ITEM 2.
|
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
|
The following is management's discussion and analysis of The First of Long Island Corporation’s financial condition and operating results during the periods included in the accompanying consolidated financial statements, and should be read in conjunction with such financial statements. The Corporation’s financial condition and operating results principally reflect those of its wholly-owned subsidiary, The First National Bank of Long Island, and subsidiaries wholly-owned by the Bank, either directly or indirectly, FNY Service Corp., The First of Long Island REIT, Inc. and The First of Long Island Agency, Inc. The consolidated entity is referred to as the “Corporation” and the Bank and its subsidiaries are collectively referred to as the “Bank.” Although the Bank’s primary service area is Nassau and Suffolk Counties, Long Island, it does have two commercial banking branches in Manhattan and two full service branches in Queens.
Overview
Net income and earnings per share for the first six months of 2016 were $15.1 million and $1.02, respectively, representing increases over the same period last year of 17.9% and 13.3%, respectively. Dividends per share increased 5.3%, from $.38 for the first six months of 2015 to $.40 for the current six-month period. Returns on average assets (ROA) and average equity (ROE) for the first half of 2016 were .94% and 11.16%, respectively, versus .92% and 10.83%, respectively, for the same period last year. Book value per share increased by 10.2% from $17.78 at year-end 2015 to $19.60 at the close of the current quarter. The credit quality of the Bank’s loan and securities portfolios remains excellent and the mortgage pipeline at quarter-end was strong at $170 million.
Analysis of Earnings – Six Month Periods
.
Net income for the first six months of 2016 was $15.1 million, an increase of $2.3 million, or 17.9%, over the same period last year. The increase is primarily attributable to an increase in net interest income of $5.7 million, or 15.6%, and a decrease in the provision for loan losses of $961,000. The impact of these items was partially offset by increases in noninterest expense, before debt extinguishment costs, of $3.4 million and income tax expense of $678,000 and a decrease in noninterest income, before securities gains, of $265,000.
The increase in net interest income was primarily driven by growth in average interest-earning assets of $423.3 million, or 15.6%. Average interest-earning assets grew mostly because of increases in the average balances of loans and nontaxable securities, partially offset by a decrease in the average balance of taxable securities. While most of the loan growth occurred in mortgage loans, commercial and industrial loans also grew partially because of the Bank’s small business credit scored loan initiative. The growth in loans and nontaxable securities was primarily funded by growth in the average balances of both noninterest-bearing checking deposits and interest-bearing deposits.
The decrease in the provision for loan losses for the current six month period versus the same period last year is largely due to lesser loan growth, the absence of an increase in specific reserves, a decrease in historical loss rates and net recoveries on loans previously charged off.
The increase in noninterest expense, before debt extinguishment costs, of $3.4 million is primarily attributable to increases in salaries, employee benefits expense, consulting expense, computer and telecommunications expense and marketing expense.
The $265,000 decrease in noninterest income, before securities gains, is primarily attributable to a decrease in real estate and sales tax refunds and decreases in Investment Management Division income and service charges on deposit accounts.
The $678,000 increase in income tax expense is attributable to higher pre-tax earnings in the current six-month period partially offset by additional New York State income tax benefits derived from the Corporation’s captive REIT.
Asset Quality.
The Bank’s allowance for loan losses to total loans decreased 3 basis points from 1.21% at year-end 2015 to 1.18% at June 30, 2016. The decrease is primarily due to improved economic conditions and a reduction in the historical loss component of the allowance for loan losses. The provision for loan losses was $392,000 and $1.4 million in the first six months of 2016 and 2015, respectively. The $392,000 provision in the first half of 2016 is primarily attributable to loan growth partially offset by improved economic conditions and the aforementioned reduction in historical losses. The $1.4 million provision in the first half of 2015 was primarily attributable to loan growth and the establishment of a $332,000 specific reserve on one loan deemed to be impaired, partially offset by improved economic conditions.
The credit quality of the Bank’s loan portfolio remains excellent. Nonaccrual loans amounted to $5.1 million, or .22% of total loans outstanding, at June 30, 2016, compared to $1.4 million, or .06%, at December 31, 2015. The increase in nonaccrual loans is primarily attributable to two related mortgage loans transferred to nonaccrual status, partially offset by loan sales and paydowns. These two mortgage loans are current on principal and interest payments and, based on new appraisals, have loan-to-value ratios of less than 50%. Troubled debt restructurings were essentially unchanged during the first half of 2016 amounting to $4.4 million, or .19% of total loans outstanding at June 30, 2016. Of the troubled debt restructurings, $3.5 million are performing in accordance with their modified terms and $860,000 are nonaccrual and included in the aforementioned amount of nonaccrual loans. Loans past due 30 through 89 days amounted to $1.3 million, or .06% of total loans outstanding, at June 30, 2016, compared to $1.0 million, or .04%, at December 31, 2015.
The credit quality of the Bank’s securities portfolio also remains excellent. The Bank’s mortgage securities are backed by mortgages underwritten on conventional terms, with 57% of these securities being full faith and credit obligations of the U.S. government and the balance being obligations of U.S. government sponsored entities. The remainder of the Bank’s securities portfolio principally consists of high quality, general obligation municipal securities rated AA or better by major rating agencies. In selecting municipal securities for purchase, the Bank uses credit agency ratings for screening purposes only and then performs its own credit analysis. On an ongoing basis, the Bank periodically assesses the credit strength of the municipal securities in its portfolio and makes decisions to hold or sell based on such assessments.
Key Strategic Initiatives
.
