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VALLEY NATIONAL BANCORP - Quarter Report: 2012 June (Form 10-Q)

Form 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

 

FORM 10-Q

 

 

(Mark One)

x Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

For the Quarterly Period Ended June 30, 2012

OR

 

¨ Transition Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

For the transition period from              to             

Commission File Number 1-11277

 

 

VALLEY NATIONAL BANCORP

(Exact name of registrant as specified in its charter)

 

 

 

New Jersey   22-2477875

(State or other jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification Number)

1455 Valley Road

Wayne, NJ

  07470
(Address of principal executive office)   (Zip code)

973-305-8800

(Registrant’s telephone number, including area code)

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

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

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

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. Common Stock (no par value), of which 197,440,489 shares were outstanding as of August 2, 2012.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

 

 

         Page
  Number  
 
PART I   FINANCIAL INFORMATION   

Item 1.

 

Financial Statements (Unaudited)

  
 

Consolidated Statements of Financial Condition as of June 30, 2012 and December 31, 2011

     2   
 

Consolidated Statements of Income for the Three and Six Months Ended June 30, 2012 and 2011

     3   
 

Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2012 and 2011

     4   
 

Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2012 and 2011

     5   
 

Notes to Consolidated Financial Statements

     7   

Item 2.

 

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

     46   

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

     82   

Item 4.

 

Controls and Procedures

     82   
PART II   OTHER INFORMATION   

Item 1.

 

Legal Proceedings

     83   

Item 1A.

 

Risk Factors

     83   

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

     83   

Item 6.

 

Exhibits

     84   

SIGNATURES

     85   

 

1


Table of Contents

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

VALLEY NATIONAL BANCORP

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (Unaudited)

(in thousands, except for share data)

 

     June 30,
2012
     December 31,
2011
 

Assets

     

Cash and due from banks

     $ 443,297           $ 372,566     

Interest bearing deposits with banks

     8,423           6,483     

Investment securities:

     

Held to maturity, fair value of $1,860,722 at June 30, 2012 and $2,027,197 at December 31, 2011

     1,805,378           1,958,916     

Available for sale

     688,788           566,520     

Trading securities

     22,039           21,938     
  

 

 

    

 

 

 

Total investment securities

     2,516,205           2,547,374     
  

 

 

    

 

 

 

Loans held for sale, at fair value

     29,970           25,169     

Non-covered loans

     11,197,315           9,527,797     

Covered loans

     226,537           271,844     

Less: Allowance for loan losses

     (129,854)          (133,802)    
  

 

 

    

 

 

 

Net loans

     11,293,998           9,665,839     
  

 

 

    

 

 

 

Premises and equipment, net

     273,626           265,475     

Bank owned life insurance

     336,612           303,867     

Accrued interest receivable

     55,040           52,527     

Due from customers on acceptances outstanding

     5,356           5,903     

FDIC loss-share receivable

     59,741           74,390     

Goodwill

     420,443           317,962     

Other intangible assets, net

     26,817           20,818     

Other assets

     548,716           586,134     
  

 

 

    

 

 

 

Total Assets

     $ 16,018,244           $ 14,244,507     
  

 

 

    

 

 

 

Liabilities

     

Deposits:

     

Non-interest bearing

     $ 3,231,722           $ 2,781,597     

Interest bearing:

     

Savings, NOW and money market

     4,991,834           4,390,121     

Time

     2,648,123           2,501,384     
  

 

 

    

 

 

 

Total deposits

     10,871,679           9,673,102     
  

 

 

    

 

 

 

Short-term borrowings

     523,122           212,849     

Long-term borrowings

     2,724,536           2,726,099     

Junior subordinated debentures issued to capital trusts (includes fair value of $149,649 at June 30, 2012 and $160,478 at December 31, 2011 for VNB Capital Trust I)

     190,495           185,598     

Bank acceptances outstanding

     5,356           5,903     

Accrued expenses and other liabilities

     199,983           174,708     
  

 

 

    

 

 

 

Total Liabilities

     14,515,171           12,978,259     
  

 

 

    

 

 

 

Shareholders’ Equity*

     

Preferred stock, no par value, authorized 30,000,000 shares; none issued

     -           -     

Common stock, no par value, authorized 232,023,233 shares; issued 197,262,005 shares at June 30, 2012 and 178,717,806 shares at December 31, 2011

     69,308           59,955     

Surplus

     1,384,729           1,179,135     

Retained earnings

     92,925           90,011     

Accumulated other comprehensive loss

     (43,867)          (62,441)    

Treasury stock, at cost (2,079 common shares at June 30, 2012 and 34,776 common shares at December 31, 2011)

     (22)          (412)    
  

 

 

    

 

 

 

Total Shareholders’ Equity

     1,503,073           1,266,248     
  

 

 

    

 

 

 

Total Liabilities and Shareholders’ Equity

     $      16,018,244           $      14,244,507     
  

 

 

    

 

 

 

 

 

* Share data reflects the five percent common stock dividend issued on May 25, 2012.

See accompanying notes to consolidated financial statements.

 

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Table of Contents

VALLEY NATIONAL BANCORP

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

(in thousands, except for share data)

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2012      2011      2012      2011  

Interest Income

           

Interest and fees on loans

     $ 143,812           $ 135,084           $ 292,272           $ 268,707     

Interest and dividends on investment securities:

           

Taxable

     18,114           28,602           38,865           58,182     

Tax-exempt

     3,227           2,429           6,346           4,934     

Dividends

     1,674           1,591           3,425           3,647     

Interest on federal funds sold and other short-term investments

     31           88           86           143     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest income

     166,858           167,794           340,994           335,613     
  

 

 

    

 

 

    

 

 

    

 

 

 

Interest Expense

           

Interest on deposits:

           

Savings, NOW and money market

     4,690           5,082           10,044           9,761     

Time

     9,276           12,616           19,461           24,782     

Interest on short-term borrowings

     369           276           622           617     

Interest on long-term borrowings and junior subordinated debentures

     30,452           32,150           61,337           65,891     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest expense

     44,787           50,124           91,464           101,051     
  

 

 

    

 

 

    

 

 

    

 

 

 

Net Interest Income

     122,071           117,670           249,530           234,562     

Provision for credit losses

     7,405           6,026           13,102           30,188     
  

 

 

    

 

 

    

 

 

    

 

 

 

Net Interest Income After Provision for Credit Losses

     114,666           111,644           236,428           204,374     
  

 

 

    

 

 

    

 

 

    

 

 

 

Non-Interest Income

           

Trust and investment services

     1,984           1,952           3,758           3,975     

Insurance commissions

     3,283           3,657           8,719           8,080     

Service charges on deposit accounts

     6,086           5,642           12,032           11,292     

Gains on securities transactions, net

     1,204           16,492           1,047           19,171     

Other-than-temporary impairment losses on securities

     -           -           -           -     

Portion recognized in other comprehensive income (before taxes)

     (550)          -           (550)          (825)    
  

 

 

    

 

 

    

 

 

    

 

 

 

Net impairment losses on securities recognized in earnings

     (550)          -           (550)          (825)    

Trading gains (losses), net

     1,609           (1,048)          621           2,334     

Fees from loan servicing

     1,149           1,170           2,308           2,367     

Gains on sales of loans, net

     3,141           1,561           6,307           5,170     

Gains on sales of assets, net

     256           146           288           203     

Bank owned life insurance

     1,632           1,880           3,591           3,586     

Change in FDIC loss-share receivable

     (7,022)          (2,669)          (7,112)          13,566     

Other

     11,258           4,752           15,616           9,403     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total non-interest income

     24,030           33,535           46,625           78,322     
  

 

 

    

 

 

    

 

 

    

 

 

 

Non-Interest Expense

           

Salary and employee benefits expense

     51,214           44,109           102,240           88,234     

Net occupancy and equipment expense

     16,903           15,467           34,265           32,653     

FDIC insurance assessment

     3,208           3,302           6,827           6,631     

Amortization of other intangible assets

     2,532           1,796           4,490           3,758     

Professional and legal fees

     3,345           3,020           6,969           6,793     

Advertising

     1,841           2,703           3,529           4,185     

Other

     12,467           12,683           27,738           24,655     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total non-interest expense

     91,510           83,080           186,058           166,909     
  

 

 

    

 

 

    

 

 

    

 

 

 

Income Before Income Taxes

     47,186           62,099           96,995           115,787     

Income tax expense

     14,366           25,205           29,644           42,308     
  

 

 

    

 

 

    

 

 

    

 

 

 

Net Income

     $ 32,820           $ 36,894           $ 67,351           $ 73,479     
  

 

 

    

 

 

    

 

 

    

 

 

 

Earnings Per Common Share*:

           

Basic

     $ 0.17           $ 0.21           $ 0.34           $ 0.41     

Diluted

     0.17           0.21           0.34           0.41     

Cash Dividends Declared per Common Share*

     0.16           0.16           0.33           0.33     

Weighted Average Number of Common Shares Outstanding*:

           

Basic

     197,246,322           178,335,522           197,088,528           178,245,603     

Diluted

     197,250,168           178,345,558           197,105,638           178,254,714     

 

 

* Share data reflects the five percent common stock dividend issued on May 25, 2012.

See accompanying notes to consolidated financial statements.

 

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VALLEY NATIONAL BANCORP

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

(in thousands)

 

     Three Months Ended June 30,      Six Months Ended June 30,  
             2012                      2011                      2012                      2011          

Net income

     $ 32,820           $ 36,894           $ 67,351           $ 73,479     

Other comprehensive income (loss), net of tax:

           

Unrealized gains and losses on available for sale securities

           

Net gains arising during the period

     2,891           6,074           7,117           7,886     

Less reclassification adjustment for net gains included in net income

     (699)          (10,043)          (604)          (11,721)    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     2,192           (3,969)          6,513           (3,835)    
  

 

 

    

 

 

    

 

 

    

 

 

 

Non-credit impairment losses on available for sale securities

           

Net change in non-credit impairment losses on securities

     4,547           491           11,617           593     

Less reclassification adjustment for credit impairment losses included in net income

     304           (58)          114           360     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     4,851           433           11,731           953     
  

 

 

    

 

 

    

 

 

    

 

 

 

Unrealized gains and losses on derivatives (cash flow hedges)

           

Net losses on derivatives arising during the period

     (3,069)          (3,792)          (2,170)          (2,960)    

Less reclassification adjustment for net losses included in net income

     811           355           1,619           690     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     (2,258)          (3,437)          (551)          (2,270)    
  

 

 

    

 

 

    

 

 

    

 

 

 

Defined benefit pension plan

           

Amortization of prior service cost

     103           93           206           185     

Amortization of net loss

     337           198           675           398     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     440           291           881           583     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total other comprehensive income (loss)

     5,225           (6,682)          18,574           (4,569)    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total comprehensive income

     $         38,045           $         30,212           $         85,925           $         68,910     
  

 

 

    

 

 

    

 

 

    

 

 

 

See accompanying notes to consolidated financial statements.

 

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Table of Contents

VALLEY NATIONAL BANCORP

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(in thousands)

 

     Six Months Ended June 30,  
Cash flows from operating activities:            2012                     2011          

Net income

     $ 67,351          $ 73,479     

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

    

Depreciation and amortization

     8,955          8,077     

Stock-based compensation

     2,701          1,276     

Provision for credit losses

     13,102          30,188     

Net amortization of premiums and accretion of discounts on securities and borrowings

     10,420          5,102     

Amortization of other intangible assets

     4,490          3,758     

Gains on securities transactions, net

     (1,047)         (19,171)    

Net impairment losses on securities recognized in earnings

     550          825     

Proceeds from sales of loans held for sale

     198,128          173,081     

Gains on sales of loans, net

     (6,307)         (5,170)    

Originations of loans held for sale

     (196,622)         (137,338)    

Gains on sales of assets, net

     (288)         (203)    

Net change in:

    

FDIC loss-share receivable (excluding reimbursements)

     7,112          (13,566)     

Trading securities

     (101)         9,793     

Fair value of borrowings carried at fair value

     (520)         (1,947)    

Cash surrender value of bank owned life insurance

     (3,591)         (3,586)    

Accrued interest receivable

     2,781          (305)    

Other assets

     95,567          25,298     

Accrued expenses and other liabilities

     (41,523)         (23,533)    
  

 

 

   

 

 

 

Net cash provided by operating activities

     161,158          126,058     
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Net loan originations

     (461,749)         (241,027)    

Loans purchased

     (117,255)         -       

Investment securities held to maturity:

    

Purchases

     (135,332)         (272,825)    

Maturities, calls and principal repayments

     329,201          339,196     

Investment securities available for sale:

    

Purchases

     (49,012)         (366,123)    

Sales

     58,585          390,861     

Maturities, calls and principal repayments

     133,496          102,250     

Death benefit proceeds from bank owned life insurance

     1,689          1,169     

Proceeds from sales of real estate property and equipment

     4,139          3,946     

Purchases of real estate property and equipment

     (8,407)         (7,513)    

Reimbursements from the FDIC under loss-sharing agreements

     7,537          22,746     

Cash and cash equivalents acquired in acquisition

     117,587          -     
  

 

 

   

 

 

 

Net cash used in investing activities

     (119,521 )       (27,320 )  
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Net change in deposits

     (181,716)         342,833     

Net change in short-term borrowings

     281,273          (21,258)    

Repayments of long-term borrowings

     (1,000)         (206,000)    

Redemption of junior subordinated debentures

     (10,000)         -     

Dividends paid to common shareholders

     (61,730)         (58,151)    

Common stock issued, net

     4,207          4,215     
  

 

 

   

 

 

 

Net cash provided by financing activities

     31,034          61,639     
  

 

 

   

 

 

 

Net change in cash and cash equivalents

     72,671          160,377     

Cash and cash equivalents at beginning of year

     379,049          366,286     
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

     $         451,720          $         526,663     
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

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VALLEY NATIONAL BANCORP

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

(in thousands)

 

     Six Months Ended June 30,  
           2012                  2011        

Supplemental disclosures of cash flow information:

     

Cash payments for:

     

Interest on deposits and borrowings

     $ 91,592           $     100,522     

Federal and state income taxes

     35,061           28,741     

Supplemental schedule of non-cash investing activities:

     

Acquisitions:

     

Non-cash assets acquired:

     

Investment securities available for sale

     275,650           -         

Loans

     1,098,948           -         

Premises and equipment, net

     9,457           -         

Accrued interest receivable

     5,294           -         

Goodwill

     101,967           -         

Other intangible assets, net

     8,050           -         

Other assets

     67,715           -         
  

 

 

    

 

 

 

Total non-cash assets acquired

     $   1,567,081           -         
  

 

 

    

 

 

 

Liabilities assumed:

     

Deposits

     1,380,293           -         

Short-term borrowings

     29,000           -         

Junior subordinated debentures issued to capital trusts

     15,645        

Other liabilities

     51,312           -         
  

 

 

    

 

 

 

Total liabilities assumed

     1,476,250           -         
  

 

 

    

 

 

 

Net non-cash assets acquired

     $ 90,831           $ -         
  

 

 

    

 

 

 

Net cash and cash equivalents acquired

     $ 117,587           $ -         

Common stock issued in acquisition

     $ 208,418           $ -         

See accompanying notes to consolidated financial statements.

 

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VALLEY NATIONAL BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1. Basis of Presentation

The unaudited consolidated financial statements of Valley National Bancorp, a New Jersey Corporation (“Valley”), include the accounts of its commercial bank subsidiary, Valley National Bank (the “Bank”), and all of Valley’s direct or indirect wholly-owned subsidiaries. All inter-company transactions and balances have been eliminated. The accounting and reporting policies of Valley conform to U.S. generally accepted accounting principles (“U.S. GAAP”) and general practices within the financial services industry. In accordance with applicable accounting standards, Valley does not consolidate statutory trusts established for the sole purpose of issuing trust preferred securities and related trust common securities. Certain prior period amounts have been reclassified to conform to the current presentation.

In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly Valley’s financial position, results of operations and cash flows at June 30, 2012 and for all periods presented have been made. The results of operations for the three and six months ended June 30, 2012 are not necessarily indicative of the results to be expected for the entire fiscal year.

In preparing the unaudited consolidated financial statements in conformity with U.S. GAAP, management has made estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated statements of financial condition and results of operations for the periods indicated. Material estimates that are particularly susceptible to change are: the allowance for loan losses; the evaluation of goodwill and other intangible assets, and investment securities for impairment; fair value measurements of assets and liabilities (including the estimated fair values recorded for acquired assets and assumed liabilities - see discussion below); and income taxes. Estimates and assumptions are reviewed periodically and the effects of revisions are reflected in the consolidated financial statements in the period they are deemed necessary. While management uses its best judgment, actual amounts or results could differ significantly from those estimates. The current economic environment has increased the degree of uncertainty inherent in these material estimates.

Certain information and footnote disclosure normally included in financial statements prepared in accordance with U.S. GAAP and industry practice have been condensed or omitted pursuant to rules and regulations of the SEC. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in Valley’s Annual Report on Form 10-K for the year ended December 31, 2011.

Effective January 1, 2012, Valley acquired State Bancorp, Inc. (“State Bancorp”), the holding company for State Bank of Long Island, a commercial bank. See Note 3 for further details regarding this acquisition.

On May 25, 2012, Valley paid a five percent common stock dividend to shareholders of record on May 11, 2012. All common share and per common share data presented in the consolidated financial statements and the accompanying notes below were adjusted to reflect the dividend.

 

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Note 2. Earnings Per Common Share

The following table shows the calculation of both basic and diluted earnings per common share for the three and six months ended June 30, 2012 and 2011:

 

     Three Months Ended
June  30,
     Six Months Ended
June  30,
 
           2012                  2011                  2012                  2011        
     (in thousands, except for share data)  

Net income

     $ 32,820           $ 36,894           $ 67,351           $ 73,479     
  

 

 

    

 

 

    

 

 

    

 

 

 

Basic weighted-average number of common shares outstanding

     197,246,322           178,335,522           197,088,528           178,245,603     

Plus: Common stock equivalents

     3,846           10,036           17,110           9,111     
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted weighted-average number of common shares outstanding

     197,250,168           178,345,558           197,105,638           178,254,714     
  

 

 

    

 

 

    

 

 

    

 

 

 

Earnings per common share:

           

Basic

     $ 0.17           $ 0.21           $ 0.34           $ 0.41     

Diluted

     0.17           0.21           0.34           0.41     

Common stock equivalents, in the table above, represent the effect of outstanding common stock options and warrants to purchase Valley’s common shares, excluding those with exercise prices that exceed the average market price of Valley’s common stock during the periods presented and therefore, would have an anti-dilutive effect on the diluted earnings per common share calculation. Anti-dilutive common stock options and warrants totaled approximately 7.7 million shares for both the three and six months ended June 30, 2012, and 7.2 million shares for both the three and six months ended June 30, 2011.

Note 3. Business Combinations

Acquisition of State Bancorp, Inc.

On January 1, 2012, Valley acquired State Bancorp, the holding company for State Bank of Long Island, a commercial bank with approximately $1.7 billion in assets, after purchase accounting adjustments, and 16 branches in Nassau, Suffolk, Queens, and Manhattan. The shareholders of State Bancorp received a fixed one- for- one exchange ratio for Valley National Bancorp common stock. The total consideration for the acquisition was $208.4 million (approximately 17.7 million shares of Valley common stock). As a condition to the closing of the merger, State Bancorp redeemed $36.8 million of its outstanding Fixed Rate Cumulative Series A Preferred Stock from the U.S. Treasury. This stock redemption was funded by a $37.0 million short-term loan from Valley to State Bancorp. The outstanding loan, included in Valley’s consolidated statement of financial condition at December 31, 2011, was subsequently eliminated as of the acquisition date and is no longer outstanding.

In connection with the acquisition, Valley acquired all of the voting and common shares of State Capital Trust I and State Capital Trust II, which are wholly-owned subsidiaries established for the sole purpose of issuing trust preferred securities and related trust common securities. Valley also assumed junior subordinated debentures issued to capital trusts with combined contractual principal balances totaling $20.6 million. Valley has the right to optionally redeem the debentures and related trust preferred securities at par prior to the maturity dates of November 7, 2032 and January 23, 2034 for each respective capital trust. These capital trusts, similar to our other capital trust subsidiaries, are not consolidated for financial statement purposes.

Additionally, a warrant issued by State Bancorp (in connection with its preferred stock issuance) to the U.S. Treasury in December 2008 was assumed by Valley as of the acquisition date. The ten-year warrant to purchase up to 489 thousand of Valley common shares has an exercise price of $11.30 per share, and is exercisable on a net exercise basis. Valley has calculated an internal value for the warrants, and may negotiate their redemption with the U.S. Treasury. However, if Valley elects not to negotiate or an agreement cannot be reached with the U.S. Treasury, the warrants will likely be sold at public auction and remain outstanding.

 

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Merger expenses totaled $109 thousand and $1.1 million for the three and six months ended June 30, 2012, respectively which were largely related to data processing conversion charges that are included in other non-interest expense on the consolidated statements of income.

The following table sets forth assets acquired and liabilities assumed in the State Bancorp acquisition at their estimated fair values as of the closing date of the transaction:

 

       January 1, 2012        
     (in thousands)    

Assets acquired:

    

Cash and cash equivalents

     $ 117,587       

Investment securities available for sale

     275,650       

Loans

     1,098,948       

Premises and equipment

     9,457       

Accrued interest receivable

     5,294       

Goodwill

     101,967       

Other intangible assets

     8,050       

Other assets

     67,715       
  

 

 

   

Total assets acquired

     $ 1,684,668       
  

 

 

   

Liabilities assumed:

    

Deposits:

    

Non-interest bearing

     $ 371,151       

Savings, NOW and money market

     596,599       

Time

     412,543       
  

 

 

   

Total deposits

     1,380,293       
  

 

 

   

Short-term borrowings

     29,000       

Junior subordinated debentures issued to capital trusts

     15,645       

Other liabilities

     51,312       
  

 

 

   

Total liabilities assumed

     $ 1,476,250       
  

 

 

   

 

Common stock issued in acquisition

     $ 208,418       

The fair value estimates are subject to change for up to one year after the closing date of the transaction if additional information relative to closing date fair values becomes available. As Valley continues to analyze the assets acquired and liabilities assumed, there may be adjustments to the recorded carrying values.

Fair Value Measurement of Assets Acquired and Liabilities Assumed

Described below are the methods used to determine the fair values of the significant assets acquired and liabilities assumed in the State Bancorp acquisition.

Cash and cash equivalents. The estimated fair values of cash and cash equivalents approximate their stated face amounts, as these financial instruments are either due on demand or have short-term maturities.

Investment securities available for sale. The estimated fair values of the investment securities available for sale were calculated utilizing Level 2 inputs. The prices for these instruments are obtained through an independent pricing service and are derived from market quotations and matrix pricing. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. Management reviewed the data and assumptions used in pricing the securities by its third party provider to ensure the highest level of significant inputs are derived from market observable data.

Loans. The acquired loan portfolio was segregated into categories for valuation purposes primarily based on loan type (commercial, mortgage, or consumer) and credit risk rating. The estimated fair values were computed by discounting

 

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the expected cash flows from the respective portfolios. Management estimated the cash flows expected to be collected at the acquisition date by using valuation models that incorporated estimates of current key assumptions, such as prepayment speeds, default rates, and loss severity rates. Prepayment assumptions were developed by reference to recent or historical prepayment speeds observed for loans with similar underlying characteristics. Prepayment assumptions were influenced by many factors including, but not limited to, forward interest rates, loan and collateral types, payment status, and current loan-to-value ratios. Default and loss severity rates were developed by reference to recent or historical default and loss rates observed for loans with similar underlying characteristics. Default and loss severity assumptions were influenced by many factors including, but not limited to, underwriting processes and documentation, vintages, collateral types, collateral locations, estimated collateral values, loan-to-value ratios, and debt-to-income ratios.

The expected cash flows from the acquired loan portfolios were discounted at estimated market rates. The market rates were estimated using a buildup approach which included assumptions with respect to funding cost and funding mix, estimated servicing cost, liquidity premium, and additional spreads, if warranted, to compensate for the uncertainty inherent in the acquired loans. The methods used to estimate the Level 3 fair values of loans are extremely sensitive to the assumptions and estimates used. While management attempted to use assumptions and estimates that best reflected the acquired loan portfolios and current market conditions, a greater degree of subjectivity is inherent in these values than in those determined in active markets.

The difference between the fair value and the expected cash flows from the acquired loans will be accreted to interest income over the remaining term of the loans in accordance with Accounting Standards Codification (“ASC”) Subtopic 310-30, “Loans and Debt Securities Acquired with Deteriorated Credit Quality.” See Note 7 for further details.

Other intangible assets. Other intangible assets consisting of core deposit intangibles (“CDI”) are measures of the value of non-maturity checking, savings, NOW and money market deposits that are acquired in a business combination excluding any large relationships, for which Valley believes there is no customer related intangible asset. The fair value of the CDI stemming from any given business combination is based on the present value of the expected cost savings attributable to the core deposit funding, relative to an alternative source of funding. The CDI is being amortized over an estimated useful life of eleven years to approximate the existing deposit relationships acquired.

Deposits. The fair values of deposit liabilities with no stated maturity (i.e., NOW and money market accounts, savings accounts, and non-interest-bearing accounts) are equal to the carrying amounts payable on demand. The fair values of certificates of deposit represent contractual cash flows, discounted to present value using interest rates currently offered on deposits with similar characteristics and remaining maturities.

Short-term borrowings. The fair value of short-term borrowings approximates their contractual principal balances, as these borrowings matured in March 2012.

Junior subordinated debentures issued to capital trusts. There is no active market for the trust preferred securities issued by State Bancorp Capital Trust I and State Bancorp Capital Trust II; therefore, the fair value of junior subordinated debentures was estimated utilizing the income approach. Under the income approach, the expected cash flows over the remaining estimated life of the debentures were discounted using Valley’s credit spread plus the three- month LIBOR (the contractual base index rate for these instruments). Valley’s credit spread was calculated based on Valley’s trust preferred securities issued by VNB Capital Trust I, which are publicly traded in an active market.

Note 4. New Authoritative Accounting Guidance

Accounting Standards Update (“ASU”) No. 2011-04, “Fair Value Measurements (Topic 820) – Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs,” was issued as a result of the effort to develop common fair value measurement and disclosure requirements in U.S. GAAP and International Financial Reporting Standards (“IFRS”). While ASU No. 2011-04 is largely consistent with existing fair value measurement principles in U.S. GAAP, it expands the existing disclosure requirements for fair value measurements and clarifies the existing guidance or wording changes to align with IFRS No. 13. Many of the requirements for the amendments in ASU No. 2011-04 do not result in a change in the application of the requirements in Topic 820. ASU No. 2011-04 became effective for Valley on January 1, 2012 and did not to have a significant impact on its consolidated financial statements. See Note 5 for the related disclosures.

 

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ASU No. 2011-05, “Comprehensive Income (Topic 220) – Presentation of Comprehensive Income,” requires an entity to present components of comprehensive income either in a single continuous statement of comprehensive income or in two separate consecutive statements. These amendments will make the financial statement presentation of other comprehensive income more prominent by eliminating the alternative to present comprehensive income within the statement of equity. As originally issued, ASU No. 2011-05 required entities to present reclassification adjustments out of accumulated other comprehensive income by component in the statement in which net income is presented and the statement in which other comprehensive income is presented (for both interim and annual financial statements). This requirement was deferred by ASU No. 2011-12, “Comprehensive Income (Topic 220) – Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards”. ASU No. 2011-05 became effective for all interim and annual periods beginning on or after December 15, 2011 with early adoption permitted, and applied retrospectively. Valley early adopted ASU No. 2011-05 for the year ended December 31, 2011 and elected to present comprehensive income in a separate consolidated statement of comprehensive income.

ASU No. 2011-08, “Intangibles – Goodwill and Other (Topic 350) Testing Goodwill for Impairment,” provides the option of performing a qualitative assessment of whether it is more likely than not that a reporting unit’s fair value is less than its carrying amount, before applying the current two-step goodwill impairment test. If the conclusion is that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, the entity would be required to conduct the current two-step goodwill impairment test. Otherwise, the entity would not need to apply the two-step test. ASU No. 2011-08 is effective for annual and interim goodwill impairment tests performed by Valley during 2012. ASU No. 2011-08 did not have a significant impact on Valley’s consolidated financial statements.

Note 5. Fair Value Measurement of Assets and Liabilities

ASC Topic 820, “Fair Value Measurements and Disclosures,” establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:

 

  Level 1    Unadjusted exchange quoted prices in active markets for identical assets or liabilities, or identical liabilities traded as assets that the reporting entity has the ability to access at the measurement date.
  Level 2    Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly (i.e., quoted prices on similar assets), for substantially the full term of the asset or liability.
  Level 3    Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).

Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

 

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Assets and Liabilities Measured at Fair Value on a Recurring and Non-recurring Basis

The following tables present the assets and liabilities that are measured at fair value on a recurring and nonrecurring basis by level within the fair value hierarchy as reported on the consolidated statements of financial condition at June 30, 2012 and December 31, 2011. The assets presented under “nonrecurring fair value measurements” in the table below are not measured at fair value on an ongoing basis but are subject to fair value adjustments under certain circumstances (e.g., when an impairment loss is recognized).

 

         June 30,    
2012
     Fair Value Measurements at Reporting Date Using:  
        Quoted Prices
 in Active Markets 

for Identical
Assets (Level 1)
     Significant
Other
Observable Inputs
(Level 2)
     Significant
  Unobservable  
Inputs

(Level 3)
 
Recurring fair value measurements:    (in thousands)  

Assets

           

Investment securities:

           

Available for sale:

           

U.S. government agency securities

     $ 54,902           $ -               $ 54,902           $ -         

Obligations of states and political subdivisions

     19,310           -               19,310           -         

Residential mortgage-backed securities

     430,019           -               386,849           43,170     

Trust preferred securities

     82,864           10,136           26,807           45,921     

Corporate and other debt securities

     52,180           28,499           23,681        

Equity securities

     49,513           28,444           21,069        
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available for sale

     688,788           67,079           532,618           89,091     

Trading securities

     22,039           -               22,039           -         

Loans held for sale (1)

     29,970           -               29,970           -         

Other assets (2)

     8,097           -               8,097           -         
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets

     $ 748,894           $ 67,079           $ 592,724           $ 89,091     
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities

           

Junior subordinated debentures issued to VNB Capital Trust I (3)

     $ 149,649           $ 149,649           $ -               $ -         

Other liabilities (2)

     27,055           -               27,055           -         
  

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities

     $ 176,704           $ 149,649           $ 27,055           $ -         
  

 

 

    

 

 

    

 

 

    

 

 

 

Non-recurring fair value measurements:

           

Collateral dependent impaired loans (4)

     $ 73,484           $ -               $ -               $ 73,484     

Loan servicing rights

     9,589           -               -               9,589     

Foreclosed assets

     18,358           -               -               18,358     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     $     101,431           $ -               $ -               $ 101,431     
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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      December 31, 
2011
     Fair Value Measurements at Reporting Date Using:  
        Quoted Prices
in Active  Markets
for Identical
Assets (Level 1)
     Significant
Other
Observable Inputs
(Level 2)
     Significant
   Unobservable  
Inputs
(Level 3)
 
     (in thousands)  

Recurring fair value measurements:

           

Assets

           

Investment securities:

           

Available for sale:

           

U.S. government agency securities

     $ 90,748           $ -           $ 90,748           $ -     

Obligations of states and political subdivisions

     20,214           -           20,214           -     

Residential mortgage-backed securities

     310,137           -           259,977           50,160     

Trust preferred securities

     70,425           19,576           23,698           27,151     

Corporate and other debt securities

     33,043           30,603           2,440           -     

Equity securities

     41,953           23,506           18,447           -     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available for sale

     566,520           73,685           415,524           77,311     

Trading securities

     21,938           -           21,938           -     

Loans held for sale (1)

     25,169           -           25,169           -     

Other assets (2)

     5,211           -           5,211           -     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets

     $ 618,838           $ 73,685           $ 467,842           $ 77,311     
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities

           

Junior subordinated debentures issued to VNB Capital Trust I (3)

     $ 160,478           $ 160,478           $ -           $ -     

Other liabilities (2)

     21,854           -           21,854           -     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities

     $ 182,332           $ 160,478           $ 21,854           $ -     
  

 

 

    

 

 

    

 

 

    

 

 

 

Non-recurring fair value measurements:

           

Collateral dependent impaired loans (4)

     $ 66,854           $ -           $ -           $ 66,854     

Loan servicing rights

     9,078           -           -           9,078     

Foreclosed assets

     15,874           -           -           15,874     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     $ 91,806           $ -           $ -           $ 91,806     
  

 

 

    

 

 

    

 

 

    

 

 

 

 

 

(1) 

Loans held for sale (which consist of residential mortgages) are carried at fair value and had contractual unpaid principal balances totaling approximately $28.7 million and $24.3 million at June 30, 2012 and December 31, 2011, respectively.

