Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark One)

 

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

For the Quarterly Period Ended June 30, 2009

OR

 

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

For the transition period from                      to                     

Commission File Number 1-11277

VALLEY NATIONAL BANCORP

(Exact name of registrant as specified in its charter)

 

New Jersey   22-2477875
(State or other jurisdiction of
Incorporation or Organization)
  (I.R.S. Employer
Identification Number)
1455 Valley Road
Wayne, NJ
  07470
(Address of principal executive office)   (Zip code)

973-305-8800

(Registrant’s telephone number, including area code)

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

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

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

 

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Common Stock (no par value), of which 143,008,655 shares were outstanding as of August 5, 2009.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

     Page Number
PART I    FINANCIAL INFORMATION   

Item 1.

  

Financial Statements (Unaudited)

  
  

Consolidated Statements of Financial Condition June 30, 2009 and December 31, 2008

   3
  

Consolidated Statements of Income Three and Six Months Ended June 30, 2009 and 2008

   4
  

Consolidated Statements of Cash Flows Six Months Ended June 30, 2009 and 2008

   5
  

Notes to Consolidated Financial Statements – June 30, 2009

   6

Item 2.

  

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

   35

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

   63

Item 4.

  

Controls and Procedures

   63
PART II    OTHER INFORMATION   

Item 1.

  

Legal Proceedings

   64

Item 1A.

  

Risk Factors

   64

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

   65

Item 4.

  

Submission of Matters to a Vote of Security Holders

   65

Item 6.

  

Exhibits

   67
SIGNATURES    68

 

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Table of Contents

PART 1 - FINANCIAL INFORMATION

 

Item 1. Financial Statements

VALLEY NATIONAL BANCORP

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (Unaudited)

(in thousands, except for share data)

 

     June 30,
2009
    December 31,
2008
 

Assets

    

Cash and due from banks

   $ 253,206      $ 237,497   

Interest bearing deposits with banks

     89,853        343,010   

Investment securities:

    

Held to maturity, fair value of $1,512,779 at June 30, 2009 and $1,069,245 at December 31, 2008

     1,575,972        1,154,737   

Available for sale

     1,319,544        1,435,442   

Trading securities

     32,821        34,236   
                

Total investment securities

     2,928,337        2,624,415   
                

Loans held for sale, at fair value

     27,596        4,542   

Loans

     9,618,377        10,143,690   

Less: Allowance for loan losses

     (100,761     (93,244
                

Net loans

     9,517,616        10,050,446   
                

Premises and equipment, net

     271,062        256,343   

Bank owned life insurance

     302,014        300,058   

Accrued interest receivable

     57,359        57,717   

Due from customers on acceptances outstanding

     5,252        9,410   

Goodwill

     295,631        295,146   

Other intangible assets, net

     24,412        25,954   

Other assets

     359,693        513,591   
                

Total Assets

   $ 14,132,031      $ 14,718,129   
                

Liabilities

    

Deposits:

    

Non-interest bearing

   $ 2,333,195      $ 2,118,249   

Interest bearing:

    

Savings, NOW and money market

     3,843,513        3,493,415   

Time

     3,143,739        3,621,259   
                

Total deposits

     9,320,447        9,232,923   
                

Short-term borrowings

     193,281        640,304   

Long-term borrowings

     2,971,829        3,008,753   

Junior subordinated debentures issued to capital trusts (includes fair value of $150,743 at June 30, 2009 and $140,065 at December 31, 2008 for VNB Capital Trust I)

     176,034        165,390   

Bank acceptances outstanding

     5,252        9,410   

Accrued expenses and other liabilities

     146,292        297,740   
                

Total Liabilities

     12,813,135        13,354,520   
                

Shareholders’ Equity*

    

Preferred stock, no par value, authorized 30,000,000 shares; issued 225,000 shares at June 30, 2009 and 300,000 shares at December 31, 2008

     219,333        291,539   

Common stock, no par value, authorized 200,430,392 shares; issued 143,766,225 shares at June 30, 2009 and 143,722,114 shares at December 31, 2008

     50,631        48,228   

Surplus

     1,047,146        1,047,085   

Retained earnings

     81,785        85,234   

Accumulated other comprehensive loss

     (33,191     (60,931

Treasury stock, at cost (1,922,451 common shares at June 30, 2009 and 1,946,882 common shares at December 31, 2008)

     (46,808     (47,546
                

Total Shareholders’ Equity

     1,318,896        1,363,609   
                

Total Liabilities and Shareholders’ Equity

   $ 14,132,031      $ 14,718,129   
                

 

* Share data reflects the five percent common stock dividend issued on May 22, 2009.

See accompanying notes to consolidated financial statements.

 

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VALLEY NATIONAL BANCORP

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

(in thousands, except for share data)

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2009     2008     2009     2008  

Interest Income

        

Interest and fees on loans

   $ 141,358      $ 134,613      $ 285,213      $ 270,242   

Interest and dividends on investment securities:

        

Taxable

     34,147        36,065        69,492        70,207   

Tax-exempt

     2,389        2,470        4,761        5,135   

Dividends

     2,709        2,345        3,982        4,597   

Interest on federal funds sold and other short-term investments

     218        406        448        1,902   
                                

Total interest income

     180,821        175,899        363,896        352,083   
                                

Interest Expense

        

Interest on deposits:

        

Savings, NOW, and money market

     5,796        11,155        11,683        25,220   

Time

     26,106        27,162        56,285        57,650   

Interest on short-term borrowings

     579        2,212        3,130        4,519   

Interest on long-term borrowings and junior subordinated debentures

     35,227        32,792        70,121        66,534   
                                

Total interest expense

     67,708        73,321        141,219        153,923   
                                

Net Interest Income

     113,113        102,578        222,677        198,160   

Provision for credit losses

     13,064        5,800        23,045        9,800   
                                

Net Interest Income after Provision for Credit Losses

     100,049        96,778        199,632        188,360   
                                

Non-Interest Income

        

Trust and investment services

     1,592        1,744        3,237        3,512   

Insurance premiums

     2,577        2,264        5,570        5,636   

Service charges on deposit accounts

     6,563        7,041        13,200        13,622   

Gains on securities transactions, net

     288        425        251        924   

Other-than-temporary impairment losses on securities

     —          (1,383     (5,905     (1,737

Portion recognized in other comprehensive income (before taxes)

     (2,434     —          1,300        —     
                                

Net impairment losses on securities recognized in earnings

     (2,434     (1,383     (4,605     (1,737

Trading losses, net

     (18,631     (301     (5,412     (3,492

Fees from loan servicing

     1,193        1,195        2,369        2,447   

Gains on sales of loans, net

     2,432        391        4,576        724   

Gains (losses) on sales of assets, net

     175        (8     349        85   

Bank owned life insurance

     1,397        2,905        2,768        6,145   

Other

     4,459        3,681        8,293        9,315   
                                

Total non-interest (loss) income

     (389     17,954        30,596        37,181   
                                

Non-Interest Expense

        

Salary expense

     31,397        30,138        63,844        60,301   

Employee benefit expense

     7,938        6,897        17,208        15,852   

Net occupancy and equipment expense

     14,344        12,775        29,895        26,256   

FDIC insurance assessment

     10,279        231        13,431        475   

Amortization of other intangible assets

     1,011        1,402        3,827        3,148   

Professional and legal fees

     2,147        1,897        4,239        4,186   

Advertising

     322        341        1,167        717   

Other

     10,668        10,278        21,441        20,502   
                                

Total non-interest expense

     78,106        63,959        155,052        131,437   
                                

Income Before Income Taxes

     21,554        50,773        75,176        94,104   

Income tax expense

     6,557        9,290        22,795        21,038   
                                

Net Income

     14,997        41,483        52,381        73,066   

Dividends on preferred stock and accretion

     5,789        —          10,013        —     
                                

Net Income Available to Common Stockholders

   $ 9,208      $ 41,483      $ 42,368      $ 73,066   
                                

Earnings Per Common Share:*

        

Basic

   $ 0.06      $ 0.31      $ 0.30      $ 0.55   

Diluted

     0.06        0.31        0.30        0.55   

Cash Dividends Declared per Common Share*

     0.19        0.19        0.38        0.38   

Weighted Average Number of Common Shares Outstanding:*

        

Basic

     141,804,034        132,252,624        141,789,818        132,219,176   

Diluted

     141,804,908        132,371,581        141,790,489        132,343,069   

 

* Share data reflects the five percent common stock dividend issued on May 22, 2009.

See accompanying notes to consolidated financial statements.

 

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VALLEY NATIONAL BANCORP

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(in thousands)

 

     Six Months Ended
June 30,
 
      2009     2008  

Cash flows from operating activities:

    

Net income

   $ 52,381      $ 73,066   

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

    

Depreciation and amortization

     6,834        7,407   

Amortization of compensation costs pursuant to long-term stock incentive plans

     2,147        3,271   

Provision for credit losses

     23,045        9,800   

Net amortization of premiums and accretion of discounts on securities

     1,776        (187

Amortization of other intangible assets

     3,827        3,148   

Gains on securities transactions, net

     (251     (924

Net impairment losses on securities recognized in earnings

     4,605        1,737   

Proceeds from sales of loans held for sale

     178,966        35,246   

Gains on loans held for sale, net

     (4,576     (724

Origination of loans held for sale

     (197,444     (35,700

Net change in trading securities

     1,415        655,120   

Gains on sales of assets, net

     (349     (85

Change in fair value of borrowings carried at fair value

     10,678        930   

Net change in cash surrender value of bank owned life insurance

     (2,768     (6,145

Net decrease in accrued interest receivable and other assets

     134,167        120,612   

Net decrease in accrued expenses and other liabilities

     (158,348     (20,033
                

Net cash provided by operating activities

     56,105        846,539   
                

Cash flows from investing activities:

    

Proceeds from sales of investment securities available for sale

     185,043        7,545   

Proceeds from maturities and prepayments of investment securities available for sale

     207,180        377,782   

Purchases of investment securities available for sale

     (225,878     (685,321

Purchases of investment securities held to maturity

     (636,201     (179,153

Proceeds from maturities and prepayments of investment securities held to maturity

     216,262        84,169   

Net decrease (increase) in loans

     509,848        (556,609

Proceeds from bank owned life insurance

     812        —     

Proceeds from sales of premises and equipment

     374        700   

Purchases of premises and equipment

     (19,336     (16,114
                

Net cash provided by (used in) investing activities

     238,104        (967,001
                

Cash flows from financing activities:

    

Net increase in deposits

     87,524        281,399   

Net decrease in short-term borrowings

     (447,023     (172,594

Advances of long-term borrowings

     —          400,000   

Repayments of long-term borrowings

     (36,001     (253,237

Redemption of preferred stock

     (75,000     —     

Dividends paid to preferred shareholder

     (7,729     —     

Dividends paid to common shareholders

     (54,007     (50,355

Common stock issued, net of cancellations

     579        765   
                

Net cash (used in) provided by financing activities

     (531,657     205,978   
                

Net (decrease) increase in cash and cash equivalents

     (237,448     85,516   

Cash and cash equivalents at beginning of period

     580,507        237,465   
                

Cash and cash equivalents at end of period

   $ 343,059      $ 322,981   
                

Supplemental disclosure of cash flow information:

    

Cash paid for interest on deposits and borrowings

   $ 147,164      $ 155,187   

Cash paid for federal and state income taxes

     27,596        30,051   

See accompanying notes to consolidated financial statements.

 

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VALLEY NATIONAL BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1. Basis of Presentation

The unaudited consolidated financial statements of Valley National Bancorp, a New Jersey corporation (“Valley”), include the accounts of its commercial bank subsidiary, Valley National Bank (the “Bank”) and all of Valley’s direct or indirect wholly-owned subsidiaries. All inter-company transactions and balances have been eliminated. The accounting and reporting policies of Valley conform to U.S. generally accepted accounting principles (“GAAP”) and general practices within the financial services industry. In accordance with applicable accounting standards, Valley does not consolidate statutory trusts established for the sole purpose of issuing trust preferred securities and related trust common securities. See Note 12 below for more detail. Certain prior period amounts have been reclassified to conform to the current presentation.

In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly Valley’s financial position, results of operations and cash flows at June 30, 2009 and for all periods presented have been made. The results of operations for the three and six months ended June 30, 2009 are not necessarily indicative of the results to be expected for the entire fiscal year. Valley has evaluated subsequent events for potential recognition and/or disclosure through August 7, 2009, the date the consolidated financial statements included in this Quarterly Report on Form 10-Q were issued.

In preparing the unaudited consolidated financial statements, management has made estimates 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. Material estimates that are particularly susceptible to change are the allowance for loan losses, income taxes, security valuations and the review of goodwill, loan servicing rights and investment securities for impairment. The current economic environment has increased the degree of uncertainty inherent in these material estimates.

Certain information and footnote disclosure normally included in financial statements prepared in accordance with GAAP and industry practice have been condensed or omitted pursuant to rules and regulations of the Securities and Exchange Commission (“SEC”). These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in Valley’s December 31, 2008 audited financial statements filed on Form 10-K.

On May 22, 2009, Valley issued a five percent common stock dividend to shareholders of record on May 8, 2009. All common share and per common share data presented in the consolidated financial statements and the accompanying notes below were adjusted to reflect the dividend.

Note 2. Earnings Per Common Share

For Valley, the numerator of both the basic and diluted earnings per common share is net income available to common stockholders (which is equal to net income less dividends on preferred stock and related discount accretion). The weighted average number of common shares outstanding used in the denominator for basic earnings per common share is increased to determine the denominator used for diluted earnings per common share by the effect of potentially dilutive common stock equivalents utilizing the treasury stock method. For Valley, common stock equivalents are common stock options and warrants (to purchase Valley’s common shares) outstanding.

 

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The following table shows the calculation of both basic and diluted earnings per common share for the three and six months ended June 30, 2009 and 2008:

 

     Three Months Ended
June 30,
   Six Months Ended
June 30,
     2009    2008    2009    2008
          (in thousands, except for share data)     

Net income

   $ 14,997    $ 41,483    $ 52,381    $ 73,066

Dividends on preferred stock and accretion

     5,789      —        10,013      —  
                           

Net income available to common stockholders

   $ 9,208    $ 41,483    $ 42,368    $ 73,066
                           

Basic weighted-average number of common shares outstanding

     141,804,034      132,252,624      141,789,818      132,219,176

Plus: Common stock equivalents

     874      118,957      671      123,893
                           

Diluted weighted-average number of common shares outstanding

     141,804,908      132,371,581      141,790,489      132,343,069
                           

Earnings per share:

           

Basic

   $ 0.06    $ 0.31    $ 0.30    $ 0.55

Diluted

     0.06      0.31      0.30      0.55

Common stock equivalents, in the table above, exclude common stock options and warrants with exercise prices that exceed the average market price of Valley’s common stock during the periods presented. Inclusion of these common stock options and warrants would be anti-dilutive to the diluted earnings per common share calculation. Anti-dilutive common stock options totaled 6.6 million for both the three and six months ended June 30, 2009 compared to 2.8 million for both the three and six months ended June 30, 2008.

Note 3. Stock – Based Compensation

Valley currently has one active employee stock option plan, the 2009 Long-Term Stock Incentive Plan (the “2009 LTSIP”), approved by shareholders on April 14, 2009. The purpose of the 2009 LTSIP is to provide additional incentive to officers and key employees of Valley and its subsidiaries whose substantial contributions are essential to the continued growth and success of Valley. The 2009 LTSIP replaced the 1999 Long-Term Stock Incentive Plan which expired on January 19, 2009 (with approximately 1.7 million unissued shares remaining).

Under the 2009 LTSIP, Valley may award shares to its employees for up to 6.4 million shares of common stock in the form of incentive stock options, non-qualified stock options, stock appreciation rights and restricted stock awards. Valley granted stock options and restricted stock awards totaling 7 thousand and 16 thousand shares, respectively, during the three and six months ended June 30, 2009. All stock options granted during 2009 were to non-executive officers and employees. The exercise price of each incentive stock option is equal to the fair market value of Valley’s common stock on the date of grant. An incentive stock option’s maximum term to exercise is 10 years from the date of grant and subject to a vesting schedule.

Valley recorded stock-based employee compensation expense for incentive stock options and restricted stock awards of $936 thousand and $1.1 million for the three months ended June 30, 2009 and 2008, respectively, and $2.1 million and $3.2 million for the six months ended June 30, 2009 and 2008, respectively. The $3.2 million expense for the six months ended June 30, 2008 includes $856 thousand which was immediately recognized for stock awards granted to retirement eligible employees. There were no stock awards granted to retirement eligible employees during the six months ended June 30, 2009, therefore, no immediate expense was recognized during the period. The fair values of all other stock awards are expensed over the vesting period. As of June 30, 2009, the unrecognized amortization expense for all stock-based employee compensation totaled approximately $8.0 million and will be recognized over an average remaining vesting period of approximately 3 years.

