,175
90,187
3,589
4,103
5,266
6,026
18,870
27,088
914
31,651
31,666
18,154
96,045
117,275
4,503
38,482
25,705
137,179
159,638
5,871
22
The following table provides information related to the evaluation of impaired loans by portfolio segment and by class of financing receivable at June 30, 2015 (in thousands):
Loans collectively evaluated for impairment
Loans individually evaluated for impairment
Loans individually evaluated for impairment for which there is a related impairment reserve
Related impairment reserve
Loans individually evaluated for impairment for which there is no related reserve
2,590,038
7,132
1,221
1,053,241
252,294
97
3,895,573
9,817
1,499
1,798,992
60,751
30,513
2,117
30,238
348,670
10,854
705
3,609
2,147,662
71,605
37,758
2,822
33,847
6,043,235
81,422
47,575
4,321
The following table provides information related to the evaluation of impaired loans by portfolio segment and by class of financing receivable at December 31, 2014 (in thousands):
2,514,060
7,396
1,116
1,063,741
2,390
242,678
3,820,479
9,852
1,363
1,734,864
66,320
42,869
6,189
23,451
343,416
14,960
10,938
1,378
4,022
2,078,280
81,280
53,807
7,567
27,473
5,898,759
91,132
63,659
8,930
23
Our loan portfolios include loans that have been modified in a troubled debt restructuring (TDR), where concessions have been granted to borrowers who have experienced financial difficulties. These concessions typically result from our loss mitigation activities and could include: extending the note’s maturity date, permitting interest only payments, reducing the interest rate to a rate lower than current market rates for new debt with similar risk, reducing the principal payment, principal forbearance or other actions. These concessions are applicable to all loan segments and classes. Certain TDRs are classified as nonperforming at the time of restructuring and may be returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period of at least six months.
When we modify loans in a TDR, we evaluate any possible impairment similar to other impaired loans based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan agreement, the loan’s observable market price or the current fair value of the collateral, less selling costs, for collateral dependent loans. If we determine that the value of the modified loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allowance estimate or a charge-off to the allowance. In periods subsequent to modification, we evaluate all TDRs, including those that have payment defaults, for possible impairment, using ASC 310-10. As a result, loans modified in a TDR may have the financial effect of increasing the specific allowance associated with the loan.
Loans modified in a TDR are closely monitored for delinquency as an early indicator of possible future default. If loans modified in a TDR subsequently default, we evaluate the loan for possible further impairment. The allowance may be increased, adjustments may be made in the allocation of the allowance, partial charge-offs may be taken to further write-down the carrying value of the loan, or the loan may be charged-off completely.
24
The following table provides a roll forward of troubled debt restructurings for the periods indicated (in thousands):
For the quarters ended June 30,
Number of contracts
Beginning TDR balance:
242
60,645
258
74,511
New TDRs
386
1,343
Re-modified TDRs
45
Net paydowns
(3,617
(2,526
Charge-offs:
(68
(130
(9
(8,244
Paid-off loans:
(53
(39
(926
(561
(219
Ending TDR balance:
231
248
63,793
Accruing TDRs
40,741
39,844
Non-accrual TDRs
15,443
23,949
For the six months ended June 30,
262
79,166
498
2,652
159
(4,440
(7,020
(99
(23
(31
(387
(8,251
(6
(1,005
(838
(1,875
The following table provides information related to troubled debt restructurings (including re-modified TDRs) by portfolio segment and by class of financing receivable during the periods indicated (dollars in thousands):
For the quarter ended June 30, 2015
For the six months ended June 30, 2015
Recorded investment at the time of modification
Current recorded investment
Current allowance
Troubled debt restructurings:
120
119
232
230
87
85
121
315
297
294
29
309
306
30
431
427
628
621
48
Troubled debt restructurings modified within the previous twelve months that have subsequently defaulted:
251
250
274
50
324
26
For the quarter ended June 30, 2014
For the six months months ended June 30, 2014
575
65
1,922
1,860
184
376
346
921
67
2,298
2,206
186
89
82
32
335
446
513
528
1,252
91
2,811
2,734
253
128
126
7,444
378
7,572
504
27
The following table provides information as of June 30, 2015 for troubled debt restructurings (including re-modified TDRs) by type of modification, by portfolio segment and class of financing receivable for modifications during the quarter ended June 30, 2015 (dollars in thousands):
Type of modification
Rate
Payment
Maturity date
74
308
The following table provides information as of June 30, 2014 for troubled debt restructurings (including re-modified TDRs) by type of modification, by portfolio segment and class of financing receivable for modifications during the quarter ended June 30, 2014 (dollars in thousands):
28
The following table provides information as of June 30, 2015 for troubled debt restructurings (including re-modified TDRs) by type of modification, by portfolio segment and class of financing receivable for modifications during the six months ended June 30, 2015 (dollars in thousands):
111
83
157
419
The following table provides information as of June 30, 2014 for troubled debt restructurings (including re-modified TDRs) by type of modification, by portfolio segment and class of financing receivable for modifications during the six months ended June 30, 2014 (dollars in thousands):
110
336
360
2,264
The following table provides information related to re-modified troubled debt restructurings by portfolio segment and by class of financing receivable for the quarter ended June 30, 2015 (dollars in thousands):
Number of re-
Type of re-modification
modified TDRs
No TDRs were re-modified during the quarter ended June 30, 2014.
The following table provides information related to re-modified troubled debt restructurings by portfolio segment and by class of financing receivable for the six months ended June 30, 2015 (dollars in thousands):
The following table provides information related to re-modified troubled debt restructurings by portfolio segment and by class of financing receivable for the six months ended June 30, 2014 (dollars in thousands):
77
81
135
158
The following table provides information related to loan payment delinquencies at June 30, 2015 (in thousands):
30-59 Days delinquent
60-89 Days delinquent
90 Days or greater delinquent
Total delinquency
Current
3,250
5,815
25,190
2,571,980
3,768
2,090
10,474
1,045,355
5,116
1,767
9,082
243,309
12,134
9,672
44,746
3,860,644
3,788
4,919
21,380
1,838,363
3,380
356,144
5,151
5,078
24,760
2,194,507
17,285
14,750
69,506
6,055,151
31
The following table provides information related to loan payment delinquencies at December 31, 2014 (in thousands):
27,443
6,970
52,109
2,469,347
5,752
1,672
14,030
1,052,101
5,572
2,435
10,457
232,287
38,767
11,077
76,596
3,753,735
4,956
18,093
1,783,091
2,262
209
5,946
352,430
7,218
2,247
24,039
2,135,521
45,985
13,324
100,635
5,889,256
Credit quality indicators: We categorize loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. We analyze loans individually by classifying the loans by credit risk. Credit relationships greater than or equal to $1.0 million classified as special mention or substandard are reviewed quarterly for deterioration or improvement to determine if the loan is appropriately classified. We use the following definitions for risk ratings other than pass:
Special mention — Loans designated as special mention have specific, well-defined risk issues, which create a high level of uncertainty regarding the long-term viability of the business. Loans in this class are considered to have high-risk characteristics. A special mention loan exhibits material negative financial trends due to company-specific or systemic conditions. If these potential weaknesses are not mitigated, they threaten the borrower’s capacity to meet its debt obligations. Special mention loans still demonstrate sufficient financial flexibility to react to and positively address the root cause of the adverse financial trends without significant deviations from their current business strategy. Their potential weaknesses deserve our close attention and warrant enhanced monitoring.
Substandard — Loans classified as substandard are inadequately protected by the current net worth and payment capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected.
Doubtful — Loans classified as doubtful have all the weaknesses inherent in those classified as substandard. In addition, those weaknesses make collection or liquidation in full highly questionable and improbable. A loan classified as doubtful exhibits discernible loss potential, but a complete loss seems very unlikely. The possibility of a loss on a doubtful loan is high, but because of certain important and reasonably specific pending factors that may strengthen the loan, its classification as an estimated loss is deferred until a more exact status can be determined.
Loss — Loans classified as loss are considered uncollectible and of such value that the continuance as a loan is not warranted. A loss classification does not mean that the loan has no recovery or salvage value; instead, it means that it is not practical or desirable to defer writing off all or a portion of a basically worthless loan even though partial recovery may be possible in the future.
The following table sets forth information about credit quality indicators, which were updated during the quarter ended June 30, 2015 (in thousands):
Pass
Special mention
Substandard
Doubtful
Loss
2,584,438
11,362
1,370
1,051,213
250,648
1,743
3,886,299
17,721
1,688,449
37,497
133,797
301,467
19,793
38,262
1,989,916
57,290
172,059
5,876,215
189,780
The following table sets forth information about credit quality indicators, which were updated during the year ended December 31, 2014 (in thousands):
2,507,269
12,763
1,424
1,059,525
240,947
1,797
3,807,741
21,166
1,618,269
36,908
145,502
505
286,234
23,690
46,280
2,172
1,904,503
60,598
191,782
2,677
5,712,244
212,948
33
(5) Goodwill and Other Intangible Assets
The following table provides information for intangible assets subject to amortization at the dates indicated (in thousands):
Amortizable intangible assets:
Core deposit intangibles — gross
30,578
Acquisitions
Less: accumulated amortization
(30,578
Core deposit intangibles — net
Customer and Contract intangible assets — gross
8,234
6,197
263
2,037
(5,738
(5,201
Customer and Contract intangible assets — net
The following table shows the actual aggregate amortization expense for the quarters and six months ended June 30, 2015 and 2014, as well as the estimated aggregate amortization expense, based upon current levels of intangible assets, for the current fiscal year and each of the five succeeding fiscal years (in thousands):
For the six months ended June 30, 2014
For the year ending December 31, 2015
1,074
For the year ending December 31, 2016
835
For the year ending December 31, 2017
597
For the year ending December 31, 2018
For the year ending December 31, 2019
260
For the year ending December 31, 2020
92
The following table provides information for the changes in the carrying amount of goodwill (in thousands):
Banks
Balance at December 31, 2013
173,031
1,613
174,644
Goodwill acquired
679
Impairment losses
Balance at December 31, 2014
173,710
175
Balance at June 30, 2015
173,885
We are in the process of performing our annual goodwill impairment test as of June 30, 2015 and do not anticipate that goodwill will be impaired. See the Overview of Critical Accounting Policies Involving Estimates section for a description of our testing procedures.