Key strategic initiatives will continue to include loan and deposit growth through effective relationship management, targeted solicitation efforts, new product offerings and continued expansion of the Bank’s branch distribution system, particularly in the New York City boroughs of Queens and Brooklyn. With respect to loan growth, the Bank plans to continue to prudently manage concentration risk and further develop its broker and correspondent relationships. All loans originated through such relationships are underwritten by Bank personnel. The Bank’s branch distribution system currently consists of forty-four branches in Nassau and Suffolk Counties, Long Island and the boroughs of Queens and Manhattan. The Bank anticipates opening new branches in Bay Ridge, Brooklyn, College Point, Queens and East Islip, Long Island during the next twelve months and continues to evaluate sites for further branch expansion. In addition to loan and deposit growth, management is also focused on growing noninterest income from existing and potential new sources, which may include the acquisition of fee-based businesses.
Challenges We Face
.
The federal funds target rate increased by twenty-five basis points in December 2015. Further increases could exert upward pressure on non-maturity deposit rates. Intermediate and long-term interest rates are impacted by national and global forces and have been low and volatile for an extended period of time. They declined significantly since year-end 2015 and could remain low for the foreseeable future. This could cause investing and lending rates to be suboptimal. There is significant price competition for loans in the Bank’s marketplace and little room for the Bank to further reduce its deposit rates. These factors will make it difficult to improve net interest margin and could result in a decline in net interest margin from its current level and inhibit earnings growth for the foreseeable future.
The banking industry continues to be faced with new and complex regulatory requirements and enhanced supervisory oversight. Banking regulators are increasingly concerned about, among other things, growth, commercial real estate concentrations, underwriting of commercial real estate and commercial and industrial loans, capital levels and cyber security. These factors are exerting downward pressure on revenues and upward pressure on required capital levels and the cost of doing business.
Net Interest Income
Average Balance Sheet; Interest Rates and Interest Differential.
The following table sets forth the average daily balances for each major category of assets, liabilities and stockholders’ equity as well as the amounts and average rates earned or paid on each major category of interest-earning assets and interest-bearing liabilities. The average balances of investment securities include unrealized gains and losses on available-for-sale securities, and the average balances of loans include nonaccrual loans.
|
|
Six Months Ended June 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
Average
|
|
|
Interest/
|
|
|
Average
|
|
|
Average
|
|
|
Interest/
|
|
|
Average
|
|
|
|
Balance
|
|
|
Dividends
|
|
|
Rate
|
|
|
Balance
|
|
|
Dividends
|
|
|
Rate
|
|
|
|
(dollars in thousands)
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-earning bank balances
|
|
$
|
43,242
|
|
|
$
|
111
|
|
|
|
.52
|
%
|
|
$
|
20,662
|
|
|
$
|
25
|
|
|
|
.24
|
%
|
Investment securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taxable
|
|
|
345,785
|
|
|
|
3,799
|
|
|
|
2.20
|
|
|
|
372,462
|
|
|
|
4,217
|
|
|
|
2.26
|
|
Nontaxable
(1)
|
|
|
460,309
|
|
|
|
10,497
|
|
|
|
4.56
|
|
|
|
435,445
|
|
|
|
10,449
|
|
|
|
4.80
|
|
Loans (1)
|
|
|
2,287,335
|
|
|
|
40,062
|
|
|
|
3.50
|
|
|
|
1,884,834
|
|
|
|
33,699
|
|
|
|
3.58
|
|
Total interest-earning assets
|
|
|
3,136,671
|
|
|
|
54,469
|
|
|
|
3.47
|
|
|
|
2,713,403
|
|
|
|
48,390
|
|
|
|
3.57
|
|
Allowance for loan losses
|
|
|
(27,711
|
)
|
|
|
|
|
|
|
|
|
|
|
(23,704
|
)
|
|
|
|
|
|
|
|
|
Net interest-earning assets
|
|
|
3,108,960
|
|
|
|
|
|
|
|
|
|
|
|
2,689,699
|
|
|
|
|
|
|
|
|
|
Cash and due from banks
|
|
|
30,165
|
|
|
|
|
|
|
|
|
|
|
|
28,404
|
|
|
|
|
|
|
|
|
|
Premises and equipment, net
|
|
|
30,958
|
|
|
|
|
|
|
|
|
|
|
|
28,839
|
|
|
|
|
|
|
|
|
|
Other assets
|
|
|
58,558
|
|
|
|
|
|
|
|
|
|
|
|
59,065
|
|
|
|
|
|
|
|
|
|
|
|
$
|
3,228,641
|
|
|
|
|
|
|
|
|
|
|
$
|
2,806,007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and Stockholders' Equity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Savings, NOW and money market deposits
|
|
$
|
1,436,975
|
|
|
|
2,343
|
|
|
|
.33
|
|
|
$
|
1,097,823
|
|
|
|
1,150
|
|
|
|
.21
|
|
Time deposits
|
|
|
306,485
|
|
|
|
2,674
|
|
|
|
1.75
|
|
|
|
323,352
|
|
|
|
3,070
|
|
|
|
1.91
|
|
Total interest-bearing deposits
|
|
|
1,743,460
|
|
|
|
5,017
|
|
|
|
.58
|
|
|
|
1,421,175
|
|
|
|
4,220
|
|
|
|
.60
|
|
Short-term borrowings
|
|
|
53,690
|
|
|
|
131
|
|
|
|
.49
|
|
|
|
61,307
|
|
|
|
94
|
|
|
|
.31
|
|
Long-term debt
|
|
|
371,500
