UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
þ | ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2008
¨ | 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
(Registrants telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class |
Name of exchange on which registered | |
Common Stock, no par value | New York Stock Exchange | |
VNB Capital Trust I 7.75% Trust Originated Securities (and the Guarantee by Valley National Bancorp with respect thereto) |
New York Stock Exchange | |
Warrants to purchase Common Stock | NASDAQ Capital Market |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes þ No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes ¨ No þ
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 þ No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, 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 þ 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 þ
The aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $1.8 billion on June 30, 2008.
There were 135,024,030 shares of Common Stock outstanding at February 24, 2009.
Documents incorporated by reference:
Certain portions of the registrants Definitive Proxy Statement (the 2009 Proxy Statement) for the 2009 Annual Meeting of Shareholders to be held April 14, 2009 will be incorporated by reference in Part III. The 2009 proxy statement will be filed within 120 days of December 31, 2008.
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The disclosures set forth in this item are qualified by Item 1ARisk Factors and the section captioned Cautionary Statement Concerning Forward-Looking Statements in Item 7Managements Discussion and Analysis of Financial Condition and Results of Operations of this report and other cautionary statements set forth elsewhere in this report.
Valley National Bancorp, headquartered in Wayne, New Jersey, is a New Jersey corporation organized in 1983 and is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended (Holding Company Act). The words Valley, the Company, we, our and us refer to Valley National Bancorp and its wholly owned subsidiaries, unless we indicate otherwise. At December 31, 2008, Valley had consolidated total assets of $14.7 billion, total loans of $10.1 billion, total deposits of $9.2 billion and total shareholders equity of $1.4 billion. In addition to its principal subsidiary, Valley National Bank (commonly referred to as the Bank in this report), Valley owns all of the voting and common shares of VNB Capital Trust I and GCB Capital Trust III, through which trust preferred securities were issued. VNB Capital Trust I and GCB Capital Trust III are not consolidated subsidiaries. See Note 12 of the consolidated financial statements.
Valley National Bank is a national banking association chartered in 1927 under the laws of the United States. Currently, the Bank has 195 full-service banking offices located throughout northern and central New Jersey and New York City. The Bank provides a full range of commercial and retail banking services. These services include the following: the acceptance of demand, savings and time deposits; extension of consumer, real estate, commercial loans; equipment leasing; personal and corporate trust, and pension and fiduciary services.
Valley National Banks wholly-owned subsidiaries are all included in the consolidated financial statements of Valley (See Exhibit 21 at Part IV, Item 15 for a complete list of subsidiaries). These subsidiaries include a mortgage servicing company; a title insurance agency; asset management advisors which are Securities and Exchange Commission (SEC) registered investment advisors; an all-line insurance agency offering property and casualty, life and health insurance; subsidiaries which hold, maintain and manage investment assets for the Bank; a subsidiary which owns and services auto loans; a subsidiary which specializes in asset-based lending; a subsidiary which offers both commercial equipment leases and financing for general aviation aircraft; and a subsidiary which specializes in health care equipment and other commercial equipment leases. The Banks subsidiaries also include real estate investment trust subsidiaries (the REIT subsidiaries) which own real estate related investments and a REIT subsidiary which owns some of the real estate utilized by the Bank and related real estate investments. Except for Valleys REIT subsidiaries, all subsidiaries mentioned above are directly or indirectly wholly-owned by the Bank. Because each REIT must have 100 or more shareholders to qualify as a REIT, each REIT has issued less than 20 percent of their outstanding non-voting preferred stock to individuals, most of whom are non-senior management Bank employees. The Bank owns the remaining preferred stock and all the common stock of the REITs.
Valley National Bank has four business segments it monitors and reports on to manage its business operations. These segments are consumer lending, commercial lending, investment management, and corporate and other adjustments. Valleys Wealth Management Division comprised of trust, asset management and insurance services, is included in the consumer lending segment. For financial data on the four business segments see Note 19 of the consolidated financial statements.
SEC Reports and Corporate Governance
We make our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K and amendments thereto available on our website at www.valleynationalbank.com without charge as soon as reasonably practicable after filing or furnishing them to the SEC. Also available on the website are Valleys Code of Conduct and Ethics that applies to all of our employees including our executive officers and directors, Valleys Audit and Risk Committee Charter, Valleys Compensation and Human Resources Committee Charter, Valleys Nominating and Corporate Governance Committee Charter as well as Valleys Corporate Governance Guidelines.
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We filed the certifications of the Chief Executive Officer (CEO) and Chief Financial Officer (CFO) required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 with respect to our Annual Report on Form 10-K as exhibits to this Report. Our CEO submitted the required annual CEOs Certification regarding the New York Stock Exchanges corporate governance listing standards within the required timeframe after the 2008 annual shareholders meeting.
Additionally, we will provide without charge, a copy of our Annual Report on Form 10-K or the Code of Conduct and Ethics to any shareholder by mail. Requests should be sent to Valley National Bancorp, Attention: Shareholder Relations, 1455 Valley Road, Wayne, NJ 07470.
Competition
The market for banking and bank-related services is highly competitive and we face substantial competition in all phases of our operations. We compete with other providers of financial services such as other bank holding companies, commercial banks, savings institutions, credit unions, mutual funds, mortgage companies, title agencies, asset managers, insurance companies and a growing list of other local, regional and national institutions which offer financial services. De novo branching by several national financial institutions and mergers between financial institutions within New Jersey and New York, as well as other neighboring states have heightened the competitive pressure in our primary markets. We compete by offering quality products and convenient services at competitive prices (including interest rates paid on deposits, interest rates charged on loans and fees charged for other non-interest related services). We continually review our products, locations, alternative delivery channels and various acquisition prospects and periodically engage in discussions regarding possible acquisitions to maintain and enhance our competitive position.
Employees
At December 31, 2008, Valley National Bank and its subsidiaries employed 2,783 full-time equivalent persons. Management considers relations with its employees to be satisfactory.
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Executive Officers
Names |
Age at December 31, 2008 |
Executive Officer Since |
Office | |||
Gerald H. Lipkin |
67 | 1975 | Chairman of the Board, President and Chief Executive Officer of Valley and Valley National Bank | |||
Peter Crocitto |
51 | 1991 | Executive Vice President, Chief Operating Officer of Valley and Valley National Bank | |||
Albert L. Engel |
60 | 1998 | Executive Vice President of Valley and Valley National Bank | |||
Alan D. Eskow |
60 | 1993 | Executive Vice President, Chief Financial Officer and Corporate Secretary of Valley and Valley National Bank | |||
James G. Lawrence |
65 | 2001 | Executive Vice President of Valley and Valley National Bank | |||
Robert M. Meyer |
62 | 1997 | Executive Vice President of Valley and Valley National Bank | |||
Elizabeth E. De Laney |
44 | 2007 | First Senior Vice President of Valley National Bank | |||
Kermit R. Dyke |
61 | 2001 | First Senior Vice President of Valley National Bank | |||
Robert E. Farrell |
62 | 1990 | First Senior Vice President of Valley National Bank | |||
Richard P. Garber |
65 | 1992 | First Senior Vice President of Valley National Bank | |||
Eric W. Gould |
40 | 2001 | First Senior Vice President of Valley National Bank | |||
Robert J. Mulligan |
61 | 1991 | First Senior Vice President of Valley National Bank | |||
Russell C. Murawski |
59 | 2007 | First Senior Vice President of Valley National Bank | |||
John H. Noonan |
62 | 2006 | First Senior Vice President of Valley National Bank | |||
Stephen P. Davey |
53 | 2002 | Senior Vice President of Valley National Bank | |||
Robert A. Ewing |
54 | 2007 | Senior Vice President of Valley National Bank |
All officers serve at the pleasure of the Board of Directors.
SUPERVISION AND REGULATION
The Banking industry is highly regulated. Statutory and regulatory controls increase a bank holding companys cost of doing business and limit the options of its management to deploy assets and maximize income. The following discussion is not intended to be a complete list of all the activities regulated by the banking laws or of the impact of such laws and regulations on Valley or Valley National Bank. It is intended only to briefly summarize some material provisions.
Bank Holding Company Regulation
Valley is a bank holding company within the meaning of the Holding Company Act. As a bank holding company, Valley is supervised by the Board of Governors of the Federal Reserve System (FRB) and is required to file reports with the FRB and provide such additional information as the FRB may require.
The Holding Company Act prohibits Valley, with certain exceptions, from acquiring direct or indirect ownership or control of more than five percent of the voting shares of any company which is not a bank and from engaging in any business other than that of banking, managing and controlling banks or furnishing services to subsidiary banks, except that it may, upon application, engage in, and may own shares of companies engaged in, certain businesses found by the FRB to be so closely related to banking as to be a proper incident thereto. The Holding Company Act requires prior approval by the FRB of the acquisition by Valley of more than five percent of the voting stock of any other bank. Satisfactory capital ratios and Community Reinvestment Act ratings and anti-money laundering policies are generally prerequisites to obtaining federal regulatory approval to make acquisitions. The policy of the FRB provides that a bank holding company is expected to act as a source of
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financial strength to its subsidiary bank and to commit resources to support the subsidiary bank in circumstances in which it might not do so absent that policy. Acquisitions through the Bank require approval of the Office of the Comptroller of the Currency of the United States (OCC). The Holding Company Act does not place territorial restrictions on the activities of non-bank subsidiaries of bank holding companies. The Gramm-Leach-Bliley Act, discussed below, allows Valley to expand into insurance, securities, merchant banking activities, and other activities that are financial in nature.
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (Interstate Banking and Branching Act) enables bank holding companies to acquire banks in states other than its home state, regardless of applicable state law. The Interstate Banking and Branching Act also authorizes banks to merge across state lines, thereby creating interstate banks with branches in more than one state. Under the legislation, each state had the opportunity to opt-out of this provision. Furthermore, a state may opt-in with respect to de novo branching, thereby permitting a bank to open new branches in a state in which the Bank does not already have a branch. Without de novo branching, an out-of-state commercial bank can enter the state only by acquiring an existing bank or branch. The vast majority of states have allowed interstate banking by merger but have not authorized de novo branching.
New Jersey enacted legislation to authorize interstate banking and branching and the entry into New Jersey of foreign country banks. New Jersey did not authorize de novo branching into the state. However, under federal law, federal savings banks which meet certain conditions may branch de novo into a state, regardless of state law.
Troubled Asset Relief Program Capital Purchase Program
In response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions, on October 3, 2008, the Emergency Economic Stabilization Act of 2008 (the EESA) was signed into law. Pursuant to the EESA, the U.S. Treasury was given the authority to, among other things, purchase up to $700 billion of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets.
On October 14, 2008, the Secretary of the U.S. Department of the Treasury announced that the Treasury will purchase equity stakes in a wide variety of banks and thrifts. Under the program, known as the Troubled Asset Relief Program Capital Purchase Program (the TARP Capital Purchase Program), from the $700 billion authorized by the EESA, the Treasury made $250 billion of capital available to U.S. financial institutions in the form of preferred stock. In conjunction with the purchase of preferred stock, the Treasury received, from participating financial institutions, warrants to purchase common stock with an aggregate market price equal to 15% of the preferred investment. Participating financial institutions were required to adopt the Treasurys standards for executive compensation and corporate governance for the period during which the Treasury holds equity issued under the TARP Capital Purchase Program.
At the invitation of the United States Treasury, we decided in November 2008 to enter into a Securities Purchase Agreement with the Treasury that provides for our participation in the TARP Capital Purchase Program. On November 14, 2008, Valley issued and sold to the Treasury 300,000 shares of Valley Fixed Rate Cumulative Perpetual Preferred Stock, with a liquidation preference of $1 thousand per share, and a ten-year warrant to purchase up to 2.3 million shares of Valleys common stock at an exercise price of $19.59 per share. Under the terms of the TARP program, the Treasurys consent will be required for any increase in our dividends paid to common stockholders (above a quarterly dividend of $0.20 per common share) or Valleys redemption, purchase or acquisition of Valley common stock or any trust preferred securities issued by Valley capital trusts until the third anniversary of the Valley senior preferred share issuance to the Treasury unless prior to such third anniversary the senior preferred shares are redeemed in whole or the Treasury has transferred all of these shares to third parties.
Participants in the TARP Capital Purchase Program were required to accept several compensation-related limitations associated with this Program. Each of our senior executive officers in November 2008 agreed in
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writing to accept the compensation standards in existence at that time under the program and thereby cap or eliminate some of their contractual or legal rights. The provisions agreed to were as follows:
| No golden parachute payments. Golden parachute payment under the TARP Capital Purchase Program means a severance payment resulting from involuntary termination of employment, or from bankruptcy of the employer, that exceeds three times the terminated employees average annual base salary over the five years prior to termination. Our senior executive officers have agreed to forego all golden parachute payments for as long as two conditions remain true: They remain senior executive officers (CEO, CFO and the next three highest-paid executive officers), and the Treasury continues to hold our equity or debt securities we issued to it under the TARP Capital Purchase Program (the period during which the Treasury holds those securities is the TARP Capital Purchase Program Covered Period.). |
| Recovery of EIP Awards and Incentive Compensation if Based on Certain Material Inaccuracies. Our senior executive officers have also agreed to a clawback provision, which means that we can recover incentive compensation paid during the TARP Capital Purchase Program Covered Period that is later found to have been based on materially inaccurate financial statements or other materially inaccurate measurements of performance. |
| No Compensation Arrangements That Encourage Excessive Risks. During the TARP Capital Purchase Program Covered Period, we are not allowed to enter into compensation arrangements that encourage senior executive officers to take unnecessary and excessive risks that threaten the value of our company. To make sure this does not happen, Valleys Compensation Committee is required to meet at least once a year with our senior risk officers to review our executive compensation arrangements in the light of our risk management policies and practices. Our senior executive officers written agreements include their obligation to execute whatever documents we may require in order to make any changes in compensation arrangements resulting from the Compensation Committees review. |
| Limit on Federal Income Tax Deductions. During the TARP Capital Purchase Program Covered Period, we are not allowed to take federal income tax deductions for compensation paid to senior executive officers in excess of $500,000 per year, with certain exceptions that do not apply to our senior executive officers. See Tax and Accounting Considerations below. |
On February 17, 2009, President Obama signed the American Recovery and Reinvestment Act of 2009 (the Stimulus Act) into law. The Stimulus Act modified the compensation-related limitations contained in the TARP Capital Purchase Program, created additional compensation-related limitations and directed the Secretary of the Treasury to establish standards for executive compensation applicable to participants in TARP, regardless of when participation commenced. Thus, the newly enacted compensation-related limitations are applicable to Valley and to the extent the Treasury may implement these restrictions unilaterally Valley will apply these provisions. The provisions may be retroactive. In their November 2008 agreements our executives did not waive their contract or legal rights with respect to these new and retroactive provisions; other officers now covered by these provisions were not asked and did not agree to waive their contract or legal rights. The compensation-related limitations applicable to Valley which have been added or modified by the Stimulus Act are as follows, which provisions must be included in standards established by the Treasury:
| No severance payments. Under the Stimulus Act golden parachutes were redefined as any severance payment resulting from involuntary termination of employment, or from bankruptcy of the employer, except for payments for services performed or benefits accrued. Consequently under the Stimulus Act Valley is prohibited from making any severance payment to our senior executive officers (defined in the Stimulus Act as the five highest paid senior executive officers) and our next five most highly compensated employees during the TARP Capital Purchase Program Covered Period. |
| Recovery of Incentive Compensation if Based on Certain Material Inaccuracies. The Stimulus Act also contains the clawback provision discussed above but extends its application to any bonus awards and other incentive compensation paid to any of our senior executive officers or next 20 most highly compensated employees during the TARP Capital Purchase Program Covered Period that is later found to have been based on materially inaccurate financial statements or other materially inaccurate measurements of performance. |
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| No Compensation Arrangements That Encourage Earnings Manipulation. Under the Stimulus Act, during the TARP Capital Purchase Program Covered Period, we are not allowed to enter into compensation arrangements that encourage manipulation of the reported earnings of Valley to enhance the compensation of any of our employees. |
| Limit on Incentive Compensation. The Stimulus Act contains a provision that prohibits the payment or accrual of any bonus, retention award or incentive compensation to any of our senior executive officers and our next 10 most highly compensated employees during the TARP Capital Purchase Program Covered Period other than awards of long-term restricted stock that (i) do not fully vest during the TARP Capital Purchase Program Covered Period, (ii) have a value not greater than one-third of the total annual compensation of the awardee and (iii) are subject to such other restrictions as determined by the Secretary of the Treasury. We do not know whether the award of incentive stock options are covered by this prohibition. The prohibition on bonus, incentive compensation and retention awards does not preclude payments required under written employment contracts entered into on or prior to February 11, 2009. |
| Compensation and Human Resources Committee Functions. The Stimulus Act requires that our Compensation and Human Resources Committee be comprised solely of independent directors and that it meet at least semiannually to discuss and evaluate our employee compensation plans in light of an assessment of any risk posed to us from such compensation plans. |
| Compliance Certifications. The Stimulus Act also requires a written certification by our Chief Executive Officer and Chief Financial Officer of our compliance with the provisions of the Stimulus Act. These certifications must be contained in Valleys Annual Report on Form 10-K [and are contained in this years Form 10-K]. |
| Treasury Review Excessive Bonuses Previously Paid. The Stimulus Act directs the Secretary of the Treasury to review all compensation paid to our senior executive officers and our next 20 most highly compensated employees to determine whether any such payments were inconsistent with the purposes of the Stimulus Act or were otherwise contrary to the public interest. If the Secretary of the Treasury makes such a finding, the Secretary of the Treasury is directed to negotiate with the TARP Capital Purchase Program recipient and the subject employee for appropriate reimbursements to the federal government with respect to the compensation and bonuses. |
| Say on Pay. Under the Stimulus Act the SEC is required to promulgate rules requiring a non-binding say on pay vote by the shareholders on executive compensation at the annual meeting during the TARP Capital Purchase Program Covered Period. |
Regulation of Bank Subsidiary
Valley National Bank is subject to the supervision of, and to regular examination by, the OCC. Various laws and the regulations thereunder applicable to Valley and its bank subsidiary impose restrictions and requirements in many areas, including capital requirements, the maintenance of reserves, establishment of new offices, the making of loans and investments, consumer protection, employment practices, bank acquisitions and entry into new types of business. There are various legal limitations, including Sections 23A and 23B of the Federal Reserve Act, which govern the extent to which a bank subsidiary may finance or otherwise supply funds to its holding company or its holding companys non-bank subsidiaries. Under federal law, no bank subsidiary may, subject to certain limited exceptions, make loans or extensions of credit to, or investments in the securities of, its parent or the non-bank subsidiaries of its parent (other than direct subsidiaries of such bank which are not financial subsidiaries) or take their securities as collateral for loans to any borrower. Each bank subsidiary is also subject to collateral security requirements for any loans or extensions of credit permitted by such exceptions.
Dividend Limitations
Valley is a legal entity separate and distinct from its subsidiaries. Valleys revenues (on a parent company only basis) result in substantial part from dividends paid by the Bank. The Banks dividend payments, without prior regulatory approval, are subject to regulatory limitations. Under the National Bank Act, dividends may be
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declared only if, after payment thereof, capital would be unimpaired and remaining surplus would equal 100 percent of capital. Moreover, a national bank may declare, in any one year, dividends only in an amount aggregating not more than the sum of its net profits for such year and its retained net profits for the preceding two years. In addition, the bank regulatory agencies have the authority to prohibit the Bank from paying dividends or otherwise supplying funds to Valley if the supervising agency determines that such payment would constitute an unsafe or unsound banking practice. See other dividend limitations to common stockholders under the Troubled Asset Relief Program Capital Purchase Program section above.
Loans to Related Parties
Valley National Banks authority to extend credit to its directors, executive officers and 10 percent stockholders, as well as to entities controlled by such persons, is currently governed by the requirements of the National Bank Act, Sarbanes-Oxley Act and Regulation O of the FRB thereunder. Among other things, these provisions require that extensions of credit to insiders (i) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features and (ii) not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of the Banks capital. In addition, extensions of credit in excess of certain limits must be approved by the Banks Board of Directors. Under the Sarbanes-Oxley Act, Valley and its subsidiaries, other than the Bank, may not extend or arrange for any personal loans to its directors and executive officers.
Community Reinvestment
Under the Community Reinvestment Act (CRA), as implemented by OCC regulations, a national bank has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate-income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institutions discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the OCC, in connection with its examination of a national bank, to assess the associations record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such association. The CRA also requires all institutions to make public disclosure of their CRA ratings. Valley National Bank received a satisfactory CRA rating in its most recent examination.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 added new legal requirements for public companies affecting corporate governance, accounting and corporate reporting.
The Sarbanes-Oxley Act of 2002 provides for, among other things:
| a prohibition on personal loans made or arranged by the issuer to its directors and executive officers (except for loans made by a bank subject to Regulation O); |
| independence requirements for audit committee members; |
| independence requirements for company outside auditors; |
| certification of financial statements within the Annual Report on Form 10-K and Quarterly Reports on Form 10-Q by the chief executive officer and the chief financial officer; |
| the forfeiture by the chief executive officer and the chief financial officer of bonuses or other incentive-based compensation and profits from the sale of an issuers securities by such officers in the twelve month period following initial publication of any financial statements that later require restatement due to corporate misconduct; |
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| disclosure of off-balance sheet transactions; |
| two-business day filing requirements for insiders filing on Form 4; |
| disclosure of a code of ethics for financial officers and filing a Current Report on Form 8-K for a change in or waiver of such code; |
| the reporting of securities violations up the ladder by both in-house and outside attorneys; |
| restrictions on the use of non-GAAP financial measures in press releases and SEC filings; |
| the creation of the Public Company Accounting Oversight Board (PCAOB); |
| various increased criminal penalties for violations of securities laws; |
| an assertion by management with respect to the effectiveness of internal control over financial reporting; and |
| a report by the companys external auditor on the effectiveness of internal control over financial reporting. |
Each of the national stock exchanges, including the New York Stock Exchange (NYSE) where Valley common securities are listed and the NASDAQ Capital Market, where certain Valley warrants are listed, have implemented corporate governance listing standards, including rules strengthening director independence requirements for boards, and requiring the adoption of charters for the nominating, corporate governance and audit committees. These rules require Valley to certify to the NYSE that there are no violations of any corporate listing standards. Valley has provided the NYSE with the certification required by the NYSE Rule.
USA PATRIOT Act
As part of the USA PATRIOT Act, Congress adopted the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 (the Anti Money Laundering Act). The Anti Money Laundering Act authorizes the Secretary of the Treasury, in consultation with the heads of other government agencies, to adopt special measures applicable to financial institutions such as banks, bank holding companies, broker-dealers and insurance companies. Among its other provisions, the Anti Money Laundering Act requires each financial institution: (i) to establish an anti-money laundering program; (ii) to establish due diligence policies, procedures and controls that are reasonably designed to detect and report instances of money laundering in United States private banking accounts and correspondent accounts maintained for non-United States persons or their representatives; and (iii) to avoid establishing, maintaining, administering, or managing correspondent accounts in the United States for, or on behalf of, a foreign shell bank that does not have a physical presence in any country. In addition, the Anti Money Laundering Act expands the circumstances under which funds in a bank account may be forfeited and requires covered financial institutions to respond under certain circumstances to requests for information from federal banking agencies within 120 hours.
Regulations implementing the due diligence requirements, require minimum standards to verify customer identity and maintain accurate records, encourage cooperation among financial institutions, federal banking agencies, and law enforcement authorities regarding possible money laundering or terrorist activities, prohibit the anonymous use of concentration accounts, and requires all covered financial institutions to have in place an anti-money laundering compliance program. The OCC, along with other banking agencies, have strictly enforced various anti-money laundering and suspicious activity reporting requirements using formal and informal enforcement tools to cause banks to comply with these provisions.
The Anti Money Laundering Act amended the Bank Holding Company Act and the Bank Merger Act to require the federal banking agencies to consider the effectiveness of any financial institution involved in a proposed merger transaction in combating money laundering activities when reviewing an application under these acts.
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Regulatory Relief Law
In late 2000, the American Home Ownership and Economic Act of 2000 instituted a number of regulatory relief provisions applicable to national banks, such as permitting national banks to have classified directors and to merge their business subsidiaries into the Bank.
Gramm-Leach-Bliley Act
The Gramm-Leach-Bliley Financial Modernization Act of 1999 (Gramm-Leach-Bliley Act) became effective in early 2000. The Gramm-Leach-Bliley Act provides for the following:
| allows bank holding companies meeting management, capital and Community Reinvestment Act standards to engage in a substantially broader range of non-banking activities than was previously permissible, including insurance underwriting and making merchant banking investments in commercial and financial companies; |
| allows insurers and other financial services companies to acquire banks; |
| removes various restrictions that previously applied to bank holding company ownership of securities firms and mutual fund advisory companies; and |
| establishes the overall regulatory structure applicable to bank holding companies that also engage in insurance and securities operations. |
If a bank holding company elects to become a financial holding company, it files a certification, effective in 30 days, and thereafter may engage in certain financial activities without further approvals. Valley has not elected to become a financial holding company.