(2) 

Derivative financial instruments are included in this category.

(3) 

The junior subordinated debentures had contractual unpaid principal obligations totaling $146.7 million and $157.0 million at June 30, 2012 and December 31, 2011, respectively.

(4) 

Excludes covered loans acquired in the FDIC-assisted transactions completed in the first quarter of 2010 and other purchased credit-impaired loans acquired in the first quarter of 2012.

 

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The following table summarizes changes in Level 3 assets, consisting of available for sale securities, measured at fair value on a recurring basis for the three months ended June 30, 2012 and 2011:

 

         Three Months Ended June 30,      
             2012                      2011          
     (in thousands)  

Balance, beginning of the period

     $ 84,720           $ 52,373     

Total net (losses) gains for the period included in:

     

Net income

     (550)          -     

Other comprehensive income

     7,847           851     

Settlements

     (2,926)          (2,006)    
  

 

 

    

 

 

 

Balance, end of the period

     $ 89,091           $ 51,218     
  

 

 

    

 

 

 

Change in unrealized losses for the period included in earnings for assets held at the end of the reporting period *

     $ (550)          $ -     
  

 

 

    

 

 

 

 

 

* Represents the net impairment losses on securities recognized in earnings for the period.

The following table summarizes changes in Level 3 assets, consisting of trading and available for sale securities, measured at fair value on a recurring basis for six months ended June 30, 2012 and 2011:

 

     Six Months Ended June 30,  
     2012      2011  
     Trading
    Securities    
     Available
For Sale
    Securities    
     Trading
    Securities    
     Available
For Sale
    Securities    
 
     (in thousands)  

Balance, beginning of the period

     $ -           $ 77,311           $ 21,903           $ 138,655     

Transfers out of Level 3:

           

Residential mortgage-backed securities

     -           -           -           (44,771)    

Trust preferred securities

     -           -           (21,903)          (17,397)    

Corporate and other debt securities

     -           -           -           (12,914)    

Equity securities

     -           -           -           (9,353)    

Total net (losses) gains for the period included in:

           

Net income

     -           (550)          -           (825)    

Other comprehensive income

     -           18,954           -           2,212     

Settlements

     -           (6,624)          -           (4,389)    
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance, end of the period

     $ -           $ 89,091           $ -           $ 51,218     
  

 

 

    

 

 

    

 

 

    

 

 

 

Change in unrealized losses for the period included in earnings for assets held at the end of the reporting period *

     $ -           $ (550)          $ -           $ (825)    
  

 

 

    

 

 

    

 

 

    

 

 

 

 

 

* Represents the net impairment losses on securities recognized in earnings for the period.

During the three and six months ended June 30, 2012 and 2011, there were no transfers of assets between Level 1 and Level 2.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following valuation techniques were used for financial instruments measured at fair value on a recurring basis. All the valuation techniques described below apply to the unpaid principal balance excluding any accrued interest or dividends at the measurement date. Interest income and expense are recorded within the consolidated statements of income depending on the nature of the instrument using the effective interest method based on acquired discount or premium.

Available for sale and trading securities. All U.S. Treasury securities, certain corporate and other debt securities, and certain common and preferred equity securities (including certain trust preferred securities) are reported at fair values

 

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utilizing Level 1 inputs. The majority of other investment securities are reported at fair value utilizing Level 2 inputs. The prices for these instruments are obtained through an independent pricing service or dealer market participants with whom Valley has historically transacted both purchases and sales of investment securities. Prices obtained from these sources include prices derived from market quotations and matrix pricing. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. Management reviews the data and assumptions used in pricing the securities by its third party provider to ensure the highest level of significant inputs are derived from market observable data. For certain securities, the inputs used by either dealer market participants or an independent pricing service, may be derived from unobservable market information (Level 3 inputs). In these instances, Valley evaluates the appropriateness and quality of the assumption and the resulting price. In addition, Valley reviews the volume and level of activity for all available for sale and trading securities and attempts to identify transactions which may not be orderly or reflective of a significant level of activity and volume. For securities meeting these criteria, the quoted prices received from either market participants or an independent pricing service may be adjusted, as necessary, to estimate fair value and this results in fair values based on Level 3 inputs. In determining fair value, Valley utilizes unobservable inputs which reflect Valley’s own assumptions about the inputs that market participants would use in pricing each security. In developing its assertion of market participant assumptions, Valley utilizes the best information that is both reasonable and available without undue cost and effort.

In calculating the fair value for the available for sale securities under Level 3, Valley prepared present value cash flow models for certain private label mortgage-backed securities and trust preferred securities. The cash flows for the residential mortgage-backed securities incorporated the expected cash flow of each security adjusted for default rates, loss severities and prepayments of the individual loans collateralizing the security. The cash flows for trust preferred securities reflected the contractual cash flow, adjusted if necessary for potential changes in the amount or timing of cash flows due to the underlying credit worthiness of each issuer. The following table presents quantitative information about Level 3 inputs used to measure the fair value of these securities at June 30, 2012:

 

Security Type

  

Valuation

Technique

  

Unobservable

Input

         Range            Weighted 
Average
 

Mortgage-backed securities

   Discounted cash flow    Prepayment rate      8.1 - 32.7     18.0
      Default rate      3.4 - 18.9        7.6   
      Loss severity      39.7 - 59.2        50.7   

Single issuer trust preferred securities

   Discounted cash flow    Loss severity      0.0 - 100.0     17.6
      Market credit spreads      6.4 - 7.0        6.7   
      Discount rate      6.8 - 8.6        7.9   

Significant increases or decreases in any of the unobservable inputs in the table above in isolation would result in a significantly lower or higher fair value measurement of the securities. Generally, a change in the assumption used for the default rate is accompanied by a directionally similar change in the assumption used for the loss severity and a directionally opposite change in the assumption used for prepayment rates.

For the Level 3 available for sale private label mortgage-backed securities, cash flow assumptions incorporated independent third party market participant data based on vintage year for each security. The discount rate utilized in determining the present value of cash flows for the mortgage-backed securities was arrived at by combining the yield on orderly transactions for similar maturity government sponsored mortgage-backed securities with (i) the historical average risk premium of similar structured private label securities, (ii) a risk premium reflecting current market conditions, including liquidity risk and (iii) if applicable, a forecasted loss premium derived from the expected cash flows of each security. The estimated cash flows for each private label mortgage-backed security were then discounted at the aforementioned effective rate to determine the fair value. The quoted prices received from either market participants or independent pricing services are weighted with the internal price estimate to determine the fair value of each instrument.

 

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For two single issuer trust preferred securities in the Level 3 available for sale trust preferred securities, the resulting estimated future cash flows were discounted at a yield, comprised of market rates applicable to the index of the underlying security, estimated market credit spread for similar non-rated securities and an illiquidity premium, if appropriate. The discount rate for each security was applied to three alternative cash flow scenarios, and subsequently weighted based on management’s expectations. The three cash flow alternatives for each security assume a scenario with full issuer repayment, a scenario with a partial issuer repayment and a scenario with a full issuer default.

For two pooled securities in the Level 3 available for sale trust preferred securities, the resulting estimated future cash flows were discounted at a yield determined by reference to similarly structured securities for which observable orderly transactions occurred. The discount rate for each security was applied using a pricing matrix based on credit, security type and maturity characteristics to determine the fair value. The fair value calculations for both securities are received from an independent valuation advisor. In validating the fair value calculation from an independent valuation advisor, Valley reviews accuracy of the inputs and the appropriateness of the unobservable inputs utilized in the valuation to ensure the fair value calculation is reasonable from a market participant perspective.

Loans held for sale. The conforming residential mortgage loans originated for sale are reported at fair value using Level 2 inputs. The fair values were calculated utilizing quoted prices for similar assets in active markets. To determine these fair values, the mortgages held for sale are put into multiple tranches, or pools, based on the coupon rate and maturity of each mortgage. The market prices for each tranche are obtained from both Fannie Mae and Freddie Mac. The market prices represent a delivery price, which reflects the underlying price each institution would pay Valley for an immediate sale of an aggregate pool of mortgages. The market prices received from Fannie Mae and Freddie Mac are then averaged and interpolated or extrapolated, where required, to calculate the fair value of each tranche. Depending upon the time elapsed since the origination of each loan held for sale, non-performance risk and changes therein were addressed in the estimate of fair value based upon the delinquency data provided to both Fannie Mae and Freddie Mac for market pricing and changes in market credit spreads. Non-performance risk did not materially impact the fair value of mortgage loans held for sale at June 30, 2012 and December 31, 2011 based on the short duration these assets were held, and the high credit quality of these loans.

Junior subordinated debentures issued to capital trusts. The junior subordinated debentures issued to VNB Capital Trust I are reported at fair value using Level 1 inputs. The fair value was estimated using quoted prices in active markets for similar assets, specifically the quoted price of the VNB Capital Trust I preferred stock traded under ticker symbol “VLYPRA” on the New York Stock Exchange. The preferred stock and Valley’s junior subordinated debentures issued to the Trust have identical financial terms and therefore, the preferred stock’s quoted price moves in a similar manner to the estimated fair value and current settlement price of the junior subordinated debentures. The preferred stock’s quoted price includes market considerations for Valley’s credit and non-performance risk and is deemed to represent the transfer price that would be used if the junior subordinated debenture were assumed by a third party. Valley’s potential credit risk and changes in such risk did not materially impact the fair value measurement of the junior subordinated debentures at June 30, 2012 and December 31, 2011.

Derivatives. Derivatives are reported at fair value utilizing Level 2 inputs. The fair value of Valley’s derivatives are determined using third party prices that are based on discounted cash flow analyses using observed market interest rate curves and volatilities. The fair values of most of the derivatives incorporate credit valuation adjustments, which consider the impact of any credit enhancements to the contracts, to account for potential nonperformance risk of Valley and its counterparties. On January 1, 2012, Valley made an accounting policy election to use the exception within ASU No. 2011-04 regarding the measurement of the exposure to the counterparty credit risk (i.e., calculating credit valuation adjustments on a net basis by counterparty portfolio). The credit valuation adjustments were not significant to the overall valuation of Valley’s derivatives at June 30, 2012 and December 31, 2011.

 

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Assets and Liabilities Measured at Fair Value on a Non-recurring Basis

The following valuation techniques were used for certain non-financial assets measured at fair value on a nonrecurring basis, including impaired loans reported at the fair value of the underlying collateral, loan servicing rights, other real estate owned and other repossessed assets (upon initial recognition or subsequent impairment) as described below.

Impaired loans. Certain impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from the collateral and are commonly referred to as “collateral dependent impaired loans.” Collateral values are estimated using Level 3 inputs, consisting of individual appraisals that are significantly adjusted based on customized discounting criteria. At June 30, 2012, non-current appraisals were discounted up to 27.1 percent based on specific market data by location and property type. During the six months ended June 30, 2012, collateral dependent impaired loans were individually re-measured and reported at fair value through direct loan charge-offs to the allowance for loan losses and/or a specific valuation allowance allocation based on the fair value of the underlying collateral. The direct collateral dependent loan charge-offs to the allowance for loan losses totaled $7.7 million and $11.6 million for the three and six months ended June 30, 2012, respectively. At June 30, 2012, collateral dependent impaired loans with a total recorded investment of $77.0 million were reduced by specific valuation allowance allocations totaling $3.6 million to a reported total net carrying amount of $73.4 million.

Loan servicing rights. Fair values for each risk-stratified group of loan servicing rights are calculated using a fair value model from a third party vendor that requires inputs that are both significant to the fair value measurement and unobservable (Level 3). The fair value model is based on various assumptions, including but not limited to, prepayment speeds, internal rate of return (“discount rate”), servicing cost, ancillary income, float rate, tax rate, and inflation. The prepayment speed and the discount rate are considered two of the most significant inputs in the model. At June 30, 2012, the fair value model used prepayment speeds (stated as constant prepayment rates) from 6.0 percent up to 25.8 percent and a discount rate of 8 percent for the valuation of the loan servicing rights. A significant degree of judgment is involved in valuing the loan servicing rights using Level 3 inputs. The use of different assumptions could have a significant positive or negative effect on the fair value estimate. Impairment charges are recognized on loan servicing rights when the amortized cost of a risk-stratified group of loan servicing rights exceeds the estimated fair value. Valley recognized net impairment charges of $401 thousand for the three months ended June 30, 2012 and net recoveries of impairment charges of $19 thousand for the six months ended June 30, 2012.

Foreclosed assets. Certain foreclosed assets (consisting of other real estate owned and other repossessed assets), upon initial recognition and transfer from loans, are re-measured and reported at fair value through a charge-off to the allowance for loan losses based upon the fair value of the foreclosed assets. The fair value of a foreclosed asset, upon initial recognition, is typically estimated using Level 3 inputs, consisting of an appraisal that is adjusted based on customized discounting criteria, similar to the criteria used for impaired loans described above. The discounts on appraisals of foreclosed assets were immaterial at June 30, 2012. During the six months ended June 30, 2012, foreclosed assets measured at fair value upon initial recognition totaled $18.3 million. In connection with the measurement and the initial recognition of the foreclosed assets, Valley recognized charge-offs to the allowance for loan losses totaling $1.2 million and $4.1 million for the three and six months ended June 30, 2012, respectively.

 

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Other Fair Value Disclosures

The following table presents the amount of gains and losses from fair value changes included in income before income taxes for financial assets and liabilities carried at fair value for the three and six months ended June 30, 2012 and 2011:

 

Reported in

Consolidated Statements

of Financial Condition

  

Reported in

Consolidated Statements

of Income

   Gains (Losses) on Change in Fair Value  
      Three Months Ended
June  30,
     Six Months Ended
June  30,
 
              2012                      2011                      2012                      2011          
          (in thousands)  

Assets:

              

Available for sale securities

  

Net impairment losses on securities

    $ (550)        $        $ (550)        $ (825)   

Trading securities

  

Trading (losses) gains, net

     (151)         (106)         101          387    

Loans held for sale

  

Gains on sales of loans, net

     3,141                  1,561          6,307                  5,170    

Liabilities:

              

Junior subordinated debentures issued to capital trusts

  

Trading gains (losses), net

     1,760          (942)         520          1,947    
     

 

 

    

 

 

    

 

 

    

 

 

 
       $         4,200         $ 513         $         6,378         $ 6,679    
     

 

 

    

 

 

    

 

 

    

 

 

 

ASC Topic 825, “Financial Instruments,” requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis.

The fair value estimates presented in the following table were based on pertinent market data and relevant information on the financial instruments available as of the valuation date. These estimates do not reflect any premium or discount that could result from offering for sale at one time the entire portfolio of financial instruments. Because no market exists for a portion of the financial instruments, fair value estimates may be based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Fair value estimates are based on existing balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. For instance, Valley has certain fee-generating business lines (e.g., its mortgage servicing operation, trust and investment management departments) that were not considered in these estimates since these activities are not financial instruments. In addition, the tax implications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.

 

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The carrying amounts and estimated fair values of financial instruments not measured and not reported at fair value on the consolidated statements of financial condition at June 30, 2012 and December 31, 2011 were as follows:

 

          June 30, 2012      December 31, 2011  
        Fair Value   
Hierarchy
      Carrying   
Amount
       Fair Value           Carrying   
Amount
       Fair Value    
                 (in thousands)         

Financial assets

              

Cash and due from banks

   Level 1      $ 443,297          $ 443,297          $ 372,566          $ 372,566    

Interest bearing deposits with banks

   Level 1      8,423          8,423          6,483          6,483    

Investment securities held to maturity:

              

U.S. Treasury securities

   Level 1      99,945          115,991          100,018          113,859    

Obligations of states and political subdivisions

   Level 2      470,133          490,592          433,284          453,201    

Residential mortgage-backed securities

   Level 2      989,820          1,023,629          1,180,104          1,230,993    

Trust preferred securities

   Level 2      193,287          174,469          193,312          174,753    

Corporate and other debt securities

   Level 2      52,193          56,041          52,198          54,391    
     

 

 

    

 

 

    

 

 

    

 

 

 

Total investment securities held to maturity

        1,805,378          1,860,722          1,958,916          2,027,197    
     

 

 

    

 

 

    

 

 

    

 

 

 

Net loans

   Level 3        11,293,998            11,286,189            9,665,839            9,645,517    

Accrued interest receivable

   Level 1      55,040          55,040          52,527          52,527    

Federal Reserve Bank and Federal Home Loan Bank stock(1)

   Level 2      146,498          146,498          129,669          129,669    

Financial liabilities

              

Deposits without stated maturities

   Level 1      8,223,556          8,223,556          7,171,718          7,171,718    

Deposits with stated maturities

   Level 2      2,648,123          2,705,541          2,501,384          2,557,119    

Short-term borrowings

   Level 1      523,122          523,122          212,849          215,179    

Long-term borrowings

   Level 2      2,724,536          3,157,469          2,726,099          3,154,150    

Junior subordinated debentures issued to capital trusts

   Level 2      40,846          40,757          25,120          25,620    

Accrued interest payable(2)

   Level 1      3,670          3,670          3,798          3,798    

 

 

(1)  Included in other assets.

(2)  Included in accrued expenses and other liabilities.

The following methods and assumptions were used to estimate the fair value of the financial assets and financial liabilities in the table above:

Cash and due from banks and interest bearing deposits with banks. The carrying amount is considered to be a reasonable estimate of fair value because of the short maturity of these items.

Investment securities held to maturity. Fair values are based on prices obtained through an independent pricing service or dealer market participants with whom Valley has historically transacted both purchases and sales of investment securities. Prices obtained from these sources include prices derived from market quotations and matrix pricing. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things (Level 2 inputs). Additionally, Valley reviews the volume and level of activity for all classes of held to maturity securities and attempts to identify transactions which may not be orderly or reflective of a significant level of activity and volume. For securities meeting these criteria, the quoted prices received from either market participants or an independent pricing service may be adjusted, as necessary. If applicable, the adjustment to fair value is derived based on present value cash flow model projections prepared by Valley utilizing assumptions similar to those incorporated by market participants.

Loans. Fair values of non-covered loans (i.e., loans which are not subject to loss-sharing agreements with the FDIC) and covered loans (i.e., loans subject to loss-sharing agreements with the FDIC) are estimated by discounting the projected future cash flows using market discount rates that reflect the credit and interest-rate risk inherent in the loan. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. Fair values estimated in this manner do not fully incorporate an exit-price approach to fair value, but instead are based on a comparison to current market rates for comparable loans.

 

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Accrued interest receivable and payable. The carrying amounts of accrued interest approximate their fair value due to the short-term nature of these items.

Federal Reserve Bank and Federal Home Loan Bank stock. FRB and FHLB stock are non-marketable equity securities and are reported at their redeemable carrying amounts, which approximate their fair value.

Deposits. The carrying amounts of deposits without stated maturities (i.e., non-interest bearing, savings, NOW, and money market deposits) approximate their estimated fair value. The fair value of time deposits is based on the discounted value of contractual cash flows using estimated rates currently offered for alternative funding sources of similar remaining maturity.

Short-term and long-term borrowings. The carrying amounts of certain short-term borrowings, including securities sold under agreement to repurchase (and from time to time, federal funds purchased and overnight FHLB borrowings) approximate their fair values because they frequently re-price to a market rate. The fair values of other short-term and long-term borrowings are estimated by obtaining quoted market prices of the identical or similar financial instruments when available. When quoted prices are unavailable, the fair values of the borrowings are estimated by discounting the estimated future cash flows using current market discount rates of financial instruments with similar characteristics, terms and remaining maturity.

Junior subordinated debentures issued to capital trusts (excluding VNB Capital Trust I). There is no active market for the trust preferred securities issued by Valley capital trusts, except for the securities issued by VNB Capital Trust I whose related debentures are carried at fair value. Therefore, the fair value of debentures not carried at fair value is estimated utilizing the income approach, whereby the expected cash flows, over the remaining estimated life of the security, are discounted using Valley’s credit spread over the current yield on a similar maturity of U.S. Treasury security or the three-month LIBOR for the variable rate indexed debentures (Level 2 inputs). Valley’s credit spread was calculated based on the exchange quoted price for Valley’s trust preferred securities issued by VNB Capital Trust I.

Note 6. Investment Securities

As of June 30, 2012, Valley had approximately $1.8 billion, $688.8 million, and $22.0 million in held to maturity, available for sale, and trading investment securities, respectively. Valley’s investment portfolios include private label mortgage-backed securities, trust preferred securities principally issued by bank holding companies (including three pooled trust preferred securities), corporate bonds primarily issued by banks, and perpetual preferred and common equity securities issued by banks. These investments may pose a higher risk of future impairment charges by Valley as a result of the unpredictable nature of the U.S. economy and its potential negative effect on the future performance of the security issuers and, if applicable, the underlying mortgage loan collateral of the security. See the “Other-Than-Temporary Impairment Analysis” section below for further discussion.

 

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Held to Maturity

The amortized cost, gross unrealized gains and losses and fair value of securities held to maturity at June 30, 2012 and December 31, 2011 were as follows:

 

       Amortized   Cost      Gross
  Unrealized  
Gains
     Gross
  Unrealized  
Losses
     Fair       Value        
     (in thousands)  

June 30, 2012

           

U.S. Treasury securities

    $ 99,945          $ 16,046          $               -         $ 115,991     

Obligations of states and political subdivisions

     470,133           20,697           (238)         490,592     

Residential mortgage-backed securities

     989,820           33,887           (78)         1,023,629     

Trust preferred securities

     193,287           4,026           (22,844)         174,469     

Corporate and other debt securities

     52,193           4,122           (274)         56,041     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investment securities held to maturity

    $ 1,805,378          $ 78,778          $ (23,434)        $ 1,860,722     
  

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2011

           

U.S. Treasury securities

    $ 100,018          $ 13,841          $        $ 113,859     

Obligations of states and political subdivisions

     433,284           19,931           (14)         453,201     

Residential mortgage-backed securities

     1,180,104           51,041           (152)         1,230,993     

Trust preferred securities

     193,312           4,308           (22,867)         174,753     

Corporate and other debt securities

     52,198           3,799           (1,606)         54,391     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investment securities held to maturity

    $     1,958,916          $     92,920          $ (24,639)        $     2,027,197     
  

 

 

    

 

 

    

 

 

    

 

 

 

The age of unrealized losses and fair value of related securities held to maturity at June 30, 2012 and December 31, 2011 were as follows:

 

     Less than
Twelve Months
     More than
Twelve Months
     Total  
       Fair Value          Unrealized  
Losses
       Fair Value          Unrealized  
Losses
       Fair Value          Unrealized  
Losses
 
     (in thousands)  

June 30, 2012

                 

Obligations of states and political subdivisions

    $ 15,027         $ (238)        $        $               -         $ 15,027         $ (238)   

Residential mortgage-backed securities

     33,248          (78)                         33,248          (78)   

Trust preferred securities

     28,694          (678)         55,587          (22,166)         84,281          (22,844)   

Corporate and other debt securities

                         -          23,659          (274)         23,659          (274)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

    $ 76,969         $ (994)        $ 79,246         $ (22,440)        $     156,215         $     (23,434)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2011

                 

Obligations of states and political subdivisions

    $ 1,854         $ (13)        $ 50         $ (1)        $ 1,904         $ (14)   

Residential mortgage-backed securities

     33,520          (152)                         33,520          (152)   

Trust preferred securities

     35,527          (730)         55,612          (22,137)         91,139          (22,867)   

Corporate and other debt securities

     14,756          (192)         7,560          (1,414)         22,316          (1,606)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

    $     85,657         $ (1,087)        $     63,222         $ (23,552)        $ 148,879         $ (24,639)   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The total number of security positions in the securities held to maturity portfolio in an unrealized loss position at June 30, 2012 was 33 as compared to 28 at December 31, 2011.

At June 30, 2012, the unrealized losses reported for trust preferred securities mostly related to 10 single-issuer securities, issued by bank holding companies. Of the 10 trust preferred securities, 3 were investment grade, 2 were non-investment grade, and 5 were not rated. All single-issuer bank trust preferred securities classified as held to maturity are paying in accordance with their terms, have no deferrals of interest or defaults and, if applicable, the issuers meet the regulatory capital requirements to be considered “well-capitalized institutions” at June 30, 2012.

 

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Management does not believe that any individual unrealized loss as of June 30, 2012 included in the table above represents other-than-temporary impairment as management mainly attributes the declines in fair value to changes in interest rates, widening credit spreads, and lack of liquidity in the market place, not credit quality or other factors. Based on a comparison of the present value of expected cash flows to the amortized cost, management believes there are no credit losses on these securities. Valley does not have the intent to sell, nor is it more likely than not that Valley will be required to sell, the securities contained in the table above before the recovery of their amortized cost basis or maturity.

As of June 30, 2012, the fair value of investments held to maturity that were pledged to secure public deposits, repurchase agreements, lines of credit, and for other purposes required by law, was $1.0 billion.

The contractual maturities of investments in debt securities held to maturity at June 30, 2012 are set forth in the table below. Maturities may differ from contractual maturities in residential mortgage-backed securities because the mortgages underlying the securities may be prepaid without any penalties. Therefore, residential mortgage-backed securities are not included in the maturity categories in the following summary.

 

     June 30, 2012  
         Amortized    
Cost
    Fair
         Value        
 
     (in thousands)  

Due in one year

     $ 125,089          $ 125,207     

Due after one year through five years

     43,210          44,738     

Due after five years through ten years

     232,085          256,224     

Due after ten years

     415,174          410,924     

Residential mortgage-backed securities

     989,820          1,023,629     
  

 

 

   

 

 

 

Total investment securities held to maturity

     $ 1,805,378          $ 1,860,722     
  

 

 

   

 

 

 

Actual maturities of debt securities may differ from those presented above since certain obligations provide the issuer the right to call or prepay the obligation prior to scheduled maturity without penalty.

The weighted-average remaining expected life for residential mortgage-backed securities held to maturity was 3.2 years at June 30, 2012.

 

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Available for Sale

The amortized cost, gross unrealized gains and losses and fair value of securities available for sale at June 30, 2012 and December 31, 2011 were as follows:

 

         Amortized    
Cost
    Gross
    Unrealized    
Gains
    Gross
    Unrealized    
Losses
    Fair
        Value        
 
     (in thousands)  

June 30, 2012

        

U.S. government agency securities

     $ 53,712          $ 1,252          $ (62)        $ 54,902     

Obligations of states and political subdivisions

     18,447          1,212          (349)        19,310     

Residential mortgage-backed securities

     424,524          10,107          (4,612)        430,019     

Trust preferred securities*

     96,874          1,808          (15,818)        82,864     

Corporate and other debt securities

     47,738          4,612          (170)        52,180     

Equity securities

     50,307          1,889          (2,683)        49,513     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total investment securities available for sale

     $ 691,602          $ 20,880          $ (23,694)        $ 688,788     
  

 

 

   

 

 

   

 

 

   

 

 

 

December 31, 2011

        

U.S. government agency securities

     $ 89,787          $ 1,204          $ (243)        $ 90,748     

Obligations of states and political subdivisions

     18,893          1,322          (1)        20,214     

Residential mortgage-backed securities

     304,631          10,950          (5,444)        310,137     

Trust preferred securities*

     106,931          78          (36,585)        70,424     

Corporate and other debt securities

     30,663          2,554          (173)        33,044     

Equity securities

     47,932          1,320          (7,299)        41,953     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total investment securities available for sale

     $ 598,837          $ 17,428          $ (49,745)        $ 566,520     
  

 

 

   

 

 

   

 

 

   

 

 

 

 

* Includes three pooled trust preferred securities, principally collateralized by securities issued by banks and insurance companies.

The age of unrealized losses and fair value of related securities available for sale at June 30, 2012 and December 31, 2011 were as follows:

 

    Less than
Twelve Months
    More than
Twelve Months
    Total  
      Fair Value         Unrealized  
Losses
      Fair Value         Unrealized  
Losses
      Fair Value         Unrealized  
Losses
 
    (in thousands)  

June 30, 2012

           

U.S. government agency securities

    $ 8,759          $ (16)        $ 7,575          $ (46)        $ 16,334          $ (62)   

Obligations of states and political subdivisions

    10,931          (349)        -                 10,931          (349)   

Residential mortgage-backed securities

    40,131          (1,524)        22,719          (3,088)        62,850          (4,612)   

Trust preferred securities

    4,049          (464)        37,045          (15,354)        41,094          (15,818)   

Corporate and other debt securities

    6,312          (97)        2,427          (73)        8,739          (170)   

Equity securities

    766          (45)        12,821          (2,638)        13,587          (2,683)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    $ 70,948          $ (2,495)        $ 82,587          $ (21,199)        $ 153,535          $ (23,694)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

December 31, 2011

           

U.S. government agency securities

    $ 7,980          $ (243)        $ -          $        $ 7,980          $ (243)   

Obligations of states and political subdivisions

    141          (1)        -                 141          (1)   

Residential mortgage-backed securities

    41,673          (1,655)        22,639          (3,789)        64,312          (5,444)   

Trust preferred securities

    23,962          (1,061)        44,758          (35,524)        68,720          (36,585)   

Corporate and other debt securities

    3,243          (173)        -                 3,243          (173)   

Equity securities

    20,570          (4,430)        12,551          (2,869)        33,121          (7,299)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    $ 97,569          $ (7,563)        $ 79,948          $ (42,182)        $ 177,517          $ (49,745)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The total number of security positions in the securities available for sale portfolio in an unrealized loss position at June 30, 2012 was 69 as compared to 43 at December 31, 2011.

 

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Of the $4.6 million unrealized losses within the residential mortgage-backed securities category of the available for sale portfolio at June 30, 2012, $2.0 million relates to three private label mortgage-backed securities that were other-than-temporarily impaired prior to June 30, 2012; for one of the securities, an additional estimated credit loss was recognized during the second quarter of 2012. The remaining $2.6 million of unrealized losses mainly relates to one investment grade private label mortgage-backed security.

The unrealized losses for trust preferred securities at June 30, 2012, in the table above mainly relate to 3 pooled trust preferred and 16 single-issuer bank issued trust preferred securities. The unrealized losses include $5.3 million attributable to trust preferred securities issued by one bank holding company with an amortized cost of $19.0 million and a fair value of $13.7 million, and $8.5 million attributable to 3 pooled trust preferred securities with an amortized cost of $20.0 million and a fair value of $11.5 million. The trust preferred issuances by one bank holding company, initially classified as held to maturity, were found be other-than-temporarily impaired during the fourth quarter of 2011 and subsequently transferred to the available for sale portfolio at December 31, 2011. The three pooled trust preferred securities included one security with an unrealized loss of $6.5 million and an investment grade rating at June 30, 2012. The other two pooled trust preferred securities had non-investment grade ratings and were initially other-than-temporarily impaired in 2008 with additional estimated credit losses recognized during the period 2009 through 2011. See “Other-Than-Temporarily Impaired Analysis” section below for more details. All of the remaining single-issuer trust preferred securities are all paying in accordance with their terms and have no deferrals of interest or defaults.

The unrealized losses existing for more than twelve months for equity securities are almost entirely related to two perpetual preferred security positions with a combined $10.0 million amortized cost and a $2.6 million unrealized loss. At June 30, 2012, these perpetual preferred securities had investment grade ratings and are currently performing and paying quarterly dividends.

Management does not believe that any individual unrealized loss as of June 30, 2012 represents an other-than-temporary impairment, except for the previously discussed impaired private mortgage-backed security, as management mainly attributes the declines in value to changes in interest rates and recent market volatility and wider credit spreads, not credit quality or other factors. Based on a comparison of the present value of expected cash flows to the amortized cost, management believes there are no credit losses on these securities. Valley has no intent to sell, nor is it more likely than not that Valley will be required to sell, the securities contained in the table above before the recovery of their amortized cost basis or, if necessary, maturity.

As of June 30, 2012, the fair value of securities available for sale that were pledged to secure public deposits, repurchase agreements, lines of credit, and for other purposes required by law, was $378.0 million.

The contractual maturities of investment securities available for sale at June 30, 2012 are set forth in the following table. Maturities may differ from contractual maturities in residential mortgage-backed securities because the mortgages underlying the securities may be prepaid without any penalties. Therefore, residential mortgage-backed securities are not included in the maturity categories in the following summary.