 

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The fair value of each option granted on the date of grant is estimated using a binomial option pricing model. The results are based on assumptions for dividend yield based on the annual dividend rate; stock volatility, based on Valley’s historical and implied stock price volatility; risk free interest rates, based on the U.S. Treasury constant maturity bonds, in effect on the actual grant dates, with a remaining term approximating the expected term of the options; and expected exercise term calculated based on Valley’s historical exercise experience.

Stock-based employee compensation cost under the fair value method was measured using the following weighted-average assumptions for stock options granted during the six months ended June 30, 2009 and 2008:

 

     Six Months Ended June 30,  
     2009     2008  

Risk-free interest rate

   1.1 - 4.0    3.4 - 5.1

Dividend yield

   4.5   4.3

Volatility

   24.0   21.0

Expected term (in years)

   6.7      7.3   

In 2005, Valley’s shareholders approved the 2004 Director Restricted Stock Plan. The plan provides the non-employee members of the Board of Directors with the opportunity to forego some or their entire annual cash retainer and certain meeting fees in exchange for shares of Valley restricted stock. The restricted shares under the plan vest 100 percent at the end of a five year vesting period, but the Board of Directors retains the right to accelerate the vesting of the restricted shares, at its discretion. Valley granted approximately 20 thousand shares under the 2004 Director Restricted Stock Plan during the six months ended June 30, 2009. There were approximately 103 thousand restricted shares outstanding under this plan as of June 30, 2009.

Note 4. Comprehensive Income

Valley’s components of other comprehensive income (“OCI”), net of deferred tax, include unrealized gains (losses) on securities available for sale (including the non-credit portion of any other-than-temporary impairment charges relating to these securities effective January 1, 2009), unrealized gains (losses) on derivatives used in cash flow hedging relationships, and the unfunded portion of its various employee, officer and director pension plans.

The following table shows changes in each component of comprehensive income for the three and six months ended June 30, 2009 and 2008.

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2009     2008     2009     2008  
           (in thousands)        
Net income    $ 14,997      $ 41,483      $ 52,381      $ 73,066   
                                

OCI, net of tax:

        

Net change in unrealized gains and losses on securities available for sale

     18,000        (26,340     32,585        (25,376

Net change in non-credit impairment losses on securities

     (1,861     —          (517     —     

Net pension benefits adjustment

     219        264        437        264   

Net change in unrealized gains and losses on derivatives used in cash flow hedging relationships

     2,593        169        2,385        169   

Less reclassification adjustment for gains and losses included in net income

     1,404        577        1,455        490   
                                

Total OCI

     20,355        (25,330     36,345        (24,453
                                
Total comprehensive income    $ 35,352      $ 16,153      $ 88,726      $ 48,613   
                                

 

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Note 5. Business Combinations and Dispositions

Acquisition

On July 1, 2008, Valley acquired Greater Community Bancorp (“Greater Community”), the holding company of Greater Community Bank, a commercial bank with approximately $1.0 billion in assets and 16 full-service branches in northern New Jersey. The purchase price of $167.8 million was paid through a combination of Valley’s common stock (approximately 9.1 million shares) and warrants (described below). The transaction generated approximately $115.8 million in goodwill and $7.5 million in core deposit intangibles subject to amortization beginning July 1, 2008. Greater Community Bank was merged into Valley National Bank as of the acquisition date.

Valley issued approximately 964 thousand warrants to purchase Valley’s common stock at $18.10 per share which are exercisable beginning July 1, 2010 and expire on June 30, 2015. The Valley warrants, which have been determined to qualify as permanent equity, are publicly traded and listed on the NASDAQ Capital Market under the ticker symbol “VLYWW.”

Pro forma results of operations including Greater Community for the three and six months ended June 30, 2008 have not been presented, as the acquisition did not have a material impact on Valley’s operating results.

Disposition

On March 31, 2008, Valley sold its wholly-owned broker-dealer subsidiary, Glen Rauch Securities, Inc., for $1.9 million, consisting of cash and a note receivable. During the fourth quarter of 2007, Valley recorded a $2.3 million ($1.5 million after-taxes) goodwill impairment loss due to its decision to sell the broker-dealer subsidiary. The subsidiary’s operations and the disposition did not materially impact Valley’s consolidated financial position or results of operations during six months ended June 30, 2008, and therefore have not been presented as discontinued operations in Valley’s consolidated financial statements.

Note 6. Recent Accounting Pronouncements

In December 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 141 (Revised 2007), “Business Combinations” (“SFAS No. 141R”), which replaces SFAS No. 141, “Business Combinations,” and applies to all transactions and other events in which one entity obtains control over one or more other businesses. SFAS No. 141R requires an acquirer, upon initially obtaining control of another entity, to recognize the assets, liabilities and any non-controlling interest in the acquiree at fair value as of the acquisition date. Contingent consideration is required to be recognized and measured at fair value on the date of acquisition rather than at a later date when the amount of that consideration may be determinable beyond a reasonable doubt. This fair value approach replaces the cost-allocation process required under SFAS No. 141 whereby the cost of an acquisition was allocated to the individual assets acquired and liabilities assumed based on their estimated fair value. SFAS No. 141R requires acquirers to expense acquisition-related costs as incurred rather than allocating such costs to the assets acquired and liabilities assumed, as was previously the case under SFAS No. 141. Under SFAS No. 141R, the requirements of SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities,” would have to be met in order to accrue for a restructuring plan in purchase accounting. Pre-acquisition contingencies are to be recognized at fair value, unless it is a non-contractual contingency that is not likely to materialize, in which case, nothing should be recognized in purchase accounting and, instead, that contingency would be subject to the probable and estimable recognition criteria of SFAS No. 5, “Accounting for Contingencies.” SFAS No. 141R is effective for all business combinations closing after January 1, 2009 and could have a significant impact on Valley’s accounting for business combinations on or after such date.

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an Amendment of ARB Statement No. 51.” This standard amends the guidance in Accounting Research Bulletin (ARB) No. 51, “Consolidated Financial Statements.” The new standard establishes

 

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accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS No. 160 clarifies that a non-controlling interest in a subsidiary, which is sometimes referred to as minority interest, is an ownership interest in the consolidated entity that should be reported as a component of equity in the consolidated financial statements. Among other requirements, SFAS No. 160 requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the non-controlling interest. It also requires disclosure, on the face of the consolidated income statement, of the amounts of consolidated net income attributable to the parent and to the non-controlling interest. Valley’s adoption of SFAS No. 160 on January 1, 2009 did not have a significant impact on Valley’s statement of condition or results of operations.

In March 2008, the FASB issued SFAS No. 161, “Disclosure about Derivative Instruments and Hedging activities, an Amendment of FASB Statement No. 133.” The new standard establishes enhanced disclosure requirements about (a) how and why an entity uses derivative instruments; (b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations; and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. Valley adopted SFAS No. 161 on January 1, 2009 and has included the applicable financial statement disclosures in Note 13 below.

In May 2009, the FASB issued SFAS No. 165, “Subsequent Events.” SFAS No. 165 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or available to be issued. SFAS No. 165 defines (i) the period after the balance sheet date during which a reporting entity’s management should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, (ii) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements, and (iii) the disclosures an entity should make about events or transactions that occurred after the balance sheet date. SFAS No. 165 became effective for Valley’s financial statements for periods ending after June 15, 2009. SFAS No. 165 did not have a significant impact on Valley’s financial statements.

In June 2009, the FASB issued SFAS No. 166, “Accounting for Transfers of Financial Assets, an Amendment of FASB Statement No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” The new standard (i) enhances reporting about transfers of financial assets, including securitizations, where companies have continuing exposure to the risks related to transferred financial assets, (ii) eliminates the concept of a “qualifying special-purpose entity” and changes the requirements for derecognizing financial assets, and (iii) requires additional disclosures about all continuing involvements with transferred financial assets including information about gains and losses resulting from transfers during the period. SFAS No. 166 is effective on January 1, 2010 and is not expected to have a significant impact on Valley’s financial statements.

In June 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R).” SFAS 167 amends FIN 46 (Revised December 2003), “Consolidation of Variable Interest Entities,” to change how a company determines when an entity that is insufficiently capitalized or is not controlled through voting or similar rights should be consolidated. The determination of whether a company is required to consolidate an entity is based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance. The new standard requires additional disclosures about the reporting entity’s involvement with variable-interest entities and any significant changes in risk exposure due to that involvement as well as its effect on the entity’s financial statements. SFAS No. 167 is effective on January 1, 2010 and is not expected to have a significant impact on Valley’s financial statements.

In June 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles, a Replacement of FASB Statement No. 162.” SFAS No. 168 establishes the FASB Accounting Standards Codification (the “Codification”) as the source of authoritative accounting principles recognized by the FASB to be applied by non-governmental entities in the preparation of financial statements in conformity with generally accepted accounting principles. Rules and interpretive releases of the

 

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SEC under authority of federal securities laws are also sources of authoritative guidance for SEC registrants. All guidance contained in the Codification carries an equal level of authority. All non-grandfathered, non-SEC accounting literature not included in the Codification is superseded and deemed non-authoritative. Valley does not expect its adoption of the Codification as of July 1, 2009 to significantly impact its consolidated financial statements.

In December 2008, the FASB issued FSP No. 132(R)-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets.” FSP No. 132(R)-1 amends SFAS No. 132(R), “Employers’ Disclosures about Pensions and Other Postretirement Benefits,” to provide guidance on an employers’ disclosures about plan assets of a defined benefit pension or other postretirement plan. FSP 132(R)-1 requires employers of public and nonpublic entities to disclose (a) more information about how investment allocation decisions are made; (b) provide more information about major categories of plan assets, including concentrations of risk and fair-value measurements, and the fair-value techniques and inputs used to measure plan assets. The disclosure requirements of FSP 132(R)-1 will be included in Valley’s financial statements beginning with the financial statements for the year ended December 31, 2009.

Effective January 1, 2009, Valley early adopted the provisions of FSP No. 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly.” FSP No. 157-4 provides additional guidance for estimating fair value in accordance with SFAS No. 157, “Fair Value Measurements,” and includes guidance on identifying circumstances that indicate a transaction is not in an orderly market. The FSP’s model includes (a) evaluating the significance and relevance of the factors to determine whether, based on the weight of the evidence, there has been a significant decrease in the volume and level of activity for the asset or liability; (b) if the reporting entity concludes there has been a significant decrease in the volume and level of activity for the asset or liability, further analysis of the transaction or the quoted prices is needed, and a significant adjustment to the transactions or quoted prices may be necessary to estimate fair value in accordance with SFAS No. 157. This FSP also requires an entity to disclose a change in valuation technique (and the related inputs) resulting from the application of the FSP and to quantify its effects. See Note 7 for discussion of the impact on valuation of certain investment securities due to the adoption of the provisions of the FSP and the impact to the consolidated financial statements.

Effective January 1, 2009, Valley early adopted the provisions of FSP No. FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments.” The FSP amends SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” and FSP FAS No. 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary Impairments and Its Application to Certain Investments,” to require that (a) an entity separately present, in the financial statement where the components of accumulated other comprehensive income are reported, amounts recognized in accumulated other comprehensive income related to held-to-maturity and available-for-sale debt securities for which an other-than-temporary impairment has been recognized and (b) only the portion of the impairment related to a credit loss is recognized in earnings. The FSP also changes the guidance to state that management must assert (a) it does not have the intent to sell the security, and (b) if the entity does not intend to sell the security, it is not more likely than not it will be required to sell the security before recovery of its amortized cost basis. This FSP requires that an entity recognize non-credit losses on held-to-maturity debt securities in other comprehensive income and amortize that amount over the remaining life of the security in a prospective manner by increasing the carrying value of the asset unless the security is subsequently sold and there are additional credit losses. This FSP also expands and increases the frequency of existing disclosures about other-than-temporary impairments for debt and equity securities. Valley’s adoption of the FSP resulted in an $8.6 million cumulative-effect adjustment, net of taxes to increase retained earnings with an offset to accumulated other comprehensive loss as of January 1, 2009 for the non-credit component of losses on debt securities for which other-than-temporary impairment was previously recognized.

On March 31, 2009, Valley early adopted the provisions of FSP No. FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments.” The FSP amends SFAS No. 107, “Disclosure about Fair Value of Financial instruments,” to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. This FSP also amends APB Opinion No. 28, “Interim Financial Reporting,” to require those disclosures in summarized financial

 

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information at interim reporting periods. Under this FSP, a publicly company shall include disclosures about the fair value of its financial instruments whenever it issues summarized financial information for interim periods. In addition, an entity shall disclose in the body of in the accompanying notes of its summarized financial information for interim periods and in its financial statements for annual reporting periods the fair value of all its financial instruments for which it is practical to estimate fair value. Valley has included the applicable fair value disclosures in Note 7 below.

On April 1, 2009, the FASB issued FSP No. 141(R)-1, “Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies.” FSP No. 141(R)-1 amends the guidance in SFAS No. 141R to require that assets acquired and liabilities assumed in a business combination that arise from contingencies be recognized at fair value if fair value can be reasonably estimated. If fair value of such an asset or liability cannot be reasonably estimated, the asset or liability would generally be recognized in accordance with SFAS No. 5, “Accounting for Contingencies,” and FASB Interpretation No. 14, “Reasonable Estimation of the Amount of a Loss.” FSP No. 141(R)-1 removes subsequent accounting guidance for assets and liabilities arising from contingencies from SFAS No.141R and requires entities to develop a systematic and rational basis for subsequently measuring and accounting for assets and liabilities arising from contingencies. FSP No. 141(R)-1 eliminates the requirement to disclose an estimate of the range of outcomes of recognized contingencies at the acquisition date. For unrecognized contingencies, entities are required to include only the disclosures required by SFAS No. 5. FSP No. 141(R)-1 also requires that contingent consideration arrangements of an acquiree assumed by the acquirer in a business combination be treated as contingent consideration of the acquirer and should be initially and subsequently measured at fair value in accordance with SFAS No. 141R. FSP No. 141(R)-1 is effective for assets or liabilities arising from contingencies in business combinations after January 1, 2009.

Note 7. Fair Value Measurement of Assets and Liabilities

Valley uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Investment securities classified as available for sale and trading securities, residential mortgage loans held for sale, junior subordinated debentures issued to VNB Capital Trust I, and derivatives are recorded at fair value on a recurring basis.

Upon the adoption of SFAS No. 159 on January 1, 2007, Valley elected to measure residential mortgage loans held for sale and the junior subordinated debentures issued to VNB Capital Trust I at fair value as part of its on-going asset/liability management strategy. Valley believes the fair value elections reduce certain timing differences and better match changes in the value of these instruments with current actions by management to manage the balance sheet and interest rate risk.

 

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SFAS No. 157 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under SFAS No. 157 are described below:

Basis of Fair Value Measurement

 

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

The following tables present the assets and liabilities that are measured at fair value on a recurring basis by level within the fair value hierarchy as reported on the consolidated statements of financial condition at June 30, 2009 and December 31, 2008. As required by SFAS No. 157, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

 

     June 30,
2009
   Fair Value Measurements at Reporting Date Using:
        Quoted Prices
in Active Markets
for Identical
Assets (Level 1)
   Significant
Other Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
          (in thousands)     
Assets:            

Investment securities:

           

Available for sale:

           

Obligations of states and political subdivisions

   $ 40,341    $ —      $ 40,341    $ —  

Residential mortgage-backed securities

     1,107,989      —        1,012,520      95,469

Trust preferred securities

     32,818      —        15,169      17,649

Corporate and other debt securities

     94,594      —        93,589      1,005

Equity securities

     43,802      4,888      30,497      8,417
                           

Total available for sale

     1,319,544      4,888      1,192,116      122,540

Trading securities

     32,821      —        —        32,821

Loans held for sale (1)

     27,596      —        27,596      —  

Other assets (2)

     7,807      —        7,807      —  
                           

Total assets

   $ 1,387,768    $ 4,888    $ 1,227,519    $ 155,361
                           
Liabilities:            

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

   $ 150,743    $ —      $ 150,743    $ —  

Other liabilities (2)

     1,111      —        1,111      —  
                           

Total liabilities

   $ 151,854    $ —      $ 151,854    $ —  
                           

 

(1) The loans held for sale had contractual unpaid principal balances totaling approximately $27.3 million at June 30, 2009.

 

(2) Derivative financial instruments are included in this category.

 

(3) The junior subordinated debentures had contractual unpaid principal obligations totaling $157.0 million at June 30, 2009.

 

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     December 31,
2008
   Fair Value Measurements at Reporting Date Using:
        Quoted Prices
in Active Markets
for Identical
Assets (Level 1)
   Significant
Other Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
          (in thousands)     
Assets:            

Investment securities:

           

Available for sale

   $ 1,435,442    $ 13,483    $ 1,421,959    $ —  

Trading securities

     34,236      —        34,236      —  

Loans held for sale (1)

     4,542      —        4,542      —  

Other assets (2)

     3,334      —        3,334      —  
                           

Total assets

   $ 1,477,554    $ 13,483    $ 1,464,071    $ —  
                           
Liabilities:            

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

   $ 140,065    $ —      $ 140,065    $ —  

Other liabilities (2)

     2,008      —        2,008      —  
                           

Total liabilities

   $ 142,073    $ —      $ 142,073    $ —  
                           

 

(1) The loans held for sale had contractual unpaid principal balances totaling approximately $4.47 million at December 31, 2008.