The OCC adopted rules to allow national banks to form subsidiaries to engage in financial activities allowed for financial holding companies. Electing national banks must meet the same management and capital standards as financial holding companies but may not engage in insurance underwriting, real estate development or merchant banking. Sections 23A and 23B of the Federal Reserve Act apply to financial subsidiaries and the capital invested by a bank in its financial subsidiaries will be eliminated from the Banks capital in measuring all capital ratios. Valley National Bank sold its one wholly owned financial subsidiary, Glen Rauch Securities, Inc, on March 31, 2008.
The Gramm-Leach-Bliley Act modified other financial laws, including laws related to financial privacy and community reinvestment.
Additional proposals to change the laws and regulations governing the banking and financial services industry are frequently introduced in Congress, in the state legislatures and before the various bank regulatory agencies. The likelihood and timing of any such changes and the impact such changes might have on Valley cannot be determined at this time.
FIRREA
Under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA), a depository institution insured by the Federal Deposit Insurance Corp (FDIC) can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with (i) the default of a commonly controlled FDIC-insured depository institution or (ii) any assistance provided by the FDIC to a commonly controlled FDIC-insured depository institution in danger of default. These provisions have commonly been referred to as FIRREAs cross guarantee provisions. Further, under FIRREA, the failure to meet capital guidelines could subject a bank to a variety of enforcement remedies available to federal regulatory authorities.
FIRREA also imposes certain independent appraisal requirements upon a banks real estate lending activities and further imposes certain loan-to-value restrictions on a banks real estate lending activities. The Bank regulators have promulgated regulations in these areas.
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Temporary Liquidity Guarantee Program
On November 21, 2008, the Board of Directors of the FDIC adopted a final rule relating to the Temporary Liquidity Guarantee Program (TLG Program). The TLG Program was announced by the FDIC on October 14, 2008, preceded by the determination of systemic risk by the Secretary of the U.S. Department of the Treasury (after consultation with the President), as an initiative to counter the system-wide crisis in the nations financial sector. Under the TLG Program the FDIC will (i) guarantee, through the earlier of maturity or June 30, 2012, certain newly issued senior unsecured debt issued by participating institutions on or after October 14, 2008, and before June 30, 2009 and (ii) provide full FDIC deposit insurance coverage for non-interest bearing transaction deposit accounts, Negotiable Order of Withdrawal (NOW) accounts paying less than 0.5% interest per annum and Interest on Lawyers Trust Accounts held at participating FDIC- insured institutions through December 31, 2009. Coverage under the TLG Program was available for the first 30 days without charge. The fee assessment for coverage of senior unsecured debt ranges from 50 basis points to 100 basis points per annum, depending on the initial maturity of the debt. The fee assessment for deposit insurance coverage is 10 basis points per quarter on amounts in covered accounts exceeding $250,000. During the first week of December 2008, we elected to participate in both guarantee programs.
FDICIA
Pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), each federal banking agency has promulgated regulations, specifying the levels at which a financial institution would be considered well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, or critically undercapitalized, and to take certain mandatory and discretionary supervisory actions based on the capital level of the institution. To qualify to engage in financial activities under the Gramm-Leach-Bliley Act, all depository institutions must be well capitalized. The financial holding company of a national bank will be put under directives to raise its capital levels or divest its activities if the depository institution falls from that level.
The OCCs regulations implementing these provisions of FDICIA provide that an institution will be classified as well capitalized if it (i) has a total risk-based capital ratio of at least 10.0 percent, (ii) has a Tier 1 risk-based capital ratio of at least 6.0 percent, (iii) has a Tier 1 leverage ratio of at least 5.0 percent, and (iv) meets certain other requirements. An institution will be classified as adequately capitalized if it (i) has a total risk-based capital ratio of at least 8.0 percent, (ii) has a Tier 1 risk-based capital ratio of at least 4.0 percent, (iii) has a Tier 1 leverage ratio of (a) at least 4.0 percent or (b) at least 3.0 percent if the institution was rated 1 in its most recent examination, and (iv) does not meet the definition of well capitalized. An institution will be classified as undercapitalized if it (i) has a total risk-based capital ratio of less than 8.0 percent, (ii) has a Tier 1 risk-based capital ratio of less than 4.0 percent, or (iii) has a Tier 1 leverage ratio of (a) less than 4.0 percent or (b) less than 3.0 percent if the institution was rated 1 in its most recent examination. An institution will be classified as significantly undercapitalized if it (i) has a total risk-based capital ratio of less than 6.0 percent, (ii) has a Tier 1 risk-based capital ratio of less than 3.0 percent, or (iii) has a Tier 1 leverage ratio of less than 3.0 percent. An institution will be classified as critically undercapitalized if it has a tangible equity to total assets ratio that is equal to or less than 2.0 percent. An insured depository institution may be deemed to be in a lower capitalization category if it receives an unsatisfactory examination rating. Similar categories apply to bank holding companies. Valley National Banks capital ratios were all above the minimum levels required for it to be considered a well capitalized financial institution at December 31, 2008.
In addition, significant provisions of FDICIA required federal banking regulators to impose standards in a number of other important areas to assure bank safety and soundness, including internal controls, information systems and internal audit systems, credit underwriting, asset growth, compensation, loan documentation and interest rate exposure.
An investment in our securities is subject to risks inherent in our business. The material risks and uncertainties that management believes affect Valley are described below. Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other
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information included or incorporated by reference in this report. The risks and uncertainties described below are not the only ones facing Valley. Additional risks and uncertainties that management is not aware of or that management currently believes are immaterial may also impair Valleys business operations. The value or market price of our securities could decline due to any of these identified or other risks, and you could lose all or part of your investment. This report is qualified in its entirety by these risk factors.
Recent Negative Developments in the Financial Services Industry and U.S. and Global Credit Markets May Adversely Impact Our Operations and Results.
Negative developments in the latter half of 2007 throughout 2008 and 2009 to date in the capital markets have resulted in uncertainty in the financial markets in general with the expectation of the general economic downturn for the remainder of 2009 and possibly beyond. Loan portfolio performances have deteriorated at many institutions resulting from, amongst other factors, a weak economy and a decline in the value of the collateral supporting their loans. The competition for our deposits has increased significantly due to liquidity concerns at many of these same institutions. Stock prices of bank holding companies, like ours, have been negatively affected by the current condition of the financial markets, as has our ability, if needed, to raise capital or borrow in the debt markets compared to recent years. As a result, there is a potential for new federal or state laws and regulations regarding lending and funding practices and liquidity standards, and financial institution regulatory agencies are expected to be very aggressive in responding to concerns and trends identified in examinations, including the expected issuance of many formal enforcement actions. Negative developments in the financial services industry and the impact of new legislation in response to those developments could negatively impact our operations by restricting our business operations, including our ability to originate or sell loans, and adversely impact our financial performance.
Declines in Value May Adversely Impact the Investment Portfolio.
As of December 31, 2008, we had approximately $1.4 billion and $1.2 billion in available for sale and held to maturity investment securities, respectively. We may be required to record impairment charges (or mark-to-market adjustments) 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 in future periods. If an impairment charge is significant enough it could affect the ability of our Bank to upstream dividends to us, which could have a material adverse effect on our liquidity and our ability to pay dividends to shareholders and could also negatively impact our regulatory capital ratios and result in our Bank not being classified as well-capitalized for regulatory purposes.
Changes in Interest Rates Can Have an Adverse Effect on Profitability.
Valleys earnings and cash flows are largely dependent upon its net interest income. Net interest income is the difference between interest income earned on interest-earning assets, such as loans and investment securities, and interest expense paid on interest-bearing liabilities, such as deposits and borrowed funds. Interest rates are sensitive to many factors that are beyond Valleys control, including general economic conditions, competition, and policies of various governmental and regulatory agencies and, in particular, the policies of the Board of Governors of the Federal Reserve. Changes in monetary policy, including changes in interest rates, could influence not only the interest Valley receives on loans and investment securities and the amount of interest it pays on deposits and borrowings, but such changes could also affect (i) Valleys ability to originate loans and obtain deposits, (ii) the fair value of Valleys financial assets and liabilities, including the held to maturity, available for sale, and trading securities portfolios, and (iii) the average duration of Valleys interest-earning assets. This also includes the risk that interest-earning assets may be more responsive to changes in interest rates than interest-bearing liabilities, or vice versa (repricing risk), the risk that the individual interest rates or rate indices underlying various interest-earning assets and interest-bearing liabilities may not change in the same degree over a given time period (basis risk), and the risk of changing interest rate relationships across the spectrum of interest-earning asset and interest-bearing liability maturities (yield curve risk), including a prolonged flat or inverted yield curve environment.
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Although management believes it has implemented effective asset and liability management strategies to reduce the potential effects of changes in interest rates on Valleys results of operations, any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on Valleys financial condition and results of operations.
The Price of Our Common Stock May Fluctuate.
The price of our common stock on the NYSE constantly changes and recently, given the uncertainty in the financial markets, has fluctuated widely. We expect that the market price of our common stock will continue to fluctuate. Holders of our common stock will be subject to the risk of volatility and changes in prices.
Our common stock price can fluctuate as a result of a variety of factors, many of which are beyond our control. These factors include:
| quarterly fluctuations in our operating and financial results; |
| operating results that vary from the expectations of management, securities analysts and investors; |
| changes in expectations as to our future financial performance, including financial estimates by securities analysts and investors; |
| events negatively impacting the financial services industry which result in a general decline in the market valuation of our common stock; |
| announcements of material developments affecting our operations or our dividend policy; |
| future sales of our equity securities; |
| new laws or regulations or new interpretations of existing laws or regulations applicable to our business; |
| changes in accounting standards, policies, guidance, interpretations or principles; and |
| general domestic economic and market conditions. |
In addition, recently the stock market generally has experienced extreme price and volume fluctuations, and industry factors and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes or credit loss trends, could also cause our stock price to decrease regardless of our operating results.
Liquidity Risk.
Liquidity risk is the potential that Valley will be unable to meet its obligations as they come due, capitalize on growth opportunities as they arise, or pay regular dividends because of an inability to liquidate assets or obtain adequate funding in a timely basis, at a reasonable cost and within acceptable risk tolerances.
Liquidity is required to fund various obligations, including credit commitments to borrowers, mortgage and other loan originations, withdrawals by depositors, repayment of borrowings, dividends to shareholders, operating expenses and capital expenditures.
Liquidity is derived primarily from retail deposit growth and retention; principal and interest payments on loans; principal and interest payments on investment securities; sale, maturity and prepayment of investment securities; net cash provided from operations and access to other funding sources.
Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity due to a market downturn or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a severe disruption of the financial markets or negative views and expectations about the prospects for the financial services industry as a whole as the recent turmoil faced by banking organizations in the domestic and worldwide credit markets deteriorates.
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We May be Adversely Affected by the Soundness of Other Financial Institutions.
Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and routinely execute transactions with counterparties in the financial services industry, including the Federal Home Loan Bank of New York, commercial banks, brokers and dealers, investment banks, and other institutional clients. Many of these transactions expose us to credit risk in the event of a default by a counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized or is liquidated at prices not sufficient to recover the full amount due to us. Any such losses could have a material adverse effect on our financial condition and results of operations.
Competition in the Financial Services Industry.
Valley faces substantial competition in all areas of its operations from a variety of different competitors, many of which are larger and may have more financial resources than Valley. Valley competes with other providers of financial services such as commercial and savings banks, savings and loan associations, credit unions, money market and mutual funds, mortgage companies, title agencies, asset managers, insurance companies and a large list of other local, regional and national institutions which offer financial services. Mergers between financial institutions within New Jersey and in neighboring states have added competitive pressure. If Valley is unable to compete effectively, it will lose market share and its income generated from loans, deposits, and other financial products will decline.
Our Preferred Shares Impact Net Income Available to Our Common Stockholders and Our Earnings Per Share.
As long as there are senior preferred shares outstanding, no dividends may be paid on our common stock unless all dividends on the senior preferred shares have been paid in full. The dividends declared on our fixed rate preferred shares will reduce the net income available to common shareholders and our earnings per common share. Additionally, warrants to purchase Valley common stock issued to the Treasury Department, in conjunction with the preferred shares, may be dilutive to our earnings per share. The senior preferred shares will also receive preferential treatment in the event of liquidation, dissolution or winding up of Valley.
Moreover, holders of our common stock are entitled to receive dividends only when, as and if declared by our board of directors. Although we have historically declared cash dividends on our common stock, we are not required to do so and our board of directors may reduce or eliminate our common stock dividend in the future. This could adversely affect the market price of our common stock.
Future Offerings of Debt or Other Securities May Adversely Affect the Market Price of Our Stock.
In the future, we may attempt to increase our capital resources or, if our or Valley National Banks capital ratios fall below the required minimums, we or Valley National Bank could be forced to raise additional capital by making additional offerings of debt or preferred equity securities, including medium-term notes, trust preferred securities, senior or subordinated notes and preferred stock. Upon liquidation, holders of our debt securities and shares of preferred stock and lenders with respect to other borrowings will receive distributions of our available assets prior to the holders of our common stock. Additional equity offerings may dilute the holdings of our existing shareholders or reduce the market price of our common stock, or both. Holders of our common stock are not entitled to preemptive rights or other protections against dilution.
Allowance For Loan Losses May Be Insufficient.
Valley maintains an allowance for loan losses based on, among other things, national and regional economic conditions, historical loss experience and delinquency trends. However, Valley cannot predict loan losses with certainty, and Valley cannot provide assurance that charge-offs in future periods will not exceed the allowance for loan losses. If net charge-offs exceed Valleys allowance, its earnings would decrease. In addition, regulatory
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agencies review Valleys allowance for loan losses and may require additions to the allowance based on their judgment about information available to them at the time of their examination. Valleys management could also decide that the allowance for loan losses should be increased. An increase in Valleys allowance for loan losses could reduce its earnings.
Loss of Lower-Cost Funding Sources.
Checking and savings, NOW, and money market deposit account balances and other forms of customer deposits can decrease when customers perceive alternative investments, such as the stock market, as providing a better risk/return tradeoff. If customers move money out of bank deposits and into other investments, Valley could lose a relatively low cost source of funds, increasing its funding costs and reducing Valleys net interest income and net income.
Changes in Primary Market Areas Could Adversely Impact Results of Operations and Financial Condition.
Much of Valleys lending is in northern and central New Jersey and New York City. As a result of this geographic concentration, a significant broad-based deterioration in economic conditions in New Jersey and the New York City metropolitan area could have a material adverse impact on the quality of Valleys loan portfolio, and accordingly, Valleys results of operations. Such a decline in economic conditions could restrict borrowers ability to pay outstanding principal and interest on loans when due, and, consequently, adversely affect the cash flows of Valleys business.
Valleys loan portfolio is largely secured by real estate collateral. A substantial portion of the real and personal property securing the loans in Valleys portfolio is located in New Jersey and New York City. Conditions in the real estate markets in which the collateral for Valleys loans are located strongly influence the level of Valleys non-performing loans and results of operations. A decline in the New Jersey and New York City metropolitan area real estate markets, as well as other external factors, could adversely affect Valleys loan portfolio.
Potential Acquisitions May Disrupt Valleys Business and Dilute Shareholder Value.
Valley regularly evaluates merger and acquisition opportunities and conducts due diligence activities related to possible transactions with other financial institutions and financial services companies. As a result, merger or acquisition discussions and, in some cases, negotiations may take place and future mergers or acquisitions involving cash, debt or equity securities may occur at any time. Acquisitions typically involve the payment of a premium over book and market values, and, therefore, some dilution of Valleys tangible book value and net income per common share may occur in connection with any future transaction. Furthermore, failure to realize the expected revenue increases, cost savings, increases in geographic or product presence, and/or other projected benefits from an acquisition could have a material adverse effect on Valleys financial condition and results of operations.
Implementation of Growth Strategies.
Valley has a strategic branch expansion initiative to expand its physical presence in New York City, including Kings and Queens counties, New York, and fill in its markets within New Jersey. Additionally, in 2007, Valley expanded the geographic presence of its auto loan dealer network into Connecticut, which network already includes Pennsylvania, New York, New Jersey, and Florida (the Florida dealer network was an insignificant portion of our overall auto loan production in 2008 and 2007 and Valley stopped loan origination activity in this state during February 2009). Valley can provide no assurances that it will successfully implement or continue these initiatives.
Valleys ability to successfully execute these initiatives depends upon a variety of factors, including its ability to attract and retain experienced personnel, the continued availability of desirable business opportunities and locations, the competitive responses from other financial institutions in Valleys new market areas, and the ability to manage growth. These initiatives could cause Valleys expenses to increase faster than revenues.
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There are considerable initial and on-going costs involved in opening branches, growing loans in new markets, and attracting new deposit relationships. These expenses could negatively impact future earnings. For example, it takes time for new branches and relationships to achieve profitability. Expenses could be further increased if there are delays in the opening of new branches or if attraction strategies are more costly than expected. Delays in opening new branches can be caused by a number of factors such as the inability to find suitable locations, zoning and construction delays, and the inability to attract qualified personnel to staff the new branch. In addition, there is no assurance that a new branch will be successful even after it has been established.
From time to time, Valley may implement new lines of business or offer new products and services within existing lines of business. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. Valley may invest significant time and resources to develop and market new lines of business and/or products and services. Initial timetables for the introduction and development of new lines of business and/or new products or services may not be achieved and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives, and shifting customer preferences, may also impact the successful implementation of a new line of business or a new product or service. Additionally, any new line of business and/or new product or service could have a significant impact on the effectiveness of Valleys system of internal controls. Failure to successfully manage these risks could have a material adverse effect on Valleys business, results of operations and financial condition.
Changes in Accounting Policies or Accounting Standards.
Valleys accounting policies are fundamental to understanding its financial results and condition. Some of these policies require use of estimates and assumptions that may affect the value of Valleys assets or liabilities and financial results. Valley identified its accounting policies regarding the allowance for loan losses, security valuations, goodwill and other intangible assets, and income taxes to be critical because they require management to make difficult, subjective and complex judgments about matters that are inherently uncertain. Under each of these policies, it is possible that materially different amounts would be reported under different conditions, using different assumptions, or as new information becomes available.
From time to time the Financial Accounting Standards Board (FASB) and the SEC change the financial accounting and reporting standards that govern the form and content of Valleys external financial statements. In addition, accounting standard setters and those who interpret the accounting standards (such as the FASB, SEC, banking regulators and Valleys outside auditors) may change or even reverse their previous interpretations or positions on how these standards should be applied. Changes in financial accounting and reporting standards and changes in current interpretations may be beyond Valleys control, can be hard to predict and could materially impact how Valley reports its financial results and condition. In certain cases, Valley could be required to apply a new or revised standard retroactively or apply an existing standard differently (also retroactively) which may result in Valley restating prior period financial statements in material amounts.
Extensive Regulation and Supervision.
Valley, primarily through its principal subsidiary, Valley National Bank, and certain non-bank subsidiaries, is subject to extensive federal and state regulation and supervision. Banking regulations are primarily intended to protect depositors funds, federal deposit insurance funds and the banking system as a whole. Such laws are not designed to protect Valley shareholders. These regulations affect Valleys lending practices, capital structure, investment practices, dividend policy and growth, among other things. Valley is also subject to a number of federal laws, which, among other things, require it to lend to various sectors of the economy and population, and establish and maintain comprehensive programs relating to anti-money laundering and customer identification. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes, especially for the TARP Capital Purchase Program (which Valley is a participant). Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect Valley in substantial and unpredictable ways. Such changes could subject Valley to additional costs, limit the types of financial services and products it may offer and/or increase the ability of
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non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on Valleys business, financial condition and results of operations. Valleys compliance with certain of these laws will be considered by banking regulators when reviewing bank merger and bank holding company acquisitions. While Valley has policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur.
In particular, the documents that we executed with the Treasury when they purchased the senior preferred stock allow the Treasury to unilaterally change the terms of the senior preferred stock or impose additional requirements on Valley and/or the Bank if there is a change in law. These changes or additional requirements could restrict Valleys ability to conduct its business, could subject Valley to additional cost and expense or could change the terms of the senior preferred stock agreement to the detriment of Valleys common shareholders. While it may be possible for Valley to redeem the senior preferred stock in the event the Treasury imposes any changes or additional requirements that Valley believes are detrimental, there can be no assurances that Valleys federal regulator will approve such redemption (as is required by law) or that Valley will have the ability to implement such redemption.
Encountering Continuous Technological Change.
The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Valleys future success depends, in part, upon its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in Valleys operations. Many of Valleys competitors have substantially greater resources to invest in technological improvements. Valley may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to its customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on Valleys business and, in turn, Valleys financial condition and results of operations.
Operational Risk.
Valley faces the risk that the design of its controls and procedures, including those to mitigate the risk of fraud by employees or outsiders, may prove to be inadequate or are circumvented, thereby causing delays in detection of errors or inaccuracies in data and information. Management regularly reviews and updates Valleys internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of Valleys controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on Valleys business, results of operations and financial condition.
Valley may also be subject to disruptions of its systems arising from events that are wholly or partially beyond its control (including, for example, computer viruses or electrical or telecommunications outages), which may give rise to losses in service to customers and to financial loss or liability. Valley is further exposed to the risk that its external vendors may be unable to fulfill their contractual obligations (or will be subject to the same risk of fraud or operational errors by their respective employees as is Valley) and to the risk that Valleys (or its vendors) business continuity and data security systems prove to be inadequate.
Valleys performance is largely dependent on the talents and efforts of highly skilled individuals. There is intense competition in the financial services industry for qualified employees. In addition, Valley faces increasing competition with businesses outside the financial services industry for the most highly skilled individuals. Valleys business operations could be adversely affected if it were unable to attract new employees and retain and motivate its existing employees.
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Claims and Litigation Pertaining to Fiduciary Responsibility.
From time to time as part of Valleys normal course of business, customers make claims and take legal action against Valley based on actions or inactions of Valley. If such claims and legal actions are not resolved in a manner favorable to Valley, they may result in financial liability and/or adversely affect the market perception of Valley and its products and services. This may also impact customer demand for Valleys products and services. Any financial liability or reputation damage could have a material adverse effect on Valleys business, which, in turn, could have a material adverse effect on its financial condition and results of operations.
Item 1B. Unresolved Staff Comments
None.
We conduct our business at 195 retail banking center locations, with 173 in northern and central New Jersey and 22 in the New York City metropolitan area. We own 91 of our banking center facilities. The other facilities are leased for various terms. Additionally, we have 12 other properties located in New Jersey and New York City that were either owned or under contract to purchase or lease as of December 31, 2008. We intend to develop these properties into new retail branch locations during 2009 and 2010.
Our principal business office is located at 1455 Valley Road, Wayne, New Jersey. Including our principal business office, we own five office buildings in Wayne, New Jersey and one building in Chestnut Ridge, New York which are used for various operations of Valley National Bank and its subsidiaries.
The total net book value of our premises and equipment (including land, buildings, leasehold improvements and furniture and equipment) was $256.3 million at December 31, 2008. We believe that all of our properties and equipment are well maintained, in good condition and adequate for all of our present and anticipated needs.
In the normal course of business, we may be a party to various outstanding legal proceedings and claims. In the opinion of management, except for the lawsuits noted below, our consolidated statements of financial condition or results of operations should not be materially affected by the outcome of such legal proceedings and claims.
American Express Travel Related Services Company (American Express) filed a lawsuit against us in the United States District Court, Southern District of New York alleging, among other claims, that we breached our contractual and fiduciary duties to American Express in connection with our activities as a depository for Southeast Airlines, a now defunct charter airline carrier. Two other parties brought similar claims related to the same incident, and such claims were either dismissed by the court or settled for an immaterial amount. American Express withdrew its lawsuit without prejudice in October of 2007. We believe Valley has meritorious defenses to the action, if reinstated, but we cannot ensure that we will prevail in such potential future litigation or be able to settle such litigation for an immaterial amount.
Item 4. Submission of Matters to a Vote of Security Holders
None.
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Item 5. | Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
Our common stock is traded on the NYSE under the ticker symbol VLY. The following table sets forth for each quarter period indicated the high and low sales prices for our common stock, as reported by the NYSE, and the cash dividends declared per common share for each quarter. The amounts shown in the table below have been adjusted for all stock dividends and stock splits.
Year 2008 | Year 2007 | |||||||||||||||||
High | Low | Dividend | High | Low | Dividend | |||||||||||||
First Quarter |
$ | 19.70 | $ | 15.77 | $ | 0.20 | $ | 24.27 | $ | 21.90 | $ | 0.20 | ||||||
Second Quarter |
19.57 | 15.58 | 0.20 | 23.98 | 21.18 | 0.20 | ||||||||||||
Third Quarter |
24.75 | 13.63 | 0.20 | 22.77 | 19.70 | 0.20 | ||||||||||||
Fourth Quarter |
23.90 | 14.00 | 0.20 | 22.34 | 16.50 | 0.20 |
There were 8,843 shareholders of record as of December 31, 2008.