(6) Guarantees
We issue standby letters of credit in the normal course of business. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Standby letters of credit generally are contingent upon the failure of the customer to perform according to the terms of the underlying contract with the third party. We are required to perform under a standby letter of credit when drawn upon by the guaranteed third party in the case of nonperformance by our customer. The credit risk associated with standby letters of credit is essentially the same as that involved in extending loans to customers and is subject to normal loan underwriting procedures. Collateral may be obtained based on management’s credit assessment of the customer. At June 30, 2015, the maximum potential amount of future payments we could be required to make under these standby letters of credit was $25.0 million, of which $24.3 million is fully collateralized. At June 30, 2015, we had a liability, which represents deferred income, of $1.2 million related to the standby letters of credit. There are no recourse provisions that would enable us to recover any amounts from third parties.
(7) Earnings Per Share
Basic earnings per common share (EPS) is computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding for the period, without considering any dilutive items. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. Stock options to purchase 1,711,080 shares of common stock with a weighted average exercise price of $12.64 per share were outstanding during the quarter ended June 30, 2015 but were not included in the computation of diluted earnings per share because the options’ exercise price was greater than the average market price of the common shares of $12.32. Stock options to purchase 4,344,225 shares of common stock with a weighted average exercise price of $12.42 per share were outstanding during the six months ended June 30, 2015 but were not included in the computation of diluted earnings per share because the options’ exercise price was greater than the average market price of the common shares of $12.11. All stock options outstanding during the quarter and six months ended June 30, 2014 were included in the computation of diluted earnings per share because the stock options’ exercise price was less than the average market price of the common shares of $13.72 and $14.09, respectively.
The computation of basic and diluted earnings per share follows (in thousands, except share data and per share amounts):
Reported net income
Weighted average common shares outstanding
91,538,172
91,491,654
91,585,766
91,324,169
Dilutive potential shares due to effect of stock options
459,833
1,039,488
364,450
1,118,462
Total weighted average common shares and dilutive potential shares
91,998,005
92,531,142
91,950,216
92,442,631
Basic earnings per share:
Diluted earnings per share:
(8) Pension and Other Post-retirement Benefits
The following table sets forth the net periodic costs for the defined benefit pension plans and post retirement healthcare plans for the periods indicated (in thousands):
Components of net periodic benefit cost
Quarter ended June 30,
Pension benefits
Other post-retirement benefits
Service cost
1,430
1,035
Interest cost
1,531
1,457
Expected return on plan assets
(2,593
(2,416
Amortization of prior service cost
(581
Amortization of the net loss
925
357
Net periodic (benefit)/ cost
712
(148
Six months ended June 30,
2,860
2,070
3,062
2,914
(5,186
(4,832
(1,162
1,850
713
(297
60
We anticipate making a contribution to our defined benefit pension plan of $4.0 million to $8.0 million during the year ending December 31, 2015.
(9) Disclosures About Fair Value of Financial Instruments
Fair value information about financial instruments, whether or not recognized in the consolidated statement of financial condition, is required to be disclosed. These requirements exclude certain financial instruments and all nonfinancial instruments. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.
Financial assets and liabilities recognized or disclosed at fair value on a recurring basis and certain financial assets and liabilities on a non-recurring basis are accounted for using a three-level hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. This hierarchy gives the highest priority to quoted prices with readily available independent data in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable market inputs (Level 3). When various inputs for measurement fall within different levels of the fair value hierarchy, the lowest level input that has a significant impact on fair value measurement is used.
Financial assets and liabilities are categorized based upon the following characteristics or inputs to the valuation techniques:
· Level 1 — Financial assets and liabilities for which inputs are observable and are obtained from reliable quoted prices for identical assets or liabilities in actively traded markets. This is the most reliable fair value measurement and includes, for example, active exchange-traded equity securities.
· Level 2 — Financial assets and liabilities for which values are based on quoted prices in markets that are not active or for which values are based on similar assets or liabilities that are actively traded. Level 2 also includes pricing models in which the inputs are corroborated by market data, for example, matrix pricing.
· Level 3 — Financial assets and liabilities for which values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. Level 3 inputs include the following:
· Quotes from brokers or other external sources that are not considered binding;
· Quotes from brokers or other external sources where it cannot be determined that market participants would in fact transact for the asset or liability at the quoted price;
· Quotes and other information from brokers or other external sources where the inputs are not deemed observable.
We are responsible for the valuation process and as part of this process may use data from outside sources in establishing fair value. We perform due diligence to understand the inputs used or how the data was calculated or derived. We also corroborate the reasonableness of external inputs in the valuation process.
The carrying amounts reported in the consolidated statement of financial condition approximate fair value for the following financial instruments: cash on hand, interest-earning deposits in other institutions, federal funds sold and other short-term investments, accrued interest receivable, accrued interest payable, and marketable securities available-for-sale.
Marketable Securities
Where available, market values are based on quoted market prices, dealer quotes, and prices obtained from independent pricing services.
Debt securities — available for sale - Generally, debt securities are valued using pricing for similar securities, recently executed transactions and other pricing models utilizing observable inputs. The valuation for most debt securities is classified as Level 2. Securities within Level 2 include corporate bonds,
37
municipal bonds, mortgage-backed securities and US government obligations. Certain corporate debt securities do not have an active market and as such the broker pricing received uses alternative methods. The fair value of these corporate debt securities is determined by using a discounted cash flow model using market assumptions, which generally include cash flow, collateral and other market assumptions. As such, these securities are included herein as Level 3 assets.
Equity securities — available for sale - Level 1 securities include publicly traded securities valued using quoted market prices. We consider the financial condition of the issuer to determine if the securities have indicators of impairment.
Debt securities — held to maturity - The fair value of debt securities held to maturity is determined in the same manner as debt securities available for sale.
Loans Receivable
Loans with comparable characteristics including collateral and re-pricing structures are segregated for valuation purposes. Characteristics include remaining term, coupon interest, and estimated prepayment speeds. Delinquent loans are separately evaluated given the impact delinquency has on the projected future cash flow of the loan and the approximate discount or market rate. Each loan pool is separately valued utilizing a discounted cash flow analysis. Projected monthly cash flows are discounted to present value using a market rate for comparable loans, which is not considered an exit price.
Federal Home Loan Bank of Pittsburgh (“FHLB”) Stock
Due to the restrictions placed on the transferability of FHLB stock it is not practical to determine the fair value.
Deposit Liabilities
The estimated fair value of deposits with no stated maturity, which includes demand deposits, money market, and other savings accounts, is the amount payable on demand. Although market premiums paid for depository institutions reflect an additional value for these low-cost deposits, adjusting fair value for any value expected to be derived from retaining those deposits for a future period of time or from the benefit that results from the ability to fund interest-earning assets with these deposit liabilities is prohibited. The fair value estimates of deposit liabilities do not include the benefit that results from the low-cost funding provided by these deposits compared to the cost of borrowing funds in the market. Fair values for time deposits are estimated using a discounted cash flow calculation that applies contractual cost currently being offered in the existing portfolio to current market rates being offered locally for deposits of similar remaining maturities. The valuation adjustment for the portfolio consists of the present value of the difference of these two cash flows, discounted at the assumed market rate of the corresponding maturity.
Borrowed Funds
Fixed rate advances are valued by comparing their contractual cost to the prevailing market cost. The carrying amount of collateralized borrowings approximates the fair value.
Junior Subordinated Debentures
The fair value of junior subordinated debentures is calculated using the discounted cash flows at the prevailing rate of interest.
Cash flow hedges — Interest rate swap agreements (“swaps”)
The fair value of the swaps is the amount we would expect to pay to terminate the agreements and is based upon the present value of the expected future cash flows using the LIBOR swap curve, the basis for the underlying interest rate.
38
Off-Balance Sheet Financial Instruments
These financial instruments generally are not sold or traded, and estimated fair values are not readily available. However, the fair value of commitments to extend credit and standby letters of credit is estimated using the fees currently charged to enter into similar agreements. Commitments to extend credit are generally short-term in nature and, if drawn upon, are issued under current market terms. At June 30, 2015 and December 31, 2014, there was no significant unrealized appreciation or depreciation on these financial instruments.
The following table sets forth the carrying amount and estimated fair value of our financial instruments included in the consolidated statement of financial condition at June 30, 2015 (in thousands):
Carrying
Estimated
amount
fair value
Level 1
Level 2
Level 3
Financial assets:
Cash and cash equivalents
Securities available-for-sale
850,002
9,223
Securities held-to-maturity
Loans receivable, net
6,389,381
FHLB Stock
Total financial assets
7,337,917
7,663,191
313,562
912,959
6,398,604
Financial liabilities:
Savings and checking deposits
4,296,954
1,413,605
925,318
138,687
786,631
Junior subordinated debentures
108,627
Cash flow hedges - swaps
5,454
Total financial liabilities
6,703,388
6,751,260
4,436,943
2,308,863
39
The following table sets forth the carrying amount and estimated fair value of our financial instruments included in the consolidated statement of financial condition at December 31, 2014 (in thousands):
898,617
10,597
6,240,079
7,231,061
7,551,364
262,486
1,004,909
6,250,676
Savings and checking accounts
4,154,228
1,498,539
919,612
162,714
756,898
109,435
6,273
6,630,954
6,689,023
4,317,878
2,364,872
Fair value estimates are made at a point-in-time, based on relevant market data and information about the instrument. The methods and assumptions detailed above were used in estimating the fair value of financial instruments at both June 30, 2015 and December 31, 2014. There were no transfers of financial instruments between Level 1 and Level 2 during the six months ended June 30, 2015.
