ITEM
2.
|
Management's
Discussion and
Analysis of Financial Condition and Results of
Operations
|
This
Quarterly Report on Form
10-Q
, as amended,
contains
a number of
forward-looking statements within
the meaning of Section 27A of the
Securities Act of 1933, as amended, or the Securities Act, and Section 21E
of
the Securities Exchange Act of 1934, as amended, or the Exchange
Act. These statements may be identified by the use of the words
“anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,”
“outlook,” “plan,” “potential,” “predict,” “project,” “should,” “will,” “would”
and similar terms and phrases, including references to assumptions.
Forward-looking
statements are based on various assumptions and analyses made by us in light
of
our management’s experience and its perception of historical trends, current
conditions and expected future developments, as well as other factors we believe
are appropriate under the circumstances. These statements are not
guarantees of future performance and are subject to risks, uncertainties and
other factors (many of which are beyond our control) that could cause actual
results to differ materially from future results expressed or implied by such
forward-looking statements. These factors include, without
limitation, the following:
·
|
the
timing and occurrence or non-occurrence of events may be subject
to
circumstances beyond our control;
|
·
|
there
may be increases in competitive pressure among financial institutions
or
from non-financial institutions;
|
·
|
changes
in the interest rate environment may reduce interest margins or affect
the
value of our investments;
|
·
|
changes
in deposit flows, loan demand or real estate values may adversely
affect
our business;
|
·
|
changes
in accounting principles, policies or guidelines may cause our financial
condition to be perceived
differently;
|
·
|
general
economic conditions, either nationally or locally in some or all
areas in
which we do business, or conditions in the real estate or securities
markets or the banking industry may be less favorable than we currently
anticipate;
|
·
|
legislative
or regulatory changes may adversely affect our
business;
|
·
|
technological
changes may be more difficult or expensive than we
anticipate;
|
·
|
success
or consummation of new business initiatives may be more difficult
or
expensive than we anticipate; or
|
·
|
litigation
or other matters before regulatory agencies, whether currently existing
or
commencing in the future, may be determined adverse to us or may
delay the
occurrence or non-occurrence of events longer than we
anticipate.
|
We
have
no obligation to update any forward-looking statements to reflect events or
circumstances after the date of this document.
Critical
Accounting Policies
Allowance
for Loan
Losses
Our
allowance for loan losses is established and maintained through a provision
for
loan losses based on our evaluation of the probable inherent losses in our
loan
portfolio. We evaluate the adequacy of our allowance on a quarterly
basis. The allowance is comprised of both specific valuation
allowances and general valuation allowances.
Specific
valuation allowances are established in connection with individual loan reviews
and the asset classification process, including the procedures for impairment
recognition under SFAS No. 114, "Accounting by Creditors for Impairment of
a
Loan, an amendment of FASB Statements No. 5 and 15," and SFAS No. 118,
"Accounting by Creditors for Impairment of a Loan - Income Recognition and
Disclosures, an amendment of FASB Statement No. 114." Such
evaluation, which includes a review of loans on which full collectibility is
not
reasonably assured, considers the estimated fair value of the underlying
collateral, if any, current and anticipated economic and regulatory conditions,
current and historical loss experience of similar loans and other factors that
determine risk exposure to arrive at an adequate loan loss
allowance.
Loan
reviews are completed quarterly for all loans individually classified by the
Asset Classification Committee. Individual loan reviews are generally
completed annually for multi-family, commercial real estate and construction
loans in excess of $2.5 million, commercial business loans in excess of
$200,000, one-to-four family loans in excess of $1.0 million and debt
restructurings. In addition, we generally review annually at least
fifty percent of the outstanding balances of multi-family, commercial real
estate and construction loans to single borrowers with concentrations in excess
of $2.5 million.