|
|
|
|
3,666
|
|
|
|
1.98
|
|
|
|
380,832
|
|
|
|
4,111
|
|
|
|
2.18
|
|
Total interest-bearing liabilities
|
|
|
2,168,650
|
|
|
|
8,814
|
|
|
|
.82
|
|
|
|
1,863,314
|
|
|
|
8,425
|
|
|
|
.91
|
|
Checking deposits
|
|
|
774,043
|
|
|
|
|
|
|
|
|
|
|
|
683,160
|
|
|
|
|
|
|
|
|
|
Other liabilities
|
|
|
14,707
|
|
|
|
|
|
|
|
|
|
|
|
22,020
|
|
|
|
|
|
|
|
|
|
|
|
|
2,957,400
|
|
|
|
|
|
|
|
|
|
|
|
2,568,494
|
|
|
|
|
|
|
|
|
|
Stockholders' equity
|
|
|
271,241
|
|
|
|
|
|
|
|
|
|
|
|
237,513
|
|
|
|
|
|
|
|
|
|
|
|
$
|
3,228,641
|
|
|
|
|
|
|
|
|
|
|
$
|
2,806,007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest income
(1)
|
|
|
|
|
|
$
|
45,655
|
|
|
|
|
|
|
|
|
|
|
$
|
39,965
|
|
|
|
|
|
Net interest spread (1)
|
|
|
|
|
|
|
|
|
|
|
2.65
|
%
|
|
|
|
|
|
|
|
|
|
|
2.66
|
%
|
Net interest margin (1)
|
|
|
|
|
|
|
|
|
|
|
2.91
|
%
|
|
|
|
|
|
|
|
|
|
|
2.94
|
%
|
(1) Tax-equivalent basis. Interest income on a tax-equivalent basis includes the additional amount of interest income that would have been earned if the Corporation's investment in tax-exempt loans and investment securities had been made in loans and investment securities subject to Federal income taxes yielding the same after-tax income. The tax-equivalent amount of $1.00 of nontaxable income was $1.54 in each period presented using the statutory Federal income tax rate.
Rate/Volume Analysis.
The following table sets forth the effect of changes in volumes, rates and rate/volume on tax-equivalent interest income, interest expense and net interest income.
|
|
Six Months Ended June 30,
|
|
|
|
2016 Versus 2015
|
|
|
|
Increase (decrease) due to changes in:
|
|
|
|
|
|
|
|
|
|
|
|
Rate/
|
|
|
Net
|
|
|
|
Volume
|
|
|
Rate
|
|
|
Volume (1)
|
|
|
Change
|
|
|
|
(in thousands)
|
|
Interest Income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-earning bank balances
|
|
$
|
27
|
|
|
$
|
28
|
|
|
$
|
31
|
|
|
$
|
86
|
|
Investment securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taxable
|
|
|
(309
|
)
|
|
|
(120
|
)
|
|
|
11
|
|
|
|
(418
|
)
|
Nontaxable
|
|
|
598
|
|
|
|
(521
|
)
|
|
|
(29
|
)
|
|
|
48
|
|
Loans
|
|
|
7,244
|
|
|
|
(714
|
)
|
|
|
(167
|
)
|
|
|
6,363
|
|
Total interest income
|
|
|
7,560
|
|
|
|
(1,327
|
)
|
|
|
(154
|
)
|
|
|
6,079
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest Expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Savings, NOW & money market deposits
|
|
|
351
|
|
|
|
652
|
|
|
|
190
|
|
|
|
1,193
|
|
Time deposits
|
|
|
(159
|
)
|
|
|
(256
|
)
|
|
|
19
|
|
|
|
(396
|
)
|
Short-term borrowings
|
|
|
(11
|
)
|
|
|
55
|
|
|
|
(7
|
)
|
|
|
37
|
|
Long-term debt
|
|
|
(84
|
)
|
|
|
(361
|
)
|
|
|
-
|
|
|
|
(445
|
)
|
Total interest expense
|
|
|
97
|
|
|
|
90
|
|
|
|
202
|
|
|
|
389
|
|
Increase (decrease) in net interest income
|
|
$
|
7,463
|
|
|
$
|
(1,417
|
)
|
|
$
|
(356
|
)
|
|
$
|
5,690
|
|
(1) Represents the change not solely attributable to change in rate or change in volume but a combination of these two factors. The rate/volume variance could be allocated between the volume and rate variances shown in the table based on the absolute value of each to the total for both.
Net Interest Income
Net interest income on a tax-equivalent basis for the first six months of 2016 was $45.7 million, an increase of $5.7 million, or 14.2%, over $40.0 million for the first half of 2015. The increase resulted primarily from an increase in average interest-earning assets of $423.3 million, or 15.6%, partially offset by a 3 basis point decline in net interest margin from 2.94% to 2.91%.
The increase in average interest-earning assets is primarily comprised of growth in the average balances of loans of $402.5 million, or 21.4%, and nontaxable securities of $24.9 million, or 5.7%, partially offset by a decrease in the average balance of taxable securities of $26.7 million, or 7.2%. While most of the loan growth occurred in mortgage loans, commercial and industrial loans also grew partially because of the Bank’s small business credit scored loan initiative.
The Bank’s continued ability to grow loans is attributable to a variety of factors including, among others, competitive pricing, targeted solicitation efforts, advertising campaigns and broker and correspondent relationships for both residential and commercial mortgages.
The growth in loans and nontaxable securities was primarily funded by growth in the average balances of noninterest-bearing checking deposits of $90.9 million, or 13.3%, and interest-bearing deposits of $322.3 million, or 22.7%. The Bank’s ongoing ability to grow deposits is attributable to, among other things, continued expansion of the Bank’s branch distribution system, targeted solicitation of local commercial businesses and municipalities, new and expanded lending relationships, new small business checking and loan products and the expansion of merchant sales relationships. In addition, management believes that the Bank’s positive reputation in its marketplace has contributed to both loan and deposit growth.
