Item 1B.Unresolved Staff Comments
None.
We conduct our business at 226 retail banking centers locations in northern and central New Jersey, the New York City boroughs of Manhattan, Brooklyn and Queens, Long Island, Florida and Alabama. We own 98 of our banking center facilities and several non-branch operating facilities. The other properties are leased for various terms.
The following table summarizes our retail banking centers in each state:
Our principal executive office is located at One Penn Plaza in Manhattan, New York. Many of our bank operations are located in Wayne, New Jersey, where we own five office buildings. Our New York City corporate headquarters are primarily used as a central hub for New York based lending activities of senior executives and other commercial lenders. We also lease six non-bank office facilities in Florida, used for operational, executive and lending purposes.
On December 1, 2019, the acquisition of Oritani added 26 banking centers mostly located in northern New Jersey. During 2020, we closed and consolidated 11 of the 26 acquired branches into nearby legacy Valley branches. See the "Executive Summary" section of Item 7. MD&A for details on other planned changes to our branch network in 2021.
The total net book value of our premises and equipment (including land, buildings, leasehold improvements and furniture and equipment) was $319.8 million at December 31, 2020. We believe that all of our properties and equipment are well maintained, in good operating condition and adequate for all of our present and anticipated needs.
Item 3.
Item 3.Legal Proceedings
In the normal course of business, we may be a party to various outstanding legal proceedings and claims. In the opinion of management, our financial condition, results of operations, and liquidity should not be materially affected by the outcome of such legal proceedings and claims.
PART II
Item 5.
Item 5.Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is traded on the NASDAQ Global Select Market under the ticker symbol “VLY”. There were 7,638 shareholders of record as of December 31, 2020.
Performance Graph
The following graph compares the cumulative total return on a hypothetical $100 investment made on December 31, 2015 in: (a) Valley’s common stock; (b) the KBW Regional Banking Index (KRX) and (c) the Standard and Poor’s (S&P) 500 Stock Index. The graph is calculated assuming that all dividends are reinvested during the relevant periods. The graph shows how a $100 investment would increase or decrease in value over time based on dividends (stock or cash) and increases or decreases in the market price of the stock.
Issuer Repurchase of Equity Securities
The following table presents the purchases of equity securities by the issuer and affiliated purchasers during the three months ended December 31, 2020:
(1)Represents repurchases made in connection with the vesting of employee stock awards.
(2)On January 17, 2007, Valley publicly announced its intention to repurchase up to 4.7 million outstanding common shares in the open market or in privately negotiated transactions. The repurchase plan has no stated expiration date. No repurchase plans or programs expired or terminated during the three months ended December 31, 2020.
Item 6.
Item 6.Selected Financial Data
Not applicable.
Item 7.
Item 7.Management’s Discussion and Analysis (MD&A) of Financial Condition and Results of Operations
The purpose of this analysis is to provide the reader with information relevant to understanding and assessing Valley’s results of operations and financial condition for each of the past two years. In order to fully appreciate this analysis, the reader is encouraged to review the consolidated financial statements and accompanying notes thereto appearing under Item 8 of this report, and statistical data presented in this document. For comparison of our results of operations for the years ended December 31, 2019 and 2018, please refer to Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations of our Report on Form 10-K for the year ended December 31, 2019, filed with the SEC on March 10, 2020.
Cautionary Statement Concerning Forward-Looking Statements
This report, both in MD&A and elsewhere, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are not historical facts and include expressions about management’s confidence and strategies and management’s expectations about our business, new and existing programs and products, acquisitions, relationships, opportunities, taxation, technology, market conditions and economic expectations. These statements may be identified by such forward-looking terminology as “should,” “expect,” “believe,” “view,” “opportunity,” “allow,” “continues,” “reflects,” “typically,” “usually,” “anticipate,” or similar statements or variations of such terms. Such forward-looking statements involve certain risks and uncertainties and our actual results may differ materially from such forward-looking statements. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements in addition to those risk factors listed under the “Risk Factors” section in Part1, Item 1A of this Annual Report on Form 10-K include, but are not limited to:
•the impact of COVID-19 on the U.S. and global economies, including business disruptions, reductions in employment and an increase in business failures, specifically among our clients;
•the impact of COVID-19 on our employees and our ability to provide services to our customers and respond to their needs as more cases of COVID-19 may arise in our primary markets;
•potential judgments, claims, damages, penalties, fines and reputational damage resulting from pending or future litigation and regulatory and government actions, including as a result of our participation in and execution of government programs related to the COVID-19 pandemic or as a result of our actions in response to, or failure to implement or effectively implement, federal, state and local laws, rules or executive orders requiring that we grant forbearances or not act to collect our loans;
•the impact of forbearances or deferrals we are required or agree to as a result of customer requests and/or government actions, including, but not limited to our potential inability to recover fully deferred payments from the borrower or the collateral;
•damage verdicts or settlements or restrictions related to existing or potential class action litigation or individual litigation arising from claims of violations of laws or regulations, contractual claims, breach of fiduciary responsibility, negligence, fraud, environmental laws, patent or trademark infringement, employment related claims, and other matters;
•a prolonged downturn in the economy, mainly in New Jersey, New York, Florida and Alabama, as well as an unexpected decline in commercial real estate values within our market areas;
•higher or lower than expected income tax expense or tax rates, including increases or decreases resulting from changes in uncertain tax position liabilities, tax laws, regulations and case law;
•the inability to grow customer deposits to keep pace with loan growth;
•a material change in our allowance for credit losses under CECL due to forecasted economic conditions and/or unexpected credit deterioration in our loan and investment portfolios;
•the need to supplement debt or equity capital to maintain or exceed internal capital thresholds;
•greater than expected technology related costs due to, among other factors, prolonged or failed implementations, additional project staffing and obsolescence caused by continuous and rapid market innovations;
•the loss of or decrease in lower-cost funding sources within our deposit base, including our inability to achieve deposit retention targets under Valley's branch transformation strategy;
•cyber-attacks, computer viruses or other malware that may breach the security of our websites or other systems to obtain unauthorized access to confidential information, destroy data, disable or degrade service, or sabotage our systems;
•results of examinations by the Office of the Comptroller of the Currency (OCC), the Federal Reserve Bank (FRB), the Consumer Financial Protection Bureau (CFPB) and other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our allowance for credit losses, write-down assets, reimburse customers, change the way we do business, or limit or eliminate certain other banking activities;
•our inability or determination not to pay dividends at current levels, or at all, because of inadequate earnings, regulatory restrictions or limitations, changes in our capital requirements or a decision to increase capital by retaining more earnings;
•unanticipated loan delinquencies, loss of collateral, decreased service revenues, and other potential negative effects on our business caused by severe weather, the COVID-19 pandemic or other external events;
•unexpected significant declines in the loan portfolio due to the lack of economic expansion, increased competition, large prepayments, changes in regulatory lending guidance or other factors; and
•the failure of other financial institutions with whom we have trading, clearing, counterparty and other financial relationships.
Critical Accounting Policies and Estimates
Our accounting and reporting policies conform, in all material respects, to U.S. GAAP. In preparing the consolidated financial statements, management has made estimates, judgments and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated statements of financial condition and results of operations for the periods indicated. Actual results could differ materially from those estimates.
Valley’s accounting policies are fundamental to understanding management’s discussion and analysis of its financial condition and results of operations. Our significant accounting policies are presented in Note 1 to the consolidated financial statements. We identified our policies for the allowance for credit losses, goodwill and other intangible assets, and income taxes to be critical because management has to make subjective and/or complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions. Management has reviewed the application of these policies with the Audit Committee of Valley’s Board of Directors.
The judgments used by management in applying the critical accounting policies discussed below may be affected by significant changes in the economic environment, which may result in changes to future financial results. Specifically, subsequent evaluations of the loan portfolio, in light of the factors then prevailing, may result in material changes in the allowance for credit losses in future periods, and the inability to collect on outstanding loans could result in increased loan losses.
Allowance for Credit Losses. Determining the allowance for credit losses for loans has historically been identified as a critical accounting estimate. On January 1, 2020, we adopted new accounting guidance which requires entities to estimate and recognize an allowance for lifetime expected credit losses for loans, unfunded credit commitments and held to maturity debt securities measured at amortized cost. Previously, an allowance for credit losses for loans was recognized based on probable incurred losses. See Notes 1, 4 and 5 to the consolidated financial statements for further discussion of our accounting policies and methodologies for establishing the allowance for credit losses.
The accounting estimates relating to the allowance for credit losses is a "critical accounting estimate" for the following reasons:
•Changes in the provision for credit losses can materially affect our financial results;
•Estimates relating to the allowance for credit losses require us to project future borrower performance, delinquencies and charge-offs, along with, when applicable, collateral values, based on a reasonable and supportable forecast period utilizing forward-looking economic scenarios in order to estimate probability of default and loss given default;
•The allowance for credit losses is influenced by factors outside of our control such as industry and business trends, geopolitical events and the effects of laws and regulations as well as economic conditions such as trends in housing prices, interest rates, gross domestic product (GDP), inflation, energy prices and unemployment; and
•Judgment is required to determine whether the models used to generate the allowance for credit losses produce an estimate that is sufficient to encompass the current view of lifetime expected credit losses.
Our estimation process is subject to risks and uncertainties, including a reliance on historical loss and trend information that may not be representative of current conditions and indicative of future performance. Changes in such estimates could significantly impact our allowance and provision for credit losses. Accordingly, our actual credit loss experience may not be in line with our expectations.
Changes in Our Allowance for Credit Losses for Loans
Valley considers it difficult to quantify the impact of changes in forecast on its allowance for credit losses. However, management believes the following discussion may enable investors to better understand the variables that drive the allowance for credit losses for loans, which amounted to $340.2 million at December 31, 2020.
As discussed further in the "Allowance for Credit Losses" section in this MD&A, we incorporated a multi-scenario economic forecast for estimating lifetime expected credit losses at December 31, 2020. As a result of the deterioration in economic conditions caused by the COVID-19 pandemic during 2020 and the related increase in economic uncertainty, we increased our probability weighting for the most severe economic scenario as compared to those at January 1, 2020. As a result, approximately $50.2 million of the $87.2 million increase in our allowance for credit losses for loans from January 1, 2020 reflected the impact of the adverse economic forecast within Valley's lifetime expected credit loss estimate, as well as other qualitative factors. Specific reserves, largely based upon management's valuation of collateral for collateral dependent loans and the present value of expected cash flows for certain troubled debt restructured loans, and quantitative reserves, based upon expected and actual transitions in the credit quality of our loan portfolio, represented $20.9 million and $16.1 million, respectively, of the remaining increase in reserves at December 31, 2020.
In addition, the valuation of certain collateral dependent loans (including New York City taxi medallion loan valuations based on the estimated value of the underlying medallions) could be adversely impacted by illiquidity or dislocation in certain markets, resulting in depressed market valuations of the underlying collateral, thus leading to additional provisions for loan losses.
Goodwill and Other Intangible Assets. We have significant goodwill and other intangible assets related to our acquisitions totaling $1.4 billion and $70.4 million at December 31, 2020, respectively. We record all assets, liabilities, and non-controlling interests in the target in purchase acquisitions, including goodwill and other intangible assets, at fair value as of the acquisition date, and expense all acquisition related costs as incurred as required by ASC Topic 805, “Business Combinations.” The initial recording of goodwill and other intangible assets requires subjective judgments concerning estimates of the fair value of the acquired assets and assumed liabilities. Goodwill is subject to annual tests for impairment or more often, if events or circumstances indicate it may be impaired. Our determination of whether or not goodwill is impaired requires us to make significant judgments and to use significant estimates and assumptions regarding estimated future cash flows. If we change our strategy or if market conditions shift, our judgments may change, which may result in adjustments to the recorded goodwill balance. Other intangible assets are amortized over their estimated useful lives and are subject to impairment tests if events or circumstances indicate a possible inability to realize the carrying amount. Such evaluation of other intangible assets is based on undiscounted cash flow projections.
On January 1, 2020, we adopted ASU No. 2017-04 intended to simplify the goodwill impairment test by eliminating a second step which required an entity to determine the implied fair value of the reporting unit’s goodwill. Instead, an impairment loss is now recognized if the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, with the impairment loss not to exceed the amount of goodwill recorded.
We perform our annual goodwill impairment test in the second quarter of each year, or more often if events or circumstances warrant. In addition to the annual impairment test, we assessed the impact of the COVID-19 pandemic on macroeconomic variables and economic forecasts and how those might impact the fair value of our reporting units each quarter end. After consideration of these variables and other possible triggering events or circumstances, as well as our operating results, we determined it was more-likely-than-not that the fair values of our four reporting units, wealth management, consumer lending, commercial lending, and investment management, were in excess of their carrying values during 2020. Therefore, we concluded there were no triggering events that would require additional goodwill impairment test of the reporting units during 2020.
Based upon Valley’s 2020 annual goodwill impairment testing, the fair values of its four reporting units were in excess of their carrying values. In 2021, we will continue to monitor and evaluate the impact of COVID-19 and its impact on our market capitalization, overall economic conditions, and any triggering events that may indicate a possible impairment of goodwill allocated to our reporting units. While not expected at this time, we may be required to record a charge to earnings should there
be a deficiency in our estimated fair value of one or more of our reporting units during our subsequent annual (or more frequent) impairment tests. See the "Business Segments" section for more information regarding our business segments/reporting units.
Fair value is determined using certain discounted cash flow and market multiple methods. Estimated cash flows may extend far into the future and, by their nature, are difficult to determine over an extended timeframe. Factors that may materially affect the estimates include, among others, impact of the COVID-19 pandemic on macroeconomic variables and economic forecasts, competitive forces, customer behaviors and attrition, changes in revenue growth trends, cost structures and technology, and changes in discount rates, growth rate, terminal values, and specific industry or market sector conditions. To assist in assessing the impact of potential goodwill or other intangible assets impairment charges at December 31, 2020, the impact of a five percent impairment charge on these intangible assets would result in a reduction in pre-tax income of approximately $72.6 million. See Note 8 to the consolidated financial statements for additional information regarding goodwill and other intangible assets.
Income Taxes. We are subject to the income tax laws of the U.S., its states and municipalities. The income tax laws of the jurisdictions in which we operate are complex and subject to different interpretations by the taxpayer and the relevant government taxing authorities. In establishing a provision for income tax expense, we must make judgments and interpretations about the application of these inherently complex tax laws to our business activities, as well as the timing of when certain items may affect taxable income.
Our interpretations may be subject to review during examination by taxing authorities and disputes may arise over the respective tax positions. We attempt to resolve these disputes during the tax examination and audit process and ultimately through the court systems when applicable. We monitor relevant tax authorities and revise our estimate of accrued income taxes due to changes in income tax laws and their interpretation by the courts and regulatory authorities on a quarterly basis. Revisions of our estimate of accrued income taxes also may result from our own income tax planning and from the resolution of income tax controversies. Such revisions in our estimates may be material to our operating results for any given quarter.
The provision for income taxes is composed of current and deferred taxes. Deferred taxes arise from differences between assets and liabilities measured for financial reporting versus income tax return purposes. Deferred tax assets are recognized if, in management’s judgment, their realizability is determined to be more likely than not. We perform regular reviews to ascertain the realizability of our deferred tax assets. These reviews include management’s estimates and assumptions regarding future taxable income, which also incorporate various tax planning strategies. In connection with these reviews, if we determine that a portion of the deferred tax asset is not realizable, a valuation allowance is established. Management determined it is more likely than not that Valley will realize its net deferred tax assets, except for immaterial valuation allowances, as of December 31, 2020 and 2019.
We also maintain a reserve related to certain tax positions that management believes contain an element of uncertainty. An uncertain tax position is measured based on the largest amount of benefit that management believes is more likely than not to be realized. During 2020 and 2019, our income tax expense reflected $1.5 million and $31.1 million increases to our tax provision related to reserve for uncertain tax liability positions and/or accrued interest related to such positions at December 31, 2020 and 2019, respectively, as compared to a $3.3 million net state tax benefit in 2018 related to the reduction of reserves at December 31, 2018 caused by the expiration of the statute of limitations for certain tax positions.
See Notes 1 and 13 to the consolidated financial statements and the "Executive Summary" and “Income Taxes” sections in this MD&A for an additional discussion on the accounting for income taxes.
New Authoritative Accounting Guidance. See Note 1 of the consolidated financial statements for a description of recent accounting pronouncements including the dates of adoption and the anticipated effect on our results of operations and financial condition.
Executive Summary
Company Overview. At December 31, 2020, Valley had consolidated total assets of $40.7 billion, total net loans of $31.9 billion, total deposits of $31.9 billion and total shareholders’ equity of $4.6 billion. Our commercial bank operations include branch office locations in northern and central New Jersey, the New York City boroughs of Manhattan, Brooklyn and Queens, Long Island, Florida and Alabama. Of our current 226 branch network, 58 percent, 17 percent, 18 percent and 7 percent of the branches are located in New Jersey, New York, Florida and Alabama, respectively. Despite targeted branch consolidation activity, we have significantly grown both in asset size and locations over the past several years primarily through bank acquisitions, including our acquisition of Oritani Financial Corp. (Oritani) and its wholly-owned subsidiary, Oritani Bank on December 1, 2019. See Note 2 to the consolidated financial statements for more information regarding the Oritani acquisition.
Impact of COVID-19. The spread of COVID-19 has created a global public health crisis that has resulted in unprecedented uncertainty, volatility and disruption in financial markets and in governmental, commercial and consumer activity in the United States and globally, including the markets that we serve. While the overall level of economic activity has improved in the second half of 2020 following the steep economic downturn in second quarter 2020, certain industries and businesses continue to be adversely impacted with a significant loss of their normal revenue streams and continue to experience business interruptions. Our outlook, which remains unchanged from the end of the third quarter 2020 indicates continued macroeconomic deterioration with higher levels of credit stress related to borrowers impacted by COVID-19 and lower valuations of collateral securing our non-performing taxi medallion loan portfolio. Uncertainties and disruptions resulting from the COVID-19 pandemic slowed our traditional new commercial loan volumes and the loan balances for residential and many consumer loan products saw moderate declines in the second half of 2020, primarily as a result of the higher level of residential mortgage loans originated for sale due to our current interest rate risk management strategies. Any sustained economic downturn due to COVID-19 and other factors, or other long-term changes in consumer and business behaviors from COVID-19 may adversely impact the value of assets that serve as collateral for our loans.
The Paycheck Protection Program (PPP) provided for in the Coronavirus Aid, Relief, and Economic Security (CARES) Act, as supplemented by the Paycheck Protection Program and Health Care Enhancement Act (Enhancement Act), was designed to aid small- and medium-sized businesses through federally guaranteed loans distributed through banks. These loans are intended to guarantee 8 to 24 weeks of payroll and other costs to help those businesses remain viable and allow their workers to pay their bills. Valley National Bank is a certified Small Business Administration (SBA) lender and facilitated approximately 13,000 SBA-approved PPP loans with balances totaling $2.2 billion as of December 31, 2020. While difficult to accurately predict, we expect the majority of these loans to be forgiven in accordance with rules, application and documentation requirements for this program.
The Consolidated Appropriations Act, 2021, which was signed into law on December 27, 2020 (Appropriations Act), provides approximately $900 billion in new COVID-19 stimulus relief partly comprised of additional funding under the PPP. The Appropriations Act also expanded borrower eligibility under the PPP to certain second draws under the program. During the first quarter 2021, Valley has approved PPP loan applications totaling approximately $534 million within its pipeline, and originated $499 million of such loans through February 19, 2021. Our future PPP loan originations may ultimately be less than the approved loan application pipeline due to normal underwriting contingencies.
We have reopened all bank branches in our network that were either temporarily closed or had reduced lobby services due to COVID-19. However, we continue to act with an abundance of caution in order to safeguard the health and wellness of our customers and employees and may limit capacity in our branch locations and/or require scheduled appointments in the future. We continue to closely monitor local conditions in the areas we serve and will take actions as circumstances warrant, which may necessitate certain branch or other office closures and reduced lobby services. Our business continuity plan continues to remain in effect with many of our non-customer facing employees continuing to work remotely as we monitor the level of the health crisis in our primary markets.
In response to the COVID-19 pandemic and its economic impact on certain customers and in accordance with provisions set forth by the CARES Act, Valley implemented short-term loan modifications, such as payment deferrals, fee waivers, extensions of repayment terms, or delays in payment that are insignificant, when requested by customers. Generally, the modification terms allow for a deferral of payments for up to 90 days, which Valley may extend for an additional 90 days. Any extensions beyond this period were made in accordance with applicable regulatory guidance. As of December 31, 2020, Valley had $361 million of outstanding loans remaining in their payment deferral period under short-term modifications. The $361 million of loans in deferral represented approximately 1.1 percent of our total loan portfolio at December 31, 2020, having decreased significantly from approximately $1.1 billion, or 3.3 percent of total loans, near the start of the third quarter 2020.
Significant uncertainties persist as to the impact of future economic conditions and stress on our customers. The severe adverse economic pressures, coupled with the implementation of an expected loss methodology for determining our provision for credit losses as required by CECL, contributed to a sharply increased provision for credit losses for the year ended December 31, 2020, following our initial adoption of CECL on January 1, 2020. We continue to monitor the impact of COVID-19 closely, as well as any effects that may result from the CARES Act, Enhancement Act and other government stimulus or Federal Reserve actions. However, the extent to which the COVID-19 pandemic will impact our operations and financial results during the first quarter 2021 and beyond is highly uncertain. See the "Operating Environment" section of MD&A for more details.
Branch Transformation. As previously disclosed, Valley has embarked on a strategy to continuously overhaul its retail network. Approximately two years ago we established the foundation of what the transformation of our branch network would look like in coming years. At that time, we identified 74 branches that did not meet certain internal performance measures, including 20 branches that were closed and consolidated by the end of the first quarter 2019. For the remaining 54 branches, we
implemented tailored action plans focused on improving profitability and deposit levels, as well as upgrades in staffing and training, within a defined timeline. During 2020, we permanently closed an additional 16 branches located in New Jersey, including the consolidation of 11 acquired Oritani branches into nearby legacy Valley branches, and 2 Florida branches. We also permanently closed one New Jersey branch in the first quarter 2021. For the overall branch network, we continue to monitor the operating performance of each branch and implement tailored action plans focused on improving profitability and deposit levels for those branches that underperform.
Annual Results. Net income totaled $390.6 million, or $0.93 per diluted common share, for the year ended December 31, 2020 compared to $309.8 million in 2019, or $0.87 per diluted common share. The increase in net income compared to 2019 was largely due to:
•a $220.9 million, or 24.6 percent, increase in our net interest income driven primarily by a $5.6 billion increase in average loan balances and a sharp reduction in interest rates of 85 basis points on the cost of total interest bearing liabilities resulting from the low interest environment, partially offset by loan yields that were 53 basis points lower and interest expense related to a $3.9 billion increase in average interest bearing liabilities; and
•a $7.5 million decrease in income tax expense largely due to a $31.1 million addition to our reserves for uncertain tax positions in 2019, partially offset by increased income taxes mostly caused by higher 2020 pre-tax income; partially offset by
•a $101.5 million increase in our provision for credit losses for loans due to the CECL adoption and the impact of the COVID-19 pandemic on the model results;
•a $31.5 million decrease in non-interest income, due in large part to a $78.5 million gain on the sale (and leaseback) of certain Bank properties recognized in 2019, partially offset by a $23.3 million increase in the gain on sale of residential mortgage loans, as well as swap fee income which increased $25.6 million to $59.0 million for 2020; and
•a $14.6 million increase in non-interest expense largely due to higher levels of expense related to our expanded franchise following the Oritani acquisition on December 1, 2019 and the COVID-19 pandemic, partially offset by a $20.0 million decrease in the loss on extinguishment of debt and a $7.1 million decrease in the amortization of tax credit investments.
See the “Net Interest Income,” “Non-Interest Income,” “Non-Interest Expense,” and “Income Taxes” sections below for more details on the items above and other infrequent items, including merger expenses and the loss on extinguishment of debt, impacting our 2020 annual results.
Operating Environment. During 2020, real gross domestic product declined 3.5 percent compared to an increase of 2.2 percent in 2019. The decline in growth was driven by decreases in household consumption, exports, restocking of inventories, business fixed investment and state and local government spending. These decreases were partially offset by increases in residential fixed investment and federal government spending, particularly from non-defense spending, which supported economic activity.
To support economic activity, the Federal Reserve reduced the target range for the federal funds rate in the first half of 2020 and began purchasing Treasury securities and agency residential and commercial mortgage-backed securities. As of the dated of this report, the target range for the federal funds rate is between zero and 0.25 percent. The Federal Reserve indicated at its recent meeting that the current stance of monetary policy is appropriate to support a return to sustained expansion of economic activity.
The 10-year U.S. Treasury note yield ended 2020 at 0.93 percent, or 99 basis points lower as compared to December 31, 2019. The spread between the 2- and 10-year U.S. Treasury note yields ended the year at 0.80 percent, or 46 basis points higher, compared to the end of 2019.
For all commercial banks in the U.S., loans and leases grew approximately 3.5 percent from December 31, 2019 to December 31, 2020. For the industry, banks reported that demand for most commercial loan products had declined sharply compared to the end of 2019. The decline was broad-based across commercial real estate lending and loans to middle market firms. However, banks reported sharply higher demand for residential mortgage loans, particularly those related to jumbo products. Additionally, the industry reported that underwriting standards had generally tightened significantly for both commercial and residential loans. Valley’s commercial and industrial originations in 2020 were primarily driven by loans associated with PPP. In addition, Valley continued to see solid demand for residential mortgage loans across its geographies during most of 2020. However, the path of economic activity is highly contingent on the progress made in combating COVID-19. Should health conditions warrant more widespread restrictions to business activity, spending and investment would
be adversely impacted. Therefore, if conditions remain subdued it could weigh on the Bank’s future financial results, as highlighted below in the MD&A.