Restrictions on Dividends and Repurchases of Common Stock and Other Securities
The timing and amount of cash dividends paid depend on our earnings, capital requirements, financial condition and other relevant factors. The primary source for dividends paid to our common stockholders is dividends paid to us from Valley National Bank. Federal laws and regulations contain restrictions on the ability of national banks, like Valley National Bank, to pay dividends. For information regarding these restrictions on the Banks dividends, see Item 1. BusinessSupervision and RegulationDividend Limitations above and Note 16 to the consolidated financial statements contained in Item 8 of this report. In addition, under the terms of the trust preferred securities issued by VNB Capital Trust I and GCB Capital Trust III, we could not pay dividends on our common stock if we deferred payments on the junior subordinated debentures which provide the cash flow for the payments on the trust preferred securities.
In November 2008, we issued 300,000 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A (commonly referred to as senior preferred shares) to the U.S. Department of the Treasury (the Treasury). Until the earlier of the third anniversary of the issuance date or the date the Treasury no longer owns any of these senior preferred shares, the consent of the Treasury is required for:
| any increase in dividends paid on our common stock above a quarterly dividend of $0.20 per common share; |
| the repurchase of common stock in any way; or |
| the repurchase or redemption of any trust preferred securities issued by us. |
There are a few exceptions to the above, including:
| an acquisition of common stock in connection with an employee benefit plan in the ordinary course of business and consistent with past practice; |
| an acquisition by us or our subsidiaries of record ownership of common stock for the beneficial ownership of any other person, including as trustees or custodians; and |
| an exchange of either common stock for other securities ranking junior to the senior preferred shares or trust preferred securities for other securities ranking junior to, or on parity with, the senior preferred shares, solely to the extent required by binding agreements existing as of November 14, 2008 or any subsequent agreement calling for the accelerated exchange of such securities for common stock. |
Notwithstanding these exceptions, in the event that Valley has not paid the required dividends on the senior preferred shares, (i) Valley may not pay any dividends on its common stock or on any stock ranking junior to or on parity with the senior preferred shares; and (ii) Valley may not repurchase or redeem its common stock or on any stock ranking junior to or on parity with the senior preferred shares.
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Performance Graph
The following graph compares the cumulative total return on a hypothetical $100 investment made on December 31, 2003 in: (a) Valleys common stock; (b) the Standard and Poors (S&P) 500 Stock Index; and (c) the Keefe, Bruyette & Woods KBW50 Bank Index. The graph is calculated assuming that all dividends are reinvested during the relevant periods. The graph shows how a $100 investment would increase or decrease in value over time based on dividends (stock or cash) and increases or decreases in the market price of the stock.
12/03 | 12/04 | 12/05 | 12/06 | 12/07 | 12/08 | |||||||||||||
Valley |
$ | 100.00 | $ | 102.84 | $ | 97.57 | $ | 116.51 | $ | 91.38 | $ | 106.40 | ||||||
KBW 50 |
100.00 | 117.98 | 118.57 | 125.23 | 94.64 | 74.14 | ||||||||||||
S&P 500 |
100.00 | 110.87 | 116.31 | 134.66 | 142.05 | 89.51 |
Issuer Repurchase of Equity Securities
There were no purchases of equity securities by the issuer or affiliated purchasers during the three months ended December 31, 2008.
Equity Compensation Plan Information
The information set forth in Item 12 of Part III of this Annual Report under the heading Equity Compensation Plan Information is incorporated by reference herein.
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Item 6. Selected Financial Data
The following selected financial data should be read in conjunction with Valleys consolidated financial statements and the accompanying notes thereto presented herein in response to Item 8.
As of or for the Years Ended December 31, | ||||||||||||||||||||
2008 | 2007 | 2006 | 2005 | 2004 | ||||||||||||||||
(in thousands, except for share data) | ||||||||||||||||||||
Summary of Operations: |
||||||||||||||||||||
Interest incometax equivalent basis (1) |
$ | 735,153 | $ | 731,188 | $ | 713,930 | $ | 631,893 | $ | 525,315 | ||||||||||
Interest expense |
308,895 | 343,322 | 316,250 | 226,659 | 146,607 | |||||||||||||||
Net interest incometax equivalent basis (1) |
426,258 | 387,866 | 397,680 | 405,234 | 378,708 | |||||||||||||||
Less: tax equivalent adjustment |
5,459 | 6,181 | 6,559 | 6,809 | 6,389 | |||||||||||||||
Net interest income |
420,799 | 381,685 | 391,121 | 398,425 | 372,319 | |||||||||||||||
Provision for credit losses |
28,282 | 11,875 | 9,270 | 4,340 | 8,003 | |||||||||||||||
Net interest income after provisions for credit losses |
392,517 | 369,810 | 381,851 | 394,085 | 364,316 | |||||||||||||||
Non-interest income: |
||||||||||||||||||||
Other-than-temporary impairment on securities (2) |
(84,835 | ) | (17,949 | ) | (4,722 | ) | (835 | ) | (140 | ) | ||||||||||
Gains on sale of assets, net |
518 | 16,051 | 3,849 | 25 | 5 | |||||||||||||||
Other non-interest income |
87,573 | 90,926 | 72,937 | 74,543 | 84,457 | |||||||||||||||
Total non-interest income |
3,256 | 89,028 | 72,064 | 73,733 | 84,322 | |||||||||||||||
Non-interest expense: |
||||||||||||||||||||
Goodwill impairment |
| 2,310 | | | | |||||||||||||||
Other non-interest expense |
285,248 | 251,602 | 250,340 | 237,591 | 220,043 | |||||||||||||||
Total non-interest expense |
285,248 | 253,912 | 250,340 | 237,591 | 220,043 | |||||||||||||||
Income before income taxes |
110,525 | 204,926 | 203,575 | 230,227 | 228,595 | |||||||||||||||
Income tax expense |
16,934 | 51,698 | 39,884 | 66,778 | 74,197 | |||||||||||||||
Net income |
93,591 | 153,228 | 163,691 | 163,449 | 154,398 | |||||||||||||||
Dividends on preferred stock and accretion |
2,090 | | | | | |||||||||||||||
Net income available to common stockholders |
$ | 91,501 | $ | 153,228 | $ | 163,691 | $ | 163,449 | $ | 154,398 | ||||||||||
Per Common Share (3): |
||||||||||||||||||||
Earnings per share: |
||||||||||||||||||||
Basic |
$ | 0.70 | $ | 1.21 | $ | 1.27 | $ | 1.30 | $ | 1.29 | ||||||||||
Diluted |
0.70 | 1.21 | 1.27 | 1.29 | 1.28 | |||||||||||||||
Dividends declared |
0.80 | 0.80 | 0.78 | 0.76 | 0.73 | |||||||||||||||
Book value |
7.94 | 7.54 | 7.47 | 7.23 | 5.89 | |||||||||||||||
Tangible book value (4) |
5.56 | 5.92 | 5.80 | 5.54 | 5.51 | |||||||||||||||
Weighted average shares outstanding: |
||||||||||||||||||||
Basic |
130,435,853 | 126,272,915 | 128,487,882 | 126,122,061 | 119,935,539 | |||||||||||||||
Diluted |
130,507,649 | 126,646,859 | 129,012,078 | 126,588,233 | 120,552,328 | |||||||||||||||
Ratios: |
||||||||||||||||||||
Return on average assets |
0.69 | % | 1.25 | % | 1.33 | % | 1.39 | % | 1.51 | % | ||||||||||
Return on average shareholders equity |
8.74 | 16.43 | 17.24 | 19.17 | 22.77 | |||||||||||||||
Return on average tangible shareholders equity (5) |
11.57 | 21.17 | 22.26 | 23.61 | 24.54 | |||||||||||||||
Average shareholders equity to average assets |
7.94 | 7.58 | 7.72 | 7.25 | 6.62 | |||||||||||||||
Dividend payout |
114.29 | 65.35 | 60.71 | 58.00 | 57.05 | |||||||||||||||
Risked-based capital: |
||||||||||||||||||||
Tier 1 capital |
11.44 | % | 9.55 | % | 10.56 | % | 10.28 | % | 11.12 | % | ||||||||||
Total capital |
13.18 | 11.35 | 12.44 | 12.16 | 11.95 | |||||||||||||||
Leverage capital |
9.10 | 7.62 | 8.10 | 7.82 | 8.28 | |||||||||||||||
Financial Condition: |
||||||||||||||||||||
Assets |
$ | 14,718,129 | $ | 12,748,959 | $ | 12,395,027 | $ | 12,436,102 | $ | 10,763,391 | ||||||||||
Net loans |
10,050,446 | 8,423,557 | 8,256,967 | 8,055,269 | 6,866,459 | |||||||||||||||
Deposits |
9,232,923 | 8,091,004 | 8,487,651 | 8,570,001 | 7,518,739 | |||||||||||||||
Shareholders equity |
1,363,609 | 949,060 | 949,590 | 931,910 | 707,598 |
See Notes to the Selected Financial Data that follows.
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Notes to Selected Financial Data
(1) | In this report a number of amounts related to net interest income and net interest margin are presented on a tax equivalent basis using a 35 percent federal tax rate. Valley believes that this presentation provides comparability of net interest income and net interest margin arising from both taxable and tax-exempt sources and is consistent with industry practice and SEC rules. |
(2) | Other-than-temporary impairment on securities is presented within the losses on securities transactions, net category of total non-interest income on the consolidated statements of income. |
(3) | All per common share amounts reflect a five percent common stock dividend issued May 23, 2008, and all prior stock splits and dividends. |
(4) | This Annual Report on Form 10-K contains supplemental financial information which has been determined by methods other than U.S. generally accepted accounting principles (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 GAAP. |
Tangible book value per common share, which is a non-GAAP measure, is computed by dividing shareholders equity less goodwill and other intangible assets by common shares outstanding as follows:
At Years Ended December 31, | |||||||||||||||
2008 | 2007 | 2006 | 2005 | 2004 | |||||||||||
($ in thousands) | |||||||||||||||
Common shares outstanding |
135,024,030 | 125,844,074 | 127,181,388 | 128,874,591 | 120,159,522 | ||||||||||
Shareholders equity |
$ | 1,363,609 | $ | 949,060 | $ | 949,590 | $ | 931,910 | $ | 707,598 | |||||
Less: Preferred stock |
291,539 | | | | | ||||||||||
Less: Goodwill and other intangible assets |
321,100 | 204,547 | 211,355 | 217,354 | 45,888 | ||||||||||
Tangible shareholders equity |
$ | 750,970 | $ | 744,513 | $ | 738,235 | $ | 714,556 | $ | 661,710 | |||||
Tangible book value per common share |
$ | 5.56 | $ | 5.92 | $ | 5.80 | $ | 5.54 | $ | 5.51 | |||||
(5) | Return on average tangible shareholders equity, 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: |
At Years Ended December 31, | ||||||||||||||||||||
2008 | 2007 | 2006 | 2005 | 2004 | ||||||||||||||||
($ in thousands) | ||||||||||||||||||||
Net income |
$ | 93,591 | $ | 153,228 | $ | 163,691 | $ | 163,449 | $ | 154,398 | ||||||||||
Average shareholders equity |
1,071,358 | 932,637 | 949,613 | 852,834 | 678,068 | |||||||||||||||
Less: Average goodwill and other intangible assets |
262,613 | 208,797 | 214,338 | 160,607 | 48,805 | |||||||||||||||
Average tangible shareholders equity |
$ | 808,745 | $ | 723,840 | $ | 735,275 | $ | 692,227 | $ | 629,263 | ||||||||||
Return on average tangible shareholders equity |
11.57 | % | 21.17 | % | 22.26 | % | 23.61 | % | 24.54 | % | ||||||||||
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Item 7. | Managements Discussion and Analysis (MD&A) of Financial Condition and Results of Operations |
The purpose of this analysis is to provide the reader with information relevant to understanding and assessing Valleys results of operations for each of the past three years and financial condition for each of the past two years. In order to fully appreciate this analysis the reader is encouraged to review the consolidated financial statements and accompanying notes thereto appearing under Item 8 of this report, and statistical data presented in this document.
Cautionary Statement Concerning Forward-Looking Statements
This Annual Report on Form 10-K, 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 managements confidence and strategies and managements 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 expect, anticipate, look, view, opportunities, allow, continues, reflects, believe, may, should, will, estimates or similar statements or variations of such terms. Such forward-looking statements involve certain risks and uncertainties. Actual results may differ materially from such forward-looking statements. Valley assumes no obligation for updating any such forward-looking statement at any time. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, but are not limited to:
| unanticipated changes in the financial markets and the resulting unanticipated effects on financial instruments in our investment portfolio; |
| volatility in earnings due to certain financial assets and liabilities held at fair value; |
| the occurrence of an other-than-temporary impairment to investment securities classified as available for sale or held to maturity; |
| unanticipated changes in the direction of interest rates; |
| stronger than anticipated competition from banks, other financial institutions and other companies; |
| changes in loan, investment and mortgage prepayment assumptions; |
| insufficient allowance for credit losses; |
| a higher level of net loan charge-offs and delinquencies than anticipated; |
| the inability to realize expected cost savings and synergies from recent acquisitions in the amounts and timeframe anticipated; |
| material adverse changes in our operations or earnings; |
| the inability to retain customers or employees acquired in recent acquisitions; |
| a decline in the economy in our primary market areas, mainly in New Jersey and New York; |
| changes in relationships with major customers; |
| changes in income tax rates; |
| higher or lower cash flow levels than anticipated; |
| inability to hire or retain qualified employees; |
| a decline in the levels of deposits or loss of alternate funding sources; |
| a decrease in loan origination volume; |
| a change in legal and regulatory barriers including issues related to compliance with anti-money laundering and bank secrecy act laws; |
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| adoption, interpretation and implementation of new or pre-existing accounting pronouncements; |
| the development of new tax strategies or the disallowance of prior tax strategies; |
| passage by Congress of a law which unilaterally amends the terms of the U.S. Treasurys investment in Valley in a way that adversely affects Valley; |
| operational risks, including the risk of fraud by employees or outsiders and unanticipated litigation pertaining to Valleys fiduciary responsibility; and |
| the inability to successfully implement new lines of business or new products and services. |
Any public statements or disclosures by Valley following this report that modify or impact any of the forward-looking statements contained in or accompanying this report will be deemed to modify or supercede such forward-looking statements in or accompanying this report.
Critical Accounting Policies and Estimates
Our accounting and reporting policies conform, in all material respects, to GAAP. In preparing the consolidated financial statements, management has made estimates, judgments and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated statements of condition and results of operations for the periods indicated. Actual results could differ significantly from those estimates.
Valleys accounting policies are fundamental to understanding managements 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. We identified our policies on the allowance for loan losses, security valuations, 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 could be most subject to revision as new information becomes available. Management has reviewed the application of these policies with the Audit and Risk Committee of Valleys Board of Directors.
Allowance for Loan Losses. The allowance for loan losses represents managements estimate of probable loan losses inherent in the loan portfolio and is the largest component of the allowance for credit losses which also includes managements estimated reserve for unfunded commercial letters of credit. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the consolidated statement of financial condition. Note 1 of the consolidated financial statements describes the methodology used to determine the allowance for loan losses and a discussion of the factors driving changes in the amount of the allowance for loan losses is included in this MD&A.
The allowance for loan losses consists of four elements: (1) specific reserves for individually impaired credits, (2) reserves for classified, or higher risk rated, loans, (3) reserves for non-classified loans based on historical loss factors, and (4) reserves based on general economic conditions and other qualitative risk factors both internal and external to Valley, including changes in loan portfolio volume, the composition and concentrations of credit, new market initiatives, and the impact of competition on loan structuring and pricing.
Valley considers it difficult to quantify the impact of changes in forecast on its allowance for loan losses. However, management believes the following discussion may enable investors to better understand the variables that drive the allowance for loan losses.
For impaired credits, if the fair value of the loans were ten percent higher or lower, the allowance would have increased or decreased by approximately $210 thousand, respectively, at December 31, 2008.
If classified loan balances were ten percent higher or lower, the allowance would have increased or decreased by approximately $2.1 million, respectively, at December 31, 2008.
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The credit rating assigned to each non-classified credit is a significant variable in determining the allowance. If each non-classified credit were rated one grade worse, the allowance would have increased by $6.8 million, while if each non-classified credit were rated one grade better there would be no change in the level of the allowance as of December 31, 2008. Additionally, if the historical loss factors used to calculate the reserve for non-classified loans were ten percent higher or lower, the allowance would have increased or decreased by $6.3 million, respectively, at December 31, 2008.
A key variable in determining the allowance is managements judgment in determining the size of the reserves based on general economic conditions and other qualitative risk factors. At December 31, 2008, these reserves were 6.2 percent of the total allowance. If the reserves were ten percent higher or lower, the allowance would have increased or decreased by $590 thousand, respectively, at December 31, 2008.
Security Valuations. Management utilizes various inputs to determine the fair value of its investment portfolio. To the extent they exist, unadjusted quoted market prices in active markets (level 1) or quoted prices on similar assets (level 2) are utilized to determine the fair value of each investment in the portfolio. In the absence of quoted prices, valuation techniques would be used to determine fair value of any investments that require inputs that are both significant to the fair value measurement and unobservable (level 3). Valuation techniques are based on various assumptions, including, but not limited to cash flows, discount rates, rate of return, adjustments for nonperformance and liquidity, and liquidation values. A significant degree of judgment is involved in valuing investments using level 3 inputs. The use of different assumptions could have a positive or negative effect on consolidated financial condition or results of operations. The other-than-temporary impairment charges recognized in 2008 and 2007 primarily relate to perpetual preferred securities issued by Fannie Mae and Freddie Mac. See the Investment Securities section below and Note 4 to the consolidated financial statements for additional information.
Management must periodically evaluate if unrealized losses (as determined based on the securities valuation methodologies discussed above) on individual securities classified as held to maturity or available for sale in the investment portfolio are considered to be other-than-temporary. The analysis of other-than-temporary impairment requires the use of various assumptions, including, but not limited to, the length of time an investments book value is greater than fair value, the severity of the investments decline, as well as any credit deterioration of the investment. If the decline in value of an investment is deemed to be other-than-temporary, the investment is written down to fair value and a non-cash impairment charge is recognized in the period of such evaluation. We recognized other-than-temporary impairment on securities of $84.8 million, $17.9 million, and $4.7 million in 2008, 2007, and 2006, respectively, within the losses on security transactions, net category of total non-interest income on the consolidated statements of income.
Goodwill and Other Intangible Assets. We record all assets and liabilities acquired in purchase acquisitions, including goodwill and other intangible assets, at fair value as required by SFAS No. 141. Goodwill totaling $295.1 million at December 31, 2008 is not amortized but is subject to annual tests for impairment or more often if events or circumstances indicate it may be impaired. Other intangible assets are amortized over their estimated useful lives and are subject to impairment tests if events or circumstances indicate a possible inability to realize the carrying amount. The initial recording of goodwill and other intangible assets requires subjective judgments concerning estimates of the fair value of the acquired assets.
The goodwill impairment test is performed in two phases. The first step compares the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired; however, if the carrying amount of the reporting unit exceeds its fair value, an additional procedure must be performed. That additional procedure compares the implied fair value of the reporting units goodwill with the carrying amount of that goodwill. An impairment loss is recorded to the extent that the carrying amount of goodwill exceeds its implied fair value.
Other intangible assets totaling $26.0 million at December 31, 2008 are evaluated for impairment if events and circumstances indicate a possible impairment. Such evaluation of other intangible assets is based on undiscounted cash flow projections.
Fair value may be determined using: market prices, comparison to similar assets, market multiples, discounted cash flow analysis and other determinants. Estimated cash flows may extend far into the future and, by their nature, are difficult to determine over an extended timeframe. Factors that may significantly affect the
26
estimates include, among others, competitive forces, customer behaviors and attrition, changes in revenue growth trends, cost structures and technology, and changes in discount rates and specific industry or market sector conditions.
Other key judgments in accounting for intangibles include useful life and classification between goodwill and other intangible assets which require amortization. See Note 9 to consolidated financial statements for additional information regarding goodwill and other intangible assets.
To assist in assessing the impact of potential goodwill or other intangible asset impairment charges at December 31, 2008, the impact of a five percent impairment charge would result in a reduction in pre-tax income of approximately $16.1 million. During the fourth quarter of 2007, Valley recognized a $2.3 million goodwill impairment charge due to its decision to sell its unprofitable broker-dealer subsidiary. See Note 3 to the consolidated financial statements for details regarding the fair value measurement which resulted in the impairment of goodwill at December 31, 2007. No impairment was recognized on goodwill or other intangible assets during the year ended December 31, 2008.
Income Taxes. The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entitys financial statements or tax returns. Judgment is required in assessing the future tax consequences of events that have been recognized in our consolidated financial statements or tax returns. Fluctuations in the actual outcome of these future tax consequences could impact our consolidated financial condition or results of operations.
In connection with determining its income tax provision under SFAS No. 109, Accounting for Income Taxes and FASB Interpretation No. 48, Accounting for Uncertainty in Income TaxesAn Interpretation of FASB Statement No. 109, we maintain a reserve related to certain tax positions and strategies that management believes contain an element of uncertainty. Periodically, we evaluate each of our tax positions and strategies to determine whether the reserve continues to be appropriate. Notes 1 and 14 to the consolidated financial statements and the Income Taxes section below include additional discussion on the accounting for income taxes.
Recent Accounting Pronouncements. See Note 1 of the consolidated financial statements for a description of recent accounting pronouncements including the dates of adoption and the effect on the results of operations and financial condition.
Executive Summary
Net income for the year ended December 31, 2008 was $93.6 million compared to $153.2 million for the year ended December 31, 2007. The decrease was largely due to (i) net losses on securities transactions totaling $79.8 million (which includes other-than-temporary impairment charges) for the year ended December 31, 2008 compared to $15.8 million in net losses for the year ended December 31, 2007, (ii) a $16.4 million increase in the provision for credit losses due to loan growth, higher net charge-offs and deterioration in economic conditions, and (iii) a $15.5 million decrease in net gains on sales of assets due to a $16.4 million immediate gain on the sale of a Manhattan branch location in the comparable 2007 period. Fully diluted earnings per common share was $0.70 for the year ended December 31, 2008 compared to $1.21 per common share for the year ended December 31, 2007. All common share data is adjusted to reflect a five percent common stock dividend issued on May 23, 2008.
In 2008, the steep decline in short-term interest rates during the second half of the year and the illiquid financial markets proved challenging to navigate for Valley and many other financial institutions. However, net interest income, the primary driver of our earnings, grew to $420.8 million, a 10 percent increase from the prior year. The majority of this increase came from solid organic loan growth spurred on by opportunities to solicit quality customers away from competitors unable to meet the credit needs of their customers throughout the year, as well as over $800 million in loans acquired in the Greater Community Bancorp (Greater Community)
27
merger completed on July 1, 2008. The increase in loans allowed us to more than mitigate a 68 basis point decline in the yield on average loans as compared to 2007. See the Net Interest Income section below for more details.
However, our 2008 annual earnings results were substantially impacted by impairment charges of $69.8 million and realized losses of $5.4 million on Fannie Mae and Freddie Mac perpetual preferred stocks whose market values drastically declined subsequent to the U.S. Governments decision to place these companies into conservatorship and suspend their preferred stock dividends in the third quarter of 2008. We also recorded additional impairment charges totaling $15.0 million primarily on two pooled trust preferred securities and one private label mortgage backed security during 2008. See the Investment Securities section below and Note 4 to the consolidated financial statements for further analysis of our investment portfolio.
Our credit quality ratios continued to reflect our conservative underwriting approach during 2008. The loan portfolios performance remained at acceptable levels given the state of the U.S. economy and the low levels of our loan delinquencies and losses relative to our peers. Total loans past due in excess of 30 days were 1.06 percent of our total loan portfolio of $10.1 billion as of December 31, 2008, an increase of only 0.06 percent from one year ago. Net loan charge-offs were $19.9 million for the year ended December 31, 2008 compared to $11.7 million for the same period in 2007 mainly due to higher automobile loan charge-offs caused by the economic crisis. Management strives to maintain superior credit quality through our conservative loan underwriting policy; however, due to the current credit market conditions and the potential for further recessionary pressure in 2009, management cannot predict that our loan portfolio will continue to perform at levels experienced during 2008. See the Non-performing Assets section below for further analysis of Valleys credit quality.
On July 1, 2008, we completed the acquisition of Greater Community, a commercial bank holding company with approximately $1.0 billion in total assets. The addition of Greater Communitys 16 full-service branches in northern New Jersey expanded our branch network and strengthened our position within this very competitive and desirable market. We have seen much of the projected cost savings and synergies expected from this in-market acquisition during the fourth quarter of 2008 and management expects these benefits to gradually increase into the first quarter of 2009 and thereafter. However, the addition of Greater Communitys 16 branch locations coupled with 10 new branches opened during the year negatively impacted most expense categories within our non-interest expense for the year ended December 31, 2008.