 

(2) Derivative financial instruments are included in this category.

 

(3) The junior subordinated debentures had contractual unpaid principal obligations totaling $157.0 million at December 31, 2008.

The following valuation techniques were used to measure the fair value of financial instruments in the table above on a recurring basis during the six months ended June 30, 2009 and the year ended December 31, 2008 unless otherwise noted. All the valuation techniques described below are based upon the unpaid principal balance only for each item selected to be carried at fair value and excludes any accrued interest or dividends at the measurement date. Interest income and expense and dividend income are recorded within the consolidated statements of income depending on the nature of the instrument using the effective interest method based on acquired discount or premium.

Available for sale and trading securities. Certain common and preferred equity securities are reported at fair value utilizing Level 1 inputs (exchange quoted prices). The majority of the other investment securities are reported at fair value utilizing Level 2 inputs. The prices for these instruments are obtained through an independent pricing service or dealer market participants with whom Valley has historically transacted both purchases and sales of investment securities. Prices obtained from these sources include prices derived from market quotations and matrix pricing. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. Management reviews the data and assumptions used in pricing the securities by its third party providers to ensure the lowest level of significant input is market observable data. For certain securities, the inputs used by either dealer market participants or independent pricing service, may be derived from unobservable market information. In these instances, Valley evaluated the appropriateness and quality of each price. In accordance with Valley’s early adoption of FSP FAS No. 157-4 on January 1, 2009, Valley reviewed the volume and level of activity for all available for sale and trading securities and attempted to identify transactions which may not be orderly or reflective of a significant level of activity and volume. For securities meeting these criteria, the quoted prices received from either market participants or an independent pricing service may be adjusted, as necessary, to estimate fair value in accordance with SFAS No. 157 (fair values based on Level 3 inputs). In determining fair value, Valley utilized unobservable inputs which reflect Valley’s own assumptions about the inputs that market participants would use in pricing each security. In developing its assertion of market participant assumptions, Valley utilized the best information that is both reasonable and available without undue cost and effort.

 

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In calculating the fair value for certain trading securities, consisting of trust preferred securities, under Level 3, Valley prepared present value cash flow models incorporating the contractual cash flow of each security adjusted, if necessary, for potential changes in the amount or timing of cash flows due to the underlying credit worthiness of each issuer. The resulting estimated prospective cash flows were discounted at a yield determined by reference to similarly structured securities for which observable orderly transactions occurred. For a majority of the securities valued under Level 3, the discount rate actually utilized reflected orderly transactions of similar issued securities by the same obligor.

In calculating the fair value for the available for sale securities under Level 3, Valley prepared present value cash flow models for certain trust preferred securities, corporate debt securities, and private label mortgage-backed securities. The cash flows for the mortgage-backed securities incorporated the expected cash flow of each security adjusted for default rates, loss severities and prepayments of the individual loans collateralizing the security. The cash flows for trust preferred securities and corporate debt securities reflected the contractual cash flow, adjusted if necessary for potential changes in the amount or timing of cash flows due to the underlying credit worthiness of each issuer.

For available for sale trust preferred securities and corporate debt securities, the resulting estimated prospective cash flows were discounted at a yield determined by reference to similarly structured securities for which observable orderly transactions occurred. The discount rate for each security was applied using a pricing matrix based on credit, security type and maturity characteristics to determine the fair value.

For available for sale private label mortgage-backed securities, cash flow assumptions incorporated independent third party market participant data based on vintage year for each security. The discount rate utilized in determining the present value of cash flows for the mortgage-backed securities was arrived at by combining the yield on orderly transactions for similar maturity government sponsored mortgage-backed securities with (a) the historical average risk premium of similar structured private label securities, (b) a risk premium reflecting current market conditions, including liquidity risk and (c) if applicable, a forecasted loss premium derived from the expected cash flows of each security. The estimated cash flows for each private label mortgage-backed security were then discounted at the aforementioned effective rate to determine the fair value.

Loans held for sale. These conforming residential mortgage loans are reported at fair value using Level 2 (significant other observable) inputs. The fair values were calculated utilizing quoted prices for similar assets in active markets. To determine these fair values, the mortgages held for sale are put into multiple tranches, or pools, based on the coupon rate of each mortgage. If the mortgages held for sale are material, the market prices for each tranche are obtained from both Fannie Mae and Freddie Mac. The market prices represent a delivery price which reflects the underlying price each institution would pay Valley for an immediate sale of an aggregate pool of mortgages. The market prices received from Fannie Mae and Freddie Mac are then averaged and interpolated or extrapolated, where required, to calculate the fair value of each tranche. Depending upon the time elapsed since the origination of each loan held for sale, non-performance risk and changes therein were addressed in the estimate of fair value based upon the delinquency data provided to both Fannie Mae and Freddie Mac for market pricing and changes in market credit spreads. Non-performance risk was deemed immaterial to the gains recognized for changes in fair value of mortgage loans held for sale during the three and six months ended June 30, 2009 and 2008 based on the short duration these assets were held, and the high credit quality of these loans.

Junior subordinated debentures issued to VNB Capital Trust I. The junior subordinated debentures issued to VNB Capital Trust I are reported at fair value using Level 2 inputs. The fair value was estimated using quoted prices in active markets for similar assets, specifically the quoted price of the VNB Capital Trust I preferred stock traded under ticker symbol “VLYPRA” on the New York Stock Exchange. The preferred stock and Valley’s junior subordinated debentures issued to the Trust have identical financial terms (see details at Note 12) and therefore, the preferred stock’s quoted prices move in a similar manner to the estimated fair value and current settlement price of the junior subordinated debentures. The preferred stock’s quoted price includes market considerations for Valley’s credit and non-performance risk and is deemed to represent the transfer price that would be used if the junior subordinated debenture were assumed by a third party. Valley’s potential credit risk and changes in such risk did not materially impact the fair value measurement of the junior subordinated debentures during the three and six months ended June 30, 2009 and 2008.

 

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Derivatives. Derivatives are reported at fair value utilizing Level 2 inputs. The fair value of Valley’s interest rate caps and interest rate swap are determined using prices obtained from a third party advisor. The fair value measurement of the interest caps is calculated by discounting the future expected cash receipts that would occur if variable interest rates rise above the strike rate of the caps. The variable interest rates used in the calculation of projected receipts on the caps are based on an expectation of future interest rates derived from observed market interest rate curves and volatilities. The fair value measurement of the interest rate swap is determined by netting the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipts are based on the expectation of future interest rates derived from observed market interest rate curves. The fair values of the derivatives incorporate credit valuation adjustments, which consider the impact of any credit enhancements to the contracts, to account for potential nonperformance risk of Valley and its counterparties. The credit valuation adjustments were not significant to the overall valuation of Valley’s derivatives at June 30, 2009 and December 31, 2008.

The changes in Level 3 assets measured at fair value on a recurring basis are summarized as follows:

 

     Three Months Ended
June 30, 2009
    Six Months Ended
June 30, 2009
 
     Trading
Securities
    Available
For Sale
Securities
    Trading
Securities
    Available
For Sale
Securities
 
     (in thousands)  
Balance, beginning of period    $ 34,306      $ 131,422      $ —        $ —     

Net transfers into Level 3 (1)

     —          —          34,236        115,343   

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

        

Net income

     4,215        —          4,285        —     

Other comprehensive income

     —          (1,878     —          18,493   

Purchases, sales, settlements, net

     (5,700     (7,004     (5,700     (11,296
                                
Balance, end of period    $ 32,821      $ 122,540      $ 32,821      $ 122,540   
                                

Net unrealized gains (losses) included in net income for the period relating to assets held at June 30, 2009 (2)

   $ 4,193  (3)    $ (2,434 (4)    $ 4,263  (3)    $ (4,605 (4) 
                                

 

(1) The amounts presented as transfers into Level 3 represents the fair value as of the beginning of the periods presented. Amounts represent transfers from Level 2 of single-issuer trust preferred securities and private label mortgage-backed securities for which significant inputs to the valuation became unobservable, largely due to reduced levels of market liquidity. Related gains and losses for the period are included in the above table.

 

(2) Represents net gains (losses) that are due to changes in economic conditions and management’s estimates of fair value.

 

(3) Included in trading losses, net within the non-interest income category on the consolidated statements of income.

 

(4) Represents the net impairment losses on securities recognized in earnings for the period.

Valley’s significant accounting policies presented in Note 1 to the consolidated financial statements included in Valley’s Annual Report on Form 10-K for the year ended December 31, 2008 require certain assets, including goodwill, loan servicing rights, core deposits, other intangible assets, certain impaired loans and other long-lived assets, such as other real estate owned, to be written down to their fair value on a nonrecurring basis through recognition of an impairment charge to the consolidated statements of income. The following nonrecurring items were adjusted by such fair value measurements during the periods noted.

 

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Loan servicing rights. For the second quarter of 2009, Valley recognized a $681 thousand recovery of previously recognized impairment charges on loan servicing rights through a valuation allowance. Impairment charges are recognized on loan servicing rights when the book value of certain stratums of the loan servicing rights portfolio exceed the stratum’s estimated fair value. Fair values for each stratum are calculated using a fair value model from a third party vendor that requires inputs that are both significant to the fair value measurement and unobservable (Level 3). The fair value model is based on various assumptions, including but not limited to, servicing cost, prepayment speed, internal rate of return, ancillary income, float rate, tax rate, and inflation. A significant degree of judgment is involved in valuing the loan servicing rights using Level 3 inputs. The use of different assumptions could have a significant positive or negative effect on the fair value estimate. Valley’s loan servicing rights had a carrying value of $9.3 million (net of a $986 thousand valuation allowance) at June 30, 2009. See Note 9 for further information.

There were no other material impairment charges incurred for financial instruments carried at fair value on a nonrecurring basis during the three or six months ended June 30, 2009 and 2008.

The following table presents the amount of gains and losses from fair value changes included in income before income taxes for financial assets and liabilities carried at fair value for the three and six months ended June 30, 2009 and 2008:

 

          Gains (Losses) on Change in Fair Value  

Reported in
Consolidated Statements

of Condition at:

  

Reported in
Consolidated Statements

of Income at:

   Three Months Ended
June 30,
    Six Months Ended
June 30,
 
      2009     2008     2009     2008  
                (in thousands)        
Assets:            
Available for sale securities    Net impairment losses    $ (2,434   $ (1,383   $ (4,605   $ (1,737
Trading securities    Trading losses, net      5,802        (2,158     5,266        (2,562
Loans held for sale    Gains on sales of loans, net      2,432        391        4,576        724   
Liabilities:            
Long-term borrowings *    Trading losses, net      —          (122     —          (1,194

Junior subordinated debentures issued to capital trusts

   Trading losses, net      (24,433     1,979        (10,678     264   
                                   
      $ (18,633   $ (1,293   $ (5,441   $ (4,505
                                   

 

* During the second quarter of 2008, Valley prepaid one fixed rate Federal Home Loan Bank advance elected to be carried at fair value under SFAS No. 159 which had a $40.0 million contractual principal obligation. No long-term borrowings were carried at fair value at June 30, 2009.

SFAS No. 107, “Disclosures about Fair Value of Financial Instruments,” as amended requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis. The methodologies for estimating the fair value of financial assets and financial liabilities that are measured at fair value on a recurring or non-recurring basis are discussed above. Below is management’s estimate of the fair value of financial instruments which were carried on the consolidated statements of financial condition at cost or amortized cost.

The fair value estimates below made at June 30, 2009 and December 31, 2008 were based on pertinent market data and relevant information on the financial instruments at that time. These estimates do not reflect any premium or discount that could result from offering for sale at one time the entire portfolio of financial instruments. Because no market exists for a portion of the financial instruments, fair value estimates may be based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

 

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

The following methods and assumptions were used to estimate the fair value of other financial assets and financial liabilities not already discussed above:

Cash and due from banks and interest bearing deposits with banks: The carrying amount is considered to be a reasonable estimate of fair value.

Investment securities held to maturity: Fair values are based on prices obtained through an independent pricing service or dealer market participants which Valley has historically transacted both purchases and sales of investment securities. Prices obtained from these sources include prices derived from market quotations and matrix pricing. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. For certain securities, for which the inputs used by either dealer market participants or independent pricing service were derived from unobservable market information, Valley evaluated the appropriateness and quality of each price. In accordance with Valley’s early adoption of FSP FAS No. 157-4, Valley reviewed the volume and level of activity for all classes of held to maturity securities and attempted to identify transactions which may not be orderly or reflective of a significant level of activity and volume. For securities meeting these criteria, the quoted prices received from either market participants or an independent pricing service may be adjusted, as necessary, to estimate fair value in accordance with SFAS No. 157. If applicable, the adjustment to fair value was derived based on present value cash flow model projections prepared by Valley utilizing assumptions similar to those incorporated by market participants.

Loans: Fair values are estimated by discounting the projected future cash flows using market discount rates that reflect the credit and interest-rate risk inherent in the loan. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal.

Accrued interest receivable and payable: The carrying amounts of accrued interest approximate their fair value.

Federal Reserve Bank and Federal Home Loan Bank stock: The redeemable carrying amount of these securities with limited marketability approximates their fair value. These securities are recorded in other assets on the consolidated statements of financial condition.

Deposits: Current carrying amounts approximate estimated fair value of demand deposits and savings accounts. The fair value of time deposits is based on the discounted value of contractual cash flows using estimated rates currently offered for alternative funding sources of similar remaining maturity.

Short-term and long-term borrowings: The fair value is estimated by obtaining quoted market prices of the identical or similar financial instruments when available. The fair value of other long-term borrowings is estimated by discounting the estimated future cash flows using market discount rates of financial instruments with similar characteristics, terms and remaining maturity.

Junior subordinated debentures issued to GCB Capital Trust III: The fair value is estimated utilizing the income approach, whereby the expected cash flows, over the remaining life of the estimated life of the security, are discounted using Valley’s credit spread over the current yield on a similar maturity U.S. Treasury security. Valley’s credit spread was calculated based on Valley’s trust preferred securities issued by VNB Capital Trust I, which are publicly traded in an active market.

 

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The carrying amounts and estimated fair values of financial instruments were as follows at June 30, 2009 and December 31, 2008:

 

     June 30, 2009    December 31, 2008
     Carrying
Amount
   Fair
Value
   Carrying
Amount
   Fair
Value
     (in thousands)
Financial assets:            

Cash and due from banks

   $ 253,206    $ 253,206    $ 237,497    $ 237,497

Interest bearing deposit with banks

     89,853      89,853      343,010      343,010

Investment securities held to maturity

     1,575,972      1,512,779      1,154,737      1,069,245

Investment securities available for sale

     1,319,544      1,319,544      1,435,442      1,435,442

Trading securities

     32,821      32,821      34,236      34,236

Loans held for sale, at fair value

     27,596      27,596      4,542      4,542

Net loans

     9,517,616      9,507,551      10,050,446      10,169,298

Accrued interest receivable

     57,359      57,359      57,717      57,717

Federal Reserve Bank and Federal Home Loan Bank stock

     140,946      140,946      150,476      150,476

Other assets*

     7,807      7,807      3,334      3,334
Financial liabilities:            

Deposits without stated maturities

     6,176,708      6,176,708      5,611,664      5,611,664

Deposits with stated maturities

     3,143,739      3,191,812      3,621,259      3,681,279

Short-term borrowings

     193,281      185,667      640,304      635,767

Long-term borrowings

     2,971,829      3,172,753      3,008,753      3,455,381

Junior subordinated debentures issued to capital trusts (carrying amount includes fair value of $150,743 at June 30, 2009 and $140,065 at December 31, 2008 for VNB Capital Trust I)

     176,034      174,869      165,390      162,936

Accrued interest payable

     27,068      27,068      32,802      32,802

Other liabilities*

     1,111      1,111      2,008      2,008

 

* Derivative financial instruments are included in this category.

Financial instruments with off-balance sheet risk, consisting of loan commitments and standby letters of credit had immaterial estimated fair values at June 30, 2009 and December 31, 2008.

Note 8. Investment Securities

As of June 30, 2009, Valley had approximately $1.6 billion and $1.3 billion in held to maturity and available for sale investment securities, respectively. Valley may be required to record impairment charges on its 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 Valley’s investment portfolio and may result in other-than-temporary impairment on certain investment securities in future periods. Valley’s investment portfolios include private label mortgage-backed securities, trust preferred securities principally issued by bank holding companies (“bank issuers”) (including three pooled securities), perpetual preferred securities issued by banks, equity securities, and bank issued corporate bonds. These investments may pose a higher risk of future impairment charges by Valley as a result of the current downturn in the U.S. economy and its potential negative effect on the future performance of these bank issuers and/or the underlying mortgage loan collateral. In addition, the majority of the bank issuers of trust preferred securities within Valley’s investment portfolio are participants in the Treasury’s TARP Capital Purchase Program. For TARP participants, dividend payments to trust preferred security holders are currently senior to and payable before dividends can be paid on the preferred stock issued under the Capital Purchase Program. Based on recent stress tests and potential recommendations by the U.S. Government and the banking regulators, some bank trust preferred issuers may elect to defer future payments of interest on such securities. Such elections

 

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by issuers of securities within Valley’s investment portfolio could adversely affect securities valuations and result in future impairment charges. Approximately $11.2 million and $150.5 million of the residential mortgage-backed securities classified as held to maturity and available for sale securities, respectively, were private label mortgage-backed securities at June 30, 2009, while the remainder of the residential mortgage-backed securities were issued by U.S. government sponsored agencies. The private label mortgage-backed securities classified as held to maturity and available for sale securities had gross unrealized losses of $201 thousand and $15.1 million, respectively, at June 30, 2009.