The
primary considerations in establishing specific valuation allowances are the
current estimated value of a loan’s underlying collateral and the loan’s payment
history. We update our estimates of collateral value when loans are
individually classified by our Asset Classification Committee as either
substandard or doubtful, as well as for special mention and watch list loans
in
excess of $2.5 million and certain other loans when the Asset Classification
Committee believes repayment of such loans may be dependent on the value of
the
underlying collateral. Updated estimates of collateral value are
obtained through appraisals, where possible. In instances where we
have not taken possession of the property or do not otherwise have access to
the
premises and therefore cannot obtain a complete appraisal, an estimate of the
value of the property is obtained based primarily on a drive-by inspection
and a
comparison of the property securing the loan with similar properties in the
area, by either a licensed appraiser or real estate broker for one-to-four
family properties, or by our internal Asset Review personnel for multi-family
and commercial real estate properties. In such cases, an internal
cash flow analysis may also be performed. Other current and
anticipated economic conditions on which our specific valuation allowances
rely
are the impact that national and/or local economic and business conditions
may
have on borrowers, the impact that local real estate markets may have on
collateral values, the level and direction of interest rates and their combined
effect on real estate values and the ability of borrowers to service
debt. For multi-family and commercial real estate loans, additional
factors specific to a borrower or the underlying collateral are
considered. These factors include, but are not limited to, the
composition of tenancy, occupancy levels for the property, cash flow estimates
and the existence of personal guarantees. We also review all
regulatory notices, bulletins and memoranda with the purpose of identifying
upcoming changes in regulatory conditions which may impact our calculation
of
specific valuation allowances. The Office of Thrift Supervision, or
OTS, periodically reviews our reserve methodology during
regulatory
examinations and any comments regarding changes to reserves or loan
classifications are considered by management in determining valuation
allowances.
Pursuant
to our policy, loan losses are charged-off in the period the loans, or portions
thereof, are deemed uncollectible. The determination of the loans on
which full collectibility is not reasonably assured, the estimates of the fair
value of the underlying collateral and the assessment of economic and regulatory
conditions are subject to assumptions and judgments by
management. Specific valuation allowances could differ materially as
a result of changes in these assumptions and judgments.
General
valuation allowances represent loss allowances that have been established to
recognize the inherent risks associated with our lending activities, but which,
unlike specific allowances, have not been allocated to particular
loans. The determination of the adequacy of the general valuation
allowances takes into consideration a variety of factors. We segment
our loan portfolio into like categories by composition and size and perform
analyses against each category. These include historical loss
experience and delinquency levels and trends. We analyze our
historical loan loss experience by category (loan type) over 3, 5, 10, 12 and
16-year periods. Losses within each loan category are stress tested
by applying the highest level of charge-offs and the lowest amount of recoveries
as a percentage of the average portfolio balance during those respective time
horizons. The resulting range of allowance percentages is used as an
integral part of our judgment in developing estimated loss percentages to apply
to the portfolio. We also consider the size, composition, risk
profile, delinquency levels and cure rates of our portfolio, as well as our
credit administration and asset management philosophies and
procedures. We monitor property value trends in our market areas by
reference to various industry and market reports, economic releases and surveys,
and our general and specific knowledge of the real estate markets in which
we
lend, in order to determine what impact, if any, such trends should have on
the
level of our general valuation allowances. In determining our
allowance coverage percentages for non-performing loans, we consider our
historical loss experience with respect to the ultimate disposition of the
underlying collateral. In addition, we evaluate and consider the
impact that existing and projected economic and market conditions may have
on
the portfolio, as well as known and inherent risks in the
portfolio. We also evaluate and consider the allowance ratios and
coverage percentages set forth in both peer group and regulatory agency data
and
any comments from the OTS resulting from their review of our general valuation
allowance methodology during regulatory examinations. Our focus,
however, is primarily on our historical loss experience and the impact of
current economic conditions. After evaluating these variables, we
determine appropriate allowance coverage percentages for each of our portfolio
segments and the appropriate level of our allowance for loan
losses. Our allowance coverage percentages are used to estimate the
amount of probable losses inherent in our loan portfolio in determining our
general valuation allowances. Our evaluation of general valuation
allowances is inherently subjective because, even though it is based on
objective data, it is management's interpretation of that data that determines
the amount of the appropriate allowance. Therefore, we annually
review the actual performance and charge-off history of our portfolio and
compare that to our previously determined allowance coverage percentages and
specific valuation allowances. In doing so, we evaluate the impact
the previously mentioned variables may have had on the portfolio to determine
which changes, if any, should be made to our assumptions and
analyses.