Loans. Total loans increased by $2.5 billion to $32.2 billion at December 31, 2020 from December 31, 2019 largely due to $2.2 billion of SBA PPP loans classified as commercial and industrial loans, as well as growth in commercial mortgage loans (including construction loans) which increased $827.1 million, or 4.7 percent during the year ended December 31, 2020. The residential mortgage category and most consumer loan categories experienced moderate declines during the year ended December 31, 2020 due to the impact of COVID-19 pandemic and a higher level of residential mortgage loans originated for sale. During the year ended December 31, 2020, we originated $1.2 billion of residential mortgage loans for sale rather than held for investment. Loans held for sale totaled $301.4 million and $76.1 million at December 31, 2020 and 2019, respectively.
Asset Quality. Prior to our adoption of the CECL standard on January 1, 2020, our past due loans and non-accrual loans which are discussed further below, excluded those loans which were classified as purchased credit impaired (PCI) loans. Under the new standard, Valley's former PCI loans are accounted for as purchased credit deteriorated (PCD) loans and, if applicable, are reported in our past due and non-accrual categories at December 31, 2020.
Total non-performing assets (NPAs), consisting of non-accrual loans, other real estate owned (OREO), other repossessed assets and non-accrual debt security increased $90.1 million, or 86.3 percent to $194.6 million at December 31, 2020 as compared to December 31, 2019. This increase was largely due to non-accrual PCD loans totaling approximately $45 million reported at December 31, 2020 and higher non-accrual taxi medallion loans within the commercial and industrial category. Non-accrual loans totaled $185.3 million, or 0.58 percent of our entire loan portfolio of $32.2 billion, at December 31, 2020 as compared to $93.1 million, or 0.31 percent of total loans, at December 31, 2019.
Total accruing past due loans (i.e., loans past due 30 days or more and still accruing interest) increased $30.8 million to $99.0 million, or 0.31 percent of total loans at December 31, 2020 as compared to $68.2 million, or 0.23 percent of total loans, at December 31, 2019. The increase was largely due to an increase in early stage delinquencies in commercial real estate category as well as approximately $11 million of accruing past due loans PCD loans reported at December 31, 2020.
Our lending strategy is based on underwriting standards designed to maintain high credit quality and we remain optimistic regarding the overall future performance of our loan portfolio. However, due to the potential for future credit deterioration caused by the downturn in economic conditions impacted by the COVID-19 pandemic and a number of our borrowers performing under short-term forbearance agreements, management cannot provide assurance that our non-performing assets will not increase substantially from the levels reported at December 31, 2020. See the “Non-performing Assets” section below for further analysis of our asset quality.
Deposits and Other Borrowings. Our mix of total deposits at December 31, 2020 as compared to December 31, 2019 reflects the shift in customer preference for deposits without stated maturities resulting from the uncertainties stemming from the COVID-19 pandemic and the low interest rates offered on our time deposits. Additionally, PPP loan originations were deposited into customers' checking accounts which increased the proportion of non-interest bearing deposits in our overall deposit mix. Average non-interest bearing deposits represented approximately 27 percent of total average deposits for the year ended December 31, 2020, whereas savings, NOW and money market accounts were 47 percent and time deposits were 26 percent of total average deposits for the year ended December 31, 2020. Average non-interest bearing deposits, savings, NOW and money market accounts, and time deposits were 25 percent, 45 percent, and 30 percent, respectively, for the year ended December 31, 2019. Average total deposits for the year ended December 31, 2020 as compared to 2019 increased by $5.4 billion due, in large part, to the aforementioned PPP loan proceeds, as well as our continuous efforts to encourage new and existing loan borrowers to maintain deposit accounts at Valley, including government deposits. Ending balances of brokered deposits (consisting of both time and money market deposit accounts) were $3.1 billion and $4.1 billion at December 31, 2020 and 2019, respectively.
While we believe the current operating environment will likely continue to be favorable for Valley’s deposit gathering initiatives, we cannot guarantee that we will be able to maintain deposit levels at or near those reported at December 31, 2020. Additionally, the vast majority of the PPP loan customers that are Valley depositors are expected to continue to use PPP funds for qualifying payroll and other costs over an 8 to 24 week total period to obtain loan forgiveness. The resulting outflow of funds for such expenditures may contribute to lower levels of deposit balances in 2021.
Average short-term borrowings decreased $448.7 million to $1.6 billion for 2020 as compared to 2019 largely due to the success of our retail and government deposit gathering efforts and a moderate shift into long-term borrowings.
Average long-term borrowings increased $899.0 million to approximately $2.9 billion for 2020 as compared to 2019 largely due to new FHLB borrowings and our $115.0 million, 5.25 percent fixed-to-floating subordinated notes issued in June
2020. For further discussion of our average interest bearing liabilities see the “Net Interest Income” section below, and for further discussion of our borrowed funds, see Note 10 to the consolidated financial statements.
Selected Performance Indicators. The following table presents our annualized performance ratios for the three years ended December 31, 2020, 2019 and 2018:
Adjusted return on average assets, adjusted return on average shareholders' equity, ROATE and adjusted ROATE included in the table above are non-GAAP measures. Management believes these measures provide information useful to management and investors in understanding our underlying operational performance, business and performance trends, and that these measures facilitate comparisons of our prior performance with the performance of others in the financial services industry. These non-GAAP financial measures should not be considered in isolation or as a substitute for or superior to financial measures calculated in accordance with U.S. GAAP. These non-GAAP financial measures may also be calculated differently from similar measures disclosed by other companies. The non-GAAP measure reconciliations are presented below.
Adjusted net income for the three years ended December 31, 2020, 2019 and 2018 was computed as follows:
(1) Severance expense is included in salary and employee benefits expense.
(2) Impairment is included in the amortization of tax credit investments.
(3) Merger related expenses are primarily within salary and employee benefits expense, professional and legal fees, and other non-interest expenses.
(4) Income tax expense related to reserves for uncertain tax positions in 2019, and a net income tax benefit related to the Tax Cuts and Jobs Act and the USAB acquisition in 2018.
(5) The gain on sale leaseback transactions is included in net gains on the sales of assets within other non-interest income.
(6) The gain from the sale of non-marketable securities is included in other non-interest.
In addition to the items used to calculate net income, as adjusted, in the tables above, our net income is, from time to time, impacted by fluctuations in the level of net gains on sales of loans and swap fees recognized from commercial loan customer transactions. These amounts can vary widely from period to period due to, among other factors, the amount of residential mortgage loans originated for sale, bulk loan portfolio sales and commercial loan customer demand for certain products. See the “Non-Interest Income” section below for more details.
Adjusted annualized return on average assets for the three years ended December 31, 2020, 2019 and 2018 was computed by dividing adjusted net income by average assets, as follows:
Adjusted annualized return on average shareholders' equity for the three years ended December 31, 2020, 2019 and 2018 was computed by dividing adjusted net income by average shareholders' equity, as follows:
ROATE and adjusted ROATE for the three years ended December 31, 2020, 2019 and 2018 were computed by dividing net income and adjusted net income, respectively, by average shareholders’ equity less average goodwill and average other intangible assets, as follows:
Net Interest Income
Net interest income consists of interest income and dividends earned on interest earning assets less interest expense on interest bearing liabilities and represents the main source of income for Valley. The net interest margin on a fully tax equivalent basis is calculated by dividing tax equivalent net interest income by average interest earning assets and is a key measurement used in the banking industry to measure income from interest earning assets.
Annual Period 2020. Net interest income on a tax equivalent basis increased by $220.2 million to $1.1 billion for 2020 as compared to 2019. The increase was mainly driven by interest income related to a $5.6 billion increase in average loan balances, including the impact of $3.4 billion of loans acquired from Oritani on December 1, 2019, and an 85 basis point reduction in the cost of our total interest bearing liabilities due to the lower interest rate environment in 2020. The changes in our average interest earning assets and interest bearing liabilities are discussed further below.
The net interest margin on a tax equivalent basis was 3.03 percent for the year ended December 31, 2020 and increased 8 basis points as compared to 2019. However, the yield on average interest earning assets decreased 59 basis points mainly attributable to decreased yield on average loans and average taxable investments. The yield on average loans decreased 53 basis points to 4.04 percent for 2020 as compared to 4.57 percent in 2019 largely due to new and refinanced loan originations at lower market interest rates, loan prepayments, and interest rates resetting on adjustable rate loans throughout 2020. Our average taxable investment portfolio yield decreased 54 basis points during 2020 as compared to the prior year due to the combination of principal repayments on higher yielding residential mortgage-backed securities, a $10.2 million increase in net premium amortization and lower yielding new investments purchased in 2020. More than offsetting the decrease in the yield on average interest earning assets, the cost of average interest bearing liabilities decreased 85 basis points to 0.99 percent for 2020 as compared to the prior year. The decrease in the overall cost as compared to 2019 was mainly due to significantly lower rates paid on our deposits products and a customer shift from higher cost maturing time deposits to deposits without stated maturities, as well as lower rates on short-term borrowings following the onset of the COVID-19 pandemic. The cost of funds was largely influenced by decreases which occurred in March 2020 totaling 150 basis points in the daily effective federal funds rate to a
target range of between zero and 0.25 percent for the remainder of 2020. The average daily effective federal funds rate was 2.16 percent in 2019.
Average interest earning assets totaling $37.0 billion for the year ended December 31, 2020 increased $6.4 billion, or 21.0 percent, as compared to 2019. Average loan balances increased $5.6 billion to $31.8 billion in 2020 and was the major driver in the $62.1 million increase in interest income on a tax equivalent basis for loans as compared to 2019. The growth in average loans during 2020 was due, in large part, to the $3.4 billion in loans acquired from Oritani, SBA PPP loans with average balances of $1.5 billion during the year ended December 31, 2020 and strong loan demand for commercial loans. These items were partially offset by principal repayments that outpaced new loan originations held for investment in the residential mortgage and consumer loan categories. The new commercial loan production in 2020 came from a blend of new and existing customer relationships with significant geographic and product diversification across our primary markets.
Average interest bearing liabilities increased $3.9 billion to $26.9 billion for the year ended December 31, 2020 from the same period in 2019 mainly due to $2.9 billion of deposits assumed in the Oritani acquisition and higher retail and government deposit balances within our branch network. The average non-interest bearing deposits and savings, NOW and money market account balances increased by $1.9 billion and $2.9 billion, respectively, largely due to deposits from PPP loan customers, higher savings rates amongst our customers and increased customer preference for deposits without stated maturities driven by the combination of the uncertainties of the pandemic and the low rates offered on our time deposit products. Average time deposits increased $604.5 million to $8.1 billion for 2020 as compared to 2019 mainly due to $1.2 billion of time deposits acquired from Oritani, partially offset by the normal run off of maturing retail CDs. Average balances for retail CDs increased by $424.6 million to $4.7 billion for the year ended December 31, 2020 as compared to the prior year. Average short-term and long-term borrowings decreased $448.7 million and increased $899.0 million in 2020, respectively, as compared to 2019 due, in part, to our ability to lock in lower rates on long-term FHLB advances to fund new loan activities. See the "Fourth Quarter 2020" section below for more information regarding changes in our interest bearing liabilities during 2020.
Fourth Quarter 2020. Net interest income on a tax equivalent basis totaling $288.8 million for the fourth quarter 2020 increased $4.7 million and $49.2 million as compared to the third quarter 2020 and fourth quarter 2019, respectively. The increase compared to the third quarter 2020 was mainly due to lower rates on our deposit products combined with a shift in customer preference towards deposits without stated maturities, as well as a reduction in average short-term and long-term borrowings funded by excess liquidity. Interest expense of $46.1 million for the three months ended December 31, 2020 decreased $8.1 million as compared to the third quarter 2020. Overall, average interest-bearing liabilities decreased $354.6 million and average non-interest bearing deposits increased $323.1 million in the fourth quarter 2020 as compared to the third quarter 2020. Interest income on a tax equivalent basis decreased $3.4 million to $335.0 million for the fourth quarter 2020 as compared to the third quarter 2020 mainly due to a 3 basis point decrease in the yield on average loans, as well as a moderate decline in interest and dividends from investment securities. The decrease was mostly attributable to principal repayments on securities, and a decline in our reinvestment activity within the available for sale investment securities portfolio largely due to the low interest rate environment.
The net interest margin on a tax equivalent basis of 3.06 percent for the fourth quarter 2020 increased 5 basis points as compared to 3.01 percent for the third quarter 2020, and increased 10 basis points from 2.96 percent for the fourth quarter 2019. The yield on average interest earning assets decreased by 4 basis points on a linked quarter basis mostly due to the impact of the lower interest rate environment. The yield on average loans decreased to 3.86 percent for the fourth quarter 2020 from 3.89 percent for the third quarter 2020 largely due to the continued repayment of higher yielding loans, partially offset by a $2.2 million increase in interest and fees from PPP loans. The increase in interest and fees on PPP loans was mostly caused by a moderate level of loan forgiveness activity and acceleration of net unamortized deferred loan fees during the fourth quarter 2020. The overall cost of average interest-bearing liabilities decreased by 11 basis points to 0.69 percent for the fourth quarter 2020 as compared to the linked third quarter 2020 due to the lower rates offered on deposit products and the shift to lower cost deposits as well as lower average short- and long-term borrowing balances with repayments funded by excess liquidity. This includes our prepayment of $534 million in higher cost long-term borrowings during December 2020 that is expected to positively impact our average cost of funds in the first quarter 2021. Our cost of total average deposits was 0.33 percent for the fourth quarter 2020 as compared to 0.41 percent for the third quarter 2020.
Looking forward, we expect ongoing interest rate pressures on the level of our net interest margin for the first quarter 2021 and beyond due to lower market rate driven yields on our overall mix of new and refinanced loan originations. However, we are encouraged by the opportunity to reprice stated maturity deposits and borrowings maturing over the 12-month period. We have over $4 billion of retail CDs maturing at an average cost of approximately 80 basis points during the first nine months of 2021.
The following table reflects the components of net interest income for each of the three years ended December 31, 2020, 2019 and 2018:
ANALYSIS OF AVERAGE ASSETS, LIABILITIES AND SHAREHOLDERS’ EQUITY AND
NET INTEREST INCOME ON A TAX EQUIVALENT BASIS
(1)Interest income is presented on a tax equivalent basis using a 21 percent federal tax rate.
(2)Loans are stated net of unearned income and include non-accrual loans.
(3)The yield for securities that are classified as available for sale is based on the average historical amortized cost.
(4)Includes junior subordinated debentures issued to capital trusts which are presented separately on the consolidated statements of condition.
(5)Interest rate spread represents the difference between the average yield on interest earning assets and the average cost of interest bearing liabilities and is presented on a fully tax equivalent basis.
(6)Net interest income as a percentage of total average interest earning assets.
The following table demonstrates the relative impact on net interest income of changes in the volume of interest earning assets and interest bearing liabilities and changes in rates earned and paid by Valley on such assets and liabilities. Variances resulting from a combination of changes in volume and rates are allocated to the categories in proportion to the absolute dollar amounts of the change in each category.
CHANGE IN NET INTEREST INCOME ON A TAX EQUIVALENT BASIS
* Interest income is presented on a tax equivalent basis using a 21 percent federal tax rate.
Non-Interest Income
Non-interest income represented 11.7 percent and 14.0 percent of total interest income plus non-interest income for 2020 and 2019, respectively. For the year ended December 31, 2020, non-interest income decreased $31.5 million as compared to the year ended December 31, 2019 largely due to the gain on the sale of several Valley properties recognized in 2019. See further details below.
The following table presents the components of non-interest income for the years ended December 31, 2020, 2019, and 2018:
Insurance commissions decreased $3.0 million for the year ended December 31, 2020 from $10.4 million in 2019 mainly due to lower volumes of business generated by the Bank's insurance agency subsidiary.
Service charges on deposit accounts decreased $5.4 million for the year ended December 31, 2020 as compared to 2019 mostly due to waived fees related to COVID-19 customer relief efforts in 2020.
Net impairment losses on securities totaling $2.9 million for the year ended December 31, 2019 relate to one special revenue bond in default of its contractual payments. See the “Investment Securities Portfolio” section of this MD&A and Note 4 to the consolidated financial statements for further details on our investment securities impairment analysis.
Fees from loan servicing increased $558 thousand for the year ended December 31, 2020 from $9.8 million in 2019 mainly due to additional fees from mortgage servicing rights of loans originated and sold by us during the year ended December 31, 2020. The aggregate principal balances of residential mortgage loans serviced by us for others increased approximately $123 million to $3.5 billion, at December 31, 2020 from $3.4 billion at December 31, 2019.
Net gains on sales of loans increased $23.3 million for the year ended December 31, 2020 as compared to 2019 largely due to higher spreads (or margins) on individual loan sales despite a slightly higher volume of residential mortgage loans sold during 2020. During 2020, we sold $1.0 billion of residential mortgages as compared to $935 million of residential mortgage loans sold during 2019, including $30 million and $436 million of pre-existing loans sold from our residential mortgage loan portfolio, respectively. Our net gains on sales of loans for each period are comprised of both gains on sales of residential mortgages and the net change in the mark to market gains and losses on our loans held for sale carried at fair value at each period end. The net gains in the fair value of loans held for sale totaled $13.5 million and $1.0 million in 2020 and 2019, respectively. Residential mortgage loan originations (including both new and refinanced loans) increased 22.3 percent to $1.9 billion for the year ended December 31, 2020 as compared to $1.6 billion in 2019. See further discussions of our residential mortgage loan origination activity under “Loans” in the "Executive Summary" section of this MD&A above and Note 3 to the consolidated financial statements for details about the fair value methodology.
Net gains on sales of assets decreased $80.2 million for the year ended December 31, 2020 as compared to 2019 primarily due to a $78.5 million gain on the sale (and leaseback) of 26 bank properties recognized during the first quarter 2019.
Other non-interest income increased $28.0 million for the year ended December 31, 2020 as compared to 2019 mainly due to a $25.6 million increase in fee income related to derivative interest rate swaps executed with commercial lending customers. Swap fee income totaled $59.0 million and $33.4 million for the years ended December 31, 2020 and 2019, respectively. A decline in commercial loan activity in 2021, as well as several other factors, could have a significant negative impact on our ability to generate swap fee income at or near the fees realized in 2020.
Non-Interest Expense
Non-interest expense increased $14.6 million to $646.1 million for the year ended December 31, 2020 as compared to 2019. The following table presents the components of non-interest expense for the years ended December 31, 2020, 2019 and 2018:
Salary and employee benefits expense increased $5.8 million for the year ended December 31, 2020 as compared to 2019. The increase was largely due to additional salaries related to Bank branch and other operational staff retained from the Oritani acquisition, higher cash incentive compensation (including $2.2 million of special bonuses paid to hourly and part-time employees to reward them for their efforts and contributions during the COVID-19 pandemic) and increased medical expenses. These additional expenses were partially offset by cost reductions from our ongoing branch transformation efforts and other operational improvements during the year ended December 31, 2020 and lower merger related charges. Change in control, severance and retention expenses related to bank acquisitions was $13.9 million for the year ended December 31, 2019. Severance costs related to operational restructuring efforts and our branch transformation strategy totaled $2.1 million and $4.8 million for the years ended December 31, 2020 and 2019, respectively.
Net occupancy and equipment expenses increased $10.8 million for the year ended December 31, 2020 as compared to 2019 largely due to higher rental expenses resulting from a sale leaseback transaction completed near the end of the first quarter 2019 and higher depreciation expense related to computer equipment and new data centers placed into service in fourth quarter 2019. In addition, during 2020, we incurred higher equipment and certain other COVID-19 pandemic related expenses which included additional cleaning services for facilities to maintain employee and customer safety. During 2020, we also incurred additional costs associated with branches and other facilities acquired from Oritani, which were partially offset by costs savings from branch closures during 2020 as compared to 2019.
The FDIC insurance assessment decreased in 2020 largely due to the Bank's improved capital position following the Oritani acquisition and retained earnings resulting from a stronger 2020 performance.
Amortization of other intangibles increased $6.6 million to $24.6 million at December 31, 2020 as compared to 2019 largely due to higher amortization expense of loan servicing rights and core deposit intangible, as well as $818 thousand of net impairment charges of loan servicing rights for the year ended December 31, 2020 as compared to net recoveries of impairment charges totaling $36 thousand in 2019. The increase in amortization of core deposits intangibles was primarily due to intangibles generated in the Oritani acquisition. See Note 8 to the consolidated financial statements for additional information.
Professional and legal fees increased $11.5 million for the year ended December 31, 2020 as compared to 2019. The increase was mainly due to higher costs from technology transformation consulting services, as well as remote work readiness costs largely incurred in the second quarter 2020.
Loss on extinguishment of debt totaling $12.0 million for the year ended December 31, 2020 reflects prepayment penalties related to the prepayments of $584.3 million of long-term borrowings primarily consisting of FHLB advances prepaid in the fourth quarter. These debt prepayments were funded by excess cash liquidity. See Note 10 to the consolidated financial statements for additional information.
Amortization of tax credit investments decreased $7.1 million for the year ended December 31, 2020 as compared to 2019 partly due to a decline in impairment. The year ended December 31, 2019 included a $2.4 million impairment charge related to investments in three federal renewable energy tax credit funds sponsored by DC Solar (See Note 14 to the consolidated financial statements for additional information). The remainder of the variance from 2019 was mainly due to
differences in the timing and amount of such investments and recognition of the related tax credits. Tax credit investments, while negatively impacting the level of our operating expenses and efficiency ratio, directly reduce our income tax expense and effective tax rate.
Other non-interest expense increased $8.8 million for the year ended December 31, 2020 as compared to 2019. This increase was largely due to higher data processing costs, certain PPP loan and other COVID-19 related costs, as well as incrementally higher operating expenses in several categories due to the expansion of our operations both organically and through the acquisition of Oritani in the fourth quarter 2019. Net gains on the sale of OREO properties included in other non-interest expense decreased $674 thousand for the year ended December 31, 2020 as compared to 2019. The negative impact of these times was partially offset by moderate decreases in several other significant components of other expense, such as travel, entertainment and business meals expense during 2020 as compared to 2019.
Efficiency Ratio. The efficiency ratio measures total non-interest expense as a percentage of net interest income plus total non-interest income. We believe this non-GAAP measure provides a meaningful comparison of our operational performance and facilitates investors’ assessments of business performance and trends in comparison to our peers in the banking industry. Our overall efficiency ratio, and its comparability to some of our peers, is negatively impacted primarily by the amortization of tax credit investments, as well as infrequent charges within non-interest income and expense, including, but not limited to the loss on extinguishment of debt, merger expenses and the net gain on sale-leaseback transactions.
The following table presents our efficiency ratio and a reconciliation of the efficiency ratio adjusted for such items during the years ended December 31, 2020, 2019 and 2018:
(1)Merger related expenses are primarily within salary and employee benefits expense, professional and legal fees, and other expense.
(2)Severance expenses are included in salary and employee benefits.
(3)Branch related asset impairment is included in net losses on sale of assets within non-interest income.
(4)The gain from the sale of non-marketable securities is included in other non-interest income.
(5)The gain on sale leaseback transactions is included in gains on the sales of assets within other non-interest income.
Management continuously monitors its expenses in an effort to optimize Valley's performance. Based upon these efforts and our revenue goals, we achieved an adjusted efficiency ratio (as shown in the table above) of 47.39 percent for 2020 that exceeded our previously announced goal of 51 percent or lower for the year. We can provide no assurance that our adjusted efficiency ratio will remain at the level reported for 2020.
Income Taxes
Income tax expense was $139.5 million for the year ended December 31, 2020, reflecting an effective tax rate of 26.3 percent, as compared to $147.0 million for the year ended 2019, reflecting an effective tax rate of 32.2 percent. The decline in the effective tax rate in 2020 as compared to 2019 was mainly due to a $31.1 million increase in the provision for income taxes related to uncertain tax liability positions during 2019. However, income tax expense declined by only $7.5 million as compared to 2019 largely due to an increase in taxable income for the year ended December 31, 2020. At December 31, 2020 and 2019, our uncertain tax liability positions relate to renewable energy tax credits and other tax benefits previously recognized from our investments in mobile generators sold and leased back by DC Solar and its affiliates.
The CARES Act did not have a material impact on our reported income tax expense for the year ended December 31, 2020.
U.S. GAAP requires that any change in judgment or change in measurement of a tax position taken in a prior annual period be recognized as a discrete event in the quarter in which it occurs, rather than being recognized as a change in effective tax rate for the current year. Our adherence to these tax guidelines may result in volatile effective income tax rates in future quarterly and annual periods. Factors that could impact management’s judgment include changes in income, tax laws and regulations, and tax planning strategies.
See additional information regarding our income taxes under our “Critical Accounting Policies and Estimates” section above, as well as Note 13 to the consolidated financial statements.
Business Segments
We have four business segments that we monitor and report on to manage our business operations. These segments are consumer lending, commercial lending, investment management, and corporate and other adjustments. Our reportable segments have been determined based upon Valley’s internal structure of operations and lines of business. Each business segment is reviewed routinely for its asset growth, contribution to income before income taxes and return on average interest earning assets and impairment (if events or circumstances indicate a possible inability to realize the carrying amount). Expenses related to the branch network, all other components of retail banking, along with the back office departments of the Bank are allocated from the corporate and other adjustments segment to each of the other three business segments. Interest expense and internal transfer expense (for general corporate expenses) are allocated to each business segment utilizing a transfer pricing methodology, which involves the allocation of operating and funding costs based on each segment's respective mix of average earning assets and/or liabilities outstanding for the period. The financial reporting for each segment contains allocations and reporting in line with our operations, which may not necessarily be comparable to any other financial institution. The accounting for each segment includes internal accounting policies designed to measure consistent and reasonable financial reporting and may result in income and expense measurements that differ from amounts under U.S. GAAP. Furthermore, changes in management structure or allocation methodologies and procedures may result in changes in reported segment financial data.
Consumer lending. The consumer lending segment represented 21.4 percent of the total loan portfolio at December 31, 2020, and was mainly comprised of residential mortgage loans and automobile loans, and to a lesser extent, home equity loans, secured personal lines of credit and other consumer loans (including credit card loans). The duration of the residential mortgage loan portfolio (which represented 13.0 percent of our total loan portfolio at December 31, 2020) is subject to movements in the market level of interest rates and forecasted prepayment speeds. The weighted average life of the automobile loans portfolio (representing 4.2 percent of total loans at December 31, 2020) is relatively unaffected by movements in the market level of interest rates. However, the average life may be impacted by new loans as a result of the availability of credit within the automobile marketplace and consumer demand for purchasing new or used automobiles. The consumer lending segment also includes the Wealth Management and Insurance Services Division, comprised of trust, asset management, and insurance services.