 

     June 30, 2012  
         Amortized    
Cost
    Fair
        Value        
 
     (in thousands)  

Due in one year

     $ 468          $ 473     

Due after one year through five years

     11,806          12,376     

Due after five years through ten years

     64,084          67,538     

Due after ten years

     140,413          128,869     

Residential mortgage-backed securities

     424,524          430,019     

Equity securities

     50,307          49,513     
  

 

 

   

 

 

 

Total investment securities available for sale

     $ 691,602          $ 688,788     
  

 

 

   

 

 

 

Actual maturities of debt securities may differ from those presented above since certain obligations provide the issuer the right to call or prepay the obligation prior to scheduled maturity without penalty.

 

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The weighted-average remaining expected life for residential mortgage-backed securities available for sale at June 30, 2012 was 3.8 years.

Other-Than-Temporary Impairment Analysis

To determine whether a security’s impairment is other-than-temporary, Valley considers several factors that include, but are not limited to the following:

 

   

The severity and duration of the decline, including the causes of the decline in fair value, such as an issuer’s credit problems, interest rate fluctuations, or market volatility;

   

Adverse conditions specifically related to the issuer of the security, an industry, or geographic area;

   

Failure of the issuer of the security to make scheduled interest or principal payments;

   

Any changes to the rating of the security by a rating agency or, if applicable, any regulatory actions impacting the security issuer;

   

Recoveries or additional declines in fair value after the balance sheet date;

   

Our ability and intent to hold equity security investments until they recover in value, as well as the likelihood of such a recovery in the near term; and

   

Our intent to sell debt security investments, or if it is more likely than not that we will be required to sell such securities before recovery of their individual amortized cost basis.

For debt securities, the primary consideration in determining whether impairment is other-than-temporary is whether or not we expect to collect all contractual cash flows.

In assessing the level of other-than-temporary impairment attributable to credit loss for debt securities, Valley compares the present value of cash flows expected to be collected with the amortized cost basis of the security. The portion of the total other-than-temporary impairment related to credit loss is recognized in earnings, while the amount related to other factors is recognized in other comprehensive income or loss. The total other-than-temporary impairment loss is presented in the consolidated statements of income, less the portion recognized in other comprehensive income or loss. Subsequent assessments may result in additional estimated credit losses on previously impaired securities. These additional estimated credit losses are recorded as reclassifications from the portion of other-than-temporary impairment previously recognized in other comprehensive income or loss to earnings in the period of such assessments. The amortized cost basis of an impaired debt security is reduced by the portion of the total impairment related to credit loss.

For residential mortgage-backed securities, Valley estimates loss projections for each security by stressing the cash flows from the individual loans collateralizing the security using expected default rates, loss severities, and prepayment speeds, in conjunction with the underlying credit enhancement (if applicable) for each security. Based on collateral and origination vintage specific assumptions, a range of possible cash flows is identified to determine whether other-than-temporary impairment exists. See the “Other-Than-Temporarily Impaired Securities” section below for further details regarding the impairment of these securities.

For the single-issuer trust preferred securities and corporate and other debt securities, Valley reviews each portfolio to determine if all the securities are paying in accordance with their terms and have no deferrals of interest or defaults. Over the past several years, an increasing number of banking institutions have been required to defer trust preferred payments and various banking institutions have been put in receivership by the FDIC. A deferral event by a bank holding company for which Valley holds trust preferred securities may require the recognition of an other-than-temporary impairment charge if Valley determines that it is more likely than not that all contractual interest and principal cash flows may not be collected. Among other factors, the probability of the collection of all interest and principal determined by Valley in its impairment analysis declines if there is an increase in the estimated deferral period of the issuer. Additionally, a FDIC receivership for any single-issuer would result in an impairment and significant loss. Including the other factors outlined above, Valley analyzes the performance of the issuers on a quarterly basis, including a review of performance data from the issuers’ most recent bank regulatory report, if applicable, to assess their credit risk and the probability of impairment of the contractual cash flows of the applicable security. All of the issuers had capital ratios at June 30, 2012 that were at or above the minimum amounts to be considered a “well-capitalized” financial institution, if applicable, and/or have maintained performance levels adequate to support the contractual cash flows of the trust preferred securities.

 

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During the fourth quarter of 2011, Valley lengthened the estimate of the timeframe over which it could reasonably anticipate receiving the expected cash flows from the trust preferred securities issued by one deferring bank holding company resulting in an $18.3 million credit impairment charge at December 31, 2011. The issuer of the trust preferred securities has deferred interest payments on these securities since late 2009 as required by an operating agreement with its bank regulators. In assessing whether a credit loss exists for the securities of the deferring issuer, Valley considers numerous other factors, including but not limited to, such factors highlighted in the bullet points above. From the dates of deferral up to and including the bank holding company’s most recent regulatory filing, the bank issuer continued to accrue and capitalize the interest owed, but not remitted to its trust preferred security holders, and at the holding company level it reported cash and cash equivalents in excess of the cumulative amount of accrued but unpaid interest owed on all of its junior subordinated debentures related to trust preferred securities. Additionally, the bank subsidiary of the issuer continued to report capital ratios that were above the minimum amounts to be considered a “well-capitalized” financial institution in its most recent regulatory filing. After assessing all available factors, including the estimated deferral period of the issuer, Valley has concluded that there is no additional credit impairment on these other-than-temporarily impaired securities at June 30, 2012. The trust preferred securities, with a combined amortized cost of $46.4 million after credit impairment charges, have net non-credit impairment charges totaling $3.8 million (before taxes) included in accumulated other comprehensive income at June 30, 2012 and are not accruing interest. The net non-credit impairment of the trust preferred securities declined from $22.9 million at December 31, 2011 mainly due to an increase in the expected cash flows (partially related to additional contractual interest payments receivable), as well as changes in the market-based discount rate used to estimate the fair value of these non-accrual securities. See Note 5 for information regarding the Level 3 valuation technique used to measure the fair value of these trust preferred securities at June 30, 2012.

For the three pooled trust preferred securities, Valley evaluates the projected cash flows from each of its tranches in the three securities to determine if they are adequate to support their future contractual principal and interest payments. Valley assesses the credit risk and probability of impairment of the contractual cash flows by projecting the default rates over the life of the security. Higher projected default rates will decrease the expected future cash flows from each security. If the projected decrease in cash flows affects the cash flows projected for the tranche held by Valley, the security would be considered to be other-than-temporarily impaired. Two of the pooled trust preferred securities were initially impaired in 2008 with additional estimated credit losses recognized during 2009 and 2011, including the $825 thousand of net impairment losses recognized during the six months ended June 30, 2011, and are not accruing interest.

The perpetual preferred securities, reported in equity securities, are hybrid investments that are assessed for impairment by Valley as if they were debt securities. Therefore, Valley assessed the creditworthiness of each security issuer, as well as any potential change in the anticipated cash flows of the securities as of June 30, 2012. Based on this analysis, management believes the declines in fair value of these securities are attributable to a lack of liquidity in the marketplace and are not reflective of any deterioration in the creditworthiness of the issuers.

Other-Than-Temporarily Impaired Securities

The following table provides information regarding our other-than-temporary impairment losses on securities recognized in earnings for the three and six months ended June 30, 2012 and 2011.

 

     Three Months Ended      Six Months Ended  
     June 30,      June 30,  
          2012                2011                2012                2011       
     (in thousands)  

Available for sale:

           

Residential mortgage-backed securities

     $ 550           $ -           $ 550           $ -     

Trust preferred securities

     -           -           -           825     
  

 

 

    

 

 

    

 

 

    

 

 

 

Net impairment losses on securities recognized in earnings

     $ 550           $ -           $ 550           $ 825     
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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For the three and six months ended June 30, 2012, Valley recognized net impairment losses on securities in earnings totaling $550 thousand due to additional estimated credit losses on one of six previously impaired private label mortgage-backed securities. At June 30, 2012, the six impaired private label mortgage-backed securities had a combined amortized cost of $45.1 million and fair value of $43.2 million, while the two previously impaired pooled trust preferred securities had a combined amortized cost and fair value of $5.4 million and $3.4 million, respectively, after recognition of all credit impairments.

For the six months ended June 30, 2011, Valley recognized net impairment losses on securities in earnings totaling $825 thousand due to additional estimated credit losses on one of two previously impaired pooled trust preferred securities.

Realized Gains and Losses

Gross gains (losses) realized on sales, maturities and other securities transactions related to investment securities included in earnings for the three and six months ended June 30, 2012 and 2011 were as follows:

 

     Three Months Ended      Six Months Ended  
     June 30,      June 30,  
           2012                  2011                  2012                  2011        
     (in thousands)  

Sales transactions:

           

Gross gains

     $ 1,234           $ 16,294           $ 1,374           $ 18,968     

Gross losses

     -           -           (298)          -     
  

 

 

    

 

 

    

 

 

    

 

 

 
     $ 1,234           $ 16,294           $ 1,076           $ 18,968     
  

 

 

    

 

 

    

 

 

    

 

 

 

Maturities and other securities transactions:

           

Gross gains

     $ 6           $ 198           $ 19           $ 208     

Gross losses

     (36)          -           (48)          (5)    
  

 

 

    

 

 

    

 

 

    

 

 

 
     $ (30)          $ 198           $ (29)          $ 203     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total gains on securities transactions, net

     $ 1,204           $ 16,492           $ 1,047           $ 19,171     
  

 

 

    

 

 

    

 

 

    

 

 

 

The following table presents the changes in the credit loss component of cumulative other-than-temporary impairment losses on debt securities classified as either held to maturity or available for sale that Valley has recognized in earnings, for which a portion of the impairment loss (non-credit factors) was recognized in other comprehensive income for the three and six months ended June 30, 2012 and 2011:

 

     Three Months Ended      Six Months Ended  
     June 30,      June 30,  
           2012                  2011                  2012                  2011        
     (in thousands)  

Balance, beginning of period

     $ 28,767           $ 11,169           $ 29,070           $ 10,500     

Additions:

           

Initial credit impairments

     -           -           -           -     

Subsequent credit impairments

     550           -           550           825     

Reductions:

           

Accretion of credit loss impairment due to an increase in expected cash flows

     (66)          (93)          (369)          (249)    
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance, end of period

     $ 29,251           $ 11,076           $ 29,251           $ 11,076     
  

 

 

    

 

 

    

 

 

    

 

 

 

The credit loss component of the impairment loss represents the difference between the present value of expected future cash flows and the amortized cost basis of the security prior to considering credit losses. The beginning balance represents the credit loss component for debt securities for which other-than-temporary impairment occurred prior to each period presented. Other-than-temporary impairments recognized in earnings for credit impaired debt securities are presented as additions in two components based upon whether the current period is the first time the debt security was credit impaired (initial credit impairment) or is not the first time the debt security was credit impaired (subsequent credit impairment). The credit loss component is reduced if Valley sells, intends to sell or believes it will be required to sell previously credit impaired debt securities. Additionally, the credit loss component is reduced if (i) Valley receives cash flows in excess of what it expected to receive over the remaining life of the credit impaired debt security, (ii) the security matures or (iii) the security is fully written down.

 

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Trading Securities

The fair value of trading securities (consisting of 3 single-issuer bank trust preferred securities) was $22.0 million and $21.9 million at June 30, 2012 and December 31, 2011, respectively. Interest income on trading securities totaled $462 thousand and $500 thousand for the three months ended June 30, 2012 and 2011, respectively, and $884 thousand and $1.1 million for the six months ended June 30, 2012 and 2011, respectively.

Note 7. Loans

Purchased Credit-Impaired (“PCI”) loans, which include loans acquired in FDIC-assisted transactions (“covered loans”) subject to loss-sharing agreements, are loans acquired at a discount that is due, in part, to credit quality. The detail of the loan portfolio as of June 30, 2012 and December 31, 2011 was as follows:

 

     June 30, 2012      December 31, 2011  
         Non-PCI          PCI                 Non-PCI          PCI         
     Loans          Loans               Total           Loans          Loans               Total       
     (in thousands)  

Non-covered loans:

                 

Commercial and industrial

     $ 1,883,867           $ 281,789           $ 2,165,656           $ 1,878,387           $ -           $ 1,878,387     

Commercial real estate:

                 

Commercial real estate

     3,719,989           721,037           4,441,026           3,574,089           -           3,574,089     

Construction

     368,705           42,934           411,639           411,003           -           411,003     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial real estate loans

     4,088,694           763,971           4,852,665           3,985,092           -           3,985,092     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Residential mortgage

     2,727,114           17,987           2,745,101           2,285,590           -           2,285,590     

Consumer:

                 

Home equity

     450,710           49,039           499,749           469,604           -           469,604     

Automobile

     778,181           -           778,181           772,490           -           772,490     

Other consumer

     154,299           1,664           155,963           136,634           -           136,634     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total consumer loans

     1,383,190           50,703           1,433,893           1,378,728           -           1,378,728     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total non-covered loans

     $   10,082,865           $   1,114,450           $  11,197,315           $   9,527,797           $ -           $     9,527,797     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Covered loans:

                 

Commercial and industrial

     $ -           $ 64,468           $ 64,468           $ -           $ 83,742           $ 83,742     

Commercial real estate

     -           136,404           136,404           -           160,651           160,651     

Construction

     -           7,074           7,074           -           6,974           6,974     

Residential mortgage

     -           14,802           14,802           -           15,546           15,546     

Consumer

     -           3,789           3,789           -           4,931           4,931     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total covered loans

     -           226,537           226,537           -           271,844           271,844     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans

     $ 10,082,865           $ 1,340,987           $ 11,423,852           $ 9,527,797           $     271,844           $ 9,799,641     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total non-covered loans are net of unearned discount and deferred loan fees totaling $1.2 million and $7.5 million at June 30, 2012 and December 31, 2011, respectively. The outstanding contractual principal balances for non-covered PCI loans and covered loans totaled $1.2 billion and $365.1 million at June 30, 2012, respectively, and $399.6 million for covered loans at December 31, 2011.

There were no sales of loans, other than from the held for sale loan portfolio, or transfers from loans held for investment to loans held for sale during the six months ended June 30, 2012 and 2011.

Purchased Credit-Impaired Loans (Including Covered Loans)

PCI loans are accounted for in accordance with ASC Subtopic 310-30 and are initially recorded at fair value (as determined by the present value of expected future cash flows) with no valuation allowance (i.e., the allowance for loan losses), and aggregated and accounted for as pools of loans based on common risk characteristics. The difference between the undiscounted cash flows expected at acquisition and the initial carrying amount (fair value) of the covered

 

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loans, or the “accretable yield,” is recognized as interest income utilizing the level-yield method over the life of each pool. Contractually required payments for interest and principal that exceed the undiscounted cash flows expected at acquisition, or the “non-accretable difference,” are not recognized as a yield adjustment, as a loss accrual or a valuation allowance. Reclassifications of the non-accretable difference to the accretable yield may occur subsequent to the loan acquisition dates due to increases in expected cash flows of the loan pools.

The following table presents information regarding the estimates of the contractually required payments, the cash flows expected to be collected, and the estimated fair value of the PCI loans acquired in the State Bancorp (see Note 3) acquisition as of January 1, 2012 and PCI loans purchased from another financial institution as of March 28, 2012:

 

         January 1, 2012              March 28, 2012      
     (in thousands)  

Contractually required principal and interest

     $ 1,333,686           $ 144,357     

Contractual cash flows not expected to be collected (non-accretable difference)

     (66,467)          (9,111)    
  

 

 

    

 

 

 

Expected cash flows to be collected

     1,267,219           135,246     

Interest component of expected cash flows (accretable yield)

     (168,271)          (17,991)    
  

 

 

    

 

 

 

Fair value of acquired loans

     $ 1,098,948           $ 117,255     
  

 

 

    

 

 

 

The following table presents changes in the accretable yield for PCI loans during the three and six months ended June 30, 2012 and 2011:

 

           Three Months Ended June 30,                   Six Months Ended June 30,         
             2012                      2011                      2012                      2011          
     (in thousands)  

Balance, beginning of period

     $ 229,802           $ 109,435           $ 66,724           $ 101,052     

Acquisitions

     -               -               186,262           -         

Accretion

     (20,385)          (8,706)          (43,569)          (16,518)    

Net reclassification from non-accretable difference

     -               788           -               16,983     
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance, end of period

     $ 209,417           $ 101,517           $ 209,417           $ 101,517     
  

 

 

    

 

 

    

 

 

    

 

 

 

The net reclassification from the non-accretable difference in the table above is due to increases in expected cash flows for certain pools of covered loans and is recognized prospectively as an adjustment to the yield over the life of the individual pools.

FDIC Loss-Share Receivable

The receivable arising from the loss-sharing agreements (referred to as the “FDIC loss-share receivable” on our consolidated statements of financial condition) is measured separately from the covered loan portfolio because the agreements are not contractually part of the covered loans and are not transferable should the Bank choose to dispose of the covered loans.

 

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Changes in FDIC loss-share receivable for three and six months ended June 30, 2012 and 2011 were as follows:

 

     Three Months ended      Six Months ended  
     June 30,      June 30,  
           2012                  2011                  2012                  2011        
     (in thousands)  

Balance, beginning of the period

     $ 69,928           $ 90,642           $ 74,390           $ 89,359     

Discount accretion of the present value at the acquisition dates

     81           145           162           291     

Effect of additional cash flows on covered loans (prospective recognition)

     (2,231)          (2,760)          (3,868)          (5,278)    

(Decrease) increase due to (recovery) impairment on covered loans

     -           (747)          -           16,932     

Other reimbursable expenses

     1,088           693           2,554           1,621     

Reimbursements from the FDIC

     (3,165)          (7,794)          (7,537)          (22,746)    

Other

     (5,960)          -               (5,960)          -         
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance, end of the period

     $ 59,741           $ 80,179           $ 59,741           $ 80,179     
  

 

 

    

 

 

    

 

 

    

 

 

 

The aggregate effect of changes in the FDIC loss-share receivable was a reduction in non-interest income of $7.0 million and $2.7 million for the three months ended June 30, 2012 and 2011, respectively, and a $7.1 million reduction and a $13.6 million increase to non-interest income for the six months ended June 30, 2012 and 2011, respectively. The second quarter and the first six months of 2012 reductions in non-interest income included $6.0 million related to the FDIC’s portion of the estimated losses on unused lines of credit assumed in the FDIC-assisted transactions, which have expired. Other non-interest income for the three and six months ended June 30, 2012 included $7.4 million for the reversal of the estimated losses on the expired lines of credit.

Loan Portfolio Risk Elements and Credit Risk Management

Credit risk management. For all of its loan types discussed below, Valley adheres to a credit policy designed to minimize credit risk while generating the maximum income given the level of risk. Management reviews and approves these policies and procedures on a regular basis with subsequent approval by the Board of Directors annually. Credit authority relating to a significant dollar percentage of the overall portfolio is centralized and controlled by the Credit Risk Management Division and by the Credit Committee. A reporting system supplements the management review process by providing management with frequent reports concerning loan production, loan quality, concentrations of credit, loan delinquencies, non-performing, and potential problem loans. Loan portfolio diversification is an important factor utilized by Valley to manage its risk across business sectors and through cyclical economic circumstances.

Commercial and industrial loans. A significant proportion of Valley’s commercial and industrial loan portfolio is granted to long standing customers of proven ability, strong repayment performance, and high character. Underwriting standards are designed to assess the borrower’s ability to generate recurring cash flow sufficient to meet the debt service requirements of loans granted. While such recurring cash flow serves as the primary source of repayment, a significant number of the loans are collateralized by borrower assets intended to serve as a secondary source of repayment should the need arise. Anticipated cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value, or in the case of loans secured by accounts receivable, the ability of the borrower to collect all amounts due from its customers. Short-term loans may be made on an unsecured basis based on a borrower’s financial strength and past performance. Valley, in most cases, will obtain the personal guarantee of the borrower’s principals to mitigate the risk. Unsecured loans, when made, are generally granted to the Bank’s most credit worthy borrowers. Unsecured commercial and industrial loans totaled $395.5 million and $337.7 million at June 30, 2012 and December 31, 2011, respectively.

Commercial real estate loans. Commercial real estate loans are subject to underwriting standards and processes similar to commercial and industrial loans. Commercial real estate loans are viewed primarily as cash flow loans and secondarily as loans secured by real property. Loans generally involve larger principal balances and longer repayment periods as compared to commercial and industrial loans. Repayment of most loans is dependent upon the cash flow generated from the property securing the loan or the business that occupies the property. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy and accordingly conservative loan to value ratios are required at origination, as well as stress tested to evaluate the impact of market changes relating to key underwriting elements. The properties securing the commercial real estate portfolio represent diverse types, with most properties located within Valley’s primary markets.

 

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Construction loans. With respect to loans to developers and builders, Valley originates and manages construction loans structured on either a revolving or non-revolving basis, depending on the nature of the underlying development project. These loans are generally secured by the real estate to be developed and may also be secured by additional real estate to mitigate the risk. Non-revolving construction loans often involve the disbursement of substantially all committed funds with repayment substantially dependent on the successful completion and sale, or lease, of the project. Sources of repayment for these types of loans may be from pre-committed permanent loans from other lenders, sales of developed property, or an interim loan commitment from Valley until permanent financing is obtained elsewhere. Revolving construction loans (generally relating to single family residential construction) are controlled with loan advances dependent upon the presale of housing units financed. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.

Residential mortgages. Valley originates residential, first mortgage loans based on underwriting standards that generally comply with Fannie Mae and/or Freddie Mac requirements. Appraisals and valuations of real estate collateral are contracted directly with independent appraisers or from valuation services and not through appraisal management companies. The Bank’s appraisal management policy and procedure is in accordance with regulatory requirements and guidance issued by the Bank’s primary regulator. Credit scoring, using FICO® and other proprietary, credit scoring models is employed in the ultimate, judgmental credit decision by Valley’s underwriting staff. Valley does not use third party contract underwriting services. Residential mortgage loans include fixed and variable interest rate loans secured by one to four family homes generally located in northern and central New Jersey, the New York City metropolitan area, and eastern Pennsylvania. Valley’s ability to be repaid on such loans is closely linked to the economic and real estate market conditions in this region. In deciding whether to originate each residential mortgage, Valley considers the qualifications of the borrower as well as the value of the underlying property.

Home equity loans. Home equity lending consists of both fixed and variable interest rate products. Valley mainly provides home equity loans to its residential mortgage customers within the footprint of its primary lending territory. Valley generally will not exceed a combined (i.e., first and second mortgage) loan-to-value ratio of 75 percent when originating a home equity loan.

Automobile loans. Valley uses both judgmental and scoring systems in the credit decision process for automobile loans. Automobile originations (including light truck and sport utility vehicles) are largely produced via indirect channels, originated through approved automobile dealers. Automotive collateral is generally a depreciating asset and there are times in the life of an automobile loan where the amount owed on a vehicle may exceed its collateral value. Additionally, automobile charge-offs will vary based on strength or weakness in the used vehicle market, original advance rate, when in the life cycle of a loan a default occurs and the condition of the collateral being liquidated. Where permitted by law, and subject to the limitations of the bankruptcy code, deficiency judgments are sought and acted upon to ultimately collect all money owed, even when a default resulted in a loss at collateral liquidation. Valley uses a third party to actively track collision and comprehensive risk insurance required of the borrower on the automobile and this third party provides coverage to Valley in the event of an uninsured collateral loss.

Other consumer loans. Valley’s other consumer loan portfolio includes direct consumer term loans, both secured and unsecured. The other consumer loan portfolio includes minor exposures in credit card loans, personal lines of credit, personal loans and loans secured by cash surrender value of life insurance. Valley believes the aggregate risk exposure of these loans and lines of credit was not significant at June 30, 2012. Unsecured consumer loans totaled approximately $85.2 million and $66.5 million, including $8.5 million and $9.1 million of credit card loans, at June 30, 2012 and December 31, 2011, respectively.

 

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Table of Contents

Credit Quality

The following tables present past due, non-accrual and current loans (excluding PCI loans, which are accounted for on a pool basis) by loan portfolio class at June 30, 2012 and December 31, 2011:

 

    Past Due and Non-Accrual Loans              
       30-89 Days   
Past Due
Loans
    Accruing Loans
   90 Days Or More   
Past Due
      Non-Accrual  
Loans
    Total
   Past  Due   
Loans
    Current
     Non-PCI     
Loans
    Total
      Non-PCI      
Loans
 
    (in thousands)  

June 30, 2012

           

Commercial and industrial

    $ 2,275          $ 512          $ 12,652          $ 15,439          $ 1,868,428          $ 1,883,867     

Commercial real estate:

           

Commercial real estate

    11,483          -              61,864          73,347          3,646,642          3,719,989     

Construction

    270          -              16,502          16,772          351,933          368,705     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial real estate loans

    11,753          -              78,366          90,119          3,998,575          4,088,694     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Residential mortgage

    10,148          727          32,045          42,920          2,684,194          2,727,114     

Consumer loans:

           

Home equity

    557          -              2,070          2,627          448,083          450,710     

Automobile

    5,055          223          373          5,651          772,530          778,181     

Other consumer

    260          23          722          1,005          153,294          154,299     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer loans

    5,872          246          3,165          9,283          1,373,907          1,383,190     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    $ 30,048          $ 1,485          $ 126,228          $ 157,761          $ 9,925,104          $ 10,082,865     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

    Past Due and Non-Accrual Loans              
       30-89 Days   
Past Due
Loans
    Accruing Loans
   90 Days Or More   
Past Due
      Non-Accrual  
Loans
    Total
   Past  Due   
Loans
    Current
     Non-PCI     
Loans
    Total
      Non-PCI      
Loans
 
    (in thousands)  

December 31, 2011

           

Commercial and industrial

    $ 4,347          $ 657          $ 26,648          $ 31,652          $ 1,846,735          $ 1,878,387     

Commercial real estate:

           

Commercial real estate

    13,115          422          42,186          55,723          3,518,366          3,574,089     

Construction

    2,652          1,823          19,874          24,349          386,654          411,003     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial real estate loans

    15,767          2,245          62,060          80,072          3,905,020          3,985,092     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Residential mortgage

    8,496          763          31,646          40,905          2,244,685          2,285,590     

Consumer loans:

           

Home equity

    989          13          2,700          3,702          465,902          469,604     

Automobile

    7,794          303          461          8,558          763,932          772,490     

Other consumer

    192          35          749          976          135,658          136,634     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer loans

    8,975          351          3,910          13,236          1,365,492          1,378,728     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    $ 37,585          $ 4,016          $ 124,264          $ 165,865          $ 9,361,932          $ 9,527,797     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

Impaired loans. Impaired loans, consisting of non-accrual commercial and industrial loans and commercial real estate loans over $250 thousand and all loans which were modified in troubled debt restructurings, are individually evaluated for impairment. PCI loans are not classified as impaired loans because they are accounted for on a pool basis. The following tables present the information about impaired loans by loan portfolio class at June 30, 2012 and December 31, 2011:

 

    Recorded     Recorded           Unpaid        
    Investment     Investment     Total      Contractual         
      With No Related         With Related        Recorded     Principal     Related  
    Allowance     Allowance       Investment       Balance       Allowance    
    (in thousands)  

June 30, 2012

         

Commercial and industrial

   $ 5,793         $ 38,592          $ 44,385         $ 53,201          $ 8,185     

Commercial real estate:

         

Commercial real estate

    36,304          75,814          112,118          124,615          9,914     

Construction

    7,282          16,324          23,606          26,714          1,121     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial real estate loans

    43,586          92,138          135,724          151,329          11,035     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Residential mortgage

    3,920          17,092          21,012          22,839          2,777     

Consumer loans:

         

Home equity

    -              272          272          272          22     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer loans

    -              272          272          272          22     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 53,299         $ 148,094          $ 201,393         $ 227,641          $ 22,019     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

December 31, 2011

         

Commercial and industrial

   $ 6,193         $ 48,665          $ 54,858         $ 71,111          $ 11,105     

Commercial real estate:

         

Commercial real estate

    26,741          56,978          83,719          91,448          7,108     

Construction

    4,253          19,998          24,251          28,066          1,408     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial real estate loans

    30,994          76,976          107,970          119,514          8,516     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Residential mortgage

    998          20,007          21,005          22,032          3,577     

Consumer loans:

         

Home equity

    -              242          242          242          45     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer loans

    -              242          242          242          45     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 38,185         $ 145,890          $ 184,075         $ 212,899          $ 23,243     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The following tables present, by loan portfolio class, the average recorded investment and interest income recognized on impaired loans for the three and six months ended June 30, 2012 and 2011:

 

    Three Months Ended June 30,  
    2012     2011  
    Average     Interest     Average     Interest  
    Recorded     Income     Recorded     Income  
         Investment              Recognized              Investment              Recognized      
    (in thousands)  

Commercial and industrial

    $ 48,888         $ 339          $ 38,274         $ 256     

Commercial real estate:

       

Commercial real estate

    98,077          302          71,384          689     

Construction

    21,412          37          34,809          96     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial real estate loans

    119,489          339          106,193          785     
 

 

 

   

 

 

   

 

 

   

 

 

 

Residential mortgage

    21,179          238          18,226          173     

Consumer loans:

       

Home equity

    274          3          82          2     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer loans

    274          3          82          2     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total

    $ 189,830         $ 919          $ 162,775         $ 1,216     
 

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents
     Six Months Ended June 30,  
     2012      2011  
     Average      Interest        Average       Interest    
     Recorded      Income      Recorded      Income  
         Investment              Recognized              Investment              Recognized      
           

(in thousands)

        

Commercial and industrial

     $ 52,094           $ 748           $ 38,158           $ 739     

Commercial real estate:

           

   Commercial real estate

     95,004           991           67,054           1,356     

   Construction

     21,742           86           34,296           262     
  

 

 

    

 

 

    

 

 

    

 

 

 

   Total commercial real estate loans

     116,746           1,077           101,350           1,618     
  

 

 

    

 

 

    

 

 

    

 

 

 

Residential mortgage

     20,889           374           18,304           381     

Consumer loans:

           

   Home equity

     277           7           82           3     
  

 

 

    

 

 

    

 

 

    

 

 

 

   Total consumer loans

     277           7           82           3     
  

 

 

    

 

 

    

 

 

    

 

 

 

 Total

  

 

  $

 

190,006  

 

  

     $ 2,206           $ 157,894           $ 2,741     
  

 

 

    

 

 

    

 

 

    

 

 

 

Interest income recognized on a cash basis, included in the table above was immaterial for the three and six months ended June 30, 2012 and 2011.

Troubled debt restructured loans. From time to time, Valley may extend, restructure, or otherwise modify the terms of existing loans, on a case-by-case basis, to remain competitive and retain certain customers, as well as assist other customers who may be experiencing financial difficulties. If the borrower is experiencing financial difficulties and a concession has been made at the time of such modification, the loan is classified as a troubled debt restructured loan (“TDR”). Valley’s PCI loans are excluded from the TDR disclosures below because they are evaluated for impairment on a pool by pool basis. When an individual PCI loan within a pool is modified as a TDR, it is not removed from its pool.

The majority of the concessions made for TDRs involve lowering the monthly payments on loans through either a reduction in interest rate below a market rate, an extension of the term of the loan without a corresponding adjustment to the risk premium reflected in the interest rate, or a combination of these two methods. The concessions rarely result in the forgiveness of principal or accrued interest. In addition, Valley frequently obtains additional collateral or guarantor support when modifying such loans. If the borrower has demonstrated performance under the previous terms and Valley’s underwriting process shows the borrower has the capacity to continue to perform under the restructured terms, the loan will continue to accrue interest. Non-accruing restructured loans may be returned to accrual status when there has been a sustained period of repayment performance (generally six consecutive months of payments) and both principal and interest are deemed collectible.

Performing TDRs (not reported as non-accrual loans) totaled $113.6 million and $101.0 million as of June 30, 2012 and December 31, 2011, respectively. Non-performing TDRs totaled $27.8 million and $15.5 million as of June 30, 2012 and December 31, 2011, respectively. All TDRs are classified as impaired loans and are included in the impaired loan disclosures above.

 

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Table of Contents

The following tables present non-PCI loans, by loan portfolio class that were modified as TDRs during the three and six months ended June 30, 2012 and 2011. The pre-modification and post-modification outstanding recorded investments disclosed in the table below represent the loan carrying amounts immediately prior to the modification and the post modification carrying amounts at June 30, 2012 and 2011, respectively.