Intermediate and long-term interest rates are significantly lower now than they were at year-end 2015 and have been low and volatile for an extended period of time. In a low interest rate environment: (1) loans are sometimes originated and investments are sometimes made at yields lower than existing portfolio yields; (2) some loans prepay in full resulting in the immediate writeoff of deferred costs; (3) prepayment speeds on mortgage securities can be elevated resulting in accelerated amortization of purchase premiums; (4) the benefit of no cost funding in the form of noninterest-bearing checking deposits and capital is suppressed; and (5) the Bank’s ability to reduce deposit rates diminishes. Despite the downward pressure that these factors exert on net interest income, the Bank’s net interest margin of 2.91% for the first six months of 2016 was only down 3 basis points from the same period last year. This is because a significant portion of the Bank’s loan portfolio was originated in a low rate environment at yields not significantly different than those available in 2015 and thus far in 2016.
Noninterest Income
Noninterest income includes service charges on deposit accounts, Investment Management Division income, gains or losses on sales of securities, and all other items of income, other than interest, resulting from the business activities of the Corporation.
Noninterest income before securities gains decreased $265,000, or 6.8%, when comparing the first six months of 2016 to the same period last year. The decrease is primarily attributable to a $177,000 decrease in real estate tax refunds and a $91,000 sales tax refund in the first quarter of 2015. Also contributing to the decrease in noninterest income were declines in Investment Management Division income of $49,000 and service charges on deposit accounts of $35,000. The decrease in Investment Management Division income was driven mainly by a decline in the value of assets under management. The decrease in service charges on deposit accounts was largely due to a reduction in deposit account overdraft activity which was offset in part by higher account maintenance fees. The impact of these items was partially offset by increased income from a variety of noninterest income initiatives including debit cards, ATM banking, sales of mutual funds and annuities and merchant services. Total income from these initiatives increased $76,000, or 17.1%, when comparing the first half of 2016 to the same period last year.
Noninterest Expense
Noninterest expense is comprised of salaries, employee benefits expense, occupancy and equipment expense and other operating expenses incurred in supporting the various business activities of the Corporation.
Noninterest expense before debt extinguishment costs increased $3.4 million, or 15.6%, when comparing the first six months of 2016 to the same period last year. The increase is primarily attributable to increases in salaries of $1.0 million, or 10.3%, employee benefits expense of $710,000, or 25.9%, consulting expense of $765,000, computer and telecommunications expense of $386,000 and marketing expense of $173,000. The increase in salaries is primarily due to new branch openings, additions to staff in the back office, higher stock-based compensation expense and normal annual salary adjustments. The increase in employee benefits expense is largely due to an increase in group health insurance expense of $230,000 resulting from increases in staff count and the rates being paid for group health insurance, higher incentive compensation costs of $132,000 and an increase in pension expense of $254,000. The increase in pension expense is primarily attributable to the 2015 return on plan assets falling short of expectation and an increase in the number of plan participants. The increase in consulting expense is due to a one-time charge of $800,000 in the second quarter of 2016 for advisory services relating to a vendor contract renegotiation. The Corporation expects that the cost savings negotiated by the consultant over the life of the contract will far exceed the one-time consulting charge. The increase in computer and telecommunications expense is mainly attributable to a growth-related increase in telecommunications capacity and one-time expenses of approximately $126,000 related to changes in the Corporation’s network and security systems.
Income Taxes
Income tax expense as a percentage of book income (“effective tax rate”) was 23.9% for the first six months of 2016 compared to 24.0% for the same period last year. The $678,000 increase in income tax expense is attributable to higher pre-tax earnings in the current six-month period partially offset by additional New York State income tax benefits derived from the Corporation’s captive REIT.
Results of Operations – Second Quarter 201
6
Versus Second Quarter 201
5
Net income for the second quarter of 2016 was $7.6 million, representing an increase of $1.3 million, or 21.4%, over $6.3 million earned in the second quarter of last year. The increase is primarily attributable to an increase in net interest income of $2.8 million and a decrease in the provision for loan losses of $803,000. The positive impact of these items was partially offset by increases in salaries of $503,000, employee benefits expense of $404,000, consulting expense of $766,000 and computer and telecommunications expense of $258,000. The increases in net interest income, salaries, employee benefits, consulting and computer and telecommunications expense occurred for substantially the same reasons discussed above with respect to the six-month periods. The decrease in the provision for loan losses was largely due to lesser loan growth and the absence of an increase in specific reserves in the current quarter versus the same quarter last year.
Application of Critical Accounting Policies
In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported asset and liability balances and revenue and expense amounts. Our determination of the allowance for loan losses is a critical accounting estimate because it is based on our subjective evaluation of a variety of factors at a specific point in time and involves difficult and complex judgments about matters that are inherently uncertain. In the event that management’s estimate needs to be adjusted based on, among other things, additional information that comes to light after the estimate is made or changes in circumstances, such adjustment could result in the need for a significantly different allowance for loan losses and thereby materially impact, either positively or negatively, the Bank’s results of operations.
The Bank’s Allowance for Loan and Lease Losses Committee (“ALLL Committee”), which is a management committee chaired by the Chief Credit Officer, meets on a quarterly basis and is responsible for determining the allowance for loan losses after considering, among other things, the results of credit reviews performed by the Bank’s independent loan review consultants and the Bank’s credit department. In addition, and in consultation with the Bank’s Chief Financial Officer and Chief Risk Officer, the ALLL Committee is responsible for implementing and maintaining accounting policies and procedures surrounding the calculation of the required allowance. The Board Loan Committee reviews and approves the Bank’s Loan Policy at least once each calendar year. The Bank’s allowance for loan losses is reviewed and ratified by the Board Loan Committee on a quarterly basis and is subject to periodic examination by the OCC whose safety and soundness examination includes a determination as to the adequacy of the allowance for loan losses to absorb probable incurred losses.