Average interest earning assets in this segment increased $269.3 million to $7.2 billion for the year ended December 31, 2020 as compared to 2019. The increase was largely due to $255 million of loans acquired from Oritani on December 1, 2019, loan growth from residential mortgage loan originations for investment during the first quarter 2020 (prior to the economic slowdown caused by the COVID-19 pandemic).
Income before income taxes generated by the consumer lending segment increased $46.6 million to $124.1 million for the year ended December 31, 2020 as compared to $77.5 million for the year ended December 31, 2019 largely due to increases of $28.5 million and $23.5 million in net interest income and non-interest income, respectively. The increase in net interest income was mostly driven by the lower cost of funding and increase in average loans, partially offset by lower yields on loans in the consumer segment. The increase in non-interest income was primarily attributable to higher net gains on sales of residential mortgage loans for the year ended December 31, 2020 as compared to 2019. The positive impact of the aforementioned items
was partially offset by increases of $4.8 million and $1.5 million in the provision for loan losses and non-interest expense, respectively. The increase in the provision for loan losses for the year ended December 31, 2020 as compared to 2019 was mainly due to the adverse economic forecast caused by COVID-19 pandemic included in our estimate of lifetime expected credit losses for this segment, as well as additional qualitative management adjustments to reflect the potential for higher levels of credit stress related to borrowers impacted by COVID-19 pandemic. See further details in the "Allowance for Credit Losses" section of this MD&A.
The net interest margin on the consumer lending portfolio increased 29 basis points to 2.92 percent for the year ended 2020 as compared to 2019 due to a 66 basis point decrease in the costs associated with our funding sources, partially offset by a 37 basis point decrease in the yield on average loans. The decrease in our funding costs was mainly due to both deposits and borrowings continuing to reprice at lower interest rates and the prepayment of the $635 million high cost FHLB advances in December 2019. The 37 basis point decrease in loan yield was largely due to lower yielding new loan volumes. See the "Executive Summary" and the "Net Interest Income" sections above for more details on our loans, deposits and other borrowings.
The return on average interest earning assets before income taxes for the consumer lending segment was 1.73 percent for 2020 compared to 1.12 percent for 2019.
Commercial lending. The commercial lending segment is mainly comprised of floating rate and adjustable rate commercial and industrial loans and construction loans, as well as fixed rate owner occupied and commercial real estate loans. Due to the portfolio’s interest rate characteristics, commercial lending is Valley’s business segment that is most sensitive to movements in market interest rates. Commercial and industrial loans totaled approximately $6.9 billion and represented 21.3 percent of the total loan portfolio at December 31, 2020. Commercial real estate loans and construction loans totaled $18.5 billion and represented 57.3 percent of the total loan portfolio at December 31, 2020.
Average interest earning assets in this segment increased $5.3 billion to $24.6 billion for the year ended December 31, 2020 as compared to 2019. The increase was primarily due to organic loan growth from $2.2 billion of PPP loans originated in 2020, as well as $3.1 billion of commercial loans acquired from Oritani on December 1, 2019.
For the year ended December 31, 2020, income before income taxes for the commercial lending segment increased $79.4 million to $448.6 million as compared to 2019. Net interest income increased $195.1 million to $863.7 million for the year ended December 31, 2020 as compared to 2019 mainly due to the combined effect of a $101.5 million increase in interest income driven by higher average loans balances and a $93.6 million decrease in interest expense caused by the reduction in our cost of funds. Non-interest income increased $23.6 million for the year ended December 31, 2020 as compared to 2019 primarily due to fee income related to derivative interest rate swaps executed with commercial loan customers which totaled $59.0 million for the year ended December 31, 2020 as compared to $33.4 million in 2019. The positive impact of the aforementioned items was partially offset by a $96.1 million increase in the provision for credit losses to $113.6 million for the year ended December 31, 2020 as compared to 2019. The increase in the provision for loan losses for the year ended December 31, 2020 as compared to 2019 was mainly due to the adverse economic forecast lifetime expected credit losses during 2020, higher specific reserves for tax medallion loans and qualitative adjustments for potential credit stress related to borrowers impacted by the COVID-19 pandemic. See the "Allowance for Credit Losses" section below for further details. Internal transfer expense increased $46.5 million to $267.6 million for the year ended December 31, 2020 as compared to 2019.
The net interest margin for this segment increased 4 basis points to 3.5 percent during 2020 as compared to 2019 due to a 66 basis point decrease in the cost of our funding sources, mostly offset by a 62 basis point decrease in the yield on average loans.
The return on average interest earning assets before income taxes for this segment was 1.82 percent for 2020 compared to 1.91 percent for the prior year period.
Investment management. The investment management segment generates a large portion of our income through investments in various types of securities and interest-bearing deposits with other banks. These investments are mainly comprised of fixed rate securities and, depending on our liquid cash position, federal funds sold and interest-bearing deposits with banks (primarily the Federal Reserve Bank of New York) as part of our asset/liability management strategies. The fixed rate investments are one of Valley’s least sensitive assets to changes in market interest rates. However, a portion of the investment portfolio is invested in shorter-duration securities to maintain the overall asset sensitivity of our balance sheet. See the “Asset/Liability Management” section below for further analysis.
Average interest earning assets increased $884.8 million to $5.2 billion for the year ended December 31, 2020 as compared to 2019 primarily due to a $930.5 million increase in average interest bearing deposits with banks, partially offset by a $45.7 million decline in average investment securities. The increase in average overnight interest bearing deposits with banks
was mainly due to our higher levels of excess liquidity levels that were maintained in the 2020 period in response to the uncertainties created by the COVID-19 pandemic. The decrease in average investment securities was mainly driven by principal repayments on securities with slower reinvestment activity caused by the low interest rate environment.
For the year ended December 31, 2020, income before income taxes for the investment management segment decreased $7.4 million to $19.6 million as compared to 2019 mainly due to increases in internal transfer expense and provision for credit losses for debt securities held to maturity totaling $7.1 million and $635 thousand, respectively.
The net interest margin for this segment decreased 29 basis points to 1.30 percent during the year ended December 31, 2020 as compared to 2019 due to a 95 basis point decrease in the yield on average investments, partially offset by a 66 basis point decrease in costs associated with our funding sources. The decrease in the yield on average investments during 2020 as compared to one year ago was largely driven by repayment and prepayment of higher yield residential mortgage-backed securities, as well as calls and maturities of state and municipal bonds. Additionally, we have recorded a higher premium amortization expense related to the increased prepayment of mortgage-backed securities and purchased lower yielding investment securities during 2020. The increase in average overnight investments with banks at low yields also contributed to the decline in the net interest margin for the investment management segment.
The return on average interest earning assets before income taxes for this segment was 0.37 percent for 2020 compared to 0.62 percent for 2019.
Corporate and other adjustments. The amounts disclosed as “corporate and other adjustments” represent income and expense items not directly attributable to a specific segment, including net securities gains and losses not reported in the investment management segment above, interest expense related to subordinated notes, amortization and impairment of tax credit investments, as well as non-core items, including the loss on extinguishment of debt and merger expenses.
The pre-tax net loss for the corporate segment totaled $62.2 million for the year ended December 31, 2020 as compared to $17.0 million in 2019. The negative change of $45.2 million was mainly due to a decrease in non-interest income coupled with an increase in non-interest expense, partially offset by higher internal transfer income.
Non-interest income decreased $79.9 million to $26.7 million for the year ended December 31, 2020 from 2019 primarily due to a $78.5 million net gain on the sale (and leaseback) of several bank locations recognized during 2019. Non-interest expense increased $16.2 million to $468.7 million for the year ended December 31, 2020 as compared to 2019 largely due to increases in net occupancy and equipment expense, salaries and employee benefits expenses, loss on extinguishment of debt, and professional and legal fees. See further details in the "Non-Interest Expense" section in this MD&A. Internal transfer income increased $52.7 million to $402.2 million for the year ended December 31, 2020 as compared to the prior year largely due to general increases related to our growth.
ASSET/LIABILITY MANAGEMENT
Interest Rate Sensitivity
Our success is largely dependent upon our ability to manage interest rate risk. Interest rate risk can be defined as the exposure of our interest rate sensitive assets and liabilities to the movement in interest rates. Our Asset/Liability Management Committee is responsible for managing such risks and establishing policies that monitor and coordinate our sources and uses of funds. Asset/Liability management is a continuous process due to the constant change in interest rate risk factors. In assessing the appropriate interest rate risk levels for us, management weighs the potential benefit of each risk management activity within the desired parameters of liquidity, capital levels and management’s tolerance for exposure to income fluctuations. Many of the actions undertaken by management utilize fair value analysis and attempts to achieve consistent accounting and economic benefits for financial assets and their related funding sources. We have predominately focused on managing our interest rate risk by attempting to match the inherent risk and cash flows of financial assets and liabilities. Specifically, management employs multiple risk management activities such as optimizing the level of new residential mortgage originations retained in our mortgage portfolio through increasing or decreasing loan sales in the secondary market, product pricing levels, the desired maturity levels for new originations, the composition levels of both our interest earning assets and interest bearing liabilities, as well as several other risk management activities.
We use a simulation model to analyze net interest income sensitivity to movements in interest rates. The simulation model projects net interest income based on various interest rate scenarios over a 12-month and 24-month period. The model is based on the actual maturity and re-pricing characteristics of rate sensitive assets and liabilities. The model incorporates certain assumptions which management believes to be reasonable regarding the impact of changing interest rates and the prepayment assumptions of certain assets and liabilities as of December 31, 2020. The model assumes changes in interest rates without any proactive change in the composition or size of the balance sheet by management. In the model, the forecasted shape of the yield
curve remains static as of December 31, 2020. The impact of interest rate derivatives, such as interest rate swaps, is also included in the model.
Our simulation model is based on market interest rates and prepayment speeds prevalent in the market as of December 31, 2020. Although the size of Valley’s balance sheet is forecasted to remain static as of December 31, 2020, in our model, the composition is adjusted to reflect new interest earning assets and funding originations coupled with rate spreads utilizing our actual originations during 2020. The model utilizes an immediate parallel shift in the market interest rates at December 31, 2020.
The assumptions used in the net interest income simulation are inherently uncertain. Actual results may differ significantly from those presented in the table above, due to the frequency and timing of changes in interest rates, and changes in spreads between maturity and re-pricing categories. Overall, our net interest income is affected by changes in interest rates and cash flows from our loan and investment portfolios. We actively manage these cash flows in conjunction with our liability mix, duration and interest rates to optimize the net interest income, while structuring the balance sheet in response to actual or potential changes in interest rates. Additionally, our net interest income is impacted by the level of competition within our marketplace. Competition can negatively impact the level of interest rates attainable on loans and increase the cost of deposits, which may result in downward pressure on our net interest margin in future periods. Other factors, including, but not limited to, the slope of the yield curve and projected cash flows will impact our net interest income results and may increase or decrease the level of asset sensitivity of our balance sheet.
Convexity is a measure of how the duration of a financial instrument changes as market interest rates change. Potential movements in the convexity of bonds held in our investment portfolio, as well as the duration of the loan portfolio may have a positive or negative impact on our net interest income in varying interest rate environments. As a result, the increase or decrease in forecasted net interest income may not have a linear relationship to the results reflected in the table below. Management cannot provide any assurance about the actual effect of changes in interest rates on our net interest income.
The following table reflects management’s expectations of the change in our net interest income over the next 12-month period considering the aforementioned assumptions. While an instantaneous and severe shift in interest rates was used in this simulation model, we believe that any actual shift in interest rates would likely be more gradual and would therefore have a more modest impact than shown in the table below.
As noted in the table above, a 100 basis point immediate increase in interest rates combined with a static balance sheet where the size, mix, and proportions of assets and liabilities remain unchanged is projected to increase net interest income over the next 12-month period by 1.93 percent as compared to December 31, 2019 (which projected an increase of 0.81 percent in net interest income over a 12-month period). Management believes the interest rate sensitivity remains within an acceptable tolerance range at December 31, 2020. However, the level of net interest income sensitivity may increase or decrease in the future as a result of several factors, including, but not limited to potential changes in secondary mortgage loan sales, deposit and borrowings strategies, the slope of the yield curve and projected cash flows.
The following table sets forth the amounts of interest earning assets and interest bearing liabilities that were outstanding at December 31, 2020 and their associated fair values. The expected cash flows are categorized based on each financial instrument’s anticipated maturity or interest rate reset date in each of the future periods presented.
INTEREST RATE SENSITIVITY ANALYSIS
The above table provides an approximation of the projected re-pricing of assets and liabilities at December 31, 2020 based on the contractual maturities, adjusted for anticipated prepayments of principal (including anticipated call dates on long-term borrowings and junior subordinated debentures), and scheduled rate adjustments. The prepayment experience reflected herein is based on historical experience combined with market consensus expectations derived from independent external sources. The actual repayments of these instruments could vary substantially if future prepayments differ from historical experience or current market expectations. While all non-maturity deposit liabilities are reflected in the 2021 column in the table above, management controls the re-pricing of the vast majority of the interest-bearing instruments within these liabilities.
Our cash flow derivatives are designed to protect us from upward movement in interest rates on certain deposits and other borrowings. The interest rate sensitivity table reflects the sensitivity at current interest rates. As a result, the notional amount of our derivatives is not included in the table. We use various assumptions to estimate fair values. See Note 3 to the consolidated financial statements for further discussion of fair value measurements.
The total gap re-pricing within one year as of December 31, 2020 was a negative $12.9 billion, representing a ratio of interest sensitive assets to interest sensitive liabilities of 0.46:1. The total gap re-pricing position, as reported in the table above, reflects the projected interest rate sensitivity of our principal cash flows based on market conditions as of December 31, 2020. As the market level of interest rates and associated prepayment speeds move, the total gap re-pricing position will change accordingly, but not likely in a linear relationship. Management does not view our one-year gap position as of December 31, 2020 as presenting an unusually high risk potential, although no assurances can be given that we are not at risk from interest rate increases or decreases.
Liquidity and Cash Requirements
Bank Liquidity. Liquidity measures the ability to satisfy current and future cash flow needs as they become due. A bank’s liquidity reflects its ability to meet loan demand, to accommodate possible outflows in deposits and to take advantage of interest rate opportunities in the marketplace. Liquidity management is carefully performed and reported by our Treasury Department to two Board committees. Among other actions, Treasury reviews historical funding requirements, current liquidity position, sources and stability of funding, marketability of assets, options for attracting additional funds, and anticipated future funding needs, including the level of unfunded commitments. Our goal is to maintain sufficient liquidity to cover current and potential funding requirements.
The Bank has no required regulatory liquidity ratios to maintain; however, it adheres to an internal liquidity policy. The current policy requires that we may not have a ratio of loans to deposits in excess of 110 percent or reliance on wholesale funding greater than 25 percent of total funding. The Bank was in compliance with the foregoing policies at December 31, 2020.
At December 31, 2020, the Bank had various contractual obligations totaling $7.9 billion and $10.1 billion of maturing liabilities due in 12 months or less and greater than 1 year, respectively.
The following table summarized maturities of contractual obligations of the Bank at December 31, 2020:
In the ordinary course of operations, the Bank enters into various financial obligations, including contractual obligations that may require future cash payments. As a financial services provider, we routinely enter into commitments to extend credit, including loan commitments, standby and commercial letters of credit. Such commitments are subject to the same credit policies and approval process accorded to loans made by the Bank. We enter into forward commitments for the future delivery of residential mortgage loans when interest rate lock commitments are entered into in order to economically hedge the effect of future changes in interest rates on Bank's commitments to fund the loans, as well as on its portfolio of mortgage loans held for sale. Commitments to extend credit and standby letters of credit are subject to change since many of these commitments are expected to expire unused or only partially used based upon our historical experience, the total amounts of these commitments do not necessarily reflect future cash requirements. At December 31, 2020 our off-balance sheet commitments totaled $7.8 billion, inclusive of commitments of $2.9 billion due in 12 months or less. See Note 16 to the consolidated financial statements for further details.
Management believes the Bank has the ability to generate and obtain adequate amounts of cash to meet its short-term and long-term obligations as they come due by utilizing various cash resources described below.
On the asset side of the balance sheet, the Bank has numerous sources of liquid funds in the form of cash and due from banks, interest bearing deposits with banks (including the Federal Reserve Bank of New York), investment securities held to maturity that are maturing within 90 days or would otherwise qualify as maturities if sold (i.e., 85 percent of original cost basis has been repaid), investment securities available for sale, loans held for sale, and, from time to time, federal funds sold and receivables related to unsettled securities transactions. Liquid assets totaled approximately $3.1 billion, representing 8.3 percent of earning assets, at December 31, 2020 and $2.2 billion, representing 6.4 percent of earning assets, at December 31, 2019. Of the $3.1 billion of liquid assets at December 31, 2020, approximately $789.0 million of various investment securities were pledged to counterparties to support our earning asset funding strategies. We anticipate the receipt of approximately $926.0 million in principal from securities in the total investment portfolio over the next 12-month period due to normally scheduled principal repayments and expected prepayments of certain securities, primarily residential mortgage-backed securities.
Additional liquidity is derived from scheduled loan payments of principal and interest, as well as prepayments received. Loan principal payments (including loans held for sale at December 31, 2020) are projected to be approximately $8.9 billion over the next 12-month period. As a contingency plan for significant funding needs, liquidity could also be derived from the sale of conforming residential mortgages from our loan portfolio, or from the temporary curtailment of lending activities.
On the liability side of the balance sheet, we utilize multiple sources of funds to meet liquidity needs, including retail and commercial deposits, brokered and municipal deposits, and short-term and long-term borrowings. Our core deposit base, which generally excludes fully insured brokered deposits and both retail and brokered certificates of deposit over $250 thousand, represents the largest of these sources. Average core deposits totaled approximately $25.8 billion and $20.4 billion for the years ended December 31, 2020 and 2019, respectively, representing 69.8 percent and 66.8 percent of average earning assets at December 31, 2020 and 2019, respectively. The level of interest bearing deposits is affected by interest rates offered, which is often influenced by our need for funds and the need to match the maturities of assets and liabilities.
The following table lists, by maturity, all certificates of deposit of $250 thousand and over at December 31, 2020:
Additional funding may be provided through deposit gathering networks and in the form of federal funds purchased obtained through our well established relationships with several correspondent banks. While these lending lines are uncommitted, management believes that we could borrow approximately $1.5 billion for a short time from these banks on a collective basis. The Bank is also a member of the Federal Home Loan Bank of New York and has the ability to borrow from them in the form of FHLB advances secured by pledges of certain eligible collateral, including but not limited to U.S. government and agency mortgage-backed securities and a blanket assignment of qualifying first lien mortgage loans, consisting of both residential mortgage and commercial real estate loans. Additionally, Valley's collateral pledged to the FHLB may be used to obtain Municipal Letters of Credit (MULOC) to collateralize certain municipal deposits held by Valley. At December 31, 2020, Valley had $700 million of MULOCs outstanding for this purpose. Furthermore, we are able to obtain overnight borrowings from the Federal Reserve Bank of New York via the discount window as a contingency for additional liquidity. At December 31, 2020, our borrowing capacity (excluding added capacity available to us by pledging PPP loans), under the Federal Reserve Bank's discount window was approximately $1.6 billion.
We also have access to other short-term and long-term borrowing sources to support our asset base, such as repos (i.e., securities sold under agreements to repurchase). Short-term borrowings (consisting of FHLB advances, repos, and from time to time, federal funds purchased) increased $55.0 million to $1.1 billion at December 31, 2020 from December 31, 2019 largely due to an increase of $60 million in FHLB advances.
Average short-term FHLB advances exceeded 30 percent of total shareholders' equity at December 31, 2019. The following table sets forth information regarding Valley’s short-term FHLB advances at the date and for the year ended December 31, 2019:
Corporation Liquidity. Valley's long-term cash requirements included obligations under subordinated debt and junior subordinated debentures issued to capital trust totaling $400 million and $60.8 million at December 31, 2020, respectively. Valley’s recurring cash requirements primarily consist of dividends to preferred and common shareholders and interest expense on subordinated notes and junior subordinated debentures issued to capital trusts. As part of our on-going asset/liability management strategies, Valley could also use cash to repurchase shares of its outstanding common stock under its share repurchase program or redeem its callable junior subordinated debentures. These cash needs are routinely satisfied by dividends collected from the Bank. Projected cash flows from the Bank are expected to be adequate to pay preferred and common dividends, if declared, and interest expense payable to subordinated note holders and capital trusts, given the current capital levels and current profitable operations of the bank subsidiary. In addition to dividends received from the Bank, Valley can satisfy its cash requirements by utilizing its own cash and potential new funds borrowed from outside sources or capital issuances. Valley also has the right to defer interest payments on the junior subordinated debentures, and therefore distributions on its trust preferred securities for consecutive quarterly periods up to five years, but not beyond the stated maturity dates, and subject to other conditions.
Investment Securities Portfolio
The primary purpose of the investment portfolio is to provide a source of earnings, be a source of liquidity, and serve as a tool for managing interest rate risk. The decision to purchase or sell securities is based upon the current assessment of long and short-term economic and financial conditions, including the interest rate environment and other statement of financial condition components. See additional information under "Interest Rate Sensitivity", "Liquidity" and "Capital Adequacy" sections elsewhere in this MD&A.
As of December 31, 2020, our investment portfolio was comprised of equity securities (mainly consisting of a money market mutual fund and investments in public and private Community Reinvestment Act funds), U.S. Treasury securities, U.S. government agency securities, taxable and tax-exempt issues of states and political subdivisions, residential mortgage-backed securities, single-issuer trust preferred securities principally issued by bank holding companies and high quality corporate bonds. Among other securities, our available for sale debt securities such as bank issued and other corporate bonds, as well as municipal special revenue bonds, that may pose a higher risk of future impairment charges to us as a result of the uncertain economic environment and its potential negative effect on the future performance of the security issuers.
There were no securities in the name of any one issuer exceeding 10 percent of shareholders’ equity, except for residential mortgage-backed securities issued by Ginnie Mae and Fannie Mae. Certain securities with limited marketability and/or restrictions, such as Federal Home Loan Bank and Federal Reserve Bank stocks, are carried at cost and are included in other assets.
Investment securities at December 31, 2020, 2019 and 2018 were as follows:
As of December 31, 2020, total investments decreased $402.4 million or 10.2 percent as compared to 2019 largely due to (i) a combined net decrease of $234.6 million in residential mortgage-backed securities within both the held to maturity and available for sale categories mainly driven by a higher level of prepayments during 2020, (ii) a combined $120.5 million decrease in obligations of states and state agencies within both the held to maturity and available for sale categories mainly due to normal maturities, sales, calls, and paydowns, and (iii) a $70.2 million decrease in held to maturity U.S. Treasury securities.
At December 31, 2020, we had $1.6 billion and $1.1 billion of residential mortgage-backed securities classified as held to maturity and available for sale, respectively. Approximately 66 percent and 56 percent of these residential mortgage-backed securities, respectively, were issued and guaranteed by Ginnie Mae. The remainder of our outstanding residential mortgage-backed security balances at December 31, 2020 were issued by either Fannie Mae or Freddie Mac.
The following table presents the remaining contractual maturities (unadjusted for any expected prepayments) with the corresponding weighted-average yields of held to maturity and available for sale debt securities at December 31, 2020:
(1)Held to maturity debt securities amounts are presented at amortized costs, stated at cost less principal reductions, if any, and adjusted for accretion of discounts and amortization of premiums. Available for sale amounts are presented at fair value.
(2)Average yields are calculated on a yield-to-maturity basis.
(3)Average yields on obligations of states and political subdivisions are generally tax-exempt and calculated on a tax-equivalent basis using a statutory federal income tax rate of 21 percent.
(4)Residential mortgage-backed securities are shown using stated final maturity.
The residential mortgage-backed securities portfolio is a significant source of our liquidity through the monthly cash flow of principal and interest. Mortgage-backed securities, like all securities, are sensitive to change in the interest rate environment, increasing and decreasing in value as interest rates fall and rise. As interest rates fall, the potential increase in prepayments can reduce the yield on the mortgage-backed securities portfolio, and reinvestment of the proceeds will be at lower yields. Conversely, rising interest rates may reduce cash flows from prepayments and extend anticipated duration of these assets. We monitor the changes in interest rates, cash flows and duration, in accordance with our investment policies. Management seeks out investment securities with an attractive spread over our cost of funds.
Allowance for Credit Losses and Impairment Analysis
Effective January 1, 2020, Valley adopted ASU No. 2016-13, "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments", which requires an estimate of lifetime expected credit losses for held to maturity debt securities established as an allowance for credit losses and replaces the other-than-temporarily impaired model for available for sale debt securities.
Available for sale debt securities. The new guidance in ASC Topic 326-30 requires credit losses to be presented as an allowance, rather than as a write-down if management does not intend to sell an available for sale debt security before recovery of its amortized cost basis. Available for sale debt securities in unrealized loss positions are evaluated for impairment related to
credit losses at least quarterly. In assessing whether a credit loss exists, we compare the present value of cash flows expected to be collected from the security with the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis for the security, a credit loss exists and an allowance for credit losses is recorded, limited to the amount the fair value is less than amortized cost basis. Declines in fair value that have not been recorded through an allowance for credit losses, such as declines due to changes in market interest rates, are recorded through other comprehensive income, net of applicable taxes.
We have evaluated all available for sale debt securities that are in an unrealized loss position as of December 31, 2020 and determined that the declines in fair value are mainly attributable to changes in market volatility, due to factors such as interest rates and spread factors, but not attributable to credit quality or other factors. Based on a comparison of the present value of expected cash flows to the amortized cost, management recognized no impairment charges during the year ended December 31, 2020 and, as a result, there was no allowance for credit losses for available for sale debt securities at December 31, 2020.