40
The following table represents assets and liabilities measured at fair value on a recurring basis at June 30, 2015 (in thousands):
assets at
Debt securities:
Government sponsored enterprises
344,964
States and political subdivisions
62,949
Corporate
9,707
Total debt securities
417,641
426,864
GNMA
26,977
FNMA
66,057
FHLMC
37,566
Non-agency
619
Collateralized mortgage obligations:
6,832
124,459
157,772
SBA
8,966
Total mortgage-backed securities
Interest rate swaps
(5,454
Total assets and liabilities
844,548
855,703
The following table represents assets and liabilities measured at fair value on a recurring basis at December 31, 2014 (in thousands):
333,505
70,145
9,830
413,505
424,102
29,216
73,497
42,119
643
8,329
139,150
178,698
10,052
(6,273
892,344
906,098
42
The table below presents a reconciliation of all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the periods indicated (in thousands):
June 30, 2015
June 30, 2014
Beginning balance
10,306
12,391
12,251
Total net realized investment gains/ (losses) and net change in unrealized appreciation/ (depreciation):
Included in net income as OTTI
Included in other comprehensive income
(1,083
152
(1,374
292
Purchases
Sales
Transfers in to Level 3
Transfers out of Level 3
Ending balance
12,543
Certain assets and liabilities are measured at fair value on a nonrecurring basis after initial recognition such as loans measured for impairment and real estate owned. The following table represents the fair value measurement for nonrecurring assets at June 30, 2015 (in thousands):
Loans measured for impairment
43,254
Real estate owned
57,118
43
Certain assets and liabilities are measured at fair value on a nonrecurring basis after initial recognition such as loans measured for impairment and real estate owned. The following table represents the fair value measurement for nonrecurring assets at December 31, 2014 (in thousands):
54,729
71,488
Impaired loans — A loan is considered to be impaired as described in the Overview of Critical Accounting Policies Involving Estimates, Allowance for Loan Losses section. We classify loans individually evaluated for impairment that require a specific or TDR reserve as nonrecurring Level 3.
Real Estate Owned — Real estate owned is comprised of property acquired through foreclosure or voluntarily conveyed by delinquent borrowers. These assets are recorded on the date acquired at the lower of the related loan balance or fair value, less estimated disposition costs, with the fair value being determined by appraisal. Subsequently, foreclosed assets are valued at the lower of the amount recorded at acquisition date or fair value, less estimated disposition costs. We classify all real estate owned as nonrecurring Level 3.
The table presents additional quantitative information about assets measured at fair value on a recurring and nonrecurring basis and for which we have utilized Level 3 inputs to determine fair value at June 30, 2015 (dollar amounts in thousands):
Valuation techniques
Significant unobservable inputs
Range (weighted average)
Debt securities
Discounted cash flow
Discount margin Default rates Prepayment speeds
0.35% to 2.10% (0.69%) 1.00% 1.00% annually
Appraisal value (1)
Estimated cost to sell
10%
Discount rate
3.75% to 6.50% (5.13%)
(1) Fair value is generally determined through independent appraisals of the underlying collateral, which may include level 3 inputs that are not identifiable, or by using the discounted cash flow method if the loan is not collateral dependent.
The significant unobservable inputs used in the fair value measurement of our debt securities are discount margins, default rates and prepayment speeds. Significant increases in any of those rates would result in a significantly lower fair value measurement.
(10) Guaranteed Preferred Beneficial Interests in the Company’s Junior Subordinated Deferrable Interest Debentures (Trust Preferred Securities) and Interest Rate Swaps
We have two statutory business trusts: Northwest Bancorp Capital Trust III, a Delaware statutory business trust and Northwest Bancorp Statutory Trust IV, a Connecticut statutory business trust (“Trusts”). These trusts exist solely to issue preferred securities to third parties for cash, issue common securities to the Company in exchange for capitalization of the Trusts, invest the proceeds from the sale of the trust securities in an equivalent amount of debentures of the Company, and engage in other activities that are incidental to those previously listed.
Northwest Bancorp Capital Trust III (Trust III) issued 50,000 cumulative trust preferred securities in a private transaction to a pooled investment vehicle on December 5, 2006 (liquidation value of $1,000 per preferred security or $50,000,000) with a stated maturity of December 30, 2035. These securities carry a floating interest rate, which is reset quarterly, equal to three-month LIBOR plus 1.38%. Northwest Bancorp Statutory Trust IV (Trust IV) issued 50,000 cumulative trust preferred securities in a private transaction to a pooled investment vehicle on December 15, 2006 (liquidation value of $1,000 per preferred security or $50,000,000) with a stated maturity of December 15, 2035. These securities carry a floating interest rate, which is reset quarterly, equal to three-month LIBOR plus 1.38%. The Trusts have invested the proceeds of the offerings in junior subordinated deferrable interest debentures issued by the Company. The structure of these debentures mirrors the structure of the trust-preferred securities. Trust III holds $51,547,000 of the Company’s junior subordinated debentures and Trust IV holds $51,547,000 of the Company’s junior subordinated debentures. These subordinated debentures are the sole assets of the Trusts. Cash distri-butions on the trust securities are made on a quarterly basis to the extent interest on the debentures is received by the Trusts. We have the right to defer payment of interest on the subordinated debentures at any time, or from time-to-time, for periods not exceeding five years. If interest payments on the subordinated debentures are deferred, the distributions on the trust preferred securities are also deferred. Interest on the subordinated debentures and distributions on the trust securities is cumulative. To date, there have been no interest deferrals. Our obligation constitutes a full, irrevocable, and unconditional guarantee on a subordinated basis of the obligations of the trust under the preferred securities.
We are currently a counterparty to three interest rate swap agreements (swaps), designating the swaps as cash flow hedges. The swaps are intended to protect against the variability of cash flows associated with Trust III and Trust IV. The first swap modifies the re-pricing characteristics of Trust III, wherein for a ten year period expiring in September 2018, the Company receives interest of three-month LIBOR from a counterparty and pays a fixed rate of 4.61% to the same counterparty calculated on a notional amount of $25.0 million. The other two swaps modify the re-pricing characteristics of Trust IV, wherein (i) for a seven year period expiring in December 2015, the Company receives interest of three-month LIBOR from a counterparty and pays a fixed rate of 3.85% to the same counterparty calculated on a notional amount of $25.0 million and (ii) for a ten year period expiring in December 2018, the Company receives interest of three-month LIBOR from a counterparty and pays a fixed rate of 4.09% to the same counterparty calculated on a notional amount of $25.0 million. The swap agreements were entered into with a counterparty that met our credit standards and the agreements contain collateral provisions protecting the at-risk party. We believe that the credit risk inherent in the contracts is not significant. At June 30, 2015, $6.1 million of cash was pledged as collateral to the counterparty.
At June 30, 2015, the fair value of the swap agreements was $(5.5) million and was the amount we would have expected to pay if the contracts were terminated. There was no material hedge ineffectiveness for these swaps.
The following table shows liability derivatives, included in other liabilities, at June 30, 2015 and December 31, 2014 (in thousands):
Notional amount
75,000
Collateral posted
6,105
6,805
(11) Legal Proceedings
We establish accruals for legal proceedings when information related to the loss contingencies represented by those matters indicates both that a loss is probable and that the amount of loss can be reasonably estimated. As of June 30, 2015 we have not accrued for any legal proceedings based on our analysis of currently available information which is subject to significant judgment and a variety of assumptions and uncertainties. Any such accruals are adjusted thereafter as appropriate to reflect changes in circumstances. Due to the inherent subjectivity of assessments and unpredictability of outcomes of legal proceedings, any amounts accrued may not represent the ultimate loss to us from legal proceedings.
46
(12) Changes in Accumulated Other Comprehensive Income
The following table shows the changes in accumulated other comprehensive income by component for the periods indicated (in thousands):
Unrealized gains and (losses) on securities available- for-sale
Change in fair value of interest rate swaps
Change in defined benefit pension plans
Balance as of March 31, 2015
6,345
(4,034
(23,534
Other comprehensive income before reclassification adjustments
(1,300
Amounts reclassified from accumulated other comprehensive income (1), (2)
(60
Net other comprehensive loss
Balance as of June 30, 2015
4,278
(3,546
(23,315
Balance as of March 31, 2014
(4,973
(3,581
3,221
Amounts reclassified from accumulated other comprehensive income (3), (4)
(342
Net other comprehensive income
Balance as of June 30, 2014
3,378
(4,875
(3,719
(1) Consists of realized gains on securities (gain on sales of investments, net) of $458, net of tax (income tax expense) of $(179).
(2) Consists of amortization of prior service cost (compensation and employee benefits) of $581 and amortization of net loss (compensation and employee benefits) of $(940), net of tax (income tax expense) of $140. See note 8.
(3) Consists of realized gains on securities (gain on sales of investments, net) of $334, net of tax (income tax expense) of $(130).
(4) Consists of amortization of prior service cost (compensation and employee benefits) of $581 and amortization of net loss (compensation and employee benefits) of $(369), net of tax (income tax expense) of $(74). See note 8.
47
Balance as of December 31, 2014
3,461
(4,078
(23,753
1,696
Balance as of December 31, 2013
(3,233
(5,224
(3,443
9,068
(2,384
(1) Consists of realized gains on securities (gain on sales of investments, net) of $569, net of tax (income tax expense) of $(222).
(2) Consists of amortization of prior service cost (compensation and employee benefits) of $1,162 and amortization of net loss (compensation and employee benefits) of $(1,880), net of tax (income tax expense) of $280. See note 8.
(3) Consists of realized gains on securities (gain on sales of investments, net) of $3,456, net of tax (income tax expense) of $(1,348).
(4) Consists of amortization of prior service cost (compensation and employee benefits) of $1,162 and amortization of net loss (compensation and employee benefits) of $(737), net of tax (income tax expense) of $(149). See note 8.
(13) Other Items
As was previously announced on December 15, 2014 the Company entered into an Agreement and Plan of Merger (“Merger Agreement”) by and between the Company and LNB Bancorp, Inc. (“LNB”). Pursuant to the Merger Agreement, LNB will merge with and into the Company, with the Company as the surviving entity. Immediately thereafter, The Lorain National Bank (“Lorain National Bank”), the wholly owned subsidiary of LNB, will merge with and into Northwest Bank, the wholly owned subsidiary of the Company, with Northwest Bank as the surviving entity.
Under the terms of the Merger Agreement, 50% of LNB’s common shares will be converted into Company common stock and the remaining 50% will be exchanged for cash. LNB’s shareholders will have the option to elect to receive either 1.461 shares of the Company’s common stock or $18.70 in cash for each LNB common share, subject to proration to ensure that, in the aggregate, 50% of LNB’s common shares will be converted into Company stock.
The transaction has been approved by the Boards of Directors of the Company and LNB as well as LNB’s shareholders and both the FDIC and the Pennsylvania Department of Banking. Additionally, the Federal Reserve Bank has issued a non-objection to a waiver request from the obligation to file an application. Completion of the transaction is subject to customary closing conditions. We anticipate both the closing and data conversion to be completed on the weekend of August 14, 2015.