On November 14, 2008, Valley completed its $300 million nonvoting senior preferred stock issuance to the U.S. Treasury under its TARP Capital Purchase Program. The issuance brought additional strength to Valleys already well-capitalized position (See Capital Adequacy section below). Although, it was not necessary for us to raise additional capital, Valley elected to participate in the program as an insurance policy against a prolonged downturn in the U.S. economy and a chance to better position us for acquisition opportunities that may result from further disruption in the financial markets. During the fourth quarter of 2008, we utilized a portion of the TARP funds in our lending operations. Total loans grew by $86.4 million during the fourth quarter, despite a $110.0 million decline in automobile loans during the same period caused by lower consumer demand and higher credit standards for such loan products. Furthermore, Valley had total new and renewed loan originations of $426.8 million during the fourth quarter of 2008.
In our Quarterly Report on Form 10-Q for the period ended September 30, 2008, we disclosed that management was reviewing certain owned branch and office real estate properties for potential sale-leaseback transactions. No sale-leaseback transaction has occurred to date; however, we continue to evaluate the projected benefits of such a transaction based on current market data. Sale-leaseback transactions allow the monetization of the appreciated market value of such properties and provide cash for future company growth, including additional growth in our loan portfolio. Furthermore, such transactions may result in the recognition of material immediate and deferred gains for financial statement purposes and allow the company to retain management of the properties over the lease term. There can be no assurance that we will complete such a transaction in the future.
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Net Interest Income
Net interest income consists of interest income and dividends earned on interest earning assets less interest expense paid on interest bearing liabilities and represents the main source of income for Valley. The net interest margin on a fully tax equivalent basis is calculated by dividing tax equivalent net interest income by average interest earning assets and is a key measurement used in the banking industry to measure income from earning assets. The net interest margin was 3.44 percent for the year ended December 31, 2008, an increase of 1 basis point compared to the same period of 2007. After declines in each of the six preceding years, the interest margin increased during 2008 largely due to managements continuing efforts to contain our cost of funds while conservatively growing our loan portfolio. However, interest rates declined dramatically during the second half of 2008 as the Federal Reserve cut the target federal funds rate nearly 200 basis points to an unprecedented low range of zero to 0.25 percent at December 31, 2008 in an attempt to ease credit and support the financial crisis in as many ways as possible. The immediate drop in interest rates combined with various other short-term liquidity strategies (including the use of additional short-term Federal Home Loan Bank advances) deployed by management caused our fourth quarter net interest income and interest margin to decline significantly from the third quarter of 2008. During the fourth quarter, we implemented interest rate floors within the loan terms of many of our new or renewed prime based loans and utilized a Valley prime lending rate (set by Valley management based on various internal and external factors) versus the New York prime lending rate to help stabilize our net interest income should market rates decline further in 2009. However, management cannot guarantee that this action and other asset/liability management strategies will prevent future declines in the net interest margin or net interest income.
Net interest income on a tax equivalent basis increased $38.4 million to $426.3 million for 2008 compared with $387.9 million for 2007. During 2008, a 69 basis point decline in interest rates paid on average interest bearing liabilities and higher average loan balances positively impacted our net interest income, but were partially offset by a 68 basis point decline in the yield on average loans and higher average interest bearing liabilities as compared to 2007. Market interest rates on interest bearing deposits were lower in 2008 as the average target federal funds rate decreased approximately 297 basis points as compared to 2007. Much of the decline in short-term interest rates came in the fourth quarter of 2008 and is expected to have a gradually positive impact on our cost of funds and net interest margin in 2009 as higher costing time deposits mature and potentially reprice at lower interest rates.
Our earning asset portfolio is comprised of both fixed rate and adjustable rate loans and investments. Many of our earning assets are priced based on the prevailing treasury rates, the Valley prime rate, or the New York prime rate. As noted above, the average federal funds rate decreased 297 basis points in 2008 partially due to three Federal Reserve cuts totaling approximately 200 basis points in the fourth quarter of 2008 to help loosen the credit markets and assist the ailing economy. As a result, Valleys prime rate has moved from 7.25 percent at December 31, 2007 to 4.50 percent at December 31, 2008, while the New York prime rate dropped even further to 3.25 percent at the end of 2008. On average, the 10-year treasury rate decreased from 4.63 percent in 2007 to 3.64 percent in 2008 and continued to decline in the first quarter of 2009, averaging 2.42 percent in January 2009, with the recent Federal Reserve actions. The decrease in both prime rates and the downward movement in the treasury rates will have a downward effect on the yield on our average earning assets in 2009.
Average loans totaling $9.4 billion for the year ended December 31, 2008 increased $1.1 million as compared to the same period for 2007 due almost equally to organic loan growth and loans acquired in the Greater Community merger. Average investment securities declined $31.1 million, or 1.1 percent in 2008 as compared to the year ended December 31, 2007. Due to the higher loan volumes, interest income on a tax equivalent basis for loans increased $12.8 million for the year ended December 31, 2008 compared with the same period in 2007, despite a 68 basis point decrease in the yield on average loans. Interest income on a tax equivalent basis for investment securities decreased $287 thousand mainly due to the decrease in average investment securities and a 31 basis point decline in yield on non-taxable securities for the twelve months in 2008 compared to the same period in 2007, partially mitigated by better yields on taxable securities. The decrease in average investment securities was mainly due to a portion of the investment cash flows reallocated to new loans as the illiquid and volatile financial markets made it increasingly difficult to identify and reinvest in investment securities with acceptable risk profiles and yields. The loss of dividends on Fannie Mae and Freddie
29
Mac preferred securities and the reduction in dividends from the Federal Home Loan Bank of New York also contributed to the decrease in interest income on investment securities from 2007. The 402 basis point decline in the yield on average federal funds sold and other interest bearing deposits combined with lower average balances within the category resulted in a decrease of $8.5 million in interest income on such investments in 2008 compared to the same period twelve month period in 2007.
Average interest bearing liabilities totaled $10.4 billion for the year ended December 31, 2008 increasing $1.0 billion from the same period in 2007 primarily due to higher long-term borrowings (mainly comprised of Federal Home Loan Bank advances), $714.9 million in deposits assumed in the acquisition of Greater Community, and new deposit initiatives at ten de novo branches and our other existing branches. The cost of savings, NOW, and money market accounts, time deposits, short-term borrowings, and long-term borrowings decreased 88, 87, 227, and 23 basis points, respectively, from 2007 due to the sharp decline in short-term interest rates. Average long-term borrowings increased $599.3 million from 2007 as we increased our long-term positions in Federal Home Loan Bank (FHLB) advances mainly during the fourth quarter of 2007 and carried the higher position for all of 2008. Average time deposits increased $216.1 million due to deposit initiatives implemented, in part, to offset fluctuations in money market and non-interest bearing account balances experienced in the fourth quarter of 2008, and time deposits totaling $216.2 million assumed in the acquisition of Greater Community on July 1, 2008. Average short-term borrowings increased $124.9 million partially due to $400 million in additional borrowings initiated near the end of the third quarter of 2008 to provide additional liquidity during a turbulent market period. These short-term borrowings, consisting of FHLB advances, were reduced to $300 million as of December 31, 2008 and have maturity dates between February and April 2009. Average savings, NOW, and money market deposits increased $62.1 million as compared to 2007 mainly due to $332.4 million in such deposits assumed from Greater Community, partially offset by some customer movement to Treasury securities during the financial crisis. We anticipate that the Federal Reserves decision to lower the target federal funds rate from 1.00 percent to a range of zero to 0.25 percent in December 2008 will positively impact our cost of deposits in 2009. However, continued competitive pricing of deposits, some depositors preference for the safety of Treasury securities due to the unpredictable financial markets and the lack of industry deposit growth may cause our short-term and long-term borrowings to further escalate in 2009.
The net interest margin on a tax equivalent basis was 3.44 percent for the year ended December 31, 2008 compared with 3.43 percent for the year ended December 31, 2007. The change was mainly attributable to the increase in average loans and a decrease in interest rates paid on all interest bearing liabilities, partially offset by a lower yield on average loans and higher average balances for all categories of interest bearing liabilities. Average interest rates earned on interest earning assets decreased 53 basis points while average interest rates paid on interest bearing liabilities decreased 69 basis points causing a 1 basis point increase in the net interest margin for Valley as compared to the year ended December 31, 2007.
During the fourth quarter of 2008, net interest income on a tax equivalent basis decreased $7.9 million and the net interest margin declined 34 basis points when compared with the third quarter of 2008. The linked quarter decreases were primarily due to a 30 basis point decline in the yield on interest earning assets during the fourth quarter of 2008 and additional interest expense related mainly to higher average interest-bearing liabilities. During the fourth quarter of 2008, the yield on interest earning assets declined due to several factors, including the U.S. Governments elimination of dividends on Freddie Mac and Fannie Mae preferred securities held in our available for sale investment portfolio, a substantial reduction in cash dividends on FHLB stock, lower yields on prime based loans, and a decrease of 98 basis points in the average target Federal funds rate which negatively affected Valleys increased cash position as compared to the third quarter of 2008. Valley continues to actively manage the interest earning assets and liabilities to maximize net interest margin and create shareholder value. Management believes that its move to require interest rate floors on most new and renewed adjusted rate loans and maintain its own Valley prime rate for such loans combined with the maturity and repricing of higher cost time deposits should help reduce the possibility of further declines in the margin. However, competitive pricing of deposits, further declines in market rates for loans and investments (including market pressures to adjust the Valley prime rate downward), and deterioration in the creditworthiness of prospective customers within our primary northern New Jersey and New York City markets could negatively impact net interest income during 2009.
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The following table reflects the components of net interest income for each of the three years ended December 31, 2008, 2007 and 2006:
ANALYSIS OF AVERAGE ASSETS, LIABILITIES AND SHAREHOLDERS EQUITY AND
NET INTEREST INCOME ON A TAX EQUIVALENT BASIS
2008 | 2007 | 2006 | |||||||||||||||||||||||||||||||
Average Balance |
Interest | Average Rate |
Average Balance |
Interest | Average Rate |
Average Balance |
Interest | Average Rate |
|||||||||||||||||||||||||
($ in thousands) | |||||||||||||||||||||||||||||||||
Assets |
|||||||||||||||||||||||||||||||||
Interest earning assets |
|||||||||||||||||||||||||||||||||
Loans (1)(2) |
$ | 9,386,987 | $ | 572,944 | 6.10 | % | $ | 8,261,111 | $ | 560,180 | 6.78 | % | $ | 8,262,739 | $ | 544,598 | 6.59 | % | |||||||||||||||
Taxable investments (3) |
2,561,299 | 144,497 | 5.64 | 2,576,336 | 142,971 | 5.55 | 2,861,562 | 146,875 | 5.13 | ||||||||||||||||||||||||
Tax-exempt investments (1)(3) |
253,560 | 15,522 | 6.12 | 269,631 | 17,335 | 6.43 | 289,194 | 18,287 | 6.32 | ||||||||||||||||||||||||
Federal funds sold and other interest bearing deposits |
182,779 | 2,190 | 1.20 | 205,175 | 10,702 | 5.22 | 79,295 | 4,170 | 5.26 | ||||||||||||||||||||||||
Total interest earning assets |
12,384,625 | 735,153 | 5.94 | 11,312,253 | 731,188 | 6.46 | 11,492,790 | 713,930 | 6.21 | ||||||||||||||||||||||||
Allowance for loan losses |
(80,436 | ) | (73,546 | ) | (75,848 | ) | |||||||||||||||||||||||||||
Cash and due from banks |
228,216 | 209,939 | 205,695 | ||||||||||||||||||||||||||||||
Other assets |
988,040 | 868,575 | 724,869 | ||||||||||||||||||||||||||||||
Unrealized losses on securities available for sale, net |
(31,982 | ) | (12,407 | ) | (48,225 | ) | |||||||||||||||||||||||||||
Total assets |
$ | 13,488,463 | $ | 12,304,814 | $ | 12,299,281 | |||||||||||||||||||||||||||
Liabilities and |
|||||||||||||||||||||||||||||||||
Interest bearing liabilities |
|||||||||||||||||||||||||||||||||
Savings, NOW and money market deposits |
$ | 3,536,655 | $ | 45,961 | 1.30 | % | $ | 3,474,558 | $ | 75,695 | 2.18 | % | $ | 3,759,058 | $ | 75,822 | 2.02 | % | |||||||||||||||
Time deposits |
3,171,057 | 117,152 | 3.69 | 2,954,930 | 134,674 | 4.56 | 2,764,696 | 112,654 | 4.07 | ||||||||||||||||||||||||
Total interest bearing deposits |
6,707,712 | 163,113 | 2.43 | 6,429,488 | 210,369 | 3.27 | 6,523,754 | 188,476 | 2.89 | ||||||||||||||||||||||||
Short-term borrowings |
555,524 | 10,163 | 1.83 | 430,580 | 17,645 | 4.10 | 434,579 | 18,211 | 4.19 | ||||||||||||||||||||||||
Long-term borrowings (4) |
3,092,524 | 135,619 | 4.39 | 2,493,228 | 115,308 | 4.62 | 2,434,778 | 109,563 | 4.50 | ||||||||||||||||||||||||
Total interest bearing liabilities |
10,355,760 | 308,895 | 2.98 | 9,353,296 | 343,322 | 3.67 | 9,393,111 | 316,250 | 3.37 | ||||||||||||||||||||||||
Non-interest bearing deposits |
1,981,744 | 1,923,785 | 1,938,439 | ||||||||||||||||||||||||||||||
Other liabilities |
79,601 | 95,096 | 18,118 | ||||||||||||||||||||||||||||||
Shareholders equity |
1,071,358 | 932,637 | 949,613 | ||||||||||||||||||||||||||||||
Total liabilities and shareholders equity |
$ | 13,488,463 | $ | 12,304,814 | $ | 12,299,281 | |||||||||||||||||||||||||||
Net interest income/interest rate spread (5) |
426,258 | 2.96 | % | 387,866 | 2.79 | % | 397,680 | 2.84 | % | ||||||||||||||||||||||||
Tax equivalent adjustment |
(5,459 | ) | (6,181 | ) | (6,559 | ) | |||||||||||||||||||||||||||
Net interest income, as |
$ | 420,799 | $ | 381,685 | $ | 391,121 | |||||||||||||||||||||||||||
Net interest margin (6) |
3.40 | % | 3.37 | % | 3.40 | % | |||||||||||||||||||||||||||
Tax equivalent adjustment |
0.04 | 0.06 | 0.06 | ||||||||||||||||||||||||||||||
Net interest margin on a fully tax equivalent basis (6) |
3.44 | % | 3.43 | % | 3.46 | % | |||||||||||||||||||||||||||
(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 statement of 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 Valley 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
Years Ended December 31, | ||||||||||||||||||||||||
2008 Compared to 2007 | 2007 Compared to 2006 | |||||||||||||||||||||||
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* |
$ | 71,944 | $ | (59,180 | ) | $ | 12,764 | $ | (107 | ) | $ | 15,689 | $ | 15,582 | ||||||||||
Taxable investments |
(838 | ) | 2,364 | 1,526 | (15,768 | ) | 11,864 | (3,904 | ) | |||||||||||||||
Tax-exempt investments* |
(1,006 | ) | (807 | ) | (1,813 | ) | (1,222 | ) | 270 | (952 | ) | |||||||||||||
Federal funds sold and other |
(1,056 | ) | (7,456 | ) | (8,512 | ) | 6,566 | (34 | ) | 6,532 | ||||||||||||||
Total increase (decrease) in interest income |
69,044 | (65,079 | ) | 3,965 | (10,531 | ) | 27,789 | 17,258 | ||||||||||||||||
Interest expense: |
||||||||||||||||||||||||
Savings, NOW and money market deposits |
1,330 | (31,064 | ) | (29,734 | ) | (5,962 | ) | 5,835 | (127 | ) | ||||||||||||||
Time deposits |
9,330 | (26,852 | ) | (17,522 | ) | 8,089 | 13,931 | 22,020 | ||||||||||||||||
Short-term borrowings |
4,145 | (11,627 | ) | (7,482 | ) | (166 | ) | (400 | ) | (566 | ) | |||||||||||||
Long-term borrowings and junior subordinated debentures |
26,536 | (6,225 | ) | 20,311 | 2,664 | 3,081 | 5,745 | |||||||||||||||||
Total increase (decrease) in interest expense |
41,341 | (75,768 | ) | (34,427 | ) | 4,625 | 22,447 | 27,072 | ||||||||||||||||
Increase (decrease) in net interest income |
$ | 27,703 | $ | 10,689 | $ | 38,392 | $ | (15,156 | ) | $ | 5,342 | $ | (9,814 | ) | ||||||||||
* | Interest income is presented on a fully tax equivalent basis using a 35 percent federal tax rate. |
Non-Interest Income
The following table presents the components of non-interest income for the years ended December 31, 2008, 2007 and 2006:
NON-INTEREST INCOME
Years ended December 31, | ||||||||||||
2008 | 2007 | 2006 | ||||||||||
(in thousands) | ||||||||||||
Trust and investment services |
$ | 7,161 | $ | 7,381 | $ | 7,108 | ||||||
Insurance premiums |
10,053 | 10,711 | 11,074 | |||||||||
Service charges on deposit accounts |
28,274 | 26,803 | 23,242 | |||||||||
Losses on securities transactions, net |
(79,815 | ) | (15,810 | ) | (5,464 | ) | ||||||
Trading gains, net |
3,166 | 7,399 | 1,208 | |||||||||
Fees from loan servicing |
5,236 | 5,494 | 5,970 | |||||||||
Gains on sales of loans, net |
1,274 | 4,785 | 1,516 | |||||||||
Gains on sales of assets, net |
518 | 16,051 | 3,849 | |||||||||
Bank owned life insurance |
10,167 | 11,545 | 8,171 | |||||||||
Other |
17,222 | 14,669 | 15,390 | |||||||||
Total non-interest income |
$ | 3,256 | $ | 89,028 | $ | 72,064 | ||||||
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Non-interest income represented 0.4 percent and 10.9 percent of total interest income plus non-interest income for 2008 and 2007, respectively. For the year ended December 31, 2008, non-interest income decreased $85.8 million or 96.3 percent, compared with the same period in 2007, mainly due to an increase in net losses on securities transactions and decreases in both net gains on sales of loans and net gains on sales of assets.
Service charges on deposit accounts increased $1.5 million, or 5.5 percent in 2008 compared with 2007 mainly due to an increase in checking fees and overdraft fees partially caused by additional deposits assumed in the acquisition of Greater Community on July 1, 2008.
Losses on securities transactions, net, increased $64.0 million to a net loss of $79.8 million for the year ended December 31, 2008. The increase was mainly due to the other-than-temporary impairment charges and realized losses of $75.2 million on Fannie Mae and Freddie Mac perpetual preferred stock, $6.4 million on one private label mortgage backed security and $7.8 million on two pooled trust preferred securities, net of gains on the sale of certain available for sale securities during 2008. During the fourth quarter of 2007, we recognized impairment charges of $17.9 million on the same Fannie Mae and Freddie Mac perpetual preferred securities. See the Investment Securities section below and Note 4 to the consolidated financial statements for further analysis of our investment portfolio.
Net trading gains decreased $4.2 million to $3.2 million for the year ended December 31, 2008 compared to $7.4 million in the same period in 2007. The decrease was primarily due to a $15.5 million decrease in mark to market adjustments on our trading portfolio from a $4.7 million net gain recorded during 2007 compared to a $10.8 million net loss recorded for 2008. Partially offsetting the decrease, the change in fair value of our junior subordinated debentures carried at fair value increased $11.1 million to a gain of $15.2 million for the year ended December 31, 2008 compared to $4.1 million gain in the same period of 2007. Losses on FHLB advances carried at fair value decreased $165 thousand to $1.2 million for 2008. The $1.2 million loss was realized on one fixed Federal Home Loan Bank advance carried at fair value, which was redeemed prior to its contractual maturity date during the second quarter of 2008. See Note 3 to the consolidated financial statements for further analysis of our financial instruments carried at fair value.
Net gains on sales of loans decreased $3.5 million to $1.3 million for the year ended December 31, 2008 compared to $4.8 million for the prior year. This decrease was primarily due to the gains realized on the sale of approximately $240 million of residential mortgage loans held for sale during 2007 that Valley elected to carry at fair value effective as of January 1, 2007.
Net gains on sales of assets decreased $15.5 million to $518 thousand for the year ended December 31, 2008 compared to approximately $16.1 million for the same period in 2007 mainly due to a $16.4 million immediate gain recognized on the sale of a Manhattan office building in the first quarter of 2007. Valley sold a nine-story building for approximately $37.5 million while simultaneously entering into a long-term lease for its branch office located on the first floor of the same building. The transaction resulted in a $32.3 million pre-tax gain, of which $16.4 million was immediately recognized in earnings in 2007 pursuant to the sale-leaseback accounting rules. The remaining deferred gain of $15.9 million is being amortized into earnings over the 20 year term of the lease, of which $650 thousand and $594 thousand was amortized to net gains on sales of assets during 2008 and 2007, respectively.
BOLI income decreased $1.4 million, or 11.9 percent for the year ended December 31, 2008 compared with the same period of 2007 primarily due to the current financial markets losses which had a negative impact on the performance of the underlying securities of the BOLI asset. BOLI income is exempt from federal and state income taxes. The BOLI asset is invested primarily in U.S. agency mortgage-backed securities and U.S. Treasuries, and the majority of the underlying portfolio is managed by one independent investment firm.
Other non-interest income increased $2.6 million or 17.4 percent for the year ended December 31, 2008 compared with the same period in 2007 mainly due to a $1.6 million gain resulting from the mandatory redemption of a portion of Valleys Class B Visa (member bank) common stock as part of Visas initial public offering in March of 2008 and a $417 thousand gain on the redemption of a portion of Valleys junior
33
subordinated debentures issued to VNB Capital Trust I during the third quarter of 2008 (See Note 12 to the consolidated financial statements for details regarding this redemption). The remaining increase was mainly due to general increases in other income associated with the Greater Community acquisition.
Non-Interest Expense
The following table presents the components of non-interest expense for the years ended December 31, 2008, 2007 and 2006:
NON-INTEREST EXPENSE
Years ended December 31, | |||||||||
2008 | 2007 | 2006 | |||||||
(in thousands) | |||||||||
Salary expense |
$ | 126,210 | $ | 116,389 | $ | 109,775 | |||
Employee benefit expense |
31,666 | 29,261 | 28,592 | ||||||
Net occupancy and equipment expense |
54,042 | 49,570 | 46,078 | ||||||
Amortization of other intangible assets |
7,224 | 7,491 | 8,687 | ||||||
Goodwill impairment |
| 2,310 | | ||||||
Professional and legal fees |
8,241 | 5,110 | 8,878 | ||||||
Advertising |
2,697 | 2,917 | 8,469 | ||||||
Other |
55,168 | 40,864 | 39,861 | ||||||
Total non-interest expense |
$ | 285,248 | $ | 253,912 | $ | 250,340 | |||
Non-interest expense increased $31.3 million to $285.2 million for the year ended December 31, 2008 from $253.9 million for the same period in 2007. Increases in salary expense, employee benefit expense, net occupancy and equipment expense, professional and legal fees, and other non-interest expense were partially offset by a decrease in goodwill impairment. We incurred additional expenses due to de novo expansion efforts in 2008 and 2007 in our target expansion areas of northern and central New Jersey, New York City, Brooklyn and Queens. De novo expansion efforts will negatively impact non-interest expense until these new branches become profitable or breakeven, typically over a period of three years. Additionally, we experienced increases in most categories of non-interest expense due to our acquisition of Greater Community on July 1, 2008. The largest component of non-interest expense is salary and employee benefit expense which totaled $157.9 million in 2008 compared with $145.7 million in 2007.
The efficiency ratio measures a banks total non-interest expense as a percentage of net interest income plus non-interest income. Valleys efficiency ratio for the year ended December 31, 2008 was 67.27 percent compared to 53.94 percent for the same period of 2007. The increase in the efficiency ratio is primarily due to a decrease in non-interest income caused, in part, by a $64.0 million increase in net losses on securities transactions during the year ended December 31, 2008. We strive to maintain a low efficiency ratio through diligent management of our operating expenses and balance sheet. However, even exclusive of net losses on securities transactions, our current and past de novo branch expansion efforts may continue to negatively impact the ratio until these new branches become profitable operations.
Salary and employee benefit expense increased a combined $12.2 million, or 8.4 percent for the year ended December 31, 2008 compared with the same period in 2007. The increase from 2007 was mainly due to our organizational growth through the acquisition of Greater Community and the addition of ten de novo branches to our branch network over the last twelve month period. At December 31, 2008, full-time equivalent staff was 2,783 compared to 2,562 at December 31, 2007.