 

     Three Months Ended June 30, 2012      Three Months Ended June 30, 2011  

Troubled Debt

Restructurings

   Number
of
  Contracts 
       Pre-Modification  
Outstanding
Recorded

Investment
       Post-Modification  
Outstanding
Recorded
Investment
     Number
of
 Contracts 
       Pre-Modification  
Outstanding
Recorded

Investment
       Post-Modification  
Outstanding
Recorded
Investment
 
     ($ in thousands)  

Commercial and industrial*

     8              $ 18,278           $ 16,623           12              $ 4,461           $ 4,437     

Commercial real estate:

                 

  Commercial real estate

     8              33,677           33,487           1              6,628           6,617     

  Construction

     2              4,557           4,254           1              1,350           1,314     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

  Total commercial real estate

     10              38,234           37,741           2              7,978           7,931     

Residential mortgage

     9              2,926           2,919           -              -              -        
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     27              $ 59,438           $ 57,283           14              $ 12,439           $ 12,368     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     Six Months Ended June 30, 2012      Six Months Ended June 30, 2011  

Troubled Debt

Restructurings

   Number
of
  Contracts 
       Pre-Modification  
Outstanding
Recorded
Investment
       Post-Modification  
Outstanding
Recorded
Investment
     Number
of
 Contracts 
       Pre-Modification  
Outstanding
Recorded
Investment
       Post-Modification  
Outstanding
Recorded
Investment
 
     ($ in thousands)  

Commercial and industrial*

     13              $ 19,700           $ 17,574           17              $ 7,485           $ 7,415     

Commercial real estate:

                 

  Commercial real estate

     14              35,726           35,453           2              8,987           8,945     

  Construction

     4              6,711           5,278           1              1,350           1,314     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

  Total commercial real estate

     18              42,437           40,731           3              10,337           10,259     

Residential mortgage

     13              3,778           3,767           -              -              -        

Consumer

     2              69           67           -              -              -        
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     46              $ 65,984           $ 62,139           20              $ 17,822           $ 17,674     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

 

* Includes 6 finance leases with pre and post-modification outstanding recorded investments totaling $272 thousand and $250 thousand, respectively, for both three and six months ended June 30, 2011. There were no material modifications to finance leases during 2012.

The majority of the TDR concessions made during the three and six months ended June 30, 2012, and 2011 involved an extension of the loan term and/or an interest rate reduction. The TDRs presented in the table above had allocated specific reserves for loan losses totaling $9.5 million and $1.9 million at June 30, 2012 and 2011, respectively. These specific reserves are included in the allowance for loan losses for loans individually evaluated for impairment disclosed in Note 8. There were no charge-offs resulting from loans modified as TDRs during the three and six months ended June 30, 2012 and 2011.

The following table presents non-PCI loans modified as TDRs within the previous 12 months from, and for which there was a payment default (90 days or more past due) during the three and six months ended June 30, 2012:

 

Troubled Debt    Three Months Ended
June 30, 2012
     Six Months Ended
June 30, 2012
 

Restructurings

Subsequently Defaulted

       Number of    
Contracts
     Recorded
    Investment    
         Number of    
Contracts
   Recorded
    Investment    
 
     ($ in thousands)  

Commercial and industrial

     -              $ -             1      $ 646     

Commercial real estate

     -              -             1      1,108     

Residential mortgage

     2         321         3      643     
  

 

 

    

 

 

    

 

  

 

 

 

Total

     2         $ 321         5      $ 2,397     
  

 

 

    

 

 

    

 

  

 

 

 

 

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Credit quality indicators. Valley utilizes an internal loan classification system as a means of reporting problem loans within commercial and industrial, commercial real estate, and construction loan portfolio classes. Under Valley’s internal risk rating system, loan relationships could be classified as “Special Mention”, “Substandard”, “Doubtful”, and “Loss.” Substandard loans include loans that exhibit well-defined weakness and are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. 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, based on currently existing facts, conditions and values, highly questionable and improbable. Loans classified as Loss are those considered uncollectible with insignificant value and are charged-off immediately to the allowance for loan losses. Loans that do not currently pose a sufficient risk to warrant classification in one of the aforementioned categories, but pose weaknesses that deserve management’s close attention are deemed to be Special Mention. Loans rated as “Pass” loans do not currently pose any identified risk and can range from the highest to average quality, depending on the degree of potential risk. Risk ratings are updated any time the situation warrants.

The following table presents the risk category of loans (excluding PCI loans) by class of loans based on the most recent analysis performed at June 30, 2012 and December 31, 2011.

 

Credit exposure -           Special                       

 

by internally assigned risk rating

          Pass            

 

    Mention   

         Substandard             Doubtful               Total        
    

(in thousands)

 

June 30, 2012

              

Commercial and industrial

     $     1,716,927           $ 75,355           $ 91,357           $ 228           $     1,883,867     

Commercial real estate

     3,487,111           62,373           170,505           -               3,719,989     

Construction

     304,710           35,321           28,488           186           368,705     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     $ 5,508,748           $ 173,049           $ 290,350           $ 414           $ 5,972,561     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

December 31, 2011

              

Commercial and industrial

     $ 1,669,943           $ 95,726           $ 112,186           $ 532           $ 1,878,387     

Commercial real estate

     3,350,475           82,612           141,002           -               3,574,089     

Construction

     329,848           42,845           38,114           196           411,003     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     $ 5,350,266           $ 221,183           $ 291,302           $ 728           $ 5,863,479     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

For residential mortgages, automobile, home equity and other consumer loan portfolio classes (excluding PCI loans), Valley also evaluates credit quality based on the aging status of the loan, which was previously presented, and by payment activity. The following table presents the recorded investment in those loan classes based on payment activity as of June 30, 2012 and December 31, 2011:

 

                                                                                   
Credit exposure -       Performing         Non-Performing      Total     

 

by payment activity

  

 

Loans

    

 

Loans

    

 

      Loans     

    
    

(in thousands)

    

June 30, 2012

           

Residential mortgage

     $ 2,695,069           $ 32,045           $     2,727,114        

Home equity

     448,640           2,070           450,710        

Automobile

     777,808           373           778,181        

Other consumer

     153,577           722           154,299        
  

 

 

    

 

 

    

 

 

    

Total

     $ 4,075,094           $ 35,210           $ 4,110,304        
  

 

 

    

 

 

    

 

 

    

 

December 31, 2011

           

Residential mortgage

     $ 2,253,944           $ 31,646           $ 2,285,590        

Home equity

     466,904           2,700           469,604        

Automobile

     772,029           461           772,490        

Other consumer

     135,885           749           136,634        
  

 

 

    

 

 

    

 

 

    

Total

     $ 3,628,762           $ 35,556           $ 3,664,318        
  

 

 

    

 

 

    

 

 

    

 

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Valley evaluates the credit quality of its PCI loan pools based on the expectation of the underlying cash flows of each pool, derived from the aging status and by payment activity of individual loans within the pool. The following table presents the recorded investment in PCI loans by class based on individual loan payment activity as of June 30, 2012 and December 31, 2011.

 

                                                                                   

Credit exposure -

by payment activity

       Performing   
Loans
     Non-Performing
Loans
     Total
    PCI  Loans    
      
            (in thousands)            

June 30, 2012

           

Commercial and industrial

     $ 336,106           $ 10,150           $ 346,257        

Commercial real estate

     801,365           56,076           857,441        

Construction

     37,172           12,836           50,008        

Residential mortgage

     26,965           5,823           32,789        

Consumer

     52,980           1,512           54,492        
  

 

 

    

 

 

    

 

 

    

Total

     $ 1,254,588           $ 86,397           $ 1,340,987        
  

 

 

    

 

 

    

 

 

    

 

December 31, 2011

           

Commercial and industrial

     $ 67,424           $ 16,318           $ 83,742        

Commercial real estate

     112,047           48,604           160,651        

Construction

     623           6,351           6,974        

Residential mortgage

     10,118           5,428           15,546        

Consumer

     4,931           -               4,931        
  

 

 

    

 

 

    

 

 

    

Total

     $ 195,143           $ 76,701           $ 271,844        
  

 

 

    

 

 

    

 

 

    

Note 8.  Allowance for Credit Losses

The allowance for credit losses consists of the allowance for losses on loans, the reserve for unfunded letters of credit, and the allowance for losses on covered loans related to credit impairment of certain covered loan pools subsequent to acquisition. Management maintains the allowance for credit losses at a level estimated to absorb probable loan losses of the loan portfolio and unfunded letter of credit commitments at the balance sheet date. The allowance for non-covered loans losses is based on ongoing evaluations of the probable estimated losses inherent in the non-covered loan portfolio, including unexpected credit impairment of non-covered PCI loan pools subsequent to the acquisition date.

The following table summarizes the allowance for credit losses at June 30, 2012 and December 31, 2011:

 

                                                              
          June 30,     
2012
      December 31, 
2011
      
     (in thousands)     

Components of allowance for credit losses:

        

Allowance for non-covered loans

     $ 118,083           $ 120,274        

Allowance for covered loans

     11,771           13,528        
  

 

 

    

 

 

    

Total allowance for loan losses

     129,854           133,802        

Allowance for unfunded letters of credit

     2,682           2,383        
  

 

 

    

 

 

    

Total allowance for credit losses

     $ 132,536           $ 136,185        
  

 

 

    

 

 

    

 

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The following table summarizes the provision for credit losses for the periods indicated:

 

       Three Months Ended June 30,             Six Months Ended June 30,       
    2012     2011     2012     2011  
    (in thousands)  

Components of provision for credit losses:

       

Provision for non-covered loans

    $ 7,429          $ 6,422          $ 12,803          $ 11,627     

Provision for covered loans

    -          (788)         -          18,094     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total provision for loan losses

    7,429          5,634          12,803          29,721     
 

 

 

   

 

 

   

 

 

   

 

 

 

Provision for unfunded letters of credit

    (24)         392          299          467     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total provision for credit losses

    $ 7,405          $ 6,026          $ 13,102          $ 30,188     
 

 

 

   

 

 

   

 

 

   

 

 

 

 

The following tables detail the activity in the allowance for loan losses by portfolio segment for the three months ended June 30, 2012 and 2011, including both covered and non-covered loans:

 

    Commercial
 and  Industrial 
      Commercial  
Real Estate
      Residential  
Mortgage
      Consumer       Unallocated          Total       
    (in thousands)  

Three Months Ended June 30, 2012:

           

Allowance for loan losses:

           

Beginning balance

    $ 73,311          $ 34,415          $ 9,837          $ 7,940          $ 7,367          $ 132,870     

Loans charged-off *

    (5,406)         (5,379)         (583)         (1,015)         -              (12,383)    

Charged-off loans recovered

    1,304          116          111          407          -              1,938     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs

    (4,102)         (5,263)         (472)         (608)         -              (10,445)    

Provision for loan losses

    1,313          6,406          1,375          (1,523)         (142)         7,429     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

    $ 70,522          $ 35,558          $ 10,740          $ 5,809          $ 7,225          $ 129,854     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Three Months Ended June 30, 2011:

           

Allowance for loan losses:

           

Beginning balance

    $ 75,871          $ 32,217          $ 11,303          $ 12,300          $ 8,156          $ 139,847     

Loans charged-off *

    (3,056)         (3,631)         (443)         (1,355)         -              (8,485)    

Charged-off loans recovered

    741          202          69          618          -              1,630     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs

    (2,315)         (3,429)         (374)         (737)         -              (6,855)    

Provision for loan losses

    2,130          3,947          107          (488)         (62)         5,634     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

    $ 75,686          $ 32,735          $ 11,036          $ 11,075          $ 8,094          $     138,626     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

* The allowance for covered loans was reduced by loan charge-offs totaling $1.8 million and $639 thousand during the second quarters of 2012 and 2011, respectively.

 

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Table of Contents

The following tables detail the activity in the allowance for loan losses by portfolio segment for the six months ended June 30, 2012 and 2011, including both covered and non-covered loans:

 

    Commercial
and Industrial
    Commercial
    Real Estate    
    Residential
    Mortgage    
      Consumer        Unallocated     Total  
    (in thousands)  

Six Months Ended June 30, 2012:

           

Allowance for loan losses:

           

Beginning balance

    $       73,649          $ 34,637          $ 9,120          $ 8,677          $ 7,719          $ 133,802     

  Loans charged-off *

    (10,213)         (6,459)         (1,759)         (2,498)         -              (20,929)    

  Charged-off loans recovered

    2,309          236          625          1,008          -              4,178     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

  Net charge-offs

    (7,904)         (6,223)         (1,134)         (1,490)         -              (16,751)    

  Provision for loan losses

    4,777          7,144          2,754          (1,378)         (494)         12,803     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

    $ 70,522          $       35,558          $         10,740          $ 5,809          $ 7,225          $ 129,854     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Six Months Ended June 30, 2011:

           

Allowance for loan losses:

           

Beginning balance

    $ 61,967          $ 30,409          $ 9,476          $ 14,499          $ 8,353          $ 124,704     

  Loans charged-off *

    (9,728)         (4,454)         (1,226)         (3,113)         -              (18,521)    

  Charged-off loans recovered

    1,189          223          90          1,220          -              2,722     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

  Net charge-offs

    (8,539)         (4,231)         (1,136)         (1,893)         -              (15,799)    

  Provision for loan losses

    22,258          6,557          2,696          (1,531)         (259)         29,721     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

    $ 75,686          $ 32,735          $ 11,036          $       11,075          $      8,094          $       138,626     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

* The allowance for covered loans was reduced by loan charge-offs totaling $1.8 million and $5.7 million during the six months ended June 30, 2012 and 2011, respectively.

The following table represents the allocation of the allowance for loan losses and the related loans by loan portfolio segment disaggregated based on the impairment methodology at June 30, 2012 and December 31, 2011, including both covered and non-covered loans:

 

    Commercial
and Industrial
      Commercial  
Real Estate
    Residential
    Mortgage    
       Consumer          Unallocated       Total  
    (in thousands)  

June 30, 2012

           

Allowance for loan losses:

           

Individually evaluated for impairment

    $ 8,185          $ 11,035          $ 2,777          $ 22          $ -              $ 22,019     

Collectively evaluated for impairment

    52,654          22,497          7,901          5,787          7,225          96,064     

Loans acquired with discounts related to credit quality

    9,683          2,026          62          -              -              11,771     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    $ 70,522          $ 35,558          $ 10,740          $ 5,809          $ 7,225          $ 129,854     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans:

           

Individually evaluated for impairment

    $ 44,385          $ 135,724          $ 21,012          $ 272          $ -              $ 201,393     

Collectively evaluated for impairment

    1,839,482          3,952,970          2,706,102          1,382,918          -              9,881,472     

Loans acquired with discounts related to credit quality

    346,257          907,449          32,789          54,492          -              1,340,987     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    $   2,230,124          $   4,996,143          $   2,759,903          $   1,437,682          $       -              $   11,423,852     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

December 31, 2011

           

Allowance for loan losses:

           

Individually evaluated for impairment

    $ 11,105          $ 8,516          $ 3,577          $ 45          $ -              $ 23,243     

Collectively evaluated for impairment

    51,588          23,611          5,481          8,632          7,719          97,031     

Loans acquired with discounts related to credit quality

    10,956          2,510          62          -              -              13,528     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    $ 73,649          $ 34,637          $ 9,120          $ 8,677          $ 7,719          $ 133,802     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans:

           

Individually evaluated for impairment

    $ 54,858          $ 107,970          $ 21,005          $ 242          $ -              $ 184,075     

Collectively evaluated for impairment

    1,823,529          3,877,122          2,264,585          1,378,486          -              9,343,722     

Loans acquired with discounts related to credit quality

    83,742          167,625          15,546          4,931          -              271,844     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

    $ 1,962,129          $ 4,152,717          $ 2,301,136          $ 1,383,659          $ -              $ 9,799,641     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Note 9. Goodwill and Other Intangible Assets

The changes in the carrying amount of goodwill as allocated to our business segments, or reporting units thereof, for goodwill impairment analysis were:

 

    Business Segment / Reporting Unit*  
   

 

Wealth
 Management 

    Consumer
     Lending     
      Commercial  
Lending
    Investment
  Management  
    Total  
    (in thousands)  

Balance at December 31, 2011

    $       20,517          $ 98,999          $ 117,689          $ 80,757          $ 317,962     

Goodwill from business combinations

    -              27,371          53,040          22,070          102,481     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at June 30, 2012

    $ 20,517          $       126,370          $       170,729          $       102,827          $       420,443     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

   * Valley’s Wealth Management Division is comprised of trust, asset management, and insurance services. This reporting unit is included in the Consumer Lending segment for financial reporting purposes.

During the six months ended June 30, 2012, goodwill from business combinations primarily related to acquisition of State Bancorp (see Note 3 for further details). There was no impairment of goodwill during the three and six months ended June 30, 2012 and 2011.

The following table summarizes other intangible assets as of June 30, 2012 and December 31, 2011:

 

    Gross   Intangible  
Assets
    Accumulated
  Amortization  
    Valuation
    Allowance    
    Net
  Intangible   Assets
 
    (in thousands)  

June 30, 2012

       

Loan servicing rights

    $ 54,363          $ (41,199)         $ (2,651)         $ 10,513     

Core deposits

    35,194          (22,369)         -           12,825     

Other

    5,878          (2,399)         -           3,479     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total other intangible assets

    $           95,435          $         (65,967)         $           (2,651)         $           26,817     
 

 

 

   

 

 

   

 

 

   

 

 

 

December 31, 2011

       

Loan servicing rights

    $ 52,046          $ (39,146)         $ (2,670)         $ 10,230     

Core deposits

    27,144          (20,363)         -           6,781     

Other

    6,121          (2,314)         -           3,807     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total other intangible assets

    $ 85,311          $ (61,823)         $ (2,670)         $ 20,818     
 

 

 

   

 

 

   

 

 

   

 

 

 

Loan servicing rights are accounted for using the amortization method. Under this method, Valley amortizes the loan servicing assets in proportion to, and over the period of, estimated net servicing revenues. On a quarterly basis, Valley stratifies its loan servicing assets into groupings based on risk characteristics and assesses each group for impairment based on fair value. Impairment charges on loan servicing rights are recognized in earnings when the amortized cost value of a stratified group of loan servicing rights exceeds its estimated fair value. Valley recorded net impairment charges on its loan servicing rights totaling $401 thousand as compared to net recoveries of impairment charges totaling $49 thousand for the three months ended June 30, 2012 and 2011, respectively, and net recoveries of impairment charges totaling $19 thousand and $101 thousand for the six months ended June 30, 2012 and 2011, respectively.

Core deposits are amortized using an accelerated method and have a weighted average amortization period of 10 years. The line item labeled “Other” included in the table above primarily consists of customer lists and covenants not to compete, which are amortized over their expected lives generally using a straight-line method and have a weighted average amortization period of 16 years. During the quarter ended March 31, 2012, Valley recorded $8.1 million in core deposits intangibles resulting from the State Bancorp acquisition. Valley evaluates core deposits and other intangibles for impairment when an indication of impairment exists. No impairment was recognized during the three and six months ended June 30, 2012 and 2011.

 

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The following presents the estimated future amortization expense of other intangible assets for the remainder of 2012 through 2016:

 

    Loan              
         Servicing          Core        
    Rights          Deposits                 Other         
    (in thousands)  

2012

    $ 848          $ 1,791          $ 328     

2013

    2,611          3,078          541     

2014

    1,994          2,359          466     

2015

    1,423          1,758          434     

2016

    1,063          1,195          233     

Valley recognized amortization expense on other intangible assets, including net impairment charges and recoveries on loan servicing rights, totaling approximately $2.5 million and $1.8 million for the three months ended June 30, 2012 and 2011, respectively, and $4.5 million and $3.8 million for the six months ended June 30, 2012 and 2011, respectively.

Note 10. Pension Plan

The Bank has a non-contributory defined benefit plan (“qualified plan”) covering most of its employees. Effective July 1, 2011, the Bank closed the qualified plan to new employees hired on or after such date. The Plan continues to operate and accrue normal benefits for existing participants. In conjunction with the eligibility change for the qualified plan, the Bank amended its 401(k) plan to increase the Bank’s matching percentage of employee contributions for non-pension participants, within certain statutory limits.

The qualified plan benefits are based upon years of credited service and the employee’s highest average compensation as defined. It is the Bank’s funding policy to contribute annually an amount that can be deducted for federal income tax purposes. Additionally, the Bank has a supplemental non-qualified, non-funded retirement plan (“non-qualified plan”) which is designed to supplement the pension plan for key officers.

The following table sets forth the components of net periodic pension expense related to the qualified and non-qualified plans for the three and six months ended June 30, 2012 and 2011:

 

     Three Months Ended      Six Months Ended  
     June 30,      June 30,  
            2012                    2011                    2012                    2011         
     (in thousands)  

Service cost

     $ 1,964           $ 1,563           $ 3,928           $ 3,126     

Interest cost

     1,598           1,525           3,196           3,049     

Expected return on plan assets

     (2,233)          (1,665)          (4,466)          (3,330)    

Amortization of prior service cost

     177           160           354           320     

Amortization of actuarial loss

     581           342           1,163           685     
  

 

 

    

 

 

    

 

 

    

 

 

 

   Total net periodic pension expense

     2,087           1,925           4,175           3,850     
  

 

 

    

 

 

    

 

 

    

 

 

 

Other changes in plan assets and benefit obligations recognized in other comprehensive income:

           

   Amortization of prior service cost

     (177)          (160)          (354)          (320)    

   Amortization of actuarial loss

     (581)          (342)          (1,163)          (685)    
  

 

 

    

 

 

    

 

 

    

 

 

 
     (758)          (502)          (1,517)          (1,005)    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total amount recognized in net periodic benefit cost and other comprehensive income (before tax)

     $ 1,329           $ 1,423           $ 2,658           $ 2,845     
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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The fair value of qualified plan assets increased approximately $28.1 million, or 29.3 percent to $123.8 million at June 30, 2012 from $95.7 million at December 31, 2011. Valley contributed $25.0 million to the qualified plan during January 2012. Valley does not expect to make any additional contributions to the qualified plan for the remainder of 2012.

Note 11. Stock–Based Compensation

Valley currently has one active employee stock option plan, the 2009 Long-Term Stock Incentive Plan (the “Employee Stock Incentive Plan”), administered by the Compensation and Human Resources Committee (the “Committee”) appointed by Valley’s Board of Directors. The Committee can grant awards to officers and key employees of Valley. The purpose of the Employee Stock Incentive Plan is to provide additional incentive to officers and key employees of Valley and its subsidiaries, whose substantial contributions are essential to the continued growth and success of Valley, and to attract and retain competent and dedicated officers and other key employees whose efforts will result in the continued and long-term growth of Valley’s business.

Under the Employee Stock Incentive Plan, Valley may award shares to its employees for up to 7.4 million shares of common stock in the form of incentive stock options, non-qualified stock options, stock appreciation rights and restricted stock awards. The essential features of each award are described in the award agreement relating to that award. The grant, exercise, vesting, settlement or payment of an award may be based upon the fair value of Valley’s common stock on the last sale price reported for Valley’s common stock on such date or the last sale price reported preceding such date. An incentive stock option’s maximum term to exercise is ten years from the date of grant and is subject to a vesting schedule. There were no stock options granted by Valley during the six months ended June 30, 2012 and 2011. Valley awarded restricted stock totaling 540 shares and 165 shares during the six months ended June 30, 2012 and 2011, respectively. As of June 30, 2012, 6.3 million shares of common stock were available for issuance under the Employee Stock Incentive Plan.

Valley recorded stock-based compensation expense for incentive stock options and restricted stock awards of $1.3 million and $613 thousand for the three months ended June 30, 2012 and 2011, respectively, and $2.7 million and $1.3 million for the six months ended June 30, 2012 and 2011, respectively. The fair values of stock awards are expensed over the vesting period. As of June 30, 2012, the unrecognized amortization expense for all stock-based employee compensation totaled approximately $5.6 million and will be recognized over an average remaining vesting period of approximately 2 years.

On January 1, 2012, Valley assumed 356 thousand shares of outstanding and vested incentive stock options under State Bancorp’s long-term stock incentive plans, of which 321 thousand shares were outstanding and exercisable as of June 30, 2012. These outstanding stock options have an aggregate weighted average exercise price of $17.41 and weighted average remaining term of 3 years.

Note 12. Guarantees

Guarantees that have been entered into by Valley include standby letters of credit of $249.6 million as of June 30, 2012. Standby letters of credit represent the guarantee by Valley of the obligations or performance of a customer in the event the customer is unable to meet or perform its obligations to a third party. Of the total standby letters of credit, $152.2 million, or 60.9 percent are secured and, in the event of non-performance by the customer, Valley has rights to the underlying collateral, which includes commercial real estate, business assets (physical plant or property, inventory or receivables), marketable securities and cash in the form of bank savings accounts and certificates of deposit. As of June 30, 2012, Valley had a $947 thousand liability related to the standby letters of credit.

Note 13. Derivative Instruments and Hedging Activities

Valley is exposed to certain risks arising from both its business operations and economic conditions. Valley principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. Valley manages economic risks, including interest rate and liquidity risks, primarily by managing the amount, sources, and duration of its assets and liabilities and, from time to time, the use of derivative financial instruments. Specifically, Valley enters into derivative financial instruments to manage exposures that arise from business activities

 

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that result in the payment of future known and uncertain cash amounts, the value of which are determined by interest rates. Valley’s derivative financial instruments are used to manage differences in the amount, timing, and duration of Valley’s known or expected cash receipts and its known or expected cash payments related to assets and liabilities outlined below.

Cash Flow Hedges of Interest Rate Risk. Valley’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, Valley uses interest rate swaps and caps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the payment of either fixed or variable-rate amounts in exchange for the receipt of variable or fixed-rate amounts from a counterparty. Interest rate caps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty if interest rates rise above the strike rate on the contract in exchange for an up-front premium.

At June 30, 2012, Valley had the following cash flow hedge derivatives:

 

   

Four forward starting interest rate swaps with a total notional amount of $300 million to hedge the changes in cash flows associated with certain prime-rate-indexed deposits, consisting of consumer and commercial money market deposit accounts. Two of the four swaps, totaling $200 million, expire in October 2016 and require Valley to pay fixed-rate amounts at approximately 4.73 percent, in exchange for the receipt of variable-rate payments at the prime rate. The other two swaps totaling $100 million will require the payment by Valley of fixed-rate amounts at approximately 5.11 percent in exchange for the receipt of variable-rate payments at the prime rate starting in July 2012 and expiring in July 2017.

 

   

Two interest rate caps with a total notional amount of $100 million, strike rates of 2.50 percent and 2.75 percent, and a maturity date of May 1, 2013 used to hedge the variability in cash flows associated with customer repurchase agreements and money market deposit accounts that have variable interest rates based on the federal funds rate.

 

   

Two interest rate caps with a total notional amount of $100 million, strike rates of 6.00 percent and 6.25 percent, and a maturity date of July 15, 2015 used to hedge the total change in cash flows associated with prime-rate-indexed deposits, consisting of consumer and commercial money market deposit accounts, which have variable interest rates indexed to the prime rate.

Fair Value Hedges of Fixed Rate Assets and Liabilities. Valley is exposed to changes in the fair value of certain of its fixed rate assets or liabilities due to changes in benchmark interest rates based on one month-LIBOR. From time to time, Valley uses interest rate swaps to manage its exposure to changes in fair value. Interest rate swaps designated as fair value hedges involve the receipt of variable rate payments from a counterparty in exchange for Valley making fixed rate payments over the life of the agreements without the exchange of the underlying notional amount.

At June 30, 2012, Valley had the following fair value hedge derivatives:

 

   

One interest rate swap with a notional amount of approximately $8.9 million used to hedge the change in the fair value of a commercial loan.

 

   

One interest rate swap with a notional amount of $51 million, maturing in March 2014, used to hedge the change in the fair value of certain fixed-rate brokered certificates of deposit entered into during 2011.

For derivatives that are designated and qualify as fair value hedges, the gain or loss on the derivative as well as the loss or gain on the hedged item attributable to the hedged risk are recognized in earnings. Valley includes the gain or loss on the hedged items in the same income statement line item as the loss or gain on the related derivatives.

Non-designated Hedges. Derivatives not designated as hedges may be used to manage Valley’s exposure to interest rate movements or to provide service to customers but do not meet the requirements for hedge accounting under U.S. GAAP. Derivatives not designated as hedges are not entered into for speculative purposes. Under a program, Valley

 

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executes interest rate swaps with commercial lending customers to facilitate their respective risk management strategies. These interest rate swaps with customers are simultaneously offset by interest rate swaps that Valley executes with a third party, such that Valley minimizes its net risk exposure resulting from such transactions. As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings. As of June 30, 2012, Valley had a total of 28 interest rate swaps with an aggregate notional amount of $116.4 million, including 14 interest rate swaps totaling $17.6 million acquired from State Bancorp, related to this program.

Amounts included in the consolidated statements of financial condition related to the fair value of Valley’s derivative financial instruments were as follows:

 

              Fair Value  
      Balance Sheet 
Line Item
            June 30,     
2012
     December 31, 
2011
 
              (in thousands)  

Asset Derivatives:

         

Derivatives designated as hedging instruments:

         

Cash flow hedge interest rate caps and swaps

   Other Assets        $ 63          $ 294     

Fair value hedge interest rate swaps

   Other Assets        826          852     
       

 

 

   

 

 

 

Total derivatives designated as hedging instruments

          $ 889          $ 1,146     
       

 

 

   

 

 

 

Derivatives not designated as hedging instruments:

         

Interest rate swaps

   Other Assets        $ 7,208          $ 4,065     
       

 

 

   

 

 

 

Total derivatives not designated as hedging instruments

          $ 7,208          $ 4,065     
       

 

 

   

 

 

 

Liability Derivatives:

         

Derivatives designated as hedging instruments:

         

Cash flow hedge interest rate caps and swaps

   Other Liabilities        $ 17,592          $ 15,649     

Fair value hedge interest rate swaps

   Other Liabilities        2,260          2,140     
       

 

 

   

 

 

 

Total derivatives designated as hedging instruments

          $ 19,852          $ 17,789     
       

 

 

   

 

 

 

Derivatives not designated as hedging instruments:

         

Interest rate swaps

   Other Liabilities        $ 7,203          $ 4,065     
       

 

 

   

 

 

 

Total derivatives not designated as hedging instruments

          $ 7,203          $ 4,065     
       

 

 

   

 

 

 

Losses included in the consolidated statements of income and in other comprehensive income, on a pre-tax basis, related to interest rate derivatives designated as hedges of cash flows were as follows:

 

    Three Months Ended
June 30,
    Six Months Ended
June 30,
 
         2012               2011               2012               2011       
    (in thousands)  

Interest rate caps on short-term borrowings and deposit accounts:

       

Amount of loss reclassified from accumulated other comprehensive loss to interest on short-term borrowings

    $ (1,398)        $ (611)        $ (2,790)        $ (1,188)   

Amount of loss recognized in other comprehensive income

    (5,288)        (6,533)        (3,739)        (5,099)   

Valley recognized a net loss of $16 thousand in other expense for hedge ineffectiveness on the cash flow hedge interest rate caps for the three months ended June 30, 2011, and net gains of $73 thousand and $34 thousand for the six months ended June 30, 2012 and 2011, respectively. No ineffectiveness on the cash flow hedge interest rate caps was recognized in the second quarter of 2012. The accumulated net after-tax losses related to effective cash flow hedges included in accumulated other comprehensive loss were $13.6 million and $13.1 million at June 30, 2012 and December 31, 2011, respectively.

 

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Amounts reported in accumulated other comprehensive loss related to cash flow interest rate derivatives are reclassified to interest expense as interest payments are made on the hedged variable interest rate liabilities. Valley estimates that $9.1 million will be reclassified as an increase to interest expense over the next twelve months.

Gains (losses) included in the consolidated statements of income related to interest rate derivatives designated as hedges of fair value were as follows:

 

    Three Months Ended
June 30,
    Six Months Ended
June 30,
 
          2012                 2011                 2012                 2011        
    (in thousands)  

Derivative - interest rate swaps:

       

Interest income - interest and fees on loans

    $ (251)        $ (218)        $ (121)        $ (58)   

Interest expense - interest on time deposits

    (67)        676         (27)        566    

Hedged item - loans and deposits:

       

Interest income - interest and fees on loans

    $ 251         $ 218         $ 121         $ 58    

Interest expense -interest on time deposits

    70         (699)        38         (581)   

During the three and six months ended June 30, 2012 and 2011, the net gains recognized in non-interest expense related to ineffectiveness of fair value hedges were immaterial. Valley also recognized a net reduction to interest expense of $139 thousand and $143 thousand for the three months ended June 30, 2012 and 2011, respectively, and $275 thousand and $186 thousand for the six months ended June 30, 2012 and 2011, respectively, related to Valley’s fair value hedges on brokered time deposits, which includes net settlements on the derivatives.