The first step in determining the allowance for loan losses is to identify loans in the Bank’s portfolio that are individually deemed to be impaired and then measure impairment losses based on either the fair value of collateral or the discounted value of expected future cash flows. In estimating the fair value of real estate collateral, management utilizes appraisals or evaluations adjusted for costs to dispose and a distressed sale adjustment, if needed. Estimating the fair value of collateral other than real estate is also subjective in nature and sometimes requires difficult and complex judgments. Determining expected future cash flows can be more subjective than determining fair values. Expected future cash flows could differ significantly, both in timing and amount, from the cash flows actually received over the loan’s remaining life.
In addition to estimating losses for loans individually deemed to be impaired, management also estimates collective impairment losses for pools of loans that are not specifically reviewed. The Bank’s highest average annualized loss experience over periods of 24, 36, 48 or 60 months is generally the starting point in determining its allowance for loan losses for each pool of loans. Management believes that this approach appropriately reflects losses from the current economic cycle and those incurred losses in the Bank’s loan portfolio. However, since future losses could vary significantly from those experienced in the past, on a quarterly basis management adjusts its historical loss experience to reflect current conditions. In doing so, management considers a variety of general qualitative factors and then subjectively determines the weight to assign to each in estimating losses. The factors include, among others: (1) delinquencies, (2) economic conditions as judged by things such as median home prices and commercial vacancy rates in the Bank’s service area and national and local unemployment levels, (3) trends in the nature and volume of loans, (4) concentrations of credit, (5) changes in lending policies and procedures, (6) experience, ability and depth of lending staff, (7) changes in the quality of the loan review function, (8) environmental risks, and (9) loan risk ratings. Substantially all of the Bank’s allowance for loan losses allocable to pools of loans that are collectively evaluated for impairment results from these qualitative adjustments to historical loss experience. Because of the nature of the qualitative factors and the difficulty in assessing their impact, management’s resulting estimate of losses may not accurately reflect actual losses in the portfolio.
Although the allowance for loan losses has two separate components, one for impairment losses on individual loans and one for collective impairment losses on pools of loans, the entire allowance for loan losses is available to absorb realized losses as they occur whether they relate to individual loans or pools of loans.
Asset Quality
The Corporation has identified certain assets as risk elements. These assets include nonaccrual loans, other real estate owned, loans that are contractually past due 90 days or more as to principal or interest payments and still accruing and troubled debt restructurings. These assets present more than the normal risk that the Corporation will be unable to eventually collect or realize their full carrying value. Information about the Corporation’s risk elements is set forth below.
|
|
June 30,
|
|
|
December 31,
|
|
|
|
2016
|
|
|
2015
|
|
|
|
(dollars in thousands)
|
|
Nonaccrual loans:
|
|
|
|
|
|
|
|
|
Troubled debt restructurings
|
|
$
|
860
|
|
|
$
|
900
|
|
Other (includes $105,000 in loans held-for-sale at 12/31/15)
|
|
|
4,217
|
|
|
|
535
|
|
Total nonaccrual loans
|
|
|
5,077
|
|
|
|
1,435
|
|
Loans past due 90 days or more and still accruing
|
|
|
-
|
|
|
|
-
|
|
Other real estate owned
|
|
|
-
|
|
|
|
-
|
|
Total nonperforming assets
|
|
|
5,077
|
|
|
|
1,435
|
|
Troubled debt restructurings - performing
|
|
|
3,530
|
|
|
|
3,581
|
|
Total risk elements
|
|
$
|
8,607
|
|
|
$
|
5,016
|
|
|
|
|
|
|
|
|
|
|
Nonaccrual loans as a percentage of total loans
|
|
|
.22
|
%
|
|
|
.06
|
%
|
Nonperforming assets as a percentage of total loans and other real estate owned
|
|
|
.22
|
%
|
|
|
.06
|
%
|
Risk elements as a percentage of total loans and other real estate owned
|
|
|
.37
|
%
|
|
|
.22
|
%
|
In addition to the Bank’s past due, nonaccrual and restructured loans, the disclosure of other potential problem loans can be found in “Note 5 – Loans” to the Corporation’s consolidated financial statements of this Form 10-Q.
Allowance and Provision for Loan Losses
The allowance for loan losses is established through provisions for loan losses charged against income. When available information confirms that specific loans, or portions thereof, are uncollectible, these amounts are charged off against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance for loan losses.
The allowance for loan losses increased $421,000 during the first six months of 2016, amounting to $27.7 million, or 1.18% of total loans, at June 30, 2016, compared to $27.3 million, or 1.21% of total loans, at December 31, 2015. During the first six months of 2016, the Bank had no loan chargeoffs, recoveries of $29,000 and recorded a provision for loan losses of $392,000. During the first six months of 2015, the Bank had loan chargeoffs and recoveries of $99,000 and $16,000, respectively, and recorded a provision for loan losses of $1.4 million. The $392,000 provision in the first half of 2016 is primarily attributable to loan growth partially offset by improved economic conditions and a decrease in historical losses. The $1.4 million provision in the first half of 2015 was primarily attributable to loan growth and the establishment of a $332,000 specific reserve on one loan deemed to be impaired, partially offset by improved economic conditions.
The allowance for loan losses is an amount that management currently believes will be adequate to absorb probable incurred losses in the Bank’s loan portfolio. As more fully discussed in the “Application of Critical Accounting Policies” section of this discussion and analysis of financial condition and results of operations, the process for estimating credit losses and determining the allowance for loan losses as of any balance sheet date is subjective in nature and requires material estimates. Actual results could differ significantly from those estimates. Other detailed information on the Bank’s allowance for loan losses, impaired loans and the aging of loans can be found in “Note 5 – Loans” to the Corporation’s consolidated financial statements included in this Form 10-Q.