Net occupancy and equipment expense increased $4.5 million, or 9.0 percent during 2008 in comparison to 2007. This increase was also largely due to our de novo branching efforts and 16 full-service branch offices acquired from Greater Community, which caused us to incur, among other things, additional rents, utilities, real
34
estate taxes, and equipment maintenance charges in connection with investments in technology and facilities. Rent, utilities, and equipment maintenance expenses increased by approximately $2.9 million, $739 thousand, and $661 thousand, respectively, during 2008 compared with the prior year.
Goodwill impairment of $2.3 million was recorded during the fourth quarter of 2007 due to Valleys decision to sell its wholly owned broker-dealer subsidiary, Glen Rauch Securities, Inc. See Notes 2 and 9 to the consolidated financial statements for further discussion.
Professional and legal fees increased $3.1 million, or 61.3 percent for the year ended December 31, 2008 compared to the same period one year ago. The increase was partially due to a $1.7 million reduction in litigation contingencies during the fourth quarter of 2007 and an increase in advisory fees caused by organizational growth during 2008.
Other non-interest expense increased $14.3 million, or 35.0 percent for the year ended December 31, 2008 compared with the same period in 2007 partly due to a $4.6 million loss recorded in the fourth quarter of 2008 on the discovery of a check fraud scheme perpetrated by a long-time commercial customer of Valley National Bank. Additionally, other non-interest expense includes a $3.1 million expense which was accelerated from future periods to the current year due to a hedging relationship terminated in November 2008 for two interest rate cap hedging relationships based on the effective federal funds rate, a $1.2 million prepayment penalty on $25.0 million in Federal Home Loan Bank advances redeemed in the third quarter of 2008 and a $1.3 million increase in other real estate owned expense during 2008. The remaining increase in other non-interest expense was primarily due to several general increases caused by de novo branching and the Greater Community acquisition. Significant components of other non-interest expense include data processing, telephone, service fees, debit card fees, postage, stationery, insurance, and title search fees.
Income Taxes
Income tax expense was $16.9 million for the year ended December 31, 2008, reflecting an effective tax rate of 15.3 percent, compared with $51.7 million for year ended December 31, 2007, reflecting an effective tax rate of 25.2 percent. The reduction in taxes compared to 2007 was due to the lower income for the 2008 period and the reversal of the $6.5 million valuation allowance attributable to the capital loss carryforward of the prior year.
Management expects that Valleys adherence to FIN 48 will continue to result in increased volatility in Valleys future quarterly and annual effective income tax rates because FIN 48 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 period in which it occurs. Factors that could impact managements judgment include changes in income, tax laws and regulations, and tax planning strategies. For 2009, Valley anticipates an effective tax rate of 31.0 percent, compared to 15.3 percent for 2008.
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. Lines of business and actual structure of operations determine each segment. Each is reviewed routinely for its asset growth, contribution to income before income taxes and return on average interest earning assets and impairment. Expenses related to the branch network, all other components of retail banking, along with the back office departments of the 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 Wealth Management Division, comprised of trust, asset management, insurance services, and broker-dealer (our broker-dealer subsidiary was sold on March 31, 2008) is included in the consumer lending segment. 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
35
internal accounting policies designed to measure consistent and reasonable financial reporting, and may not necessarily conform to GAAP. For financial data on the four business segments see Note 19 to the consolidated financial statements.
Consumer lending. The consumer lending segment is mainly comprised of residential mortgages, home equity loans and automobile loans. The duration of the loan portfolio is subject to movements in the market level of interest rates and forecasted residential mortgage prepayment speeds. The average weighted 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 the availability of credit within the automobile marketplace.
Income before income taxes increased $12.9 million to $72.0 million for the year ended December 31, 2008 as compared with the same period in 2007. The return on average interest earning assets before income taxes increased to 1.71 percent compared with 1.53 percent for the comparable 2007 period. The increase resulted from an increase in net interest income, partially offset by an increase in the provision for loan losses and internal transfer expense. Net interest income increased $25.4 million to $151.1 million when compared to $125.7 million for the same period last year, primarily as a result of a $345.0 million increase in average consumer lending balances and a decrease in funding costs, partially offset by a decrease in the yield on average loans. The interest yield on loans decreased 17 basis points to 5.94 percent for the year ended December 31, 2008 from 6.11 percent for the prior year period, while the interest expense associated with funding sources decreased 51 basis points to 2.35 percent for the year ended December 31, 2008 from 2.86 percent for the prior year period.
Commercial lending. The commercial lending segment is mainly comprised of floating rate and adjustable rate commercial loans, as well as fixed rate owner occupied and commercial mortgage loans. Due to the portfolios interest rate characteristics, commercial lending is Valleys most sensitive business segment to movements in market interest rates.
During 2008, the Federal Reserve incrementally decreased the target federal funds rate six times from 5.25 percent at the beginning of the year to approximately zero percent on December 16, 2008. Many of our earning assets in the commercial lending segment are priced based on the Valley prime rate or the New York prime rate. As a result of the Federal Reserve rate cuts, Valleys prime rate has moved from 7.25 percent at December 31, 2007 to 4.50 percent at December 31, 2008, while the New York prime rate dropped even further to 3.25 percent at the end of 2008. During the fourth quarter of 2008, we implemented interest rate floors within the loan terms of many of our new and renewed prime based loans to help stabilize our net interest income should the market rates decline further in 2009. The decline in both prime rates may potentially lower interest income in future periods depending on our ability to grow the commercial lending portfolio, or other loan portfolios and our ability to mitigate such decreases in interest rates.
For the year ended December 31, 2008, income before income taxes decreased $19.5 million to $85.3 million compared with the year ended December 31, 2007, primarily due to increases in the provision for loans losses, non-interest expense, and internal transfer expense, partially offset by an increase in net interest income. The return on average interest earning assets before income taxes was 1.65 percent compared with 2.39 percent for the prior year period. The increase in net interest income was primarily due to average interest earning assets increasing $780.9 million to $5.2 billion as we acquired loans from Greater Community in the third quarter of 2008 and experienced solid organic loan growth since the 2007 period. Partially offsetting the increase was a 74 basis points decrease in yield on average loans mainly caused by the Federal Reserves cut of short-term rates. The costs associated with our funding sources decreased 51 basis points to 2.35 percent for the year ended December 31, 2008.
Investment management. The investment management segment is mainly comprised of fixed rate investments, trading securities and, depending on our liquid cash position, federal funds sold. The fixed rate investments are one of Valleys least sensitive assets to changes in market interest rates. Net gains and losses on the change in fair value of trading securities and other-than-temporary impairment charges of investment securities are reflected in the corporate and other adjustments segment.
36
For the year ended December 31, 2008, income before income taxes increased $6.8 million to $69.2 million compared with the year ended December 31, 2007 primarily due to an increase in net interest income, partially offset by a decrease in non-interest income. The return on average interest earning assets before income taxes increased to 2.31 percent compared with 2.04 percent for the prior year period. The increase was a result of decrease in funding costs of 51 basis points to 2.35 percent, partially offset by a decrease in yield on average investments of 21 basis points to 5.67 percent. Average investments decreased $53.5 million from $3.1 billion in the 2007 period mainly caused by a decline in short-term trading securities held due to current market conditions and solid loan growth.
Corporate segment. The corporate and other adjustments segment represents income and expense items not directly attributable to a specific segment, including trading and securities gains (losses) not classified in the investment management segment above, interest expense related to the junior subordinated debentures issued to capital trusts, interest expense related to $100 million in subordinated notes issued in July 2005, as well as income and expense from derivative financial instruments.
The loss before income taxes for the corporate segment was $116.0 million for the year ended December 31, 2008 compared with a $21.3 million loss for the year ended December 31, 2007. The loss increased primarily due to other-than-temporary impairment charges on investment securities totaling $84.8 million in 2008 as compared to $17.9 million in 2007, as well as, a decrease in other non-interest income. Non-interest expense increased $25.9 million mainly due to increases in general expenses related to de novo branching and was partially offset by an increase of $14.5 million in internal transfer income.
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. Valleys Asset/Liability Management Committee is responsible for managing such risks and establishing policies that monitor and coordinate our sources, uses and pricing 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 managements tolerance for exposure to income fluctuations. Many of the actions undertaken by management utilize fair value analysis and attempt 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 of financial assets and liabilities. Specifically, management employs multiple risk management activities such as divestures, 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. With the adoption of SFAS No. 159, management has the fair value measurement option available for new financial assets, financial liabilities, and derivative transactions potentially entered into as part of its on-going interest rate 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 December 31, 2008. The model assumes changes in interest rates without any proactive change in the composition of the balance sheet by management. In the model, the forecasted shape of the yield curve remains static as of December 31, 2008. 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 December 31, 2008. New interest earning assets and interest bearing liability originations and rate spreads are estimated utilizing our actual originations during the fourth quarter of 2008. The model utilizes an immediate parallel shift in the market interest rates at December 31, 2008.
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The following table reflects managements expectations of the change in our net interest income over a one-year period in light of the aforementioned assumptions:
Immediate Changes Interest Rates |
Change in Net Interest Income Over One Year Horizon |
||||||
At December 31, 2008 | |||||||
Dollar Change |
Percentage Change |
||||||
($ in thousands) | |||||||
+3.00% |
$ | 23,795 | 5.33 | % | |||
+2.00 |
17,324 | 3.88 | |||||
+1.00 |
7,070 | 1.58 | |||||
(1.00) |
(10,884 | ) | (2.44 | ) |
Valleys ratio of sensitive assets to sensitive liabilities increased to 1.32 over a 12-month period, largely as a result of the Greater Community acquisition, changes in market prepayment speeds and balance sheet management strategies implemented throughout 2008. As a result, the forecasted change in net interest income over a one year time horizon is more sensitive to rising interest rates than the results reported one-year ago. As of December 31, 2008, Valleys 12-month forecasted repricing and maturing assets totaled $6.4 billion, an increase of approximately $2.0 billion from the year ago period. Forecasted 12-month repricing/maturing forecasted cash flow in the loan portfolio increased $1.5 billion to $4.6 billion, mainly due to the assets acquired in conjunction with the Greater Community merger. Expected repricing/maturing cash flow in the Investment portfolio (including interest bearing cash and Federal Funds), increased approximately $550 million, attributable to an increase in market prepayment speeds, coupled with a decline in the duration on newly originated investments in 2008. Partially mitigating the $2.0 billion increase in asset sensitivity was an expansion of approximately $240 million in forecasted repricing/maturing cash flow associated with Valleys funding sources. Valleys time deposit portfolio increased $842.2 million from December 31, 2007. Nearly 90 percent of the net increase in time deposits, reflect originations with stated maturities less than one year. Conversely, the expected repricing/maturing cash flow associated with Valleys borrowing portfolio decreased by approximately $500 million. As a result of the above indicated changes in Valleys anticipated repricing/maturing cash flow, as of December 31, 2008, Valleys balance sheet asset sensitivity has expanded from the forecast one year ago.
In addition to the overall growth in our asset sensitivity level, the severity of the expected change under immediate changes in levels of interest rates increased as well, in part due to the implementation of floors on many of our prime based loans, combined with utilizing a Valley prime lending rate (set internally by management) versus the New York prime lending rate. Additionally, we entered into $200 million notional value of interest rate caps, which protect us from upward increases in interest rates. These actions have expanded the expected net interest income benefits in rising interest rate environments, while simultaneously decreasing the expected severity of lost interest income in declining interest rate environments.
As noted in the table above, we are slightly more susceptible to a decrease in interest rates under a scenario with an immediate parallel change in the level of market interest rates than an increase in interest rates under the same assumptions. However, the likelihood of a 100 basis point decrease in interest rates as of December 31, 2008 was considered to be unlikely given current interest rate levels. Other factors, including, but not limited to, 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.
Our interest rate caps designated as cash flow hedging relationships, which are the majority of the derivative financial instruments entered into by the Company, are designed to protect us from upward movements in interest rates based on the prime and federal funds rates. Due to the current low level of interest rates and the strike rate of these instruments, they are expected to have little impact over the next twelve month period on our net interest income under the scenarios outlined above. As of December 31, 2008, the effect of a 300 basis point increase in interest rates on our derivative holdings would result in an annual $883 thousand positive variance in net interest income. The effect of a 100 basis point decrease in interest rates on our derivative holdings would result in an annual $478 thousand negative variance in net interest income. See Note 15Commitments and Contingencies for further information on our derivative transactions.
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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 rates to optimize the net interest income, while prudently structuring the balance sheet to manage changes in interest rates. Additionally, our net interest income is impacted by the level of competition within our marketplace. Competition can increase the cost of deposits and impact the level of interest rates attainable on loans, which may result in downward pressure on our net interest margin in future periods.
Convexity is a measure of how the duration of a bond 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 to 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.
The following table sets forth the amounts of interest earning assets and bearing liabilities, outstanding on December 31, 2008 and their associated fair values. The expected cash flows are categorized based on each financial instruments anticipated maturity or interest rate reset date. The amount of assets and liabilities shown, which reprice or mature during a particular period, were determined based on the earlier of the term to repricing or the term to repayment, inclusive of the impact of market level prepayment speeds.
INTEREST RATE SENSITIVITY ANALYSIS
Rate | 2009 | 2010 | 2011 | 2012 | 2013 | Thereafter | Total Balance |
Fair Value | ||||||||||||||||||||
($ in thousands) | ||||||||||||||||||||||||||||
Interest sensitive assets: |
||||||||||||||||||||||||||||
Interest bearing deposits with banks |
0.30 | % | $ | 343,010 | $ | | $ | | $ | | $ | | $ | | $ | 343,010 | $ | 343,010 | ||||||||||
Investment securities held to maturity |
6.06 | 600,822 | 172,970 | 81,639 | 54,645 | 24,591 | 220,070 | 1,154,737 | 1,069,245 | |||||||||||||||||||
Investment securities available for sale |
5.59 | 794,100 | 280,417 | 128,454 | 65,995 | 33,713 | 132,763 | 1,435,442 | 1,435,442 | |||||||||||||||||||
Trading securities |
10.13 | | | | | | 34,236 | 34,236 | 34,236 | |||||||||||||||||||
Loans held for sale |
5.90 | 4,542 | | | | | | 4,542 | 4,542 | |||||||||||||||||||
Loans: |
||||||||||||||||||||||||||||
Commercial |
5.52 | 1,445,980 | 205,535 | 156,639 | 56,400 | 51,007 | 49,811 | 1,965,372 | 1,955,662 | |||||||||||||||||||
Mortgage |
5.84 | 2,037,589 | 956,645 | 859,161 | 668,991 | 669,706 | 912,444 | 6,104,536 | 6,060,693 | |||||||||||||||||||
Consumer |
5.66 | 1,137,301 | 407,477 | 240,755 | 130,631 | 61,696 | 95,922 | 2,073,782 | 2,246,187 | |||||||||||||||||||
Total interest sensitive assets |
5.62 | % | $ | 6,363,344 | $ | 2,023,044 | $ | 1,466,648 | $ | 976,662 | $ | 840,713 | $ | 1,445,246 | $ | 13,115,657 | $ | 13,149,017 | ||||||||||
Interest sensitive liabilities: |
||||||||||||||||||||||||||||
Deposits: |
||||||||||||||||||||||||||||
Savings, NOW and money market |
0.64 | % | $ | 1,071,105 | $ | 707,072 | $ | 707,072 | $ | 336,055 | $ | 168,028 | $ | 504,083 | $ | 3,493,415 | $ | 3,493,415 | ||||||||||
Time |
3.53 | 3,072,986 | 130,286 | 163,927 | 106,958 | 66,063 | 81,039 | 3,621,259 | 3,681,279 | |||||||||||||||||||
Short-term borrowings |
1.99 | 640,304 | | | | | | 640,304 | 635,767 | |||||||||||||||||||
Long-term borrowings |
4.24 | 58,160 | 62,171 | 207,569 | 148,407 | 1,003 | 2,531,443 | 3,008,753 | 3,455,381 | |||||||||||||||||||
Junior subordinated debentures |
7.64 | | | | | | 165,390 | 165,390 | 162,936 | |||||||||||||||||||
Total interest sensitive liabilities |
2.78 | % | $ | 4,842,555 | $ | 899,529 | $ | 1,078,568 | $ | 591,420 | $ | 235,094 | $ | 3,281,955 | $ | 10,929,121 | $ | 11,428,778 | ||||||||||
Interest sensitivity gap |
$ | 1,520,789 | $ | 1,123,515 | $ | 388,080 | $ | 385,242 | $ | 605,619 | $ | (1,836,709 | ) | $ | 2,186,536 | $ | 1,720,239 | |||||||||||
Ratio of interest sensitive assets to interest sensitive |
1.31:1 | 2.25:1 | 1.36:1 | 1.65:1 | 3.58:1 | 0.44:1 | 1.20:1 | 1.15:1 | ||||||||||||||||||||
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Expected maturities are contractual maturities adjusted for all projected payments of principal. For investment securities, loans, long-term borrowings and junior subordinated debentures, expected maturities are based upon contractual maturity or call dates, projected repayments and prepayments of principal. The prepayment experience reflected herein is based on historical experience combined with market consensus expectations derived from independent external sources. The actual maturities of these instruments could vary substantially if future prepayments differ from historical experience or current market expectations. Repricing data for each instrument reflects the contractual interest rate/reset date. For non-maturity deposit liabilities, in accordance with standard industry practice and our historical experience, decay factors were used to estimate deposit runoff. Our cash flow derivatives are designed to protect us from upward movement in interest rates. The interest rate sensitivity table reflects the sensitivity at current interest rates. As a result, the notional amount of our derivatives is not included in the table. We use various assumptions to estimate fair values. See Note 3 of the consolidated financial statements for further discussion of fair value measurements.
The total gap re-pricing within one year as of December 31, 2008 was a positive $1.5 billion, representing a ratio of interest sensitive assets to interest sensitive liabilities of 1.31:1. The acquisition of Greater Community, coupled with changes in market prepayment speeds and balance sheet management strategies implemented throughout 2008, increased our asset sensitivity from December 31, 2007. The total gap re-pricing position, as reported in the table above, reflects the projected interest rate sensitivity of our principal cash flows based on market conditions as of December 31, 2008. As the market level of interest rates and associated prepayment speeds move, the total gap re-pricing position will change accordingly, but not likely in a linear relationship. Management does not view our one year gap position as of December 31, 2008 as presenting an unusually high risk potential, although no assurances can be given that we are not at risk from interest rate increases or decreases.
Fair Value Measurement
Effective January 1, 2007, Valley elected early adoption of SFAS Nos. 159 and 157. SFAS No. 159 issued on February 15, 2007, generally permits the measurement of selected eligible financial instruments at fair value at specified election dates.
Valleys adoption of SFAS No. 159 reflects managements desire to mitigate the impact of changing interest rate and other market risks related to certain financial instruments that may have a greater propensity to those changes than other financial instruments on Valleys balance sheet. Managements efforts to reduce price and market risk of financial instruments with the highest potential future earnings volatility (the dispersion of net income under various market conditions and levels of interest rates, which may include the potential fluctuation in the yield and expected total return of each financial instrument) and prepayment risk are consistent with Valleys risk management activities. Management believes that the fair value option for select financial assets and liabilities will enable it to achieve this objective by providing enhanced flexibility, including the ability to utilize derivative transactions without applying the complex hedge accounting provisions of SFAS No. 133.
Upon adoption on January 1, 2007, Valley elected to record the following pre-existing financial assets and financial liabilities at fair value:
| Investment securities with a carrying value totaling $1.3 billion, a weighted average yield of 5.15 percent and an estimated duration greater than 3 years. Approximately $498.9 million of the $1.3 billion in investment securities were previously categorized as held to maturity securities. This entire portfolio was transferred to trading securities. |
| Residential mortgage loans with a carrying value totaling $254.4 million, a weighted average yield of 4.96 percent and an estimated duration greater than 3 years. This entire portfolio was transferred to loans held for sale. |
| Federal Home Loan Bank advances with a carrying value totaling $40 million, a fixed weighted average cost of 6.96 percent and an estimated duration of approximately 2.6 years. |
| Junior subordinated debentures issued to VNB Capital Trust I with a carrying value totaling $206.2 million, a fixed coupon rate of 7.75 percent and an estimated duration greater than 10 years. |
40
During the first quarter of 2007, management worked closely with its advisor in the derivatives market, at a considerable cost, to construct a hedging strategy for the trading securities portfolio. As a result of this extensive evaluation process, Valley executed a series of interest rate derivative transactions with notional amounts totaling approximately $1.0 billion in April 2007. The purpose of the derivative transactions was to offset volatility in changes in the market value of over $800 million in trading securities consisting primarily of mortgage-backed securities transferred from the available for sale portfolio at January 1, 2007 by transforming these fixed rate assets into floating rates in anticipation of a steepening yield curve. However, the derivative transactions did not offset the volatility in the trading securities to the extent expected due to several factors, including the financial markets forward expectations of interest rate movements and the unusual expansion of credit spreads in the marketplace. To that end, Valley terminated the derivatives entire notional amounts and sold the corresponding trading securities through several transactions over a number of weeks during the second quarter of 2007. The ineffectiveness and ultimately, the termination of the derivatives and hedged securities sold resulted in a $2.0 million net loss recorded in net trading gains during the second quarter of 2007. The hedged securities were part of approximately $1.0 billion in mortgage-backed securities issued by Fannie Mae, Freddie Mac and private institutions that were sold during the second quarter of 2007. The investment proceeds were primarily reinvested in short-term U.S. treasury securities, short-term other government agencies and short-term corporate debt classified as trading securities under SFAS No. 115, with the remainder of the proceeds used to fund loan growth and to offset a reduction in funding due to the redemption of the $20.6 million in junior subordinated debentures issued to VNB Capital Trust I during the second quarter of 2007. Many of the short-term instruments within trading securities portfolio matured in 2008 and the proceeds were reallocated to loans or provided for other liquidity needs during the year.
At adoption, some of Valleys specific asset/liability management goals included shortening the duration of the investment portfolio, limiting the risk that the duration for certain assets would extend beyond expected levels, increasing the asset sensitivity of the balance sheet, increasing the stability of returns on certain financial instruments and modifying some of its interest bearing liabilities with the expectation of a future steepening of the yield curve. As early as April 2007, but worsening significantly in the second half of 2007 and throughout 2008, many changes occurred within the economy and financial markets, which directly impacted these strategies employed by Valley, specifically, widening credit spreads and limited liquidity for mortgage related products (including both loans and investments). Additionally, as a result of the market volatility, many of the variables relied upon within Valleys initial rationale for adopting fair value on an instrument level basis witnessed dramatic changes. While Valley did not invest in subprime mortgages, CDOs, SIVs and other forms of exotic high risk financial instruments, the industry wide turmoil, caused by such instruments, directly impacted the pricing and availability of various financial instruments, including those which Valley holds and may effect trades in. Specifically, Valleys purchase decisions for investment securities, as well as the balance sheet classification election for each security purchased, were greatly impacted by these changes in the financial markets. As a result of the changes in market variables during the second half of 2007, including a steepening of the yield curve, Valley engaged in a leverage strategy involving the purchase of certain mortgage-backed securities classified as available for sale matched with additional fixed rate Federal Home Loan Bank advances during the fourth quarter of 2007 which effected the composition of the investment portfolio as well as the interest bearing liabilities as of December 31, 2007 and throughout the year ended December 31, 2008.
41
The following table presents the assets and liabilities measured at fair value on a recurring basis as reported on the consolidated statements of financial condition at December 31, 2008 and 2007:
December 31, | ||||||
2008 | 2007 | |||||
(in thousands) | ||||||
Assets: |
||||||
Investment securities: |
||||||
Available for sale |
$ | 1,435,442 | $ | 1,606,410 | ||
Trading securities |
34,236 | 722,577 | ||||
Loans held for sale |
4,542 | 2,984 | ||||
Other assets* |
3,334 | | ||||
Total assets |
$ | 1,477,554 | $ | 2,331,971 | ||
Liabilities: |
||||||
Long-term Federal Home Loan Bank advance |
$ | | $ | 41,359 | ||
Junior subordinated debentures issued to VNB Capital Trust I |
140,065 | 163,233 | ||||
Other liabilities* |
2,008 | 424 | ||||
Total liabilities |
$ | 142,073 | $ | 205,016 | ||
* | Derivative financial instruments are included in this category. |
During the year ended December 31, 2008, our available for sale and trading balances continued to decline as a result of severe turbulence in the financial markets that limited the asset/liability strategies management could deploy at acceptable risk tolerances, as well as the need to fund strong loan growth during the same period.
SFAS No. 159 prohibits the election of the fair value option for deposit liabilities which are withdrawable on demand. These types of deposits are a material component of Valleys balance sheet and risk management activities and accordingly, set certain limitations on the number and amount of financial instruments management ultimately selected for fair value measurement at January 1, 2007 and during the years ended December 31, 2008 and 2007.