Our
loss
experience in 2007 has been consistent with our experience over the past several
years and in recent years has been primarily attributable to a small number
of
loans. Our 2007 analyses did not result in any change in our
methodology for determining our general and specific valuation allowances or
our
emphasis on the factors that we consider in establishing such
allowances. Accordingly, such analyses did not indicate that any
material changes in our allowance coverage percentages were
required. However, our recent increases in non-
performing
loans and net loan charge-offs for the 2007 third quarter resulted in a
determination to record a provision for loan losses. The balance of
our allowance for loan losses represents management’s best estimate of the
probable inherent losses in our loan portfolio at September 30, 2007 and
December 31, 2006.
Actual
results could differ from our estimates as a result of changes in economic
or
market conditions. Changes in estimates could result in a material
change in the allowance for loan losses. While we believe that the
allowance for loan losses has been established and maintained at levels that
reflect the risks inherent in our loan portfolio, future adjustments may be
necessary if portfolio performance or economic or market conditions differ
substantially from the conditions that existed at the time of the initial
determinations.
For
additional information regarding our allowance for loan losses, see “Provision
for Loan Losses” and “Asset Quality” in this document and Part II, Item 7,
“MD&A,” in our 2006 Annual Report on Form 10-K and any amendments
thereto.
Comparison
of Financial Condition as of September 30, 2007 and December 31, 2006 and
Operating
Results for the Three and Nine Months Ended September 30, 2007 and
2006
Results
of Operations
Provision
for Loan
Losses
The
provision for loan losses was $500,000 for the three and nine months ended
September 30, 2007, reflecting the higher levels of non-performing loans and
net
loan charge-offs experienced during the 2007 third quarter. No
provision for loan losses was recorded for the three and nine months ended
September 30, 2006. The allowance for loan losses was $78.3 million
at September 30, 2007 and $79.9 million at December 31, 2006. The
allowance for loan losses as a percentage of non-performing loans decreased
to
95.06% at September 30, 2007, from 134.55% at December 31, 2006, primarily
due
to an increase in non-performing loans. The allowance for loan losses
as a percentage of total loans was 0.49% at September 30, 2007 and 0.53% at
December 31, 2006. We believe our allowance for loan losses has been
established and maintained at levels that reflect the risks inherent in our
loan
portfolio, giving consideration to the composition and size of our loan
portfolio, charge-off experience and non-accrual and non-performing
loans. The balance of our allowance for loan losses represents
management’s best estimate of the probable inherent losses in our loan portfolio
at September 30, 2007 and December 31, 2006.
We
review
our allowance for loan losses on a quarterly basis. Material factors
considered during our quarterly review are our historical loss experience and
the impact of current economic conditions. Our net loan charge-off
experience was four basis points of average loans outstanding, annualized,
for
the three months ended September 30, 2007 and two basis points of average loans
outstanding, annualized, for the nine months ended September 30, 2007, compared
to three basis points of average loans outstanding, annualized, for the three
months ended September 30, 2006 and one basis point of average loans
outstanding, annualized, for the nine months ended September 30,
2006. Net loan charge-offs totaled $1.6 million for the three months
ended September 30, 2007 and $2.2 million for the nine months ended September
30, 2007. Net loan charge-offs totaled $1.1 million for the three
months ended September 30, 2006 and $1.2 million for the nine months ended
September 30, 2006. Net loan charge-offs included a $1.5 million
charge-off in the 2007 third quarter related to a non-performing construction
loan which was sold and a $947,000 charge-off in the 2006 third quarter related
to a non-performing multi-family loan which was sold in 2006.