During 2019, Valley recognized a $2.9 million impairment charge under the other-than-temporary impairment model on one special revenue bond classified as available for sale included in obligations of states and state agencies category. At December 31, 2020, the impaired security had an adjusted amortized cost and fair value of $680 thousand and $815 thousand, respectively. There was no impairment recognized in earnings during the year ended December 31, 2018.
Held to maturity debt securities. As discussed further in Note 4 to the consolidated financial statements, Valley has a zero loss expectation for certain securities within the held to maturity portfolio, including, U.S. Treasury securities, U.S. agency securities, residential mortgage-backed securities issued by Ginnie Mae, Fannie Mae and Freddie Mac, and collateralized municipal bonds. To measure the expected credit losses on held to maturity debt securities that have loss expectations, Valley estimates the expected credit losses using a discounted cash flow model developed by a third party. Assumptions used in the model for pools of securities with common risk characteristics include the historical lifetime probability of default and severity of loss in the event of default, with the model incorporating several economic cycles of loss history data to calculate expected credit losses given default at the individual security level. At December 31, 2020, held to maturity debt securities were carried net of allowance for credit losses totaling $1.4 million. The provision totaled $635 thousand for the year ended December 31, 2020 driven mainly by our negative economic forecast incorporated within the allowance model since the onset of the COVID-19 pandemic. There were no net charge-offs of debt securities during 2020.
Investment grades. The investment grades in the table below reflect the most current independent analysis performed by third parties of each security as of the date presented and not necessarily the investment grades at the date of our purchase of the securities. For many securities, the rating agencies may not have performed an independent analysis of the tranches owned by us, but rather an analysis of the entire investment pool. For this and other reasons, we believe the assigned investment grades may not accurately reflect the actual credit quality of each security and should not be viewed in isolation as a measure of the quality of our investment portfolio.
The following table presents the held to maturity and available for sale debt investment securities portfolios by investment grades at December 31, 2020.
* Rated using external rating agencies. Ratings categories include entire range. For example, “A Rated” includes A+, A, and A-. Split rated securities with two ratings are categorized at the higher of the rating levels.
The debt securities held to maturity portfolio included $143.0 million in investments not rated by the rating agencies with aggregate unrealized losses of $7.4 million at December 31, 2020 related to four single-issuer bank trust preferred issuances with a combined amortized cost of $36.0 million.
See Note 4 to the consolidated financial statements for additional information regarding our investment securities portfolio.
Loan Portfolio
The following table reflects the composition of the loan portfolio for the years indicated.
* Includes net unearned discount and deferred loan fees of $95.8 million at December 31, 2020, and net unearned premiums and deferred loan fees of $12.6 million, $21.5 million, $22.2 million, and $15.3 million at December 31, 2019, 2018, 2017, and 2016, respectively. Net unearned discounts and deferred loans fees at December 31, 2020 include the non-credit discount on purchased credit deteriorated (PCD) loans and $43.2 million of net unearned fees related to PPP loans.
Total loans increased by $2.5 billion, or 8.5 percent to $32.2 billion at December 31, 2020 from December 31, 2019 mainly due to approximately $2.2 billion of SBA PPP loans within commercial and industrial loans, as well as continued annual growth in our commercial real estate loan portfolio. Upon our adoption of the CECL standard on January 1, 2020, we recorded a $61.6 million gross-up for PCD loans (mainly commercial and industrial and commercial real estate loans) that increased the amortized cost basis of loans with a corresponding increase to the allowance for credit losses. During 2020, Valley also originated $1.2 billion of residential mortgage loans for sale rather than investment. Loans held for sale totaled $301.4 million and $76.1 million at December 31, 2020 and 2019, respectively. See additional information regarding our residential mortgage loan activities below.
Commercial and industrial loans totaled $6.9 billion at December 31, 2020 and increased $2.0 billion from December 31, 2019 mainly due to PPP loan originations. Excluding the PPP loans, commercial and industrial loans decreased $116.4 million largely due to our selective underwriting and tempered loan demand caused by the COVID-19 pandemic, particularly in the New Jersey and New York markets during the fourth quarter 2020, and our existing small to middle market lending relationships becoming more strategic with new capital expenditures due to the economic uncertainty. Commercial and industrial loans included PPP loans of approximately $2.2 billion, net of unearned net deferred fees totaling $43.2 million at December 31, 2020. Valley expects the majority of these borrowers to qualify for loan forgiveness under the guidelines of the SBA program. During 2021, PPP loan forgiveness and the unknown full impact of the COVID-19 pandemic could likely weigh on Valley's ability to grow the commercial and industrial loan portfolio.
Commercial real estate loans (excluding construction loans) increased $728.3 million to $16.7 billion at December 31, 2020 from December 31, 2019. The increase was mainly due to strong loan volumes within our loan commitment pipeline, including many pre-existing, longstanding borrowers, an active refinance market driven by low interest rates as well as some slower repayment activity caused by the COVID-19 pandemic. Construction loans totaled $1.7 billion at December 31, 2020 and increased $98.8 million from December 31, 2019, mainly driven by loan advances on new and existing construction
projects, partially offset by the run-off of completed existing projects, and, to a lesser extent, migration of such completed projects to permanent financing during 2020. Construction demand in our Florida markets, which have mostly reopened during the current COVID-19 pandemic, remains robust as compared to the Northeast and we intend to be strategically competitive for the strongest borrowers and projects in that market.
Residential mortgage loans totaled $4.2 billion at December 31, 2020 and decreased by $193.4 million from December 31, 2019 largely due to loan principal repayment and refinance activity and higher levels of residential mortgage loans originated for sale due to current interest rate risk management strategies. Our new and refinanced residential mortgage loan originations increased 22.3 percent to $1.9 billion for the year ended December 31, 2020 as compared to $1.6 billion in 2019. Of the $1.9 billion in total originations, $367 million represented Florida residential mortgage loans. During 2020, we sold $1.0 billion of residential mortgages as compared to $934.5 million of residential mortgage loans sold during 2019, including $30 million and $436 million of pre-existing loans sold from our residential mortgage loan portfolio, respectively. We retain mortgage originations based on credit criteria and loan to value levels, the composition of our interest earning assets and interest bearing liabilities and our ability to manage the interest rate risk associated with certain levels of these instruments. From time to time, we purchase residential mortgage loans originated by, and sometimes serviced by, other financial institutions based on several factors, including current loan origination volumes, market interest rates, excess liquidity, CRA and other asset/liability management strategies. Purchased residential mortgage loans are generally selected using Valley’s normal underwriting criteria at the time of purchase and are sometimes partially or fully guaranteed by third parties or insured by government agencies such as the Federal Housing Administration. Valley purchased approximately $24.3 million and $35 million of 1-4 family loans, qualifying for CRA purposes during 2020 and 2019, respectively. We may continue to sell a large portion of our new fixed rate residential mortgage loan originations during 2021 based upon normal management of the interest rate risk and mix of the interest earning assets on our balance sheet.
Consumer loans totaled $2.7 billion at December 31, 2020 and decreased $151.5 million from December 31, 2019 mainly due to decreases in automobile and home equity loan portfolios. Automobile loans decreased $95.7 million or 6.6 percent to $1.4 billion at December 31, 2020 from December 31, 2019 as our new indirect auto loan volumes did not keep pace with the normal portfolio repayment and refinance activity during 2020. New loan originations have declined since the beginning of the second quarter 2020 mostly due to a combination of tightening our underwriting policies and impact of the COVID-19 pandemic. During 2020, our Florida dealership network contributed $84.6 million in auto loan originations, representing approximately 17 percent of Valley's total new auto loan production for 2020 as compared to $169 million, or 23 percent, of total originations in 2019. Home equity loans decreased $55.7 million in 2020 from $487.3 million at December 31, 2019. New home equity loan volumes and customer usage of existing home equity lines of credit continue to be modest and outpaced by repayment activity, despite the favorable low interest rate environment. Other consumer loans totaled $913.3 million at December 31, 2020 and remained relatively unchanged as compared to 2019 mainly due to both tempered usage and demand within our collateralized personal lines of credit portfolio.
Most of our lending is in northern and central New Jersey, New York City, Long Island, and Florida, with the exception of smaller auto and residential mortgage loan portfolios derived primarily from other neighboring states of New Jersey, which could present a geographic and credit risk due to the recent economic downturn within these regions caused by the COVID-19 pandemic and the uncertain path forward to restart the U.S. economy. To mitigate our geographic risks, we make efforts to maintain a diversified portfolio as to type of borrower and loan to guard against a potential downward turn in any one economic sector.
For 2021, we remain cautiously optimistic about overall loan growth, exclusive of PPP loans. In the early stages of the first quarter 2021, our loan origination pipelines remain robust and organic growth opportunities, especially in Florida, appear to have returned to closer to pre-pandemic levels. However, there can be no assurance that those positive trends will continue, or balances will not decline from December 31, 2020 given the potential for unforeseen changes in consumer confidence, the economy, and other market conditions. In addition, while difficult to accurately predict, we believe that many of our SBA PPP loans will become eligible for forgiveness in 2021 in accordance with the rules of this program and is highly likely to result in a large reduction in these loan balances.
The following table reflects the contractual maturity distribution of the commercial and industrial and construction loans within our loan portfolio as of December 31, 2020:
We may renew loans at maturity when requested by a customer. In such instances, we generally conduct a review which includes an analysis of the borrower’s financial condition and, if applicable, a review of the adequacy of collateral via a new appraisal from an independent, bank approved, certified or licensed property appraiser or readily available market resources. A rollover of the loan at maturity may require a principal reduction or other modified terms.
Non-performing Assets
Prior to our adoption of the CECL standard on January 1, 2020, our past due loans and non-accrual loans discussed further below excluded those loans which were classified as purchased credit impaired (PCI) loans. Under previous U.S. GAAP, the PCI loans (acquired at a discount that is due, in part, to credit quality) were accounted for on a pool basis and were not subject to delinquency classification in the same manner as loans originated by Valley. Under the CECL standard, Valley's former PCI loan pools are accounted for as PCD loans on a loan level basis and, if applicable, are reported in our past due and non-accrual loans at December 31, 2020.
Non-performing assets (NPAs) include non-accrual loans, other real estate owned (OREO), other repossessed assets (which consist of automobiles and taxi medallions) and non-accrual debt securities at December 31, 2020. Loans are generally placed on non-accrual status when they become past due in excess of 90 days as to payment of principal or interest. Exceptions to the non-accrual policy may be permitted if the loan is sufficiently collateralized and in the process of collection. OREO is acquired through foreclosure on loans secured by land or real estate. OREO and other repossessed assets are reported at the lower of cost or fair value, less cost to sell. Non-performing assets totaling $194.6 million at December 31, 2020 increased $90.1 million, or 86.3 percent, from December 31, 2019 (as shown in the table below) mainly due to higher non-accrual loans in most loan categories, including approximately $45 million of non-accrual PCD loans (largely in the commercial loan categories) reported at December 31, 2020. The increase in non-accruals within non-PCD loans was mainly due to the negative impact of the COVID-19 pandemic. NPAs as a percentage of total loans and NPAs totaled 0.60 percent and 0.35 percent at December 31, 2020 and 2019, respectively. We believe our total NPAs has remained relatively low as a percentage of the total loan portfolio over the past five years, despite the uptick in 2020 related to non-accrual PCD loans (not required to be reported as non-performing in prior periods) and borrowers impacted by COVID-19. The level of NPAs is reflective of our consistent approach to the loan underwriting criteria for both Valley originated loans and loans purchased from third parties. For additional details, see the "Credit quality indicators" section in Note 5 to the consolidated financial statements.
Our lending strategy is based on underwriting standards designed to maintain high credit quality and we remain optimistic regarding the overall future performance of our loan portfolio. However, due to the potential for future credit deterioration caused by the uncertain economic recovery from the COVID -19 pandemic recession, lack of, or inadequate additional federal stimulus and a number of our borrowers that are performing under short-term forbearance agreements, management cannot provide assurance that our non-performing assets will not increase substantially from the levels reported at December 31, 2020.
The following table sets forth by loan category, accruing past due and non-performing assets on the dates indicated in conjunction with our asset quality ratios:
*Past due loans and non-accrual loans presented at December 31, 2019, 2018, 2017, and 2016, respectively, exclude PCI loans. Prior to January 1, 2020, PCI loans were accounted for on a pool basis under U.S. GAAP and were not subject to delinquency classification.
Loans past due 30 to 59 days increased $23.1 million to $69.7 million at December 31, 2020 as compared to $46.6 million at December 31, 2019 partially due to a $12.3 million matured commercial real estate loan and two commercial real estate loan relationships with a combined total of $16.8 million reported in this delinquency category at December 31, 2020. While one of these loans is internally classified as substandard, management believes it is well secured and in the process of collection.
Loans past due 60 to 89 days increased $1.4 million to $15.8 million at December 31, 2020 as compared to December 31, 2019 mostly due to higher residential mortgage loan delinquencies caused by a few larger borrowers.
Loans 90 days or more past due and still accruing increased $6.2 million to $13.5 million at December 31, 2020 as compared to December 31, 2019 mainly due to higher commercial and industrial loan delinquencies. Residential mortgage loan delinquencies increased $1.1 million as compared to 2019 primarily due to one large loan included in this category at December 31, 2020. All the loans past due 90 days or more and still accruing are considered to be well secured and in the process of collection.
Non-accrual loans increased $92.2 million to $185.3 million at December 31, 2020 as compared to December 31, 2019. Commercial and industrial non-accrual loans increased $38.1 million mainly due to the reclassification of $34.2 million of previously accruing taxi medallion loans to non-accrual status during the first quarter of 2020 and $12.7 million of non-accrual PCD loans included at December 31, 2020. See further discussion of our taxi medallion loan portfolio below. The $37.9 million increase in non-accrual commercial real estate loans was largely due to six loan relationships totaling $20.8 million and $22.1 of non-accrual PCD included at December 31, 2020.
Although the timing of collection is uncertain, management believes that most of the non-accrual loans at December 31, 2020, are well secured and largely collectible based on, in part, our quarterly review of collateral dependent loans and the valuation of the underlying collateral, if applicable. If interest on non-accrual loans had been accrued in accordance with the original contractual terms, such interest income would have amounted to approximately $6.2 million, $2.5 million and $3.6 million for the years ended December 31, 2020, 2019 and 2018, respectively; none of these amounts were included in interest income during these periods.
During 2020, we continued to closely monitor the performance of our New York City and Chicago taxi medallion loans totaling $90.6 million and $6.9 million, respectively, within the commercial and industrial loan portfolio at December 31, 2020. Due to continued negative trends in estimated fair valuations of the underlying taxi medallion collateral, a weak operating environment for ride services and uncertain borrower performance, the remainder of our previously accruing taxi medallion loans were placed on non-accrual status during the first quarter 2020. At December 31, 2020, non-accrual taxi medallion loans totaling $97.5 million had related reserves of $66.4 million, or 68.1 percent of such loans, within the allowance for loan losses as compared to $63.3 million with related reserves of $25.0 million December 31, 2019.
Valley's historical taxi medallion lending criteria was conservative in regard to capping the loan amounts in relation to the prevailing market valuations, as well as obtaining personal guarantees and other collateral in certain instances. However, the severe decline in the market valuation of taxi medallions over the last several years has adversely affected the estimated fair valuation of these loans and, as a result, increased the level of our allowance for loan losses at December 31, 2020 (See the "Allowance for Credit Losses" section below). Potential further declines in the market valuation of taxi medallions and the stressed operating environment within both New York City and Chicago due to the COVID-19 pandemic could also negatively impact the future performance of this portfolio. For example, a 25 percent further decline in our current estimated market value of the taxi medallions would require additional allocated reserves of $5.5 million within the allowance for loan losses based upon taxi medallion loan balances at December 31, 2020.
OREO (which consisted of 25 commercial and residential properties) decreased to $5.1 million at December 31, 2020 as compared to $9.4 million at December 31, 2019. During 2020, we transferred 14 properties totaling $4.0 million and sold 19 properties for total proceeds of $9.0 million. The sales of OREO properties resulted in net gains of $674 thousand for the year ended December 31, 2020 as compared to net gains of $1.3 million for the year ended December 31, 2019. See Notes 1 and 3 to the consolidated financial statements for additional information regarding OREO and other repossessed assets, including our foreclosed asset activity.
TDRs represent loan modifications for customers experiencing financial difficulties where a concession has been granted. Performing TDRs (i.e., TDRs not reported as loans 90 days or more past due and still accruing or as non-accrual loans) decreased $15.6 million to $57.4 million at December 31, 2020 as compared to $73.0 million at December 31, 2019 mainly due to paydowns of several commercial and industrial loans during 2020. Performing TDRs consisted of 87 loans and 119 loans (primarily in the commercial and industrial loan and commercial real estate portfolios) at December 31, 2020 and 2019, respectively. On an aggregate basis, the $57.4 million in performing TDRs at December 31, 2020 had a modified weighted
average interest rate of approximately 4.68 percent as compared to a pre-modification weighted average interest rate of 4.94 percent. See Note 5 to the consolidated financial statements for additional disclosures regarding our TDRs.
Loan Forbearance. In response to the COVID-19 pandemic and its economic impact to certain customers, Valley implemented short-term loan modifications such as payment deferrals, fee waivers, extensions of repayment terms, or delays in payment that are insignificant, when requested by customers. Generally, the modification terms allow for a deferral of payments for up to 90 days, which Valley may extend for an additional 90 days. Any extensions beyond this period were done in accordance with applicable regulatory guidance.
The following table presents the outstanding loan balances and number of loans in an active payment deferral period under short-term modifications as of December 31, 2020:
During the fourth quarter 2020, active loan forbearances decreased from approximately 1,400 loans with total outstanding balances of $1.1 billion remaining as of September 30, 2020.
Higher Risk COVID-19 Credit Exposures. Valley has identified certain borrower industries as being potentially exposed to the effects of economic shutdowns related to the COVID-19 pandemic. The following table presents non-PPP loans and active deferrals in the COVID-19 exposure industries at December 31, 2020:
As of December 31, 2020, Valley had approximately $2.2 billion, or 7.2 percent of total loans (excluding PPP loans), that were made to borrowers in these industries. Active deferrals in this category totaled approximately $50 million, or 2.3 percent of total loans in COVID-19 exposed industries at December 31, 2020, as compared to $158 million, or 7.1 percent of total loans at September 30, 2020. Approximately 90 percent of total loan balances within the higher risk industries were pass-rated under Valley’s internal risk rating system as of December 31, 2020.
Potential Problem Loans
Although we believe that substantially all risk elements at December 31, 2020 have been disclosed in the categories presented above, it is possible that for a variety of reasons, including economic conditions, certain borrowers may be unable to comply with the contractual repayment terms on certain real estate and commercial loans. As part of the analysis of the loan portfolio, management determined that there were approximately $258.8 million and $91.7 million in potential problem loans at December 31, 2020 and 2019, respectively. The increase from 2019 was mainly due to many of the risk rating downgrades resulting from the adverse impacts of the COVID-19 pandemic had on borrowers, as well as inclusion of PCD loans, which were previously excluded and were accounted for under ASC Subtopic 310-30. Potential problem loans were not classified as non-accrual loans in the non-performing asset table above. Potential problem loans are defined as performing loans for which management has concerns about the ability of such borrowers to comply with the loan repayment terms and which may result in a non-performing loan. Our decision to include performing loans in potential problem loans does not necessarily mean that management expects losses to occur, but rather that management recognizes potential problem loans carry a higher probability of default. At December 31, 2020, the potential problem loans consisted of various types of performing commercial loan
credits, including industries highlighted in the "Higher Risk COVID-19 Credit Exposures" table above, that are internally risk rated substandard because the loans exhibited well-defined weaknesses and required additional attention by management. See further discussion regarding our internal loan classification system at Note 5 to the consolidated financial statements. There can be no assurance that Valley has identified all of its potential problem loans at December 31, 2020.
Asset Quality and Risk Elements
Lending is one of the most important functions performed by Valley and, by its very nature, lending is also the most complicated, risky and profitable part of our business. For our commercial loan portfolio, comprised of commercial and industrial loans, commercial real estate loans, and construction loans, a separate credit department is responsible for risk assessment and periodically evaluating overall creditworthiness of a borrower. Additionally, efforts are made to limit concentrations of credit to minimize the impact of a downturn in any one economic sector. We believe our loan portfolio is diversified as to type of borrower and loan. However, loans collateralized by real estate represent approximately 72 percent of total loans at December 31, 2020. Most of the loans collateralized by real estate are in northern and central New Jersey, New York City and Florida presenting a geographical credit risk if there was a further significant broad-based deterioration in economic conditions within these regions impacted by COVID-19 pandemic. See Item 1A. Risk Factors -"Risks Related to the COVID-19 Pandemic".
Consumer loans are comprised of residential mortgage loans, home equity loans, automobile loans and other consumer loans. Residential mortgage loans are secured by 1-4 family properties mostly located in New Jersey, New York and Florida. We do provide mortgage loans secured by homes beyond this primary geographic area; however, lending outside this primary area has generally consisted of loans made in support of existing customer relationships, as well as targeted purchases of certain loans guaranteed by third parties. Our mortgage loan originations are comprised of both jumbo (i.e., loans with balances above conventional conforming loan limits) and conventional loans based on underwriting standards that generally comply with Fannie Mae and/or Freddie Mac requirements. The weighted average loan-to-value ratio of all residential mortgage originations in 2020 was 68 percent while FICO® (independent objective criteria measuring the creditworthiness of a borrower) scores averaged 757. Home equity and automobile loans are secured loans and are made based on an evaluation of the collateral and the borrower’s creditworthiness. In addition to our primary markets, automobile loans are mostly originated in several other contiguous states. Due to the level of our underwriting standards applied to all loans, management believes the out of market loans generally present no more risk than those made within the market. However, each loan or group of loans made outside of our primary markets poses different geographic risks based upon the economy of that particular region.
Management realizes that some degree of risk must be expected in the normal course of lending activities. Allowances are maintained to absorb such lifetime expected credit losses inherent in the portfolio.
Allowance for Credit Losses
The allowance for credit losses (ACL) includes the allowance for loan losses and the reserve for unfunded commercial letters of credit. Effective January 1, 2020, we adopted the new CECL standard, which is based on lifetime expected credit losses rather than incurred losses. Periods prior to 2020 have been reported in accordance with previously applicable GAAP, which followed the incurred credit losses methodology. See the table below and Notes 1 and 5 to the consolidated financial statements for further details on the impact of the Day 1 CECL adoption and the incurred credit losses methodology.
Under CECL, our methodology to establish the allowance for loan losses has two basic components: (1) a collective reserve component for estimated expected credit losses for pools of loans that share common risk characteristics and (2) an individual reserve component for loans that do not share risk characteristics, consisting of collateral dependent, TDR, and expected TDR loans. Valley also maintains a separate allowance for unfunded credit commitments mainly consisting of undisbursed non-cancellable lines of credit, new loan commitments and commercial letters of credit.
Valley estimated the collective ACL using a current expected credit losses methodology which is based on relevant information about historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the loan balances. In estimating the component of the allowance on a collective basis we use a transition matrix model which calculates an expected life of loan loss percentage for each loan pool by generating probability of default and loss given default metrics. The metrics are based on the migration of loans from performing to loss by credit quality rating or delinquency categories using historical life-of-loan analysis periods for each loan portfolio pool and the severity of loss based on the aggregate net lifetime losses. The model's expected losses based on loss history are adjusted for qualitative factors. Among other things, these adjustments include and account for differences in: (i) the impact of the reasonable and supportable economic forecast, relative probability weightings and reversion period, (ii) other asset specific risks to the extent they do not exist in the historical loss information, and (iii) net expected recoveries of charged off loan balances. These adjustments are based on qualitative factors not reflected in the quantitative model but are likely to impact the measurement of estimated credit
losses. The expected lifetime loss rate is the life of loan loss percentage from the transition matrix model plus the impact of the adjustments for qualitative factors. The expected credit losses are the product of multiplying the model’s expected lifetime loss rate by the exposure at default at period end on an undiscounted basis.
Valley utilizes a two-year reasonable and supportable forecast period followed by a one-year period over which estimated losses revert to historical loss experience for the remaining life of the loan on a straight-line basis. The forecasts consist of a multi-scenario economic forecast model to estimate future credit losses and is governed by a cross-functional committee. The committee meets each quarter to determine which economic scenarios developed by Moody's will be incorporated into the model, as well as the relative probability weightings of the selected scenarios, based upon all readily available information. The model projects economic variables under each scenario based on detailed statistical analyses. We have identified and selected key variables that most closely correlated to our historical credit performance, which include: GDP, unemployment and the Case-Shiller Home Price Index.
During the fourth quarter 2020, we continued to incorporate a probability weighted three-scenario economic forecast, including Moody's Baseline, S-3 and S-4 scenarios. At December 31, 2020, Valley maintained a higher combined weighting on the S-3 and S-4 alternative downside scenarios as compared to the Moody's Baseline scenario to reflect downside risk factors, including, but not limited to the unknown effect of the latest federal economic stimulus to promote a strong economic recovery, loan customers with payment deferrals, increasing COVID-19 infection rates in many locales and the efficacy of COVID-19 vaccines and the timing of the vaccine distribution across the U.S. Each of these risk factors may affect the performance of Valley’s loan portfolio over time.
The S-4 forecast is the most severe economic scenario and included the following assumptions at December 31, 2020:
•The COVID-19 pandemic will persist and meaningfully impact the economy;
•The national unemployment rate will remain elevated throughout 2021 and 2022, with a peak at 11.5 percent in the third quarter 2022;
•An overall decline in spending on a wide range of products and services;
•A prolonged economic downturn will persist until the fourth quarter 2021 with real GDP growth resuming by mid-year 2022; and
•The target federal funds interest rate will remain at or near zero for the foreseeable future.
The allowance for credit losses for loans methodology and accounting policy are fully described in Note 1 to the consolidated financial statements.
The following table summarizes the relationship among loans, loans charged-off, loan recoveries, the provision for credit losses and the allowance for credit losses for the years indicated:
(1) The adjustment represents an increase in the allowance for credit losses for loans as a result of the adoption of ASU 2016-13 effective January 1, 2020.