The gains included in the consolidated statements of income related to derivative instruments not designated as hedging instruments totaled $217 thousand for the six months ended June 30, 2012 and were immaterial for the three months ended June 30, 2012. There were no gains or losses included in the consolidated statements of income related to derivative instruments not designated as hedging instruments for the three and six months ended June 30, 2011.

Credit Risk Related Contingent Features. By using derivatives, Valley is exposed to credit risk if counterparties to the derivative contracts do not perform as expected. Management attempts to minimize counterparty credit risk through credit approvals, limits, monitoring procedures and obtaining collateral where appropriate. Credit risk exposure associated with derivative contracts is managed at Valley in conjunction with Valley’s consolidated counterparty risk management process. Valley’s counterparties and the risk limits monitored by management are periodically reviewed and approved by the Board of Directors.

Valley has agreements with its derivative counterparties providing that if Valley defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then Valley could also be declared in default on its derivative counterparty agreements. Additionally, Valley has an agreement with several of its derivative counterparties that contains provisions that require Valley’s debt to maintain an investment grade credit rating from each of the major credit rating agencies, from which it receives a credit rating. If Valley’s credit rating is reduced below investment grade or such rating is withdrawn or suspended, then the counterparty could terminate the derivative positions, and Valley would be required to settle its obligations under the agreements. As of June 30, 2012, Valley was in compliance with the provisions of its derivative counterparty agreements.

As of June 30, 2012, the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements was $26.6 million. Valley has derivative counterparty agreements that require minimum collateral posting thresholds for certain counterparties. No collateral has been assigned or posted by Valley’s counterparties under the agreements at June 30, 2012. At June 30, 2012, Valley had $23.8 million in collateral posted with its counterparties.

 

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Note 14. Business Segments

The information under the caption “Business Segments” in Management’s Discussion and Analysis is incorporated herein by reference.

Item 2. Management’s Discussion and Analysis (“MD&A”) of Financial Condition and Results of Operations

The following MD&A should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this report. The words “Valley,” “the Company,” “we,” “our” and “us” refer to Valley National Bancorp and its wholly owned subsidiaries, unless we indicate otherwise. Additionally, Valley’s principal subsidiary, Valley National Bank, is commonly referred as the “Bank” in this MD&A.

The MD&A contains supplemental financial information, described in the sections that follow, which has been determined by methods other than U.S. generally accepted accounting principles (“ U.S. GAAP”) that management uses in its analysis of our performance. Management believes these non-GAAP financial measures provide information useful to investors in understanding our underlying operational performance, our business and performance trends and facilitates comparisons with the performance of others in the financial services industry. These non-GAAP financial measures should not be considered in isolation or as a substitute for or superior to financial measures calculated in accordance with U.S. GAAP.

Cautionary Statement Concerning Forward-Looking Statements

This Quarterly Report on Form 10-Q, both in the MD&A and elsewhere, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are not historical facts and include expressions about management’s confidence and strategies and management’s expectations about new and existing programs and products, acquisitions, relationships, opportunities, taxation, technology, market conditions and economic expectations. These statements may be identified by such forward-looking terminology as “should,” “expect,” “believe,” “view,” “opportunity,” “allow,” “continues,” “reflects,” “typically,” “usually,” “anticipate,” or similar statements or variations of such terms. Such forward-looking statements involve certain risks and uncertainties and our actual results may differ materially from such forward-looking statements. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements in addition to those risk factors disclosed in Valley’s Annual Report on Form 10-K for the year ended December 31, 2011 include, but are not limited to:

 

   

A severe decline in the general economic conditions of New Jersey and the New York Metropolitan area;

   

declines in value in our investment portfolio, including additional other-than-temporary impairment charges on our investment securities;

   

unanticipated deterioration in our loan portfolio;

   

Valley’s inability to pay dividends at current levels, or at all, because of inadequate future earnings, regulatory restrictions or limitations, and changes in the composition of qualifying regulatory capital and minimum capital requirements (including those resulting from the U.S. implementation of Basel III requirements);

   

higher than expected increases in our allowance for loan losses;

   

higher than expected increases in loan losses or in the level of nonperforming loans;

   

unexpected changes in interest rates;

   

higher than expected tax rates, including increases resulting from changes in tax laws, regulations and case law;

   

an unexpected decline in real estate values within our market areas;

   

charges against earnings related to the change in fair value of our junior subordinated debentures;

   

higher than expected FDIC insurance assessments;

   

the failure of other financial institutions with whom we have trading, clearing, counterparty and other financial relationships;

   

lack of liquidity to fund our various cash obligations;

   

unanticipated reduction in our deposit base;

   

potential acquisitions that may disrupt our business;

   

government intervention in the U.S. financial system and the effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve;

   

legislative and regulatory actions (including the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act and related regulations) subject us to additional regulatory oversight which may result in increased compliance costs and/or require us to change our business model;

   

changes in accounting policies or accounting standards;

 

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our inability to promptly adapt to technological changes;

   

our internal controls and procedures may not be adequate to prevent losses;

   

claims and litigation pertaining to fiduciary responsibility, environmental laws and other matters;

   

the inability to realize expected cost savings and revenue synergies from the merger of State Bancorp with Valley in the amounts or in the timeframe anticipated;

   

inability to retain State Bancorp’s customers and employees;

   

lower than expected cash flows from purchased credit impaired loans; and

   

other unexpected material adverse changes in our operations or earnings.

We assume no obligation for updating such forward-looking statements at any time.

Critical Accounting Policies and Estimates

Valley’s accounting policies are fundamental to understanding management’s discussion and analysis of its financial condition and results of operations. Our significant accounting policies are presented in Note 1 to the consolidated financial statements included in Valley’s Annual Report on Form 10-K for the year ended December 31, 2011. We identified our policies on the allowance for loan losses, security valuations and impairments, goodwill and other intangible assets, and income taxes to be critical because management has to make subjective and/or complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions. Management has reviewed the application of these policies with the Audit Committee of Valley’s Board of Directors. Our critical accounting policies are described in detail in Part II, Item 7 in Valley’s Annual Report on Form 10-K for the year ended December 31, 2011.

New Authoritative Accounting Guidance

See Note 4 to the consolidated financial statements for a description of new authoritative accounting guidance including the respective dates of adoption and effects on results of operations and financial condition.

Executive Summary

Company Overview. At June 30, 2012, Valley had consolidated total assets of $16.0 billion, total net loans of $11.0 billion, total deposits of $11.0 billion and total shareholders’ equity of $1.5 billion. Our commercial bank operations include branch office locations in northern and central New Jersey and the New York City Boroughs of Manhattan, Brooklyn and Queens, as well as Long Island, New York. Of our current 211 branch network, 79 percent and 21 percent of the branches are located in New Jersey and New York, respectively. We have grown both in asset size and locations significantly over the past several years primarily through both bank acquisitions and de novo branch expansion, including our most recent bank transaction discussed below. See Item 1 of Valley’s Annual Report on Form 10-K for the year ended December 31, 2011 for more details regarding our past merger activity.

Acquisition of State Bancorp, Inc. (“State Bancorp”). On January 1, 2012, Valley acquired State Bancorp, the holding company for State Bank of Long Island, a commercial bank with $1.7 billion in assets, $1.1 billion in loans and $1.4 billion in deposits, after purchase accounting adjustments, and 16 branches in Nassau, Suffolk, Queens, and Manhattan. We believe our expansion into this attractive area of the Long Island market has already provided additional lending, retail, and wealth management service opportunities to further strengthen our New York Metropolitan operations and will continue to grow Valley brand recognition in these markets. During February 2012, we integrated State Bancorp’s systems into Valley with minimal disruption to our customer service and operations. Our ability to put this integration quickly behind us and our management team’s clear focus on this new market opportunity should help us effectively compete and benefit from this transaction during the remainder of 2012. Additionally, we diligently look for future opportunities to support our new efforts in the Long Island market both through gradual de novo branch expansion and other potential bank acquisitions.

The shareholders of State Bancorp received a fixed one- for- one exchange ratio for Valley National Bancorp common stock. The total consideration for the acquisition totaled $208.4 million (approximately 17.7 million shares of Valley common stock). The transaction generated approximately $102.0 million in goodwill and $8.1 million in core deposit

 

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intangible assets subject to amortization. As a condition to the closing of the merger, State Bancorp redeemed $36.8 million of its outstanding Fixed Rate Cumulative Series A Preferred Stock from the U.S. Treasury. The stock redemption was funded by a $37.0 million short-term loan from Valley to State Bancorp. The loan, included in Valley’s consolidated financial statements at December 31, 2011, was subsequently eliminated as of the acquisition date and is no longer outstanding. See additional details in Note 3 to the consolidated financial statements.

Quarterly Results. Net income for the second quarter of 2012 was $32.8 million, or $0.17 per diluted common share, compared to $36.9 million, or $0.21 per diluted common share for the second quarter of 2011. The $4.1 million decrease in quarterly net income as compared to the same quarter one year ago was largely due to: (i) a $9.5 million decline in non-interest income mainly caused by a $15.3 million decrease in net gains on securities transactions as we sold $157.2 million more investment securities classified as available for sale during the second quarter of 2011 as compared to the same period in 2012, partially offset by an increase in net trading gains related to mark to market gains on our junior subordinated debentures carried at fair value, higher net gains on sales of loans and the recognition of other income related to certain infrequent FDIC-assisted transaction items (discussed in more detail in the “Other Income” section below), and (ii) a $8.4 million increase in non-interest expense primarily due to increases in salary and employee benefits resulting from the acquisition of State Bancorp, higher medical health insurance expense and stock award compensation, partially offset by (iii) a 10.2 percent decrease in our effective tax rate largely due to an incremental tax provision recorded in the second quarter of 2011 caused by a change in state tax law, and (iv) a $3.0 million increase in net interest income after provision for credit losses attributable to lower funding costs and loan growth (both through acquisition and organic production) partly offset by declining taxable investment security income due to lower rates and average balances. See the “Net Interest Income,” “Other Income,” “Other Expense” and “Loan Portfolio” sections below for more details on the items above impacting our second quarter of 2012 results.

Economic Overview and Indicators. During the second quarter of 2012, the U.S. economy has shown discouraging signs of weakness through many of the common macroeconomic indicators used to assess its health, particularly job growth. Many questions about the recovery remain as economic growth has slowed and is deemed likely to remain slow based on some of the most recent comments from the Federal Reserve. Additionally, fear of the so-called fiscal cliff (i.e., the combination of scheduled tax increases and cuts in federal spending) set for the end of 2012 combined with the economic challenges of the European Union may tip the U.S. economy back into a recession and negatively impact the job market. However, many economists feel that the U.S. recovery will continue at a moderate pace despite these on-going recessionary risks.

The U.S. housing market showed some positive signs during the quarter, but remains choppy due to a weak job market and slower economic growth. The Commerce Department reported in July that housing starts rose 6.9 percent in June 2012 to a seasonally adjusted annual rate of 760,000 units, the highest rate since October 2008. However, permits for new construction, which are considered a gauge of future demand, declined 3.7 percent in June to an annual rate of 755,000 and new home sales declined in June after sales jumped to a two-year high in May. Additionally, the National Association of Realtors recently reported that existing home sales fell 5.4 percent in June 2012 as compared to the prior linked month of May, but that inventory (including distressed properties) continues to shrink and home prices are rising as a result. Despite the declines in June from a strong May, many economists expect housing will add to economic growth this year for the first time since 2005. We are optimistic that the housing trends will remain relatively positive going forward due, in part, to the Fed’s sustained support of the historical low level of mortgage interest rates, but we remain cautious as the percentage of consumers with new foreclosures and bankruptcies in New Jersey and New York also remain at historically high levels as last reported during the second quarter of 2012.

Unemployment, one of the primary economic deterrents to our ability to sustain loan growth and asset quality, has ranged from a low of 8.2 percent in December 2011 to a high of 8.9 percent in March 2012 for the New York City Metropolitan area over the last twelve month period and was 8.8 percent for June 2012. From a national perspective, the latest U.S. unemployment figure of 8.3 percent in July 2012 increased slightly from 8.1 percent reported in April 2012 (which was the lowest level of unemployment reported since early 2009). Monthly job growth figures remained disappointing during the second quarter, and despite higher than expected job growth during July 2012, the Federal Reserve has expressed a view that the unemployment rate may not improve further in 2012. The Fed has maintained support of a target range of zero to 0.25 percent for the federal funds rates in the first half of 2012 and has indicated that the anticipated economic conditions will likely warrant these exceptionally low levels for the federal funds rate through and potentially beyond the end of 2014. We believe a low-rate, high unemployment environment, which is reflective of our current operating environment, will continue to challenge our business operations and results in many ways during the remainder of 2012 and the foreseeable future, as highlighted throughout the remaining MD&A discussion below.

 

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The following economic indicators are just a few of many factors that may be used to assess the market conditions in our primary markets of northern and central New Jersey and the New York City metropolitan area, Long Island, New York. Generally, market conditions have improved from one year ago, however, as outlined above, economic uncertainty, persistent unemployment, as well as high vacancy rates may continue to put pressure on the performance of some borrowers and the level of new loan demand within our area.

 

     For the Month Ended  
Key Economic Indicators:    June 30,
2012
     March 31,
2012
     December 31,
2011
     September 30,
2011
     June 30,
2011
 

Unemployment rate:

              

U.S.

         8.20%                 8.20%                 8.50%                 9.00%                 9.10%       

New York Metro Region*

         8.80%                 8.90%                 8.20%                 8.60%                 8.60%       

New Jersey

         9.60%                 9.00%                 9.10%                 9.40%                 9.40%       

New York

         8.90%                 8.50%                 8.20%                 8.30%                 8.20%       

 

     Three Months Ended  
     June 30,
2012
     March 31,
2012
     December 31,
2011
     September 30,
2011
     June 30,
2011
 
     ($ in millions)  

Personal income:

              

New Jersey

     NA              $     475,702              $     474,531              $     470,405              $     467,296        

New York

     NA              $ 999,909              $ 993,931              $ 985,581              $ 979,226        

New consumer bankruptcies:

              

New Jersey

     NA              0.15%           0.16%           0.15%           0.17%     

New York

     NA              0.08%           0.10%           0.09%           0.12%     

Change in home prices:

              

U.S.

     NA              -2.00%           -3.80%           0.10%           4.00%     

New York Metro Region*

     NA              -1.78%           -3.70%           0.72%           0.01%     

New consumer foreclosures:

              

New Jersey

     NA              0.08%           0.04%           0.07%           0.06%     

New York

     NA              0.06%           0.05%           0.06%           0.06%     

Rental vacancy rates:

              

New Jersey

       10.50%           11.60%           10.80%           9.50%           7.90%     

New York

     5.60%           6.30%           6.30%           7.40%           6.40%     

 

NA - not available

* As reported by the Bureau of Labor Statistics for the NY-NJ-PA Metropolitan Statistical Area.

Sources: Bureau of Labor Statistics, Bureau of Economic Analysis, Federal Reserve Bank of New York, S&P Indices, and the U.S. Census Bureau.

Loans. Overall, our total loan portfolio grew by 9.8 percent on an annualized basis during the second quarter of 2012. Total non-covered loans (i.e., loans which are not subject to our loss-sharing agreements with the FDIC) increased by $300.0 million to $11.2 billion at June 30, 2012 from March 31, 2012. Our residential mortgage and commercial real estate (excluding construction) loans experienced solid organic growth of $213.9 million and $93.5 million, or 33.8 percent and 8.6 percent, respectively, on an annualized basis, during the second quarter of 2012 as compared to March 31, 2012. Total covered loans (i.e., loans subject to our loss-sharing agreements with the FDIC) decreased to $226.5 million, or 2.0 percent of our total loans, at June 30, 2012 as compared to $252.2 million at March 31, 2012 mainly due to normal payment activity.

 

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During the six months ended June 30, 2012, we have originated over $1.0 billion in new and refinanced residential mortgage loans and retained approximately 81 percent of these loans in our portfolio. The mortgage volume has increased approximately 82 percent compared to the same six month period of 2011 and is largely the result of the historically low interest rate environment, the success of our low-fixed price residential mortgage refinance programs and our strong emphasis in the New York Metro area supported by our expanded network of 44 full service branches in the New York boroughs and Long Island after the acquisition of State Bancorp on January 1, 2012. We believe the residential refinance activity should continue at or above the first half of 2012 levels through the remainder of 2012 assuming that market conditions do not adversely change. Mindful of the increased interest rate risk associated with extending the duration of our overall earning assets, we intend to increase the amount of mortgage loan originations for sale into the secondary market during the second half of 2012. We believe this decision should materially increase gains on the sale of loans recognized in our non-interest income during the third quarter of 2012, while allowing us to maintain the appropriate mix of earning assets on our balance sheet. See further details on our loan activities, including the covered loan portfolio, under the “Loan Portfolio” section below.

Asset Quality. Given the slow economic recovery, elevated unemployment levels, higher delinquency rates reported throughout the banking industry, and the declines in property values we believe our loan portfolio’s credit performance remained at an acceptable level at June 30, 2012. Our past due loans and non-accrual loans, discussed further below, exclude purchased credit-impaired (“PCI”) loans. PCI loans include loans that were acquired as part of FDIC-assisted transactions in 2010 (“covered loans”) and all loans acquired in the merger with State Bancorp on January 1, 2012 and loans purchased by Valley in March 2012. Under U.S. GAAP, the PCI loans (acquired at a discount that is due, in part, to credit quality) are accounted for on a pool basis and are not subject to delinquency classification in the same manner as loans originated by Valley.

Total loans (excluding PCI loans) past due in excess of 30 days were $157.8 million, or 1.38 percent of our total loan portfolio of $11.4 billion as of June 30, 2012 compared to $169.9 million, or 1.52 percent of total loans of $11.1 billion at March 31, 2012. The decrease of $12.1 million in delinquent loan balances was mainly due to declines in construction and residential mortgage loans within the 30 to 89 days past due loan category, partially offset by higher commercial real estate loans within the same past due category. Non-accrual loans increased $1.0 million to $126.2 million at June 30, 2012 as compared to $125.2 million at March 31, 2012 mainly due to a new non-accrual commercial real estate loan with a recorded investment totaling $11.8 million, partially offset by the migration of two commercial loans secured by aircraft totaling $9.2 million prior to transfer to other repossessed assets during the second quarter of 2012. Based upon our quarterly review of the portfolio, we do not believe the increase in the past due commercial real estate loans represents a material trend, however, there were two new potential problems loans accounting for approximately $6.5 million of the $11.5 million commercial real estate loans within the 30 to 89 days past due category at June 30, 2012. Commercial real estate loans delinquent 30 days or more totaled $73.3 million, or 1.65 percent of the $4.4 billion in total non-covered commercial real estate loans at June 30, 2012.

Although the timing of collection is uncertain, we believe most of our non-accrual loans are well secured and, ultimately, collectible. Our lending strategy is based on underwriting standards designed to maintain high credit quality and we remain optimistic regarding the overall future performance of our loan portfolio. However, due to the potential for future credit deterioration caused by the unpredictable direction of the economy and high levels of unemployment, management cannot provide assurance that our non-performing assets will not increase from the levels reported as of June 30, 2012. See the “Non-performing Assets” section below for further discussion and analysis of our credit quality.

Deposits and Other Borrowings. Total deposits decreased $85.5 million to approximately $10.9 billion at June 30, 2012 from March 31, 2012 mostly due to lower time deposit balances. Valley’s time deposits totaling $2.6 billion at June 30, 2012 declined $62.5 million as compared to March 31, 2012 largely due to the continued run-off of maturing higher cost certificates of deposit and the low level of interest rates currently offered on such products. During the second quarter of 2012, savings, NOW and money market accounts also declined by $21.7 million due to lower municipal deposit balances, partially offset by growth in our retail deposits which continue to benefit from the migration of some maturing certificate of deposits to these account types. Valley’s non-interest bearing deposits totaling $3.2 billion at June 30, 2012 remained relatively unchanged as compared to March 31, 2012.

Over the last three consecutive quarters, we actively reduced the costs associated with our borrowings. In June 2012, we modified the terms of $100 million in FHLB advances within our long-term borrowings. The modifications resulted

 

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in a reduction of the interest rate on these funds, an extension of their maturity dates to 10 years from the date of modification, and a conversion of the debt to non-callable for period of 4 years. We similarly modified the terms of $150 million and $435 million in FHLB advances and other borrowings during the three months ended March 31, 2012 and December 31, 2011, respectively. After the modifications, the weighted average interest rate on these borrowings declined by 0.82 percent to 3.91 percent. There were no gains, losses, penalties or fees incurred in the modification transactions. Additionally, Valley redeemed $10.3 million of the principal face amount of its outstanding junior subordinated debentures issued to VNB Capital Trust I and $10.0 million of the face value of the related trust preferred securities during January 2012.

Selected Performance Indictors. The following table presents our annualized performance ratios for the periods indicated:

 

     Three Months Ended June 30,      Six Months Ended June 30,  
             2012                      2011                      2012                      2011          

Return on average assets

     0.83%           1.03%           0.86%           1.03%     

Return on average shareholders’ equity

     8.75                11.24              9.05              11.24        

Return on average tangible shareholders’ equity (“ROATE”)

       12.49                15.22                12.95                15.24        

ROATE, which is a non-GAAP measure, is computed by dividing net income by average shareholders’ equity less average goodwill and average other intangible assets, as follows:

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2012      2011      2012      2011  
            ($ in thousands)         

Net income

     $ 32,820              $ 36,894              $ 67,351              $ 73,479        
  

 

 

    

 

 

    

 

 

    

 

 

 

Average shareholders’ equity

         1,499,516                  1,312,501                  1,488,825                  1,307,708        

Less: Average goodwill and other intangible assets

     (448,451)             (342,590)             (448,866)             (343,245)       
  

 

 

    

 

 

    

 

 

    

 

 

 

Average tangible shareholders’ equity

     $ 1,051,065              $ 969,911              $ 1,039,959              $ 964,463        
  

 

 

    

 

 

    

 

 

    

 

 

 

Annualized ROATE

     12.49%           15.22%           12.95%           15.24%     
  

 

 

    

 

 

    

 

 

    

 

 

 

Management believes the ROATE measure provides information useful to management and investors in understanding our underlying operational performance, our business and performance trends and the measure facilitates comparisons with the performance of others in the financial services industry. This non-GAAP financial measure should not be considered in isolation or as a substitute for or superior to financial measures calculated in accordance with U.S. GAAP.

All of the above ratios are, from time to time, impacted by net trading gains and losses, net gains and losses on securities transactions, and net impairment losses on securities recognized in non-interest income. These amounts can vary widely from period to period due to the recognition of non-cash gains or losses on the change in the fair value of our junior subordinated debentures carried at fair value and our trading securities portfolio, the level of sales of our investment securities classified as available for sale, and the results of our quarter impairment analysis of the held to maturity and available for sale investment portfolios. See the “Non-Interest Income” section below for more details.

Net Interest Income

Net interest income on a tax equivalent basis was $123.8 million for the second quarter of 2012, a $5.3 million decrease from the first quarter of 2012 and an increase of $4.9 million from the second quarter of 2011. The linked quarter decrease was mainly caused by a 33 basis point decline in the yield on average loans, partially offset by strong organic

 

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residential and commercial real estate mortgage loan growth, as well as lower costs on most of our interest-bearing liabilities during the second quarter of 2012 as we offered lower rates on most of our deposits and modified the interest rates on $100 million of FHLB advances within our long-term borrowings.

Average interest earning assets were $14.1 billion for the second quarter of 2012 as compared to approximately $12.8 billion for the second quarter of 2011 largely due to $1.1 billion in loans acquired from State Bancorp and the organic growth of our commercial real estate and residential mortgage loans over the last twelve month period. Compared to the first quarter of 2012, average interest earning assets increased $118.2 million mainly due to the residential mortgage and commercial real estate loan growth which largely contributed to a $341.3 million increase in average total loans to $11.3 billion for the three months ended June 30, 2012. However, average taxable investments decreased $206.0 million in the second quarter of 2012 as compared to the first quarter of 2012 mainly due to significant principal payments and prepayments received on residential mortgage-backed securities over the last two quarters and the sale of approximately $49.0 million and $37.7 million of U.S. Treasury and government agency securities in April and June 2012, respectively. Average federal funds sold and other interest bearing deposits decreased $41.8 million from the first quarter of 2012 due to lower excess cash balances maintained at the Federal Reserve Bank of New York for most of the second quarter of 2012 because of strong loan demand.

Average interest bearing liabilities increased $670.7 million to approximately $11.0 billion for the second quarter of 2012 compared with the second quarter of 2011 mainly due to deposits and borrowings assumed from State Bancorp totaling $1.4 billion, partially offset by the maturity of $206 million of higher cost long-term FHLB advances during the first half of 2011, normal run-off of maturing high cost certificate of deposit balances over the past twelve month period, and some attrition of the assumed deposit balances in the first half of 2012. Compared to the first quarter of 2012, average interest bearing liabilities decreased $22.0 million for the second quarter of 2012 mostly due to the time deposit run-off caused by the current low interest rates offered on certificates of deposit, partly offset by an increase in average short-term borrowings. Average short-term borrowings increased $138.5 million as compared to the linked quarter ended March 31, 2012 mainly due to an increase in overnight federal funds purchased and low-cost short-term FHLB borrowings used to fund some of our residential mortgage loan originations during the second quarter of 2012.

Interest income, on a tax equivalent basis decreased $7.2 million for the second quarter of 2012 compared to the first quarter of 2012 primarily due to a $4.6 million decrease in interest income on average loans caused by a 33 basis point decline in yield caused by the historically low interest rate environment, a high volume of refinance and prepayment activity, and a decline in accretion recognized on PCI loans, partially offset by an increase in average loans. Interest income from taxable investments on a tax equivalent basis also decreased $2.7 million or 12.1 percent for the three months ended June 30, 2012 as compared to the first quarter of 2012. The quarter over quarter decrease was driven by lower average taxable investment balances and a 15 basis point decline in yield caused by principal payments and prepayments of higher yielding securities, accelerated premium amortization on certain mortgage-backed securities, and new lower yielding securities purchased during the first and second quarters of 2012.

Interest expense decreased $1.9 million for the second quarter of 2012 as compared to the first quarter of 2012 mostly due to a decline in the cost of savings, NOW, and money market deposits caused by lower rates offered on such products, as well as lower costs of all other interest-bearing liabilities, combined with lower average time deposit balances during the second quarter of 2012.

The net interest margin on a tax equivalent basis was 3.52 percent for the second quarter of 2012, a decrease of 18 basis points from 3.70 percent in the linked first quarter of 2012, and a 19 basis point decline from 3.71 percent for the quarter ended June 30, 2011. The yield on average interest earning assets decreased by 25 basis points on a linked quarter basis mainly as a result of a decline in accretion recognized on PCI loans and lower yields on both average loans and taxable investments caused by the historically low interest rate environment. The accretion recognized on higher yielding covered PCI loans declined from the first quarter of 2012 as these loans continued to experience significant repayments. The volume of refinance or prepayment of higher yielding non-PCI loans remained relatively high for the second quarter of 2012 and also negatively impacted the yield on average loans. The yield on average taxable investments declined quarter over quarter due to several factors, including prepayments of higher yielding securities, accelerated premium amortization on certain mortgage-backed securities, and new securities yielding lower market rates. The cost of average interest bearing liabilities declined 6 basis points from 1.69 percent in the first quarter of 2012 mainly due to a 5 basis point decline in the cost of average savings, NOW and money market deposits caused by

 

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lower rates offered on such products and a $150.8 million decline in average time deposits mainly resulting from the run-off of maturing higher rate certificates of deposit. The cost of long-term borrowings also decreased 5 basis points to 4.18 percent for the second quarter of 2012 from the linked quarter primarily due to the aforementioned interest rate modifications of $250 million in FHLB advances during the second and first quarters of 2012. Our cost of total deposits was 0.51 percent for the second quarter of 2012 compared to 0.57 percent for the three months ended March 31, 2012.

We believe our margin may continue to face compression into the foreseeable future due to the current low level of interest rates on most interest earning asset alternatives and the Federal Reserve’s indications that it will attempt to keep these historically low interest rates through, and potentially beyond, the end of 2014 in an effort to assist the U.S. economic recovery. However, we continue to tightly manage our balance sheet and our cost of funds to optimize our returns.

 

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The following table reflects the components of net interest income for the three months ended June 30, 2012, March 31, 2012 and June 30, 2011:

Quarterly Analysis of Average Assets, Liabilities and Shareholders’ Equity and

Net Interest Income on a Tax Equivalent Basis

 

    Three Months Ended  
    June 30, 2012     March 31, 2012     June 30, 2011  
    Average
Balance
    Interest     Average
Rate
    Average
Balance
    Interest     Average
Rate
    Average
Balance
    Interest     Average
Rate
 
    ($ in thousands)  

Assets

                 

Interest earning assets:

                 

Loans (1)(2)

    $     11,297,942          $     143,837            5.09%            $     10,956,666          $     148,470          5.42%            $ 9,619,959        $     135,085            5.62%       

Taxable investments (3)

    2,263,054          19,788          3.50               2,469,057          22,502          3.65               2,698,706          30,193            4.48          

Tax-exempt investments (1)(3)

    464,681          4,965          4.27               439,927          4,799          4.36               372,002          3,737            4.02          

Federal funds sold and other interest bearing deposits

    52,348          31            0.24               94,127          55          0.23               137,372          88            0.26          
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest earning assets

    14,078,025          168,621            4.79               13,959,777          175,826          5.04               12,828,039          169,103            5.27          
   

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

 

Allowance for loan losses

    (134,805)             (135,449)             (142,019)        

Cash and due from banks

    419,989              467,313              361,281         

Other assets

    1,442,592              1,453,509              1,206,211         

Unrealized (losses) gains on securities available for sale, net

    (14,753)             (32,005)             21,771         
 

 

 

       

 

 

       

 

 

     

Total assets

    $ 15,791,048              $ 15,713,145              $     14,275,283         
 

 

 

       

 

 

       

 

 

     

Liabilities and shareholders’ equity

                 

Interest bearing liabilities:

                 

Savings, NOW and money market deposits

    $ 5,064,315          $ 4,690            0.37%            $ 5,072,431          $ 5,354          0.42%               $ 4,431,929          $ 5,082            0.46%       

Time deposits

    2,661,794          9,276            1.39               2,812,582          10,185          1.45               2,815,223          12,616            1.79          
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest bearing deposits

    7,726,109          13,966            0.72               7,885,013          15,539          0.79               7,247,152          17,698            0.98          

Short-term borrowings

    376,150          369            0.39               237,676          253          0.43               167,864          276            0.66          

Long-term borrowings (4)

    2,916,670          30,452            4.18               2,918,216          30,885          4.23               2,933,165          32,150            4.38          
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest bearing liabilities

    11,018,929          44,787            1.63               11,040,905          46,677          1.69               10,348,181          50,124            1.94          
   

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

 

Non-interest bearing deposits

    3,204,242              3,111,959              2,554,909         

Other liabilities

    68,361              82,148              59,692         

Shareholders’ equity

    1,499,516              1,478,133              1,312,501         
 

 

 

       

 

 

       

 

 

     

Total liabilities and shareholders’ equity

    $ 15,791,048              $ 15,713,145              $ 14,275,283         
 

 

 

       

 

 

       

 

 

     

Net interest income/interest rate spread (5)

      $ 123,834            3.16%              $ 129,149          3.35%              $ 118,979            3.33%       
     

 

 

     

 

 

   

 

 

     

 

 

   

 

 

 

Tax equivalent adjustment

      (1,763)             (1,690)             (1,309)      
   

 

 

       

 

 

       

 

 

   

Net interest income, as reported

      $ 122,071              $ 127,459              $ 117,670       
   

 

 

       

 

 

       

 

 

   

Net interest margin (6)

          3.47%                3.65%                  3.67%       

Tax equivalent effect

          0.05%                0.05%                  0.04%       
     

 

 

       

 

 

       

 

 

 

Net interest margin on a fully tax equivalent basis (6)

          3.52%                3.70%                  3.71%       
     

 

 

       

 

 

       

 

 

 

 

(1) Interest income is presented on a tax equivalent basis using a 35 percent federal tax rate.
(2) Loans are stated net of unearned income and include non-accrual loans.
(3) The yield for securities that are classified as available for sale is based on the average historical amortized cost.
(4) Includes junior subordinated debentures issued to capital trusts which are presented separately on the consolidated statements of financial condition.
(5) Interest rate spread represents the difference between the average yield on interest earning assets and the average cost of interest bearing liabilities and is presented on a fully tax equivalent basis.
(6) Net interest income as a percentage of total average interest earning assets.