As of June 30, 2015, LNB had total assets of $1.238 billion (unaudited) and net income of $2.3 million (unaudited) and $4.1 (unaudited) for the quarter and six months ended June 30, 2015, respectively.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements:
In addition to historical information, this document may contain certain forward-looking statements, as defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements contained herein are subject to certain risks and uncertainties that could cause actual results to differ materially from those expressed or implied in the forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, as they reflect management’s analysis only as of the date of this report. We have no obligation to revise or update these forward-looking statements to reflect events or circumstances that arise after the date of this report.
Important factors that might cause such a difference include, but are not limited to:
· changes in laws, government regulations or policies affecting financial institutions, including regulatory fees and capital requirements;
· general economic conditions, either nationally or in our market areas, that are different than expected;
· competition among other financial institutions and non-depository entities;
· inflation and changes in the interest rate environment that impact our margins or the fair value of financial instruments;
· changes in the securities markets;
· our ability to enter new markets successfully, capitalize on growth opportunities and our ability to successfully integrate acquired entities, if any;
· changes in consumer spending, borrowing and savings habits;
· our ability to continue to increase and manage our business and personal loans;
· possible impairments of securities held by us, including those issued by government entities and government sponsored enterprises;
· the impact of the economy on our loan portfolio (including cash flow and collateral values), investment portfolio, customers and capital market activities;
· the impact of the current governmental effort to restructure the U.S. financial and regulatory system;
· changes in the financial performance and/or condition of our borrowers; and
· the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Securities and Exchange Commission, the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters.
Overview of Critical Accounting Policies Involving Estimates
Please refer to Note 1 of the Notes to Consolidated Financial Statements in Item 8 of Part II of our 2014 Annual Report on Form 10-K.
Executive Summary and Comparison of Financial Condition
Total assets at June 30, 2015 were $7.865 billion, an increase of $89.5 million, or 1.2%, from $7.775 billion at December 31, 2014. This increase in assets was due to increases in net loans receivable of $143.2 million and interest-earning deposits in other financial institutions of $55.6 million, which were partially offset by a decrease in marketable securities of $93.4 million. The net increase in total assets was funded by increases in total deposits and borrowed funds of $61.9 million and $10.9 million, respectively.
Total loans receivable increased by $134.8 million, or 2.2%, to $6.125 billion at June 30, 2015, from $5.990 billion at December 31, 2014. Loans funded during the six months ended June 30, 2015, of $996.5 million exceeded loan maturities, principal repayments and mortgage loan sales of $851.0 million. Our business banking loan portfolio increased by $59.7 million, or 2.8%, to $2.219 billion at June 30, 2015 from $2.160 billion at December 31, 2014, as we continue to emphasize the origination of commercial and commercial real estate loans. Our personal banking loan portfolio increased by $75.1 million, or 2.0%, to $3.905 billion at June 30, 2015 from $3.830 billion at December 31, 2014. This increase is primarily attributable to an increase in residential mortgage loans of $75.7 million as a result of the success of our wholesale lending division and improvements made to the application and underwriting processes which we implemented in the second half of last year.
Total deposits increased by $61.9 million, or 1.1%, to $5.694 billion at June 30, 2015 from $5.633 billion at December 31, 2014. Noninterest-bearing demand deposits increased by $71.1 million, or 8.0%, to $962.3 million at June 30, 2015 from $891.2 million at December 31, 2014. Interest-bearing demand deposits increased by $53.8 million, or 6.2%, to $928.4 million at June 30, 2015 from $874.6 million at December 31, 2014. Savings deposits increased by $53.7 million, or 4.4%, to $1.263 billion at June 30, 2015 from $1.209 billion at December 31, 2014. Partially offsetting these increases was a decrease in time deposits of $80.8 million, or 5.5%, to $1.398 billion at June 30, 2015 from $1.478 billion at December 31, 2014. Additionally, money market deposit accounts decreased by $35.9 million, or 3.0%, to $1.143 billion at June 30, 2015 from $1.179 billion at December 31, 2014. We believe the increase in more liquid deposit accounts is due primarily to customers’ continued reluctance to lock in time deposits at these historically low rates. In addition, our checking account marketing campaign has been successful in attracting new customers.
Borrowed funds increased by $11.0 million, or 1.2%, to $899.1 million at June 30, 2015, from $888.1 million at December 31, 2014. During the first quarter of 2015 we borrowed $85.0 million from the FHLB with an average maturity of 8.2 years and an average interest rate of 2.40%. Our intention was to lock in long-term, low-cost borrowings before market interest rates increase in order to fund the FHLB advances that mature in 2015. Partially offsetting this increase was a decrease of $24.0 million in collateralized borrowings and the maturities of $50.0 million of FHLB advances.
Total shareholders’ equity at June 30, 2015 was $1.068 billion, or $11.28 per share, an increase of $5.7 million, or 0.5%, from $1.063 billion, or $11.22 per share, at December 31, 2014. This increase in equity was the result of net income during the six months ended June 30, 2015 of $31.5 million and a decrease in accumulated other comprehensive loss of $1.8 million due to an improvement in the net unrealized gain of the investment securities portfolio. Partially offsetting these increases was the payment of cash dividends of $25.9 million and the repurchase of 497,800 shares of common stock for $6.0 million during the six months ended June 30, 2015.
Financial institutions and their holding companies are subject to various regulatory capital requirements. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by the regulators that, if undertaken, could have a direct material effect on a company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, financial institutions must meet specific capital guidelines that involve quantitative measures of its assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting guidelines. Capital amounts and classifications are also subject to qualitative judgments made by the regulators about components, risk-weighting and other factors.
In July 2013, the FDIC and the other federal regulatory agencies issued a final rule that revised their leverage and risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. Among other things, the rule establishes a new Common Equity Tier 1 (“CET1”) minimum capital requirement (4.5% of risk-weighted assets) and increases the minimum Tier 1 capital to risk-based assets requirement (from 4% to 6% of risk-weighted assets). The rule limits an organization’s capital distributions and certain discretionary bonus payments if the organization does not hold a “capital conservation buffer” consisting of 2.5% of CET1 capital to risk-weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements.
The final rule became effective for Northwest on January 1, 2015. The capital conservation buffer requirement will be phased in beginning January 1, 2016 and ending January 1, 2019, when the full capital conservation buffer requirement will be effective. The final rule also officially implements these consolidated capital requirements for savings and loan holding companies, such as the Company, effective January 1, 2015.
51
Quantitative measures, established by regulation to ensure capital adequacy, require financial institutions to maintain minimum amounts and ratios (set forth in the table below) of Total, CET1 and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital to average assets (as defined). Capital ratios are presented in the tables below. Dollar amounts in the accompanying tables are in thousands.
At June 30, 2015
Minimum capital
Well capitalized
Actual
requirements
Ratio
Total capital (to risk weighted assts)
Northwest Bancshares, Inc.
1,082,600
20.28
427,091
8.00
533,864
10.00
Northwest Bank
861,704
16.18
426,039
532,549
Tier 1 capital (to risk weighted assets)
1,023,404
19.17
320,318
6.00
802,644
15.07
319,529
CET1 capital (to risk weighted assets)
923,404
17.30
240,239
4.50
347,011
6.50
239,647
346,157
Tier 1 capital (leverage) (to average assets)
13.16
310,981
4.00
388,726
5.00
10.34
310,442
388,053
At December 31, 2014
requirements (1)
1,062,802
20.29
945,652
18.09
418,104
522,629
Tier I capital (to risk weighted assets)
997,049
19.04
880,290
16.84
209,052
313,578
Tier I capital (leverage) (to average assets)
12.80
11.55
304,883
381,104
(1) The Federal Reserve did not have formal capital requirements established for savings and loan holding companies at December 31, 2014.
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The following table shows the Basel III regulatory capital levels that must be maintained to avoid limitations on capital distributions and discretionary bonus payments for the periods indicated:
Basel III Regulatory Capital Requirements
January 1,
2016
2017
2018
2019
Common equity tier 1 ratio plus capital conservation buffer
5.125
5.75
6.375
7.00
Tier 1 risk-based capital ratio plus capital conservation buffer
6.625
7.25
7.875
8.50
Total risk-based capital ratio plus capital conservation buffer
8.625
9.25
9.875
10.50
We are required to maintain a sufficient level of liquid assets, as determined by management and reviewed for adequacy by the FDIC and the Pennsylvania Department of Banking during their regular examinations. Northwest monitors its liquidity position primarily using the ratio of unencumbered available-for-sale liquid assets as a percentage of deposits and borrowings (“liquidity ratio”). Northwest’s liquidity ratio at June 30, 2015 was 11.6%. We adjust liquidity levels in order to meet funding needs for deposit outflows, payment of real estate taxes and insurance on mortgage loan escrow accounts, repayment of borrowings and loan commitments. At June 30, 2015 Northwest had $1.786 billion of additional borrowing capacity available with the FHLB, including $150.0 million on an overnight line of credit, as well as $210.4 million of borrowing capacity available with the Federal Reserve Bank and $80.0 million with two correspondent banks.
We paid $12.9 million and $104.6 million in cash dividends during the quarters ended June 30, 2015 and 2014, respectively, and $25.9 million and $125.8 million for the six months ended June 30, 2015 and 2014, respectively. The common stock dividend payout ratio (dividends declared per share divided by net income per share) was 82.4% and 807.1% for the quarters ended June 30, 2015 and 2014, respectively, on regular dividends of $0.14 per share for the quarter ended June 30, 2015 and on regular dividends of $0.13 per share and a special dividend of $1.00 per share for the quarter ended June 30, 2014. The common stock dividend payout ratio was 82.4% and 453.3% for the six months ended June 30, 2015 and 2014, respectively, on regular dividends of $0.28 per share for the six months ended June 30, 2015 and on regular dividends of $0.26 per share and special dividends of $1.10 per share for the six months ended June 30, 2014. On July 15, 2015, the Board of Directors declared a dividend of $0.14 per share payable on August 13, 2015 to shareholders of record as of July 30, 2015. This represents the 83rd consecutive quarter we have paid a cash dividend.