The amount of future chargeoffs and provisions for loan losses will be affected by, among other things, economic conditions on Long Island and in New York City. Such conditions could affect the financial strength of the Bank’s borrowers and will affect the value of real estate collateral securing the Bank’s mortgage loans.
Loans secured by real estate represent approximately 95% of the Bank’s total loans outstanding at June 30, 2016. Most of these loans were made to borrowers domiciled on Long Island and in the boroughs of New York City. Although economic conditions are showing signs of improvement, they have been sluggish for an extended period of time. These conditions have caused some of the Bank’s borrowers to be unable to make the required contractual payments on their loans and could cause the Bank to be unable to realize the full carrying value of such loans through foreclosure or other collection efforts.
Future provisions and chargeoffs could also be affected by environmental impairment of properties securing the Bank’s mortgage loans. At the present time, management is not aware of any environmental pollution originating on or near properties securing the Bank’s loans that would materially affect the carrying value of such loans.
Cash Flows and Liquidity
Cash Flows.
The Corporation’s primary sources of cash are deposits, maturities and amortization of loans and investment securities, operations and borrowings. The Corporation uses cash from these and other sources to fund loan growth, purchase investment securities, repay borrowings, expand and improve its physical facilities, pay cash dividends and for general operating purposes.
During the first six months of 2016, the Corporation’s cash and cash equivalent position increased by $11.4 million, from $39.6 million at December 31, 2015 to $51.0 million at June 30, 2016. The increase occurred primarily because cash provided by deposit growth, paydowns and sales of securities, paydowns of loans, proceeds from issuance of common stock and operations exceeded cash used to repay short-term borrowings, originate loans and purchase securities.
Securities increased $122.1 million during the first six months of 2016, from $752.1 million at year-end 2015 to $874.2 million at June 30, 2016. The increase is mainly attributable to purchases of $203.4 million of available-for-sale securities, partially offset by maturities and redemptions of $48.6 million and sales of $41.0 million of available-for-sale securities during the period.
During the first six months of 2016, total deposits grew $340.2 million, or 14.9%, to $2.6 billion at June 30, 2016. The increase was attributable to growth in savings, NOW and money market deposits of $366.8 million, or 30.7%, partially offset by decreases in time deposits of $14.0 million and noninterest-bearing checking balances of $12.6 million. The growth in savings, NOW and money market deposits is mainly attributable to new branch openings and an increase in municipal deposit balances.
Borrowings include Federal Home Loan Bank (“FHLB”) borrowings and liabilities under repurchase agreements. Total borrowings decreased $160.3 million, or 27.8%, during the first six months of 2016. The decrease is attributable to a reduction in short-term borrowings of $153.8 million and a decrease in long-term debt of $6.5 million. From a funding perspective, the net decrease in total borrowings during the first half of 2016 was driven by the growth in deposits discussed above. Long-term debt totaled $359.2 million at June 30, 2016, representing 86% of total borrowings at quarter-end. The Bank’s long-term fixed rate borrowing position and time deposits are intended to reduce the impact that an eventual increase in interest rates could have on the Bank’s earnings.
Liquidity
.
The Bank has a board committee approved Liquidity Policy and Liquidity Contingency Plan, which are intended to ensure that the Bank has sufficient liquidity at all times to meet the ongoing needs of its customers in terms of credit and deposit outflows, take advantage of earnings enhancement opportunities and respond to liquidity stress conditions should they arise.
The Bank has both internal and external sources of liquidity that can be used to fund loan growth and accommodate deposit outflows. The Bank’s primary internal sources of liquidity are its overnight investments, investment securities designated as available-for-sale, maturities and monthly payments on its investment securities and loan portfolios and operations. At June 30, 2016, the Bank had approximately $393 million of unencumbered available-for-sale securities.
The Bank is a member of the Federal Reserve Bank of New York (“FRB”) and the Federal Home Loan Bank of New York (“FHLB of New York”), has repurchase agreements in place with a number of brokerage firms and commercial banks and has a federal funds line with a commercial bank. In addition to customer deposits, the Bank’s primary external sources of liquidity are secured borrowings from the FRB, FHLB of New York and repurchase agreement counterparties. In addition, the Bank can purchase overnight federal funds under its existing line. However, the Bank’s FRB membership, FHLB of New York membership, repurchase agreements and federal funds line do not represent legal commitments to extend credit to the Bank. The amount that the Bank can potentially borrow is currently dependent on, among other things, the amount of unencumbered eligible securities and loans that the Bank can use as collateral and the collateral margins required by the lenders. Based on the Bank’s unencumbered securities and loan collateral, a substantial portion of which is in place at the FRB and FHLB of New York, the Bank had borrowing capacity of approximately $1.6 billion at June 30, 2016.
Deleveraging Transactions
In April 2016, the Bank completed a deleveraging transaction. The primary purpose of the transaction was to eliminate inefficient leverage and thereby provide capital to accommodate growth. The transaction involved the sale of $40.3 million of mortgage securities at a gain of $1.8 million and utilization of most of the resulting proceeds to prepay $30.0 million of long-term debt at a cost of $1.8 million. The transaction positively impacted the second quarter Tier 1 leverage capital ratio by approximately 8 basis points, and had an immaterial positive impact on net interest income and net interest margin. The Bank completed a similar deleveraging transaction in the second quarter of 2015. The 2015 transaction involved the sale of $61.8 million of securities at a gain of $995,000 and utilization of the resulting proceeds to prepay $63.5 million of long-term debt at a cost of $1.1 million
Capital
Stockholders’ equity totaled $305.7 million at June 30, 2016, an increase of $54.7 million from $250.9 million at December 31, 2015. The most significant reason for the increase was the sale of 1,300,000 shares of common stock through an underwritten public offering at a price of $29 per share. The proceeds of the offering amounted to $35.3 million, net of $2.4 million of issuance costs, and will be used to support continued growth. The other primary reasons for the increase in stockholders’ equity were net income of $15.1 million, an increase in the after-tax amount of unrealized gains on available-for-sale securities of $6.0 million and the issuance of shares under the Corporation’s stock-based compensation, dividend reinvestment and stock purchase plans of $3.7 million, partially offset by cash dividends declared of $6.0 million.