See additional discussion and analysis of the adoption of SFAS Nos. 159 and 157 at Notes 1, 3, 4 and 12 to the consolidated financial statements.
Liquidity
Bank Liquidity. Liquidity measures the ability to satisfy current and future cash flow needs as they become due. A banks 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 managements 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.
Valley National 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 deposits $100 thousand and over, federal funds purchased, repurchase agreements and Federal Home Loan Bank advances) greater than 50 percent of total assets. At December 31, 2008, we were in compliance with the foregoing policies.
On the asset side of the balance sheet, we have numerous sources of liquid funds in the form of cash and due from banks, interest bearing deposits with banks, federal funds sold, investment securities held to maturity maturing within one year, investment securities available for sale, trading securities and loans held for sale.
42
These liquid assets totaled approximately $2.1 billion and $2.6 billion at December 31, 2008 and 2007, respectively, representing 16.4 percent and 23.0 percent of earning assets, and 14.2 percent and 20.6 percent of total assets at December 31, 2008 and 2007, respectively. Of the $2.1 billion of liquid assets at December 31, 2008, approximately $1.4 billion of various investment securities were pledged to counter parties to support our earning asset funding strategies.
Additional liquidity is derived from scheduled loan payments of principal and interest, as well as prepayments received. Loan principal payments are projected to be approximately $4.6 billion over the next twelve months. As a contingency plan for significant funding needs, liquidity could also be derived from the sale of residential mortgages, commercial mortgages, and home equity loans, as these are all marketable portfolios, 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 $7.4 billion and $7.1 billion for the years ended December 31, 2008 and 2007, representing 59.7 percent and 62.9 percent of average earning assets at December 31, 2008 and 2007, 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. Brokered certificates of deposit totaled $2.9 million at December 31, 2008 and 2007.
In the event that additional short-term liquidity is needed, Valley National Bank has established relationships with several correspondent banks to provide short-term borrowings in the form of federal funds purchased. While, at December 31, 2008, there were no firm lending commitments in place, management believes that we could borrow approximately $1.0 billion for a short time from these banks on a collective basis. Valley National 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 mortgage-backed securities and a blanket assignment of qualifying residential mortgage loans. Additionally, funds could be borrowed overnight from the Federal Reserve Bank via the discount window as a contingency for additional liquidity.
The following table lists, by maturity, all certificates of deposit of $100 thousand and over at December 31, 2008 (in thousands):
Less than three months |
$ | 560,432 | |
Three to six months |
438,817 | ||
Six to twelve months |
527,174 | ||
More than twelve months |
204,726 | ||
$ | 1,731,149 | ||
We have access to a variety of short-term and long-term borrowing sources to support our asset base. Short-term borrowings include federal funds purchased, securities sold under agreements to repurchase (repos), treasury tax and loan accounts, and FHLB advances. Short-term borrowings increased by $35.1 million to $640.3 million at December 31, 2008 compared to $605.2 million at December 31, 2007 primarily due to an additional $200.0 million short-term FHLB advances, partly offset by declines in federal funds purchased, short-term repos, and treasury tax and loan accounts of $80.0 million, $59.0 million, and $25.9 million, respectively. At December 31, 2008, nearly all short-term repos represent customer deposit balances being swept into this vehicle overnight.
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The following table sets forth information regarding Valleys short-term repos at the dates and for the periods indicated:
Years Ended December 31, | ||||||||||||
2008 | 2007 | 2006 | ||||||||||
($ in thousands) | ||||||||||||
Securities sold under agreements to repurchase: |
||||||||||||
Average balance outstanding |
$ | 418,518 | $ | 412,035 | $ | 337,819 | ||||||
Maximum outstanding at any month-end during the period |
437,272 | 449,595 | 386,897 | |||||||||
Balance outstanding at end of period |
335,510 | 394,512 | 355,823 | |||||||||
Weighted average interest rate during the period |
1.51 | % | 4.08 | % | 4.12 | % | ||||||
Weighted average interest rate at the end of the period |
0.81 | % | 2.92 | % | 4.29 | % |
Corporation Liquidity. Valleys recurring cash requirements primarily consist of dividends to preferred and common shareholders and interest expense on junior subordinated debentures issued to VNB Capital Trust I and GCB Capital Trust III. These cash needs are routinely satisfied by dividends collected from Valley National Bank, along with cash flows from investment securities held at the holding company. See Note 16 Shareholders Equity in the accompanying notes to the consolidated financial statements included elsewhere in this report regarding restrictions to such subsidiary bank dividends. Projected cash flows from these sources are expected to be adequate to pay preferred and common dividends and interest expense payable to capital trusts, given the current capital levels and current profitable operations of its subsidiary.
Historically, Valley also used cash to repurchase shares of its outstanding common stock, from time to time, under its share repurchase program, purchase preferred securities issued by VNB Capital Trust I (and extinguish the corresponding junior subordinated debentures), or call for early redemption part of its junior subordinated debentures issued to VNB Capital Trust I at their stated par value. The cash required for these activities was met by using Valleys own funds and dividends received from Valley National Bank. On November 14, 2008, Valley issued $300 million in nonvoting senior preferred shares to the Treasury under its TARP Capital Purchase Program mainly to support growth in our lending operations and better position Valley for a potentially extended downturn in the U.S. economy. Under the terms of the program, the Treasurys consent will be required for any increase in our dividends paid to common stockholders (above a quarterly dividend of $0.20 per common share) or our redemption, purchase or acquisition of Valley common stock or any trust preferred securities issued by our capital trusts until the third anniversary of the Valley senior preferred share issuance to the Treasury unless prior to such third anniversary the senior preferred shares are redeemed in whole or the Treasury has transferred all of these shares to third parties.
Investment Securities Portfolio
Securities are classified as held to maturity and carried at amortized cost when Valley has the positive intent and ability to hold them to maturity. Securities are classified as available for sale when they might be sold before maturity, and are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax. Securities classified as trading are held primarily for sale in the short term or as part of our balance sheet management strategies and are carried at fair value, with unrealized gains and losses included immediately in other income. Valley determines the appropriate classification of securities at the time of purchase. Securities with limited marketability and/or restrictions, such as Federal Home Loan Bank and Federal Reserve Bank stocks, are carried at cost in other assets.
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Investment securities at December 31, 2008, 2007 and 2006 were as follows:
2008 | 2007 | 2006 | |||||||
(in thousands) | |||||||||
Held to maturity: |
|||||||||
U.S. Treasury securities |
$ | | $ | | $ | 10,009 | |||
U.S. government agency securities |
24,958 | | | ||||||
Obligations of states and political subdivisions |
201,858 | 230,201 | 233,592 | ||||||
Mortgage-backed securities |
593,275 | 52,073 | 342,798 | ||||||
Corporate and other debt securities |
334,646 | 273,839 | 423,016 | ||||||
Total investment securities held to maturity |
$ | 1,154,737 | $ | 556,113 | $ | 1,009,415 | |||
Available for sale: |
|||||||||
U.S. Treasury securities |
$ | | $ | 5,133 | $ | 9,851 | |||
U.S. government agency securities |
102,564 | 326,086 | 390,930 | ||||||
Obligations of states and political subdivisions |
48,191 | 43,828 | 47,852 | ||||||
Mortgage-backed securities |
1,215,386 | 1,049,596 | 1,256,637 | ||||||
Corporate and other debt securities |
34,504 | 85,288 | 26,968 | ||||||
Total debt securities |
1,400,645 | 1,509,931 | 1,732,238 | ||||||
Equity securities |
34,797 | 96,479 | 37,743 | ||||||
Total investment securities available for sale |
$ | 1,435,442 | $ | 1,606,410 | $ | 1,769,981 | |||
Trading*: |
|||||||||
U.S. government agency securities |
$ | | $ | 224,945 | $ | | |||
Obligations of states and political subdivisions |
| 2,803 | 4,655 | ||||||
Mortgage-backed securities |
| 28,959 | | ||||||
Corporate and other debt securities |
34,236 | 465,870 | | ||||||
Total trading securities |
$ | 34,236 | $ | 722,577 | $ | 4,655 | |||
Total investment securities |
$ | 2,624,415 | $ | 2,885,100 | $ | 2,784,051 | |||
* | See discussion at Notes 3 and 4 of the consolidated financial statements of Valleys early adoption of SFAS Nos. 159 and 157 on January 1, 2007. |
The following table presents the maturity distribution schedule with its corresponding weighted-average yields of held to maturity and available for sale securities at December 31, 2008:
U.S. Government Agency Securities |
Obligations of States and Political Subdivisions |
Mortgage-Backed Securities (5) |
Corporate and Other Debt Securities |
Total (4) | ||||||||||||||||||||||||||
Amount (1) |
Yield (2) |
Amount (1) |
Yield (2) (3) |
Amount (1) |
Yield (2) |
Amount (1) |
Yield (2) |
Amount (1) |
Yield (2) |
|||||||||||||||||||||
($ in thousands) | ||||||||||||||||||||||||||||||
Held to maturity: |
||||||||||||||||||||||||||||||
0-1 year |
$ | | | % | $ | 36,617 | 4.06 | % | $ | 9 | 7.19 | % | $ | | | % | $ | 36,626 | 4.06 | % | ||||||||||
1-5 years |
| | 58,124 | 5.94 | 2 | 7.92 | 648 | 5.62 | 58,774 | 5.94 | ||||||||||||||||||||
5-10 years |
| | 58,656 | 6.38 | 28,179 | 4.76 | 43,192 | 6.79 | 130,027 | 6.16 | ||||||||||||||||||||
Over 10 years |
24,958 | 5.71 | 48,461 | 6.21 | 565,085 | 5.60 | 290,806 | 7.21 | 929,310 | 6.14 | ||||||||||||||||||||
Total securities |
$ | 24,958 | 5.71 | % | $ | 201,858 | 5.79 | % | $ | 593,275 | 5.56 | % | $ | 334,646 | 7.15 | % | $ | 1,154,737 | 6.06 | % | ||||||||||
Available for sale: |
||||||||||||||||||||||||||||||
0-1 year |
$ | 1,016 | 5.13 | % | $ | 2,050 | 6.17 | % | $ | 1,168 | 5.00 | % | $ | | | % | $ | 4,234 | 5.59 | % | ||||||||||
1-5 years |
1,004 | 5.10 | 36,537 | 6.99 | 9,056 | 7.31 | 968 | 5.17 | 47,565 | 6.98 | ||||||||||||||||||||
5-10 years |
| | 3,128 | 7.75 | 37,770 | 5.30 | 688 | 7.21 | 41,586 | 5.51 | ||||||||||||||||||||
Over 10 years |
100,544 | 5.36 | 6,476 | 6.82 | 1,167,392 | 5.51 | 32,848 | 7.08 | 1,307,260 | 5.55 | ||||||||||||||||||||
Total securities |
$ | 102,564 | 5.35 | % | $ | 48,191 | 6.98 | % | $ | 1,215,386 | 5.52 | % | $ | 34,504 | 7.03 | % | $ | 1,400,645 | 5.59 | % | ||||||||||
(1) | Held to maturity amounts are presented at amortized costs, stated at cost less principal reductions, if any, and adjusted for accretion of discounts and amortization of premiums. Available for sale amounts are presented at fair value. |
(2) | Average yields are calculated on a yield-to-maturity basis. |
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(3) | Average yields on obligations of states and political subdivisions are generally tax-exempt and calculated on a tax-equivalent basis using a statutory federal income tax rate of 35 percent. |
(4) | Excludes equity securities which have indefinite maturities. |
(5) | Mortgage-backed securities are shown using stated final maturity. |
Our investment portfolio is mainly comprised of U.S. government and federal agency securities, tax-exempt issues of states and political subdivisions, mortgage-backed securities, single-issuer trust preferred securities, corporate bonds, and equity securities. There were no securities in the name of any one issuer exceeding 10 percent of shareholders equity, except for securities issued by U.S. government agencies, which includes the Fannie Mae and the Freddie Mac. The decision to purchase or sell securities is based upon the current assessment of long and short-term economic and financial conditions, including the interest rate environment and other statement of financial condition components.
At December 31, 2008, we had $593.3 million and $1.2 billion of mortgage-backed securities classified as held to maturity and available for sale securities, respectively. The majority of these mortgage-backed securities held by Valley are issued or backed by federal agencies. Approximately $13.3 million and $130.6 million of the mortgage-backed securities classified as held to maturity and available for sale securities, respectively, were private label mortgage-backed securities. The mortgage-backed securities portfolio is a significant source of our liquidity through the monthly cash flow of principal and interest. Mortgage-backed securities, like all securities, are sensitive to change in the interest rate environment, increasing and decreasing in value as interest rates fall and rise. As interest rates fall, the increase in prepayments can reduce the yield on the mortgage-backed securities portfolio, and reinvestment of the proceeds will be at lower yields. Conversely, rising interest rates will reduce cash flows from prepayments and extend anticipated duration of these assets. We monitor the changes in interest rates, cash flows and duration, in accordance with our investment policies. Management seeks out investment securities with an attractive spread over our cost of funds.
As of December 31, 2008, we had $1.4 billion of securities classified available for sale, a decrease of $171.0 million from December 31, 2007. As of December 31, 2008, the available for sale securities had a net unrealized loss of $32.7 million, net of deferred taxes, compared to a net unrealized loss of $778 thousand, net of deferred taxes, at December 31, 2007. Available for sale securities are not considered trading account securities, but rather are securities which may be sold on a non-routine basis.
As of December 31, 2008 and 2007, we had a total of $34.2 million and $722.6 million, respectively, in trading account securities. The decrease was mainly due to the maturity and sale of short-term U.S. government agencies, mortgage-backed securities, and short-term corporate debt classified as trading and the reallocation of such proceeds to new loan originations during 2008. As of December 31, 2008, the entire trading portfolio consisted of $34.2 million in trust preferred securities originally transferred to trading securities upon the adoption of SFAS No. 159 on January 1, 2007.
Other-Than-Temporary Impairment Analysis
Management evaluates the held to maturity and available for sale investment securities portfolios quarterly for other-than-temporary impairment. Other-than-temporary impairment means we believe the securitys impairment is due to factors that could include its inability to pay interest or dividends, its potential for default, and/or other factors. When a held to maturity or available for sale security becomes other-than-temporarily impaired, we have to record the amount of its impairment as a realized securities loss in our income statement and permanently reduce stockholders equity and earnings by the amount of the loss. When a held to maturity security becomes other-than-temporarily impaired, its value at the time of impairment becomes its new amortized cost basis.
To determine whether a securitys impairment is other-than-temporary, we consider factors that include:
| The causes of the decline in fair value, such as credit problems, interest rate fluctuations, or market volatility. |
| The severity and duration of the decline. |
| Our ability and intent to hold these investments until they recover in value, mature, or are called. |
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For debt securities, the primary consideration in determining whether impairment is other-than-temporary is whether or not it is probable that current or future contractual cash flows have or may be impaired.
The investment grades in the table below reflect multiple third parties independent analysis of each security. 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, from our perspective, the assigned investment grades may not reflect the actual credit quality of each investment.
The following table presents the held to maturity and available for sale investment securities portfolios by investment grades at December 31, 2008:
December 31, 2008 | |||||||||||||
Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized Losses |
Fair Value | ||||||||||
(in thousands) | |||||||||||||
Held to maturity: |
|||||||||||||
Investment grades* |
|||||||||||||
AAA Rated |
$ | 652,820 | $ | 7,655 | $ | (870 | ) | $ | 659,605 | ||||
AA Rated |
123,318 | 1,366 | (3,425 | ) | 121,259 | ||||||||
A Rated |
195,209 | 2,985 | (28,361 | ) | 169,833 | ||||||||
BBB Rated |
44,899 | 192 | (12,294 | ) | 32,797 | ||||||||
Not rated |
138,491 | 147 | (52,887 | ) | 85,751 | ||||||||
Total investment securities held to maturity |
$ | 1,154,737 | $ | 12,345 | $ | (97,837 | ) | $ | 1,069,245 | ||||
Available for sale: |
|||||||||||||
Investment grades* |
|||||||||||||
AAA Rated |
$ | 1,345,344 | $ | 22,689 | $ | (46,152 | ) | $ | 1,321,881 | ||||
AA Rated |
70,698 | 450 | (17,498 | ) | 53,650 | ||||||||
A Rated |
38,661 | 122 | (13,126 | ) | 25,657 | ||||||||
BBB Rated |
8,979 | 125 | (108 | ) | 8,996 | ||||||||
Non-investment grade |
10,675 | 11 | | 10,686 | |||||||||
Not rated |
14,972 | 66 | (466 | ) | 14,572 | ||||||||
Total investment securities available for sale |
$ | 1,489,329 | $ | 23,463 | $ | (77,350 | ) | $ | 1,435,442 | ||||
* | Rated using external rating agencies (primarily S&P and Moodys). Ratings categories include 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 $138.5 million in investments not rated by the rating agencies with aggregate unrealized losses of $52.9 million at December 31, 2008. The unrealized losses for this category relate primarily to 10 single-issuer bank trust preferred securities. These securities are all paying in accordance with their terms and have no deferrals of interest or defaults. Additionally, we analyze the performance of the issuers on a quarterly basis, including a review of the issuers most recent bank regulatory report to assess the companys credit risk and the probability of impairment of the contractual cash flows of the applicable security. Based upon our fourth quarter review, all 10 issuers appear to meet the regulatory minimum requirements to be considered well-capitalized financial institution at December 31, 2008.
Subsequent Downgrades to Securities Ratings
Corporate and other debt securities within the available for sale portfolio includes the one pooled trust preferred security, which is collateralized by trust preferred securities principally issued by banks, with an amortized cost of $17.8 million and a fair value of $7.2 million at December 31, 2008. At December 31, 2008, this pooled security had an investment grade rating of AAA and a $10.6 million unrealized loss reported for AAA rated available for sale securities in the table above. In late January 2009, S&P downgraded the securitys
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rating to BBB-. The security is performing in accordance with its contractual terms and we have the ability and intent to hold the security until market price recovery, which could be maturity. The overall issuance of $192 million includes one bank which is currently deferring interest payments and one default, the two issuers represent a combined 4.5 percent of the overall security. As part of our impairment analysis, we reviewed the underlying banks current financial performance, as well as their participation in the Treasurys TARP program to assist us in applying the appropriate constant default rate to our cash flow projections for the security. At December 31, 2008, no other-than-temporary impairment was recorded for the security, as our super senior tranche of this security had projected cash flows not less than their future contractual principal and interest payments. The downgrade to the securitys rating in January 2009 did not change managements assessment that the security is temporarily impaired.
In late January 2009, three AAA rated private label mortgage-backed securities classified as available for sale were downgraded by Moodys to non-investment grade securities. These securities had a combined fair value of $38.6 million and an unrealized loss of $11.0 million at December 31, 2008. As a result, management updated its fourth quarter review of the tranches of these security issuances. To determine the range and likelihood of potential principal and interest losses on these tranches, management prepared cash flow projections encompassing multiple market assumptions, including constant default rates well above the securities actual loss experience. Based upon these cash flow projections, management projected that all future contractual principal and interest payments will be received and no other-than-temporary impairment existed as of December 31, 2008.
Other-than-Temporarily Impaired Securities
For the year ended December 31, 2008, we recognized other-than-temporary impairment charges of $84.8 million ($49.9 million after taxes) on securities classified as available for sale and held to maturity. The impairment charges primarily relate to Fannie Mae and Freddie Mac perpetual preferred stocks classified as available for sale with a combined adjusted book value of $1.3 million after write downs totaling $69.8 million recorded primarily in the third and fourth quarters of 2008. During the third and fourth quarters of 2008, the market values of these securities significantly declined after the U.S. Government placed Fannie Mae and Freddie Mac into conservatorship and suspended their preferred stock dividends. Valley recognized a $17.9 million ($10.4 million after taxes) impairment charge on the same Freddie Mac and Fannie Mae perpetual preferred securities during the fourth quarter of 2007. The valuation of these securities could increase over the course of future market cycles if these institutions become viable institutions and are able to pay dividends on these securities.
During September of 2008, prior to the recognition of the 2008 impairment charges discussed above, we sold 50 percent of our position in one of the Fannie Mae perpetual preferred stocks classified as available for sale and realized a loss of $5.4 million. This security had a total book value of $9.2 million prior to the date of sale.
During the fourth quarter of 2008, we recorded $14.2 million of other-than-temporary impairment on two of the three pooled trust preferred securities owned by Valley, principally collateralized by securities issued by banks, included in corporate and other debt securities within the investment securities held to maturity portfolio and one private label mortgage-backed security classified as available for sale. The other-than-temporary impairment was recorded for these securities, as each of our tranches in the three securities had projected cash flows below their future contractual principal and interest payments. After the write down, the mortgage-backed security had an adjusted carrying value of $9.4 million at December 31, 2008. The two pooled trust preferred securities had a total adjusted carrying value of $1.1 million and were transferred from held to maturity to the available for sale portfolio subsequent to the recognition of the other-than-temporary impairment. After the analysis, management no longer had a positive intent to hold the pooled securities to their maturity dates due to the significant deterioration in both issuers creditworthiness. As a result, we were required to transfer such securities, under the provisions of SFAS No. 115, out of the held to maturity classification at December 31, 2008.
Other-than-temporary impairment is a non-cash charge and not necessarily an indicator of a permanent decline in value. Security valuations require significant estimates, judgments and assumptions by management and are considered a critical accounting policy of Valley. See the Critical Accounting Policies and Estimates section above for further discussion of this policy.
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Loan Portfolio
The following table reflects the composition of the loan portfolio for the five years ended December 31, 2008:
LOAN PORTFOLIO
At December 31, | ||||||||||||||||||||
2008 | 2007 | 2006 | 2005 | 2004 | ||||||||||||||||
($ in thousands) | ||||||||||||||||||||
Commercial |
$ | 1,965,372 | $ | 1,563,150 | $ | 1,466,862 | $ | 1,449,919 | $ | 1,259,997 | ||||||||||
Total commercial loans |
1,965,372 | 1,563,150 | 1,466,862 | 1,449,919 | 1,259,997 | |||||||||||||||
Construction |
510,519 | 402,806 | 526,318 | 471,560 | 368,120 | |||||||||||||||
Residential mortgage |
2,269,935 | 2,063,242 | 2,106,306 | 2,083,004 | 1,853,408 | |||||||||||||||
Commercial mortgage |
3,324,082 | 2,370,345 | 2,309,217 | 2,234,950 | 1,745,155 | |||||||||||||||
Total mortgage loans |
6,104,536 | 4,836,393 | 4,941,841 | 4,789,514 | 3,966,683 | |||||||||||||||
Home equity |
607,700 | 554,830 | 571,138 | 565,960 | 517,325 | |||||||||||||||
Credit card |
9,916 | 10,077 | 8,764 | 9,044 | 9,691 | |||||||||||||||
Automobile |
1,364,343 | 1,447,838 | 1,238,145 | 1,221,525 | 1,079,050 | |||||||||||||||
Other consumer |
91,823 | 83,933 | 104,935 | 94,495 | 99,412 | |||||||||||||||
Total consumer loans |
2,073,782 | 2,096,678 | 1,922,982 | 1,891,024 | 1,705,478 | |||||||||||||||
Total loans* |
$ | 10,143,690 | $ | 8,496,221 | $ | 8,331,685 | $ | 8,130,457 | $ | 6,932,158 | ||||||||||
As a percent of total loans: |
||||||||||||||||||||
Commercial loans |
19. 4 | % | 18.4 | % | 17.6 | % | 17.8 | % | 18.2 | % | ||||||||||
Mortgage loans |
60.2 | 56.9 | 59.3 | 58.9 | 57.2 | |||||||||||||||
Consumer loans |
20.4 | 24.7 | 23.1 | 23.3 | 24.6 | |||||||||||||||
Total |
100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||||
* | Total loans are net of unearned discount and deferred loan fees totaling $4.8 million, $3.5 million, $5.1 million, $6.3 million and $6.6 million at December 31, 2008, 2007, 2006, 2005 and 2004, respectively. |
During 2008, loans increased $1.6 billion, or 19.4 percent, to $10.1 billion at December 31, 2008 from $8.5 billion at December 31. 2007. The increase is mainly due to $812.5 million in loans acquired from Greater Community and solid organic loan growth which was primarily comprised of increases in the commercial mortgage and commercial loans, partially offset by a decrease in automobile loans. Our lending opportunities to new quality borrowers expanded during 2008 due, in part, to our larger lending branch presence, through the acquisition of 16 full-service branches from Greater Community and de novo branching, as well as less competition from other financial institutions negatively impacted by capital constraints, and the markets credit and liquidity crisis.
Commercial loans increased $402.2 million or 25.7 percent to approximately $2.0 billion in 2008, partly due to loans acquired from Greater Community of $130.8 million, and solid organic loan growth, which included the continued benefits of a larger commercial lending team in 2008 and expanded lending opportunities with new quality customers unable to find financing at other financial institutions with less available lending resources being negatively impacted by the current market credit and liquidity crisis.