The
composition of our loan portfolio has remained relatively consistent over the
last several years. At September 30, 2007, our loan portfolio was
comprised of 72% one-to-four family mortgage loans, 19% multi-family mortgage
loans, 7% commercial real estate loans and 2% other loan
categories. Our loan-to-value ratios upon origination are low
overall, have been consistent over the past several years and provide some
level
of protection in the event of default should property values
decline. For further discussion of our loan-to-value ratios, see
“Asset Quality.”
Our
non-performing loans continue to remain at low levels relative to the size
of
our loan portfolio. Our non-performing loans, which are comprised
primarily of mortgage loans, increased $22.9 million to $82.3 million, or 0.52%
of total loans, at September 30, 2007, from $59.4 million, or 0.40% of total
loans, at December 31, 2006. This increase was primarily due to an
increase of $27.1 million in non-performing one-to-four family mortgage loans,
partially offset by a decrease of $6.2 million in non-performing multi-family
mortgage loans. We sold non-performing mortgage loans totaling $9.4
million, primarily multi-family and commercial real estate loans, during the
nine months ended September 30, 2007. For further discussion of the
sale of these loans, including the impact the sale may have had on our
non-performing loans, non-performing assets and related ratios at September
30,
2007, see “Asset Quality.” The increase in non-performing loans and
assets occurred primarily during the 2007 third quarter.
We
continue to closely monitor the local and national real estate markets and
other
factors related to risks inherent in our loan portfolio. Subprime
mortgage lending, which has been the riskiest sector of the residential housing
market, is not a market that we have ever actively pursued. We
believe the slow down in the housing market has not had a discernable negative
impact on our loan loss experience as measured by trends in our net loan
charge-offs and losses on real estate owned. Our loss experience in
2007 has been relatively consistent with our experience over the past several
years and in recent years has been primarily attributable to a small number
of
loans. Our non-performing mortgage loans had an average loan-to-value
ratio, based on current principal balance and original appraised value, of
71%
at September 30, 2007 and December 31, 2006. The average age of our
non-performing mortgage loans since origination was 3.9 years at September
30,
2007. Therefore, the majority of non-performing mortgage loans in our
portfolio were originated prior to 2006, when real estate values were rising,
and would likely have current loan-to-value ratios equal to or lower than those
at the origination date. In reviewing the loan-to-value ratios of our
non-performing loans at September 30, 2007 and December 31, 2006, we determined
that there was no additional inherent loss in our non-performing loan portfolio
compared to the estimates included in our existing
methodology. Additionally, we continue to adhere to prudent
underwriting standards. We underwrite our one-to-four family mortgage
loans primarily based upon our evaluation of the borrower’s ability to
pay. We generally do not obtain updated estimates of collateral value
for loans until classified or requested by our Asset Classification
Committee. We monitor property value trends in our market areas to
determine what impact, if any, such trends may have on our loan-to-value ratios
and the adequacy of the allowance for loan losses. Based on our
review of property value trends, including updated estimates of collateral
value
on classified loans, we do not believe the current slow down in the housing
market had a discernable negative impact on the value of our non-performing
loan
collateral as of September 30, 2007. Since we determined there was
sufficient collateral value to support our non-performing loans and we have
not
experienced an increase in related loan charge-offs, no change to our allowance
coverage percentages was required. However, based on our evaluation
of the foregoing factors, and in recognition of the recent increases in
non-performing loans and net loan charge-offs, our 2007 third quarter analyses
indicated that a modest provision for loan losses was warranted for the period
ended September 30, 2007.