(2) Charge-offs and recoveries presented for periods prior to January 1, 2020 exclude loans formerly accounting for as PCI loans.
(3) Periods prior to January 1, 2020 represent the allowance and provision for unfunded letters of credit only.
Our net loan charge-offs increased $22.1 million to $38.0 million in 2020 as compared to $15.9 million in 2019 mainly due to higher gross charge-offs in the commercial and industrial loan category. The higher level of commercial and industrial loan charge-offs in 2020 was largely driven by taxi medallion partial loan charge-offs totaling $12.5 million for the year ended
December 31, 2020 (as compared to $6.5 million for 2019) and the partial and full charge-offs of two loans totaling $7.8 million and $6.0 million, respectively.
While net charge-offs increased largely due to borrowers impacted by the COVID-19 pandemic during 2020, they have remained within management's expectations for the credit quality of Valley's loan portfolio and its underwriting standards. During the five-year period ended December 31, 2020, our net charge-offs were at a high of 0.12 percent of average loans during 2020 and near zero during 2018. While we have a positive outlook for the future performance of the loan portfolio, there can be no assurance that our levels of net charge-offs will not deteriorate in 2021, especially given the uncertain course of the economic recovery, labor markets and the number of our COVID-19 impacted borrowers that remained in active deferral of contractual payments at December 31, 2020.
The following table summarizes the allocation of the allowance for credit losses to specific loan portfolio categories for the past five years ended December 31,:
* CECL was adopted January 1, 2020. Prior periods reflect the allowance for credit losses for loans under the incurred loss model.
The allowance for credit losses for loans, comprised of our allowance for loan losses and unfunded credit commitments (including letters of credit), as a percentage of total loans was 1.09 percent at December 31, 2020 and 0.55 percent at December 31, 2019. The allowance for credit losses for loans increased $186.8 million at December 31, 2020 as compared to December 31, 2019 largely due to Valley's Day 1 CECL adoption adjustment of $99.6 million recorded on January 1, 2020 and the reserve build under CECL during 2020. The reserve build in 2020 reflected several factors, including deterioration in Valley's macroeconomic outlook since the onset of the COVID-19 pandemic, additional qualitative management adjustments to reflect the potential for higher levels of credit stress related to borrowers negatively impacted by the pandemic, the impact of lower valuations of collateral securing our non-performing taxi medallion loan portfolio and additional quantitative reserves, based upon expected and actual transitions in the credit quality of our loan portfolio. As a result, the provision for credit losses increased $100.9 million to $125.1 million in 2020 as compared to 2019.
Loan Repurchase Contingencies
We engage in the origination of residential mortgages for sale into the secondary market. Our loan sales totaled approximately $1.0 billion, $935 million and $676 million for 2020, 2019 and 2018, respectively. During 2020 and 2019, loan sales increased significantly from 2018 as new loan originations and refinance activity strengthened due to a favorably low interest rate environment complemented, from time to time, by sales from the held for investment portfolio.
In connection with loan sales, we make representations and warranties, which, if breached, may require us to repurchase such loans, substitute other loans or indemnify the purchasers of such loans for actual losses incurred due to such loans. However, the performance of our loans sold has been historically strong due to our strict underwriting standards and procedures. Over the past several years, we have experienced a nominal amount of repurchase requests, only a few of which have actually resulted in repurchases by Valley (only two loan repurchases in 2020 and four loan repurchases in 2019). None of the loan repurchases resulted in material loss. Accordingly, no reserves pertaining to loans sold were established on our consolidated financial statements at December 31, 2020 and 2019. See Item 1A. Risk Factors - "We may incur future losses in
connection with repurchases and indemnification payments related to mortgages that we have sold into the secondary market” of this report for additional information.
Capital Adequacy
A significant measure of the strength of a financial institution is its shareholders’ equity. At December 31, 2020 and 2019, shareholders’ equity totaled approximately $4.6 billion and $4.4 billion, or 11.3 percent and 11.7 percent of total assets, respectively. During 2020, total shareholders’ equity increased by $207.9 million primarily due to (i) net income of $390.6 million, (ii) an increase in other comprehensive income of $24.5 million, and (iii) a $13.0 million increase attributable to the effect of share issuances under our stock incentive plan. These positive changes were partially offset by (i) cash dividends declared on common and preferred stock totaling a combined $192.0 million and (ii) a $28.2 million net cumulative effect adjustment to retained earnings for the adoption of new accounting guidance as of January 1, 2020.
Valley and Valley National Bank are subject to the regulatory capital requirements administered by the Federal Reserve Bank and the OCC. Quantitative measures established by regulation to ensure capital adequacy require Valley and Valley National Bank to maintain minimum amounts and ratios of common equity Tier 1 capital, total and Tier 1 capital to risk-weighted assets, and Tier 1 capital to average assets, as defined in the regulations.
We are required to maintain common equity Tier 1 capital to risk-weighted assets ratio of 4.5 percent, Tier 1 capital to risk-weighted assets of 6.0 percent, ratio of total capital to risk-weighted assets of 8.0 percent, and minimum leverage ratio of 4.0 percent, plus a 2.5 percent capital conservation buffer added to the minimum requirements for capital adequacy purposes. As of December 31, 2020 and 2019, Valley and Valley National Bank exceeded all capital adequacy requirements. See Note 17 to the consolidated financial statements for Valley’s and Valley National Bank’s regulatory capital positions and capital ratios at December 31, 2020 and 2019.
For regulatory capital purposes, in connection with the Federal Reserve Board’s final interim rule as of April 3, 2020, 100 percent of the CECL Day 1 impact to shareholders' equity equaling $28.2 million after-tax will be deferred for a two-year period ending January 1, 2022, at which time it will be phased in on a pro-rata basis over a three-year period ending January 1, 2025. Additionally, 25 percent of the reserve build (i.e., provision for credit losses less net charge-offs) for the year ended December 31, 2020 will be phased in over the same time frame.
Typically, our primary source of capital growth is through retention of earnings. Our rate of earnings retention is derived by dividing undistributed earnings per common share by earnings (or net income available to common shareholders) per common share. Our retention ratio was 52.7 percent and 49.4 percent for the years ended December 31, 2020 and 2019, respectively.
Cash dividends declared amounted to $0.44 per common share for both years ended December 31, 2020 and 2019. The Board is committed to examining and weighing relevant facts and considerations, including its commitment to shareholder value, each time it makes a cash dividend decision. The Federal Reserve has cautioned all bank holding companies about distributing dividends which may reduce the level of capital or not allow capital to grow considering the increased capital levels as required under the Basel III rules. Prior to the date of this filing, Valley has received no objection or adverse guidance from the FRB or the OCC regarding the current level of its quarterly common stock dividend. However, the FRB recently reiterated its long-standing guidance that banking organizations should consult them before declaring dividends in excess of earnings for the corresponding quarter. The renewed guidance was largely due to the increased risk of the COVID-19 pandemic negatively impacting the future level of bank earnings. See Item 1A. Risk Factors of this report for additional information.
Valley maintains an effective shelf registration statement with the SEC that allows us to periodically offer and sell in one or more offerings, individually or in any combination, our common stock, preferred stock and other non-equity securities. The shelf registration statement provides Valley with capital raising flexibility and enables Valley to promptly access the capital markets in order to pursue growth opportunities that may become available in the future and permits Valley to comply with any changes in the regulatory environment that call for increased capital requirements. Valley’s ability, and any decision to issue and sell securities pursuant to the shelf registration statement, is subject to market conditions and Valley’s capital needs at such time. Additional equity offerings may dilute the holdings of our existing shareholders or reduce the market price of our common stock, or both. Such offerings may be necessary in the future due to several reasons beyond management’s control, including numerous external factors that could negatively impact the strength of the U.S. economy or our ability to maintain or increase the level of our net income. See Note 18 to the consolidated financial statements for additional information on Valley’s preferred stock issuances.
Item 7A.
Item 7A.Quantitative and Qualitative Disclosures About Market Risk
Information regarding Quantitative and Qualitative Disclosures About Market Risk is discussed in the "Interest Rate Sensitivity" section contained in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and it is incorporated herein by reference.
Item 8.
Item 8.Financial Statements and Supplementary Data
VALLEY NATIONAL BANCORP
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
See accompanying notes to consolidated financial statements.
VALLEY NATIONAL BANCORP
CONSOLIDATED STATEMENTS OF INCOME
See accompanying notes to consolidated financial statements.
VALLEY NATIONAL BANCORP
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
See accompanying notes to consolidated financial statements.
VALLEY NATIONAL BANCORP
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
See accompanying notes to consolidated financial statements.
VALLEY NATIONAL BANCORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to consolidated financial statements.
VALLEY NATIONAL BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Note 1)
Business
Valley National Bancorp, a New Jersey Corporation (Valley), is a bank holding company whose principal wholly-owned subsidiary is Valley National Bank (the “Bank”), a national banking association providing a full range of commercial, retail and trust and investment services largely through its offices and ATM network throughout northern and central New Jersey, the New York City boroughs of Manhattan, Brooklyn and Queens, Long Island, Florida and Alabama. The Bank is subject to intense competition from other financial service providers and is subject to the regulation of certain federal and state agencies and undergoes periodic examinations by certain regulatory authorities.
Valley National Bank’s subsidiaries are all included in the consolidated financial statements of Valley. These subsidiaries include, but are not limited to:
•an insurance agency offering property and casualty, life and health insurance;
•an asset management adviser that is a registered investment adviser with the Securities and Exchange Commission (SEC);
•a title insurance agency in New York, which also provides services in New Jersey;
•subsidiaries which hold, maintain and manage investment assets for the Bank;
•a subsidiary which specializes in health care equipment lending and other commercial equipment leases; and
•a subsidiary which owns and services New York commercial loans.
The Bank’s subsidiaries also include real estate investment trust subsidiaries (the “REIT” subsidiaries) which own real estate related investments and a REIT subsidiary which owns some of the real estate utilized by the Bank and related real estate investments. Except for Valley’s REIT subsidiaries and its insurance agency (10% of which is owned by the insurance agency's co-CEOs), all subsidiaries mentioned above are directly or indirectly wholly-owned by the Bank. Because each REIT subsidiary must have 100 or more shareholders to qualify as a REIT, each REIT subsidiary has issued less than 20 percent of its outstanding non-voting preferred stock to individuals, most of whom are current and former Bank employees. The Bank owns the remaining preferred stock and all the common stock of the REITs.
Basis of Presentation
The consolidated financial statements of Valley include the accounts of its commercial bank subsidiary, Valley National Bank and all of Valley’s direct or indirect wholly-owned subsidiaries. All inter-company transactions and balances have been eliminated. The accounting and reporting policies of Valley conform to U.S. generally accepted accounting principles (U.S. GAAP) and general practices within the financial services industry. In accordance with applicable accounting standards, Valley does not consolidate statutory trusts established for the sole purpose of issuing trust preferred securities and related trust common securities. See Note 11 for more details. Certain prior period amounts have been reclassified to conform to the current presentation.
Significant Estimates. In preparing the consolidated financial statements in conformity with U.S. GAAP, management has made estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated statements of financial condition and results of operations for the periods indicated. Material estimates that require application of management’s most difficult, subjective or complex judgment and are particularly susceptible to change include: the allowance for credit losses, the evaluation of goodwill and other intangible assets for impairment, and income taxes. Estimates and assumptions are reviewed periodically, and the effects of revisions are reflected in the consolidated financial statements in the period they are deemed necessary. While management uses its best judgment, actual amounts or results could differ significantly from those estimates. The current economic environment has increased the degree of uncertainty inherent in these material estimates. Actual results may differ from those estimates. Also, future amounts and values could differ materially from those estimates due to changes in values and circumstances after the balance sheet date.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, interest bearing deposits in other banks (including the Federal Reserve Bank of New York) and, from time to time, overnight federal funds sold. The Bank is required to maintain reserve balances in cash or on deposit with the Federal Reserve Bank based on a
percentage of deposits. These reserve balances totaled $896.1 million and $114.4 million at December 31, 2020 and 2019, respectively.
Investment Securities
Debt securities are classified at the time of purchase based on management’s intention, as securities available-for-sale or securities held-to-maturity. Investment securities classified as held-to-maturity are those that management has the positive intent and ability to hold until maturity. Investment securities held-to-maturity are carried at amortized cost, adjusted for amortization of premiums and accretion of discounts using the level-yield method over the contractual term of the securities, adjusted for actual prepayments, or to call date if the security was purchased at premium. Investment securities classified as available-for-sale are carried at fair value with unrealized holding gains and losses reported as a component of other comprehensive income or loss, net of tax. Realized gains or losses on the available-for-sale securities are recognized by the specific identification method and are included in net gains and losses on securities transactions. Equity securities are stated at fair value with any unrealized and realized gains and losses reported in non-interest income. Investments in Federal Home Loan Bank and Federal Reserve Bank stock, which have limited marketability, are carried at cost in other assets. Security transactions are recorded on a trade-date basis.
Interest income on investments includes amortization of purchase premiums and discounts. Valley discontinues the recognition of interest on debt securities if the securities meet both of the following criteria: (i) regularly scheduled interest payments have not been paid or have been deferred by the issuer, and (ii) full collection of all contractual principal and interest payments is not deemed to be the most likely outcome.
Allowance for Credit Losses for Held to Maturity Debt Securities
On January 1, 2020, Valley adopted Accounting Standards Update (ASU) No. 2016-13, which requires us to estimate and recognize an allowance for credit losses for held to maturity debt securities using the current expected credit loss methodology (CECL).
Valley's CECL model includes a zero loss expectation for certain securities within the held to maturity portfolio, and therefore Valley is not required to estimate an allowance for credit losses related to these securities. After an evaluation of qualitative factors, Valley identified the following securities types which it believes qualify for this exclusion: U.S. Treasury securities, U.S. agency securities, residential mortgage-backed securities issued by Ginnie Mae, Fannie Mae and Freddie Mac, and collateralized municipal bonds commonly referred to as Tax Exempt Mortgage Securities (TEMS).
To measure the expected credit losses on held to maturity debt securities that have loss expectations, Valley estimates the expected credit losses using a discounted cash flow model developed by a third-party. Assumptions used in the model for pools of securities with common risk characteristics include the historical lifetime probability of default and severity of loss in the event of default, with the model incorporating several economic cycles of loss history data to calculate expected credit losses given default at the individual security level. The model is adjusted for a probability weighted multi-scenario economic forecast to estimate future credit losses. Valley uses a two-year reasonable and supportable forecast period, followed by a one-year period over which estimated losses revert to historical loss experience for the remaining life of the investment security. The economic forecast methodology and governance for debt securities is aligned with Valley's economic forecast used for the loan portfolio. Accrued interest receivable is excluded from the estimate of credit losses.
See the "New Authoritative Accounting Guidance" section below and Note 4 for more details regarding our adoption of ASU No. 2016-13 and the allowance for credit losses for held to maturity securities.
Impairment of Available for Sale Debt Securities
The impairment model for available for sale debt securities differs from the CECL methodology applied to held to maturity debt securities because the available for sale debt securities are measured at fair value rather than amortized cost. Available for sale debt securities in unrealized loss positions are evaluated for impairment related to credit losses on a quarterly basis. In performing an assessment of whether any decline in fair value is due to a credit loss, Valley considers the extent to which the fair value is less than the amortized cost, changes in credit ratings, any adverse economic conditions, as well as all relevant information at the individual security level, such as credit deterioration of the issuer or collateral underlying the security. In assessing the impairment, Valley compares the present value of cash flows expected to be collected with the amortized cost basis of the security. If it is determined that the decline in fair value was due to credit losses, an allowance for credit losses is recorded, limited to the amount the fair value is less than amortized cost basis. The non-credit related decrease in the fair value, such as a decline due to changes in market interest rates, is recorded in other comprehensive income, net of tax. Valley also assesses the intent to sell the securities (as well as the likelihood of a near-term recovery). If Valley intends to sell
an available for sale debt security or it is more likely than not that Valley will be required to sell the security before recovery of its amortized cost basis, the debt security is written down to its fair value and the write down is charged to the debt security’s fair value at the reporting date with any incremental impairment reported in earnings. See Note 4 for additional information.
Prior to January 1, 2020, Valley evaluated its investment securities classified as held to maturity and available for sale for other-than temporary impairment. Valley's evaluation of other-than-temporary impairment considered factors that included, among others, the causes of the decline in fair value, such as credit problems, interest rate fluctuations, or market volatility; and the severity and duration of the decline. Valley also assessed the intent and ability to hold the securities (as well as the likelihood of a near-term recovery), and the intent to sell the securities and whether it is more likely than not that Valley was required to sell the securities before the recovery of their amortized cost basis. Once a debt security was deemed to be other-than-temporarily impaired, it was written down to fair value with the estimated credit related component was recognized as an other-than-temporary impairment charge in non-interest income. The non-credit related component was recorded as an adjustment to accumulated other comprehensive income (loss), net of tax.
Loans Held for Sale
Loans held for sale generally consist of residential mortgage loans originated and intended for sale in the secondary market and are carried at their estimated fair value on an instrument-by-instrument basis as permitted by the fair value option election under U.S. GAAP. Changes in fair value are recognized in non-interest income in the accompanying consolidated statements of income as a component of net gains on sales of loans. Origination fees and costs related to loans originated for sale (and carried at fair value) are recognized as earned and as incurred. Loans held for sale are generally sold with loan servicing rights retained by Valley. Gains recognized on loan sales include the value assigned to the rights to service the loan. See the “Loan Servicing Rights” section below.
Loans and Loan Fees
Loans are reported at their outstanding principal balance net of any unearned income, charge-offs, unamortized deferred fees and costs on originated loans and premium or discounts on purchased loans, except for purchased credit deteriorated (PCD) loans recorded at the purchase price, including non-credit discounts, plus the allowance for credit losses expected at the time of acquisition. Loan origination and commitment fees, net of related costs are deferred and amortized as an adjustment of loan yield over the estimated life of the loans approximating the effective interest method.
Loans are deemed to be past due when the contractually required principal and interest payments have not been received as they become due. Loans are placed on non-accrual status generally, when they become 90 days past due and the full and timely collection of principal and interest becomes uncertain. When a loan is placed on non-accrual status, interest accruals cease and uncollected accrued interest is reversed and charged against current income. Cash collections from non-accrual loans are generally credited to the loan balance, and no interest income is recognized on these loans until the principal balance has been determined to be fully collectible. A loan in which the borrowers’ obligation has not been released in bankruptcy courts may be restored to an accruing basis when it becomes well secured and is in the process of collection, or all past due amounts become current under the loan agreement and collectability is no longer doubtful.
Allowance for Credit Losses for Loans
As noted previously, Valley adopted ASU No. 2016-13 on January 1, 2020, and thus 2020 follows the current expected credit losses methodology. Prior periods have been reported in accordance with previously applicable GAAP, which followed the incurred credit losses methodology. The following policies noted are under the current expected credit losses methodology. A summary of Valley’s previous policies under the incurred credit losses methodology follows at the end of this section.
The allowance for credit losses (ACL) is a valuation account that is deducted from the amortized cost basis to present the net amount expected to be collected on the loans. Loans are charged off against the allowance when management believes the uncollectibility of a loan balance is confirmed. Provisions for credit losses for loans and recoveries on loan previously charged-off by Valley are added back to the allowance.
Under CECL, Valley's methodology to establish the allowance for credit losses for loans has two basic components: (1) a collective reserve component for estimated lifetime expected credit losses for pools of loans that share common risk characteristics and (2) an individual reserve component for loans that do not share common risk characteristics. Previously, an allowance for loan losses was recognized based on probable incurred losses.
Reserves for loans that share common risk characteristics. Valley estimated the collective ACL using a current expected credit losses methodology which is based on relevant information about historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the loan balances. In estimating the component of the
allowance on a collective basis, Valley uses a transition matrix model which calculates an expected life of loan loss percentage for each loan pool by generating probability of default and loss given default metrics. The metrics are based on the migration of loans from performing to loss by credit quality rating or delinquency categories using historical life-of-loan analysis periods for each loan portfolio pool, and the severity of loss, based on the aggregate net lifetime losses. The model's expected losses based on loss history are adjusted for qualitative factors. Among other things, these adjustments include and account for differences in: (i) the impact of the reasonable and supportable economic forecast, probability weightings and reversion period, (ii) other asset specific risks to the extent they do not exist in the historical loss information, and (iii) net expected recoveries of charged off loan balances. These adjustments are based on qualitative factors not reflected in the quantitative model but are likely to impact the measurement of estimated credit losses. The expected lifetime loss rate is the life of loan loss percentage from the transition matrix model plus the impact of the adjustments for qualitative factors. The expected credit losses are the product of multiplying the model’s expected lifetime loss rate by the exposure at default at period end on an undiscounted basis.
Valley utilizes a two-year reasonable and supportable forecast period followed by a one-year period over which estimated losses revert to historical loss experience for the remaining life of the loan on a straight-line basis. The forecasts consist of a multi-scenario economic forecast model to estimate future credit losses that is governed by a cross-functional committee. The committee meets each quarter to determine which economic scenarios developed by Moody's will be incorporated into the model, as well as the relative probability weightings of the selected scenarios, based upon all readily available information. The model projects economic variables under each scenario based on detailed statistical analyses. Valley has identified and selected key variables that most closely correlated to its historical credit performance, which include: GDP, unemployment and the Case-Shiller Home Price Index.
The loan credit quality data utilized in the transition matrix model is based on an internal credit risk rating system for the commercial and industrial loan and commercial real estate loan portfolio segments and delinquency aging status for the residential and consumer loan portfolio segments. Loans are risk-rated based on an internal credit risk grading process that evaluates, among other things: (i) the obligor’s ability to repay; (ii) the underlying collateral, if any; and (iii) the economic environment and industry in which the borrower operates. This analysis is performed at the relationship manager level for all commercial and industrial loans and commercial real estate loans, and evaluated by the Loan Review Department on a test basis. Loans with a grade that is below “Pass” grade are adversely classified. Once a loan is adversely classified, the assigned relationship manager and/or a special assets officer in conjunction with the Credit Risk Management Department analyzes the loan to determine whether the loan is a collateral dependent asset (i.e., repayment is expected to be provided substantially through the sale or operation of the collateral) and the need to specifically assign a specific valuation allowance for loan losses to the loan, as discussed further below.
Reserves for loans that that do not share common risk characteristics. Valley measures specific reserves for individual loans that do not share common risk characteristics with other loans, consisting of collateral dependent, troubled debt restructured (TDR) loans, and expected TDR loans, based on the amount of lifetime expected credit losses calculated on those loans and charge-offs of those amounts determined to be uncollectible. Factors considered by Valley in measuring the extent of expected credit loss include payment status, collateral value, borrower financial condition, guarantor support and the probability of collecting scheduled principal and interest payments when due. Collateral dependent loan balances are written down to the estimated current fair value (less estimated selling costs) of each loan’s underlying collateral resulting in an immediate charge-off to the allowance, excluding any consideration for personal guarantees that may be pursued in the Bank’s collection process. If repayment is based upon future expected cash flows, the present value of the expected future cash flows discounted at the loan’s original effective interest rate is compared to the carrying value of the loan, and any shortfall is recorded as the allowance for credit losses. The effective interest rate used to discount expected cash flows is adjusted to incorporate expected prepayments, if applicable.
Valley elected to exclude accrued interest on loans from the amortized cost of loans held for investment. The accrued interest is presented separately in the consolidated statements of financial condition.
Loans charge-offs. Loans rated as "loss" within Valley's internal rating system are charged-off. Commercial loans are generally assessed for full or partial charge-off to the net realizable value for collateral dependent loans when a loan is between 90 or 120 days past due or sooner if it is probable that a loan may not be fully collectable. Residential loans and home equity loans are generally charged-off to net realizable value when the loan is 120 days past due (or sooner when the borrowers’ obligation has been released in bankruptcy). Automobile loans are fully charged-off when the loan is 120 days past due or partially charged-off to the net realizable value of collateral, if the collateral is recovered prior to such time. Unsecured consumer loans are generally fully charged-off when the loan is 150 days past due.
Under the incurred credit losses methodology utilized in the prior periods, the allowance for credit losses was maintained at a level estimated to absorb probable credit losses inherent in the loan portfolio, as well as other credit risk related charge-offs. The allowance is based on ongoing evaluations of the probable estimated losses inherent in the non-purchase credit impaired
(PCI) loan portfolio and off-balance sheet unfunded letters of credit, as well as reserves for impairment of PCI loans subsequent to their acquisition date. Valley had no allowance reserves related to PCI loans at December 31, 2019.
The Bank’s methodology for evaluating the appropriateness of the allowance included grouping the loan portfolio into loan segments based on common risk characteristics, tracking the historical levels of classified loans and delinquencies, estimating the appropriate loss look-back and loss emergence periods related to historical losses for each loan segment, providing specific reserves on impaired loans, and assigning incremental reserves where necessary based upon qualitative and economic outlook factors including numerous variables, such as the nature and trends of recent loan charge-offs. Additionally, the volume of non-performing loans, concentration risks by size, type, and geography, new markets, collateral adequacy, credit policies and procedures, staffing, underwriting consistency, loan review and economic conditions are taken into consideration.
The allowance for loan losses consists of four elements: (i) specific reserves for individually impaired credits, (ii) reserves for adversely classified, or higher risk rated, loans that are not impaired, (iii) reserves for other loans based on historical loss factors (using the appropriate loss look-back and loss emergence periods) adjusted for both internal and external qualitative risk factors to Valley, including the aforementioned factors, as well as changes in both organic and purchased loan portfolio volumes, the composition and concentrations of credit, new market initiatives, and the impact of competition on loan structuring and pricing, and (iv) an allowance for PCI loan pools impaired subsequent to the acquisition date, if applicable.
The allowances established for probable losses on specific loans are based on a regular analysis and evaluation of the loans. Loans are evaluated based on an internal credit risk rating system for the commercial and industrial loan and commercial real estate loan portfolio segments and non-performing loan status for the residential and consumer loan portfolio segments. Loans are risk-rated based on an internal credit risk grading process that evaluates, among other things: (i) the obligor’s ability to repay; (ii) the underlying collateral, if any; and (iii) the economic environment and industry in which the borrower operates.