Mortgage loans, comprised of construction, residential and commercial mortgage loans, increased $1.3 billion, or 26.2 percent during 2008 to $6.1 billion at December 31, 2008 mainly due to $629.3 million in mortgage loans acquired from Greater Community and organic commercial mortgage loan growth. Excluding $493.0 million and $44.5 million, respectively, in loans acquired through the Greater Community acquisition, commercial mortgage and construction loans grew organically by $460.8 million or 19.4 percent and $63.2
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million or 15.7 percent, respectively. The organic growth seen in our commercial mortgage loan portfolio is primarily attributable to the expansion of our lending teams throughout our growing branch network and our continued ability to benefit from the dislocation in the credit markets. Construction loans increased mainly due to one $60.0 million loan to acquire a residential building (which the customer intends to convert to condominiums) in New York City in the fourth quarter of 2008. Residential mortgages increased $206.7 million to $2.3 billion at December 31, 2008 as compared to December 31, 2007, partly due to $91.8 million in mortgage loans acquired through the Greater Community acquisition. Excluding these acquired loans, residential mortgage loans increased $114.9 million during 2008; however, mortgage loan originations declined during the second half of the year due to a decline in home sales and refinancing activity, a drop in housing prices, and a downturn in the U.S. economy. We may experience further declines in residential mortgage loan volumes during 2009 if the economy continues to weaken. Additionally, based on our desired interest rate sensitivity position, we may increase the amount of residential mortgages sold in the secondary market.
Consumer loans decreased $22.9 million to approximately $2.1 billion at December 31, 2008 compared to the same period in 2007, primarily due to a decline in automobile loans, partly offset by the Greater Community acquisition which added $52.4 million in loans (primarily home equity loans) to our consumer portfolio at July 1, 2008. Our automobile loan portfolio declined $83.5 million during 2008 mainly as a result of deterioration in consumer demand for such products during the current economic downturn and tightening of our already conservative auto loan credit standards for potential customers during the second half of the year.
Much of our lending is in northern and central New Jersey and New York City, with the exception of the out-of-state auto loan portfolio, Small Business Administration (SBA) loans and a small amount of out-of-state residential mortgage loans. However, efforts are made to maintain a diversified portfolio as to type of borrower and loan to guard against a potential downward turn in any one economic sector. As a result of our lending, this could present a geographic and credit risk if there was a significant broad based downturn of the economy within the region. At this point in the U.S. economic downturn, our primary lending markets have performed better than the national average and other regions of the U.S. However, we can provide no assurance that our markets will not deteriorate beyond their current levels in the future and cause an increase in the credit risk of our loan portfolio.
The following table reflects the contractual maturity distribution of the commercial and construction loan portfolios as of December 31, 2008:
One Year or Less |
One to Five Years |
Over Five Years |
Total | |||||||||
(in thousands) | ||||||||||||
Commercialfixed rate |
$ | 622,010 | $ | 201,997 | $ | 21,428 | $ | 845,435 | ||||
Commercialadjustable rate |
823,970 | 267,584 | 28,383 | 1,119,937 | ||||||||
Constructionfixed rate |
19,503 | 19,934 | | 39,437 | ||||||||
Constructionadjustable rate. |
322,895 | 148,187 | | 471,082 | ||||||||
$ | 1,788,378 | $ | 637,702 | $ | 49,811 | $ | 2,475,891 | |||||
Prior to maturity of each loan with a balloon payment and if the borrower requests an extension, we generally conduct a review which normally includes an analysis of the borrowers financial condition and, if applicable, a review of the adequacy of collateral. A rollover of the loan at maturity may require a principal paydown.
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Non-performing Assets
Non-performing assets include non-accrual loans, other real estate owned (OREO), and other repossessed assets which consists of one aircraft and automobiles at December 31, 2008. Loans are generally placed on a 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 at the time of acquisition and at the lower of fair value, less estimated costs to sell, or cost thereafter. The level of non-performing assets remained relatively low as a percentage of the total loan portfolio as shown in the table below.
The following table sets forth non-performing assets and accruing loans which were 90 days or more past due as to principal or interest payments on the dates indicated in conjunction with asset quality ratios for Valley:
LOAN QUALITY
At December 31, | ||||||||||||||||||||
2008 | 2007 | 2006 | 2005 | 2004 | ||||||||||||||||
($ in thousands) | ||||||||||||||||||||
Loans past due in excess of 90 days and still accruing |
$ | 15,557 | $ | 8,462 | $ | 3,775 | $ | 4,442 | $ | 2,870 | ||||||||||
Non-accrual loans |
33,073 | 30,623 | 27,244 | 25,794 | 30,274 | |||||||||||||||
Other real estate owned |
8,278 | 609 | 779 | 2,023 | 480 | |||||||||||||||
Other repossessed assets |
4,317 | 1,466 | 844 | 608 | 861 | |||||||||||||||
Total non-performing assets |
$ | 45,668 | $ | 32,698 | $ | 28,867 | $ | 28,425 | $ | 31,615 | ||||||||||
Troubled debt restructured loans |
$ | 7,628 | $ | 8,363 | $ | 713 | $ | 821 | $ | 104 | ||||||||||
Total non-performing loans as a % of loans |
0.33 | % | 0.36 | % | 0.33 | % | 0.32 | % | 0.44 | % | ||||||||||
Total non-performing assets as a % of loans |
0.45 | % | 0.38 | % | 0.35 | % | 0.35 | % | 0.46 | % | ||||||||||
Allowance for loan losses as a % of non-performing loans |
281.93 | % | 237.29 | % | 274.25 | % | 291.49 | % | 217.01 | % |
Non-accrual loans have ranged from a low of $25.8 million to a high of $33.1 million over the last five years. Our non-accrual experience as a percentage of total loans indicates that the amount of non-accrual loans is historically low and there is no guarantee that this low level will continue. If interest on non-accrual loans had been accrued in accordance with the original contractual terms, such interest income would have amounted to approximately $2.7 million, $2.8 million and $2.1 million for the years ended December 31, 2008, 2007, and 2006, respectively; none of these amounts were included in interest income during these periods. Interest income recognized on loans once classified as non-accrual loans totaled $9 thousand, $45 thousand and $498 thousand for the years ended December 31, 2008, 2007, and 2006, respectively. No mortgage loans classified as loans held for sale and carried at fair value were on non-accrual status at December 31, 2008.
OREO increased $7.7 million to $8.3 million at December 31, 2008 as compared to $609 thousand at December 31, 2007. The increase was mainly comprised of two commercial loan properties and one commercial mortgage loan property. Other repossessed assets increased approximately $2.8 million to $4.3 million at December 31, 2008 from $1.5 million at December 31, 2007, mainly due to one $2.3 million commercial loan collateralized by an aircraft that was repossessed and transferred to other repossessed assets during the second quarter of 2008.
Loans 90 days or more past due and still accruing, which were not included in the non-performing category, are presented in the above table. These loans ranged from 0.04 percent to 0.15 percent of total loans for the last five years and increased $7.1 million to $15.6 million, or 0.15 percent of total loans at December 31, 2008 compared to $8.5 million or 0.10 percent at December 31, 2007. Loans past due 90 days or more and still accruing include matured performing loans in the normal process of renewal which totaled approximately $4.0 million and $2.2 million December 31, 2008 and 2007, respectively. Loans past due 90 days or more and still
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accruing represent most loan types and are generally well secured and in the process of collection. At December 31, 2008, no mortgage loans classified loans held for sale were 90 days or more past due and still accruing interest.
Troubled debt restructured loans, with modified terms and not reported as loans 90 days or more past due and still accruing or non-accrual, are presented in the table above. These restructured loans totaled $7.6 million and $8.4 million at December 31, 2008 and 2007, respectively. Restructured loans consist of 3 commercial loans and 15 commercial lease relationships at December 31, 2008. Of the 15 lease relationships, 13 had outstanding balances of less than $50 thousand at December 31, 2008. One of the commercial loan relationships had an unused line of credit and an unfunded construction loan commitment totaling $2.1 million at December 31, 2008.
Total loans past due in excess of 30 days were 1.06 percent of all loans at December 31, 2008 compared with 1.0 percent at December 31, 2007 and include matured loans in the normal process of renewal totaling approximately $6.9 million and $7.5 million at December 31, 2008 and 2007, respectively. We strive to keep the loans past due in excess of 30 days at these current low levels, however, there is no guarantee that these low levels will continue.
Although we believe that substantially all risk elements at December 31, 2008 have been disclosed in the categories presented above, it is possible that for a variety of reasons, including economic conditions, certain borrowers may be unable to comply with the contractual repayment terms on certain real estate and commercial loans. As part of the analysis of the loan portfolio, management determined that there were approximately $26.8 million and $7.2 million in potential problem loans at December 31, 2008 and 2007, respectively, which were not classified as non-accrual loans in the non-performing asset table above. Potential problem loans are defined as performing loans for which management has serious doubts as to the ability of such borrowers to comply with the present loan repayment terms and which may result in a non-performing loan. Our decision to include performing loans in 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. Of the $26.8 million in potential problem loans as of December 31, 2008, approximately $7.0 million is considered at risk after collateral values and guarantees are taken into consideration. At December 31, 2008, the potential problem loans consist of various types of credits, including commercial mortgages, revolving commercial lines of credit and commercial leases.
In our Quarterly Reports on Form 10-Q for the period ended June 30, 2008 and September 30, 2008, management reported that one performing commercial mortgage loan totaling approximately $25.7 million was a potential problem loan. During the fourth quarter of 2008, the commercial buildings securing the loan were sold to a third party that assumed the debt with modified terms and conditions. After a cash down payment by the new borrower and settlement of certain escrow balances, the debt (i.e., the loans principal balance) was $20.7 million at December 31, 2008. The loan remains a criticized loan under Valleys internal loan review process as of December 31, 2008 and, as a result, is closely monitored by management. Although, management feels the loan (secured by two office buildings totaling 286,000 square feet located in New York City) is well-collateralized, and is performing, there can be no assurance that the loan will not become a potential problem loan or that Valley will not incur a loss related to the loan in the future.
There can be no assurance that Valley has identified all of its potential problem loans at December 31, 2008.
Asset Quality and Risk Elements
Lending is one of the most important functions performed by Valley and, by its very nature, lending is also the most complicated, risky and profitable part of our business. For commercial loans, construction loans and commercial mortgage loans, a separate credit department is responsible for risk assessment, credit file maintenance and periodically evaluating overall creditworthiness of a borrower. Additionally, efforts are made to limit concentrations of credit so as to minimize the impact of a downturn in any one economic sector. Our loan portfolio is diversified as to type of borrower and loan. However, loans collateralized by real estate represent approximately 60 percent of total loans at December 31, 2008. Most of the loans collateralized by real estate are in northern and central New Jersey and New York City, presenting a geographical and credit risk if there was a significant downturn of the economy within the region.
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Residential mortgage loans are secured by 1-4 family properties generally located in counties where we have branch presence and counties contiguous thereto (including Pennsylvania). We do provide mortgage loans secured by homes beyond this primary geographic area, however, lending outside this primary area is generally made in support of existing customer relationships. Underwriting policies that are based on Fannie Mae and Freddie Mac guidelines are adhered to for loan requests of conforming and non-conforming amounts. The weighted average loan-to-value ratio of all residential mortgage originations in 2008 was 59 percent while FICO® (independent objective criteria measuring the creditworthiness of a borrower) scores averaged 746.
Consumer loans are comprised of home equity loans, credit card loans, automobile loans and other consumer loans. Home equity and automobile loans are secured loans and are made based on an evaluation of the collateral and the borrowers creditworthiness. In addition to New Jersey, automobile loans are primarily originated in several other states. Due to the level of our underwriting standards applied to all loans, management believes the out of the state loans generally present no more risk than those made within New Jersey. However, each loan or group of loans made outside of our primary markets poses some additional geographic risk based upon the economy of that particular region.
Management realizes that some degree of risk must be expected in the normal course of lending activities. Allowances are maintained to absorb such loan losses inherent in the portfolio. The allowance for credit losses and related provision are an expression of managements evaluation of the credit portfolio and economic climate.
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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 on the years indicated:
Years ended December 31, | ||||||||||||||||||||
2008 | 2007 | 2006 | 2005 | 2004 | ||||||||||||||||
($ in thousands) | ||||||||||||||||||||
Average loans outstanding |
$ | 9,386,987 | $ | 8,261,111 | $ | 8,262,739 | $ | 7,637,973 | $ | 6,541,993 | ||||||||||
Beginning balanceAllowance for credit losses |
$ | 74,935 | $ | 74,718 | $ | 75,188 | $ | 65,699 | $ | 64,650 | ||||||||||
Loans charged-off: |
||||||||||||||||||||
Commercial |
(6,760 | ) | (5,808 | ) | (6,078 | ) | (1,921 | ) | (6,551 | ) | ||||||||||
Construction |
| | | | | |||||||||||||||
MortgageCommercial |
(500 | ) | (1,596 | ) | (448 | ) | (307 | ) | (212 | ) | ||||||||||
MortgageResidential |
(501 | ) | (103 | ) | (644 | ) | (108 | ) | (117 | ) | ||||||||||
Consumer |
(14,902 | ) | (7,628 | ) | (4,918 | ) | (5,265 | ) | (6,258 | ) | ||||||||||
(22,663 | ) | (15,135 | ) | (12,088 | ) | (7,601 | ) | (13,138 | ) | |||||||||||
Charged-off loans recovered: |
||||||||||||||||||||
Commercial |
627 | 1,427 | 528 | 1,474 | 3,394 | |||||||||||||||
Construction |
| | | | | |||||||||||||||
MortgageCommercial |
6 | 254 | 181 | 129 | 237 | |||||||||||||||
MortgageResidential |
| 17 | 54 | 130 | 51 | |||||||||||||||
Consumer |
2,141 | 1,779 | 1,585 | 1,765 | 2,502 | |||||||||||||||
2,774 | 3,477 | 2,348 | 3,498 | 6,184 | ||||||||||||||||
Net charge-offs |
(19,889 | ) | (11,658 | ) | (9,740 | ) | (4,103 | ) | (6,954 | ) | ||||||||||
Provision charged for credit losses |
28,282 | 11,875 | 9,270 | 4,340 | 8,003 | |||||||||||||||
Additions from acquisitions |
11,410 | | | 9,252 | | |||||||||||||||
Ending balanceAllowance for credit losses |
$ | 94,738 | $ | 74,935 | $ | 74,718 | $ | 75,188 | $ | 65,699 | ||||||||||
Components of allowance for credit losses: |
||||||||||||||||||||
Allowance for loan losses |
$ | 93,244 | $ | 72,664 | $ | 74,718 | $ | 75,188 | $ | 65,699 | ||||||||||
Reserve for unfunded letters of credit* |
1,494 | 2,271 | | | | |||||||||||||||
Allowance for credit losses |
$ | 94,738 | $ | 74,935 | $ | 74,718 | $ | 75,188 | $ | 65,699 | ||||||||||
Components of provision for credit losses: |
||||||||||||||||||||
Provision for loan losses |
$ | 29,059 | $ | 12,751 | $ | 9,270 | $ | 4,340 | $ | 8,003 | ||||||||||
Provision for unfunded letters of credit* |
(777 | ) | (876 | ) | | | | |||||||||||||
Provision for credit losses |
$ | 28,282 | $ | 11,875 | $ | 9,270 | $ | 4,340 | $ | 8,003 | ||||||||||
Ratio of net charge-offs during the period to average loans outstanding during the period |
0.21 | % | 0.14 | % | 0.12 | % | 0.05 | % | 0.11 | % | ||||||||||
Allowance for loan losses as a % of loans |
0.92 | % | 0.86 | % | 0.90 | % | 0.92 | % | 0.95 | % | ||||||||||
Allowance for credit losses as a % of loans |
0.93 | % | 0.88 | % | 0.90 | % | 0.92 | % | 0.95 | % |
* | Effective January 1, 2007, Valley transferred $3.1 million of the allowance for loan losses related to commercial lending letters of credit to other liabilities. |
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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. The allowance is based on ongoing evaluations of the probable estimated losses inherent in the loan portfolio. Our methodology for evaluating the appropriateness of the allowance includes segmentation of the loan portfolio into its various components, tracking the historical levels of criticized loans and delinquencies, and assessing the nature and trend of loan charge-offs. 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, and economic conditions are taken into consideration.
The Banks allocated allowance is calculated by applying loss factors to outstanding loans and unfunded commitments. The formula is based on the internal risk grade of loans or pools of loans. Any change in the risk grade of performing and/or non-performing loans affects the amount of the related allowance. Loss factors are based on the Banks historical loss experience and may be adjusted for significant changes in the current loan portfolio quality that, in managements judgment, affect the collectibility of the portfolio as of the evaluation date.
The allowance contains reserves identified as the unallocated portion in the table below to cover inherent losses within a given loan category which have not been otherwise reviewed or measured on an individual basis. Such reserves include managements evaluation of the national and local economy, loan portfolio volumes, the composition and concentrations of credit, credit quality and delinquency trends. These reserves reflect managements attempt to ensure that the overall allowance reflects a margin for imprecision and the uncertainty that is inherent in estimates of probable credit losses. Net charge-off levels have remained relatively low in the last five years, but have increased to a high of 0.21 percent of average loans in 2008 from a low of 0.05 percent in 2005. The 2008 increase in net charge-offs was mainly due to higher automobile loan charge-offs caused by the financial crisis. During the second half of the year, we tightened our credit standards on automobile loans and the demand for such products also declined substantially during the same period reducing our auto portfolio balance. Despite these efforts, there can be no guarantee that our net charge-off levels for automobile loans and our other generally well secured loan categories will not continue to rise during 2009 given the current downturn in the U.S. economy and its potential effect on the future performance of our loan portfolio.
The provision for credit losses was $28.3 million in 2008 compared to $11.9 million in 2007. The $16.4 million increase reflects the increase in the loan portfolio (excluding the $812.5 million in loans acquired from Greater Community), the increased level of net loan charge-offs and delinquencies, and the deterioration in economic conditions during the year ended December 31, 2008.
The following table summarizes the allocation of the allowance for credit losses to specific loan categories for the past five years:
Years ended December 31, | ||||||||||||||||||||||||||||||
2008 | 2007 | 2006 | 2005 | 2004 | ||||||||||||||||||||||||||
($ in thousands) | ||||||||||||||||||||||||||||||
Allowance Allocation |
Percent of Loan Category to Total Loans |
Allowance Allocation |
Percent of Loan Category to Total Loans |
Allowance Allocation |
Percent of Loan Category to Total Loans |
Allowance Allocation |
Percent of Loan Category to Total Loans |
Allowance Allocation |
Percent of Loan Category to Total Loans |
|||||||||||||||||||||
Loan category: |
||||||||||||||||||||||||||||||
Commercial* |
$ | 44,163 | 19.4 | % | $ | 31,638 | 18.4 | % | $ | 31,888 | 17.6 | % | $ | 34,828 | 17.8 | % | $ | 29,166 | 18.2 | % | ||||||||||
Mortgage |
30,354 | 60.2 | 23,660 | 56.9 | 27,942 | 59.3 | 28,200 | 58.9 | 23,033 | 57.2 | ||||||||||||||||||||
Consumer |
14,318 | 20.4 | 10,815 | 24.7 | 8,189 | 23.1 | 8,174 | 23.3 | 7,884 | 24.6 | ||||||||||||||||||||
Unallocated |
5,903 | N/A | 8,822 | N/A | 6,699 | N/A | 3,986 | N/A | 5,616 | N/A | ||||||||||||||||||||
$ | 94,738 | 100.0 | % | $ | 74,935 | 100.0 | % | $ | 74,718 | 100.0 | % | $ | 75,188 | 100.0 | % | $ | 65,699 | 100.0 | % | |||||||||||
* | Includes the reserve for unfunded letters of credit totaling $1.5 million and $2.3 million at December 31, 2008 and 2007, respectively. |
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At December 31, 2008, the allowance for credit losses amounted to $94.7 million or 0.93 percent of loans, as compared to $74.9 million or 0.88 percent at December 31, 2007. The allowance was adjusted by provisions charged against income, charge-offs, net of recoveries, as well as an additional amount recorded in connection with the Greater Community acquisition. The five basis point increase in the allowance for credit losses as a percentage of total loans from 2007 was mainly due to loan growth, including non-acquisition related expansion in commercial mortgage and commercial loan categories, additional reserves of $11.4 million assumed in the Greater Community acquisition (which totaled 1.4 percent of the $812.5 million loans acquired on July 1, 2008) and higher loss factors for automobile loans. Allocations of the allowance for impaired loans decreased $500 thousand from 2007 mainly due to the relative value of the assets collateralizing the majority of these impaired loans. See Note 5 to the consolidated financial statements for further analysis of the impaired loan portfolio. Increases in non-performing loans at December 31, 2008, as noted in the Non-performing Asset section above, had a relatively minor impact on the level of the allowance for credit losses primarily due to the generally well secured nature of these credits. Loans past due in excess of 90 days and still accruing were up by 0.05 percent to 0.15 percent of total loans at December 31, 2008 as compared to December 31, 2007, driven primarily by a number of well collateralized commercial and residential mortgage credits. These factors had a relatively minor impact on the level of the allowance for credit losses at December 31, 2008.
Management believes that the unallocated allowance is appropriate given the current weakened economic climate, the size of the loan portfolio and delinquency trends at December 31, 2008.
The impaired loan portfolio is primarily collateral dependent. Impaired loans and their related specific allocations to the allowance for loan losses totaled $22.4 million and $2.1 million, respectively, at December 31, 2008 and $28.9 million and $2.6 million, respectively, at December 31, 2007. The average balance of impaired loans during 2008, 2007 and 2006 was approximately $25.3 million, $23.8 million and $20.7 million, respectively. The amount of interest that would have been recorded under the original terms for impaired loans was $984 thousand for 2008, $1.3 million for 2007, and $1.2 million for 2006. Interest was not collected on these impaired loans during these periods.
Capital Adequacy
A significant measure of the strength of a financial institution is its shareholders equity. At December 31, 2008 and December 31, 2007, shareholders equity totaled $1.4 billion and $949.1 million, respectively, or 9.3 percent and 7.4 percent of total assets, respectively. The increase in total shareholders equity during the year ended December 31, 2008 was mainly the result of the issuance of $300.0 million in nonvoting senior preferred shares, the additional capital issued in the Greater Community acquisition totaling $167.8 million, net income of $93.6 million, and treasury stock issued for stock-based compensation, including stock option swap exercises, partially offset by cash dividends declared to common shareholders of $104.4 million, dividends and accretion on preferred stock of $2.1 million, and an increase in accumulated other comprehensive loss.
Included in shareholders equity as a component of accumulated other comprehensive loss at December 31, 2008 was a $32.7 million net unrealized loss on investment securities available for sale, net of deferred tax compared to a $778 thousand net unrealized loss, net of deferred tax at December 31, 2007. Also, included as a component of accumulated other comprehensive loss at December 31, 2008 was $23.2 million, representing the unfunded portion of Valleys various pension obligations, due to the adoption of SFAS No. 158 on December 31, 2006 and a $5.0 million unrealized loss on derivatives, net of deferred tax used in cash flow hedging relationships.
On January 17, 2007, Valleys Board of Directors approved the repurchase of up to 3.9 million common shares. Purchases may be made from time to time in the open market or in privately negotiated transactions generally not exceeding prevailing market prices. Repurchased shares are held in treasury and are expected to be used for general corporate purposes. Valley made no purchases of its outstanding shares during the year ended December 31, 2008. Valley purchased approximately 475 thousand shares during 2007 pursuant to this plan at an average cost of $19.49 per share. Valleys Board of Directors previously authorized the repurchase of up to 3.2 million shares of Valleys outstanding common stock on May 14, 2003. During 2007, Valley repurchased the
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remaining 1.2 million shares of its common stock under the 2003 publicly announced program at an average cost of $22.78 per share. No further repurchases will be made under the terms of the nonvoting senior preferred shares sold to the Treasury while such shares are owned by the Treasury.
On November 14, 2008, Valley issued $300 million in nonvoting senior preferred shares to the Treasury under its TARP Capital Purchase Program mainly to support growth in our lending operations and better position Valley for a potentially extended downturn in the U.S. economy. Our senior preferred shares will pay a cumulative dividend rate of five percent per annum for the first five years and will reset to a rate of nine percent per annum after year five. Under the terms of the program, the Treasurys consent will be required for any increase in our dividends paid to common stockholders (above a quarterly dividend of $0.20 per common share) or our redemption, purchase or acquisition of Valley common stock or any trust preferred securities issued by our capital trusts until the third anniversary of the Valley senior preferred share issuance to the Treasury unless prior to such third anniversary the senior preferred shares are redeemed in whole or the Treasury has transferred all of these shares to third parties. The senior preferred shares are 100 percent allowable in Tier I Capital for Regulatory purposes.