Held to Maturity

The amortized cost, gross unrealized gains and losses and fair value of securities held to maturity at June 30, 2009 and December 31, 2008 were as follows:

 

     June 30, 2009    December 31, 2008
     Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
    Fair
Value
   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
    Fair
Value
     (in thousands)

U.S. government agency securities

   $ —      $ —      $ —        $ —      $ 24,958    $ 65    $ —        $ 25,023

Obligations of states and political subdivisions

     224,006      2,321      (1,008     225,319      201,858      2,428      (701     203,585

Residential mortgage-backed securities

     1,017,322      11,218      (4,213     1,024,327      593,275      7,076      (785     599,566

Trust preferred securities

     281,829      862      (69,481     213,210      281,824      229      (91,151     190,902

Corporate and other debt securities

     52,815      424      (3,316     49,923      52,822      2,547      (5,200     50,169
                                                         

Total investment securities held to maturity

   $ 1,575,972    $ 14,825    $ (78,018   $ 1,512,779    $ 1,154,737    $ 12,345    $ (97,837   $ 1,069,245
                                                         

The age of unrealized losses and fair value of related securities held to maturity at June 30, 2009 and December 31, 2008 were as follows:

 

     June 30, 2009  
     Less than
Twelve Months
    More than
Twelve Months
    Total  
     Fair
Value
   Unrealized
Losses
    Fair
Value
   Unrealized
Losses
    Fair
Value
   Unrealized
Losses
 
     (in thousands)  

Obligations of states and political subdivisions

   $ 48,168    $ (916   $ 5,441    $ (92   $ 53,609    $ (1,008

Residential mortgage-backed securities

     458,875      (4,012     10,964      (201     469,839      (4,213

Trust preferred securities

     25,489      (1,725     161,489      (67,756     186,978      (69,481

Corporate and other debt securities

     7,296      (245     16,880      (3,071     24,176      (3,316
                                             

Total

   $ 539,828    $ (6,898   $ 194,774    $ (71,120   $ 734,602    $ (78,018
                                             

 

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     December 31, 2008  
     Less than
Twelve Months
    More than
Twelve Months
    Total  
     Fair
Value
   Unrealized
Losses
    Fair
Value
   Unrealized
Losses
    Fair
Value
   Unrealized
Losses
 
     (in thousands)  

Obligations of states and political subdivisions

   $ 27,346    $ (661   $ 3,853    $ (40   $ 31,199    $ (701

Residential mortgage-backed securities

     36,985      (785     —        —          36,985      (785

Trust preferred securities

     89,816      (24,111     88,642      (67,040     178,458      (91,151

Corporate and other debt securities

     29,389      (4,677     3,000      (523     32,389      (5,200
                                             

Total

   $ 183,536    $ (30,234   $ 95,495    $ (67,603   $ 279,031    $ (97,837
                                             

The unrealized losses on investment securities held to maturity are primarily due to changes in interest rates (including, in certain cases, changes in credit spreads) and lack of liquidity in the market place. The total number of security positions in the securities held to maturity portfolio in an unrealized loss position at June 30, 2009 was 134 compared to 87 at December 31, 2008.

The unrealized losses reported on obligations of states and political subdivisions all relate to securities with investment grade ratings and are believed by management to have been caused not by credit risk, but changes in interest rates.

Unrealized losses reported for residential mortgage-backed securities relate primarily to securities issued by government agencies and two AAA rated private label securities (with a combined amortized cost of $11.2 million and an unrealized loss of $201 thousand at June 30, 2009). Due to an illiquid and inactive market, the fair values for both of these two securities were based upon internal cash flow models that use significant unobservable data (i.e., Level 3 inputs discussed in detail at Note 7).

Unrealized losses reported for trust preferred securities relate to 36 single-issuer securities, mainly issued by bank holding companies. Of the 36 trust preferred securities, 23 are investment grade, 2 were non-investment grade, and 11 are not rated as of June 30, 2009. Additionally, $23.6 million in unrealized losses at June 30, 2009 relate to securities issued by one bank holding company with a combined amortized cost of $55.0 million. Valley privately negotiated the purchase of the $55.0 million in trust preferred securities from the bank issuer and holds all of the securities of two issuances. In August 2009, the bank issuer elected to defer its normal quarterly interest payment on one of the security issuances. Typical of most trust preferred issuances, the bank issuer may defer interest payments for up to five years with interest payable on the deferred balance. The bank issuer is currently operating under an agreement with its bank regulators. The agreement requires, among other things, the issuer to receive permission from the regulators prior to resuming its scheduled payments on both security issuances. However, the issuer’s principal subsidiary bank reported, in its most recent regulatory filing, that it meets the regulatory minimum requirements to be considered a “well-capitalized institution” as of June 30, 2009. Based on this information, management believes that Valley will receive all principal and interest contractually due on both security issuances. Valley will continue to closely monitor the credit risk of this issuer, and, if there is significant deterioration, Valley may be required to recognize other-than-temporary impairment on such securities in future periods. All other trust preferred securities classified as held to maturity are paying in accordance with their terms and have no deferrals of interest or defaults.

Unrealized losses reported for corporate and other debt securities relate mainly to one investment rated bank issued corporate bond with a $9.0 million amortized cost and a $2.6 million unrealized loss. The security is paying in accordance with its terms. Additionally, management analyzes the performance of the corporate and other debt issuers on a quarterly basis, including a review of the issuer’s most recent bank regulatory filings, if applicable, to assess credit risk and the probability of impairment of the contractual cash flows of the applicable security. Based upon management’s quarterly review, all of the issuers have maintained performance levels adequate to support the contractual cash flows of the securities and, if applicable, appear to meet the regulatory minimum requirements to be considered a “well-capitalized” financial institution. Due to an illiquid and

 

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inactive market, Valley used Level 3 fair value measurements for 27 and 6 individual trust preferred securities and corporate bonds, respectively, out of a total of 40 and 12 of such instruments, respectively, classified as held to maturity at June 30, 2009.

Management does not believe that any individual unrealized loss as of June 30, 2009 included in the table above represents an other-than-temporary impairment as management mainly attributes the declines in value to changes in interest rates and lack of liquidity in the market place, not credit quality or other factors. Based on a comparison of the present value of expected cash flows to the amortized cost, management believes there are no credit losses on these securities. Valley has no intent to sell, nor is it more likely than not that Valley will be required to sell, the securities contained in the table above before the recovery of their amortized cost basis or maturity.

As of June 30, 2009 the fair value of investments held to maturity that were pledged to secure public deposits, repurchase agreements, lines of credit and for other purposes required by law, was $360.4 million.

The contractual maturities of investments in debt securities held to maturity at June 30, 2009 are set forth in the table below. Maturities may differ from contractual maturities in mortgage-backed securities because the mortgages underlying the securities may be prepaid without any penalties. Therefore, mortgage-backed securities are not included in the maturity categories in the following summary.

 

     June 30, 2009
     Amortized
Cost
   Fair
Value
     (in thousands)

Due in one year

   $ 44,565    $ 44,624

Due after one year through five years

     70,548      71,238

Due after five years through ten years

     79,116      79,894

Due after ten years

     364,421      292,696

Residential mortgage-backed securities

     1,017,322      1,024,327
             

Total investment securities held to maturity

   $ 1,575,972    $ 1,512,779
             

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

The weighted-average remaining expected life for residential mortgage-backed securities held to maturity was 1.7 years at June 30, 2009.

 

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Available for Sale

The amortized cost, gross unrealized gains and losses and fair value of investment securities available for sale at June 30, 2009 and December 31, 2008 were as follows:

 

     June 30, 2009    December 31, 2008
     Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
    Fair
Value
   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
    Fair
Value
     (in thousands)

U.S. government agency securities

   $ —      $ —      $ —        $ —      $ 101,787    $ 785    $ (8   $ 102,564

Obligations of states and political subdivisions

     39,562      861      (82     40,341      47,371      930      (110     48,191

Residential mortgage-backed securities

     1,089,251      33,892      (15,154     1,107,989      1,229,248      21,692      (35,554     1,215,386

Trust preferred securities*

     56,906      30      (24,118     32,818      49,621      25      (20,299     29,347

Corporate and other debt securities

     97,687      1,882      (4,975     94,594      11,919      —        (6,762     5,157

Equity securities

     49,463      1,699      (7,360     43,802      49,383      31      (14,617     34,797
                                                         

Total investment securities available for sale

   $ 1,332,869    $ 38,364    $ (51,689   $ 1,319,544    $ 1,489,329    $ 23,463    $ (77,350   $ 1,435,442
                                                         

 

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

The age of unrealized losses and fair value of related investment securities available for sale at June 30, 2009 and December 31, 2008 were as follows:

 

     June 30, 2009  
     Less than
Twelve Months
    More than
Twelve Months
    Total  
     Fair
Value
   Unrealized
Losses
    Fair Value    Unrealized
Losses
    Fair Value    Unrealized
Losses
 
     (in thousands)  

Obligations of states and political subdivisions

   $ 2,954    $ (29   $ 743    $ (53   $ 3,697    $ (82

Residential mortgage-backed securities

     367      (1     138,031      (15,153     138,398      (15,154

Trust preferred securities

     4,775      (2,240     27,517      (21,878     32,292      (24,118

Corporate and other debt securities

     7,516      (165     5,163      (4,810     12,679      (4,975

Equity securities

     829      (421     35,126      (6,939     35,955      (7,360
                                             

Total

   $ 16,441    $ (2,856   $ 206,580    $ (48,833   $ 223,021    $ (51,689
                                             

 

     December 31, 2008  
     Less than
Twelve Months
    More than
Twelve Months
    Total  
     Fair
Value
   Unrealized
Losses
    Fair
Value
   Unrealized
Losses
    Fair
Value
   Unrealized
Losses
 
     (in thousands)  

U.S. government agency securities

   $ 1,004    $ (8   $ —      $ —        $ 1,004    $ (8

Obligations of states and political subdivisions

     3,515      (109     856      (1     4,371      (110

Residential mortgage-backed securities

     191,002      (24,902     55,948      (10,652     246,950      (35,554

Trust preferred securities

     18,334      (8,159     8,948      (12,140     27,282      (20,299

Corporate and other debt securities

     1,656      (290     3,500      (6,472     5,156      (6,762

Equity securities

     19,815      (11,092     8,802      (3,525     28,617      (14,617
                                             

Total

   $ 235,326    $ (44,560   $ 78,054    $ (32,790   $ 313,380    $ (77,350
                                             

 

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The total number of security positions in the available for sale portfolio in an unrealized loss position at June 30, 2009 was 82 compared to 190 at December 31, 2008. The unrealized losses for residential mortgage-backed securities relate primarily to 18 individual private label mortgage-backed securities with a combined amortized cost of $150.5 million and unrealized losses totaling $15.1 million. Of these securities, 14 securities had investment grade ratings and 4 had a non-investment grade rating at June 30, 2009. Two of the four non-investment grade securities were found to be other-than-temporarily impaired based on management’s impairment analysis at June 30, 2009 (described in the section below).

Within the residential mortgage-backed securities category of the available for sale portfolio, Valley owns 20 individual private label mortgage-backed securities. Management estimates the loss projections for each security by stressing the individual loans collateralizing the security and determining a range of expected default rates, loss severities, and prepayment speeds, in conjunction with the underlying credit enhancement (if applicable) for each security. Based on collateral and origination vintage specific assumptions, a range of possible cash flows was identified to determine whether other-than-temporary impairment existed as of June 30, 2009. Four private label mortgage-backed securities (including three securities previously found to be other-than-temporarily impaired during the first quarter of 2009 and one security impaired during the fourth quarter of 2008) classified as available for sale were deemed to have other-than-temporary impairment related to additional estimated credit losses totaling $2.4 million, which were charged to earnings in the second quarter of 2009. Due to Valley’s early adoption of FSP FAS 115-2, the amortized cost of the private label mortgage-backed security previously impaired at December 31, 2008 was increased by $6.2 million at January 1, 2009, representing the non-credit portion of the $6.4 million impairment charge taken during the fourth quarter of 2008. After all impairment charges, the four securities had a combined amortized cost and fair value of $46.9 million and $41.6 million, respectively, at June 30, 2009.

In evaluating the range of likely future cash flows for each of the four impaired private label mortgage-backed securities, Valley applied security specific as well as market assumptions, based on the credit characteristics of each security to multiple cash flow models. Multiple present value cash flow analyses were utilized in determining future expected cash flows. Under certain stress scenarios estimated future losses may arise. For the four securities in which Valley recorded an other-than-temporary impairment, the average portfolio FICO score ranged from 713 to 727 and the weighted average loan to value ratio at origination was between 61 percent and 73 percent. Additional cash flow assumptions incorporated expected default rates ranging from 3.30 percent to 8.40 percent and loss severity expectations ranging from 51 percent to 59 percent. Each security’s cash flows were discounted at the security’s effective interest rate. Although management recognized other-than-temporary impairment charges on the securities, each security is currently performing in accordance with its contractual obligations.

At June 30, 2009, the unrealized losses for trust preferred securities in the tables above relate to 19 single-issuer bank trust preferred securities and 3 pooled trust preferred securities. All the single-issuer trust preferred securities classified as available for sale had investment grade ratings at June 30, 2009. These single-issuer securities are all paying in accordance with their terms and have no deferrals of interest or defaults. Additionally, as previously noted above, management analyzes the performance of the bank issuers on a quarterly basis, including a review of the issuer’s most recent bank regulatory report to assess the company’s credit risk and the probability of impairment of the contractual cash flows of the applicable security. Based upon management’s quarterly review, all of the issuers appear to meet the regulatory minimum requirements to be considered a “well-capitalized” financial institution and have maintained performance levels adequate to support the contractual cash flows of the securities.

Valley owns three pooled trust preferred securities, collateralized by securities principally issued by banks, with a combined amortized cost and fair value of $26.1 million and $10.9 million, respectively at June 30, 2009. Two of the three securities were other-than-temporarily impaired at December 31, 2008 and resulted in an impairment charge of $7.8 million to earnings, as each of Valley’s tranches in the two securities had projected cash flows below their future contractual principal and interest payments. Due to Valley’s early adoption of FSP FAS 115-2, the amortized cost amounts for these securities were increased by a total of $7.5 million at January 1, 2009 for the non-credit portion of the $7.8 million impairment charge taken during the fourth quarter of 2008.

 

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As of June 30, 2009, the total fair value for the two securities, based on a level 3 valuation method described in Note 7, was $1.5 million. Based upon management’s assessment, the total unrealized losses of $7.1 million on the two securities at June 30, 2009 is solely attributable to factors other than credit.

The one other pooled trust preferred security’s rating was downgraded from BBB- to BB- by S&P in March 2009, although Moody’s has maintained its rating equivalent to AA since November 2008 and a stable outlook on the security. The security is performing in accordance with its contractual terms and management has no present intent to sell, nor is it more likely than not that Valley will be required to sell such security before market price recovery, which could be maturity. The overall issuance of approximately $192 million includes three banks that deferred interest payments and one bank in default of payment. These four issuers combined represent 8.8 percent of the overall security. As part of its impairment analysis, management reviewed the underlying banks’ current financial performance, as well as their participation in the U.S. Department of the Treasury’s TARP Capital Purchase Program to assist management in applying the appropriate constant default rate to its cash flow projections for the security. At June 30, 2009, no other-than-temporary impairment was recorded for the security, as Valley’s super senior tranche of this security had projected cash flows no less than their future contractual principal and interest payments. The downgrade to the security’s rating in March 2009 did not change management’s assessment that the security is temporarily impaired.

Unrealized losses reported for corporate and other debt securities relate mainly to one investment rated bank issued corporate bond with a $10.0 million amortized cost and a $4.8 million unrealized loss. The security is paying in accordance with its terms. Additionally, management analyzes the performance of the corporate and other debt issuers on a quarterly basis, including a review of the issuer’s most recent bank regulatory filings, if applicable, to assess credit risk and the probability of impairment of the contractual cash flows of the applicable security. Based upon management’s quarterly review, all of the issuers have maintained performance levels adequate to support the contractual cash flows of the securities and, if applicable, appear to meet the regulatory minimum requirements to be considered a “well-capitalized” financial institution.