For
further discussion of the methodology used to evaluate the allowance for loan
losses, see “Critical Accounting Policies-Allowance for Loan Losses” and for
further discussion of our loan portfolio composition and non-performing loans,
see “Asset Quality.”
Asset
Quality
Non-Performing
Assets
The
following table sets forth information regarding non-performing assets at the
dates indicated.
|
|
At
September 30,
|
|
At
December 31,
|
(Dollars
in Thousands)
|
|
2007
|
|
2006
|
Non-accrual
delinquent mortgage loans
|
|
|
$
77,761
|
|
|
|
$
58,110
|
|
Non-accrual
delinquent consumer and other loans
|
|
|
1,453
|
|
|
|
818
|
|
Mortgage
loans delinquent 90 days or more and
|
|
|
|
|
|
|
|
|
still accruing interest (1)
|
|
|
3,103
|
|
|
|
488
|
|
Total
non-performing loans
|
|
|
82,317
|
|
|
|
59,416
|
|
Real
estate owned, net (2)
|
|
|
4,336
|
|
|
|
627
|
|
Total
non-performing assets
|
|
|
$
86,653
|
|
|
|
$
60,043
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-performing
loans to total loans
|
|
|
0.52
|
%
|
|
|
0.40
|
%
|
Non-performing
loans to total assets
|
|
|
0.38
|
|
|
|
0.28
|
|
Non-performing
assets to total assets
|
|
|
0.40
|
|
|
|
0.28
|
|
Allowance
for loan losses to non-performing loans
|
|
|
95.06
|
|
|
|
134.55
|
|
Allowance
for loan losses to total loans
|
|
|
0.49
|
|
|
|
0.53
|
|
(1)
|
Mortgage
loans delinquent 90 days or more and still accruing interest consist
solely of loans delinquent 90 days or more as to their maturity date
but
not their interest due.
|
(2)
|
Real
estate acquired as a result of foreclosure or by deed in lieu of
foreclosure is recorded at the lower of cost or fair value, less
estimated
selling costs, and is comprised of one-to-four family properties.
|
Non-performing
assets increased $26.7 million to $86.7 million at September 30, 2007, from
$60.0 million at December 31, 2006. Our ratio of non-performing
assets to total assets was 0.40% at September 30, 2007 and 0.28% at December
31,
2006. Non-performing loans, the most significant component of
non-performing assets, increased $22.9 million to $82.3 million at September
30,
2007, from $59.4 million at December 31, 2006. The ratio of
non-performing loans to total loans was 0.52% at September 30, 2007 and 0.40%
at
December 31, 2006. Non-performing mortgage loans, the most
significant component of non-performing loans, totaled $80.9 million at
September 30, 2007 and $58.6 million at December 31, 2006. The
increases in non-performing loans and assets were primarily due to an increase
of $27.1 million in non-performing one-to-four family mortgage loans, partially
offset by a decrease of $6.2 million in non-performing multi-family mortgage
loans. The increase in non-performing loans and assets occurred
primarily during the 2007 third quarter. We believe the increase is
primarily due to the overall increase in our loan portfolio and to the softening
of the real estate market. Despite the increase in non-performing
loans at September 30, 2007, our non-performing loans continue to remain at
low
levels relative to the size of our loan portfolio.
During
the nine months ended September 30, 2007, we sold $9.4 million of non-performing
mortgage loans, primarily multi-family and commercial real estate loans, of
which $2.3 million were non-performing as of December 31, 2006. The
remainder became non-performing during 2007. We are unable to
determine with any degree of certainty whether some or all of these loans would
have remained non-performing as of September 30, 2007 had they not been sold,
particularly in light of our aggressive collection efforts and prior experience
with other
borrowers. However,
assuming the $9.4 million of non-performing loans sold were not sold and were
both outstanding and non-performing at September 30, 2007, our non-performing
loans would have totaled $91.7 million, or an increase of $32.3 million from
December 31, 2006, and our non-performing assets would have totaled $96.1
million, or an increase of $36.1 million from December 31,
2006. Additionally, at September 30, 2007, our ratio of
non-performing loans to total loans would have increased to 0.57%, our ratio
of
non-performing assets to total assets would have increased to 0.44% and the
allowance for loan losses as a percentage of total non-performing loans would
have decreased to 85.31%.