During 2016, the Corporation’s Board of Directors increased the amount of stock that an individual can purchase on a quarterly basis under the stock purchase component of the Dividend Reinvestment and Stock Purchase Plan from $20,000 to $50,000. This change is expected to provide additional capital that can be used to accommodate future growth.
The Corporation’s capital management policy is designed to build and maintain capital levels that exceed regulatory standards and appropriately provide for growth. The Basel III regulatory capital ratios of the Corporation and the Bank as of June 30, 2016 are as follows:
|
|
Corporation
|
|
|
Bank
|
|
|
|
|
|
|
|
|
|
|
Tier 1 leverage
|
|
|
8.92
|
%
|
|
|
8.93
|
%
|
Common Equity Tier 1 risk-based
|
|
|
14.86
|
%
|
|
|
14.90
|
%
|
Tier 1 risk-based
|
|
|
14.86
|
%
|
|
|
14.90
|
%
|
Total risk-based
|
|
|
16.11
|
%
|
|
|
16.15
|
%
|
The public offering of common stock and, to a much lesser extent, the deleveraging transaction and retained net income were primary drivers of a 100 basis point increase in the Corporation’s Tier 1 leverage capital ratio during the second quarter.
The Corporation and the Bank exceeded the Basel III minimum capital adequacy requirements, including the Capital Conservation Buffer of .625% for the Bank for 2016, and the Bank was well capitalized under the Prompt Corrective Action provisions at June 30, 2016.
The Corporation’s Shareholder Rights Protection Plan expired on August 1, 2016 and was not renewed by the Board of Directors.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Bank invests in interest-earning assets, which are funded by interest-bearing deposits and borrowings, noninterest-bearing deposits and capital. The Bank’s results of operations are subject to risk resulting from interest rate fluctuations generally and having assets and liabilities that have different maturity, repricing, and prepayment/withdrawal characteristics. The Bank defines interest rate risk as the risk that the Bank's net interest income and/or economic value of equity (“EVE”) will change when interest rates change. The principal objective of the Bank’s asset liability management activities is to optimize current and future net interest income while at the same time maintain acceptable levels of interest rate and liquidity risk and facilitate the funding needs of the Bank.
The Bank monitors and manages interest rate risk through a variety of techniques including traditional gap analysis and the use of interest rate sensitivity models. Both gap analysis and interest rate sensitivity modeling involve a variety of significant estimates and assumptions and are done at a specific point in time. Changes in the estimates and assumptions made in gap analysis and interest rate sensitivity modeling could have a significant impact on projected results and conclusions. Therefore, these techniques may not accurately reflect the actual impact of changes in the interest rate environment on the Bank’s net interest income or EVE.
Traditional gap analysis involves arranging the Bank’s interest-earning assets and interest-bearing liabilities by repricing periods and then computing the difference, or interest-rate sensitivity gap, between the assets and liabilities which are estimated to reprice during each time period and cumulatively through the end of each time period. Gap analysis requires estimates as to when individual categories of interest-sensitive assets and liabilities will reprice and assumes that assets and liabilities assigned to the same repricing period will reprice at the same time and in the same amount. Among other things, gap analysis does not fully take into account the fact that the repricing of some assets and liabilities is discretionary and subject to competitive and other pressures.
Through use of interest rate sensitivity modeling, the Bank first projects net interest income over a five-year time period assuming a static balance sheet and no changes in interest rates from current levels. Utilization of a static balance sheet ensures that interest rate risk embedded in the Bank’s current balance sheet is not masked by assumed balance sheet growth or contraction. Net interest income is then projected over a five-year time period utilizing: (1) a static balance sheet and various interest rate change scenarios, including both ramped and shock changes and changes in the shape of the yield curve; and (2) a most likely balance sheet growth scenario and these same interest rate change scenarios. The interest rate scenarios modeled are based on, among other things, the shape of the current yield curve and the relative level of rates and management’s expectations as to potential future yield curve shapes and rate levels.
The Bank also uses interest rate sensitivity modeling to calculate EVE in the current rate environment assuming shock increases and decreases in interest rates. EVE is the difference between the present value of expected future cash flows from the Bank’s assets and the present value of the expected future cash flows from the Bank’s liabilities. Present values are determined using discount rates that management believes are reflective of current market conditions. EVE can capture long-term interest rate risk that would not be captured in a five-year projection of net interest income.
In utilizing interest rate sensitivity modeling to project net interest income and calculate EVE, management makes a variety of estimates and assumptions which include, among others, the following: (1) how much and when yields and costs on individual categories of interest-earning assets and interest-bearing liabilities will change in response to projected changes in market interest rates; (2) future cash flows, including prepayments of mortgage assets and calls of municipal securities; (3) cash flow reinvestment assumptions; (4) appropriate discount rates to be applied to loan, deposit and borrowing cash flows; and (5) decay or runoff rates for nonmaturity deposits such as checking, savings, NOW and money market accounts. The repricing of loans and borrowings and the reinvestment of loan and security cash flows are generally assumed to be impacted by the full amount of each assumed rate change, while the repricing of nonmaturity deposits is not. For nonmaturity deposits, management makes estimates of how much and when it will need to change the rates paid on the Bank’s various deposit products in response to changes in general market interest rates. These estimates are based on, among other things, product type, management’s experience with needed deposit rate adjustments in prior interest rate change cycles, and management’s assessment of competitive conditions in its marketplace.