The allowance allocations for other loans (i.e., risk rated loans that are not adversely classified and loans that are not risk rated) are calculated by applying historical loss factors for each loan portfolio segment to the applicable outstanding loan portfolio balances. Loss factors are calculated using statistical analysis supplemented by management judgment. The statistical analysis considers historical default rates, historical loss severity in the event of default, and the average loss emergence period for each loan portfolio segment. The management analysis includes an evaluation of loan portfolio volumes, the composition and concentrations of credit, credit quality and current delinquency trends.
Allowance for Unfunded Credit Commitments
The allowance for unfunded credit commitments consists of undisbursed non-cancellable lines of credit, new loan commitments and commercial letters of credit valued using a similar CECL methodology as used for loans. Management's estimate of expected losses inherent in these off-balance sheet credit exposures also incorporates estimated utilization rate over the commitment's contractual period or an expected pull-through rate for new loan commitments. The allowance for unfunded credit commitments is included in accrued expenses and other liabilities on the consolidated statements of financial condition.
See Note 5 for a discussion of Valley’s loan credit quality and additional allowance for credit losses.
Leases
Lessor Arrangements. Valley's lessor arrangements primarily consist of direct financing and sales-type leases for equipment included in the commercial and industrial loan portfolio. Lease agreements may include options to renew and for the lessee to purchase the leased equipment at the end of the lease term.
Lessee Arrangements. Valley's lessee arrangements predominantly consist of operating and finance leases for premises and equipment. The majority of the operating leases include one or more options to renew that can significantly extend the lease terms. Valley’s leases have a wide range of lease expirations through the year 2062.
Operating and finance leases are recognized as right of use (ROU) assets and lease liabilities in the consolidated statements of financial position. The ROU assets represent the right to use underlying assets for the lease terms and lease liabilities represent Valley’s obligations to make lease payments arising from the lease. The ROU assets include any prepaid lease payments and initial direct costs, less any lease incentives. At the commencement dates of leases, ROU assets and lease liabilities are initially recognized based on their net present values with the lease terms including options to extend or terminate the lease when Valley is reasonably certain that the options will be exercised to extend. ROU assets are amortized into net occupancy and equipment expense over the expected lives of the leases.
Lease liabilities are discounted to their net present values on the balance sheet based on incremental borrowing rates as determined at the lease commencement dates using quoted interest rates for readily available borrowings, such as fixed rate FHLB borrowings, with similar terms as the lease obligations. Lease liabilities are reduced by actual lease payments.
See Note 6 for additional information on Valley's lease related assets and obligations.
Premises and Equipment, Net
Premises and equipment are stated at cost less accumulated depreciation computed using the straight-line method over the estimated useful lives of the related assets. Estimated useful lives range from 3 years for capitalized software to up to 40 years for buildings. Leasehold improvements are amortized over the term of the lease or estimated useful life of the asset, whichever is shorter. Major improvements are capitalized, while repairs and maintenance costs are charged to operations as incurred. Upon retirement or disposition, any gain or loss is credited or charged to operations. See Note 7 for further details.
Bank Owned Life Insurance
Valley owns bank owned life insurance (BOLI) to help offset the cost of employee benefits. BOLI is recorded at its cash surrender value. Valley’s BOLI is invested primarily in U.S. Treasury securities and residential mortgage-backed securities issued by government sponsored enterprises and Ginnie Mae. The majority of the underlying investment portfolio is managed by one independent investment firm. The change in the cash surrender value is included as a component of non-interest income and is exempt from federal and state income taxes as long as the policies are held until the death of the insured individuals.
Other Real Estate Owned
Valley acquires other real estate owned (OREO) through foreclosure on loans secured by real estate. OREO is reported at the lower of cost or fair value, as established by a current appraisal (less estimated costs to sell) and it is included in other assets. Any write-downs at the date of foreclosure are charged to the allowance for loan losses. Expenses incurred to maintain these properties, unrealized losses resulting from valuation write-downs after the date of foreclosure, and realized gains and losses upon sale of the properties are included in other non-interest expense. OREO totaled $5.1 million and $9.4 million at December 31, 2020 and 2019, respectively. OREO included foreclosed residential real estate properties totaling $1.0 million and $2.1 million at December 31, 2020 and 2019, respectively. Residential mortgage and consumer loans secured by residential real estate properties for which formal foreclosure proceedings are in process totaled $1.9 million and $2.8 million at December 31, 2020 and 2019, respectively.
Goodwill
Intangible assets resulting from acquisitions under the acquisition method of accounting consist of goodwill and other intangible assets (see “Other Intangible Assets” below). Goodwill represents the excess of the cost of businesses acquired over the fair value of the net assets acquired and is not amortized. The initial recording of goodwill and other intangible assets requires subjective judgments concerning estimates of the fair value of the acquired assets and assumed liabilities. Goodwill is subject to annual tests for impairment or more often, if events or circumstances indicate it may be impaired.
Prior to January 1, 2020, goodwill impairment was determined using a two-step quantitative test. On January 1, 2020, Valley adopted ASU No. 2017-04, which simplified the impairment test by eliminating the step two requirement to calculate the implied fair value of goodwill to measure a goodwill impairment charge. Instead, an impairment loss is recognized if the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, with the impairment loss not to exceed the amount of goodwill allocated to the unit (formerly step one of the two-step test). Goodwill is allocated to Valley's reporting unit, which is a business segment or one level below, at the date goodwill is recorded. Under current accounting guidance, Valley may choose to perform an optional qualitative assessment to determine whether it is necessary to perform the single-step quantitative goodwill impairment test for one or more reporting units each annual period.
Valley reviews goodwill for impairment annually during the second quarter using a quantitative test, or more frequently if a triggering event indicates impairment may have occurred. Our determination of whether or not goodwill is impaired requires us to make judgments, and use significant estimates and assumptions regarding estimated future cash flows. If we change our strategy or if market conditions shift, our judgments may change, which may result in adjustments to the recorded goodwill balance.
Other Intangible Assets
Other intangible assets primarily consist of loan servicing rights (largely generated from loan servicing retained by the Bank on residential mortgage loan originations sold in the secondary market to government sponsored enterprises), core
deposits (the portion of an acquisition purchase price which represents value assigned to the existing deposit base) and, to a much lesser extent, customer lists obtained through acquisitions. Other intangible assets are amortized using various methods over their estimated lives and are periodically evaluated for impairment whenever events or changes in circumstances indicate the carrying amount of the assets may not be recoverable from future undiscounted cash flows. If impairment is deemed to exist, an adjustment is recorded to earnings in the current period for the difference between the fair value of the asset and its carrying amount. See further details regarding loan servicing rights below.
Loan Servicing Rights
Loan servicing rights are recorded when originated mortgage loans are sold with servicing rights retained, or when servicing rights are purchased. Valley initially records the loan servicing rights at fair value. Subsequently, the loan servicing rights are carried at the lower of unamortized cost or market (i.e., fair value). The fair values of the loan servicing rights for each risk-stratified group of loan servicing rights are calculated using a fair value model from a third party vendor that uses various inputs and assumptions, including but not limited to, prepayment speeds, internal rate of return (“discount rate”), servicing cost, ancillary income, float rate, tax rate, and inflation. The prepayment speed and the discount rate are considered two of the most significant inputs in the model.
Unamortized costs associated with acquiring loan servicing rights, net of any valuation allowances, are included in other intangible assets in the consolidated statements of financial condition and are accounted for using the amortization method. Valley amortizes the loan servicing assets in proportion to and over the period of estimated net servicing revenues. On a quarterly basis, Valley stratifies its loan servicing assets into groupings based on risk characteristics and assesses each group for impairment based on fair value. A valuation allowance is established through an impairment charge to earnings to the extent the unamortized cost of a stratified group of loan servicing rights exceeds its estimated fair value. Increases in the fair value of impaired loan servicing rights are recognized as a reduction of the valuation allowance, but not in excess of such allowance. The amortization of loan servicing rights is recorded in non-interest income.
Stock-Based Compensation
Compensation expense for restricted stock units, restricted stock and stock option awards (i.e., non-vested stock awards) is based on the fair value of the award on the date of the grant and is recognized ratably over the service period of the award. Beginning in 2019, Valley's long-term incentive compensation plan was amended to include a service period requirement for award grantees who are eligible for retirement pursuant to which an award will vest at one-twelfth per month after the grant date, which requires the grantees to continue service with Valley for one year in order for the award to fully vest. Compensation expense for these awards is amortized monthly over a one year period after the grant date. Prior to 2019, award grantees who were eligible for retirement did not have a service period requirement. Compensation expense for these awards is recognized immediately in earnings. The service period for non-retirement eligible employees is the shorter of the stated vesting period of the award or the period until the employee’s retirement eligibility date. The fair value of each option granted is estimated using a binomial option pricing model. The fair value of restricted stock units and awards is based upon the last sale price reported for Valley’s common stock on the date of grant or the last sale price reported preceding such date, except for performance-based stock awards with a market condition. The grant date fair value of a performance-based stock award that vests based on a market condition is determined by a third party specialist using a Monte Carlo valuation model. See Note 12 for additional information.
Fair Value Measurements
In general, fair values of financial instruments are based upon quoted market prices, where available. When observable market prices and parameters are not fully available, management uses valuation techniques based upon internal and third party models requiring more management judgment to estimate the appropriate fair value measurements. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value, including adjustments based on internal cash flow model projections that utilize assumptions similar to those incorporated by market participants. Other adjustments may include amounts to reflect counterparty credit quality and Valley’s creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. See Note 3 for additional information.
Revenue Recognition
Valley's revenue contracts generally have a single performance obligation, as the promise to transfer the individual goods or services is not separately identifiable, or distinct from other obligations within the contracts. Valley does not have a material amount of long-term customer agreements that include multiple performance obligations requiring price allocation and differences in the timing of revenue recognition. Valley has no customer contracts with variable fee agreements based upon performance. Valley's revenue within the scope of ASC Topic 606 includes: (i) trust and investment services income from investment management, investment advisory, trust, custody and other products; (ii) service charges on deposit accounts from
checking accounts, savings accounts, overdrafts, insufficient funds, ATM transactions and other activities; and (iii) other income from fee income related to derivative interest rate swaps executed with commercial loan customers, and fees from interchange, wire transfers, credit cards, safe deposit box, ACH, lockbox and various other products and services-related income.
Income Taxes
Valley uses the asset and liability method to provide income taxes on all transactions recorded in the consolidated financial statements. This method requires that income taxes reflect the expected future tax consequences of temporary differences between the carrying amounts of assets or liabilities for book and tax purposes. Accordingly, a deferred tax asset or liability for each temporary difference is determined based on the enacted tax rates that will be in effect when the underlying items of income and expense are expected to be realized.
Valley’s expense for income taxes includes the current and deferred portions of that expense. Deferred tax assets are recognized if, in management's judgment, their realizability is determined to be more likely than not. A valuation allowance is established to reduce deferred tax assets to the amount we expect to realize. Deferred income tax expense or benefit results from differences between assets and liabilities measured for financial reporting versus income-tax return purposes. The effect on deferred taxes of a change in tax rates is recognized in income tax expense in the period that includes the enactment date.
Valley maintains a reserve related to certain tax positions that management believes contain an element of uncertainty. An uncertain tax position is measured based on the largest amount of benefit that management believes is more likely than not to be realized. Periodically, Valley evaluates each of its tax positions and strategies to determine whether the reserve continues to be appropriate.
Comprehensive Income
Comprehensive income or loss is defined as the change in equity of a business entity during a period due to transactions and other events and circumstances, excluding those resulting from investments by and distributions to shareholders. Comprehensive income consists of net income and other comprehensive income or loss. Valley’s components of other comprehensive income or loss, net of deferred tax, include: (i) unrealized gains and losses on securities available for sale; (ii) unrealized gains and losses on derivatives used in cash flow hedging relationships; and (iii) the pension benefit adjustment for the unfunded portion of its various employee, officer, and director pension plans. Income tax effects are released from accumulated other comprehensive income on an individual unit of account basis. Valley presents comprehensive income and its components in the consolidated statements of comprehensive income for all periods presented. See Note 19 for additional disclosures.
Earnings Per Common Share
In Valley's computation of the earnings per common share, the numerator of both the basic and diluted earnings per common share is net income available to common shareholders (which is equal to net income less dividends on preferred stock). The weighted average number of common shares outstanding used in the denominator for basic earnings per common share is increased to determine the denominator used for diluted earnings per common share by the effect of potentially dilutive common stock equivalents utilizing the treasury stock method.
The following table shows the calculation of both basic and diluted earnings per common share for the years ended December 31, 2020, 2019 and 2018:
Common stock equivalents represent the dilutive effect of additional common shares issuable upon the assumed vesting or exercise, if applicable, of restricted stock units and common stock options to purchase Valley’s common shares. Common stock options with exercise prices that exceed the average market price of Valley’s common stock during the periods presented may have an anti-dilutive effect on the diluted earnings per common share calculation and therefore are excluded from the diluted earnings per share calculation along with restricted stock units. Potential anti-dilutive weighted common shares totaled approximately 1.7 million, 288 thousand, and 2.1 million for the years ended December 31, 2020, 2019 and 2018, respectively.
Preferred and Common Stock Dividends
Valley issued 4.6 million and 4.0 million shares of non-cumulative perpetual preferred stock in June 2015 and August 2017, respectively, which were initially recorded at fair value. See Note 18 for additional details on the preferred stock issuances. The preferred shares are senior to Valley common stock, whereas the current year dividends must be paid before Valley can pay dividends to its common shareholders. Preferred dividends declared are deducted from net income for computing income available to common shareholders and earnings per common share computations.
Cash dividends to both preferred and common shareholders are payable and accrued when declared by Valley's Board of Directors.
Treasury Stock
Treasury stock is recorded using the cost method and accordingly is presented as a reduction of shareholders’ equity.
Derivative Instruments and Hedging Activities
As part of its asset/liability management strategies and to accommodate commercial borrowers, Valley has used interest rate swaps to hedge variability in cash flows or fair values caused by changes in interest rates. Valley also uses derivatives not designated as hedges for non-speculative purposes to (1) manage its exposure to interest rate movements related to a service for commercial lending customers, (2) share the risk of default on the interest rate swaps related to certain purchased or sold loan participations through the use of risk participation agreements and (3) manage the interest rate risk of mortgage banking activities with customer interest rate lock commitments and forward contracts to sell residential mortgage loans. Valley also has hybrid instruments, consisting of market linked certificates of deposit with an embedded swap contract. Valley records all derivatives including embedded derivatives as assets or liabilities at fair value on the consolidated statements of financial condition.
Derivatives used to hedge the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Derivatives used to hedge the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. For derivatives designated as cash flow hedges, the effective portion of changes in the fair value of the derivative is initially reported in other comprehensive income or loss and subsequently reclassified to earnings when the hedged transaction affects earnings, and the ineffective portion of changes in the fair value of the derivative is recognized directly in earnings. For derivatives designated as fair value hedges, changes in the fair value of the derivative and the hedged item related to the hedged risk are recognized in earnings. On a quarterly basis, Valley assesses the effectiveness of each hedging relationship by comparing the changes in cash flows or fair value of the derivative hedging instrument with the changes in cash flows or fair value of the designated hedged item or transaction. If a hedging relationship is terminated due to ineffectiveness, and the derivative instrument is not re-designated to a new hedging relationship, the subsequent change in fair value of such instrument is charged directly to earnings. Derivatives not designated as hedges do not meet the hedge accounting requirements under U.S. GAAP. Changes in fair value of derivatives not designated in hedging relationships are recorded directly in earnings. Valley calculates the credit valuation adjustments to the fair value of derivatives designated as fair value hedges on a net basis by counterparty portfolio, as an accounting policy election.
New Authoritative Accounting Guidance
New Accounting Guidance Adopted in 2020. ASU No. 2016-13, "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments" amends the accounting guidance on the impairment of financial instruments. The FASB issued an amendment to replace the incurred loss impairment methodology under prior accounting guidance with a new CECL model.
Valley adopted ASU No. 2016-13 on January 1, 2020 using the modified retrospective approach for all financial assets measured at amortized cost (except for PCD loans) and off-balance sheet credit exposures. At adoption, Valley recorded a $100.4 million increase to its allowance for credit losses, including reserves of $92.5 million, $7.1 million and $793 thousand
related to loans, unfunded credit commitments and held to maturity debt securities, respectively. Of the $92.5 million in loan reserves, $61.6 million represents PCD loan related reserves which were recognized through a gross-up that increased the amortized cost basis of loans with a corresponding increase to the allowance for credit losses, and therefore resulted in no impact to shareholders' equity. The remaining non-credit discount of $97.7 million related to PCD loans is accreted into interest income over the life of the loans at the effective interest rate effective January 1, 2020. Valley elected the prospective transition approach for PCD loans that were previously classified as purchased-credit impaired (PCI) loans. Under this guidance, Valley was not required to reassess whether PCI loans met the PCD loans criteria as of the date of the date of adoption. The non-PCD loan related increase to the allowance for credit losses of $38.8 million, including the reserves for unfunded loan commitments and held to maturity debt securities, was offset in shareholders' equity and deferred tax assets. See Notes 4 and 5 for allowance for credit losses required disclosures. Reporting periods prior to the adoption date are presented in accordance with previously applicable GAAP.
ASU No. 2017-04, "Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment" eliminates the requirement to calculate the implied fair value of goodwill (i.e., Step 2 of the current goodwill impairment test guidance) to measure a goodwill impairment charge. Instead, an entity will be required to record an impairment charge based on the excess of a reporting unit’s carrying amount over its fair value (i.e., measure the charge based on Step 1 of the current guidance). In addition, ASU No. 2017-04 eliminates the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test. However, an entity will be required to disclose the amount of goodwill allocated to each reporting unit with a zero or negative carrying amount of net assets. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. ASU No. 2017-04 was effective for Valley on January 1, 2020 and Valley applied this new guidance in its annual goodwill impairment test performed during the second quarter 2020.
New Accounting Guidance Issued in 2020. ASU No. 2020-04, "Reference Rate Reform (Topic 848)" provides optional expedients and exceptions for applying U.S. GAAP to contract modifications and hedging relationships that reference LIBOR or another reference rate expected to be discontinued, subject to meeting certain criteria. Under the new guidance, an entity can elect by accounting topic or industry subtopic to account for the modification of a contract affected by reference rate reform as a continuation of the existing contract, if certain conditions are met. In addition, the new guidance allows an entity to elect on a hedge-by-hedge basis to continue to apply hedge accounting for hedging relationships in which the critical terms change due to reference rate reform, if certain conditions are met. A one-time election to sell and/or transfer held to maturity debt securities that reference a rate affected by reference rate reform is also allowed. ASU No. 2020-04 became effective for all entities as of March 12, 2020 and can apply to all LIBOR reference rate modifications any time through December 31, 2022. Management is currently evaluating the impact of the ASU on Valley’s consolidated financial statements. Valley has established a working group to identify and prepare fall back language and replacement provisions. In addition, the working group is evaluating substitute indices for LIBOR and testing Valley's models and systems that currently use LIBOR to ensure reference rates change readiness.
New Accounting Guidance Adopted in the First Quarter 2021. ASU No. 2020-08, "Codification Improvements to Subtopic 310-20, Receivables-Nonrefundable Fees and Other Costs" provides clarification and affects the guidance previously issued by ASU No. 2017-08 “Receivables -Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities.” ASU No. 2020-08 clarifies that an entity should reevaluate whether a debt security with multiple call dates is within the scope of paragraph 310-20-35-33. For each reporting period, to the extent that the amortized cost basis of an individual callable debt security exceeds the amount repayable by the issuer at the next call date, the premium should be amortized to the next call date, unless the guidance to consider estimated prepayments is applied. Valley adopted ASU No. 2020-08 on January 1, 2021. This new guidance is not expected to have a significant impact on Valley’s consolidated financial statements.
ASU No. 2021-01 "Reference Rate Reform (Topic 848)" extends some of Topic 848’s optional expedients to derivative contracts impacted by the discounting transition, including for derivatives that do not reference LIBOR or other reference rates that are expected to be discontinued. ASU No. 2021-01 is effective for all entities immediately upon issuance and may be elected retrospectively to eligible modifications as of any date from the beginning of the interim period that includes March 12, 2020, or prospectively to new modifications made on or after any date within the interim period including January 7, 2021. The ASU No. 2021-01 is not expected to have a significant impact on Valley’s consolidated financial statements.
BUSINESS COMBINATIONS (Note 2)
Oritani Financial Corp.
On December 1, 2019, Valley completed its acquisition of Oritani Financial Corp. ("Oritani") and its wholly-owned subsidiary, Oritani Bank. Oritani had approximately $4.3 billion in assets, $3.4 billion in net loans and $2.9 billion in deposits, after purchase accounting adjustments, and a branch network of 26 locations. The acquisition represented a significant addition to Valley's New Jersey franchise, and meaningfully enhanced its presence in the Bergen County market. The common shareholders of Oritani received 1.60 shares of Valley common stock for each Oritani share that they owned prior to the merger. The total consideration for the acquisition was approximately $835.3 million, consisting of 71.1 million shares of Valley common stock and the outstanding Oritani stock-based awards.
Merger expenses totaled $1.9 million and $16.6 million for the years ended December 31, 2020 and 2019, respectively, which primarily related to salary and employee benefits, as well as professional and legal, net occupancy and equipment, and other expenses. These expenses are included in non-interest expense on the consolidated statements of income.
During 2020, Valley revised the estimated fair values of the acquired assets as of the Oritani acquisition date due to additional information obtained that existed as of December 1, 2019. The adjustments mostly related to the fair value of certain loans, current taxes payable and the valuation of deferred tax assets as of the acquisition date. These adjustments resulted in an $8.8 million increase in goodwill (see Note 8 for amount of goodwill as allocated to Valley's business segments).
Had the acquisition of Oritani taken place on the beginning of the following annual periods presented, Valley’s revenues (defined as the sum of net interest income and non-interest income), net income, basic earnings per share, and diluted earnings per share would have equaled the amounts indicated in the following table for the years ended December 31, 2019 and 2018:
USAmeriBancorp, Inc.
On January 1, 2018, Valley completed its acquisition of USAmeriBancorp, Inc. (USAB) headquartered in Clearwater, Florida. USAB, largely through its wholly-owned subsidiary, USAmeriBank, had approximately $5.1 billion in assets, $3.7 billion in net loans and $3.6 billion in deposits, after purchase accounting adjustments, and maintained a branch network of 29 offices. The acquisition represented a significant addition to Valley’s Florida presence, primarily in the Tampa Bay market. The acquisition also brought Valley to the Birmingham, Montgomery, and Tallapoosa areas in Alabama, where USAB maintained 15 of its branches. The common shareholders of USAB received 6.1 shares of Valley common stock for each USAB share they owned prior to the merger. The total consideration for the acquisition was approximately $737 million, consisting of 64.9 million shares of Valley common stock and the outstanding USAB stock-based awards.
Merger expenses totaled $17.4 million for the year ended December 31, 2018, which primarily related to salary and employee benefits and other expenses are included in non-interest expense on the consolidated statements of income.
FAIR VALUE MEASUREMENT OF ASSETS AND LIABILITIES (Note 3)
Accounting Standards Codification (ASC) Topic 820, “Fair Value Measurements” establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:
•Level 1 - Unadjusted exchange quoted prices in active markets for identical assets or liabilities, or identical liabilities traded as assets that the reporting entity has the ability to access at the measurement date.
•Level 2 - Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly (i.e., quoted prices on similar assets) for substantially the full term of the asset or liability.
•Level 3 - Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).
Assets and Liabilities Measured at Fair Value on a Recurring Basis and Non-Recurring Basis
The following tables present the assets and liabilities that are measured at fair value on a recurring and non-recurring basis by level within the fair value hierarchy as reported on the consolidated statements of financial condition at December 31, 2020 and 2019. The assets presented under “non-recurring fair value measurements” in the table below are not measured at fair value on an ongoing basis but are subject to fair value adjustments under certain circumstances (e.g., when an impairment loss is recognized).
(1)Includes equity securities measured as net asset value (NAV) per share (or its equivalent) as a practical expedient totaling $7.8 million at December 31, 2020. These securities have not been classified in the fair value hierarchy.
(2)Represents residential mortgage loans held for sale that are carried at fair value and had contractual unpaid principal balances totaling approximately $286.4 million and $74.5 million at December 31, 2020 and 2019, respectively.
(3)Derivative financial instruments are included in this category.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The following valuation techniques were used for financial instruments measured at fair value on a recurring basis. All of the valuation techniques described below apply to the unpaid principal balance, excluding any accrued interest or dividends at the measurement date. Interest income and expense are recorded within the consolidated statements of income depending on the nature of the instrument using the effective interest method based on acquired discount or premium.
Equity Securities. The fair value of equity securities largely consists of a publicly traded mutual fund, a Community Reinvestment Act (CRA) investment fund that is carried at quoted prices in active markets and privately held CRA funds measured at NAV.
Available for sale debt securities. All U.S. Treasury securities are reported at fair value utilizing Level 1 inputs. The majority of other investment securities are reported at fair value utilizing Level 2 inputs. The prices for these instruments are obtained through an independent pricing service or dealer market participants with whom Valley has historically transacted both purchases and sales of investment securities. Prices obtained from these sources include prices derived from market quotations and matrix pricing. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. Management reviews the data and assumptions used in pricing the securities by its third party provider to ensure the highest level of significant inputs are derived
from market observable data. In addition, Valley reviews the volume and level of activity for all available for sale securities and attempts to identify transactions which may not be orderly or reflective of a significant level of activity and volume.
In calculating the fair value of one impaired special revenue bond (within obligations of states and political subdivisions in the table above) under Level 3, Valley prepared its best estimate of the present value of the cash flows to determine an internal price estimate. In determining the internal price, Valley utilized recent financial information and developments provided by the issuer, as well as other unobservable inputs which reflect Valley’s own assumptions about the inputs that market participants would use in pricing of the defaulted security. A quoted price received from an independent pricing service was weighted with the internal price estimate to determine the fair value of the instrument at December 31, 2020 and 2019. See Note 4 for additional information regarding this impaired security.