The unrealized losses on equity securities, including those more than twelve months, are related primarily to perpetual preferred securities. As allowed under the guidance issued by the Office of the Chief Accountant of the SEC in October 2008, these hybrid investments are assessed for impairment by Valley as if they were debt securities. Therefore, Valley assessed the creditworthiness of each security issuer, as well as any potential change in the anticipated cash flows of the securities as of June 30, 2009. Based on this analysis, management believes the declines in prices are attributable to a lack of liquidity in the marketplace and are not reflective of the underlying value of these instruments. All of the perpetual preferred securities with unrealized losses at June 30, 2009 have investment grade ratings and are currently performing and paying quarterly dividends.

Management does not believe that any individual unrealized loss as of June 30, 2009 represents an other-than-temporary impairment, except for the four private label mortgage-backed securities discussed above, as management mainly attributes the declines in value to changes in interest rates and recent market volatility, not credit quality or other factors. Based on a comparison of the present value of expected cash flows to the amortized cost, management believes there are no credit losses on these securities. Valley has no intent to sell, nor is it more likely than not than Valley will be required to sell, the securities contained in the table above before the recovery of their amortized cost basis or, if necessary, maturity.

As of June 30, 2009, the fair value of securities available for sale that were pledged to secure public deposits, repurchase agreements, lines of credit and for other purposes required by law, was $795.6 million.

 

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The contractual maturities of investments in debt securities available for sale at June 30, 2009, are set forth in the following table. Maturities may differ from contractual maturities in mortgage-backed securities because the mortgages underlying the securities may be prepaid without any penalties. Therefore, mortgage-backed securities are not included in the maturity categories in the following summary.

 

     June 30, 2009
     Amortized
Cost
   Fair
Value
     (in thousands)

Due in one year

   $ 9,005    $ 9,187

Due after one year through five years

     38,999      39,742

Due after five years through ten years

     74,362      75,931

Due after ten years

     71,789      42,893

Residential mortgage-backed securities

     1,089,251      1,107,989

Equity securities

     49,463      43,802
             

Total investment securities available for sale

   $ 1,332,869    $ 1,319,544
             

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

The weighted-average remaining expected life for residential mortgage-backed securities available for sale was 3.9 years at June 30, 2009.

Gross gains (losses) realized on sales, maturities and other securities transactions related to investment securities included in earnings for the three and six months ended June 30, 2009 and 2008 were as follows:

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2009     2008     2009     2008  
     (in thousands)  

Sales transactions:

        

Gross gains

   $ 258      $ 320      $ 258      $ 722   

Gross losses

     —          (12     (36     (31
                                
     258        308        222        691   
                                

Maturities and other securities transactions:

        

Gross gains

     34        121        51        237   

Gross losses

     (4     (4     (22     (4
                                
     30        117        29        233   
                                

Gains on securities transactions, net

   $ 288      $ 425      $ 251      $ 924   
                                

The following table presents the changes in the credit loss component of the amortized cost of debt securities classified as either held to maturity or available for sale that Valley has written down for such loss as an other-than-temporary impairment recognized in earnings. The credit loss component of the amortized cost represents the difference between the present value of expected future cash flows and the amortized cost basis of the security prior to considering credit losses. The beginning balance represents the credit loss component for debt securities for which other-than-temporary impairment occurred prior to the period presented. Other-than-temporary impairment recognized in earnings in the three and six month periods ended June 30, 2009, for credit impaired debt securities is presented as additions in two components based upon whether the current period is the first time the debt security was credit impaired (initial credit impairment) or is not the first time the debt security was credit impaired (subsequent credit impairments). The credit loss component is reduced if Valley sells, intends to sell or believes it will be required to sell previously credit impaired debt securities. Additionally, the credit loss component is reduced if (i) Valley receives the cash flows in excess of what it expected to receive over the remaining life of the credit impaired debt security, (ii) the security matures or (iii) the security is fully written down.

 

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Changes in the credit loss component of credit impaired debt securities were:

 

     Three Months Ended
June 30, 2009
   Six Months Ended
June 30, 2009
     (in thousands)

Balance, beginning of period

   $ 2,720    $ 549

Additions:

     

Initial credit impairments

     —        2,171

Subsequent credit impairments

     2,434      2,434
             

Balance, end of period

   $ 5,154    $ 5,154
             

Trading Securities

The fair values of trading securities at June 30, 2009 and December 31, 2008 were as follows:

 

     June 30,
2009
   December 31,
2008
     (in thousands)

Trust preferred securities

   $ 32,821    $ 34,236
             

Total trading securities

   $ 32,821    $ 34,236
             

Interest income on trading securities totaled $817 thousand and $2.3 million for the three months ended June 30, 2009 and 2008, respectively, and $2.5 million and $6.4 million for the six months ended June 30, 2009 and 2008, respectively.

Note 9. Goodwill and Other Intangible Assets

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

 

     Business Segment / Reporting Unit*:  
     Wealth
Management
    Consumer
Lending
   Commercial
Lending
   Investment
Management
   Total  
     (in thousands)  

Balance at December 31, 2007

   $ 18,192      $ 54,537    $ 57,020    $ 50,086    $ 179,835   

Goodwill related to bank subsidiary sold

     (100     —        —        —        (100

Goodwill from business combinations

     93        39,103      50,736      25,479      115,411   
                                     

Balance at December 31, 2008

     18,185        93,640      107,756      75,565      295,146   

Goodwill from business combinations

     —          165      213      107      485   
                                     

Balance at June 30, 2009

   $ 18,185      $ 93,805    $ 107,969    $ 75,672    $ 295,631   
                                     

 

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

 

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During the third quarter of 2008, we recorded $115.3 million in goodwill in connection with the acquisition of Greater Community on July 1, 2008 and $93 thousand in goodwill from an earn-out payment resulting from an acquisition by Valley in 2006. The earn-out payment was based upon predetermined profitability targets in accordance with the merger agreement. During the second quarter of 2009, Valley recorded an additional $485 thousand in goodwill related to the valuation of certain deferred tax assets acquired from Greater Community.

During the fourth quarter of 2007, Valley recorded a $2.3 million goodwill impairment charge due to its decision to sell its broker-dealer subsidiary, Glen Rauch Securities, Inc. On March 31, 2008, Valley sold the broker-dealer subsidiary resulting in $100 thousand reduction in goodwill during the first quarter of 2008. See Note 5 for further details on the transaction.

No impairment losses on goodwill or intangibles other than loan servicing rights were incurred during the three and six months ended June 30, 2009 and 2008.

The following table summarizes other intangible assets as of June 30, 2009 and December 31, 2008:

 

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

June 30, 2009

  

Loan servicing rights

   $ 68,478    $ (57,808   $ (986   $ 9,684

Core deposits

     25,584      (12,235     —          13,349

Other

     5,792      (4,413     —          1,379
                             

Total other intangible assets

   $ 99,854    $ (74,456   $ (986   $ 24,412
                             

December 31, 2008

         

Loan servicing rights

   $ 66,624    $ (56,800   $ (532   $ 9,292

Core deposits

     38,177      (23,028     —          15,149

Other

     5,792      (4,279     —          1,513
                             

Total other intangible assets

   $ 110,593    $ (84,107   $ (532   $ 25,954
                             

Loan servicing rights are amortized using the amortization method. Under this method, Valley amortizes the loan servicing assets in proportion to and over the period of estimated net servicing revenues. On a quarterly basis, Valley assesses the loan servicing asset for impairment based on fair value at each reporting date. At each reporting date, if the book value of an individual loan servicing asset exceeds fair value, an impairment charge is charged to earnings for the amount of the book value over fair value. For the three months ended June 30, 2009 and 2008, Valley recognized recoveries of previously recognized impairment charges totaling $681 thousand and $90 thousand, respectively. For the six months ended June 30, 2009 and 2008, Valley recognized impairment charges, net of recoveries on its loan servicing rights of $454 thousand and $126 thousand, respectively.

Core deposits are amortized using an accelerated method and have a weighted average amortization period of 10 years. The column labeled “Other” included in the table below consists of customer lists and covenants not to compete, which are amortized over their expected life using a straight line method and have a weighted average amortization period of 14 years.

The following presents the estimated future amortization expense of other intangible assets for the remainder of 2009 through 2013:

 

       Loan
Servicing
Rights
     Core
Deposits
     Other
       (in thousands)

2009

     $ 1,442      $ 1,625      $ 133

2010

       2,308        2,985        266

2011

       1,777        2,544        234

2012

       1,234        2,104        217

2013

       944        1,663        114

 

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Valley recognized amortization expense on other intangible assets of $1.0 million and $1.4 million for the three months ended June 30, 2009 and 2008, respectively and $3.8 million and $3.1 million for the six months ended June 30, 2009 and 2008, respectively.

Note 10. Pension Plan

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

On December 31, 2006, Valley adopted the provisions of SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—An Amendment of SFAS No. 87, 88, 106, and 132R.” This standard requires an employer to: (a) recognize in its statement of financial position an asset for a plan’s overfunded status or a liability for a plan’s underfunded status; (b) measure a plan’s assets and its obligations that determine its funded status as of the end of the employer’s fiscal year; and (c) recognize changes in the funded status of a defined benefit postretirement plan in the year in which the changes occur. Those changes will be reported in other comprehensive income (loss).

The following table sets forth the components of net periodic pension expense related to the pension plans for the three and six months ended June 30, 2009 and 2008:

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2009     2008     2009     2008  
     (in thousands)  

Service cost

   $ 1,304      $ 1,212      $ 2,608      $ 2,441   

Interest cost

     1,274        1,187        2,548        2,374   

Expected return on plan assets

     (1,429     (1,474     (2,858     (2,948

Amortization of prior service cost

     149        136        298        273   

Amortization of actuarial loss

     227        91        454        181   
                                

Total net periodic pension expense

     1,525        1,152        3,050        2,321   

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

        

Amortization of prior service cost

     (149     (136     (298     (273

Amortization of acturial loss

     (227     (91     (454     (181
                                
     (376     (227     (752     (454
                                

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

   $ 1,149      $ 925      $ 2,298      $ 1,867   
                                

The fair value of qualified plan assets increased approximately $6.8 million, or 11.2 percent to $67.5 million at June 30, 2009 from $60.7 million at December 31, 2008. Valley contributed $5.0 million to the qualified plan during the first quarter of 2009, based upon actuarial estimates. Valley does not expect to make any additional contributions during the remainder of 2009.

Note 11. Guarantees

Guarantees that have been entered into by Valley include standby letters of credit of $176.3 million as of June 30, 2009. Standby letters of credit represent the guarantee by Valley of the obligations or performance of a

 

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customer in the event the customer is unable to meet or perform its obligations to a third party. Of the total standby letters of credit, $99.5 million, or 56.4 percent are secured and, in the event of non performance by the customer, Valley has rights to the underlying collateral, which includes commercial real estate, business assets (physical plant or property, inventory or receivables), marketable securities and cash in the form of bank savings accounts and certificates of deposit. Valley had a $707 thousand liability recorded as of June 30, 2009 relating to the standby letters of credit.

Note 12. Junior Subordinated Debentures Issued To Capital Trusts

Valley established VNB Capital Trust I, a statutory trust, for the sole purpose of issuing trust preferred securities and related trust common securities. The proceeds from such issuances were used by the trust to purchase an equivalent amount of junior subordinated debentures of Valley. GCB Capital Trust III was established by Greater Community prior to Valley’s acquisition of Greater Community, and the junior subordinated notes issued by Greater Community to GCB Capital Trust III were assumed by Valley upon completion of the acquisition on July 1, 2008. The junior subordinated debentures, the sole assets of the trusts, are unsecured obligations of Valley, and are subordinate and junior in right of payment to all present and future senior and subordinated indebtedness and certain other financial obligations of Valley. Valley wholly owns all of the common securities of each trust. The trust preferred securities qualify, and are treated by Valley as Tier I regulatory capital.

On January 1, 2007, Valley elected to measure the junior subordinated debentures issued to VNB Capital Trust I at fair value under SFAS No. 159. For the three and six months ended June 30, 2009, net trading losses include $24.4 million and $10.7 million in non-cash losses, respectively, for the change in the fair value of the junior subordinated debentures issued to VNB Capital Trust I. For the comparable three and six months ended June 30, 2008, net trading losses include $2.0 million and $264 thousand of non-cash gains, respectively, for the change in the fair value of these debentures.

The table below summarizes the outstanding junior subordinated debentures and the related trust preferred securities issued by each trust as of June 30, 2009:

 

     June 30, 2009  
     VNB Capital
Trust I
    GCB Capital
Trust III
 
     ($ in thousands)  

Junior Subordinated Debentures:

    

Carrying value (1)

   $ 150,743      $ 25,291   

Contractual principal balance

     157,024        24,743   

Annual interest rate (2)

     7.75     6.96

Stated maturity date

     December 15, 2031        July 30, 2037   

Initial call date

     November 7, 2006        July 30, 2017   

Trust Preferred Securities:

    

Face value

   $ 152,313      $ 24,000   

Annual distribution rate (2)

     7.75     6.96

Issuance date

     November 2001        July 2007   

Distribution dates (3)

     Quarterly        Quarterly   

 

(1) The carrying value for GCB Capital Trust III includes an unamortized purchase accounting premium of $548 thousand.

 

(2) Interest on GCB Capital Trust III is fixed until July 30, 2017, then resets to 3-month LIBOR plus 1.4 percent. The annual interest rate excludes the effects of the purchase accounting adjustments.

 

(3) All cash distributions are cumulative.

The trusts’ ability to pay amounts due on the trust preferred securities is solely dependent upon Valley making payments on the related junior subordinated debentures. Valley’s obligation under the junior subordinated debentures and other relevant trust agreements, in aggregate, constitutes a full and unconditional guarantee by

 

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Valley of the trusts’ obligations under the trust preferred securities issued. Under the junior subordinated debenture agreements, Valley has the right to defer payment of interest on the debentures and, therefore, distributions on the trust preferred securities, for up to five years, but not beyond the stated maturity date in the table above. Currently, Valley has no intention to exercise its right to defer interest payments on the debentures.

The trust preferred securities are subject to mandatory redemption, in whole or in part, upon repayment of the junior subordinated debentures at the stated maturity date or upon an earlier call date for redemption at par. The junior subordinated notes issued to VNB Capital Trust I are currently callable by Valley. Potential future purchases of the trust preferred securities issued by the trusts or redemption of its junior subordinated debentures is not permitted for up to approximately three years, without prior consent, under the terms of the U.S. Department of Treasury’s TARP Capital Purchase Program which Valley elected to participate in on November 14, 2008. See information under the caption “Capital Adequacy” in Management’s Discussion and Analysis section for further details.

The trust preferred securities described above are included in Valley’s consolidated Tier 1 capital and total capital at June 30, 2009 and December 31, 2008. In March 2005, the Board of Governors of the Federal Reserve System issued a final rule allowing bank holding companies to continue to include qualifying trust preferred capital securities in their Tier 1 capital for regulatory capital purposes, subject to a 25 percent limitation to all core (Tier 1) capital elements, net of goodwill less any associated deferred tax liability. The amount of trust preferred securities and certain other elements in excess of the limit could be included in total capital, subject to restrictions. The final rule originally provided a five-year transition period, ending March 31, 2009, for application of the aforementioned quantitative limitation, however, in March 2009, the Board of Governors of the Federal Reserve Board voted to delay the effective date until March 2011. As of June 30, 2009 and December 31, 2008, 100 percent of the trust preferred securities qualified as Tier I capital under the final rule adopted in March 2005.

Note 13. Derivative Instruments and Hedging Activities

Valley is exposed to certain risks arising from both its business operations and economic conditions. Valley principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. Valley manages economic risks, including interest rate, liquidity, and credit risk, primarily by managing the amount, sources, and duration of its assets and liabilities and, from time to time, the use of derivative financial instruments. Specifically, Valley enters into derivative financial instruments to manage exposures that arise from business activities that result in the payment of future known and uncertain cash amounts, the value of which are determined by interest rates. Valley’s derivative financial instruments are used to manage differences in the amount, timing, and duration of Valley’s known or expected cash receipts and its known or expected cash payments principally related to certain variable-rate borrowings and fixed-rate loan assets.

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

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 of 2008, 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). On February 20, 2009, Valley

 

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re-designated the caps to hedge the variable cash flows associated with customer repurchase agreements and money market deposit accounts products that have variable interest rates based on the federal funds rate. The change in fair value of these derivatives while not designated as hedges (from January 1, 2009 through February 20, 2009) totaled a $369 thousand gain and is included in other income for the six months ended June 30, 2009.

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.

Fair Value Hedges of Interest Rate Risk. Valley is exposed to changes in the fair value of certain of its fixed rate assets due to changes in benchmark interest rates based on one month-LIBOR. From time to time, Valley uses interest rate swaps to manage its exposure to changes in fair value. Interest rate swaps designated as fair value hedges involve the receipt of variable rate payments from a counterparty in exchange for Valley making fixed rate payments over the life of the agreements without the exchange of the underlying notional amount. As of June 30, 2009, Valley had one interest rate swap with a notional amount of $9.3 million.