Nonperforming Assets
The following table sets forth information with respect to nonperforming assets. Nonaccrual loans are those loans on which the accrual of interest has ceased. Generally, when a loan is 90 days past due, we fully reverse all accrued interest thereon and cease to accrue interest thereafter. Exceptions are made for loans that have contractually matured, are in the process of being modified to extend the maturity date and are otherwise current as to principal and interest, and well secured loans that are in process of collection. Loans may also be placed on nonaccrual before they reach 90 days past due if conditions exist that call into question our ability to collect all contractual interest. Other nonperforming assets represent property acquired through foreclosure or repossession. Foreclosed property is carried at the lower of its fair value less estimated costs to sell, or the principal balance of the related loan.
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(Dollars in thousands)
Loans 90 days or more delinquent:
10,215
4,359
Total loans 90 days or more delinquent
Total real estate owned (REO)
Total loans 90 days or more delinquent and REO
51,335
58,085
Total loans 90 days or more delinquent to net loans receivable
0.62
0.70
Total loans 90 days or more delinquent and REO to total assets
0.65
0.75
Nonperforming assets:
Nonaccrual loans - loans 90 days or more delinquent
Nonaccrual loans - loans less than 90 days delinquent
Loans 90 days or more past maturity and still accruing
Total nonperforming loans
58,381
80,043
Total nonperforming assets
72,245
96,802
Nonaccrual troubled debt restructured loans *
24,459
Accruing troubled debt restructured loans
37,329
Total troubled debt restructured loans
* Included in nonaccurual loans above.
A loan is considered to be impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement including both contractual principal and interest payments. The amount of impairment is required to be measured using one of three methods: (1) the present value of expected future cash flows discounted at the loan’s effective interest rate; (2) the loan’s observable market price; or (3) the fair value of collateral if the loan is collateral dependent. If the measure of the impaired loan is less than the recorded investment in the loan, a specific allowance is allocated for the impairment. Impaired loans at June 30, 2015 and December 31, 2014 were $115.5 million and $137.2 million, respectively.
Allowance for Loan Losses
Our Board of Directors has adopted an “Allowance for Loan and Lease Losses” (“ALL”) policy designed to provide management with a systematic methodology for determining and documenting the ALL each reporting period. This methodology was developed to provide a consistent process and review procedure to ensure that the ALL is in conformity with GAAP, our policies and procedures and other supervisory and regulatory guidelines.
On an ongoing basis, the Credit Administration department, as well as loan officers, branch managers and department heads, review and monitor the loan portfolio for problem loans. This portfolio monitoring includes a review of the monthly delinquency reports as well as historical comparisons and trend analysis. In addition, a meeting is held every quarter with each region to monitor the performance and status of loans on an internal watch list. On an on-going basis the loan officer in conjunction with a portfolio manager grades or classifies problem loans or potential problem loans based upon their knowledge of the lending relationship and other information previously accumulated. This rating is also reviewed independently by our Loan Review department on a periodic basis. Our loan grading system for
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problem loans is consistent with industry regulatory guidelines which classify loans as “substandard”, “doubtful” or “loss.” Loans that do not expose us to risk sufficient to warrant classification in one of the previous categories, but which possess some weaknesses, are designated as “special mention”. A “substandard” loan is any loan that is 90 days or more contractually delinquent or is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified as “doubtful” have all the weaknesses inherent in those classified as “substandard” with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions or values, highly questionable and improbable. Loans classified as “loss” are considered uncollectible so that their continuance as assets without the establishment of a specific loss allowance is not warranted.
Credit relationships that have been classified as substandard or doubtful and are greater than or equal to $1.0 million are reviewed by the Credit Administration department for possible impairment. A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement, including both contractual principal and interest payments.
If an individual loan is deemed to be impaired, the Credit Administration department determines the proper measure of impairment for each loan based on one of three methods: (1) the present value of expected future cash flows discounted at the loan’s effective interest rate; (2) the loan’s observable market price; or (3) the fair value of the collateral if the loan is collateral dependent, less costs of sale or disposal. If the measurement of the impaired loan is more or less than the recorded investment in the loan, the Credit Administration department adjusts the specific allowance associated with that individual loan accordingly.
If a substandard or doubtful loan is not considered individually for impairment, it is grouped with other loans that possess common characteristics for impairment evaluation and analysis. This segmentation is accomplished by grouping loans of similar product types, risk characteristics and industry concentration into homogeneous pools. Historical loss ratios are analyzed and adjusted based on delinquency trends as well as the current economic, political, regulatory and interest rate environment and used to estimate the current measure of impairment.
The individual impairment measures along with the estimated loss for each homogeneous pool are consolidated into one summary document. This summary schedule along with the support documentation used to establish this schedule is presented to management’s Credit Committee on a quarterly basis. The Credit Committee reviews the processes and documentation presented, reviews the concentration of credit by industry and customer, lending products and activity, competition and collateral values, as well as economic conditions in general and in each of our market areas. Based on this review and discussion, the appropriate amount of ALL is estimated and any adjustments to reconcile the actual ALL with this estimate are determined. In addition, the Credit Committee considers if any changes to the methodology are needed. The Credit Committee also reviews and discusses delinquency trends, nonperforming asset amounts and ALL levels and ratios compared to our peer group as well as state and national statistics. Similarly, following the Credit Committee’s review and approval, a review is performed by the Risk Management Committee of the Board of Directors on a quarterly basis.
In addition to the reviews by management’s Credit Committee and the Board of Directors’ Risk Management Committee, regulators from either the FDIC or the Pennsylvania Department of Banking perform an extensive review on an annual basis for the adequacy of the ALL and its conformity with regulatory guidelines and pronouncements. Any recommendations or enhancements from these
independent parties are considered by management and the Credit Committee and implemented accordingly.
We acknowledge that this is a dynamic process and consists of factors, many of which are external and out of our control that can change often, rapidly and substantially. The adequacy of the ALL is based upon estimates using all the information previously discussed as well as current and known circumstances and events. There is no assurance that actual portfolio losses will not be substantially different than those that were estimated.
We utilize a consistent methodology each period when analyzing the adequacy of the allowance for loan losses and the related provision for loan losses. As part of the analysis as of June 30, 2015, we considered the economic conditions in our markets, such as unemployment and bankruptcy levels as well as changes in estimates of real estate collateral values. In addition, we considered the overall trends in asset quality, specific reserves already established for criticized loans, historical loss rates and collateral valuations. As a result of this analysis, the allowance for loan losses decreased by $8.4 million, or 12.5%, to $59.1 million, or 0.96% of total loans, at June 30, 2015 from $67.5 million, or 1.13% of total loans, at December 31, 2014. This decrease is primarily attributable to the continued improvement in overall asset quality as classified loans and non-accrual loans delinquent 90 days or more decreased by $25.9 million and $3.9 million, respectively, compared to December 31, 2014. Additionally, we have enhanced the procedures for determining environmental reserves and the loss emergence period eliminating the unallocated portion of the allowance for loan losses. This resulted in the allocation of previously unallocated reserves.
We also consider how the levels of non-accrual loans and historical charge-offs have influenced the required amount of allowance for loan losses. Nonaccrual loans of $58.0 million or 0.95% of total loans receivable, at June 30, 2015 decreased by $21.8 million, or 27.3%, from $79.8 million, or 1.33% of total loans receivable, at December 31, 2014. As a percentage of average loans, annualized net charge-offs decreased to 0.34% for the six months ended June 30, 2015 compared to 0.41% for the year ended December 31, 2014 despite charge-offs in the current year of $6.1 million on a loan to a seed wholesaler and $2.0 million on a loan to a hotel operator.
Comparison of Operating Results for the Quarters Ended June 30, 2015 and 2014
Net income for the quarter ended June 30, 2015 was $15.3 million, or $0.17 per diluted share, an increase of $2.6 million, or 20.8%, from $12.7 million, or $0.14 per diluted share, for the quarter ended June 30, 2014. The increase in net income resulted from a decrease in the provision for loan losses of $7.2 million, or 87.3%, and an increase in noninterest income of $98,000, or 0.6%. Partially offsetting these improvements were increases in income tax expense of $2.8 million, or 62.6%, and noninterest expense of $1.3 million, or 2.5% and a decrease in net interest income of $595,000, or 0.9%. Annualized, net income for the quarter ended June 30, 2015 represents a 5.77% and 0.78% return on average equity and return on average assets, respectively, compared to 4.77% and 0.64% for the same quarter last year. A discussion of significant changes follows.
Interest Income
Total interest income decreased by $1.0 million, or 1.3%, to $76.0 million for the quarter ended June 30, 2015 from $77.0 million for the quarter ended June 30, 2014. This decrease is the result of decreases in both the average balance and average yield on interest earning assets. The average balance of interest earning assets decreased by $67.6 million, or 0.9%, to $7.343 billion for the quarter ended June 30, 2015 from $7.410 billion for the quarter ended June 30, 2014 while the average yield earned on interest earning assets decreased to 4.15% for the quarter ended June 30, 2015 from 4.17% for the quarter ended June 30, 2014.
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Interest income on loans receivable increased by $259,000, or 0.4%, to $71.0 million for the quarter ended June 30, 2015 from $70.7 million for the quarter ended June 30, 2014. This increase in interest income on loans receivable can be attributed to an increase in the average balance of loans receivable which increased by $240.4 million, or 4.1%, to $6.074 billion for the quarter ended June 30, 2015 from $5.834 billion for the quarter ended June 30, 2014. This increase is due to continued success in growing business banking relationships and the retention of the residential mortgage loans originated by our wholesale lending function. Partially offsetting this increase was a decline in the average yield which decreased to 4.69% for the quarter ended June 30, 2015 from 4.86% for the quarter ended June 30, 2014. The continued decline in average yield is due primarily to the historically low level of market interest rates.
Interest income on mortgage-backed securities decreased by $608,000, or 22.8%, to $2.1 million for the quarter ended June 30, 2015 from $2.7 million for the quarter ended June 30, 2014. This decrease is the result of decreases in both the average balance and average yield. The average balance of mortgage-backed securities decreased by $123.3 million, or 20.5%, to $477.8 million for the quarter ended June 30, 2015 from $601.1 million for the quarter ended June 30, 2014 due primarily to redirecting cash flows from these securities to fund loan growth, repurchase our common stock and to pay dividends over the past year. The average yield on mortgage-backed securities decreased to 1.72% for the quarter ended June 30, 2015 from 1.77% for the quarter ended June 30, 2014 due primarily to the pay-down of higher rate securities.