Loans held for sale. Residential mortgage loans originated for sale are reported at fair value using Level 2 inputs. The fair values were calculated utilizing quoted prices for similar assets in active markets. The market prices represent a delivery price, which reflects the underlying price each institution would pay Valley for an immediate sale of an aggregate pool of mortgages. Non-performance risk did not materially impact the fair value of mortgage loans held for sale at December 31, 2020 and 2019 based on the short duration these assets were held and the credit quality of these loans.
Derivatives. Derivatives are reported at fair value utilizing Level 2 inputs. The fair values of Valley’s derivatives are determined using third party prices that are based on discounted cash flow analysis using observed market inputs, such as the LIBOR, Overnight Index Swap and Secured Overnight Financing Rate (SOFR) curves for all cleared derivatives. The fair value of mortgage banking derivatives, consisting of interest rate lock commitments to fund residential mortgage loans and forward commitments for the future delivery of such loans (including certain loans held for sale at December 31, 2020 and 2019), is determined based on the current market prices for similar instruments. The fair values of most of the derivatives incorporate credit valuation adjustments, which consider the impact of any credit enhancements to the contracts, to account for potential nonperformance risk of Valley and its counterparties. The credit valuation adjustments were not significant to the overall valuation of Valley’s derivatives at December 31, 2020 and 2019.
Assets and Liabilities Measured at Fair Value on a Non-recurring Basis
The following valuation techniques were used for certain non-financial assets measured at fair value on a non-recurring basis, including collateral dependent loans reported at the fair value of the underlying collateral, loan servicing rights and foreclosed assets, which are reported at fair value upon initial recognition or subsequent impairment as described below.
Collateral dependent loans. Collateral dependent loans are loans where foreclosure of the collateral is probable, or where the borrower is experiencing financial difficulty and substantially all of the repayment is expected from the collateral. Collateral values are estimated using Level 3 inputs, consisting of individual third-party appraisals that may be adjusted based on certain discounting criteria. Certain real estate appraisals may be discounted based on specific market data by location and property type. At December 31, 2020, collateral dependent loans were individually re-measured and reported at fair value through direct loan charge-offs to the allowance for loan losses based on the fair value of the underlying collateral. The collateral dependent loan direct charge-offs to the allowance for loan losses totaled $4.5 million and $2.1 million for the years ended December 31, 2020 and 2019, respectively. At December 31, 2020, collateral dependent loans, primarily consisting of taxi medallion loans, with a total amortized cost of $104.4 million and $74.6 million at December 31, 2020 and 2019, respectively, were reduced by specific allowance for loan losses allocations totaling $69.1 million and $35.5 million to a reported total net carrying amount of $35.2 million and $39.1 million at December 31, 2020 and 2019, respectively.
Loan servicing rights. Fair values for each risk-stratified group of loan servicing rights are calculated using a fair value model from a third party vendor that requires inputs that are both significant to the fair value measurement and unobservable (Level 3). The fair value model is based on various assumptions, including but not limited to, prepayment speeds, internal rate of return (discount rate), servicing cost, ancillary income, float rate, tax rate, and inflation. The prepayment speed and the discount rate are considered two of the most significant inputs in the model. At December 31, 2020, the fair value model used a blended prepayment speed (stated as constant prepayment rates) of 19.8 percent and a discount rate of 9.6 percent for the valuation of the loan servicing rights. A significant degree of judgment is involved in valuing the loan servicing rights using Level 3 inputs. The use of different assumptions could have a significant positive or negative effect on the fair value estimate. Impairment charges are recognized on loan servicing rights when the amortized cost of a risk-stratified group of loan servicing rights exceeds the estimated fair value. Certain loan servicing rights were re-measured at fair value totaling $15.6 million and $1.6 million at December 31, 2020 and 2019, respectively. See Note 8 for additional information.
Foreclosed assets. Certain foreclosed assets (consisting of other real estate owned and other repossessed assets included in other assets), upon initial recognition and transfer from loans, are re-measured and reported at fair value using Level 3 inputs, consisting of a third-party appraisal less estimated cost to sell. When an asset is acquired, the excess of the loan balance over fair value, less estimated selling costs, is charged to the allowance for loan losses. If further declines in the estimated fair value
of the asset occur, an asset is re-measured and reported at fair value through a write-down recorded in non-interest expense. The adjustments to the appraisals of foreclosed assets ranged from 1.5 percent to 22 percent at December 31, 2020 and were not material at December 31, 2019.
Other Fair Value Disclosures
ASC Topic 825, “Financial Instruments,” requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis.
The fair value estimates presented in the following table were based on pertinent market data and relevant information on the financial instruments available as of the valuation date. These estimates do not reflect any premium or discount that could result from offering for sale at one time the entire portfolio of financial instruments. Because no market exists for a portion of the financial instruments, fair value estimates may be based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
Fair value estimates are based on existing balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. For instance, Valley has certain fee-generating business lines (e.g., its mortgage servicing operation, trust and investment management departments) that were not considered in these estimates since these activities are not financial instruments. In addition, the tax implications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.
The carrying amounts and estimated fair values of financial instruments not measured and not reported at fair value on the consolidated statements of financial condition at December 31, 2020 and 2019 were as follows:
(1)Represents equity securities without a readily determinable fair value measured at costs less impairment, if any.
(2)The carrying amount is presented gross without the allowance for credit losses.
(3)Included in other assets.
(4)Included in accrued expenses and other liabilities.
INVESTMENT SECURITIES (Note 4)
Equity Securities
Equity securities carried at fair value totaled $29.4 million and $41.4 million at December 31, 2020 and 2019, respectively. At December 31, 2020, Valley's equity securities consisted of one publicly traded money market mutual fund, CRA investments both public traded and privately held and, to a lesser extent, equity securities without readily determinable fair values.
Available for Sale Debt Securities
The amortized cost, gross unrealized gains and losses and fair value of investment securities available for sale at December 31, 2020 and 2019 were as follows:
The age of unrealized losses and fair value of related securities available for sale at December 31, 2020 and 2019 were as follows:
Within the available for sale debt securities portfolio, the total number of security positions in an unrealized loss position at December 31, 2020 was 58 as compared to 182 at December 31, 2019.
As of December 31, 2020, the fair value of securities available for sale that were pledged to secure public deposits, repurchase agreements, lines of credit, and for other purposes required by law, was $789.0 million.
The contractual maturities of available for sale debt securities at December 31, 2020 are set forth in the following table. Maturities may differ from contractual maturities in residential mortgage-backed securities because the mortgages underlying the securities may be prepaid without any penalties. Therefore, residential mortgage-backed securities are not included in the maturity categories in the following summary.
Actual maturities of available for sale debt securities may differ from those presented above since certain obligations provide the issuer the right to call or prepay the obligation prior to scheduled maturity without penalty.
The weighted-average remaining expected life for residential mortgage-backed securities available for sale was 3.4 years at December 31, 2020.
Impairment Analysis of Available for Sale Debt Securities
Valley's available for sale debt securities portfolio includes corporate bonds and revenue bonds, among other securities. These types of securities may pose a higher risk of future impairment charges by Valley as a result of the unpredictable nature of the U.S. economy and its potential negative effect on the future performance of the security issuers, including due to the economic effects of COVID-19 pandemic.
Available for sale debt securities in unrealized loss positions are evaluated for impairment related to credit losses on a quarterly basis. See Note 1 for further information regarding Valley's accounting policy. Valley has evaluated available for sale debt securities that are in an unrealized loss position as of December 31, 2020 included in the table above and has determined that the declines in fair value are mainly attributable to market volatility, not credit quality or other factors. Based on a comparison of the present value of expected cash flows to the amortized cost, management recognized no impairment during the year ended December 31, 2020 and, as a result, there was no allowance for credit losses for available for sale debt securities at December 31, 2020.
During 2019, Valley recognized a $2.9 million impairment charge on one special revenue bond classified as available for sale (within the obligations of states and state agencies in the tables above). The impairment was due to severe credit deterioration disclosed by the issuer in the second quarter 2019, as well as the issuer's default on its contractual payment. At December 31, 2020, the non-accruing impaired security had an adjusted amortized cost and fair value of $680 thousand and $815 thousand, respectively. At December 31, 2020, the revenue bonds, included in the obligations of states and political subdivisions, are a mix of municipal bonds with investment grade ratings or non-rated revenue bonds mostly secured by Ginnie Mae securities that are commonly referred to as Tax Exempt Mortgage Securities (TEMS) and paying in accordance with their contractual terms.
Held to Maturity Debt Securities
The amortized cost, gross unrealized gains and losses and fair value of investment debt securities held to maturity at December 31, 2020 and 2019 were as follows:
The age of unrealized losses and fair value of related securities held to maturity at December 31, 2020 and 2019 were as follows:
Within the securities held to maturity portfolio, the total number of security positions in an unrealized loss position at December 31, 2020 was 13 as compared to 82 at December 31, 2019.
As of December 31, 2020, the fair value of debt securities held to maturity that were pledged to secure public deposits, repurchase agreements, lines of credit, and for other purposes required by law was $1.4 billion.
The contractual maturities of investments in debt securities held to maturity at December 31, 2020 are set forth in the table below. Maturities may differ from contractual maturities in residential mortgage-backed securities because the mortgages underlying the securities may be prepaid without any penalties. Therefore, residential mortgage-backed securities are not included in the maturity categories in the following summary.
Actual maturities of held to maturity debt securities may differ from those presented above since certain obligations provide the issuer the right to call or prepay the obligation prior to scheduled maturity without penalty.
The weighted-average remaining expected life for residential mortgage-backed securities held to maturity was 4.2 years at December 31, 2020.
Credit Quality Indicators
Valley monitors the credit quality of the held to maturity debt securities utilizing the most current credit ratings from external rating agencies. The following table summarizes the amortized cost of held to maturity debt securities by external credit rating at December 31, 2020 and 2019.
Obligations of states and political subdivisions include municipal bonds and revenue bonds issued by various municipal corporations. At December 31, 2020, most of the obligations of states and political subdivisions were rated investment grade and a large portion of the "non-rated" category included TEMS securities secured by Ginnie Mae securities. Trust preferred securities consist of non-rated single-issuer securities, issued by bank holding companies. Corporate bonds consist of debt primarily issued by banks.
Allowance for Credit Losses for Held to Maturity Debt Securities
Valley has a zero loss expectation for certain securities within the held to maturity portfolio, and therefore it is not required to estimate an allowance for credit losses related to these securities under the CECL standard. After an evaluation of qualitative factors, Valley identified the following securities types which it believes qualify for this exclusion: U.S. Treasury securities, U.S. agency securities, residential mortgage-backed securities issued by Ginnie Mae, Fannie Mae and Freddie Mac, and collateralized municipal bonds called TEMS. To measure the expected credit losses on held to maturity debt securities that have loss expectations, Valley estimates the expected credit losses using a discounted cash flow model developed by a third-party. See Note 1 for further details.
At December 31, 2020, held to maturity debt securities were carried net of allowance for credit losses totaling $1.4 million. Valley recorded a provision for credit losses of $635 thousand during the year December 31, 2020. There were no net charge-offs of debt securities in the respective periods.
Realized Gains and Losses
Gross gains and losses realized on sales, maturities and other securities transactions included in earnings for the years ended December 31, 2020, 2019 and 2018 were as follows:
Net gains on sales transactions for the year ended December 31, 2020 (as presented in the table above) primarily related to the sales of $30 million of certain available for sale municipal securities. Net losses on sales transactions in 2018 primarily related to the sales of equity securities previously classified as available for sale, certain municipal securities acquired from USAB and all of Valley's private label mortgage-backed securities classified as available for sale, including securities that were previously impaired.
LOANS AND ALLOWANCE FOR CREDIT LOSSES FOR LOANS (Note 5)
The detail of the loan portfolio as of December 31, 2020 and 2019 was as follows:
* Includes $2.2 billion of loans originated under the SBA Paycheck Protection Program (PPP), net of unearned fees totaling $43.2 million at December 31, 2020.
Total loans include net unearned discounts and deferred loan fees of $95.8 million at December 31, 2020 and net unearned premiums and deferred loan costs totaling and $12.6 million at December 31, 2019. Net unearned discounts and deferred loan fees at December 31, 2020 include the non-credit discount on PCD loans and net unearned fees related to PPP loans.
Accrued interest on loans, which is excluded from the amortized cost of loans held for investment, totaled $90.2 million and $86.3 million at December 31, 2020 and December 31, 2019, respectively, and is presented separately in the consolidated statements of financial condition.
Valley transferred and sold $30.0 million and $436.5 million of residential mortgage loans from the loan portfolio to loans held for sale in 2020 and 2019, respectively. Valley transferred and sold $798 million of commercial real estate loans
from the loan portfolio to loans held for sale in 2019. Excluding the loan transfers, there were no other sales of loans from the held for investment portfolio during the years December 31, 2020 and 2019.
Related Party Loans
In the ordinary course of business, Valley has granted loans to certain directors, executive officers and their affiliates (collectively referred to as “related parties”). These loans were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other unaffiliated persons and do not involve more than normal risk of collectability. All loans to related parties are performing as of December 31, 2020.
The following table summarizes the changes in the total amounts of loans and advances to the related parties during the year ended December 31, 2020:
Loan Portfolio Risk Elements and Credit Risk Management
Credit risk management. For all loan types discussed below, Valley adheres to a credit policy designed to minimize credit risk while generating the maximum income given the level of risk appetite. Management reviews and approves these policies and procedures on a regular basis with subsequent approval by the Board of Directors annually. Credit authority relating to a significant dollar percentage of the overall portfolio is centralized and controlled by the Credit Risk Management Division and by the Credit Committee. A reporting system supplements the management review process by providing management with frequent reports concerning loan production, loan quality, internal loan classification, concentrations of credit, loan delinquencies, non-performing, and potential problem loans. Loan portfolio diversification is an important factor utilized by Valley to manage its risk across business sectors and through cyclical economic circumstances.
Commercial and industrial loans. A significant portion of Valley’s commercial and industrial loan portfolio is granted to long standing customers of proven ability, strong repayment performance, and high character. Underwriting standards are designed to assess the borrower’s ability to generate recurring cash flow sufficient to meet the debt service requirements of loans granted. While such recurring cash flow serves as the primary source of repayment, a significant number of the loans are collateralized by borrower assets intended to serve as a secondary source of repayment should the need arise. Anticipated cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value, or in the case of loans secured by accounts receivable, the ability of the borrower to collect all amounts due from its customers. Short-term loans may be made on an unsecured basis based on a borrower’s financial strength and past performance. Whenever possible, Valley will obtain the personal guarantee of the borrower’s principals to mitigate the risk. Unsecured loans, when made, are generally granted to the Bank’s most credit worthy borrowers. Unsecured commercial and industrial loans totaled $2.7 billion (including $2.2 billion of SBA guaranteed PPP loans) and $606.1 million at December 31, 2020 and 2019, respectively. The commercial portfolio also includes taxi medallion loans totaling approximately $97.5 million with related reserves of $66.4 million at December 31, 2020. All of these loans are on non-accrual status due to ongoing weakness exhibited in the taxi industry caused by strong competition from alternative ride-sharing services and the economic stress caused by COVID-19 pandemic.
Commercial real estate loans. Commercial real estate loans are subject to underwriting standards and processes similar to commercial and industrial loans but generally they involve larger principal balances and longer repayment periods as compared to commercial and industrial loans. Commercial real estate loans are viewed primarily as cash flow loans and secondarily as loans secured by real property. Repayment of most loans is dependent upon the cash flow generated from the property securing the loan or the business that occupies the property. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy and accordingly, conservative loan to value ratios are required at origination, as well as stress tested to evaluate the impact of market changes relating to key underwriting elements. The properties securing the commercial real estate portfolio represent diverse types, with most properties located within Valley’s primary markets.
Construction loans. With respect to loans to developers and builders, Valley originates and manages construction loans structured on either a revolving or non-revolving basis, depending on the nature of the underlying development project. These loans are generally secured by the real estate to be developed and may also be secured by additional real estate to mitigate the risk. Non-revolving construction loans often involve the disbursement of substantially all committed funds with repayment
substantially dependent on the successful completion and sale, or lease, of the project. Sources of repayment for these types of loans may be from pre-committed permanent loans from other lenders, sales of developed property, or an interim loan commitment from Valley until permanent financing is obtained elsewhere. Revolving construction loans (generally relating to single-family residential construction) are controlled with loan advances dependent upon the presale of housing units financed. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.
Residential mortgages. Valley originates residential, first mortgage loans based on underwriting standards that generally comply with Fannie Mae and/or Freddie Mac requirements. Appraisals and valuations of real estate collateral are contracted directly with independent appraisers or from valuation services and not through appraisal management companies. The Bank’s appraisal management policy and procedure is in accordance with regulatory requirements and guidance issued by the Bank’s primary regulator. Credit scoring, using FICO® and other proprietary credit scoring models are employed in the ultimate, judgmental credit decision by Valley’s underwriting staff. Valley does not use third party contract underwriting services. Residential mortgage loans include fixed and variable interest rate loans secured by one to four family homes mostly located in northern and central New Jersey, the New York City metropolitan area, and Florida. Valley’s ability to be repaid on such loans is closely linked to the economic and real estate market conditions in these regions. In deciding whether to originate each residential mortgage, Valley considers the qualifications of the borrower as well as the value of the underlying property.
Home equity loans. Home equity lending consists of both fixed and variable interest rate products. Valley mainly provides home equity loans to its residential mortgage customers within the footprint of its primary lending territory. Valley generally will not exceed a combined (i.e., first and second mortgage) loan-to-value ratio of 80 percent when originating a home equity loan.
Automobile loans. Valley uses both judgmental and scoring systems in the credit decision process for automobile loans. Automobile originations (including light truck and sport utility vehicles) are largely produced via indirect channels, originated through approved automobile dealers. Automotive collateral is generally a depreciating asset and there are times in the life of an automobile loan where the amount owed on a vehicle may exceed its collateral value. Additionally, automobile charge-offs will vary based on the strength or weakness of the used vehicle market, original advance rate, when in the life cycle of a loan a default occurs and the condition of the collateral being liquidated. Where permitted by law, and subject to the limitations of the bankruptcy code, deficiency judgments are sought and acted upon to ultimately collect all money owed, even when a default resulted in a loss at collateral liquidation. Valley uses a third party to actively track collision and comprehensive risk insurance required of the borrower on the automobile and this third party provides coverage to Valley in the event of an uninsured collateral loss.
Other consumer loans. Valley’s other consumer loan portfolio includes direct consumer term loans, both secured and unsecured. The other consumer loan portfolio includes exposures in personal lines of credit (mainly those secured by cash surrender value of life insurance), credit card loans and personal loans. Unsecured consumer loans totaled approximately $49.4 million and $53.9 million, including $8.8 million and $8.2 million of credit card loans, at December 31, 2020 and 2019, respectively. Management believes the aggregate risk exposure to unsecured loans and lines of credit was not significant at December 31, 2020.
Credit Quality
The following table presents past due, current and non-accrual loans without an allowance for credit losses by loan portfolio class (including PCD loans) at December 31, 2020:
The following table presents past due, non-accrual and current loans by loan portfolio class at December 31, 2019. At December 31, 2019, purchased credit-impaired (PCI) loans were excluded from past due and non-accrual loans reported because they continued to earn interest income from the accretable yield at the pool level. The PCI loan pools are accounted for as PCD loans (on a loan level basis with a related allowance for credit losses) under the CECL standard adopted at January 1, 2020 and reported in the past due loans and non-accrual loans in the table above at December 31, 2020.
If interest on non-accrual loans had been accrued in accordance with the original contractual terms, such interest income would have amounted to approximately $6.2 million, $2.5 million, and $3.6 million for the years ended December 31, 2020, 2019 and 2018, respectively; none of these amounts were included in interest income during these periods.
Credit quality indicators. Valley utilizes an internal loan classification system as a means of reporting problem loans within commercial and industrial, commercial real estate, and construction loan portfolio classes. Under Valley’s internal risk rating system, loan relationships could be classified as “Pass,” “Special Mention,” “Substandard,” “Doubtful,” and “Loss.” Substandard loans include loans that exhibit well-defined weakness and are characterized by the distinct possibility that Valley will sustain some loss if the deficiencies are not corrected. Loans classified as Doubtful have all the weaknesses inherent in those classified as Substandard with the added characteristic that the weaknesses present make collection or liquidation in full, based on currently existing facts, conditions and values, highly questionable and improbable. Loans classified as Loss are those considered uncollectible with insignificant value and are charged-off immediately to the allowance for loan losses, and, therefore, not presented in the table below. Loans that do not currently pose a sufficient risk to warrant classification in one of the aforementioned categories but pose weaknesses that deserve management’s close attention are deemed Special Mention. Loans rated as Pass do not currently pose any identified risk and can range from the highest to average quality, depending on the degree of potential risk. Risk ratings are updated any time the situation warrants.
The following table presents the internal loan classification risk by loan portfolio class by origination year (including PCD loans) based on the most recent analysis performed at December 31, 2020:
For residential mortgages, automobile, home equity and other consumer loan portfolio classes, Valley also evaluates credit quality based on the aging status of the loan, which was previously presented, and by payment activity. The following table presents the amortized cost in those loan classes (including PCD loans) based on payment activity by origination year as of December 31, 2020:
The following table presents the credit exposure by internally assigned risk rating by class of loans (excluding PCI loans) based on the most recent analysis performed at December 31, 2019:
For residential mortgages, automobile, home equity and other consumer loan portfolio classes (excluding PCI loans), Valley also evaluates credit quality based on the aging status of the loan, which was previously presented, and by payment activity. The following table presents the recorded investment in those loan classes based on payment activity as of December 31, 2019:
The following table presents the recorded investment in PCI loans by class based on individual loan payment activity as of December 31, 2019:
Troubled debt restructured loans. From time to time, Valley may extend, restructure, or otherwise modify the terms of existing loans, on a case-by-case basis, to remain competitive and retain certain customers, as well as assist other customers who may be experiencing financial difficulties. If the borrower is experiencing financial difficulties and a concession has been made at the time of such modification, the loan is classified as a troubled debt restructured loan (TDR). At the adoption of ASU 2016-13, Valley was not required to reassess whether modifications to individual PCI loans prior to January 1, 2020 met the TDR loan criteria.
Generally the concessions made for TDRs involve lowering the monthly payments on loans through either a reduction in interest rate below a market rate, an extension of the term of the loan without a corresponding adjustment to the risk premium reflected in the interest rate, or a combination of these two methods. The concessions may also involve payment deferrals but rarely result in the forgiveness of principal or accrued interest. In addition, Valley frequently obtains additional collateral or guarantor support when modifying such loans. If the borrower has demonstrated performance under the previous terms of the loan and Valley’s underwriting process shows the borrower has the capacity to continue to perform under the restructured terms, the loan will continue to accrue interest. Non-accruing restructured loans may be returned to accrual status when there has been a sustained period of repayment performance (generally six consecutive months of payments) and both principal and interest are deemed collectible.
Performing TDRs (not reported as non-accrual loans) totaled $57.4 million and $73.0 million as of December 31, 2020 and 2019, respectively. Non-performing TDRs totaled $92.8 million and $65.1 million as of December 31, 2020 and 2019, respectively.
The following table presents pre- and post-modification amortized cost of loans by loan class modified as TDRs (excluding PCI loans prior to the adoption of ASU 2016-13) during the years ended December 31, 2020 and 2019. The pre-modification and post-modification outstanding recorded investments disclosed in the table below represent the loan carrying amounts immediately prior to the modification and the carrying amounts at December 31, 2020 and 2019, respectively.
The total TDRs presented in the table above had allocated a specific allowance for loan losses that totaled $21.1 million and $36.0 million at December 31, 2020 and 2019, respectively. There were $7.7 million and $4.9 million in loan charge-offs related to loans modified as TDRs for the years ended December 31, 2020 and 2019, respectively. At December 31, 2020, the commercial and industrial loan category in the above table mostly consisted of non-accrual TDR taxi medallion loans classified as substandard and doubtful. Valley did not extend any commitments to lend additional funds to borrowers whose loans have been modified as TDRs during the year ended December 31, 2020.
Loans modified as TDRs (excluding PCI loan modifications prior to the adoption of ASU 2016-13) in the years ended December 31, 2020 and 2019, and for which there was a payment default (90 or more days past due) were as follows:
Coronavirus Aid, Relief, and Economic Security (CARES) Act loan modifications. In response to the COVID-19 pandemic and its economic impact to certain customers, Valley implemented short-term loan modifications such as payment deferrals, fee waivers, extensions of repayment terms, or delays in payment that were insignificant, when requested by customers. These modifications complied with the CARES Act to provide temporary payment relief to those borrowers directly impacted by COVID-19 who were not more than 30 days past due as of December 31, 2019. Generally, the modification terms allow for a deferral of payments for up to 90 days, which Valley may extend for an additional 90 days. Any extensions beyond this period were made in accordance with applicable regulatory guidance. As of December 31, 2020, Valley had approximately $361 million of outstanding loans remaining in their payment deferral period under short-term modifications. Under the applicable guidance, none of these loans were considered TDRs as of December 31, 2020.
Collateral dependent loans. Loans are collateral-dependent when the debtor is experiencing financial difficulty and repayment is expected to be provided substantially through the sale or operation of the collateral. When Valley determines that foreclosure is probable, the collateral dependent loan balances are written down to the estimated current fair value (less estimated selling costs) resulting in an immediate charge-off to the allowance, excluding any consideration for personal guarantees that may be pursued in the Bank’s collection process.
The following table presents collateral dependent loans by class as of December 31, 2020:
Commercial and industrial loans reported in the table above are primarily collateralized by taxi medallions. Commercial real estate loans are collateralized by real estate and construction loans. Residential and home equity loans are collateralized by residential real estate.