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

Non-designated Hedges. Valley does not use derivatives for speculative purposes. Derivatives not designated as hedges are used to manage Valley’s exposure to interest rate movements and other identified risks but do not meet the strict hedge accounting requirements of SFAS No. 133. During the first quarter of 2009, Valley entered into and terminated three interest rate swaps not designated as hedges to potentially offset the change in market fair value of certain trading securities. During the fourth quarter 2008, as previously mentioned above, two interest rate caps (due to mismatches in index) did not qualify for hedge accounting and were subsequently re-designated during February 2009. Changes in the fair value of derivatives not designated in hedging relationships are recorded directly in earnings. As of June 30, 2009, Valley had no outstanding derivatives that were not designated in hedging relationships.

 

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

 

          Fair Value
Asset Derivatives    Balance Sheet
Location
   June 30,
2009
   December 31,
2008
          (in thousands)

Derivatives designated as hedging instruments under SFAS No. 133:

        

Cash flow hedge interest rate caps on short-term borrowings and deposit accounts

   Other Assets    $ 7,807    $ 2,090
                

Total derivatives designated as hedging instruments under SFAS No. 133

      $ 7,807    $ 2,090
                

Derivatives not designated as hedging instruments under SFAS No. 133:

        

Cash flow hedge interest rate caps on short-term borrowings and deposit accounts

   Other Assets    $ —      $ 1,244
                

Total derivatives not designated as hedging instruments under SFAS No. 133

      $ —      $ 1,244
                

Liability Derivatives

        

Derivatives designated as hedging instruments under SFAS No. 133:

        

Fair value hedge commercial loan interest rate swap

   Other Liabilities    $ 1,111    $ 2,008
                

Total derivatives designated as hedging instruments under SFAS No. 133

      $ 1,111    $ 2,008
                

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

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2009     2008     2009     2008  
     (in thousands)  

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

        

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

   $ (80   $ (7   $ (128   $ (7

Amount of gain recognized in other comprehensive income

     4,469        165        3,902        165   

For the three and six months ended June 30, 2009, Valley recognized $202 thousand gain in other income for hedge ineffectiveness on the cash flow hedge interest rate caps. No material ineffectiveness existed on the cash flow hedge interest rate caps during the three and six months ended June 30, 2008. The accumulated net after-tax loss related to effective cash flow hedges included in accumulated other comprehensive loss totaled $2.5 million and $5.0 million at June 30, 2009 and December 31, 2008, respectively.

Amounts reported in accumulated other comprehensive loss related to cash flow interest rate derivatives are reclassified to interest expense as interest payments are made on the hedged variable interest rate liabilities. During the next twelve months, Valley estimates that $613 thousand will be reclassified as an increase to interest expense.

 

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

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2009     2008     2009     2008  
     (in thousands)  

Derivative

  

Commercial loan interest rate swap:

        

Interest income - Interest and fees on loans

   $ 465      $ 418      $ 898      $ (13

Hedged item

        

Commercial loan:

        

Interest income - Interest and fees on loans

     (465     (418     (898     13   

Gains (losses) included in the consolidated statements of income related to derivative instruments not designated as hedging instruments under SFAS No. 133 were as follows:

 

     Three Months Ended
June 30,
   Six Months Ended
June 30,
     2009    2008    2009    2008
     (in thousands)

Non-designated hedge interest rate derivatives:

           

Other non-interest income

   $ —      $ —      $ 369    $ —  

Trading gains (losses), net

     —        —        1,984      —  

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

Valley has agreements with its derivative counterparties that contain a provision where if Valley defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then Valley could also be declared in default on its derivative obligations.

As of June 30, 2009, the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements was approximately $1.2 million. Valley has derivative counterparty agreements that require minimum collateral posting thresholds for certain counterparties. At June 30, 2009, neither Valley nor its counterparties have exceeded such minimum thresholds and no collateral has been assigned or posted.

Note 14. Business Segments

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

 

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

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

The MD&A contains supplemental financial information, described in the sections that follow, which has been determined by methods other than U.S. generally accepted accounting principles (“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.

Cautionary Statement Concerning Forward-Looking Statements

This Quarterly Report on Form 10-Q, both in the MD&A and elsewhere, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are not historical facts and include expressions about management’s confidence and strategies and management’s expectations about new and existing programs and products, acquisitions, relationships, opportunities, taxation, technology, market conditions and economic expectations. These statements may be identified by such forward-looking terminology as “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. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, but are not limited to those risk factors disclosed in Valley’s Annual Report on Form 10-K for the year ended December 31, 2008. We assume no obligation for updating any such forward-looking statement at any time.

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.

Valley’s accounting policies are fundamental to understanding management’s discussion and analysis of its financial condition and results of operations. Our significant accounting policies are presented in Note 1 to the consolidated financial statements included in Valley’s Annual Report on Form 10-K for the year ended December 31, 2008. 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 Valley’s Board of Directors.

The judgments used by management in applying the critical accounting policies discussed below may be affected by a further and prolonged deterioration in the economic environment, which may result in changes to future financial results. Specifically, subsequent evaluations of the loan portfolio, in light of the factors then prevailing, may result in significant changes in the allowance for loan losses in future periods, and the inability to collect on outstanding loans could result in increased loan losses. In addition, the valuation of certain securities in our investment portfolio could be negatively impacted by illiquidity or dislocation in marketplaces resulting in significantly depressed market prices thus leading to further impairments.

 

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Allowance for Loan Losses. The allowance for loan losses represents management’s estimate of probable loan losses inherent in the loan portfolio and is the largest component of the allowance for credit losses which also includes management’s 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 included in Valley’s Annual Report on Form 10-K for the year ended December 31, 2008 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.

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.

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 investment’s book value is greater than fair value, the severity of the investment’s decline, as well as any credit deterioration of the investment. If the decline in value of an equity investment security 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. For debt investment securities deemed to be other-than-temporarily impaired, the investment is written down by the impairment related to the estimated credit loss and the non-credit related impairment is recognized in other comprehensive income. See Notes 7 and 8 to the consolidated financial statements and the “Investment Securities Portfolio” section in this MD&A below for additional information.

Goodwill and Other Intangible Assets. Valley records all assets, liabilities, and non-controlling interest in the acquiree in purchase acquisitions, including goodwill and other intangible assets, at fair value as of the acquisition date as required by SFAS No. 141R. Goodwill totaling $295.6 million at June 30, 2009 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 unit’s 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.

 

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The initial recording and subsequent impairment tests of goodwill and other intangible assets are subject to the provisions of SFAS No. 157, which Valley adopted as of January 1, 2007.

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 entity’s 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 Taxes—An 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 in Valley’s Annual Report on Form 10-K for the year ended December 31, 2008, and the “Income Taxes” section below include additional discussion on the accounting for income taxes.

Executive Summary

Net income for the second quarter of 2009 was $15.0 million compared to $41.5 million for the same period of 2008. The decrease was largely due to (i) a $18.3 million increase in net trading losses which includes a $24.4 million non-cash charge related to the change in the fair value of our junior subordinated debentures carried at fair value in the second quarter of 2009 compared to a non-cash gain of $2.0 million on such debentures for the same period of 2008, (ii) a $14.1 million increase in non-interest expense caused by a $10.0 million increase in FDIC insurance assessments (including a industry-wide FDIC special assessment as of June 30, 2009 which was approximately $6.5 million) and higher operating expenses relating to the addition of Greater Community’s 16 full-service branches and 5 de novo branches opened since June 30, 2008 and (iii) a $7.3 million increase in the provision of credit losses due to higher net charge-offs and deterioration in economic conditions, partially offset by (iv) a $10.5 million increase in net interest income due to loan growth since June 30, 2008, including loans acquired through the acquisition of Greater Community Bancorp on July 1, 2008 and lower interest expense on deposits. Adjusting for a five percent stock dividend issued May 22, 2009, fully diluted earnings per common share were $0.06 for the second quarter of 2009 as compared to $0.31 per share for the second quarter of 2008. Accrued preferred dividends and accretion of the discount on preferred stock issued by Valley in November 2008 to the U.S. Treasury reduced fully diluted earnings per common share by $0.04 for the three months ended June 30, 2009. All common share data presented in this report was adjusted to reflect the stock dividend.

Mindful of the current recession and the low level of our loan delinquencies and losses relative to other financial institutions, management believes that our credit quality remains good. Our performance ratios for the second quarter of 2009 do reflect the negative impact of the current financial crisis as total loans past due in excess of 30 days increased 0.15 percent to 1.49 percent of our total loan portfolio of $9.6 billion as of June 30, 2009 compared to 1.34 percent of total loans at March 31, 2009. Valley’s non-accrual loans increased $10.3 million to $57.7 million, or 0.60 percent of total loans at June 30, 2009 as compared to $47.4 million, or 0.48 percent of total loans at March 31, 2009. The increase was mainly due to three commercial mortgage loan relationships and one commercial loan being moved to non-accrual status. In general, our non-accrual loans are well secured and, as a result, we do not expect potential losses on such loans to be near their current outstanding levels. Our focus is to maintain superior credit quality through a time-tested underwriting approach; however, due to the potential for further credit deterioration caused by a prolonged recession, management cannot predict that our loan portfolio will continue to perform at levels experienced during the three months ended June 30, 2009. See “Non-performing Assets” section at page 57 for further analysis of our credit quality.

 

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We extended over $450 million in new credits during the second quarter of 2009 despite a decline of 8.9 percent on an annualized basis in our overall loan portfolio mainly due to management’s decision to sell most refinanced and new residential mortgage loan originations in the secondary market, as well as continued declines in our automobile portfolio caused by the lack of consumer demand and our strict underwriting standards. Our deposit mix changed during the second quarter of 2009 as non-interest bearing deposits and low cost savings, NOW, and money market accounts increased to approximately 66 percent of our total deposits at June 30, 2009 from 61 percent at March 31, 2009. The increase was primarily due to higher customer balances that may be reflective of the surge in the U.S. household savings rate caused in part by the recession and branch efforts to attract such deposits, as well as the decline in high cost time deposits as management chose to be less competitive on interest rates in order to retain maturing certificates of deposit. Management continues to actively manage interest rate risk on the balance sheet for the long-term as it used much of its excess liquidity from the reduction in the loan portfolio to offset maturing high cost short-term FHLB advances and certificates of deposit. Management may continue to allow the size of the balance sheet to contract based on, among other things, the current level of interest rates, the sale of residential mortgage loans and the decline in the automobile portfolio, as well as our ability to attract and maintain quality loan relationships in the current economic recession.

Management continues to assess the expected impact of the recession on our operations and our ability to maintain a well-capitalized position. Based on such an assessment, in the beginning of June 2009, we repurchased from the U.S. Department of the Treasury 75,000 out of the 300,000 shares of our Series A Fixed Rate Cumulative Perpetual Preferred Stock that were issued to the Treasury on November 14, 2008 under the Capital Purchase Program. The aggregate purchase price for the repurchased preferred shares was approximately $75.2 million (including accrued and unpaid dividends) and resulted in an accelerated accretion charge of $1.9 million to retained earnings in the second quarter of 2009 based on the difference between the par value of $75 million and the carrying value of $73.1 million. The reduction in our preferred shares should increase net income available to common stockholders in future periods as preferred dividends payable will decline. Management will continue to assess the changes in the economic environment, our credit risk, capital position, and other factors prior to any future redemption requests.

Additionally, we entered into an equity distribution agreement during June 2009 to sell from time to time up to 5.67 million shares of our no par value common stock. Sales of the newly issued shares are made through ordinary brokers’ transactions on the New York Stock Exchange at market prices prevailing at the time of sale or as otherwise agreed by us and the sales agent. Under the agreement, we issued approximately 43 thousand shares at a weighted average price of $12.29, excluding transaction fees, during June 2009. During the third quarter, we issued an additional 1.9 million shares (including unsettled trades) at a weighted average price of approximately $13.08, excluding transaction fees, through August 6, 2009 under this agreement. Net proceeds raised from the shares issued under the agreement may be used to redeem additional amounts of our preferred stock held by the Treasury.

For the three months ended June 30, 2009, we reported an annualized return on average shareholders’ equity (“ROE”) of 4.41 percent and an annualized return on average assets (“ROA”) of 0.42 percent which includes intangible assets. Our annualized return on average tangible shareholders’ equity (“ROATE”) was 5.77 percent for the second quarter of 2009. The comparable ratios for the second quarter of 2008 were an annualized ROE of 17.20 percent, an annualized ROA of 1.28 percent, and an annualized ROATE of 21.76 percent. All of the above ratios were impacted by the change in fair value of our junior subordinated debentures carried at fair value. Net income included a non-cash charge of $24.4 million ($15.9 million after-taxes) for the second quarter of 2009 compared to a non-cash gain of $2.0 million ($1.3 million after-taxes) for the same period of 2008 due to the change in fair value of the debentures.

 

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

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2009     2008     2009     2008  
     ($ in thousands)  

Net income

   $ 14,997      $ 41,483      $ 52,381      $ 73,066   
                                

Average shareholders’ equity

     1,359,500        964,914        1,363,352        959,077   

Less: Average goodwill and other intangible assets

     (320,434     (202,410     (320,534     (203,104
                                

Average tangible shareholders’ equity

   $ 1,039,066      $ 762,504      $ 1,042,818      $ 755,973   
                                

Annualized ROATE

     5.77     21.76     10.05     19.33
                                

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

Net Interest Income

Net interest income on a tax equivalent basis increased $10.5 million or 10.1 percent to $114.4 million for the second quarter of 2009 compared to the same quarter of 2008. The increase from the second quarter of 2008 was mainly a result of a $5.6 million or 35 basis point decline in funding costs on average interest bearing liabilities and a $873.3 million increase in average loans, partially offset by a 33 basis point decline in the yield on average interest earning assets and a $478.1 million increase in average interest bearing liabilities. Both the declines in cost and yield resulted mainly from a decrease in short-term interest rates as the average target federal funds rate decreased approximately 208 basis points for the second quarter of 2009 compared to the same period in 2008. Average loan and deposit balances grew as compared to the three months ended June 30, 2008 mainly due to the acquisition of Greater Community on July 1, 2008.

For the second quarter of 2009, average loans and average federal funds sold and other interest bearing deposits increased $873.3 million and $237.6 million, respectively, while average investment securities decreased $63.6 million, each as compared to the second quarter of 2008. Compared to the first quarter of 2009, average loans decreased by $244.8 million primarily due to decreases in the residential mortgage and automobile loan portfolios. The decline in both loan portfolios continued during the second quarter of 2009 as expected by management. The decrease in residential mortgage loans was due to the sale of most refinanced loans and new loan originations in the secondary market based on the current level of interest rates and management strategies for balance sheet credit and interest rate risk. Our automobile loan portfolio has declined for four consecutive quarters mainly due to the slowdown in new and used car sales, as well as our strict underwriting standards in light of current economic conditions.

Average interest bearing liabilities for the quarter ended June 30, 2009 increased $478.1 million or 4.8 percent compared with the same quarter of 2008. Compared to the first quarter of 2009, average interest bearing liabilities decreased $337.5 million or 3.1 percent. Average total interest bearing deposits decreased $106.3 million or 1.5 percent from the first quarter of 2009 mainly due to a decrease in higher cost average time deposits partially offset by an increase in lower cost average savings, NOW, and money market deposits and average non-interest bearing deposits. Average time deposits declined 6.6 percent during the second quarter as management chose to be less competitive on interest rates to retain certificates of deposit due to growth in the other deposit categories and less funding needs as loan volumes declined during the period. The increases in both average non-interest bearing and average savings, NOW, and money market deposits were mainly due to higher customer balances caused in part by focused branch sales efforts and may be reflective of the surge in the

 

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U.S. household savings rate caused in part by the economic recession. Average short-term borrowings decreased $236.5 million or 52.0 percent from the linked quarter due to $200 million in short-term FHLB advances that matured between February and March of 2009 and $100 million that matured in April 2009. Short-term borrowings, primarily consisting of customer repo account balances, did not include FHLB advances at June 30, 2009.

Interest on loans, on a tax equivalent basis, decreased $2.5 million or 1.7 percent for the second quarter of 2009 compared to the first quarter of 2009 due to the aforementioned decline in average loan balances, partially offset by a 4 basis point increase in the tax equivalent yield on average loans as compared to the linked quarter. Interest from investments, on a tax equivalent basis, increased $238 thousand for the three months ended June 30, 2009 compared to the quarter ended March 31, 2009 mainly due to a 6 basis point increase in the tax equivalent yield, partially offset by lower average balances.

Interest expense for the three months ended June 30, 2009 decreased $5.8 million or 7.9 percent compared to the quarter ended March 31, 2009 resulting mainly from a decrease in average time deposits caused by maturing high cost certificates of deposit coupled with a decrease in average short-term FHLB advances.