Interest income on investment securities decreased by $340,000, or 13.0%, to $2.3 million for the quarter ended June 30, 2015 from $2.6 million for the quarter ended June 30, 2014. This decrease is the result of decreases in both the average balance and average yield. The average yield of investment securities decreased to 1.88% for the quarter ended June 30, 2015 from 2.06% for the quarter ended June 30, 2014. This decrease is primarily the result of higher rate, tax-free, municipal securities maturing or being called and when replaced, being replaced by lower yielding, shorter duration government agency securities. The average balance of investment securities decreased by $24.6 million, or 4.9%, to $482.7 million for the quarter ended June 30, 2015 from $507.3 million for the quarter ended June 30, 2014. This decrease is due primarily to the maturity or call of municipal and government agency securities and the use of these proceeds to primarily fund loan growth.
Regular dividends on FHLB stock decreased by $222,000, or 31.9%, to $475,000 for the quarter ended June 30, 2015 from $697,000 for the quarter ended June 30, 2014. This decrease is due primarily to the timing of when the FHLB resumed the payment of regular dividends in 2014. As a result, the average yield decreased to 5.35% for the quarter ended June 30, 2015 from 6.34% for the quarter ended June 30, 2014. Additionally, the average balance decreased by $8.3 million, or 19.0%, to $35.6 million for the quarter ended June 30, 2015 from $43.9 million for the quarter ended June 30, 2014. FHLB dividends are included in the taxable investment securities line of the interest income section of our Consolidated Statements of Income.
Interest income on interest-earning deposits decreased by $106,000, or 37.1%, to $180,000 for the quarter ended June 30, 2015 from $286,000 for the quarter ended June 30, 2014. This decrease is due to a decrease in the average balance of $151.7 million, or 35.8%, to $272.7 million for the quarter ended June 30, 2015 from $424.4 million for the quarter ended June 30, 2014, due to the utilization of cash to fund loan growth, repurchase our common stock and pay dividends over the past year. The average yield on interest-earning deposits decreased slightly to 0.26% for the quarter ended June 30, 2015 from 0.27% for the quarter ended June 30, 2014.
Interest Expense
Interest expense decreased by $422,000, or 3.0%, to $13.8 million for the quarter ended June 30, 2015 from $14.2 million for the quarter ended June 30, 2014. This decrease in interest expense was due primarily to a decrease in the average balance of interest-bearing liabilities, which decreased by $118.9 million, or 2.0%, to $5.773 billion for the quarter ended June 30, 2015 from $5.892 billion for the quarter ended June 30, 2014. The decrease in average interest-bearing liabilities resulted primarily from a reduction in average time deposits of $188.8 million, or 11.8%, compared to last year, as consumers continue to shift investment priorities to demand deposit products as well as to withdraw funds for living expenses. The decrease in time deposits was partially offset by an increase in the average balance of borrowed funds of $57.1 million, or 6.5%, from the prior year due to $85.0 million of FHLB advances borrowed during the first quarter of 2015 in order to lock-in low rate, long-term funding to replace advances maturing this year. The average cost of interest-bearing liabilities decreased slightly to 0.96% for the quarter ended June 30, 2015 from 0.97% for the quarter ended June 30, 2014 as a result of the change in deposit mix and lower interest rates on new FHLB advances.
Net Interest Income
Net interest income decreased by $595,000, or 0.9%, to $62.2 million for the quarter ended June 30, 2015 from $62.8 million for the quarter ended June 30, 2014. This decrease is attributable to the factors discussed above. Redirecting existing funds and cash flow from investment securities to fund loan growth helped mitigate overall lower market interest rates as we maintained our net interest spread and margin. Our net interest rate spread decreased by one basis point to 3.19% for the quarter ended June 30, 2015 from 3.20% for the quarter ended June 30, 2014 and our net interest margin remained unchanged at 3.39% for the quarters ended June 30, 2015 and 2014.
Provision for Loan Losses
The provision for loan losses decreased by $7.2 million, or 87.3%, to $1.1 million for the quarter ended June 30, 2015 from $8.3 million for the quarter ended June 30, 2014. This decrease is due primarily to continued improvements in overall asset quality as classified loans decreased by $19.5 million, or 9.3%, to $191.2 million at June 30, 2015 from $210.7 million at June 30, 2014. In addition, total nonaccrual loans decreased by $38.8 million, or 40.1%, to $58.0 million at June 30, 2015 from $96.8 million at June 30, 2014 and loans 90 days or more delinquent decreased by $13.8 million, or 26.9%, to $37.5 million at June 30, 2015 from $51.3 million at June 30, 2014. Additionally, during the prior years’ quarter two business banking loans required combined provisions of $3.2 million.
In determining the amount of the current period provision, we considered current economic conditions, including unemployment levels and bankruptcy filings, and changes in real estate values and the impact of these factors on the quality of our loan portfolio and historical loss factors. We analyze the allowance for loan losses as described in the section entitled “Allowance for Loan Losses.” The provision that is recorded is sufficient, in our judgment, to bring this reserve to a level that reflects the losses inherent in our loan portfolio relative to loan mix, economic conditions and historical loss experience.
Noninterest Income
Noninterest income increased by $98,000, or 0.6%, to $16.5 million for the quarter ended June 30, 2015 from $16.4 million for the quarter ended June 30, 2014. The increase is primarily attributable to increases in gain on sale of investments and service charges and fees. Gain on sale of investments increased by $217,000, or 62.2%, to $566,000 for the quarter ended June 30, 2015 from $349,000 for the quarter ended June 30, 2014. This increase is due primarily to a $360,000 recovery on a called security for which we had previously recorded other-than-temporary-impairment. Service charges and fees increased by $186,000, or 2.1%, to $9.2 million for the quarter ended June 30, 2015 from $9.0 million for the quarter ended June 30, 2014 due primarily to an increase in the number of loan and transaction deposit customers
as well as adjustments to deposit account fees made in late 2014. Partially offsetting these increases was a decrease in other operating income of $249,000, or 25.1% to $742,000 for the quarter ended June 30, 2015 from $991,000 for the quarter ended June 30, 2014 due primarily to an insurance settlement received in 2014.
Noninterest Expense
Noninterest expense increased by $1.3 million, or 2.5%, to $55.1 million for the quarter ended June 30, 2015 from $53.8 million for the quarter ended June 30, 2014. This increase is primarily the result of increases in processing expenses, compensation and employee benefits and acquisition costs. Processing expense increased by $753,000, or 11.3%, to $7.4 million for the quarter ended June 30, 2015 from $6.6 million for the quarter ended June 30, 2014, due primarily to technology upgrades including the implementation of software that provides our customers with enhanced security for online financial transactions. Compensation and employee benefits increased by $377,000, or 1.3%, to $28.9 million for the quarter ended June 30, 2015 from $28.5 million for the quarter ended June 30, 2014. This increase is primarily the result of increased retirement benefit costs during the current year. Additionally, expenses totaling $467,000 were incurred during the quarter ended June 30, 2015 related to the impending acquisition of LNB Bancorp, Inc. Partially offsetting these increases was a decrease in office operations of $360,000, or 9.3%, to $3.5 million for the quarter ended June 30, 2015 from $3.9 million for the quarter ended June 30, 2014 due primarily to reduced collection costs. Professional services also declined from the prior year by $123,000, or 6.9%, to $1.7 million for the quarter ended June 30, 2015 from $1.8 million for the quarter ended June 30, 2014 as a result of the completion of a third party review of our compliance management system.
Income Taxes
The provision for income taxes increased by $2.8 million, or 62.6%, to $7.2 million for the quarter ended June 30, 2015 from $4.4 million for the quarter ended June 30, 2014. This increase in income tax expense is primarily the result of an increase in pretax income of $5.4 million, or 31.6%, and a reduction in tax-free income from municipal bonds as well as a lower amount of Pennsylvania state tax credits anticipated for 2015. Our effective tax rate for the quarter ended June 30, 2015 was 32.0% compared to 25.9% for the quarter ended June 30, 2014. Additionally, the prior year benefited from the tax deductibility of the special common stock dividend paid on shares held by our benefit plans. We anticipate our effective tax rate to be between 31.0% and 33.0% during 2015.
Comparison of Operating Results for the Six Months Ended June 30, 2015 and 2014
Net income for the six months ended June 30, 2015 was $31.5 million, or $0.34 per diluted share, an increase of $4.2 million, or 15.4%, from $27.3 million, or $0.30 per diluted share, for the six months ended June 30, 2014. The increase in net income resulted from a decrease in the provision for loan losses of $13.8 million, or 87.6%, and an increase in net interest income of $1.3 million, or 1.0%. Partially offsetting these improvements were increases in income tax expense of $4.3 million, or 45.0%, and noninterest expense of $1.8 million, or 1.8%, and a decrease in noninterest income of $4.6 million, or 13.0%. Annualized, net income for the six months ended June 30, 2015 represents a 5.97% and 0.81% return on average equity and return on average assets, respectively, compared to 4.97% and 0.69% for the same six month period last year. A discussion of significant changes follows.
Total interest income increased by $537,000, or 0.4%, to $152.9 million for the six months ended June 30, 2015 from $152.3 million for the six months ended June 30, 2014. This increase is the result of an increase in the average yield earned on interest earning assets to 4.19% for the six months ended June 30, 2015 from 4.17% for the six months ended June 30, 2014 and a special dividend of $1.0 million from the FHLB received in the first quarter of 2015. Partially offsetting these factors was a decrease in the average
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balance on interest earning assets of $49.6 million, or 0.7%, to $7.311 billion for the six months ended June 30, 2015 from $7.361 billion for the six ended June 30, 2014.
Interest income on loans receivable increased by $1.7 million, or 1.2%, to $141.7 million for the six months ended June 30, 2015 from $140.0 million for the six months ended June 30, 2014. This increase in interest income on loans receivable can be attributed to an increase in the average balance of loans receivable of $218.2 million, or 3.7%, to $6.047 billion for the six months ended June 30, 2015 from $5.829 billion for the six months ended June 30, 2014. This increase is due to continued success in growing business banking relationships and the retention of the residential mortgage loans originated by our wholesale lending function. Partially offsetting this increase was a decline in the average yield which decreased to 4.73% for the six months ended June 30, 2015 from 4.85% for the six months ended June 30, 2014. The continued decline in average yield is due primarily to the historically low level of market interest rates.