 

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The following table reflects the components of net interest income for the six months ended June 30, 2012 and 2011:

Analysis of Average Assets, Liabilities and Shareholders’ Equity and

Net Interest Income on a Tax Equivalent Basis

 

     Six Months Ended  
     June 30, 2012      June 30, 2011  
     Average Balance      Interest      Average
Rate
     Average Balance      Interest      Average
Rate
 
                   ($ in thousands)                

Assets

                 

Interest earning assets:

                 

Loans (1)(2)

     $     11,127,304           $     292,307             5.25%             $ 9,539,527           $     268,710             5.63%       

Taxable investments (3)

     2,366,056           42,290             3.57                2,760,602           61,829             4.48          

Tax-exempt investments (1)(3)

     452,304           9,764             4.32                385,948           7,591             3.93          

Federal funds sold and other interest bearing deposits

     73,238           86             0.23                108,451           143             0.26          
  

 

 

    

 

 

       

 

 

    

 

 

    

Total interest earning assets

     14,018,902           344,447             4.91                12,794,528           338,273             5.29          
  

 

 

    

 

 

       

 

 

    

 

 

    

Allowance for loan losses

     (135,127)                (134,523)          

Cash and due from banks

     443,651                 345,229           

Other assets

     1,448,051                 1,218,498           

Unrealized (losses) gains on securities available for sale, net

     (23,379)                21,206           
  

 

 

          

 

 

       

Total assets

     $ 15,752,098                 $     14,244,938           
  

 

 

          

 

 

       

Liabilities and shareholders’ equity

                 

Interest bearing liabilities:

                 

Savings, NOW and money market deposits

     $ 5,068,373           $ 10,044             0.40%             $ 4,368,097           $ 9,761             0.45%       

Time deposits

     2,737,188           19,461             1.42                2,773,832           24,782             1.79          
  

 

 

    

 

 

       

 

 

    

 

 

    

Total interest bearing deposits

     7,805,561           29,505             0.76                7,141,929           34,543             0.97          

Short-term borrowings

     306,913           622             0.41                204,621           617             0.60          

Long-term borrowings (4)

     2,917,443           61,337             4.20                3,002,966           65,891             4.39          
  

 

 

    

 

 

       

 

 

    

 

 

    

Total interest bearing liabilities

     11,029,917           91,464             1.66                10,349,516           101,051             1.95          
  

 

 

    

 

 

       

 

 

    

 

 

    

Non-interest bearing deposits

     3,158,101                 2,522,000           

Other liabilities

     75,255                 65,714           

Shareholders’ equity

     1,488,825                 1,307,708           
  

 

 

          

 

 

       

Total liabilities and shareholders’ equity

     $ 15,752,098                 $ 14,244,938           
  

 

 

          

 

 

       

Net interest income/interest rate spread (5)

        $ 252,983             3.25%                $ 237,222             3.34%       
        

 

 

          

 

 

 

Tax equivalent adjustment

        (3,453)                (2,660)       
     

 

 

          

 

 

    

Net interest income, as reported

        $ 249,530                 $ 234,562        
     

 

 

          

 

 

    

Net interest margin (6)

             3.56%                     3.67%       

Tax equivalent effect

             0.05%                     0.04%       
        

 

 

          

 

 

 

Net interest margin on a fully tax equivalent basis (6)

             3.61%                     3.71%       
        

 

 

          

 

 

 

 

(1) Interest income is presented on a tax equivalent basis using a 35 percent federal tax rate.
(2) Loans are stated net of unearned income and include non-accrual loans.
(3) The yield for securities that are classified as available for sale is based on the average historical amortized cost.
(4) Includes junior subordinated debentures issued to capital trusts which are presented separately on the consolidated statements of financial condition.
(5) Interest rate spread represents the difference between the average yield on interest earning assets and the average cost of interest bearing liabilities and is presented on a fully tax equivalent basis.
(6) Net interest income as a percentage of total average interest earning assets.

 

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The following table demonstrates the relative impact on net interest income of changes in the volume of interest earning assets and interest bearing liabilities and changes in rates earned and paid by us on such assets and liabilities. Variances resulting from a combination of changes in volume and rates are allocated to the categories in proportion to the absolute dollar amounts of the change in each category.

Change in Net Interest Income on a Tax Equivalent Basis

 

     Three Months Ended
June 30, 2012
Compared with June 30, 2011
     Six Months Ended
June 30, 2012
Compared with June 30, 2011
 
     Change Due to
Volume
     Change Due to
Rate
     Total Change      Change Due to
Volume
     Change Due to
Rate
     Total Change  
     (in thousands)  

Interest Income:

                 

Loans*

     $ 22,130           $ (13,378)          $ 8,752         $ 42,579         $ (18,982)        $ 23,597     

Taxable investments

     (4,422)          (5,983)              (10,405)          (8,097)          (11,442)              (19,539)    

Tax-exempt investments*

     978           250           1,228           1,386           787           2,173     

Federal funds sold and other interest bearing deposits

     (51)          (6)          (57)          (43)          (14)          (57)    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total increase (decrease) in interest income

     18,635           (19,117)          (482)          35,825           (29,651)          6,174     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Interest Expense:

                 

Savings, NOW and money market deposits

     666           (1,058)          (392)          1,461           (1,178)          283     

Time deposits

     (657)          (2,683)          (3,340)          (323)          (4,998)          (5,321)    

Short-term borrowings

     238           (145)          93           247           (242)          5     

Long-term borrowings and junior subordinated debentures

     (180)          (1,518)          (1,698)          (1,845)          (2,709)          (4,554)    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total decrease in interest expense

     67           (5,404)          (5,337)          (460)          (9,127)          (9,587)    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total increase (decrease) in net interest income

     $     18,568           $     (13,713)          $ 4,855           $     36,285         $     (20,524)        $ 15,761     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

* Interest income is presented on a tax equivalent basis using a 35 percent tax rate.

Non-Interest Income

The following table presents the components of non-interest income for the three and six months ended June 30, 2012 and 2011:

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2012      2011      2012      2011  
     (in thousands)  

Trust and investment services

     $ 1,984           $ 1,952           $ 3,758           $ 3,975     

Insurance commissions

     3,283           3,657           8,719           8,080     

Service charges on deposit accounts

     6,086           5,642           12,032           11,292     

Gains on securities transactions, net

     1,204           16,492           1,047           19,171     

Net impairment losses on securities recognized in earnings

     (550)          -           (550)          (825)    

Trading gains (losses), net

           

Trading securities

     (151)          (106)          101           387     

Junior subordinated debentures carried at fair value

     1,760           (942)          520           1,947     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total trading gains (losses), net

     1,609           (1,048)          621           2,334     

Fees from loan servicing

     1,149           1,170           2,308           2,367     

Gains on sales of loans, net

     3,141           1,561           6,307           5,170     

Gains on sales of assets, net

     256           146           288           203     

Bank owned life insurance

     1,632           1,880           3,591           3,586     

Change in FDIC loss-share receivable

     (7,022)          (2,669)          (7,112)          13,566     

Other

     11,258           4,752           15,616           9,403     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total non-interest income

     $     24,030           $     33,535           $     46,625           $     78,322     
  

 

 

    

 

 

    

 

 

    

 

 

 

Net gains on securities transactions decreased $15.3 million and $18.1 million for the three and six months ended June 30, 2012, respectively, as compared with the same periods in 2011 mainly due to lower gains recognized on the sale of $86.7

 

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million in U.S. Treasury and government agency securities sold during the second quarter of 2012 as compared to gains recognized on sale of $253.0 million and $492.0 million in residential mortgage-backed securities, preferred securities, and U.S. Treasury securities classified as available for sale in during the three and six months ended June 30, 2011, respectively.

Net impairment losses on securities increased $550 thousand during the quarter ended June 30, 2012 as compared to the same period in 2011 as no credit impairment losses on securities were recognized during the second quarter of 2011. During the three and six months ended June 30, 2012, we recognized $550 thousand in additional estimated credit losses on one previously impaired pooled trust preferred security. See the “Investment Securities Portfolio” section of this MD&A and Note 6 to the consolidated financial statements for further details on our investment securities impairment analysis.

Net trading gains represent the non-cash mark to market valuation of our junior subordinated debentures (issued by VNB Capital Trust I) carried at fair value and the non-cash mark to market valuations of a small number of single-issuer trust preferred securities held in our trading securities portfolio. Net trading gains increased $2.7 million to $1.6 million for the second quarter of 2012, and decreased $1.7 million to $621 thousand for the six months ended June 30, 2012 as compared to the same periods in 2011, mainly due to the change in the non-cash mark to market adjustments on our junior subordinated debentures carried at fair value.

Net gains on sales of loans also increased $1.6 million and $1.1 million for the three and six months ended June 30, 2012, respectively, primarily due to higher volumes of conforming residential loans originated and sold into the secondary market during 2012 as compared to the same periods in 2011 due, in part, to the continued success of our low-fixed rate refinance program and the historically low level of market interest rates. We expect the positive trend in higher gains to continue as we expand our mortgage operations in Long Island, New York through our acquisition of State Bancorp on January 1, 2012 and as we increase loan sales in an effort to maintain the appropriate level of interest risk on our balance sheet.

The Bank and the FDIC share in the losses on loans and real estate owned as part of the loss-sharing agreements entered into on both of our FDIC-assisted transactions completed in March 2010. The asset arising from the loss-sharing agreements is referred to as the “FDIC loss-share receivable” on our consolidated statements of financial condition. Within the non-interest income category, we may recognize income or expense related to the change in the FDIC loss-share receivable resulting from (i) a change in the estimated credit losses on the pools of covered loans, (ii) income from reimbursable expenses incurred during the period, (iii) accretion of the discount resulting from the present value of the receivable recorded at the acquisition dates, and (iv) prospective recognition of decreases in the receivable attributable to better than originally expected cash flows on certain covered loan pools. During the quarter ended June 30, 2012, we recognized a $7.0 million net reduction in non-interest income attributable of changes in the FDIC loss-share receivable, largely due to a $6.0 million reduction in the FDIC’s portion of estimated losses related to unused lines of credit assumed in FDIC-assisted transactions as compared to $2.7 million reduction for the same quarter in 2011. During the six months ended June 30, 2011, we recognized a $13.6 million increase mainly due to additional impairment of certain covered loan pools. See “FDIC Loss-Share Receivable Related to Covered Loans and Foreclosed Assets” section below in this MD&A and Note 7 to the consolidated financial statements for further details.

Other non-interest income increased $6.5 million and $6.2 million for the three months and six months ended June 30, 2012, respectively, as compared to the same periods in 2011 largely due to the reversal of $7.4 million in purchase accounting valuation liabilities related to expired and unused lines of credit assumed in FDIC-assisted transactions that resulted in corresponding reduction in our FDIC loss-share receivable portion of such estimated losses as of the acquisition.

 

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Non-Interest Expense

The following table presents the components of non-interest expense for the three and six months ended June 30, 2012 and 2011:

 

     Three Months Ended
June 30,
     Six Months Ended
June 30,
 
     2012      2011      2012      2011  
     (in thousands)  

Salary and employee benefits expense

     $ 51,214           $ 44,109           $ 102,240           $ 88,234     

Net occupancy and equipment expense

     16,903           15,467           34,265           32,653     

FDIC insurance assessment

     3,208           3,302           6,827           6,631     

Amortization of other intangible assets

     2,532           1,796           4,490           3,758     

Professional and legal fees

     3,345           3,020           6,969           6,793     

Advertising

     1,841           2,703           3,529           4,185     

Other

     12,467           12,683           27,738           24,655     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total non-interest expense

     $     91,510           $     83,080           $     186,058           $     166,909     
  

 

 

    

 

 

    

 

 

    

 

 

 

Salary and employee benefits expense increased $7.1 million and $14.0 million for the three and six months ended June 30, 2012, respectively as compared to the same periods in 2011 largely due to additional salary and benefit expenses related to employees acquired in the State Bancorp acquisition. Medical health insurance expense also contributed $1.6 million and $3.1 million to the increases from the respective comparable periods of 2011, while incentive compensation expenses related to stock awards increased $673 thousand and $1.4 million, respectively, in the three and six months ended June 30, 2012. Additionally, salary and employee benefits expenses remained relatively flat at $51.0 million as compared to the linked quarter ended March 31, 2012 as cost savings achieved from our consolidation of State Bancorp’s operations during the second quarter of 2012 were more than offset by the increase in medical health insurance expense. Our health care expenses are at times volatile due to our election to self fund a large portion of our insurance plan and these medical expenses are expected to fluctuate based on our plan experience into the foreseeable future.

Net occupancy and equipment expenses increased $1.4 million and $1.6 million for the three and six months ended June 30, 2012, respectively, as compared to the same periods in 2011 mainly due to additional expenses associated with the 16 branches acquired from State Bancorp, partially offset by lower seasonal maintenance expenses during the 2012 periods.

Amortization of other intangible assets increased $736 thousand for the quarter ended June 30, 2012, as compared to the same period in 2011 due to our recognition of net impairment charges totaling $401 thousand on certain loan servicing rights during the second quarter of 2012, as well as additional amortization expense primarily related to core deposits intangibles assumed from State Bancorp. See Note 9 to the consolidated financial statements for additional information regarding our other intangible assets.

Advertising expense decreased $862 thousand and $656 thousand during the three and six months ended June 30, 2012, respectively, as compared to the same periods in 2011 mainly due to a lower volume of promotional activity during the second quarter of 2012. Advertising expense is expected to moderately increase during the third quarter of 2012 from the linked second quarter as we kick off a new promotional campaign targeted for the New York Metro area, including our new Long Island markets.

Other non-interest expense increased $3.1 million to $27.7 million for the six months ended June 30, 2012 as compared to the same period in 2011 mainly due to several general increases caused by the State Bancorp acquisition, including merger expenses totaling $902 thousand related mainly to data processing conversion charges.

The efficiency ratio measures total non-interest expense as a percentage of net interest income plus total non-interest income. Our efficiency ratio was 62.63 percent and 62.82 percent for the three and six months ended June 30, 2012, respectively, compared to 54.95 percent and 53.35 percent for the same periods in 2011. The negative upward movement in our efficiency ratio during 2012 as compared to the same periods of 2011 was largely attributable to declines in net gains on securities transactions and increases in non-interest expense related, in part, to higher medical health insurance expense and merger expenses. We strive to maintain a low efficiency ratio through diligent

 

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management of our operating expenses and balance sheet. We believe this non-GAAP measure provides a meaningful comparison of our operational performance and facilitates investors’ assessments of business performance and trends in comparison to our peers in the banking industry.

Income Taxes

Income tax expense was $14.4 million and $25.2 million for the quarter ended June 30, 2012 and 2011, respectively. The provision for income taxes for the quarter ended June 30, 2012 resulted in an effective tax rate of 30.4 percent compared with 40.6 percent in the quarter ended June 30, 2011. The 10.2 percent decrease in the effective tax rate was largely due to an incremental tax provision caused by a change in state tax law recognized in the second quarter of 2011.

Income tax expense was $29.6 million and $42.3 million for the six months ended June 30, 2012 and 2011, respectively. The effective tax rate decreased by 5.9 percent to 30.6 percent for the six months ended June 30, 2012 as compared to 36.5 percent for the same period of 2011 mainly due to the aforementioned incremental tax provision in 2011 related to a change in state tax law.

U.S. GAAP requires that any change in judgment or change in measurement of a tax position taken in a prior annual period be recognized as a discrete event in the quarter in which it occurs, rather than being recognized as a change in effective tax rate for the current year. Our adherence to these tax guidelines may result in volatile effective income tax rates in future quarterly and annual periods. Factors that could impact management’s judgment include changes in income, tax laws and regulations, and tax planning strategies. For remainder of 2012, we anticipate that our effective tax rate will approximate 32 percent.

Business Segments

We have four business segments that we monitor and report on to manage our business operations. These segments are consumer lending, commercial lending, investment management, and corporate and other adjustments. Our reportable segments have been determined based upon Valley’s internal structure of operations and lines of business. Each business segment is reviewed routinely for its asset growth, contribution to income before income taxes and return on average interest earning assets and impairment (if events or circumstances indicate a possible inability to realize the carrying amount). Expenses related to the branch network, all other components of retail banking, along with the back office departments of our subsidiary bank are allocated from the corporate and other adjustments segment to each of the other three business segments. Interest expense and internal transfer expense (for general corporate expenses) are allocated to each business segment utilizing a “pool funding” methodology, whereas each segment is allocated a uniform funding cost based on each segments’ average earning assets outstanding for the period. The financial reporting for each segment contains allocations and reporting in line with our operations, which may not necessarily be comparable to any other financial institution. The accounting for each segment includes internal accounting policies designed to measure consistent and reasonable financial reporting, and may not necessarily conform to U.S. GAAP. Furthermore, changes in management structure or allocation methodologies and procedures may result in changes in reported segment financial data. Certain prior period amounts have been reclassified to conform to the current presentation.

 

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The following tables present the financial data for the three months ended June 30, 2012 and 2011:

 

     Three Months Ended June 30, 2012  
     Consumer Lending      Commercial Lending      Investment
Management
     Corporate
and Other
Adjustments
     Total  
     ($ in thousands)  

Average interest earning assets

     $     3,975,534              $     7,322,408              $     2,780,083              $ -           $     14,078,025        

Income (loss) before income taxes

     14,708              29,549              6,866                  (3,937)          47,186        

Annualized return on average interest earning assets (before tax)

     1.48%           1.61%           0.99%           N/A           1.34%     

 

     Three Months Ended June 30, 2011  
     Consumer Lending      Commercial Lending      Investment
Management
     Corporate
and Other
Adjustments
     Total  
     ($ in thousands)  

Average interest earning assets

     $     3,383,153              $     6,236,806              $     3,208,080              $ -           $     12,828,039        

Income before income taxes

     12,734              27,675              11,841                  9,849           62,099        

Annualized return on average interest earning assets (before tax)

     1.51%           1.77%           1.48%           N/A           1.94%   

Consumer Lending

The consumer lending segment is mainly comprised of residential mortgage loans, home equity loans and automobile loans. Residential mortgage loans, including $14.8 million of covered loans, totaled approximately $2.8 billion and represented 24.2 percent of our loan portfolio at June 30, 2012. The duration of the residential mortgage loan portfolio is subject to movements in the market level of interest rates and forecasted prepayment speeds. The weighted average life of the automobile loans within the portfolio is relatively unaffected by movements in the market level of interest rates. However, the average life may be impacted by new loans as a result of the availability of credit within the automobile marketplace and consumer demand for purchasing new or used automobiles.

Average assets for the three months ended June 30, 2012 increased $592.4 million from $3.4 billion for the second quarter of 2011. The increase was mainly due to the strong organic growth in our non-covered residential mortgage loans caused by the sustained low level of market interest rates during the first quarter of 2012, our aggressive promotion of our mortgage refinance programs, and our decision to hold for investment many of our new loan originations (approximately 81 percent) rather than sell them into the secondary market based on the current yields available on other investment alternatives and the composition of our balance sheet. Home equity loans also moderately increased from the 2011 period due to PCI loans acquired from State Bancorp. Partially offsetting these increases, automobile loan balances declined as compared to the second quarter of 2011 as, prior to the second quarter of 2012, the loan originations have been unable to outpace principal repayments due to numerous reasons, including the weak economy, high unemployment, and strong competition for quality loan credits.

Income before income taxes increased $2.0 million to $14.7 million for the three months ended June 30, 2012 as compared with the same period in 2011 mainly due to higher net interest income resulting from higher average loan balances, a lower provision for loan losses mainly due to improved performance and outlook for our automobile loan portfolio and an increase in other non-interest income, partially offset by a $2.9 million increase in the internal transfer expense.

The net interest margin decreased 40 basis points to 3.32 percent for the second quarter of 2012 as a result of a 68 basis point decrease in interest yield, partially offset by a 28 basis point decrease in costs associated with our funding sources.

 

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During the second quarter of 2012, our cost of funds continued to be positively impacted by the run-off of maturing high cost certificates of deposit, lower interest rates offered on most of our deposit products, and interest rate modifications to certain long-term borrowings during the fourth quarter of 2011 and the first half of 2012.

Commercial Lending

The commercial lending segment is mainly comprised of floating rate and adjustable rate commercial and industrial loans, as well as fixed rate owner occupied and commercial real estate loans. Due to the portfolio’s interest rate characteristics, commercial lending is Valley’s business segment that is most sensitive to movements in market interest rates. Commercial and industrial loans, including $64.5 million of covered loans, totaled approximately $2.2 billion and represented 19.5 percent of the total loan portfolio at June 30, 2012. Commercial real estate loans and construction loans, including $143.5 million of covered loans, totaled $5.0 billion and represented 43.7 percent of the total loan portfolio at June 30, 2012.

Average assets within commercial lending increased $1.1 billion to $7.3 billion for the three months ended June 30, 2012 as compared to the second quarter of 2011. This increase was primarily attributable to loans acquired in the State Bancorp acquisition and purchased during the first quarter of 2012, as well as organic commercial real estate loan growth.

For the three months ended June 30, 2012, income before income taxes increased $1.9 million to $29.5 million as compared to the same quarter in 2011 mainly due to increases in net interest income and non-interest income, partially offset by higher internal transfer expense and higher provision for loan losses. The net interest income increased $9.2 million as compared with the second quarter of 2011 and was mainly driven by higher average loan balances coupled with lower cost of funds, partially offset by a 44 basis point decline in loan yields. Non-interest income increased $2.4 million compared with the same period a year ago and was mostly attributable to other income resulting from the reversal of a purchase accounting liability for unused lines of credit assumed from State Bancorp which subsequently expired in 2012. The provision for loan losses increased $3.2 million to $7.4 million as compared to $4.2 million for the same quarter in 2011, mainly due to higher net charge-offs and increased specific reserves for impaired loans.

The net interest margin decreased 16 basis points to 4.31 percent for the second quarter of 2012 as compared to the same quarter one year ago mainly as a result of a 44 basis point decrease in yield on average loans, partially offset by the 28 basis point decrease in the costs of our funding sources. The yield on average loans was negatively impacted by a high volume of prepayments of higher yielding loans, and refinanced and new loans originated at lower rates during the second quarter of 2012.

Investment Management

The investment management segment generates a large portion of our income through investments in various types of securities. These securities are mainly comprised of fixed rate investments, trading securities, and depending on our liquid cash position, federal funds sold and interest-bearing deposits with banks (primarily the Federal Reserve Bank of New York), as part of our asset/liability management strategies. The fixed rate investments are one of Valley’s assets that are least sensitive assets to changes in market interest rates. However, a sizeable portion of the investment portfolio is invested in shorter-duration securities to maintain the overall asset sensitivity of our balance sheet (see the “Asset/Liability Management” section below for further analysis). Net gains and losses on the change in fair value of trading securities and net impairment losses on securities are reflected in the corporate and other adjustments segment.

Average investments decreased $428.0 million to $2.8 billion during the second quarter of 2012 as compared to the same quarter in 2011 primarily due to significant principal payments and prepayments received on residential mortgage-backed securities, security sales, and a lower level of excess liquidity available for reinvestment due to funding of strong loan growth. During the second quarter of 2012, we continued to retain a substantial portion of our residential mortgage loan originations, included in our consumer lending segment, to offset the decline in our residential mortgage-backed securities portfolio due to normal payments and prepayments of principal. Currently, the yields on our mortgage loan originations are more attractive than most mortgage-backed security investment alternatives.

 

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Income before income taxes decreased $5.0 million to $6.9 million for the second quarter of 2012 compared to the three months ended June 30, 2011 primarily due to a $5.9 million decrease in net interest income, partially offset by a $1.2 million decrease in the internal transfer expense. The decrease in net interest income was mainly driven by a 70 basis point decline in the yield on investments resulting from the reinvestment of principal and interest received from higher yielding securities into new securities yielding lower market interest rates and accelerated premium amortization on certain mortgage-backed securities, partially offset by lower cost of funds.

The net interest margin decreased 42 basis points to 2.40 for the second quarter of 2012 as compared to the same quarter one year ago mainly as a result of the 70 basis point decrease in the yield on investments, partially offset by lower costs associated with our funding sources.

Corporate and other adjustments

The amounts disclosed as “corporate and other adjustments” represent income and expense items not directly attributable to a specific segment, including net trading and securities gains (losses), and net impairment losses on securities not reported in the investment management segment above, interest expense related to the junior subordinated debentures issued to capital trusts, the change in fair value of Valley’s junior subordinated debentures carried at fair value, interest expense related to certain subordinated notes, as well as income and expense from derivative financial instruments.

The loss before income taxes for the corporate segment was $3.9 million for the three months ended June 30, 2012, a decrease of $13.7 million from $9.8 million income for the same quarter in 2011. The decrease was mainly due to a $13.5 million decrease in non-interest income during the second quarter of 2012. This decrease was mainly attributable to a $15.3 million decrease in net gains on securities transactions, partially offset by a $2.7 million increase in net trading gains during the second quarter of 2012 primarily due to non-cash mark to market losses on our trust preferred debentures carried at fair value.

The following tables present the financial data for the six months ended June 30, 2012 and 2011:

 

     Six Months Ended June 30, 2012  
     Consumer
Lending
     Commercial
Lending
     Investment
Management
     Corporate
and Other
Adjustments
     Total  
     ($ in thousands)  

Average interest earning assets

     $     3,851,981              $     7,275,323              $     2,891,598              $ -           $     14,018,902        

Income (loss) before income taxes

     27,713              66,911              14,034                  (11,663)          96,995        

Annualized return on average interest earning assets (before tax)

     1.44%           1.84%           0.97%           N/A           1.38%     

 

     Six Months Ended June 30, 2011  
     Consumer Lending      Commercial Lending      Investment
Management
     Corporate and
Other
Adjustments
     Total  
     ($ in thousands)  

Average interest earning assets

     $     3,344,247              $     6,195,280              $     3,255,001              $ -           $     12,794,528        

Income (loss) before income taxes

     28,300              53,787              23,201                   10,499           115,787        

Annualized return on average interest earning assets (before tax)

     1.69%           1.74%           1.43%           N/A           1.81%     

 

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Consumer Lending

Average interest earning assets for the six months ended June 30, 2012 increased $507.7 million as compared to the same period in 2011. This increase reflects the aforementioned growth in our residential mortgage portfolio due, in part, to the prolonged low level of market interest rates, partially offset by declines in our automobile and home equity loan portfolios as compared to one year ago.

Income before income taxes was $27.7 million for the six months ended June 30, 2012 and remained relatively unchanged as compared to the same period in 2011. Net interest income increased $2.7 million for the first half of 2012 as compared to the same period in 2011 mainly due the high volume of new mortgage loan originations over the last twelve months. The provision for loan losses was $2.6 million for the six months ended June 30, 2012, representing a decline of $1.2 million as compared to the same period of 2011. The decrease mostly reflected lower levels of loan charge-offs and an improved outlook for the automobile loan portfolio.

The net interest margin decreased 35 basis points to 3.38 percent for the six months ended June 30, 2012 as compared to the same period of 2011 due to a 62 basis point decrease in interest yield, partially offset by a 27 basis point decrease in costs associated with our funding sources.

Commercial Lending

Average interest earning assets for the six months ended June 30, 2012 increased $1.1 billion as compared to the same period in 2011. This increase mainly reflects loans acquired in the State Bancorp acquisition and purchased during the first quarter of 2012, as well as organic growth within the commercial real estate loan portfolio due to solid loan demand from a broad range of borrowers within our primary markets, as well as our continued emphasis on co-op loan lending in the New York Metro area.

For the six months ended June 30, 2012, income before income taxes increased $13.1 million to $66.9 million compared with the same period one year ago. The increase was primarily due to higher net interest income coupled with a decline in the provision for loan losses, partially offset by a decrease in non-interest income and higher internal transfer expense. Net interest income increased $24.2 million during the first half of 2012 to $162.3 million as compared to $138.0 million for the same period in 2011 and was mainly driven by higher average loan balances. The provision for loan losses decreased $15.9 million during the first six months of 2012 as compared to the same period in 2011 due to an $18.1 million decline in the provision for covered loan loans, partially offset by a slightly higher provision for non-covered loans. Non-interest income decreased $13.3 million for the six months ended June 30, 2012 as compared to the same period in 2011 mainly due to other income recognized in 2011 resulting from an increase in our FDIC loss-share receivable related to covered loan pools with additional impairment after the date of acquisition. Internal transfer expense increased $12.0 million to $61.3 million for the six months ended June 30, 2012 as compared to the same period of 2011 primarily due to additional costs associated with our acquisition of State Bancorp and higher allocations due to the increased size of the commercial loan portfolio.

The net interest margin was 4.46 percent for the six months ended June 30, 2012 and remained relatively unchanged from the same period of 2011 as a 26 basis point decrease in the yield on average loans was entirely offset by 27 basis point decrease in the costs of our funding sources.

Investment Management

Average investments decreased $363.4 million during the six months ended June 30, 2012 as compared to the same period one year ago primarily due to normal and accelerated repayments of principal and lower reinvestment due to solid loan growth and lower levels of excess liquidity.

Income before income taxes decreased $9.2 million to $14.0 million for the six months ended June 30, 2012 compared to $23.2 million for the same period of 2011 primarily due to an $11.0 million decrease in net interest income, partly offset by a $1.9 million decrease in the internal transfer expense due to the decline in average investments.

 

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The net interest margin decreased 40 basis points during the first half of 2012 as compared to the same period one year ago as a result of a 67 basis point decrease in yield on investments, partially offset by a 27 basis point decrease in costs associated with our funding sources. The net interest margin for investment management was negatively impacted by the repayment and sales of certain higher yielding securities over the last twelve month period that were mostly replaced with securities yielding lower current market interest rates.

Corporate Segment

The income before income taxes for the corporate segment decreased $22.2 million to a $11.7 million loss for the six months ended June 30, 2012 as compared to a $10.5 million gain for the same period of 2011. Non-interest income decreased $20.0 million for the first six months of 2012 primarily due to an $18.1 million decrease in net gains on securities transactions and a $1.7 million decrease in net trading gains mainly due to non-cash mark to market gains on our trust preferred debentures carried at fair value.

ASSET/LIABILITY MANAGEMENT

Interest Rate Sensitivity

Our success is largely dependent upon our ability to manage interest rate risk. Interest rate risk can be defined as the exposure of our interest rate sensitive assets and liabilities to the movement in interest rates. Our Asset/Liability Management Committee is responsible for managing such risks and establishing policies that monitor and coordinate our sources and uses of funds. Asset/Liability management is a continuous process due to the constant change in interest rate risk factors. In assessing the appropriate interest rate risk levels for us, management weighs the potential benefit of each risk management activity within the desired parameters of liquidity, capital levels and management’s tolerance for exposure to income fluctuations. Many of the actions undertaken by management utilize fair value analysis and attempts to achieve consistent accounting and economic benefits for financial assets and their related funding sources. We have predominately focused on managing our interest rate risk by attempting to match the inherent risk and cash flows of financial assets and liabilities. Specifically, management employs multiple risk management activities such as the level of lower yielding new residential mortgage originations retained in our mortgage portfolio through sales in the secondary market, change in product pricing levels, change in desired maturity levels for new originations, change in balance sheet composition levels as well as several other risk management activities.

We use a simulation model to analyze net interest income sensitivity to movements in interest rates. The simulation model projects net interest income based on various interest rate scenarios over a twelve and twenty-four month period. The model is based on the actual maturity and re-pricing characteristics of rate sensitive assets and liabilities. The model incorporates certain assumptions which management believes to be reasonable regarding the impact of changing interest rates and the prepayment assumptions of certain assets and liabilities as of June 30, 2012. The model assumes changes in interest rates without any proactive change in the composition or size of the balance sheet by management. In the model, the forecasted shape of the yield curve remains static as of June 30, 2012. The impact of interest rate derivatives, such as interest rate swaps and caps, is also included in the model.

Our simulation model is based on market interest rates and prepayment speeds prevalent in the market as of June 30, 2012. Although the size of Valley’s balance sheet is forecasted to remain static as of June 30, 2012 in our model, the composition is adjusted to reflect new interest earning assets and funding originations coupled with rate spreads utilizing our actual originations during the second quarter of 2012. The model utilizes an immediate parallel shift in the market interest rates at June 30, 2012.