The net interest margin on a tax equivalent basis was 3.52 percent for the second quarter of 2009, an increase of 17 basis points from 3.35 percent for the linked quarter ended March 31, 2009 and increased 4 basis points as compared to the second quarter of 2008. The increase from the linked quarter was largely the result of a continued decline in our cost of funds and a decline in average interest earning assets caused by lower loan volume and loan sales, as well as a decrease in the cost of average short term borrowings. The yield on average interest earning assets increased by 5 basis points on a linked quarter basis mainly due to a 4 basis point increase in yield on average loans as compared to the three months ended March 31, 2009.

 

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The following table reflects the components of net interest income for the three months ended June 30, 2009, March 31, 2009 and June 30, 2008:

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

Net Interest Income on a Tax Equivalent Basis

 

    Three Months Ended  
    June 30, 2009     March 31, 2009     June 30, 2008  
    Average
Balance
    Interest     Average
Rate
    Average
Balance
    Interest     Average
Rate
    Average
Balance
    Interest     Average
Rate
 
    ($ in thousands)  

Assets

                 

Interest earning assets:

                 

Loans (1)(2)

  $ 9,770,280      $ 141,361      5.79   $ 10,015,090      $ 143,859      5.75   $ 8,897,004      $ 134,619      6.05

Taxable investments (3)

    2,651,711        36,856      5.56        2,663,019        36,618      5.50        2,723,835        38,410      5.64   

Tax-exempt investments (1)(3)

    253,104        3,676      5.81        245,791        3,649      5.94        244,551        3,800      6.22   

Federal funds sold and other interest bearing deposits

    312,755        218      0.28        331,091        230      0.28        75,138        406      2.16   
                                                                 

Total interest earning assets

    12,987,850        182,111      5.61        13,254,991        184,356      5.56        11,940,528        177,235      5.94   
                                               

Allowance for loan losses

    (97,883         (94,487         (73,258    

Cash and due from banks

    240,571            245,636            212,584       

Other assets

    1,111,167            1,115,270            901,798       

Unrealized losses on securities available for sale, net

    (27,520         (50,150         (21,421    
                                   

Total assets

  $ 14,214,185          $ 14,471,260          $ 12,960,231       
                                   

Liabilities and shareholders’ equity Interest bearing liabilities:

                 

Savings, NOW and money market deposits

  $ 3,701,125      $ 5,796      0.63   $ 3,565,543      $ 5,887      0.66   $ 3,479,046      $ 11,155      1.28

Time deposits

    3,411,551        26,106      3.06        3,653,422        30,179      3.30        2,981,166        27,162      3.64   
                                                                 

Total interest bearing deposits

    7,112,676        31,902      1.79        7,218,965        36,066      2.00        6,460,212        38,317      2.37   

Short-term borrowings

    218,281        579      1.06        454,774        2,551      2.24        555,799        2,212      1.59   

Long-term borrowings (4)

    3,171,422        35,227      4.44        3,166,137        34,894      4.41        3,008,249        32,792      4.36   
                                                                 

Total interest bearing liabilities

    10,502,379        67,708      2.58        10,839,876        73,511      2.71        10,024,260        73,321      2.93   
                                               

Non-interest bearing deposits

    2,256,954            2,160,116            1,893,688       

Other liabilities

    95,352            104,021            77,369       

Shareholders’ equity

    1,359,500            1,367,247            964,914       
                                   

Total liabilities and shareholders’ equity

  $ 14,214,185          $ 14,471,260          $ 12,960,231       
                                   

Net interest income/interest rate spread (5)

    $ 114,403      3.03     $ 110,845      2.85     $ 103,914      3.01
                             

Tax equivalent adjustment

      (1,290         (1,281         (1,336  
                                   

Net interest income, as reported

    $ 113,113          $ 109,564          $ 102,578     
                                   

Net interest margin (6)

      3.48       3.31       3.44

Tax equivalent effect

      0.04          0.04          0.04   
                             

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

      3.52       3.35       3.48
                             

 

(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 trust which are presented separately on the consolidated statements 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 reflects the components of net interest income for the six months ended June 30, 2009 and 2008:

Analysis of Average Assets, Liabilities and Shareholders’ Equity and

Net Interest Income on a Tax Equivalent Basis

 

     Six Months Ended  
     June 30, 2009     June 30, 2008  
     Average
Balance
    Interest     Average
Rate
    Average
Balance
    Interest     Average
Rate
 
     ($ in thousands)  

Assets

            

Interest earning assets:

            

Loans (1)(2)

   $ 9,892,009      $ 285,220      5.77   $ 8,718,408      $ 270,257      6.20

Taxable investments (3)

     2,657,334        73,474      5.53        2,657,318        74,804      5.63   

Tax-exempt investments (1)(3)

     249,468        7,325      5.87        249,626        7,900      6.33   

Federal funds sold and other interest bearing deposits

     321,872        448      0.28        133,261        1,902      2.85   
                                            

Total interest earning assets

     13,120,683        366,467      5.59        11,758,613        354,863      6.04   
                                

Allowance for loan losses

     (96,194         (73,017    

Cash and due from banks

     243,090            212,090       

Other assets

     1,113,206            884,774       

Unrealized losses on securities available for sale, net

     (38,772         (11,117    
                        

Total assets

   $ 14,342,013          $ 12,771,343       
                        

Liabilities and shareholders’ equity

            

Interest bearing liabilities:

            

Savings, NOW and money market deposits

   $ 3,633,709      $ 11,683      0.64   $ 3,432,808      $ 25,220      1.47

Time deposits

     3,531,818        56,285      3.19        2,949,919        57,650      3.91   
                                            

Total interest bearing deposits

     7,165,527        67,968      1.90        6,382,727        82,870      2.60   

Short-term borrowings

     335,874        3,130      1.86        481,263        4,519      1.88   

Long-term borrowings (4)

     3,168,794        70,121      4.43        2,992,742        66,534      4.45   
                                            

Total interest bearing liabilities

     10,670,195        141,219      2.65        9,856,732        153,923      3.12   
                                

Non-interest bearing deposits

     2,208,803            1,884,956       

Other liabilities

     99,663            70,578       

Shareholders’ equity

     1,363,352            959,077       
                        

Total liabilities and shareholders’ equity

   $ 14,342,013          $ 12,771,343       
                        

Net interest income/interest rate spread (5)

     $ 225,248      2.94     $ 200,940      2.92
                    

Tax equivalent adjustment

       (2,571         (2,780  
                        

Net interest income, as reported

     $ 222,677          $ 198,160     
                        

Net interest margin (6)

       3.39       3.37

Tax equivalent effect

       0.04          0.05   
                    

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

       3.43       3.42
                    

 

(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 trust which are presented separately on the consolidated statements 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

 

     Three Months Ended
June 30, 2009
Compared with June 30, 2008
    Six Months Ended
June 30, 2009
Compared with June 30, 2008
 
     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 *

   $ 12,813      $ (6,071   $ 6,742      $ 34,707      $ (19,744   $ 14,963   

Taxable investments

     (1,008     (546     (1,554     —          (1,330     (1,330

Tax-exempt investments *

     130        (254     (124     (5     (570     (575

Federal funds sold and other interest bearing deposits

     407        (595     (188     1,208        (2,662     (1,454
                                                

Total increase (decrease) in interest income

     12,342        (7,466     4,876        35,910        (24,306     11,604   
                                                

Interest Expense:

            

Savings, NOW and money market deposits

     672        (6,031     (5,359     1,398        (14,935     (13,537

Time deposits

     3,624        (4,680     (1,056     10,288        (11,653     (1,365

Short-term borrowings

     (1,054     (579     (1,633     (1,355     (34     (1,389

Long-term borrowings and junior subordinated debentures

     1,804        631        2,435        3,897        (310     3,587   
                                                

Total increase (decrease) in interest expense

     5,046        (10,659     (5,613     14,228        (26,932     (12,704
                                                

Increase in net interest income

   $ 7,296      $ 3,193      $ 10,489      $ 21,682      $ 2,626      $ 24,308   
                                                

 

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

Non-Interest (Loss) Income

The following table presents the components of non-interest (loss) income for each of the three and six months ended June 30, 2009 and 2008:

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2009     2008     2009     2008  
     (in thousands)  

Trust and investment services

   $ 1,592      $ 1,744      $ 3,237      $ 3,512   

Insurance premiums

     2,577        2,264        5,570        5,636   

Service charges on deposit accounts

     6,563        7,041        13,200        13,622   

Gains on securities transactions, net

     288        425        251        924   

Net impairment losses on securities recognized in earnings

     (2,434     (1,383     (4,605     (1,737

Trading losses, net

     (18,631     (301     (5,412     (3,492

Fees from loan servicing

     1,193        1,195        2,369        2,447   

Gains on sales of loans, net

     2,432        391        4,576        724   

Gains (losses) on sales of assets, net

     175        (8     349        85   

Bank owned life insurance (“BOLI”)

     1,397        2,905        2,768        6,145   

Other

     4,459        3,681        8,293        9,315   
                                

Total non-interest (loss) income

   $ (389   $ 17,954      $ 30,596      $ 37,181   
                                

Non-interest income for the second quarter of 2009 decreased $18.3 million to a non-interest loss of $389 thousand as compared to non-interest income of approximately $18.0 million for the quarter ended June 30, 2008 mainly due to net trading losses of $18.6 million in the second quarter of 2009.

 

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Net impairment losses on securities increased $1.1 million and $2.9 million, respectively for the three and six months ended June 30, 2009 compared to the same periods of 2008. The three and six months ended June 30, 2009, includes other-than-temporary impairment charges for additional estimated credit losses on four private label mortgage-backed securities (three of the four securities were originally deemed to be other-than-temporarily impaired in the first quarter of 2009 and one security was originally impaired in the fourth quarter of 2008). The three months ended June 30, 2008 included other-than-temporary impairment charges on equity securities issued by two financial institutions and one Freddie Mac perpetual preferred security. The six months ended June 30, 2008 includes total other-than-temporary impairment charges on four equity securities issued by banks and two Freddie Mac perpetual preferred securities.

Net trading losses increased $18.3 million and $1.9 million, respectively for the three and six months ended June 30, 2009 compared with the same periods in 2008 mainly due to non-cash losses of $24.4 million and $10.7 million, respectively for the three and six months ended June 30, 2009 compared to non-cash gains of $2.0 million and $264 thousand, respectively for the same periods in 2008 related to the change in the fair value of our junior subordinated debentures carried at fair value. These higher losses were partially offset by increased gains on the mark to market of trading securities and realized gains on sales of trading securities during the 2009 periods. The 2008 periods also included a $1.2 million loss realized on one fixed FHLB advance carried at fair value, which was redeemed prior to its contractual maturity date during the second quarter of 2008.

Net gains on sale of loans increased $2.0 million and $3.9 million, respectively, for the three and six months ended June 30, 2009, compared to the same periods in 2008 mainly due to the sale of approximately $175 million of residential mortgages originated in the first six months of 2009 and a mark to market gain on higher balances of loans held for sale at fair value as of June 30, 2009. Valley is currently selling most conforming refinanced and new residential mortgage loan originations in the secondary market due to the historically low level of current interest rates and continued concern about future credit deterioration. As of January 1, 2007, Valley elected to carry all of its loans held for sale at fair value under the fair value option provision of SFAS No. 159.

BOLI income decreased $1.5 million and $3.4 million, respectively for the three and six months ended June 30, 2009 compared with the same period of 2008, mainly due to the severe downturn in financial markets and its negative impact on the performance of the underlying investment securities of the BOLI asset.

Other non-interest income decreased $1.0 million for the six months ended June 30, 2009 compared with the same period in 2008 mainly due to a $1.6 million gain in the first quarter of 2008 resulting from the mandatory redemption of a portion of Valley’s Class B Visa (member bank) common stock as part of Visa Inc.’s initial public offering that occurred in March of 2008. Partially offsetting the decrease was a moderate increase in other income associated with the acquisition of Greater Community on July 1, 2008.

 

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Non-Interest Expense

The following table presents the components of non-interest expense for each of the three and six months ended June 30, 2009 and 2008:

 

     Three Months Ended
June 30,
   Six Months Ended
June 30,
     2009    2008    2009    2008
     (in thousands)

Salary expense

   $ 31,397    $ 30,138    $ 63,844    $ 60,301

Employee benefit expense

     7,938      6,897      17,208      15,852

Net occupancy and equipment expense

     14,344      12,775      29,895      26,256

FDIC insurance assessment

     10,279      231      13,431      475

Amortization of other intangible assets

     1,011      1,402      3,827      3,148

Professional and legal fees

     2,147      1,897      4,239      4,186

Advertising

     322      341      1,167      717

Other

     10,668      10,278      21,441      20,502
                           

Total non-interest expense

   $ 78,106    $ 63,959    $ 155,052    $ 131,437
                           

Non-interest expense increased approximately $14.1 million, or 22.1 percent for the three months ended June 30, 2009 compared to the same period in 2008 and increased $23.6 million, or 18.0 percent for the six months ended June 30, 2009 compared with the same period in 2008. The increase was mainly due to an increase in the FDIC insurance assessment and Valley’s acquisition of Greater Community and its 16 full-service branches on July 1, 2008, as well as 5 de novo branches opened since June 30, 2008.

The efficiency ratio measures total non-interest expense as a percentage of net interest income plus total non-interest income. Our efficiency ratio was 69.29 percent and 61.22 percent for the three and six months ended June 30, 2009, respectively, compared with 53.06 percent and 55.85 percent for the same periods in 2008. For the three and six month period, the increase in the efficiency ratio is primarily due to lower non-interest income in 2009 compared to 2008 mainly attributable to an $18.3 million increase in net trading losses during the second quarter of 2009, and an increase in the FDIC insurance assessment, partially offset by an increase in net interest income. We strive to maintain a low efficiency ratio through diligent management of our operating expenses and balance sheet. However, 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 $2.3 million, or 6.2 percent for the three months ended June 30, 2009 compared with the same period in 2008 and increased a combined $4.9 million, or 6.4 percent for the six months ended June 30, 2009 compared with the same period in 2008. The increases in the three and six month periods are mainly due to additional operating expenses related to the acquired Greater Community branches and the de novo branches opened during the last twelve months, including increases in payroll taxes, health care insurance and pension costs, partially offset by a decrease in stock-based incentive compensation.

Net occupancy and equipment expense increased $1.6 million, or 12.3 percent for the three months ended June 30, 2009 compared with the same period in 2008 and increased $3.6 million, or 13.9 percent for the six months ended June 30, 2009 compared with the same period in 2008. The increase is largely due to the addition of 16 full-service branches from the acquisition of Greater Community, as well as 5 de novo branches since June 30, 2008.

The FDIC insurance assessment increased $10.0 million for the three months ended June 30, 2009 compared with the same period in 2008 and increased $13.0 million for the six months June 30, 2009 compared with the same period in 2008. The majority of the increases are due to a second quarter 2009 five basis point special assessment (imposed on all insured depository institutions based on total assets minus Tier 1 capital as of June

 

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30, 2009) which totaled $6.5 million for Valley. The FDIC insurance assessment also increased for the 2009 periods due to the depletion of our prior period FDIC acquisition credits during the first quarter of 2009, higher normal assessment rates and our election to participate in the FDIC’s Temporary Liquidity Guarantee Program.

Income Taxes

Income tax expense was $6.6 million for the three months ended June 30, 2009, reflecting an effective tax rate of 30.4 percent, compared with $9.3 million for the same period of 2008, reflecting an effective tax rate of 18.3 percent. The increase compared to the prior comparable quarter was primarily due to lower tax advantaged income (caused by a reduction in BOLI income, and a decrease in non-taxable income and dividends from investment securities), increased state tax expense and a $6.5 million reduction in Valley’s deferred tax asset valuation allowance in the second quarter of 2008.

Income tax expense was $22.8 million for the six months ended June 30, 2009 compared with $21.0 million for the same period in 2008, reflecting effective tax rates of 30.3 percent and 22.4 percent, respectively. The increase was mainly due to lower tax advantaged income, higher state tax expense, and the reduction of Valley’s deferred tax asset valuation allowance in the second quarter of 2008.

Management expects that Valley’s adherence to FIN 48 will continue to result in increased volatility in Valley’s 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 management’s judgment include changes in income, tax laws and regulations, and tax planning strategies. For the remainder of 2009, Valley anticipates that its effective tax rate will approximate 30.0 percent.

Business Segments

We have four business segments that we monitor and report on to manage our business operations. These segments are consumer lending, commercial lending, investment management, and corporate and other adjustments. 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 (if events or circumstances indicate a possible inability to realize the carrying amount). Expenses related to the branch network, all other components of retail banking, along with the back office departments of our subsidiary bank are allocated from the corporate and other adjustments segment to each of the other three business segments. Interest expense and internal transfer expense (for general corporate expenses) are allocated to each business segment utilizing a “pool funding” methodology, whereas each segment is allocated a uniform funding cost based on each segments’ average earning assets outstanding for the period. The 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 internal accounting policies designed to measure consistent and reasonable financial reporting, and may not necessarily conform to GAAP.