Interest income on mortgage-backed securities decreased by $1.2 million, or 21.4%, to $4.3 million for the six months ended June 30, 2015 from $5.5 million for the six months ended June 30, 2014. This decrease is the result of decreases in both the average balance and average yield. The average balance of mortgage-backed securities decreased by $118.9 million, or 19.4%, to $492.2 million for the six months ended June 30, 2015 from $611.1 million for the six months ended June 30, 2014 due primarily to redirecting cash flows from these securities to fund loan growth, repurchase our common stock and pay dividends over the past year. The average yield on mortgage-backed securities decreased to 1.74% for the six months ended June 30, 2015 from 1.79% for the six months ended June 30, 2014 due primarily to the pay-down of higher rate securities.
Interest income on investment securities decreased by $682,000, or 12.8%, to $4.7 million for the six months ended June 30, 2015 from $5.3 million for the six months ended June 30, 2014. This decrease is the result of decreases in both the average balance and average yield. The average yield on investment securities decreased to 1.93% for the six months ended June 30, 2015 from 2.11% for the six months ended June 30, 2014. This decrease is primarily the result of higher rate, tax-free, municipal securities maturing or being called and if replaced, being replaced by lower yielding, shorter duration government agency securities. The average balance of investment securities decreased by $22.9 million, or 4.5%, to $484.4 million for the six months ended June 30, 2015 from $507.3 million for the six months ended June 30, 2014. This decrease is due primarily to the maturity or call of municipal and government agency securities and the use of these proceeds to fund loan growth.
Dividends on FHLB stock increased by $905,000, or 93.0%, to $1.9 million for the six months ended June 30, 2015 from $973,000 for the six months ended June 30, 2014. This increase is due a $1.0 million special dividend paid in the first quarter of 2015. Additionally, the average yield, exclusive of the special dividend, increased to 4.71% for the six months ended June 30, 2015 from 4.44% for the six months ended June 30, 2014. Partially offsetting these factors was a decrease in the average balance of $7.9 million, or 18.2%, to $35.9 million for the six months ended June 30, 2015 from $43.8 million for the six months ended June 30, 2014. FHLB dividends are included in the taxable investment securities line of the interest income section of our Consolidated Statements of Income.
Interest income on interest-earning deposits decreased by $167,000, or 34.4%, to $319,000 for the six months ended June 30, 2015 from $486,000 for the six months ended June 30, 2014. This decrease is due to a decrease in the average balance of $118.1 million, or 31.9%, to $252.2 million for the six months ended June 30, 2015 from $370.3 million for the six months ended June 30, 2014, due to the utilization of cash to fund loan growth, repurchase our common stock and pay dividends over the past year. The average
yield on interest-earning deposits decreased slightly to 0.25% for the six months ended June 30, 2015 from 0.26% for the six months ended June 30, 2014.
Interest expense decreased by $727,000, or 2.6%, to $27.7 million for the six months ended June 30, 2015 from $28.4 million for the six months ended June 30, 2014. This decrease in interest expense was due to a decrease in the average balance of interest-bearing liabilities, which decreased by $95.5 million, or 1.6%, to $5.782 billion for the six months ended June 30, 2015 from $5.878 billion for the six months ended June 30, 2014. The decrease in average interest-bearing liabilities resulted primarily from a reduction in average time deposits of $190.8 million, or 11.8%, compared to last year, as consumers continue to shift investment priorities to demand deposit products as well as to utilize funds for living expenses. The decrease in time deposits was partially offset by an increase in the average balance of borrowed funds of $68.3 million, or 7.8%, from the prior year due primarily to $85.0 million of FHLB advances borrowed during the first quarter of 2015 and an increase of $27.0 million, or 0.8%, in non-maturity deposit accounts. The average cost of interest-bearing liabilities remained unchanged at 0.97% for the six months ended June 30, 2015 and 2014.
Net interest income increased by $1.3 million, or 1.0%, to $125.2 million for the six months ended June 30, 2015 from $123.9 million for the six months ended June 30, 2014. This increase is attributable to the factors discussed above. Solid loan growth enabled us to redirect cash flows from lower yielding cash and investments which helped offset overall lower market interest rates and increase our net interest spread and margin. Our net interest rate spread increased to 3.22% for the six months ended June 30, 2015 from 3.20% for the six months ended June 30, 2014 and our net interest margin increased to 3.40% for the six months ended June 30, 2015 from 3.37% for the six months ended June 30, 2014.
The provision for loan losses decreased by $13.8 million, or 87.6%, to $2.0 million for the six months ended June 30, 2015 from $15.8 million for the six months ended June 30, 2014. This decrease is due primarily to continued improvements in overall asset quality as classified loans decreased by $19.5 million, or 9.3%, to $191.2 million at June 30, 2015 from $210.7 million at June 30, 2014 and total delinquent loans decreased by $15.2 million, or 18.0%, to $69.5 million at June 30, 2015 from $84.7 million at June 30, 2014. In addition, total nonaccrual loans decreased by $38.8 million, or 40.1%, to $58.0 million at June 30, 2015 from $96.8 million at June 30, 2014 and loans 90 days or more delinquent decreased by $13.8 million, or 26.9%, to $37.5 million at June 30, 2015 from $51.3 million at June 30, 2014. Additionally, during the first half of the prior year two business banking loans required combined reserves of $8.2 million.
Noninterest income decreased by $4.6 million, or 13.0%, to $31.2 million for the six months ended June 30, 2015 from $35.8 million for the six months ended June 30, 2014. The decrease is primarily attributable to a decrease in the gain on sale of investments and an increase in loss on real estate owned. Gain on sale of investments decreased by $3.0 million, or 82.1%, to $661,000 for the six months ended June
61
30, 2015 from $3.7 million for the six months ended June 30, 2014 as a result of the sale of equity securities during the first half of 2014. Loss on real estate owned increased by $890,000, or 127.7%, to $1.6 million for the six months ended June 30, 2015 from $697,000 for the six months ended June 30, 2014. This increase is due primarily to the write-down of one commercial property in the first quarter of 2015. Partially offsetting these factors was an increase in services charges and fees of $437,000, or 2.5%, to $17.9 million for the six months ended June 30, 2015 from $17.5 million for the six months ended June 30, 2014. This increase is due primarily to an increase in the number of loan and transaction deposit customers as well as adjustments to deposit account fees made in late 2014.
Noninterest expense increased by $1.8 million, or 1.8%, to $108.8 million for the six months ended June 30, 2015 from $107.0 million for the six months ended June 30, 2014. This increase is primarily the result of increases in processing expenses, marketing expenses and acquisition costs. Processing expense increased by $1.4 million, or 10.3%, to $14.6 million for the six months ended June 30, 2015 from $13.2 million for the six months ended June 30, 2014, due primarily to software and software amortization expense related to upgrades made during the past two years and the implementation of software that provides our customers with enhanced security for online financial transactions. Marketing expenses increased by $598,000, or 13.1%, to $5.2 million for the six months ended June 30, 2015 from $4.6 million for the six months ended June 30, 2014. This increase is primarily the result of the timing of loan and checking account campaigns. Additionally, expenses totaling $814,000 were incurred during the six months ended June 30, 2015 related to the impending acquisition of LNB. Partially offsetting these increases was a decrease in office operations of $437,000, or 5.7%, to $7.2 million for the six months ended June 30, 2015 from $7.6 million for the six months ended June 30, 2014 due primarily to reduced collection costs. Professional services also declined from the prior year by $393,000, or 10.2%, to $3.4 million for the six months ended June 30, 2015 from $3.8 million for the six months ended June 30, 2014 as a result of the completion of a third party review of our compliance management system during 2014.
The provision for income taxes increased by $4.3 million, or 45.0%, to $14.0 million for the six months ended June 30, 2015 from $9.7 million for the six months ended June 30, 2014. This increase in income tax expense is primarily the result of an increase in pretax income of $8.5 million, or 23.1%, and a reduction in tax free income from municipal bonds as well as a lower amount of Pennsylvania state tax credits anticipated for 2015. Our effective tax rate for the six months ended June 30, 2015 was 30.8% compared to 26.2% for the six months ended June 30, 2014. Additionally, the prior year benefited from the tax deductibility of the special common stock dividends paid on shares held by our benefit plans. We anticipate our effective tax rate to be between 31.0% and 33.0% during 2015.
Average Balance Sheet
The following table sets forth certain information relating to the Company’s average balance sheet and reflects the average yield on interest- earning assets and average cost of interest-bearing liabilities for the periods indicated. Such yields and costs are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods presented. Average balances are calculated using daily averages.
Avg.
Average
yield/
balance
Interest
cost (f)
Assets:
Interest-earning assets:
Loans receivable (a) (b) (includes FTE adjustments of $460 and $540, respectively)
6,073,911
71,445
4.72
5,833,540
71,266
4.90
Mortgage-backed securities (c)
477,800
1.72
601,066
1.77
Investment securities (c) (includes FTE adjustments of $615 and $860, respectively)
482,670
2,887
2.39
507,315
3,472
2.74
FHLB stock
35,608
5.35
43,944
697
6.34
Other interest-earning deposits
272,691
0.26
424,434
0.27
Total interest-earning assets (includes FTE adjustments of $1,075 and $1,400, respectively)
7,342,680
77,045
4.21
7,410,299
78,387
4.23
Noninterest earning assets (d)
529,528
528,914
7,872,208
7,939,213
Liabilities and shareholders’ equity:
Interest-bearing liabilities:
1,263,785
838
1,239,563
821
920,071
0.06
896,014
149
0.07
1,147,017
759
1,182,542
792
1,409,740
3,963
1.13
1,598,523
4,659
1.17
Borrowed funds (e)
929,744
6,929
2.99
872,653
6,623
3.04
1,172
1,170
4.49
Total interest-bearing liabilities
5,773,451
0.96
5,892,389
0.97
957,912
852,253
Noninterest-bearing liabilities
77,075
128,072
6,808,438
6,872,714
Shareholders’ equity
1,063,770
1,066,499
Net interest income/ Interest rate spread
63,253
3.25
64,173
3.26
Net interest-earning assets/ Net interest margin
1,569,229
3.45
1,517,910
3.46
Ratio of interest-earning assets to interest-bearing liabilities
1.27X
1.26X
(a) Average gross loans includes loans held as available-for-sale and loans placed on nonaccrual status.