The information provided in the following table is based on a variety of estimates and assumptions that management believes to be reasonable, the more significant of which are set forth hereinafter. The base case information in the table shows (1) a calculation of the Corporation’s EVE at June 30, 2016 arrived at by discounting estimated future cash flows at rates that management believes are reflective of current market conditions and (2) an estimate of net interest income on a tax-equivalent basis for the year ending June 30, 2017 assuming a static balance sheet, the adjustment of repricing balances to current rate levels, and the reinvestment at current rate levels of cash flows from maturing assets and liabilities in a mix of assets and liabilities that mirrors the Bank’s strategic plan. In addition, in calculating EVE, cash flows for nonmaturity deposits are based on a base case average life of 7.0 years as determined by a nonmaturity deposit study conducted during 2015.
The rate change information in the table shows estimates of net interest income on a tax-equivalent basis for the year ending June 30, 2017 and calculations of EVE at June 30, 2016 assuming rate changes of plus 100, 200 and 300 basis points and minus 100 basis points. The rate change scenarios were selected based on, among other things, the relative level of current interest rates and are: (1) assumed to be shock or immediate changes, (2) occur uniformly across the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities, and (3) impact the repricing and reinvestment of all assets and liabilities, except nonmaturity deposits, by the full amount of the rate change. In projecting future net interest income under the indicated rate change scenarios, activity is simulated by assuming that cash flows from maturing assets and liabilities are reinvested in a mix of assets and liabilities that mirrors the Bank’s strategic plan. The changes in EVE from the base case have not been tax affected.
|
|
Economic Value of Equity
|
|
|
Net Interest Income for
|
|
|
|
at June 30, 2016
|
|
|
Year Ending June 30, 2017
|
|
|
|
|
|
|
|
Percent Change
|
|
|
|
|
|
|
Percent Change
|
|
|
|
|
|
|
|
From
|
|
|
|
|
|
|
From
|
|
Rate Change Scenario (dollars in thousands)
|
|
Amount
|
|
|
Base Case
|
|
|
Amount
|
|
|
Base Case
|
|
+ 300 basis point rate shock
|
|
$
|
328,982
|
|
|
|
-6.2
|
%
|
|
$
|
79,251
|
|
|
|
-14.9
|
%
|
+ 200 basis point rate shock
|
|
|
384,833
|
|
|
|
9.8
|
%
|
|
|
91,307
|
|
|
|
-1.9
|
%
|
+ 100 basis point rate shock
|
|
|
379,312
|
|
|
|
8.2
|
%
|
|
|
92,748
|
|
|
|
-0.4
|
%
|
Base case (no rate change)
|
|
|
350,614
|
|
|
|
-
|
|
|
|
93,106
|
|
|
|
-
|
|
- 100 basis point rate shock
|
|
|
247,305
|
|
|
|
-29.5
|
%
|
|
|
87,914
|
|
|
|
-5.6
|
%
|
As shown in the preceding table, assuming a static balance sheet, an immediate decrease in interest rates of 100 basis points or an immediate increase in interest rates of 100, 200 or 300 basis points could negatively impact the Bank’s net interest income for the year ending June 30, 2017. The Bank’s net interest income could be negatively impacted in a shock down 100 basis point scenario because, among other things, the rates currently being paid on many of the Bank’s deposit products are approaching zero and there is little room to reduce them. In the shock up 100, 200 or 300 basis point scenarios, net interest income could be negatively impacted because it is assumed that the Bank will need to make more significant changes to the rates paid on its nonmaturity deposits in order to remain competitive. Changes in management’s estimates as to the rates that will need to be paid on nonmaturity deposits could have a significant impact on the net interest income amounts shown for each scenario in the table.
Forward-Looking Statements
This report on Form 10-Q and the documents incorporated into it by reference contain various forward-looking statements. These forward-looking statements include statements of goals; intentions and expectations; estimates of risks and of future costs and benefits; assessments of probable loan losses; assessments of market risk; and statements of the ability to achieve financial and other goals. Forward-looking statements are typically identified by words such as “would,” “should,” “could,” “believe,” “expect,” “anticipate,” “intend,” “outlook,” “estimate,” “forecast,” “project” and other similar words and expressions. Forward-looking statements are subject to numerous assumptions, risks and uncertainties which may change over time. Forward-looking statements speak only as of the date they are made. We do not assume any duty and do not undertake to update our forward-looking statements. Because forward-looking statements are subject to assumptions and uncertainties, actual results or future events could differ, possibly materially, from those that we anticipated in our forward-looking statements and future results could differ materially from historical performance.
Our forward-looking statements are subject to the following principal risks and uncertainties: general economic conditions and trends, either nationally or locally; conditions in the securities markets; fluctuations in the trading price of our common stock; changes in interest rates; changes in deposit flows, and in the demand for deposit and loan products and other financial services; changes in real estate values; changes in the quality or composition of our loan or investment portfolios; changes in competitive pressures among financial institutions or from non-financial institutions; our ability to retain key members of management; changes in legislation, regulation, and policies; and a variety of other matters which, by their nature, are subject to significant uncertainties. We provide greater detail regarding some of these factors in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2015, in Part I under “Item 1A. Risk Factors.” Our forward-looking statements may also be subject to other risks and uncertainties, including those that we may discuss elsewhere in other documents we file with the SEC from time to time.