 

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The following tables present the financial data for the three months ended June 30, 2009 and 2008:

 

     Three Months Ended June 30, 2009  
     Consumer
Lending
    Commercial
Lending
    Investment
Management
    Corporate
and Other
Adjustments
    Total  
     ($ in thousands)  

Average interest earning assets

   $ 3,844,580      $ 5,925,700      $ 3,217,570      $ —        $ 12,987,850   

Income (loss) before income taxes

     16,828        16,703        15,532        (27,509     21,554   

Annualized return on average interest earning assets (pre-tax)

     1.75     1.13     1.93     N/A        0.66

 

N/A - not applicable

  

     Three Months Ended June 30, 2008  
     Consumer
Lending
    Commercial
Lending
    Investment
Management
    Corporate
and Other
Adjustments
    Total  
     ($ in thousands)  

Average interest earning assets

   $ 4,189,681      $ 4,707,323      $ 3,043,524      $ —        $ 11,940,528   

Income (loss) before income taxes

     15,750        19,990        20,175        (5,142     50,773   

Annualized return on average interest earning assets (pre-tax)

     1.50     1.70     2.65     N/A        1.70

 

N/A - not applicable

  

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.

For the three months ended June 30, 2009, income before income taxes increased $1.1 million to $16.8 million, compared with the three months ended June 30, 2008. The return on average interest earning assets before income taxes increased to 1.75 percent compared with 1.50 percent for the prior year period. The increase was primarily due to a higher non-interest income and lower internal transfer expense, partially offset by a decrease in net interest income and a higher provision for loan losses. Non-interest income increased $3.3 million to $12.4 million when compared to $9.1 million for the same period last year primarily as a result of an increase in the net gains on sales of loans, as Valley elected to continue to sell most conforming refinanced and new residential mortgage loan originations (priced at the current low level of interest rates) in the secondary market during the 2009 period. Net interest income decreased $2.1 million to $35.8 million when compared to $37.9 million for the same period last year, primarily as a result of a $7.7 million decrease in interest income partially offset by a $5.6 million decrease in interest expense. The average yield on loans decreased 27 basis points to 5.66 percent, while the interest expense associated with funding sources decreased 37 basis points to 1.94 percent.

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 portfolio’s interest rate characteristics, commercial lending is Valley’s most sensitive business segment to movements in market interest rates.

 

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During the last twelve months, the Federal Reserve has incrementally decreased the target federal funds rate three times, to a historical low of between zero and 25 basis points, causing the average federal funds rate to decline by approximately 208 basis points for the second quarter of 2009 as compared to the same quarter of 2008. Many of our earning assets in the commercial lending segment are priced based on Valley’s prime rate (set by Valley management based on various internal and external factors) or the New York prime rate. As a result of the 2008 Federal Reserve rate cuts, Valley’s prime rate has moved from 5.00 percent at June 30, 2008 to 4.50 percent at June 30, 2009 while the New York prime rate dropped even further to 3.25 percent at the end of the second quarter of 2009 from 5.00 percent at June 30, 2008. Beginning in the fourth quarter of 2008, we started to actively implement interest rate floors within the loan terms of many of our new and renewed prime based loans to help stabilize our net interest income.

For the three months ended June 30, 2009, income before income taxes decreased $3.3 million to $16.7 million compared with the three months ended June 30, 2008, primarily due to increases in the provision for loan losses and internal transfer expense, partially offset by an increase in net interest income. The return on average interest earning assets before income taxes was 1.13 percent compared with 1.70 percent for the prior year period. The increase in net interest income was primarily due to average loans increasing $1.2 billion to $5.9 billion due to the acquisition of Greater Community in the third quarter of 2008 and solid organic loan growth during the 2008 period. Partially offsetting the increase was a 27 basis point decrease in the yield on average loans mainly caused by the decline in short-term market interest rates. The cost associated with our funding sources decreased 37 basis points to 1.94 percent for the three months ended June 30, 2009.

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 and interest-bearing deposits with banks (primarily the Federal Reserve Bank of New York). The fixed rate investments are one of Valley’s least sensitive assets to changes in market interest rates. However, as we continue to shift the composition of the investment portfolio to shorter-duration securities, the sensitivity to market interest rate will increase. 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.

For the three months ended June 30, 2009, income before income taxes decreased $4.6 million to $15.5 million compared with the three months ended June 30, 2008, primarily due to an increase in internal transfer expense and a decrease in non-interest income, partially offset by a slight increase in net interest income. Average investments increased $174.0 million to $3.2 billion at June 30, 2009. The return on average interest earning assets before income taxes decreased to 1.93 percent compared with 2.65 percent for the prior year period. The average yield on investments decreased 52 basis points to 5.31 percent and the rate associated with funding sources decreased 37 basis points to 1.94 percent.

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, the change in fair value of Valley’s junior subordinated debentures carried at fair value, 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 $27.5 million for the three months ended June 30, 2009 when compared with a $5.1 million loss for the three months ended June 30, 2008. The increase was due to a decrease in non-interest income and an increase in non-interest expense, partially offset by an increase in internal transfer income. The decrease in non-interest income is primarily due to a $24.4 million non-cash charge for the three months ended June 30, 2009 related to the change in the fair value of our junior subordinated debentures. Non-interest expense increased $13.0 million mainly due to a $10.0 million increase in the FDIC insurance assessment that was partially the result of an industry-wide special assessment in the second quarter of 2009.

 

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The following tables present the financial data for our four segments for the six months ended June 30, 2009 and 2008:

 

     Six Months Ended June 30, 2009  
     Consumer
Lending
    Commercial
Lending
    Investment
Management
    Corporate
and Other
Adjustments
    Total  
     ($ in thousands)  

Average interest earning assets

   $ 3,962,303      $ 5,929,706      $ 3,228,674      $ —        $ 13,120,683   

Income (loss) before income taxes

     30,887        37,128        30,386        (23,225     75,176   

Annualized return on average interest earning assets (pre-tax)

     1.56     1.25     1.88     N/A        1.15

 

N/A - not applicable

  

     Six Months Ended June 30, 2008  
     Consumer
Lending
    Commercial
Lending
    Investment
Management
    Corporate
and Other
Adjustments
    Total  
     ($ in thousands)  

Average interest earning assets

   $ 4,124,679      $ 4,593,729      $ 3,040,205      $ —        $ 11,758,613   

Income (loss) before income taxes

     32,404        39,415        36,539        (14,254     94,104   

Annualized return on average interest earning assets (pre-tax)

     1.57     1.72     2.40     N/A        1.60

 

N/A - not applicable

  

Consumer Lending

For the six months ended June 30, 2009, income before income taxes decreased $1.5 million to $30.9 million, compared with the six months ended June 30, 2008 primarily as a result of higher provision for loan losses, partially offset by an increase in non-interest income. The increase in non-interest income is mainly due to the sale of approximately $175 million of residential mortgages originated in the first six months of 2009 as part of management’s asset/liability management strategies due to the low level of current interest rates. Net interest income remained relatively flat at $72.2 million compared to $72.3 million for the six months ended June 30, 2008 as a result of a $162.4 million decrease in average loans and 32 basis point decrease in interest yield on average loans was partially offset by a 46 basis point decrease in the cost of funds.

Commercial Lending

For the six months ended June 30, 2009, income before income taxes decreased $2.3 million to $37.1 million compared with the same period of 2008, primarily due to higher provision for loan losses and internal transfer expense, partially offset by an increase in net interest income. The $23.1 million increase in net interest income was primarily a result of a $1.3 billion increase in average interest earning assets and a 46 basis point reduction in funding costs, partially offset by a 53 basis point reduction in interest yield on average loans. The return on average interest earning assets before income taxes was 1.25 percent compared with 1.72 percent for the prior year period due to the decline in short-term rates.

Investment Management

For the six months ended June 30, 2009, income before income taxes decreased $6.2 million to $30.4 million compared with the same period of 2008, primarily due to an increase in internal transfer expense and a decrease in non-interest income and, partially offset by an increase in net interest income. Average interest earning

 

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assets increased $188.5 million to $3.2 billion for the six months ended June 30, 2009. The return on average interest earning assets before income taxes decreased to 1.88 percent compared with 2.40 percent for the prior year period. The yield on average investments, which includes federal funds sold, decreased 53 basis points to 5.28 percent and the costs associated with funding sources decreased 46 basis points to 2.01 percent.

Corporate Segment

The loss before income taxes for the corporate segment increased $9.0 million to a loss of $23.2 million for the six months ended June 30, 2009 when compared with a loss of $14.2 million for the six months ended June 30, 2008, primarily due to a decrease in non-interest income and an increase in non-interest expense, partially offset by an increase in internal transfer income. The decrease in non-interest income is primarily due to a $10.7 million loss recorded for the three months ended June 30, 2009 related to a non-cash charge on the change in the fair value of our junior subordinated debentures. Non-interest expense increased $20.0 million during the 2009 period mainly due to a $13.0 million increase in the FDIC insurance assessment as well as general increased expenses related to the acquisition of Greater Community on July 1, 2008 and de novo branching costs since June 30, 2008.

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. Valley’s 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 management’s tolerance for exposure to income fluctuations. Many of the actions undertaken by management utilize fair value analysis and attempts to achieve consistent accounting and economic benefits for financial assets and their related funding sources. We have predominately focused on managing our interest rate risk by attempting to match the inherent risk of financial assets and liabilities. Specifically, management employs multiple risk management activities such as divestures (including sales of lower yielding residential mortgage originations), change in product pricing levels, change in desired maturity levels for new originations, change in balance sheet composition levels as well as several other risk management activities.

We use a simulation model to analyze net interest income sensitivity to movements in interest rates. The simulation model projects net interest income based on various interest rate scenarios over a twelve and twenty-four month period. The model is based on the actual maturity and re-pricing characteristics of rate sensitive assets and liabilities. The model incorporates certain assumptions which management believes to be reasonable regarding the impact of changing interest rates and the prepayment assumptions of certain assets and liabilities as of June 30, 2009. The model assumes changes in interest rates without any proactive change in the composition or size of the balance sheet by management. In the model, the forecasted shape of the yield curve remains static as of June 30, 2009. The impact of interest rate derivatives, such as interest rate swaps and caps, is also included in the model.

Our simulation model is based on market interest rates and prepayment speeds prevalent in the market as of June 30, 2009. Although the size of Valley’s balance sheet is forecasted to remain constant as of June 30, 2009, the composition is adjusted to reflect new interest earning assets and interest bearing liability originations and rate spreads utilizing our actual originations during the second quarter of 2009. The model utilizes an immediate parallel shift in the market interest rates at June 30, 2009.

 

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The following table reflects management’s expectations of the change in our net interest income over a one-year period in light of the aforementioned assumptions:

 

     Change in Net Interest
Income Over One Year

Horizon
At June 30, 2009
 

Immediate Changes in Levels of Interest Rates

   Dollar
Change
    Percentage
Change
 
     ($ in thousands)  

+3.00%

   $ 5,467      1.14

+2.00

     4,052      0.85   

+1.00

     (2,634   (0.55

(1.00)

     (24,079   (5.04

As noted in the table above, we are 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 June 30, 2009 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 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.

Liquidity

Bank Liquidity. Liquidity measures the ability to satisfy current and future cash flow needs as they become due. A bank’s liquidity reflects its ability to meet loan demand, to accommodate possible outflows in deposits and to take advantage of interest rate opportunities in the marketplace. Liquidity management is monitored by management’s 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 June 30, 2009, 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. These liquid assets totaled approximately $1.8 billion and $2.1 billion at June 30, 2009 and December 31, 2008, respectively, representing 14.0 percent and 16.4 percent of earning assets, and 12.5 percent and 14.2 percent of total assets at June 30, 2009 and December 31, 2008, respectively. Of the $1.8 billion of liquid assets at June 30, 2009, approximately $1.1 billion of various investment securities were pledged to counterparties to support our earning asset funding strategies.

 

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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 $3.9 billion over the next twelve months. As a contingency plan for significant funding needs, liquidity could also be derived from the sale of existing 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 $7.9 billion for the second quarter of 2009 and $7.4 billion for the year ended December 31, 2008, representing 60.8 percent and 59.7 percent of average earning assets at June 30, 2009 and December 31, 2008, 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.

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 June 30, 2009, 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 residential 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. During the second quarter of 2009, we expanded our ability to borrow from the discount window to over $400 million at June 30, 2009, from approximately $150 million at March 31, 2009, as we provided additional collateral loans consisting primarily of automobile loans.

We have access to a variety of short-term and long-term borrowing sources to support our asset base. Short-term borrowings may include from time to time federal funds purchased, repos, treasury tax and loan accounts, and FHLB advances. Short-term borrowings decreased approximately $447.0 million to $193.3 million at June 30, 2009 compared to $640.3 million at December 31, 2008 primarily due to the maturity of $300.0 million in short-term FHLB advances and a $155.4 million decrease in customer repos due to a migration of funds to non-interest bearing and money market deposits. At June 30, 2009, all short-term repos represent customer deposit balances being swept into this vehicle overnight.

Corporation Liquidity. Valley’s recurring cash requirements primarily consist of dividends to preferred and common shareholders and interest expense on junior subordinated debentures issued to capital trusts. 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 “Capital Adequacy” section below regarding restrictions to such subsidiary bank dividends. Projected cash flows from these sources are expected to be adequate to pay preferred and common dividends, if declared, and interest expense payable to capital trusts, given the current capital levels and current profitable operations of the bank 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) in the open market, 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 Valley’s 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 the 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 Treasury’s consent will be required for any increase in our dividends paid to common stockholders (above a quarterly dividend of $0.19 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.

 

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On June 3, 2009, we repurchased 75,000 out of our 300,000 senior preferred shares from the Treasury. The aggregate purchase price for the repurchased preferred shares was approximately $75.2 million (including accrued and unpaid dividends). The repayment was made with available cash held at the holding company, and did not require additional cash dividends from our subsidiary bank.

Investment Securities Portfolio

As of June 30, 2009, we had approximately $1.6 billion and $1.3 billion in held to maturity and available for sale investment securities, respectively. We may be required to record impairment charges on our investment securities if they suffer a decline in value that is considered other-than-temporary. Numerous factors, including lack of liquidity for re-sales of certain investment securities, absence of reliable pricing information for investment securities, adverse changes in business climate, adverse actions by regulators, or unanticipated changes in the competitive environment could have a negative effect on our investment portfolio and may result in other-than-temporary impairment on certain investment securities in future periods. Our investment portfolio includes private label mortgage-backed securities, trust preferred securities principally issued by bank holding companies (“bank issuers”) (including three pooled securities), perpetual preferred securities issued by banks, and bank issued corporate bonds. These investments may pose a higher risk of future impairment charges by us as a result of the current downturn in the U.S. economy and its potential negative effect on the future performance of these bank issuers and/or the underlying mortgage loan collateral. In addition, the majority of the bank issuers of trust preferred securities within our investment portfolio are participants in the Treasury’s TARP Capital Purchase Program. For TARP participants, dividend payments to trust preferred security holders are currently senior to and payable before dividends can be paid on the preferred stock issued under the Capital Purchase Program. Based on recent stress tests and potential recommendations by the U.S. Government and the banking regulators, some bank trust preferred issuers may elect to defer future payments of interest on such securities. Such elections by issuers of securities within our investment portfolio could adversely affect securities valuations and result in future impairment charges if collection of deferred and accrued interest (or principal upon maturity) is deemed unlikely by management.

Other-Than-Temporary Impairment Analysis. Management evaluates the held to maturity and available for sale investment securities portfolios quarterly for other-than-temporary impairment under the provisions of FSP FAS 115-2 adopted effective January 1, 2009 (see more details at Note 6 and 8). Other-than-temporary impairment means we believe the security’s impairment is due to factors that could include its inability to pay interest or dividends, its potential for default, and/or other factors. When a held to maturity or available for sale debt security is assessed for other-than-temporary impairment, we have to first consider (a) whether we intend to sell the security, and (b) whether it is more likely than not that we will be required to sell the security prior to recovery of its amortized cost basis. If one of these circumstances apply to a security, an other-than-temporary impairment loss is recognized in the statement of income equal to the full amount of the decline in fair value below amortized cost. If neither of these circumstances apply to a security, but we do not expect to recover the entire amortized cost basis, an other-than-temporary impairment loss has occurred that must be separated into two categories: (a) the amount related to credit loss, and (b) the amount related to other factors. In assessing the level of other-than-temporary impairment attributable to credit loss, we compare the present value of cash flows expected to be collected with the amortized cost basis of the security. The portion of the total other-than-temporary impairment related to credit loss is recognized in earnings, while the amount related to other factors is recognized in other comprehensive income. The total other-than-temporary impairment loss is presented in the statement of income, less the portion recognized in other comprehensive income. When a debt security becomes other-than-temporarily impaired, its amortized cost basis is reduced to reflect the portion of the total impairment related to credit loss.

To determine whether a security’s impairment is other-than-temporary, 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.

 

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Our ability and intent to hold equity security investments until they recover in value, mature, or are called.

 

   

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

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, we believe 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 June 30, 2009:

 

     June 30, 2009
     Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
    Fair Value
     (in thousands)

Held to maturity:

          

Investment grades*

          

AAA Rated

   $ 1,058,577    $ 11,761    $ (4,351   $ 1,065,987