(b) Interest income includes accretion/ amortization of deferred loan fees/ expenses, which were not material.
(c) Average balances do not include the effect of unrealized gains or losses on securities held as available-for-sale.
(d) Average balances include the effect of unrealized gains or losses on securities held as available-for-sale.
(e) Average balances include FHLB borrowings and collateralized borrowings.
(f) Annualized. Shown on a fully tax-equivalent basis (“FTE”). The FTE basis adjusts for the tax benefit of income on certain tax exempt loans and investments using the federal statutory rate of 35% for each period presented. We believe this measure to be the preferred industry measurement of net interest income and provides relevant comparison between taxable and non-taxable amounts. GAAP basis yields were: Loans — 4.69% and 4.86%, respectively; Investment securities — 1.88% and 2.06%, respectively; interest-earning assets — 4.15% and 4.17%, respectively. GAAP basis net interest rate spreads were 3.19% and 3.20%, respectively; and GAAP basis net interest margins were 3.39% and 3.39%, respectively.
Rate/ Volume Analysis
(Dollars in Thousands)
The following table represents the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected interest income and interest expense during the periods indicated. Information is provided in each category with respect to (i) changes attributable to changes in volume (changes in volume multiplied by prior rate), (ii) changes attributable to changes in rate (changes in rate multiplied by prior volume), and (iii) net change. Changes that cannot be attributed to either rate or volume have been allocated to both rate and volume.
Quarters ended June 30, 2015 and 2014
Net
Volume
Change
Interest earning assets:
(2,766
2,945
(77
(531
(608
Investment securities
(416
(169
(585
(100
(122
(222
(4
(102
(106
Total interest-earning assets
(3,363
2,021
(21
(18
(24
(33
(146
(550
(696
(119
425
(292
(422
Net change in net interest income
(3,071
2,151
(920
64
Loans receivable (a) (b) (includes FTE adjustments of $931 and $1,084, respectively)
6,046,741
142,627
4.76
5,828,500
141,132
4.88
492,209
1.74
611,050
1.79
Investment securities (c) (includes FTE adjustments of $1,341 and $1,752, respectively)
484,366
6,006
2.48
507,334
7,099
2.80
FHLB stock (g)
35,872
1,878
4.71
43,830
973
4.44
252,210
0.25
370,292
Total interest-earning assets (includes FTE adjustments of $2,272 and $2,836, respectively)
7,311,398
155,122
4.25
7,361,006
155,149
569,689
573,837
7,881,087
7,934,843
1,247,854
1,224,042
1,624
899,260
873,972
288
1,156,079
1,524
1,178,202
1,574
1,430,989
8,020
1,621,745
9,425
945,192
13,904
2.97
876,897
13,180
3.03
2,330
2,327
5,782,468
5,877,952
936,090
833,750
98,992
114,994
6,817,550
6,826,696
1,063,537
1,108,147
127,431
3.28
126,731
1,528,930
1,483,054
3.44
1.25X
(f) Annualized. Shown on a fully tax-equivalent basis (“FTE”). The FTE basis adjusts for the tax benefit of income on certain tax exempt loans and investments using the federal statutory rate of 35% for each period presented. We believe this measure to be the preferred industry measurement of net interest income and provides relevant comparison between taxable and non-taxable amounts. GAAP basis yields were: Loans — 4.73% and 4.85%, respectively; Investment securities — 1.93% and 2.11%, respectively; interest-earning assets — 4.19% and 4.17%, respectively. GAAP basis net interest rate spreads were 3.22% and 3.20%, respectively; and GAAP basis net interest margins were 3.40% and 3.37%, respectively.
(g) Excludes the $1.0 million special dividend paid in February 2015 from the average yield calculation.
Six months ended June 30, 2015 and 2014
(3,833
5,328
(105
(1,062
(1,167
(808
(285
(1,093
1,099
(194
905
(12
(155
(167
(3,659
3,632
(26
(20
(30
(50
(336
(1,069
(1,405
(281
1,005
(672
(55
(727
(2,987
3,687
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As the holding company for a savings bank, one of our primary market risks is interest rate risk. Interest rate risk is the sensitivity of net interest income to variations in interest rates over a specified time period. The sensitivity results from differences in the time periods in which interest rate sensitive assets and liabilities mature or re-price. We attempt to control interest rate risk by matching, within acceptable limits, the re-pricing periods of assets and liabilities. We have attempted to limit our exposure to interest sensitivity by increasing core deposits, enticing customers to extend certificates of deposit maturities, borrowing funds with fixed-rates and longer maturities and by shortening the maturities of our assets by emphasizing the origination of more short-term fixed rate loans and adjustable rate loans. We also continue to sell a portion of the long-term, fixed-rate mortgage loans that we originate. In addition, we purchase shorter term or adjustable-rate investment securities and mortgage-backed securities.
We have an Asset/Liability Committee consisting of members of management which meets monthly to review market interest rates, economic conditions, the pricing of interest-earning assets and
interest-bearing liabilities and the balance sheet structure. On a quarterly basis, this Committee also reviews the interest rate risk position and cash flow projections.
The Board of Directors has a Risk Management Committee which meets quarterly and reviews interest rate risk and trends, our interest sensitivity position, the liquidity position and the market risk inherent in the investment portfolio.
In an effort to assess interest rate risk and market risk, we utilize a simulation model to determine the effect of immediate incremental increases and decreases in interest rates on net income and the market value of equity. Certain assumptions are made regarding loan prepayments and decay rates of savings and interest-bearing demand accounts. Because it is difficult to accurately project the market reaction of depositors and borrowers, the effect of actual changes in interest rates on these assumptions may differ from simulated results. We have established the following guidelines for assessing interest rate risk:
Net interest income simulation. Given a non-parallel shift of 100 basis points (“bps”), 200 bps and 300 bps in interest rates, the estimated net income may not decrease by more than 5%, 10% and 15%, respectively, within a one-year period.
Net income simulation. Given a non-parallel shift of 100 basis points (“bps”), 200 bps and 300 bps in interest rates, the estimated net income may not decrease by more than 10%, 20% and 30%, respectively, within a one-year period.
Market value of equity simulation. The market value of equity is the present value of assets and liabilities. Given a non-parallel shift of 100 bps, 200 bps and 300 bps in interest rates, the market value of equity may not decrease by more than 15%, 30% and 35%, respectively, from the computed economic value at current interest rate levels.
The following table illustrates the simulated impact of a 100 bps, 200 bps or 300 bps upward or a 100 bps downward movement in interest rates on net income, return on average equity, earnings per share and market value of equity. This analysis was prepared assuming that interest-earning asset and interest-bearing liability levels at June 30, 2015 remain constant. The impact of the rate movements was computed by simulating the effect of an immediate and sustained shift in interest rates over a twelve-month period from June 30, 2015 levels.
Increase
Decrease
Non-parallel shift in interest rates over the next 12 months
100 bps
200 bps
300 bps
Projected percentage increase/ (decrease) in net interest income
(1.4
)%
(2.0
(3.2
(4.2
Projected percentage increase/ (decrease) in net income
(2.9
(3.3
(5.2
(13.6
Projected increase/ (decrease) in return on average equity
(2.8
(3.1
(5.0
(13.3
Projected increase/ (decrease) in earnings per share
(0.02
(0.03
(0.04
(0.09
Projected percentage increase/ (decrease) in market value of equity
(3.7
(8.7
(14.4
(2.4
The figures included in the table above represent projections that were computed based upon certain assumptions including prepayment rates and decay rates. These assumptions are inherently uncertain and, as a result, cannot precisely predict the impact of changes in interest rates. Actual results may differ significantly due to timing, magnitude and frequency of interest rate changes and changes in market conditions.
ITEM 4. CONTROLS AND PROCEDURES
Under the supervision of and with the participation of management, including the Principal Executive Officer and Principal Financial Officer, we evaluated the effectiveness of the design and operation of its disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of the end of the period covered by this quarterly report (the “Evaluation Date”). Based upon that evaluation, the Principal Executive Officer and Principal Financial Officer concluded that, as of the Evaluation Date, these disclosure controls and procedures were effective.
There were no changes in the internal controls over financial reporting during the period covered by this report or in other factors that have materially affected, or are reasonably likely to materially affect the internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We are subject to a number of asserted and unasserted claims encountered in the normal course of business. We believe that any additional liability, other than that which has already been accrued, that may result from such potential litigation will not have a material adverse effect on the financial statements. However, we cannot presently determine whether or not any claims against us will have a material adverse effect on our results of operations in any future reporting period. See note 11.
Item 1A. Risk Factors
There are no material changes to the risk factors as previously discussed in Item 1A, to Part I of our 2014 Annual Report on Form 10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
a.) Not applicable.
b.) Not applicable.
c.) The following table discloses information regarding the repurchase of shares of common stock during the quarter ending June 30, 2015:
Month
Number of shares purchased
Average price paid per share
Total number of shares purchased as part of a publicly announced repurchase plan (1)
Maximum number of shares yet to be purchased under the plan (1)
April
111,300
12.18
195,989
May
5,300
12.40
190,689
June
63,200
12.51
127,489
179,800
12.30
Total number of shares purchased as part of a publicly announced repurchase plan (2)
Maximum number of shares yet to be purchased under the plan (2)
5,000,000
(1) Reflects the program for 4,750,000 shares announced September 26, 2011. This program does not have an expiration date.
(2) Reflects the program for 5,000,000 shares announced December 13, 2012. This program does not have an expiration date.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Mine Safety Disclosures
Item 5. Other Information
Item 6. Exhibits
31.1 Certification of the Chief Executive Officer pursuant to Rule 13a-15 or 15d-15 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer pursuant to Rule 13a-15 or 15d-15 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS XBRL Instance Document
101.SCH XBRL Taxonomy Extension Schema Document
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF XBRL Taxonomy Extension Definition Linkbase Document
101.LAB XBRL Taxonomy Extension Label Linkbase
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed by the undersigned thereunto duly authorized.
(Registrant)
Date:
August 10, 2015
By:
/s/ William J. Wagner
William J. Wagner
President and Chief Executive Officer
(Duly Authorized Officer)
/s/ Gerald J. Ritzert
Gerald J. Ritzert
Controller
(Principal Accounting Officer)