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ITEM
2.
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Management's
Discussion and
Analysis of Financial Condition and Results of
Operations
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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:
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the
timing and occurrence or non-occurrence of events may be subject
to
circumstances beyond our control;
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there
may be increases in competitive pressure among financial institutions
or
from non-financial institutions;
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·
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changes
in the interest rate environment may reduce interest margins or
affect the
value of our investments;
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·
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changes
in deposit flows, loan demand or real estate values may adversely
affect
our business;
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·
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changes
in accounting principles, policies or guidelines may cause our
financial
condition to be perceived
differently;
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·
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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;
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·
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legislative
or regulatory changes may adversely affect our
business;
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technological
changes may be more difficult or expensive than we
anticipate;
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success
or consummation of new business initiatives may be more difficult
or
expensive than we anticipate; or
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·
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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.
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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 are 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. 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. The balance of our allowance for loan losses represents
management’s best estimate of the probable inherent losses in our loan portfolio
at March 31, 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 March 31, 2007 and December 31, 2006
and
Operating Results for the Three
Months Ended March 31, 2007 and 2006
Results
of
Operations
Provision
for Loan
Losses
During
the three months ended March 31, 2007 and 2006, no provision for loan losses
was
recorded. The allowance for loan losses totaled $80.1 million at
March 31, 2007 and $79.9 million at December 31, 2006. The balance of
our allowance for loan losses represents management’s best estimate of the
probable inherent losses in our loan portfolio at March 31, 2007 and 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
composition of our loan portfolio has remained consistent over the last several
years. At March 31, 2007, our loan portfolio was comprised of 69%
one-to-four family mortgage loans, 20% multi-family mortgage loans, 7%
commercial real estate loans and 4% other loan categories. 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 $8.5 million to $67.9 million, or
0.45%
of total loans, at March 31, 2007, from $59.4 million, or 0.40% of total
loans,
at December 31, 2006. This increase was primarily due to increases in
non-performing one-to-four family mortgage loans. During the three
months ended March 31, 2007, we sold $2.3 million of non-performing multi-family
mortgage loans. 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 March 31, 2007, see “Asset
Quality.”
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. During the three months
ended March 31, 2007, net recoveries totaled $155,000, compared to net
charge-offs of $16,000 for the three months ended March 31, 2006, representing
less than one basis point of average loans outstanding during both the three
months ended March 31, 2007 and 2006. 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. The average loan-to-value ratios, based on current
principal balance and original appraised value, of total one-to-four family
loans outstanding as of March 31, 2007, by year of origination, were 67%
for the
three months ended March 31, 2007, 67% for 2006, 69% for 2005, 69% for 2004
and
58% for pre-2004 originations. As of March 31, 2007, average
loan-to-value ratios, based on current principal balance and original appraised
value, of
total
multi-family and commercial real estate loans outstanding, by year of
origination, were 64% for the three months ended March 31, 2007, 68% for
2006,
67% for 2005, 64% for 2004 and 59% for pre-2004 originations.
As
previously discussed, there has been a slow down in the housing market,
particularly during the second half of 2006. We are closely
monitoring the local and national real estate markets and other factors related
to risks inherent in the loan portfolio. We believe this 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 non-performing mortgage loans have not increased
substantially and had an average loan-to-value ratio, based on current principal
balance and original appraised value, of 71% at March 31, 2007 and December
31,
2006. The average age of our non-performing mortgage loans since
origination was 3.8 years at March 31, 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 March 31,
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. 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 March 31, 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. Based on our evaluation of the
foregoing factors, our 2007 analyses indicated that no provision for loan
losses
was warranted for the three months ended March 31, 2007 and that our allowance
for loan losses at March 31, 2007 was adequate.
The
allowance for loan losses as a percentage of non-performing loans decreased
to
117.90% at March 31, 2007, from 134.55% at December 31, 2006, primarily due
to
the increase in non-performing loans from December 31, 2006 to March 31,
2007. The allowance for loan losses as a percentage of total loans
was 0.53% at both March 31, 2007 and December 31, 2006. 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 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.
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At
March
31,
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At
December
31,
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(Dollars
in
Thousands)
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2007
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Non-accrual
delinquent mortgage loans
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$66,344
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$58,110
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Non-accrual
delinquent consumer and other loans
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1,122
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818
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Mortgage
loans delinquent 90 days or more and
still
accruing interest (1)
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473
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488
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Total
non-performing loans
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67,939
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59,416
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Real
estate owned, net (2)
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458
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627
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Total
non-performing assets
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$68,397
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$60,043
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Non-performing
loans to total loans
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0.45
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%
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0.40
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%
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Non-performing
loans to total assets
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0.32
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0.28
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Non-performing
assets to total assets
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0.32
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0.28
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Allowance
for loan losses to non-performing loans
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117.90
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134.55
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Allowance
for loan losses to total loans
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0.53
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0.53
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(1)
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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.
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(2)
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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.
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Non-performing
assets increased $8.4 million to $68.4 million at March 31, 2007, from $60.0
million at December 31, 2006. Non-performing loans, the most
significant component of non-performing assets, increased $8.5 million to
$67.9
million at March 31, 2007, from $59.4 million at December 31,
2006. As previously discussed, these increases were primarily due to
increases in non-performing one-to-four family mortgage loans. At
March 31, 2007, approximately 26% of total non-performing loans are
interest-only loans and 35% of total non-performing loans are reduced
documentation loans. At March 31, 2007, there were no non-performing
interest-only multi-family and commercial real estate loans and we do not
originate reduced documentation multi-family and commercial real estate
loans. The average loan-to-value ratio of our non-performing mortgage
loans, based on current principal balance and original appraised value, was
71%
at March 31, 2007 and December 31, 2006. Our non-performing loans
continue to remain at low levels relative to the size of our loan
portfolio. The ratio of non-performing loans to total loans was 0.45%
at March 31, 2007 and 0.40% at December 31, 2006. Our ratio of
non-performing assets to total assets was 0.32% at March 31, 2007 and 0.28%
at
December 31, 2006.
During
the three months ended March 31, 2007, we sold $2.3 million of non-performing
multi-family mortgage loans, of which $499,000 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 March
31,
2007 had they not been sold, particularly in light of our aggressive collection
efforts and prior experience with other borrowers. However, assuming
the $2.3 million of non-performing loans sold were not sold and were both
outstanding and non-performing at March 31, 2007, our non-performing loans
would
have totaled $70.2 million, or an increase of $10.8 million from December
31,
2006, and our non-performing assets would have totaled $70.7 million, or
an
increase of $10.7 million from December 31, 2006. Additionally, at
March 31, 2007, our ratio of non-performing loans to total loans would have
increased to 0.47%, our ratio of non-performing
assets
to
total assets would have increased to 0.33% and the allowance for loan losses
as
a percentage of total non-performing loans would have decreased to
114.06%.
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 March 31, 2007, $17.1 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 March 31, 2007 and 2006 had been performing in accordance
with their original terms, we would have recorded interest income, with respect
to such loans, of $1.2 million for the three months ended March 31, 2007
and
$794,000 for the three months ended March 31, 2006. This compares to
actual payments recorded as interest income, with respect to such loans,
of
$261,000 for the three months ended March 31, 2007 and $165,000 for the three
months ended March 31, 2006.
In
addition to the non-performing loans, we had $824,000 of potential problem
loans
at March 31, 2007, compared to $734,000 at December 31, 2006. Such
loans are 60-89 days delinquent as shown in the following table.