 

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The following table reflects management’s expectations of the change in our net interest income over the next twelve months period in light of the aforementioned assumptions:

 

     Estimated Change in
Future Net Interest Income
 

Changes in Interest Rates

   Dollar
    Change    
         Percentage    
Change
 
(in basis points)    ($ in thousands)  

+200

     $ 2,506            0.51%       

+100

         (1,005)           (0.20)         

-100

     (336)           (0.07)         

The assumptions used in the net interest income simulation are inherently uncertain. Actual results may differ significantly from those presented in the table above, due to the frequency and timing of changes in interest rates, and changes in spreads between maturity and re-pricing categories. Overall, our net interest income is affected by changes in interest rates and cash flows from our loan and investment portfolios. We actively manage these cash flows in conjunction with our liability mix, duration and interest rates to optimize the net interest income, while structuring the balance sheet in response to actual or potential changes in interest rates. Additionally, our net interest income is impacted by the level of competition within our marketplace. Competition can negatively impact the level of interest rates attainable on loans and increase the cost of deposits, which may result in downward pressure on our net interest margin in future periods. Other factors, including, but not limited to, the slope of the yield curve and projected cash flows will impact our net interest income results and may increase or decrease the level of asset sensitivity of our balance sheet.

Convexity is a measure of how the duration of a financial instrument changes as market interest rates change. Potential movements in the convexity of bonds held in our investment portfolio, as well as the duration of the loan portfolio may have a positive or negative impact on our net interest income in varying interest rate environments. As a result, the increase or decrease in forecasted net interest income may not have a linear relationship to the results reflected in the table above. Management cannot provide any assurance about the actual effect of changes in interest rates on our net interest income.

As noted in the table above, we are more susceptible to an increase in interest rates under a scenario with an immediate parallel change in the level of market interest rates than a decrease in interest rates under the same assumptions. A 100 basis point immediate increase in interest rates is projected to moderately decrease net interest income over the next twelve months by 0.20 percent. Our balance sheet sensitivity to such a move in interest rates is partly due to the fact that many of our adjustable rate loans are tied to the Valley prime rate (set by management), which currently exceeds the U.S. prime rate by 125 basis points. Due to its current level above the U.S. prime rate, the Valley prime rate is not projected to increase under the 100 basis points immediate increase scenario in our simulation. Other factors, including, but not limited to, the slope of the yield curve and projected cash flows will impact our net interest income results and may increase or decrease the level of asset sensitivity of our balance sheet.

Although we do not expect our Valley prime rate loan portfolio to have an immediate benefit to our interest income in a rising interest rate environment, we have positioned a large portion of our investment portfolio in short-duration securities and residential mortgage-backed securities that will allow us to benefit from a potential rise in interest rates. In addition to these asset balances repricing, we expect interest income on many of our residential mortgage-backed securities with unamortized purchase premiums to improve if interest rates were to move upward and prepayment speeds on the underlying mortgages decline. The decline in prepayments will lengthen the expected life of each security and reduce the amount of premium amortization expense recognized against interest income each period. However, many of the residential mortgage-backed securities have rapidly paid down in the current low interest rate environment, and the resulting acceleration of the securities’ premium amortization has negatively impacted our interest income during the six months ended June 30, 2012 and may continue to do so if the market interest rates remain relatively low.

 

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Our interest rate caps and swaps designated as cash flow hedging relationships are designed to protect us from upward movements in interest rates on certain deposits and short-term borrowings based on the prime and effective federal funds rates. We have cash flow hedge interest rate caps with a $300 million notional value, which protect us from upward increases in interest rates on certain deposits and short-term borrowings. During the third quarter of 2011, two of the cash flow hedge interest rate swaps with a notional amount of $200 million began to pay fixed and receive floating rates. The other two swaps totaling $100 million will begin to pay fixed and receive floating rates in July 2012. The floating rate leg of the transaction is indexed to the U.S. prime rate as reported by The Wall Street Journal. Additionally, we utilize interest rate swaps at times to effectively convert fixed rate loans and deposits to floating rate instruments. Most of these actions are expected to benefit our net interest income in a rising interest rate environment. However, due to the current low and expected future levels of market interest rates and the strike rate of these instruments, the cash flow hedge interest rate caps and swaps are expected to have a moderately negative impact on our net interest income over the next twelve-month period. See Note 13 to the consolidated financial statements for further details on our derivative transactions.

Liquidity

Bank Liquidity

Liquidity measures the ability to satisfy current and future cash flow needs as they become due. A bank’s liquidity reflects its ability to meet loan demand, to accommodate possible outflows in deposits and to take advantage of interest rate opportunities in the marketplace. Liquidity management is monitored by our Asset/Liability Management Committee and the Investment Committee of the Board of Directors of Valley National Bank, which review historical funding requirements, current liquidity position, sources and stability of funding, marketability of assets, options for attracting additional funds, and anticipated future funding needs, including the level of unfunded commitments. Our goal is to maintain sufficient asset-based liquidity to cover potential funding requirements in order to minimize our dependence on volatile and potentially unstable funding markets.

The Bank has no required regulatory liquidity ratios to maintain; however, it adheres to an internal liquidity policy. The current policy maintains that we may not have a ratio of loans to deposits in excess of 120 percent and non-core funding (which generally includes certificates of deposit $100 thousand and over, federal funds purchased, repurchase agreements and FHLB advances) greater than 50 percent of total assets. The Bank was in compliance with the foregoing policies at June 30, 2012.

On the asset side of the balance sheet, the Bank has numerous sources of liquid funds in the form of cash and due from banks, interest bearing deposits with banks (including the Federal Reserve Bank of New York), investment securities held to maturity that are maturing within 90 days or would otherwise qualify as maturities if sold (i.e., 85 percent of original cost basis has been repaid), investment securities available for sale, trading securities, loans held for sale, and, from time to time, federal funds sold and receivables related to unsettled securities transactions. These liquid assets totaled approximately $1.3 billion, representing 9.2 percent of earning assets, at June 30, 2012 and $1.2 billion, representing 9.8 percent of earning assets, at December 31, 2011. Of the $1.3 billion of liquid assets at June 30, 2012, approximately $378 million of various investment securities were pledged to counterparties to support our earning asset funding strategies. We anticipate the receipt of approximately $613 million in principal from securities in the total investment portfolio over the next twelve months due to normally scheduled principal repayments and expected prepayments of certain securities, primarily residential mortgage-backed securities.

Additional liquidity is derived from scheduled loan payments of principal and interest, as well as prepayments received. Loan principal payments (including loans held for sale at June 30, 2012) are projected to be approximately $4.1 billion over the next twelve months. As a contingency plan for significant funding needs, liquidity could also be derived from the sale of conforming residential mortgages from our loan portfolio, or from the temporary curtailment of lending activities.

On the liability side of the balance sheet, we utilize multiple sources of funds to meet liquidity needs. Our core deposit base, which generally excludes certificates of deposit over $100 thousand as well as brokered certificates of deposit, represents the largest of these sources. Core deposits averaged approximately $9.7 billion and $8.6 billion for the second

 

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quarter of 2012 and for the year ended December 31, 2011, respectively, representing 68.8 percent and 67.0 percent of average earning assets for the same periods of 2012 and 2011, respectively. The level of interest bearing deposits is affected by interest rates offered, which is often influenced by our need for funds and the need to match the maturities of assets and liabilities.

Additional funding may be provided from short-term liquidity borrowings through deposit gathering networks and in the form of federal funds purchased obtained through our well established relationships with several correspondent banks. While there are no firm lending commitments currently in place, management believes that we could borrow approximately $970 million for a short time from these banks on a collective basis. The Bank is also a member of the Federal Home Loan Bank of New York and has the ability to borrow from them in the form of FHLB advances secured by pledges of certain eligible collateral, including but not limited to U.S. government and agency mortgage-backed securities and a blanket assignment of qualifying first lien mortgage loans, consisting of both residential mortgage and commercial real estate loans. Furthermore, we are able to obtain overnight borrowings from the Federal Reserve Bank via the discount window as a contingency for additional liquidity. At June 30, 2012, our borrowing capacity under the Fed’s discount window was approximately $1.1 billion.

We also have access to other short-term and long-term borrowing sources to support our asset base, such as securities sold under agreements to repurchase (“repos”). Our short-term borrowings increased $310.3 million to $523.1 million at June 30, 2012 as compared to $212.8 million at December 31, 2011 due to overnight federal funds purchased and FHLB advances totaling $225.0 million and $150.0 million, respectively, partially offset by a decrease in short-term customer repo balances. At June 30, 2012, all short-term repos represent customer deposit balances being swept into this vehicle overnight.

Corporation Liquidity

Valley’s recurring cash requirements primarily consist of dividends to common shareholders and interest expense on junior subordinated debentures issued to capital trusts. These cash needs are routinely satisfied by dividends collected from the Bank, along with cash flows from investment securities held at the holding company. Projected cash flows from these sources are expected to be adequate to pay common dividends, if declared, and interest expense payable to capital trusts, given the current capital levels and current profitable operations of the bank subsidiary. In addition to dividends received from the Bank, Valley can satisfy its cash requirements by utilizing its own funds, cash and sale of investments, as well as potential borrowed funds from outside sources. In the event Valley would exercise the right to defer payments on the junior subordinated debentures, and therefore distributions on its trust preferred securities, Valley would be unable to pay dividends on its common stock until the deferred payments are made.

As part of our on-going asset/liability management strategies, Valley could use cash to repurchase shares of its outstanding common stock under its share repurchase program or redeem its callable junior subordinated debentures issued to VNB Capital Trust I, State Bancorp Capital Trust I, and State Bancorp Capital Trust II using Valley’s own funds and/or dividends received from the Bank, as well as new borrowed funds or capital issuances.

Investment Securities Portfolio

As of June 30, 2012, we had approximately $1.8 billion, $688.8 million, and $22.0 million in held to maturity, available for sale and trading securities, respectively. At June 30, 2012, our investment portfolio was comprised of U.S Treasury securities, U.S. government agencies, tax-exempt issues of states and political subdivisions, residential mortgage-backed securities (including 16 private label mortgage-backed securities), single-issuer trust preferred securities principally issued by bank holding companies (including 3 pooled securities), corporate bonds (most of which were purchased prior to the financial crisis in 2008 and 2009) primarily issued by banks, and perpetual preferred and common equity securities issued by banks. There were no securities in the name of any one issuer exceeding 10 percent of shareholders’ equity, except for residential mortgage-backed securities issued by Ginnie Mae.

Among other securities, our investments in the private label mortgage-backed securities, trust preferred securities, perpetual preferred securities, equity securities, and corporate bonds may pose a higher risk of future impairment charges to us as a result of the persistently weak economic conditions and its potential negative effect on the future performance of the security issuers and, if applicable, the underlying mortgage loan collateral of the security.

 

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Other-Than-Temporary Impairment Analysis

We may be required to record impairment charges on our investment securities if they suffer a decline in value that is considered other-than-temporary. Numerous factors, including lack of liquidity for re-sales of certain investment securities, absence of reliable pricing information for investment securities, adverse changes in business climate, adverse actions by regulators, or unanticipated changes in the competitive environment could have a negative effect on our investment portfolio and may result in other-than temporary impairment on our investment securities in future periods.

Other-than-temporary impairment means we believe the security’s impairment is due to factors that could include its inability to pay interest or dividends, its potential for default, and/or other factors. As a result of the current authoritative accounting guidance, when a held to maturity or available for sale debt security is assessed for other-than-temporary impairment, we have to first consider (i) whether we intend to sell the security, and (ii) whether it is more likely than not that we will be required to sell the security prior to recovery of its amortized cost basis. If one of these circumstances applies to a security, an other-than-temporary impairment loss is recognized in the statement of income equal to the full amount of the decline in fair value below amortized cost. If neither of these circumstances applies to a security, but we do not expect to recover the entire amortized cost basis, an other-than-temporary impairment loss has occurred that must be separated into two categories: (i) the amount related to credit loss, and (ii) the amount related to other factors. In assessing the level of other-than-temporary impairment attributable to credit loss, we compare the present value of cash flows expected to be collected with the amortized cost basis of the security. As discussed above, the portion of the total other-than-temporary impairment related to credit loss is recognized in earnings, while the amount related to other factors is recognized in other comprehensive income or loss. The total other-than-temporary impairment loss is presented in the statement of income, less the portion recognized in other comprehensive income or loss. The amount of an additional other-than-temporary impairment related to credit losses recognized during the period may be recorded as a reclassification adjustment from the accumulated other comprehensive loss. When a debt security becomes other-than-temporarily impaired, its amortized cost basis is reduced to reflect the portion of the total impairment related to credit loss. To determine whether a security’s impairment is other-than-temporary, Valley considers several factors that include, but are not limited to the following:

 

   

The severity and duration of the decline, including the causes of the decline in fair value, such as credit problems, interest rate fluctuations, or market volatility;

   

Adverse conditions specifically related to the security, an industry, or geographic area;

   

Failure of the issuer of the security to make scheduled interest or principal payments;

   

Any changes to the rating of the security by a rating agency or, if applicable, any regulatory actions impacting the security issuer;

   

Recoveries or additional declines in fair value after the balance sheet date;

   

Our ability and intent to hold equity security investments until they recover in value, as well as the likelihood of such a recovery in the near term; and

   

Our intent to sell debt security investments, or if it is more likely than not that we will be required to sell such securities before recovery of their individual amortized cost basis.

For debt securities, the primary consideration in determining whether impairment is other-than-temporary is whether or not we expect to collect all contractual cash flows. See “Other-Than-Temporary Impairment Analysis” section of Note 6 to the consolidated financial statements for additional information regarding our quarterly impairment analysis by security type.

The investment grades in the table below reflect the most current independent analysis performed by third parties of each security as of the date presented and not necessarily the investment grades at the date of our purchase of the securities. For many securities, the rating agencies may not have performed an independent analysis of the tranches owned by us, but rather an analysis of the entire investment pool. For this and other reasons, we believe the assigned investment grades may not accurately reflect the actual credit quality of each security and should not be viewed in isolation as a measure of the quality of our investment portfolio.

 

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The following table presents the held to maturity and available for sale investment securities portfolios by investment grades at June 30, 2012.

 

     June 30, 2012  
     Amortized Cost      Gross
Unrealized
Gains
     Gross
Unrealized
Losses
     Fair Value  
            (in thousands)         

Held to maturity

           

Investment grades:*

           

AAA Rated

     $   1,213,875           $   57,698           $ (78)          $   1,271,495     

AA Rated

     199,538           11,168           (235)          210,471     

A Rated

     31,343           951           (151)          32,143     

BBB Rated

     172,582           8,134           (2,678)          178,038     

Non-investment grade

     10,491           -           (4,902)          5,589     

Not rated

     177,549           827           (15,390)          162,986     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investment securities held to maturity

     $ 1,805,378           $ 78,778           $   (23,434)          $   1,860,722     
  

 

 

    

 

 

    

 

 

    

 

 

 

Available for sale

           

Investment grades:*

           

AAA Rated

     $ 420,872           $ 12,935           $ (177)          $ 433,630     

AA Rated

     3,229           176           -           3,405     

A Rated

     44,045           2,106           (7,973)          38,178     

BBB Rated

     74,712           2,182           (6,320)          70,574     

Non-investment grade

     76,984           1,800           (3,487)          75,297     

Not rated

     71,760           1,681           (5,737)          67,704     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investment securities available for sale

     $ 691,602           $ 20,880           $ (23,694)          $ 688,788     
  

 

 

    

 

 

    

 

 

    

 

 

 

 

* Rated using external rating agencies (primarily S&P and Moody's). Ratings categories include the entire range. For example, "A rated" includes A+, A, and A-. Split rated securities with two ratings are categorized at the higher of the rating levels.

The held to maturity portfolio includes investments with non-investment grade ratings with amortized costs and unrealized losses totaling $10.5 million and $4.9 million, respectively, at June 30, 2012. The unrealized losses for this category primarily relate to one single-issuer trust preferred security. The held to maturity portfolio also includes $177.5 million in investments not rated by the rating agencies with aggregate unrealized losses of $15.4 million at June 30, 2012. The unrealized losses for this category almost entirely relate to 5 single-issuer bank trust preferred issuances with a combined amortized cost of $45.9 million. All single-issuer bank trust preferred and corporate debt securities classified as held to maturity, including the aforementioned five securities, are paying in accordance with their terms, have no deferrals of interest or defaults. Additionally, we analyze the performance of each issuer on a quarterly basis, including a review of performance data from the issuer’s most recent bank regulatory report to assess the company’s credit risk and the probability of impairment of the contractual cash flows of the applicable security. Based upon our quarterly review at June 30, 2012, all of the issuers appear to meet the regulatory capital minimum requirements to be considered a “well-capitalized” financial institution and/or have maintained performance levels adequate to support the contractual cash flows of the security.

The available for sale portfolio includes investments with non-investment grade ratings with amortized costs and fair values totaling $77.0 million and $75.3 million, respectively, at June 30, 2012. The $3.5 million in unrealized losses for this category are largely related to 3 private label mortgage-backed securities (including one security with additional estimated credit impairment during the second quarter of 2012) and 2 pooled trust preferred securities found to be other-than-temporarily impaired prior to 2012. The available for sale portfolio also includes investments not rated by the rating agencies with aggregate fair values and unrealized losses of $71.8 million and $5.7 million, respectively, at June 30, 2012. The unrealized losses for this category are largely attributable to trust preferred securities issued by one bank holding company that were other-than-temporarily impaired at December 31, 2011. See further details regarding the impaired securities in the “Other-than-temporarily impaired securities” section below.

 

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Other-Than-Temporarily Impaired Securities

Other-than-temporary impairment is a non-cash charge and not necessarily an indicator of a permanent decline in value. Security valuations require significant estimates, judgments and assumptions by management and are considered a critical accounting policy of Valley.

During the three months ended June 30, 2012, we recorded additional estimated credit impairment charges in earnings totaling $550 thousand on one of the six impaired private label mortgage-backed securities. For the six months ended June 30, 2011, Valley recognized net impairment losses on securities in earnings totaling $825 thousand due to additional estimated credit losses on one of the two previously impaired pooled trust preferred securities. See Note 6 to the consolidated financial statements for further details.

Loan Portfolio

Purchased Credit-Impaired (“PCI”) loans, which include loans acquired in FDIC-assisted transactions (“covered loans”) subject to loss-sharing agreements, are loans acquired at a discount that is due, in part, to credit quality. At June 30, 2012, our non-covered loan portfolio includes approximately $1.1 billion of PCI loans acquired from State Bancorp and purchased from another financial institution during the first quarter of 2012. See further details regarding these transactions and the non-covered PCI loans at Notes 3 and 7 to the consolidated financial statements and our MD&A discussion below.

The following table reflects the composition of the loan portfolio as of the dates presented:

 

     June 30,
2012
     March 31,
2012
     December 31,
2011
     September 30, 2011      June 30,
2011
 
     ($ in thousands)  

Non-covered loans

              

Commercial and industrial

     $ 2,165,656            $ 2,170,378            $ 1,878,387            $ 1,833,211            $ 1,825,782      

Commercial real estate:

              

Commercial real estate

     4,441,026            4,347,542            3,574,089            3,524,891            3,486,597      

Construction

     411,639            430,906            411,003            401,166            413,951      
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial real estate

     4,852,665            4,778,448            3,985,092            3,926,057            3,900,548      
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Residential mortgage

     2,745,101            2,531,166            2,285,590            2,172,601            2,147,362      

Consumer:

              

Home equity

     499,749            507,560            469,604            477,517            484,812      

Automobile

     778,181            764,082            772,490            785,443            807,489      

Other consumer

     155,963            145,703            136,634            122,862            116,606      
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total consumer loans

     1,433,893            1,417,345            1,378,728            1,385,822            1,408,907      
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total non-covered loans

     11,197,315            10,897,337            9,527,797            9,317,691            9,282,599      
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Covered loans (1)

     226,537            252,185            271,844            282,396            308,424      
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans (2)

     $     11,423,852            $     11,149,522           $     9,799,641            $     9,600,087            $     9,591,023      
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

As a percent of total loans:

              

Commercial and industrial

     18.9%          19.4%          19.2%          19.2%          19.0%    

Commercial real estate

     42.5             42.9             40.6             40.9             40.7       

Residential mortgage

     24.0             22.7             23.3             22.6             22.4       

Consumer loans

     12.6             12.7             14.1             14.4             14.7       

Covered loans

     2.0             2.3             2.8             2.9             3.2       
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     100.0%          100.0%          100.0%          100.0%          100.0%    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Covered loans primarily consist of commercial real estate loans and commercial and industrial loans.
(2) Total loans are net of unearned discount and deferred loan fees totaling $1.2 million, $4.4 million, $7.5 million, $7.9 million, and $7.7 million at June 30, 2012, March 31, 2012, December 31, 2011, September 30, 2011, and June 30, 2011, respectively.

 

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Non-covered Loans

Non-covered loans (loans not subject to loss-sharing agreements with the FDIC) increased approximately $300.0 million to $11.2 billion at June 30, 2012 from March 31, 2012 and $1.7 billion from December 31, 2011. The quarter over quarter increase was mainly attributable to organic loan growth in residential mortgage loans and commercial real estate portfolios (excluding construction loans), partially offset by decreases in several other loan categories during the second quarter of 2012. The $1.7 billion increase from December 31, 2011 was largely the result of PCI loans acquired from State Bancorp on January 1, 2012 and the organic loan growth experienced in the residential mortgage and commercial real estate loan portfolios during the first half of 2012.

Commercial and industrial loans remained relatively unchanged from March 31, 2012 due to soft loan demand coupled with strong competition for quality credits. Although we are encouraged by new lending opportunities, partly caused by our expansion into the Long Island, New York marketplace during 2012, we believe these difficult lending conditions may continue to challenge our ability to achieve significant loan growth in this category during the remainder of 2012 as economic uncertainty has tempered loan demand.

Commercial real estate loans (excluding construction loans) increased $93.5 million, or 8.6 percent on an annualized basis, from March 31, 2012. The continued quarter over quarter growth in this loan category is largely a product of our strong business emphasis on co-op loan lending in the New York Metro area and increased new loan demand across a broad range of borrowers in our primary markets, as well as a increase loan activity generated from our acquisition of State Bancorp in the first quarter of 2012. However, construction loans decreased $19.3 million from March 31, 2012 due to continued paydowns, as loan demand has remained tepid due to the current state of the U.S. economy and slow growth in new homes sales.

Residential mortgage loans increased $213.9 million from March 31, 2012 primarily due to solid organic growth seen from the continued success of our low fixed-price refinance programs and the current low level of market interest rates. During the second quarter of 2012, we internally originated over $478 million in new and refinanced residential mortgage loans. We continued to retain a majority of our residential mortgage loan originations (81 percent during the second quarter of 2012 as compared to 79 percent in the first quarter of 2012) and hold them for investment purposes rather than sell the loans in the secondary market. Our decision to retain certain mortgage originations is based on credit criteria and loan to value levels, the composition of our interest earning assets and interest bearing liabilities and our ability to manage the interest rate risk associated with certain levels of these instruments. During the third quarter of 2012, we intend to sell a much higher percentage of our new and refinanced residential mortgage loan origination in an effort to increase gains within our non-interest income while maintaining an acceptable level of interest rate risk on our balance sheet.

Total consumer loans increased $16.5 million from March 31, 2012 mainly due to an increase in automobile loans, partially offset by a decrease in home equity loans. Automobile loans increased $14.1 million from March 31, 2012 mainly due to a stronger consumer demand, expanded dealer relationships, and some improvement in market rate pricing that has allowed us to more efficiently compete for quality credits. Home equity loans decreased by $7.8 million from March 31, 2012, as loan origination volumes continued to be outpaced by normal loan payments and prepayments during the second quarter of 2012 due to, among other factors, many borrowers electing to rollover loan balances into refinanced first residential mortgages, high unemployment levels, as well as our strict underwriting standards.

Purchased Credit-Impaired Loans (Including Covered Loans)

PCI loans are comprised of the aforementioned loans acquired and purchased in the first quarter of 2012 and covered loans for which the Bank will share losses with the FDIC which totaled $1.1 billion and $226.5 million, respectively, at June 30, 2012. Our covered loans, consisting primarily of commercial real estate loans and commercial and industrial loans, were acquired from LibertyPointe Bank and The Park Avenue Bank as a part of two FDIC-assisted transactions during the first quarter of 2010. As required by U.S. GAAP, all of our PCI loans are accounted under ASC Subtopic 310-30. This accounting guidance requires the PCI loans to be aggregated and accounted for as pools of loans based on common risk characteristics. A pool is accounted for as one asset with a single composite interest rate, an aggregate fair value and expected cash flows.

 

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For PCI loan pools accounted for under ASC Subtopic 310-30, the difference between the contractually required payments due and the cash flows expected to be collected, considering the impact of prepayments, is referred to as the non-accretable difference. The contractually required payments due represent the total undiscounted amount of all uncollected principal and interest payments. Contractually required payments due may increase or decrease for a variety of reasons, e.g. when the contractual terms of the loan agreement are modified, when interest rates on variable rate loans change, or when principal and/or interest payments are received. The Bank estimates the undiscounted cash flows expected to be collected by incorporating several key assumptions including probability of default, loss given default, and the amount of actual prepayments after the acquisition dates. The non-accretable difference, which is neither accreted into income nor recorded on our consolidated balance sheet, reflects estimated future credit losses and uncollectable contractual interest expected to be incurred over the life of the loans. The excess of the undiscounted cash flows expected at the acquisition date over the carrying amount (fair value) of the PCI loans is referred to as the accretable yield. This amount is accreted into interest income over the remaining life of the loans, or pool of loans, using the level yield method. The accretable yield is affected by changes in interest rate indices for variable rate loans, changes in prepayment assumptions, and changes in expected principal and interest payments over the estimated lives of the loans. Prepayments affect the estimated life of PCI loans and could change the amount of interest income, and possibly principal, expected to be collected. Reclassifications of the non-accretable difference to the accretable yield may occur subsequent to the loan acquisition dates due to increases in expected cash flows of the loan pools.

At both acquisition and subsequent quarterly reporting dates Valley uses a third party service provider to assist with determining the contractual and estimated cash flows. Valley provides the third party with updated loan-level information derived from Valley’s main operating system, contractually required loan payments and expected cash flows for each loan pool individually reviewed by Valley. Using this information, the third party provider determines both the contractual cash flows and cash flows expected to be collected. The loan-level information used to reforecast the cash flows is subsequently aggregated on a pool basis. The expected payment data, discount rates, impairment data and changes to the accretable yield received back from the third party are reviewed by Valley to determine whether this information is accurate and the resulting financial statement effects are reasonable.

Similar to contractual cash flows, we reevaluate expected cash flows on a quarterly basis. Unlike contractual cash flows which are determined based on known factors, significant management assumptions are necessary in forecasting the estimated cash flows. We attempt to ensure the forecasted expectations are reasonable based on the information currently available; however, due to the uncertainties inherent in the use of estimates, actual cash flow results may differ from our forecast and the differences may be significant. To mitigate such differences, we carefully prepare and review the assumptions utilized in forecasting estimated cash flows.

At the time of acquisition, the estimated cash flows on our PCI loans were derived based on observable market information, as well as Valley’s own specific assumptions regarding each loan. Valley performed credit due diligence on the majority of the loans acquired in 2012 and the FDIC-assisted transactions. In addition, Valley engaged a third party to perform credit valuations and expected cash flow forecasts on the acquired loans. The initial expected cash flows for loans accounted for under ASC Subtopic 310-30 were prepared on a loan-level basis utilizing the assumptions developed by Valley in conjunction with the third party. In accordance with ASC Subtopic 310-30, the individual loan-level cash flow assumptions were then aggregated on the basis of pools of loans with similar risk characteristics. Thereafter, on a quarterly basis, Valley analyzes the actual cash flow versus the forecasts at the loan pool level and variances are reviewed to determine their cause. In re-forecasting future estimated cash flow, Valley will adjust the credit loss expectations for loan pools, as necessary. These adjustments are based, in part, on actual loss severities recognized for each loan type, as well as changes in the probability of default. For periods in which Valley does not reforecast estimated cash flows, the prior reporting period’s estimated cash flows are adjusted to reflect the actual cash received and credit events which transpired during the current reporting period.

 

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The following tables summarize the changes in the carrying amounts of non-covered PCI loans and covered loans (net of the allowance for losses on covered loans), and the accretable yield on these loans for the three and six months ended June 30, 2012 and 2011.

 

     Three Months Ended June 30,  
     2012      2011  
   Carrying
Amount, Net
     Accretable
Yield
     Carrying
Amount, Net
     Accretable
Yield
 
     (in thousands)  

Non-covered PCI loans:

        

Balance, beginning of the period

     $     1,165,169           $     171,450           $ -           $ -     

Acquisitions

     -           -           -           -     

Accretion

     15,625           (15,625)          -           -     

Payments received

     (66,344)          -           -           -     
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance, end of the period

     $ 1,114,450           $ 155,825           $ -           $ -     
  

 

 

    

 

 

    

 

 

    

 

 

 

Covered loans:

           

Balance, beginning of the period

     $ 238,657           $ 58,352           $     316,429           $     109,435     

Accretion

     4,760           (4,760)          8,706           (8,706)    

Payments received

     (27,321)          -           (35,283)          -     

Net increase in expected cash flows

     -           -           -           788     

Transfers to other real estate owned

     (1,330)          -           (935)          -     

Provision for losses on covered loans

     -           -           788           -     
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance, end of the period

     $ 214,766           $ 53,592           $ 289,705           $ 101,517     
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     Six Months Ended June 30,  
     2012      2011  
     Carrying
Amount, Net
     Accretable
Yield
     Carrying
Amount, Net
     Accretable
Yield
 
     (in thousands)  

Non-covered PCI loans:

        

Balance, beginning of the period

     $ -           $ -           $ -           $ -     

Acquisitions

     1,216,203           186,262           -           -     

Accretion

     30,437           (30,437)          -           -     

Payments received

     (132,190)          -           -           -     
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance, end of the period

     $     1,114,450           $     155,825           $ -           $ -     
  

 

 

    

 

 

    

 

 

    

 

 

 

Covered loans:

           

Balance, beginning of the period

     $ 258,316           $ 66,724           $     350,277           $     101,052     

Accretion

     13,132           (13,132)          16,518           (16,518)    

Payments received

     (50,757)          -           (58,061)          -     

Net increase in expected cash flows

     -           -           -           16,983     

Transfers to other real estate owned

     (5,925)          -           (935)          -     

Provision for losses on covered loans

     -           -           (18,094)          -     
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance, end of the period

     $ 214,766           $ 53,592           $ 289,705           $ 101,517     
  

 

 

    

 

 

    

 

 

    

 

 

 

Covered loans in the table above are presented net of the allowance for losses on covered loans, which totaled $11.8 million and $13.5 million at June 30, 2012 and December 31, 2011, respectively, as compared to $18.7 million at June 30, 2011. This allowance was established due to a decrease in the expected cash flows for certain pools of covered loans based on higher levels of credit impairment than originally forecasted by us at the acquisition dates. During the six months ended June 30, 2011, we recorded a provision for losses on covered loans totaling $18.1 million as a component of our provision for credit losses in the consolidated statement of income. The 2011 provision for losses on covered loans was partially offset by an increase in our FDIC loss-share receivable of $16.9 million during the six months ended June 30, 2011 for the FDIC’s portion of the additional estimated credit losses under the loss sharing agreements (see table in the next section below).

 

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Although we recognized credit impairment for certain pools in 2011 and 2010, on an aggregate basis the acquired pools of covered loans continue to perform better than originally expected. Based on our current estimates, we expect to receive more future cash flows than originally modeled at the acquisition dates. For the pools with better than expected cash flows, the forecasted increase is recorded as a prospective adjustment to our interest income on these loan pools over future periods. The decrease in the FDIC loss-share receivable due to the increase in expected cash flows for these loan pools is recognized on a prospective basis over the shorter period of the lives of the loan pools and the loss-share agreements accordingly. We reduced the FDIC loss-share receivable by $2.2 million and $3.9 million during the three and six months ended June 30, 2012, respectively, due to the prospective recognition of the effect of additional cash flows from pooled loans with a corresponding reduction in non-interest income for the period. See section below for further details regarding the FDIC loss-share receivable.