In conjunction with the purchase of our senior preferred shares, the Treasury received a ten year warrant to purchase up to approximately 2.3 million of Valley common shares with an aggregate market price equal to $45 million or 15 percent of the senior preferred investment. The warrant has several unique features, including our right to reduce the number of shares of Valley common stock underlying the warrant by 50 percent if before December 31, 2009 we issue $300 million of equity capital, and the fact that the warrant is exercisable on a net exercise basis. Our common stock underlying the warrant represents approximately 1.7 percent of our outstanding common shares at December 31, 2008. The warrants exercise price of $19.59 per share was calculated based on the average of closing prices of Valleys common stock on the 20 trading days ending on the last trading day prior to the date of the Treasurys approval of our application under the program.
Valley may redeem the senior preferred shares three years after the date of the Treasurys investment, or earlier if it raises in an equity offering net proceeds equal to the amount of the senior preferred shares to be redeemed. It must raise proceeds equal to at least 25% of the issue price of the senior preferred shares to redeem any senior preferred shares prior to the end of the third year. The redemption price is equal to the sum of the liquidation amount per share and any accrued and unpaid dividends on the senior preferred shares up to, but excluding, the date fixed for redemption. Notwithstanding the foregoing limitations, under the Recovery Act the Treasury may, after consultation with Valleys federal regulator, permit Valley at any time to redeem the senior preferred shares. Upon such redemption, the Treasury will liquidate at the current market price the warrant that Valley issued to the Treasury.
Our senior preferred shares and the warrant issued under the TARP program qualify and are accounted for as permanent equity on our balance sheet. Of the $300 million in issuance proceeds, $291.4 million and $8.6 million were allocated to the senior preferred shares and the warrant, respectively, based upon their estimated relative fair values as of November 14, 2008. The discount of $8.6 million recorded for the senior preferred shares is being amortized to retained earnings over a five year estimated life of the securities based on the likelihood of their redemption by us within that timeframe.
Risk-based 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 and GCB Capital Trust III, 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 Banks 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.
Valleys regulatory capital position included $176.3 million and $160.0 million of its outstanding trust preferred securities issued by capital trusts as of December 31, 2008 and 2007, respectively. Including these securities and our senior preferred shares, Valleys capital position under risk-based capital guidelines was $1.3 billion, or 11.4 percent of risk-weighted assets for Tier 1 capital and $1.5 billion or 13.2 percent for total risk-
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based capital at December 31, 2008. The comparable ratios at December 31, 2007 were 9.6 percent for Tier 1 capital and 11.4 percent for total risk-based capital. At December 31, 2008 and 2007, Valley was in compliance with the leverage requirement having Tier 1 leverage ratios of 9.1 percent and 7.6 percent, respectively. The Banks ratios at December 31, 2008 were all above the minimum levels required for Valley to be considered well capitalized, which require Tier I capital to risk-adjusted assets of at least 6 percent, total risk-based capital to risk-adjusted assets of 10 percent and a minimum leverage ratio of 5 percent.
In March 2005, the Federal Reserve Board issued a final rule that would continue to allow the inclusion of trust preferred securities in Tier I capital, but with stricter quantitative limits. The new quantitative limits will become effective on March 31, 2009. The aggregate amount of trust preferred securities and certain other capital elements would be limited to 25 percent of Tier I capital elements, net of goodwill. The amount of trust preferred securities and certain other elements in excess of the limit could be included in total capital, subject to restrictions. Based on the final rule issued in March 2005, Valley included all of its outstanding trust preferred securities in Tier I capital at December 31, 2008 and 2007. See Note 12 of the consolidated financial statements for additional information.
Book value per common share amounted to $7.94 at December 31, 2008 compared with $7.54 per common share at December 31, 2007.
The 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 net income available to common stockholders per common share. Primarily due to the other-than-temporary impairment charges and realized losses on investment securities held in the available for sale and held to maturity portfolios, our cash dividend pay-out per common share for the year ended December 31, 2008 was greater than our earnings for the same period, thereby causing the earnings retention rate to be zero for the same period. Our annual rate of earnings retention is expected to increase in 2009, unless we were to experience adverse effects, such as incurring additional impairment charges within our investment securities portfolio or due to the occurrence of one or more of the risk factors inherent to our business disclosed in Part I, Item 1A of this report. The retention ratio for the comparable year ended December 31, 2007 was 34.5 percent. Cash dividends declared amounted to $0.80 per common share for the years ended December 31, 2008 and 2007. Valleys Board of Directors continues to believe that cash dividends are an important component of shareholder value and at its current level of performance and capital, we expect to continue our current dividend policy of a quarterly cash distribution of earnings to our shareholders within the restrictions of the Treasurys TARP program relating to our senior preferred shares described above.
Off-Balance Sheet Arrangements
Contractual Obligations. In the ordinary course of operations, Valley enters into various financial obligations, including contractual obligations that may require future cash payments. Further discussion of the nature of each obligation is included in Notes 10, 11, 12, and 15 of the consolidated financial statements.
The following table presents significant fixed and determinable contractual obligations to third parties by payment date as of December 31, 2008:
One Year or Less |
One to Three Years |
Three to Five Years |
Over Five Years |
Total | |||||||||||
(in thousands) | |||||||||||||||
Time deposits |
$ | 3,072,986 | $ | 294,213 | $ | 173,021 | $ | 81,039 | $ | 3,621,259 | |||||
Long-term borrowings |
59,494 | 270,305 | 29,729 | 2,649,225 | 3,008,753 | ||||||||||
Junior subordinated debentures issued to capital trusts* |
| | | 181,767 | 181,767 | ||||||||||
Operating leases |
13,051 | 24,902 | 23,962 | 145,568 | 207,483 | ||||||||||
Capital expenditures |
10,425 | | | | 10,425 | ||||||||||
Total |
$ | 3,154,410 | $ | 593,061 | $ | 225,325 | $ | 3,056,891 | $ | 7,029,687 | |||||
* | Amounts presented are the contractual principal balances. The junior subordinated debentures issued to VNB Capital Trust I are carried at fair value of $140.1 million on the consolidated statement of condition at December 31, 2008. |
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Valley also has obligations under its pension benefit plans, not included in the above table, as further described in Note 13 of the consolidated financial statements.
Commitments. As a financial services provider, we routinely enter into commitments to extend credit, including loan commitments, standby and commercial letters of credit. While these contractual obligations represent our future cash requirements, a significant portion of commitments to extend credit may expire without being drawn on based upon our historical experience. Such commitments are subject to the same credit policies and approval process accorded to loans made by the Bank. For additional information, see Note 15 of the consolidated financial statements.
The following table shows the amounts and expected maturities of significant commitments as of December 31, 2008:
One Year or Less |
One to Three Years |
Three to Five Years |
Over Five Years |
Total | |||||||||||
(in thousands) | |||||||||||||||
Commitments under commercial loans and lines of credit |
$ | 1,680,951 | $ | 170,721 | $ | 17,404 | $ | 155,549 | $ | 2,024,625 | |||||
Home equity and other revolving lines of credit |
646,482 | | | | 646,482 | ||||||||||
Outstanding commercial mortgage loan commitments |
170,647 | 153,314 | 1,000 | | 324,961 | ||||||||||
Standby letters of credit |
142,490 | 6,969 | 11,200 | 15,942 | 176,601 | ||||||||||
Outstanding residential mortgage loan commitments |
34,703 | | | | 34,703 | ||||||||||
Commitments under unused lines of creditcredit card |
44,766 | 37,721 | | | 82,487 | ||||||||||
Commercial letters of credit |
9,918 | | | | 9,918 | ||||||||||
Commitments to sell loans |
15,750 | | | | 15,750 | ||||||||||
Commitments to fund civic and community investments |
1,081 | 608 | | | 1,689 | ||||||||||
Other |
10,787 | 3,102 | 629 | | 14,518 | ||||||||||
Total |
$ | 2,757,575 | $ | 372,435 | $ | 30,233 | $ | 171,491 | $ | 3,331,734 | |||||
Included in the other commitments are projected earn-outs of $507 thousand that are scheduled to be paid over the next three year period in conjunction with our acquisition of an insurance agency (which was merged with Masters Coverage Corp., a wholly-owned subsidiary of Valley National Bank) in 2006. These earn-outs are paid in accordance with predetermined profitability targets. The balance of the other category represents approximate amounts for contractual communication and technology costs.
Derivative Financial Instruments. Use of derivative financial instruments is one of several ways in which Valley can manage its interest rate risk. In general, the assets and liabilities generated through the ordinary course of business activities do not naturally create offsetting positions with respect to repricing, basis or maturity characteristics. Valley has used certain derivative instruments, principally interest rate swaps and caps, as part of its asset/liability management practices to adjust the interest rate sensitivity of its loan portfolio, deposits and the overall balance sheet.
Fair Value HedgeInterest Rate Swap
In 2005, Valley entered into a $9.7 million amortizing notional interest rate swap to hedge changes in the fair value of a fixed rate loan that it made to a commercial borrower. Valley has designated the interest rate swap as a fair value hedge according to SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. The changes in the fair value of the interest rate swap are recorded through earnings and are offset by the changes in fair value of the hedged fixed rate loan. As of December 31, 2008 and December 31, 2007, the
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interest rate swap had a fair value of $2.0 million and $424 thousand, respectively, included in other liabilities on the consolidated statements of financial condition. No material hedge ineffectiveness existed on the interest rate swap during the years ended December 31, 2008, 2007 and 2006.
Cash Flow HedgeInterest Rate Swap
In 2004, Valley entered into interest rate swap transactions designated as cash flow hedges which effectively converted $300 million of its prime-based floating rate commercial loans to a fixed rate. The cash flow hedges involved the receipt of fixed-rate amounts in exchange for variable-rate payments over the life of the agreements without exchange of the underlying principal amount. The cash flow hedges expired on August 1, 2006.
Prior to the cash flow hedge expiration in 2006, unrealized losses, net of tax benefits, reported in accumulated other comprehensive income related to cash flow hedges were reclassified to interest income as interest payments were received on the applicable variable rate loans. For the year ended December 31, 2006, unrealized losses of $3.2 million were reclassified out of other comprehensive income as the hedged forecasted transactions occurred and recognized as a component of interest income. No material hedge ineffectiveness existed on the interest rate swap during the years ended December 31, 2006.
Cash Flow HedgeInterest Rate Caps
In the second quarter of 2008, Valley purchased two interest rate caps designated as cash flow hedges to protect against movements in interest rates above the caps strike rate based on the effective federal funds rate. The interest rate caps have an aggregate notional amount of $100.0 million, strike rates of 2.50 percent and 2.75 percent, and a maturity date of May 1, 2013. Through November of 2008, the caps were used to hedge the variable cash flows associated with customer repurchase agreements (included in short-term borrowings) and money market deposit accounts that had variable interest rates based on an effective federal funds rate less 25 basis points. During November, the hedging relationship was terminated since the rates paid on the customer repurchase agreements and money market deposit accounts did not trend with the effective federal funds rate (this was caused by historically unprecedented low level of the effective federal funds rate thereby causing Valley to modify the benchmark used to pay interest on these accounts). As a result, from the termination date of the hedging relationship in November of 2008 through December 31, 2008, a $2.4 million change in fair value of these derivatives not designated as hedges was included in other expense for the year ended December 31, 2008. As of December 31, 2008, the two interest rate caps were not redesignated in a new hedging relationship and are subject to future changes in their fair value which will be charged to our earnings.
In the third quarter of 2008, Valley purchased two interest rate caps designated as cash flow hedges, to reduce its exposure to movements in interest rates above the caps strike rate based on the prime interest rate (as published in The Wall Street Journal). The interest rate caps have an aggregate notional amount of $100.0 million, strike rates of 6.00 percent and 6.25 percent, and a maturity date of July 15, 2015. The caps are 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 of 2.75 percent below the prime rate.
At December 31, 2008, the federal funds and prime based interest rate caps had a combined fair value of $3.3 million included in other assets. For the year ended December 31, 2008, other comprehensive loss includes $5.0 million for changes in net unrealized losses on the cash flow hedges, net of taxes. Amounts reported in accumulated other comprehensive income related to the interest rate caps are reclassified to interest expense as interest payments are made on the hedged variable interest rate liabilities. For the year ended December 31, 2008, the change in net unrealized losses on the cash flow hedges reflect a reclassification of approximately $747 thousand from accumulated other comprehensive income to interest expense. Of this amount, $642 thousand was due to our acceleration of amounts related to the total forecasted changes in cash flows that are not probable to occur. We estimate an unrealized loss of $318 thousand, net of tax, will be reclassified out of other comprehensive loss and realized as an addition to interest expense during 2009.
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For the year ended December 31, 2008, Valley recognized a loss of $21 thousand in other expense for hedge ineffectiveness on the federal funds based interest rate caps. There was no ineffectiveness recognized on the prime based interest rate caps during 2008.
Other Derivative Transactions
During the second quarter of 2007, Valley executed and subsequently terminated a series of interest rate derivative transactions with a notional amount of approximately $1.0 billion. The intended purpose of the derivative transactions was to offset volatility in changes in the market value of over $800 million in trading securities consisting primarily of mortgage-backed securities transferred from the available for sale portfolio at January 1, 2007. These hedged securities were sold during the second quarter of 2007 in conjunction with the termination of the derivative transactions. See further discussion of these transactions at Note 3 to the consolidated financial statements.
Trust Preferred Securities. In addition to the commitments and derivative financial instruments of the types described above, our off balance sheet arrangements include a $5.5 million ownership interest in the common securities of our statutory trusts to issue trust preferred securities. See Capital Adequacy section above in this Item 7 and Note 12 of the consolidated financial statements.
Results of Operations2007 Compared to 2006
Net income was $153.2 million or $1.21 per diluted share, return on average assets was 1.25 percent and return on average shareholders equity was 16.43 percent for 2007. This compares with net income of $163.7 million or $1.27 per diluted share in 2006, return on average assets of 1.33 percent and return on average shareholders equity of 17.24 percent in 2006.
Net interest income on a tax equivalent basis decreased to $387.9 million for 2007 compared with $397.7 million for 2006. During 2007, the yield on average interest earning assets increased over 2006, but was more than offset by an increase in the interest rates paid on average interest bearing liabilities and higher average balances in time deposits and long-term borrowings.
The net interest margin on a tax equivalent basis was 3.43 percent for the year ended December 31, 2007 compared with 3.46 percent for the same period in 2006. The change was mainly attributable to the increase in interest paid on time deposits and long-term borrowings and an increase in the average balance of such interest bearing liabilities, partially offset by a higher yield on average loans and investments. Average interest rates earned on interest earning assets increased 25 basis points while average interest rates paid on interest bearing liabilities increased 30 basis points causing a compression in the net interest margin in 2007 for Valley as compared to the year ended December 31, 2006.
Average loans totaling $8.3 billion for the year ended December 31, 2007 remained flat as compared to the same period in 2006. Average investments securities declined $304.8 million, or 9.7 percent in 2007 as compared to the year ended December 31, 2006. Despite the flat loan volumes, interest income on a tax equivalent basis for loans increased $15.6 million for the year ended December 31, 2007 compared with the same period in 2006 due to a 19 basis point increase in the yield on average loans. Interest income on a tax equivalent basis for investment securities decreased $4.9 million or 2.9 percent mainly due to the decrease in average investment securities for the twelve months in 2007 compared to the same period in 2006. The decrease in average investment securities was mainly due to investment cash flows reallocation to federal funds sold, held through most of the third quarter of 2007, as well as $75.0 million allocated to an additional investment in bank owned life insurance during the second quarter of 2007.
Average interest bearing liabilities totaling $9.4 billion for the year ended December 31, 2007 remained relatively unchanged from the same period in 2006. Average time deposits increased $190.2 million, or 6.9 percent due to some movement of lower yielding deposit accounts to time deposits as the yield on average time deposits increased 49 basis points from 2006, as well as new time deposit accounts from the six de novo branches
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opened in 2007 and other existing branches. Average long-term borrowings increased $58.5 million from 2006 as Valley increased its long-term positions in lower cost Federal Home Loan Bank advances during the fourth quarter of 2007. Average savings, NOW, and money market deposits decreased $284.5 million, or 7.6 percent for 2007 as compared to 2006 mainly due to aggressive pricing by our competitors in the marketplace, as well as customer movement from lower yielding deposit accounts to higher yielding alternatives, such as certificates of deposit.
Non-interest income represented 10.9 percent and 9.2 percent of total interest income plus non-interest income for 2007 and 2006, respectively. For the year ended December 31, 2007, non-interest income increased $17.0 million or 23.5 percent, compared with the same period in 2006.
Service charges on deposit accounts increased $3.6 million, or 15.3 percent in 2007 compared with 2006 mainly due to stronger overdraft fee collection initiatives implemented by management throughout Valleys branch network operations during 2007.
Losses on securities transactions, net, increased $10.3 million to a net loss of $15.8 million for the year ended December 31, 2007. The increase was mainly due to an other-than-temporary impairment charge totaling $17.9 million ($10.4 million after-taxes) with regard to Fannie Mae and Freddie Mac perpetual preferred securities during the fourth quarter of 2007. During 2006, Valley recognized a net loss of $5.5 million mainly due to a $4.7 million impairment charge recognized on certain mortgage-backed and equity securities classified as available for sale and a $2.1 million loss on trust preferred securities called for redemption prior to their scheduled maturity date, partially offset by various gains on securities transactions throughout 2006.
Net gains on trading securities increased $6.2 million for the year ended December 31, 2007 compared with the same period in 2006 mainly due to $2.7 million in net unrealized gains on Valleys Junior subordinated debentures issued to VNB Capital Trust I and one Federal Home Loan Bank held at fair value and increased trading activity in 2007 resulting from Valleys early adoption of SFAS Nos. 157 and 159. Valley elected to fair value investment securities with a total carrying amount of approximately $1.3 billion at January 1, 2007. During the second quarter of 2007, Valley executed a series of interest rate derivative transactions designed to hedge the market risk inherent in the trading securities. The derivative transactions did not offset the volatility in the trading securities to the extent expected and as a result Valley sold approximately $1.0 billion of these securities and simultaneously terminated the derivative transactions. The majority of these securities sold during the second quarter of 2007 were replaced with shorter duration investments held in trading securities as of December 31, 2007.
Gains on sales of loans, net, increased $3.3 million to $4.8 million for the year ended December 31, 2007 compared to $1.5 million for the prior year. This increase was primarily due to the gains realized on the sale of approximately $240 million of residential mortgage loans held for sale during 2007 that Valley elected to carry at fair value effective as of January 1, 2007.
Gains on sales of assets, net increased $12.2 million, to $16.1 million for the year-ended December 31, 2007 compared to $3.8 million for the same period in 2006 mainly due to a $16.4 million immediate gain recognized on the sale of a Manhattan office building in the first quarter of 2007. Valley sold the nine-story building for approximately $37.5 million while simultaneously entering into a long-term lease for its branch office located on the first floor of the same building. The transaction resulted in a $32.3 million pre-tax gain, of which $16.4 million was immediately recognized in earnings in 2007 and $15.9 million was deferred and amortized into earnings over the 20 year term of the lease pursuant to the sale-leaseback accounting rules. Approximately $594 thousand of the initial deferred gain was amortized to net gains on sales of assets during 2007. During 2006, Valley sold an office building located in Manhattan that was originally intended for construction of a new branch, however, Valley ultimately decided to sell the property and not pursue the project. The transaction resulted in $3.8 million gain recognized in the fourth quarter of 2006.
BOLI income increased $3.4 million, or 41.3 percent for year-ended December 31, 2007 compared with the same period of 2006 due to income generated from an additional BOLI investment of $75.0 million during the second quarter of 2007 which was invested to offset rising employee benefit costs.
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Non-interest expense increased $3.6 million thousand to $253.9 million for the year-ended December 31, 2007 from $250.3 million for the same period in 2006. Increases in salary expense, employee benefit expense, goodwill impairment, and net occupancy and equipment expense were partially offset with decreases in amortization of other intangible assets, professional and legal fees, and advertising. Valley incurred additional expenses due to de novo expansion efforts in 2007 and 2006 in its target expansion areas of northern and central New Jersey, New York City, Brooklyn and Queens. These expansion efforts will negatively impact non-interest expense until these new branches become profitable or breakeven, typically over a period of three years. The largest component of non-interest expense is salary and employee benefit expense which totaled $145.7 million in 2007 compared with $138.4 million in 2006.
Income tax expense was $51.7 million for the year ended December 31, 2007, reflecting an effective tax rate of 25.2 percent, compared with $39.9 million for the year ended December 31, 2006, reflecting an effective tax rate of 19.6 percent. The increase in 2007 income tax expense reflects a $13.5 million tax benefit recognized during the comparable 2006 period due to managements reassessment of required tax accruals.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
For information regarding Quantitative and Qualitative Disclosures About Market Risk, see Part II, Item 7, Managements Discussion and Analysis of Financial Condition and Results of OperationsInterest Rate Sensitivity.
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Item 8. Financial Statements and Supplementary Data
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
December 31, | ||||||||
2008 | 2007 | |||||||
(in thousands except for share data) |
||||||||
Assets |
||||||||
Cash and due from banks |
$ | 237,497 | $ | 218,896 | ||||
Interest bearing deposits with banks |
343,010 | 9,569 | ||||||
Federal funds sold |
| 9,000 | ||||||
Investment securities: |
||||||||
Held to maturity, fair value of $1,069,245 at December 31, 2008 and $548,353 at December 31, 2007 |
1,154,737 | 556,113 | ||||||
Available for sale |
1,435,442 | 1,606,410 | ||||||
Trading securities |
34,236 | 722,577 | ||||||
Total investment securities |
2,624,415 | 2,885,100 | ||||||
Loans held for sale, at fair value |
4,542 | 2,984 | ||||||
Loans |
10,143,690 | 8,496,221 | ||||||
Less: Allowance for loan losses |
(93,244 | ) | (72,664 | ) | ||||
Net loans |
10,050,446 | 8,423,557 | ||||||
Premises and equipment, net |
256,343 | 227,553 | ||||||
Bank owned life insurance |
300,058 | 273,613 | ||||||
Accrued interest receivable |
57,717 | 56,578 | ||||||
Due from customers on acceptances outstanding |
9,410 | 8,875 | ||||||
Goodwill |
295,146 | 179,835 | ||||||
Other intangible assets, net |
25,954 | 24,712 | ||||||
Other assets |
513,591 | 428,687 | ||||||
Total Assets |
$ | 14,718,129 | $ | 12,748,959 | ||||
Liabilities |
||||||||
Deposits: |
||||||||
Non-interest bearing |
$ | 2,118,249 | $ | 1,929,555 | ||||
Interest bearing: |
||||||||
Savings, NOW and money market |
3,493,415 | 3,382,474 | ||||||
Time |
3,621,259 | 2,778,975 | ||||||
Total deposits |
9,232,923 | 8,091,004 | ||||||
Short-term borrowings |
640,304 | 605,154 | ||||||
Long-term borrowings (includes fair value of $41,359 for a Federal Home Loan Bank advance at December 31, 2007) |
3,008,753 | 2,801,195 | ||||||
Junior subordinated debentures issued to capital trusts (includes fair value of $140,065 at December 31, 2008 and $163,233 at December 31, 2007 for VNB Capital Trust I) |
165,390 | 163,233 | ||||||
Bank acceptances outstanding |
9,410 | 8,875 | ||||||
Accrued expenses and other liabilities |
297,740 | 130,438 | ||||||
Total Liabilities |
13,354,520 | 11,799,899 | ||||||
Shareholders Equity |
||||||||
Preferred stock, no par value, authorized 30,000,000 shares; issued 300,000 shares at December 31, 2008 |
291,539 | | ||||||
Common stock, no par value, authorized 190,886,088 shares; issued 136,970,912 shares at December 31, 2008 and 128,503,294 shares at December 31, 2007 |
48,228 | 43,185 | ||||||
Surplus |
1,047,085 | 879,892 | ||||||
Retained earnings |
85,234 | 104,225 | ||||||
Accumulated other comprehensive loss |
(60,931 | ) | (12,982 | ) | ||||
Treasury stock, at cost (1,946,882 common shares at December 31, 2008 and 2,659,220 common shares at December 31, 2007) |
(47,546 | ) | (65,260 | ) | ||||
Total Shareholders Equity |
1,363,609 | 949,060 | ||||||
Total Liabilities and Shareholders Equity |
$ | 14,718,129 | $ | 12,748,959 | ||||
See accompanying notes to consolidated financial statements.
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CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31, | ||||||||||||
2008 | 2007 | 2006 | ||||||||||
(in thousands, except for share data) | ||||||||||||
Interest Income |
||||||||||||
Interest and fees on loans |
$ | 572,918 | $ | 560,066 | $ | 544,440 | ||||||
Interest and dividends on investment securities: |
||||||||||||
Taxable |
137,763 | 134,969 | 140,979 | |||||||||
Tax-exempt |
10,089 | 11,268 |