The
following table provides further details on the composition of our
non-performing one-to-four family and multi-family and commercial real estate
mortgage loans in dollar amounts, percentages of the portfolio and loan-to-value
ratios, based on current principal balance and original appraised value, at
the
dates indicated.
|
|
At
September 30, 2007
|
|
At
December 31, 2006
|
|
|
|
|
|
Percent
|
|
Loan
|
|
|
|
|
Percent
|
|
Loan
|
|
|
|
|
|
of
|
|
-to-
|
|
|
|
|
of
|
|
-to-
|
(Dollars
in Thousands)
|
|
Amount
|
|
Total
|
|
Value
|
|
Amount
|
|
Total
|
|
Value
|
Non-performing
loans:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One-to-four
family:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Full
documentation interest-only
|
|
|
$
17,121
|
|
|
|
25.11
|
%
|
|
|
77
|
%
|
|
|
$
8,513
|
|
|
|
20.70
|
%
|
|
|
77
|
%
|
Full
documentation amortizing
|
|
|
19,095
|
|
|
|
28.00
|
|
|
|
70
|
|
|
|
16,404
|
|
|
|
39.89
|
|
|
|
71
|
|
Reduced
documentation interest-only
|
|
|
20,871
|
|
|
|
30.61
|
|
|
|
72
|
|
|
|
5,945
|
|
|
|
14.46
|
|
|
|
74
|
|
Reduced
documentation
amortizing
|
|
|
11,101
|
|
|
|
16.28
|
|
|
|
66
|
|
|
|
10,262
|
|
|
|
24.95
|
|
|
|
68
|
|
Total
one-to-four family
|
|
|
$
68,188
|
|
|
|
100.00
|
%
|
|
|
72
|
%
|
|
|
$
41,124
|
|
|
|
100.00
|
%
|
|
|
72
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Multi-family
and commercial real estate:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Full
documentation
amortizing
|
|
|
$
9,404
|
|
|
|
100.00
|
%
|
|
|
65
|
%
|
|
|
$
17,474
|
|
|
|
100.00
|
%
|
|
|
70
|
%
|
At
September 30, 2007, the geographic composition of our non-performing one-to-four
family mortgage loans was consistent with the geographic composition of our
one-to-four family mortgage loan portfolio and, as of September 30, 2007, did
not indicate a negative trend in any one particular geographic
location.
We
discontinue accruing interest on mortgage loans when such loans become 90 days
delinquent as to their interest due, even though in some instances the borrower
has only missed two payments. At September 30, 2007, $24.1 million of
mortgage loans classified as non-performing had missed only two payments,
compared to $17.3 million at December 31, 2006. We discontinue
accruing interest on consumer and other loans when such loans become 90 days
delinquent as to their payment due. In addition, we reverse all
previously accrued and uncollected interest through a charge to interest
income. While loans are in non-accrual status, interest due is
monitored and income is recognized only to the extent cash is received until
a
return to accrual status is warranted.
If
all
non-accrual loans at September 30, 2007 and 2006 had been performing in
accordance with their original terms, we would have recorded interest income,
with respect to such loans, of $3.8 million for the nine months ended September
30, 2007 and $2.5 million for the nine months ended September 30,
2006. This compares to actual payments recorded as interest income,
with respect to such loans, of $1.8 million for the nine months ended September
30, 2007 and $1.1 million for the nine months ended September 30,
2006.
In
addition to non-performing loans, we had $1.7 million of potential problem
loans
at September 30, 2007, compared to $734,000 at December 31,
2006. Such loans are 60-89 days delinquent as shown in the following
table.