FDIC Loss-Share Receivable Related to Covered Loans and Foreclosed Assets

The receivable arising from the loss sharing agreements (referred to as the “FDIC loss-share receivable” on our statements of financial condition) is measured separately from the covered loan pools because the agreements are not contractually part of the covered loans and are not transferable should the Bank choose to dispose of the covered loans. As of the acquisition dates for the two FDIC-assisted transactions, we recorded an aggregate FDIC loss-share receivable of $108.0 million, consisting of the present value of the expected future cash flows the Bank expected to receive from the FDIC under the loss sharing agreements. The FDIC loss-share receivable is reduced as the loss sharing payments are received from the FDIC for losses realized on covered loans and other real estate owned acquired in the FDIC-assisted transactions. Actual or expected losses in excess of the acquisition date estimates, accretion of the acquisition date present value discount, and other reimbursable expenses covered by the FDIC loss-sharing agreements will result in an increase in the FDIC loss-share receivable and the immediate recognition of non-interest income in our financial statements, together with an increase in the non-accretable difference. A decrease in expected losses would generally result in a corresponding decline in the FDIC loss-share receivable and the non-accretable difference. Reductions in the FDIC loss-share receivable due to actual or expected losses that are less than the acquisition date estimates are recognized prospectively over the shorter of (i) the estimated life of the applicable pools of covered loans or (ii) the term of the loss sharing agreements with the FDIC.

The following table presents changes in FDIC loss-share receivable for three and six months ended June 30, 2012 and 2011:

 

     Three Months ended
June 30,
     Six Months ended
June 30,
 
     2012      2011      2012      2011  
            (in thousands)         

Balance, beginning of the period

     $   69,928           $   90,642           $   74,390           $   89,359     

Discount accretion of the present value at the acquisition dates

     81           145           162           291     

Effect of additional cash flows on covered loans (prospective recognition)

     (2,231)          (2,760)          (3,868)          (5,278)    

(Decrease) increase due to (recovery) impairment on covered loans

     -           (747)          -           16,932     

Other reimbursable expenses

     1,088           693           2,554           1,621     

Reimbursements from the FDIC

     (3,165)          (7,794)          (7,537)          (22,746)    

Other

     (5,960)          -           (5,960)          -     
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance, end of the period

     $ 59,741           $ 80,179           $ 59,741           $ 80,179     
  

 

 

    

 

 

    

 

 

    

 

 

 

The aggregate effect of changes in the FDIC loss-share receivable was a reduction in non-interest income of $7.0 million and $2.7 million for the three months ended June 30, 2012 and 2011, respectively, and a $7.1 million reduction and a $13.6 million increase to non-interest income for the six months ended June 30, 2012 and 2011, respectively. The second quarter and the first six months of 2012 reductions in non-interest income included $6.0 million related to the FDIC’s portion of the estimated losses on unused lines of credit assumed in the FDIC-assisted transactions, which have expired.

 

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Non-performing Assets

Non-performing assets (excluding PCI loans) include non-accrual loans, other real estate owned (“OREO”), and other repossessed assets which consist of four aircraft and several automobiles at June 30, 2012. Loans are generally placed on non-accrual status when they become past due in excess of 90 days as to payment of principal or interest. Exceptions to the non-accrual policy may be permitted if the loan is sufficiently collateralized and in the process of collection. OREO is acquired through foreclosure on loans secured by land or real estate. OREO and other repossessed assets are reported at the lower of cost or fair value, less cost to sell at the time of acquisition and at the lower of fair value, less estimated costs to sell, or cost thereafter. Given the state of the economic recovery, and comparable to many of our peers, the level of non-performing assets remained relatively low as a percentage of the total loan portfolio and non-performing assets at June 30, 2012, but has increased since December 31, 2011 as shown in the table below.

Our past due loans and non-accrual loans in the table below exclude our non-covered and covered PCI loans. Under U.S. GAAP, the PCI loans (acquired at a discount that is due, in part, to credit quality) are accounted for on a pool basis and are not subject to delinquency classification in the same manner as loans originated by Valley.

The following table sets forth by loan category, accruing past due and non-performing assets on the dates indicated in conjunction with our asset quality ratios:

 

     June 30,
2012
    March 31,
2012
    December 31,
2011
    September 30,
2011
    June 30,
2011
 
     ($ in thousands)  

Accruing past due loans: (1)

          

30 to 89 days past due:

          

Commercial and industrial

     $ 2,275      $ 5,531      $ 4,347      $ 9,866        $ 10,915   

Commercial real estate

     11,483        8,897        13,115        22,220        7,710   

Construction

     270        9,312        2,652        —          1,710   

Residential mortgage

     10,148        12,988        8,496        12,556        13,819   

Consumer

     5,872        5,330        8,975        9,456        8,661   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total 30 to 89 days past due

     30,048        42,058        37,585        54,098        42,815   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

90 or more days past due:

          

Commercial and industrial

     512        —        $ 657        164        12   

Commercial real estate

     —          711        422        268        1,682   

Construction

     —          —          1,823        2,216        —     

Residential mortgage

     727        1,749        763        721        687   

Consumer

     246        214        351        483        319   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total 90 or more days past due

     1,485        2,674        4,016        3,852        2,700   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total accruing past due loans

   $ 31,533      $ 44,732      $ 41,601      $ 57,950        $ 45,515   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Non-accrual loans:(1)

          

Commercial and industrial

   $ 12,652      $ 24,196      $ 26,648      $ 16,737        $ 15,882   

Commercial real estate

     61,864        47,433        42,186        41,453        43,041   

Construction

     16,502        17,704        19,874        14,449        22,004   

Residential mortgage

     32,045        32,291        31,646        31,401        29,815   

Consumer

     3,165        3,583        3,910        3,645        3,009   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total non-accrual loans

     126,228        125,207        124,264        107,685        113,751   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other real estate owned (“OREO”) (2)

     14,724        14,119        15,227        14,091        10,797   

Other repossessed assets

     8,548        1,769        796        822        929   

Non-accrual debt securities(3)

     45,921        38,502        27,151        —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total non-performing assets (“NPAs”)

   $ 195,421      $ 179,597      $ 167,438      $ 122,598        $   125,477   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Performing troubled debt restructured loans

   $ 113,610      $ 96,152      $ 100,992      $ 103,690        $ 101,444   

Total non-accrual loans as a % of loans

     1.10     1.12     1.27     1.12     1.19

Total NPAs as a % of loans and NPAs

     1.68        1.59        1.27        1.26        1.29   

Total accruing past due and non-accrual loans as a % of loans

     1.38        1.52        1.69        1.73        1.66   

Allowance for losses on non-covered loans as a % of non-accrual loans

     93.55        95.32        96.79        114.01        105.41   

 

(1)

Past due loans and non-accrual loans exclude PCI loans that are accounted for on a pool basis.

(2) 

This table excludes OREO properties related to the FDIC-assisted transactions totaling $11.2 million, $11.0 million, $6.4 million, $6.2 million, and 6.7 million at June 30, 2012, March 31, 2012, December 31, 2011, September 30, 2011, and June 30, 2011, respectively, and is subject to the loss-sharing agreements with the FDIC.

(3) 

Includes other-than-temporarily impaired trust preferred securities classified as available for sale, which are presented at carrying value, net of unrealized losses totaling $5.8 million, $13.2 million and $24.6 million at June 30, 2012, March 31, 2012 and December 31, 2011, respectively.

 

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Total NPAs increased $15.8 million to $195.4 million at June 30, 2012 from March 31, 2012 mainly due to one new non-accrual commercial real estate loan totaling $11.8 million and a $7.4 million increase in the estimated fair value of non-accrual debt securities (consisting of other-than-temporarily impaired trust preferred securities classified as available for sale) totaling $45.9 million at June 30, 2012. The increase in the carrying value of non-accrual debt securities from December 31, 2011 was entirely due to a decrease in the unrealized losses (or non-credit impairment) on such securities. There was no change in the number of debt securities on non-accrual status during the six months ended June 30, 2012.

Loans past due 30 to 89 days decreased $12.0 million to $30.0 million at June 30, 2012 compared to March 31, 2012 mainly due to lower delinquencies within construction loans and commercial and industrial loans partially offset by an increase in delinquencies within commercial real estate loans. Commercial real estate loans within this past due category increased $2.6 million to $11.5 million at June 30, 2012 mainly due to the inclusion of two new potential problem loans totaling $6.5 million. A potential problem loan is a performing loan for which management has concerns about the ability of the borrower to comply with the loan repayment terms and which may result in a non-performing loan. Of the $6.5 million, approximately $2.1 million is estimated to be at risk after collateral values and guarantees are taken into consideration. Our decision to characterize such performing loans as potential problem loans does not necessarily mean that management expects losses to occur, but that management recognizes potential problem loans carry a higher probability of default.

Loans past due 90 days or more and still accruing decreased $1.2 million to $1.5 million at June 30, 2012 compared to $2.7 million at March 31, 2012. The decrease was mainly due to declines in the residential mortgage and commercial real estate loan categories caused by loans that are no longer past due.

Non-accrual loans increased $1.0 million to $126.2 million at June 30, 2012 as compared to $125.2 million at March 31, 2012 mainly due to the new non-accrual commercial real estate loan with a recorded investment totaling $11.8 million, partially offset by the migration of two commercial loans secured by aircraft to other repossessed assets during the second quarter of 2012, totaling $9.2 million prior to transfer. Although the timing of collection is uncertain, management believes that most of the non-accrual loans are well secured and largely collectible based on, in part, our quarterly review of impaired loans. Our impaired loans, mainly consisting of non-accrual and troubled debt restructured commercial and commercial real estate loans, totaled $201.4 million and had $22.0 million in related specific reserves included in our total allowance for loan losses at June 30, 2012.

OREO (which consists of 25 commercial and residential properties) and other repossessed assets, excluding OREO subject to loss-sharing agreements with the FDIC, totaled $14.7 million and $8.5 million, respectively, at June 30, 2012 as compared to $14.1 million and $1.8 million, respectively, at March 31, 2012. The $6.7 million increase in other repossessed assets was due to the transfer of two aircraft at their estimated fair values (less selling costs) of $6.6 million that collateralized two non-accrual commercial loans. The transfers resulted in partial loan charge-offs totaling $2.6 million to our allowance of loan losses during the second quarter of 2012.

Troubled debt restructured loans (“TDRs”) represent loan modifications for customers experiencing financial difficulties where a concession has been granted. Performing TDRs (i.e., TDRs not reported as loans 90 days or more past due and still accruing or as non-accrual loans) totaled $113.6 million at June 30, 2012 and consisted of 85 loans (primarily in the commercial and industrial loan and commercial real estate portfolios) as compared to 71 loans totaling $96.2 million at March 31, 2012. On an aggregate basis, the $113.6 million in performing TDRs at June 30, 2012 had a modified weighted average interest rate of approximately 4.73 percent as compared to a pre-modification weighted average interest rate of 5.72 percent.

Allowance for Credit Losses

The allowance for credit losses consists of the allowance for losses on non-covered loans, the allowance for unfunded letters of credit, and the allowance for losses on covered loans related to credit impairment of certain covered loan pools subsequent to acquisition. Management maintains the allowance for credit losses at a level estimated to absorb probable losses inherent in the loan portfolio and unfunded letters of credit commitments at the balance sheet dates, based on

 

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ongoing evaluations of the loan portfolio. Our methodology for evaluating the appropriateness of the allowance for non-covered loans includes:

 

   

segmentation of the loan portfolio based on the major loan categories, which consist of commercial, commercial real estate (including construction), residential mortgage and other consumer loans;

   

tracking the historical levels of classified loans and delinquencies;

   

assessing the nature and trend of loan charge-offs;

   

providing specific reserves on impaired loans;

   

evaluating the non-covered PCI loan pools for additional credit impairment subsequent to the acquisition dates; and

   

applying economic outlook factors, assigning specific incremental reserves where necessary.

Additionally, the volume of non-performing loans, concentration risks by size, type, and geography, new markets, collateral adequacy, credit policies and procedures, staffing, underwriting consistency, loan review and economic conditions are taken into consideration when evaluating the adequacy of the allowance for credit losses. Allowance for credit losses methodology and accounting policy are fully described in Part II, Item 7 and Note 1 to the consolidated financial statements in Valley’s Annual Report on Form 10-K for the year ended December 31, 2011.

While management utilizes its best judgment and information available, the ultimate adequacy of the allowance for credit losses is dependent upon a variety of factors largely beyond our control, including the view of the Office of the Comptroller of the Currency (“OCC”) toward loan classifications, performance of the loan portfolio, and the economy. The OCC may require, based on their judgments about information available to them at the time of their examination, that certain loan balances be charged off or require that adjustments be made to the allowance for loan losses when their credit evaluations differ from those of management.

 

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The following table summarizes the relationship among loans, loans charged-off, loan recoveries, the provision for credit losses and the allowance for credit losses for the periods indicated:

 

    Three Months Ended     Six Months Ended  
    June 30,
2012
    March 31,
2012
    June 30,
2011
    June 30,
2012
    June 30,
2011
 
                ($ in thousands)              

Average loans outstanding

  $ 11,297,942      $ 10,956,666      $ 9,619,959      $ 11,127,304      $ 9,539,527   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Beginning balance - Allowance for credit losses

  $ 135,576      $ 136,185      $ 141,722      $ 136,185      $ 126,504   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans charged-off:

         

Commercial and industrial

    (5,406)        (4,807)        (3,056)        (10,213)        (9,728)   

Commercial real estate

    (4,895)        (570)        (3,631)        (5,465)        (4,454)   

Construction

    (484)        (510)        —          (994)        —     

Residential mortgage

    (583)        (1,176)        (443)        (1,759)        (1,226)   

Consumer

    (1,015)        (1,483)        (1,355)        (2,498)        (3,113)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    (12,383)        (8,546)        (8,485)        (20,929)        (18,521)   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Charged-off loans recovered:

         

Commercial and industrial

    1,304        1,005        741        2,309        1,189   

Commercial real estate

    66        120        5        186        26   

Construction

    50        —          197        50        197   

Residential mortgage

    111        514        69        625        90   

Consumer

    407        601        618        1,008        1,220   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    1,938        2,240        1,630        4,178        2,722   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs*

    (10,445)        (6,306)        (6,855)        (16,751)        (15,799)   

Provision charged for credit losses

    7,405        5,697        6,026        13,102        30,188   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance - Allowance for credit losses

  $ 132,536      $ 135,576      $ 140,893      $ 132,536      $ 140,893   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Components of allowance for credit losses:

         

Allowance for non-covered loans

  $ 118,083      $ 119,342      $ 119,907      $ 118,083      $ 119,907   

Allowance for covered loans

    11,771        13,528        18,719        11,771        18,719   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan losses

    129,854        132,870        138,626        129,854        138,626   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for unfunded letters of credit

    2,682        2,706        2,267        2,682        2,267   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for credit losses

  $ 132,536      $ 135,576      $ 140,893      $ 132,536      $ 140,893   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Components of provision for credit losses:

         

Provision for losses on non-covered loans

  $ 7,429      $ 5,374      $ 6,422      $ 12,803      $ 11,627   

Provision for losses on covered loans

    —          —          (788)        —          18,094   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Provision for loan losses

    7,429        5,374        5,634        12,803        29,721   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Provision for unfunded letters of credit

    (24)        323        392        299        467   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Provision for credit losses

  $ 7,405      $ 5,697      $ 6,026      $ 13,102      $ 30,188   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ratio of net charge-offs of non-covered loans to average loans outstanding

    0.31     0.23     0.26     0.27     0.21

Ratio of total net charge-offs to average loans outstanding

    0.37        0.23        0.29        0.30        0.33   

Allowance for non-covered loan losses as a % of non-covered loans

    1.05        1.10        1.29        1.05        1.29   

Allowance for credit losses as a % of total loans

    1.16        1.22        1.47        1.16        1.47   

 

* Includes $1.8 million of covered loan charge-offs for both the three and six months ended June 30, 2012 and $639 thousand and $5.8 million for the three and six months ended June 30, 2011, respectively. These charge-offs are substantially offset by reimbursements under the FDIC loss-sharing agreements.

Net loan charge-offs totaling $10.4 million for the second quarter of 2012 increased $4.1 million and $3.6 million from the three months ended March 31, 2012 and June 30, 2011, respectively. During the second quarter of 2012, the net charge-offs on non-covered loans totaled $8.7 million and were largely related to a $4.6 million partial charge-off of one non-performing impaired commercial real estate loan based upon its lower collateral valuation at June 30, 2012, as well as $2.6 million in combined partial charge-offs of two commercial loans resulting from the transfer of their collateral (two aircraft) to other repossessed assets. Loan charge-offs of impaired covered loan pools totaled $1.8 million during the second quarter of 2012 as compared to $5.8 million for the second quarter of 2011. There were no loan charge-offs in our impaired covered loan pools during the first quarter of 2012. Charge offs on impaired covered loan pools are substantially covered by loss-sharing agreements with the FDIC.

 

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The provision for credit losses totaled $7.4 million for the second quarter of 2012 as compared to $5.7 million for the linked first quarter of 2012 and $6.0 million for the second quarter of 2011. The increase from the prior periods is mainly due to a higher net charge-offs and increased specific reserves for impaired loans, partially offset by improved performance and economic outlook mainly within the consumer loan portfolio. During the first six months of 2012, we did not record provision for losses on covered loans related to credit impairment of the certain pools of covered loans and/or decreases in the additional cash flows expected to be collected due to changes in estimates after acquisition. Comparatively we recorded a $788 thousand reduction in the provision for covered loans losses during the second quarter of 2011 and a $18.1 million provision for the six months ended June 30, 2011.

The following table summarizes the allocation of the allowance for credit losses to specific loan portfolio categories and the allocations as a percentage of each loan category:

 

     June 30, 2012      March 31, 2012      June 30, 2011  
     Allowance
Allocation
     Allocation
as a % of
Loan
Category (2)
     Allowance
Allocation
     Allocation
as a % of
Loan
Category
     Allowance
Allocation
     Allocation
as a % of
Loan
Category
 
                   ($ in thousands)                

Loan Category:

                 

Commercial and Industrial loans (1)

     $ 63,521           2.93%          $ 65,061           3.00%          $ 59,919           3.28%    

Commercial real estate loans:

                 

Commercial real estate

     20,900           0.47%          18,568           0.43%          18,310           0.53%    

Construction

     12,632           3.07%          13,337           3.10%          13,863           3.35%    
  

 

 

       

 

 

       

 

 

    

Total commercial real estate loans

     33,532           0.69%          31,905           0.67%          32,173           0.82%    

Residential mortgage loans

     10,678           0.39%          9,775           0.39%          10,913           0.51%    

Consumer loans:

                 

Home equity

     1,872           0.37%          2,245           0.44%          2,791           0.58%    

Auto and other consumer

     3,937           0.42%          5,695           0.63%          8,284           0.90%    
  

 

 

       

 

 

       

 

 

    

Total consumer loans

     5,809           0.41%          7,940           0.56%          11,075           0.79%    

Unallocated

     7,225           -              7,367           -              8,094           -        
  

 

 

       

 

 

       

 

 

    

Allowance for non-covered loans and unfunded letters of credit

     120,765           1.08%          122,048           1.12%          122,174           1.32%    

Allowance for covered loans

     11,771           5.20%          13,528           5.36%          18,719           6.07%    
  

 

 

       

 

 

       

 

 

    

Total allowance for credit losses

   $     132,536           1.16%        $     135,576           1.22%        $     140,893           1.47%    
  

 

 

       

 

 

       

 

 

    

 

(1) Includes the reserve for unfunded letters of credit.

The allowance for non-covered loans and unfunded letters of credit as a percentage of total non-covered loans was 1.08 percent at June 30, 2012 as compared to 1.12 percent and 1.32 percent at March 31, 2012 and June 30, 2011, respectively. The allocation percentages in the commercial and commercial real estate loan categories shown in the table above increased from June 30, 2011 largely due to non-covered PCI loans acquired from State Bancorp on January 1, 2012 and commercial real estate loans purchased from another financial institution in March 2012. The PCI loans have been recorded at fair value based on an initial estimate of expected cash flows, including a reduction for estimated credit losses and, in the case of State Bancorp, without carryover of the loan portfolio’s historical allowance for loan losses. The PCI loans are accounted for on a pool basis and were initially recorded net of fair valuation discounts related to credit totaling over $53 million and $5 million, respectively, which may be used to absorb potential future losses on such loans before any allowance for loan losses is recognized subsequent to acquisition. Additionally, the allocated reserves for auto and other consumer loans declined from March 31, 2012 as loss experience and the outlook for the automobile portfolio continued to improve during the second quarter of 2012. Our allowance for non-covered loans and unfunded letters of credit as a percentage of total non-covered loans (excluding non-covered PCI loans with carrying values totaling approximately $1.1 billion) was 1.20 percent at June 30, 2012 as compared to 1.25 percent and 1.32 percent at March 31, 2012 and June 30, 2011, respectively.

 

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Management believes that the unallocated allowance is appropriate given the uncertain economic outlook, the size of the loan portfolio and level of loan delinquencies at June 30, 2012.

Capital Adequacy

A significant measure of the strength of a financial institution is its shareholders’ equity. At June 30, 2012 and December 31, 2011, shareholders’ equity totaled approximately $1.5 billion and $1.3 billion or 9.4 percent and 8.9 percent of total assets, respectively. During the six months ended June 30, 2012, total shareholders’ equity increased $236.8 million mainly due to the additional capital issued in the State Bancorp acquisition totaling $208.4 million, net income of $67.4 million, a $18.6 million decrease in our accumulated other comprehensive loss, $4.1 million in net proceeds from 338 thousand shares from the reissuance of treasury stock and authorized common shares issued under our dividend reinvestment plan, partially offset by cash dividends declared on common stock totaling $64.4 million.

On March 23, 2012, Valley filed a shelf registration statement on Form S-3 with the SEC, which became effective immediately. This shelf registration statement allows Valley to periodically offer and sell in one or more offerings, individually or in any combination, an unlimited aggregate amount of Valley’s common stock and preferred stock. The shelf registration statement provides Valley with capital raising flexibility and enables Valley to promptly access the capital markets in order to pursue growth opportunities that may become available in the future or permit Valley to comply with any changes in the regulatory environment that call for increased capital requirements. Valley’s ability, and any decision to issue and sell securities pursuant to the shelf registration statement, is subject to market conditions and Valley’s capital needs at such time.

Risk-based capital guidelines define a two-tier capital framework. Tier 1 capital consists of common shareholders’ equity and eligible long-term borrowing related to VNB Capital Trust I, GCB Capital Trust III, State Bancorp Capital Trust I and State Bancorp Capital Trust II less disallowed intangibles and adjusted to exclude unrealized gains and losses, net of deferred tax. Total risk-based capital consists of Tier 1 capital, Valley National Bank’s subordinated borrowings and the allowance for credit losses up to 1.25 percent of risk-adjusted assets. Risk-adjusted assets are determined by assigning various levels of risk to different categories of assets and off-balance sheet activities.

 

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The following table presents Valley’s and Valley National Bank’s actual capital positions and ratios under risk-based capital guidelines at June 30, 2012 and December 31, 2011.

 

     Actual      Minimum Capital
Requirements
     To Be Well Capitalized
Under Prompt Corrective

Action Provision
 
     Amount      Ratio      Amount      Ratio      Amount      Ratio  
                   ($ in thousands)                       

As of June 30, 2012

                 

Total Risk-based Capital

                 

Valley

     $     1,432,205           12.2%              $     941,966           8.0%              $ N/A           N/A%     

Valley National Bank

     1,361,774           11.6              940,317           8.0              1,175,396           10.0     

Tier 1 Risk-based Capital

                 

Valley

     1,239,669           10.5              470,983           4.0              N/A           N/A     

Valley National Bank

     1,169,238           10.0              470,158           4.0              705,238           6.0     

Tier 1 Leverage Capital

                 

Valley

     1,239,669           8.1              611,877           4.0              N/A           N/A     

Valley National Bank

     1,169,238           7.7              611,044           4.0              763,805           5.0     

As of December 31, 2011

                 

Total Risk-based Capital

                 

Valley

     $ 1,312,945           12.8%           $ 823,705           8.0%           $ N/A           N/A%     

Valley National Bank

     1,255,714           12.3              819,274           8.0                  1,024,092           10.0     

Tier 1 Risk-based Capital

                 

Valley

     1,124,833           10.9              411,853           4.0              N/A           N/A     

Valley National Bank

     1,067,602           10.4              409,637           4.0              614,455           6.0     

Tier 1 Leverage Capital

                 

Valley

     1,124,833           8.1              557,210           4.0              N/A           N/A     

Valley National Bank

     1,067,602           7.7              555,785           4.0              694,731           5.0     

Valley’s Tier 1 capital position included $186.3 million and $176.3 million of its outstanding trust preferred securities issued by capital trusts as of June 30, 2012 and December 31, 2011, respectively. The net increase of $10 million was attributable to $20 million of trust preferred securities assumed in the State Bancorp acquisition, partially offset by the redemption of $10.0 million of the face value of VNB Capital Trust I trust preferred securities during the first quarter of 2012.

The trust preferred securities of VNB Capital Trust I, GCB Capital Trust III, and State Bancorp Capital Trusts I and II are included in Valley’s consolidated Tier 1 capital and total capital for regulatory purposes at June 30, 2012. Under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”), Valley’s outstanding trust preferred securities continue to qualify as Tier 1 capital but Valley will be unable to issue replacement or additional trust preferred securities that would qualify as Tier 1 capital. Under recently proposed regulatory capital rules, Valley’s trust preferred securities will be phased out as Tier 1 capital over time starting in 2013, despite the Dodd-Frank Act authority. These recently proposed rules also require a Common Equity Tier 1 capital ratio of at least 4.5 percent, with a capital conservation buffer of 2.5 percent phased in starting in 2016. See the “Basel III” section in Part I Item1 of Valley’s Annual Report on Form 10-K for the year ended December 31, 2011 for additional details regarding Common Equity Tier 1 capital requirement. The recently proposed rules make a number of other changes as well to our qualifying capital position and ratio computations, which are currently under review by Valley and subject to commentary from the industry before made final.

 

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Management believes the tangible book value per share ratio provides information useful to management and investors in understanding our underlying operational performance, our business and performance trends and facilitates comparisons with the performance of others in the financial services industry. This non-GAAP financial measure should not be considered in isolation or as a substitute for or superior to financial measures calculated in accordance with U.S. GAAP. Tangible book value is computed by dividing shareholders’ equity less goodwill and other intangible assets by common shares outstanding as follows:

 

     June 30,
2012
     December 31,
2011
 
     ($ in thousands except for share data)  

Common shares outstanding

         197,259,926               178,683,030     
  

 

 

    

 

 

 

Shareholders’ equity

     $ 1,503,073           $ 1,266,248     

Less: Goodwill and other intangible assets

             447,260           338,780     
  

 

 

    

 

 

 

Tangible shareholders’ equity

     $ 1,055,813           $ 927,468     

Tangible book value per common share

     $ 5.35           $ 5.19     

Book value per share

     $ 7.62           $ 7.09     

Typically, our primary source of capital growth is through retention of earnings. Our rate of earnings retention is derived by dividing undistributed earnings per common share by earnings (or net income) per common share. Our retention ratio was 3.4 percent for the six months ended June 30, 2012. While we expect that our rate of earnings retention to remain at acceptable levels in future periods, potential future mark to market losses on our junior subordinated debentures, net impairment losses on securities, and other deterioration in earnings and our balance sheet resulting from the weak economic conditions may negatively impact our future earnings and ability to maintain our dividend at current levels.

Cash dividends declared amounted to $0.33 per common share for both the six months ended June 30, 2012 and 2011, but, consistent with its conservative philosophy, the Board is committed to examine and weigh relevant facts and considerations, including its commitment to shareholder value, each time it makes a cash dividend decision in this economic environment. The Federal Reserve has cautioned bank holding companies about distributing dividends which reduce its capital. Also, the Office of the Comptroller of the Currency has cautioned banks to carefully consider the dividend payout ratio to ensure they maintain sufficient capital to be able to lend to credit worthy borrowers.

Off-Balance Sheet Arrangements, Contractual Obligations and Other Matters

For a discussion of Valley’s off-balance sheet arrangements and contractual obligations see information included in Valley’s Annual Report on Form 10-K for the year ended December 31, 2011 in the MD&A section – “Off-Balance Sheet Arrangements” and Notes 12 and 13 to the consolidated financial statements included in this report.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Market risk refers to potential losses arising from changes in interest rates, foreign exchange rates, equity prices, and commodity prices. Valley’s market risk is composed primarily of interest rate risk. See page 64 for a discussion of interest rate sensitivity.

Item 4. Controls and Procedures

Valley’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), with the assistance of other members of Valley’s management, have evaluated the effectiveness of Valley’s disclosure controls and procedures (as defined in Rule 13a-15(e) or Rule 15d-15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on such evaluation, Valley’s CEO and CFO have concluded that Valley’s disclosure controls and procedures are effective.

 

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Valley’s CEO and CFO have also concluded that there have not been any changes in Valley’s internal control over financial reporting during the quarter ended June 30, 2012 that have materially affected, or are reasonably likely to materially affect, Valley’s internal control over financial reporting.

Valley’s management, including the CEO and CFO, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, provides reasonable, not absolute, assurance that the objectives of the control system are met. The design of a control system reflects resource constraints and the benefits of controls must be considered relative to their costs. Because there are inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Valley have been or will be detected.

These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns occur because of simple error or mistake. Controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events. There can be no assurance that any design will succeed in achieving its stated goals under all future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with the policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

In the normal course of business, we may be a party to various outstanding legal proceedings and claims. There have been no material changes in the legal proceedings previously disclosed under Part I, Item 3 of Valley’s Annual Report on Form 10-K for the year ended December 31, 2011.

Item 1A. Risk Factors

There has been no material change in the risk factors previously disclosed under Part I, Item 1A of Valley’s Annual Report on Form 10-K for the year ended December 31, 2011.

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

During the quarter, we did not sell any equity securities not registered under the Securities Act of 1933, as amended. Purchases of equity securities by the issuer and affiliated purchasers during the three months ended June 30, 2012:

 

Period

   Total Number of
  Shares Purchased  
       Average
Price Paid
    Per Share    
   Total Number of Shares
Purchased as Part of
Publicly Announced
                Plans (1)                 
   Maximum Number of
Shares  that May Yet Be
Purchased Under the Plans (1)

April 1, 2012 to April 30, 2012

   _      _                _                4,112,465

May 1, 2012 to May 31, 2012

   _      _                _                4,112,465

June 1, 2012 to June 30, 2012

   2,732 (2)      $        10.87                  _                4,112,465
  

 

       

 

  

Total

   2,732                          _               
  

 

       

 

  

 

(1)

On January 17, 2007, Valley publicly announced its intention to repurchased up to 4.7 million outstanding common shares in the open market or in privately negotiated transactions. The repurchase plan has no stated expiration date. No repurchase plans or programs expired or terminated during the three months ended June 30, 2012.

(2)

Represents repurchases made in connection with the vesting of employee stock awards.

 

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Item 6. Exhibits

 

(3) Articles of Incorporation and By-laws:

 

  A. Restated Certificate of Incorporation of the Registrant, incorporated herein by reference to the Registrant’s Form 8-K Current Report filed on May 24, 2012.
  B. By-laws of the Registrant, as amended, incorporated herein by reference to the Registrant’s Form 8-K Current Report filed on January 31, 2011.

 

(31.1) Certification pursuant to Securities Exchange Rule 13a-14(a)/15d-14(a) signed by Gerald H. Lipkin, Chairman of the Board, President and Chief Executive Officer of the Company.*

 

(31.2) Certification pursuant to Securities Exchange Rule 13a-14(a)/15d-14(a) signed by Alan D. Eskow, Senior Executive Vice President and Chief Financial Officer of the Company.*

 

(32) Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, signed by Gerald H. Lipkin, Chairman of the Board, President and Chief Executive Officer of the Company and Alan D. Eskow, Senior Executive Vice President and Chief Financial Officer of the Company.*

 

(101)

Interactive Data File *, **

 

* Filed herewith.
** As provided in Rule 406T of Regulation S-T, this information is deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 and 12 of the Securities Act of 1933 and is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

   VALLEY NATIONAL BANCORP
               (Registrant)

Date: August 9, 2012

   /s/ Gerald H. Lipkin
        Gerald H. Lipkin
        Chairman of the Board, President
        and Chief Executive Officer

Date: August 9, 2012

   /s/ Alan D. Eskow
        Alan D. Eskow
        Senior Executive Vice President and
        Chief Financial Officer

 

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