Purchased Credit-Impaired Loans
The table below includes disclosure requirements prior to the adoption of ASU No. 2016-13 on January 1, 2020, and presents changes in the accretable yield for PCI loans for the year ended December 31, 2019:
The net decrease in expected cash flows for certain pools of loans (included in the table above) is recognized prospectively as an adjustment to the yield over the estimated remaining life of the individual pools. The net decrease in the expected cash flows totaling approximately $11.0 million for the year ended December 31, 2019 was largely due to the high volume of contractual principal prepayments caused by the low level of market interest rates.
Allowance for Credit Losses for Loans
The allowance for credit losses for loans under the new CECL standard adopted on January 1, 2020, consisted of the allowance for loan losses and the allowance for unfunded credit commitments. Prior periods reflect the allowance for credit losses for loans under the incurred loss model under the previously applicable U.S. GAAP. The following table summarizes the allowance for credit losses for loans at December 31, 2020 and 2019:
The following table summarizes the provision for credit losses for loans for the years ended December 31, 2020, 2019 and 2018:
The following table details the activity in the allowance for loan losses by portfolio segment for the years ended December 31, 2020 and 2019:
* Includes a $61.6 million increase representing the estimated expected credit losses for PCD loans as a result of the adoption of CECL on January 1, 2020.
Valley incorporated a multi-scenario economic forecast for estimating lifetime expected credit losses at December 31, 2020. As a result of the deterioration in economic conditions caused by the COVID-19 pandemic during 2020 and the related increase in economic uncertainty, Valley increased its probability weighting for the most severe economic scenario as compared to those at January 1, 2020. The increase in the allowance for credit losses for loans from January 1, 2020 reflected the impact of the adverse economic forecast within Valley's lifetime expected credit loss estimate, as well as other qualitative factors.
The following table represents the allocation of the allowance for loan losses and the related loans by loan portfolio segment disaggregated based on the allowance measurement methodology for the years ended December 31, 2020 and 2019.
Impaired loans. Impaired loans disclosures presented below as of December 31, 2019 represent requirements prior to the adoption of ASU No. 2016-13 on January 1, 2020. Impaired loans, consisting of non-accrual commercial and industrial loans and commercial real estate loans over $250 thousand and all loans which were modified in troubled debt restructurings, are individually evaluated for impairment. PCI loans were not classified as impaired loans because they are accounted for on a pool basis and were paying as expected.
The following table presents information about impaired loans by loan portfolio class at December 31, 2019:
Interest income recognized on a cash basis for impaired loans classified as non-accrual was not material for the years ended December 31, 2019 and 2018.
LEASES (Note 6)
The following table presents the components of the right of use (ROU) assets and lease liabilities in the consolidated statements of financial condition by lease type at December 31, 2020 and 2019.
Net occupancy and equipment expense included lease cost of $29.0 million, net of sublease income of $3.5 million, for the year ended December 31, 2018.
In 2019, Valley closed a sale-leaseback transaction for 26 properties, consisting of 25 branches and 1 corporate office, for an aggregate sales price of $100.5 million. As a result, Valley recorded a pre-tax net gain totaling $78.5 million in 2019. Additionally, Valley recorded ROU assets and lease obligations totaling $78.4 million, respectively, for the lease of the 26 properties with an expected term of 12.0 years and operating lease costs of $7.9 million within occupancy and equipment expense on a straight-line basis annually over the term of the lease.
The following table presents the components by lease type, of total lease cost recognized in the consolidated statements of income for the years ended December 31, 2020 and 2019:
The following table presents supplemental cash flow information related to leases for the years ended December 31, 2020 and 2019:
The following table presents supplemental information related to leases at December 31, 2020 and 2019:
The following table presents a maturity analysis of lessor and lessee arrangements outstanding as of December 31, 2020:
The total net investment in direct financing and sales-type leases was $643.5 million and $478.8 million at December 31, 2020 and 2019, respectively, comprised of $641.3 million and $477.1 million in lease receivables and $2.2 million and $1.7 million in unguaranteed residuals, respectively. Total lease income was $25.2 million, $19.4 million and $14.7 million for the years ended December 31, 2020, 2019, and 2018, respectively.
PREMISES AND EQUIPMENT, NET (Note 7)
At December 31, 2020 and 2019, premises and equipment, net consisted of:
Depreciation and amortization of premises and equipment included in non-interest expense for the years ended December 31, 2020, 2019 and 2018 was approximately $30.6 million, $29.4 million, and $27.6 million, respectively.
GOODWILL AND OTHER INTANGIBLE ASSETS (Note 8)
The changes in the carrying amount of goodwill as allocated to our business segments, or reporting units thereof, for goodwill impairment analysis were:
* Valley’s Wealth Management Division is comprised of trust, asset management and insurance services. This reporting unit is included in the Consumer Lending segment for financial reporting purposes.
Certain estimates for acquired assets and assumed liabilities are subject to change for up to one year after the acquisition date. During 2020, goodwill from business combinations reflects the effect of the combined adjustments to the estimated fair values of certain loans, current taxes payable and deferred tax assets as of the acquisition date. See Note 2 for further details.
There was no impairment of goodwill during the years ended December 31, 2020, 2019 and 2018.
The following tables summarize other intangible assets as of December 31, 2020 and 2019:
Core deposits are amortized using an accelerated method and have a weighted average amortization period of 8.9 years. The line item labeled “Other” included in the table above primarily consists of customer lists which are amortized over their expected lives generally using a straight-line method and have a weighted average amortization period of 7.6 years. Valley recorded $20.7 million of core deposit intangibles resulting from the Oritani acquisition. Valley evaluates core deposits and other intangibles for impairment when an indication of impairment exists. No impairment was recognized during the years ended December 31, 2020, 2019 and 2018.
The following table summarizes the change in loan servicing rights during the years ended December 31, 2020, 2019 and 2018:
Loan servicing rights are accounted for using the amortization method. As shown in the above table, Valley recorded net impairment charges on its loan servicing rights totaling $818 thousand for the year ended December 31, 2020 and net recoveries impairment charges totaling $36 thousand and $388 thousand for the years ended December 31, 2019 and 2018, respectively.
The Bank is a servicer of residential mortgage loan portfolios, and it is compensated for loan administrative services performed for mortgage servicing rights of loans originated and sold by the Bank, and to a lesser extent, purchased mortgage servicing rights. The aggregate principal balances of residential mortgage loans serviced by the Bank for others approximated $3.5 billion, $3.4 billion and $3.2 billion at December 31, 2020, 2019 and 2018, respectively. The outstanding balance of loans serviced for others is not included in the consolidated statements of financial condition.
Valley recognized amortization expense on other intangible assets, including net recoveries of impairment charges on loan servicing rights (reflected in the table above), of $24.6 million, $18.1 million and $18.4 million for the years ended December 31, 2020, 2019 and 2018, respectively.
The following table presents the estimated amortization expense of other intangible assets over the next five-year period:
DEPOSITS (Note 9)
Included in time deposits are certificates of deposit over $250 thousand totaling $1.4 billion and $1.7 billion at December 31, 2020 and 2019, respectively. Interest expense on time deposits of $250 thousand or more totaled approximately $4.5 million, $5.8 million and $6.6 million in 2020, 2019 and 2018, respectively.
The scheduled maturities of time deposits as of December 31, 2020 were as follows:
Deposits from certain directors, executive officers and their affiliates totaled $97.3 million and $67.1 million at December 31, 2020 and 2019, respectively.
BORROWED FUNDS (Note 10)
Short-Term Borrowings
Short-term borrowings at December 31, 2020 and 2019 consisted of the following:
The weighted average interest rate for short-term borrowings was 0.38 percent and 1.68 percent at December 31, 2020 and 2019, respectively. Short-term FHLB advances totaling $200 million were hedged with cash flow interest rate swaps at December 31, 2020. See Note 15 for additional details.
Long-Term Borrowings
Long-term borrowings at December 31, 2020 and 2019 consisted of the following:
FHLB Advances. Long-term FHLB advances had a weighted average interest rate of 2.02 percent and 2.23 percent at December 31, 2020 and 2019, respectively. FHLB advances are secured by pledges of certain eligible collateral, including but not limited to, U.S. government and agency mortgage-backed securities and a blanket assignment of qualifying first lien mortgage loans, consisting of both residential mortgage and commercial real estate loans. Long-term FHLB advances totaling $900 million were hedged with cash flow interest rate swaps at December 31, 2020. See Note 15 for additional details.
Long-Term Borrowings
The long-term FHLB advances at December 31, 2020 are scheduled for contractual balance repayments as follows:
There are no FHLB advances with scheduled repayments in years 2021 and thereafter, reported in the table above, which are callable for early redemption by the FHLB during 2021.
In December 2020, Valley prepaid $534.3 million of long-term FHLB advances scheduled to mature in 2021 and 2022 with a weighted average effective interest rate of 2.48 percent. The transaction was funded with excess cash liquidity and accounted for as an early debt extinguishment resulting in a loss of $9.7 million reported within non-interest expense for the year ended December 31, 2020. In December 2019, Valley prepaid $635.0 million of long-term FHLB advances. These prepaid borrowings had contractual maturity dates in 2021 and 2022 and a weighted average interest rate of 3.93 percent. The debt prepayment was funded by cash proceeds from the sale of commercial real estate loans and overnight borrowings. The transaction was also accounted for as an early debt extinguishment and resulted in a loss of $32.0 million for the year ended December 31, 2019.
Subordinated Debt. On June 5, 2020, Valley issued $115 million of 5.25 percent Fixed-to-Floating Rate subordinated notes issued in due June 15, 2030 and callable in whole or in part on or after June 15, 2025 or upon the occurrence of certain events. Interest on the subordinated notes during the initial five-year term through June 15, 2025 is payable semi-annually on June 15 and December 15. Thereafter, interest is expected to be set based on Three-Month Term SOFR plus 514 basis points and paid quarterly through maturity of the notes. The subordinated notes had a net carrying value of $113.3 million at December 31, 2020.
At December 31, 2020, Valley also had the following subordinated debt outstanding:
•$100 million of 4.55 percent subordinated debentures (notes) issued in June 2015 and due June 30, 2025 with no call dates or prepayments allowed unless certain conditions exist. Interest on the subordinated notes is payable semi-annually in arrears on June 30 and December 30 of each year. The subordinated notes had a net carrying value of $99.5 million and $99.4 million at December 31, 2020 and 2019, respectively.
•$125 million of 5.125 percent subordinated notes issued in September 2013 and due September 27, 2023 with no call dates or prepayments allowed, unless certain conditions exist. Interest on the subordinated debentures is payable semi-annually in arrears on March 27 and September 27 of each year. In conjunction with the issuance, Valley entered into an interest rate swap transaction used to hedge the change in the fair value of the subordinated notes. In August 2016, the fair value interest rate swap with a notional amount of $125 million was terminated resulting in an adjusted fixed annual interest rate of 3.32 percent on the subordinated notes, after amortization of the derivative valuation adjustment recorded at the termination date. The subordinated notes had a net carrying value of $130.5 million and $132.4 million at December 31, 2020 and 2019, respectively.
•$60 million of 6.25 percent subordinated notes, assumed on January 1, 2018 in connection with the acquisition of USAB. The notes are due April 1, 2026 callable beginning April 1, 2021. Interest on the subordinated debentures is payable semi-annually in arrears on April 1 and October 1 of each year. After purchase accounting adjustments, the subordinated notes had a net carrying value of $60.1 million and $60.6 million at December 31, 2020 and 2019, respectively.
Long-term securities sold under agreements to repurchase (repos). The long-term repos had a weighted average interest rate of 3.37 percent and 1.94 percent at December 31, 2020 and 2019, respectively. Long-term repos outstanding as of December 31, 2020 all have maturities in 2021.
In September 2020, Valley prepaid $50 million of long-term institutional repo borrowings with an interest rate of 3.70 percent and an original contractual maturity date in January 2022. The debt prepayment was funded by excess cash liquidity.
The transaction was accounted for as an early debt extinguishment resulting in a loss of $2.4 million for the year ended December 31, 2020.
Pledged Securities. The fair value of securities pledged to secure public deposits, repurchase agreements, lines of credit, FHLB advances and for other purposes required by law approximated $2.1 billion and $2.3 billion for December 31, 2020 and 2019, respectively.
JUNIOR SUBORDINATED DEBENTURES ISSUED TO CAPITAL TRUSTS (Note 11)
All of the statutory trusts presented in the table below were acquired in past bank acquisitions. These trusts were established for the sole purpose of issuing trust preferred securities and related trust common securities. The proceeds from such issuances were used by the trust to purchase an equivalent amount of junior subordinated debentures issued by the acquired bank, and now assumed by Valley. The junior subordinated debentures, the sole assets of the trusts, are unsecured obligations of Valley, and are subordinate and junior in right of payment to all present and future senior and subordinated indebtedness and certain other financial obligations of Valley. Valley does not consolidate its capital trusts based on U.S. GAAP but wholly owns all of the common securities of each trust.
The table below summarizes the outstanding junior subordinated debentures and the related trust preferred securities issued by each trust as of December 31, 2020 and 2019:
(1)The carrying values include unamortized purchase accounting adjustments at December 31, 2020 and 2019.
(2)All cash distributions are cumulative.
The trust preferred securities are subject to mandatory redemption, in whole or in part, upon repayment of the junior subordinated debentures at the stated maturity date or upon early redemption. The trusts’ ability to pay amounts due on the trust preferred securities is solely dependent upon Valley making payments on the related junior subordinated debentures. Valley’s obligation under the junior subordinated debentures and other relevant trust agreements, in aggregate, constitutes a full and unconditional guarantee by Valley of the trusts’ obligations under the trust preferred securities issued. Under the junior subordinated debenture agreements, Valley has the right to defer payment of interest on the debentures and, therefore, distributions on the trust preferred securities, for up to five years, but not beyond the stated maturity dates in the table above. Currently, Valley has no intention to exercise its right to defer interest payments on the debentures.
The trust preferred securities are included in Valley’s total risk-based capital (as Tier 2 capital) for regulatory purposes at December 31, 2020 and 2019.
BENEFIT PLANS (Note 12)
Pension Plan
The Bank has a non-contributory defined benefit plan (qualified plan) covering most of its employees. The qualified plan benefits are based upon years of credited service and the employee’s highest average compensation as defined. Additionally, the Bank has a supplemental non-qualified, non-funded retirement plan, which is designed to supplement the pension plan for key officers, and Valley has a non-qualified, non-funded directors’ retirement plan (both of these plans are referred to as the “non-qualified plans” below).
Effective December 31, 2013, the benefits earned under the qualified and non-qualified plans were frozen. As a result, Valley re-measured the projected benefit obligation of the affected plans and the funded status of each plan at June 30, 2013. Consequently, participants in each plan will not accrue further benefits and their pension benefits will be determined based on their compensation and service as of December 31, 2013. Plan benefits will not increase for any compensation or service earned after such date. All participants were immediately vested in their frozen accrued benefits if they were employed by the Bank as of December 31, 2013.
The following table sets forth the change in the projected benefit obligation, the change in fair value of plan assets and the funded status and amounts recognized in Valley’s consolidated financial statements for the qualified and non-qualified plans at December 31, 2020 and 2019:
* Includes accrued interest receivable of $623 thousand and $641 thousand as of December 31, 2020 and 2019, respectively.
Amounts recognized as a component of accumulated other comprehensive loss as of year-end that have not been recognized as a component of the net periodic pension expense for Valley’s qualified and non-qualified plans are presented in the following table. Valley expects to recognize approximately $1.5 million of the net actuarial loss reported in the following table as of December 31, 2020 as a component of net periodic pension expense during 2021.
The non-qualified plans had a projected benefit obligation, accumulated benefit obligation, and fair value of plan assets as follows:
In determining discount rate assumptions, management looks to current rates on fixed-income corporate debt securities that receive a rating of AA or higher from either Moody’s or S&P with durations equal to the expected benefit payments streams required of each plan. The weighted average discount rate used in determining the actuarial present value of benefit obligations for the qualified and non-qualified plans was 2.52 percent and 3.32 percent as of December 31, 2020 and 2019, respectively.
The net periodic pension income for the qualified and non-qualified plans reported within other non-interest expense included the following components for the years ended December 31, 2020, 2019 and 2018:
Valley estimated the interest cost component of net periodic pension income (as shown in the table above) using a spot rate approach for the plans by applying the specific spot rates along the yield curve to the relevant projected cash flows. Valley believes this provides a better estimate of interest costs than a single weighted average discount rate derived from the yield curve used to measure the benefit obligation at the beginning of the applicable period.
Other changes in the qualified and non-qualified plan assets and benefit obligations recognized in other comprehensive income for the years ended December 31, 2020 and 2019 were as follows:
The benefit payments, which reflect expected future service, as appropriate, expected to be paid in future years are presented in the following table:
The weighted average discount rate, expected long-term rate of return on assets and rate of compensation increase used in determining Valley’s pension expense for the years ended December 31, 2020, 2019 and 2018 were as follows:
The expected rate of return on plan assets assumption is based on the concept that it is a long-term assumption independent of the current economic environment and changes would be made in the expected return only when long-term inflation expectations change, asset allocations change materially or when asset class returns are expected to change for the long-term.
In accordance with Section 402 (c) of ERISA, the qualified plan’s investment managers are granted full discretion to buy, sell, invest and reinvest the portions of the portfolio assigned to them consistent with the Bank’s Pension Committee’s policy and guidelines. The target asset allocation set for the qualified plan is an approximate equal weighting of 50 percent fixed income securities and 50 percent equity securities. Although much depends upon market conditions, the absolute investment objective for the equity portion is to earn at least a mid-to-high single digit return, after adjustment by the Consumer Price Index (CPI), over rolling five-year periods. Relative performance should be above the median of a suitable grouping of other equity portfolios and a suitable index over rolling three-year periods. For the fixed income portion, the absolute objective is to earn a positive annual real return, after adjustment by the CPI, over rolling five-year periods. Relative performance should be better than the median performance of bonds when judged against a suitable index of other fixed income portfolios and above the Merrill Lynch Intermediate Government/Corporate Index over rolling three-year periods. Cash equivalents will be invested in money market funds or in other high quality instruments approved by the Trustees of the qualified plan.
The exposure of the plan assets of the qualified plan to risk is limited by the Bank’s Pension Committee’s diversification of the investments into various investment options with multiple asset managers. The Pension Committee engages an investment management advisory firm that regularly monitors the performance of the asset managers and ensures they are within compliance of the policies adopted by the Trustees. If the risk profile and overall return of assets managed are not in line with the risk objectives or expected return benchmarks for the qualified plan, the advisory firm may recommend the termination of an asset manager to the Pension Committee. In general, the plan assets of the qualified plan are investment securities that are well-diversified in terms of industry, capitalization and asset class.
The following table presents the qualified plan weighted-average asset allocations by asset category that are measured at fair value on a recurring basis by level within the fair value hierarchy under ASC Topic 820. Financial assets are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. See Note 3 for further details regarding the fair value hierarchy.
The following is a description of the valuation methodologies used for assets measured at fair value:
Equity securities, U.S. Treasury securities and cash and money market funds are valued at fair value in the table above utilizing exchange quoted prices in active markets for identical instruments (Level 1 inputs). Mutual funds are measured at their respective net asset values, which represents fair values of the securities held in the funds based on exchange quoted prices available in active markets (Level 1 inputs).
Corporate bonds and U.S. government agency securities are reported at fair value utilizing Level 2 inputs. The prices for these investments are derived from market quotations and matrix pricing obtained through an independent pricing service. Such fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things.
Based upon actuarial estimates, Valley does not expect to make any contributions to the qualified plan. Funding requirements for subsequent years are uncertain and will significantly depend on whether the plan’s actuary changes any assumptions used to calculate plan funding levels, the actual return on plan assets, changes in the employee groups covered by the plan, and any legislative or regulatory changes affecting plan funding requirements. For tax planning, financial planning, cash flow management or cost reduction purposes, Valley may increase, accelerate, decrease or delay contributions to the plan to the extent permitted by law.
Other Qualified Plan
On December 1, 2019, Valley assumed obligations under Oritani’s Pentegra Defined Benefit Plan for Financial Institutions (“Pentegra DB Plan”). The Pentegra DB Plan's Employer Identification Number is 13-5645888 and the Plan Number is 333. The Pentegra DB Plan is a tax-qualified defined-benefit multiple-employer plan. Under the Pentegra DB Plan, contributions made by a participating employer may be used to provide benefits to participants of other participating employers. The Pentegra DB Plan was frozen as of December 31, 2008. During 2020, Valley withdrew from the Pentegra DB Plan and distributed annuities to participants based on the actuarial computation of their pension benefit. Valley recognized approximately $1.1 million of expense included in other non-interest expense related to the final contribution to the Pentegra DB Plan and distribution of the annuities for the year ended December 31, 2020.
Other Non-Qualified Plans
Valley maintains separate non-qualified plans for former directors and senior management of Merchants Bank of New York acquired in January of 2001. At December 31, 2020 and 2019, the remaining obligations under these plans were $1.4 million and $1.6 million, respectively, of which $399 thousand and $451 thousand, respectively, were funded by Valley. As of December 31, 2020 and 2019, all of the obligations were included in other liabilities and $731 thousand (net of a $286 thousand tax benefit) and $803 thousand (net of a $314 thousand tax benefit), respectively, were recorded in accumulated other comprehensive loss. The $1.0 million in accumulated other comprehensive loss will be reclassified to expense on a straight-line basis over the remaining benefit periods of these non-qualified plans.
Valley assumed, in the Oritani acquisition on December 1, 2019, certain obligations under non-qualified retirement plans described below:
•Non-qualified benefit equalization plans (BEP) that provided supplemental benefits to certain eligible executives and officers. The BEP plans were terminated on November 30, 2019 and the funded obligation under the BEP plans totaled $26.8 million on December 31, 2019. The accrued benefits were fully distributed to the participants on July 1, 2020.
•Non-qualified benefit equalization pension plan that provided benefits to certain officers who were disallowed certain benefits under former Oritani’s qualified pension plan. This plan was terminated on November 30, 2019 and the accrued benefits are payable to plan participants in five equal installments beginning annually on December 1, 2020 through December 1, 2024. The funded obligation under this plan totaled $1.3 million and $1.6 million at December 31, 2020 and 2019, respectively.
•Supplemental Executive Retirement Income Agreement (the SERP) for the former CEO of Oritani. The SERP is a retirement benefit with a minimum payment period of 20 years upon death, disability, normal retirement, early retirement or separation from service after a change in control. Distributions from the plan began on July 1, 2020. The funded obligation under the SERP totaled $13.6 million and $13.0 million at December 31, 2020 and 2019, respectively. Valley recorded $1.5 million of expenses related to the SERP for the year ended December 31, 2020.
The above Oritani non-qualified plans are secured by investments in money market mutual funds which are held in a trust and classified as equity securities on the consolidated statements of financial condition at both December 31, 2020 and 2019.
Valley also assumed an Executive Group Life Insurance Replacement (“Split-Dollar”) Plan from Oritani. The Split-Dollar plan provides life insurance benefits to certain eligible employees upon death while employed or following termination of employment due to disability, retirement or change in control. Participants in the Split-Dollar plan are entitled to up to two times their base annual salary, as defined by the plan. The accrued liability for the Split-Dollar plan totaled $1.8 million and $961 thousand at December 31, 2020 and 2019, respectively. Valley recorded $812 thousand of expenses related to the Split-Dollar plan for the year ended December 31, 2020.
Bonus Plan
Valley National Bank and its subsidiaries may award cash incentive and merit bonuses to its officers and employees based upon a percentage of the covered employees’ compensation as determined by the achievement of certain performance objectives. Amounts charged to salary expense were $25.1 million, $19.1 million and $18.8 million during 2020, 2019 and 2018, respectively.
Savings and Investment Plan
Valley National Bank maintains a 401(k) plan that covers eligible employees of the Bank and its subsidiaries and allows employees to contribute a percentage of their salary, with the Bank matching a certain percentage of the employee contribution in cash invested in accordance with each participant’s investment elections. The Bank recorded $10.1 million, $8.6 million and $8.5 million in expense for contributions to the plan for the years ended December 31, 2020, 2019 and 2018, respectively.
Deferred Compensation Plan
Valley has a non-qualified, unfunded deferred compensation plan maintained for the purpose of providing deferred compensation for selected employees participating in the 401(k) plan whose contributions are limited as a result of the limitations under section 401(a)(17) of the IRS Code. Each participant in the plan is permitted to defer per calendar year, up to five percent of the portion of the participant’s salary and cash bonus above the limit in effect under the Company's 401(k) plan and receive employer matching contributions that become fully vested after two years of participation in the plan. Plan participants also receive an annual interest crediting on their balances held as of December 31 each year. Benefits are generally paid to a participant in a single lump sum following the participant’s separation from service with Valley. Valley recorded plan expenses of $372 thousand, $273 thousand and $262 thousand for the years ended December 31, 2020, 2019 and 2018, respectively. As of December 31, 2020 and 2019, Valley had an unsecured general liability of $1.7 million and $1.0 million, respectively, included in accrued expenses and other liabilities in connection with this plan.
Stock Based Compensation
Valley currently has one active employee stock plan, the 2016 Long-Term Stock Incentive Plan (the 2016 Plan), adopted by Valley’s Board of Directors on January 29, 2016 and approved by its shareholders on April 28, 2016. The 2016 Plan is administered by the Compensation and Human Resources Committee (the Committee) appointed by Valley’s Board of Directors. The Committee can grant awards to officers and key employees of Valley. The primary purposes of the 2016 Plan are to provide additional incentive to officers and key employees of Valley and its subsidiaries, whose substantial contributions are
essential to the continued growth and success of Valley, and to attract and retain competent and dedicated officers and other key employees whose efforts will result in the continued and long-term growth of Valley’s business.
Under the 2016 Plan, Valley may award shares of common stock in the form of stock appreciation rights, both incentive and non-qualified stock options, restricted stock and restricted stock units (RSUs) to its employees and non-employee directors (for acting in their roles as board members). As of December 31, 2020, 3.0 million shares of common stock were available for issuance under the 2016 Plan. The essential features of each award are described in the award agreement relating to that award. The grant, exercise, vesting, settlement or payment of an award may be based upon the fair value of Valley’s common stock on the last sale price reported for Valley’s common stock on such date or the last sale price reported preceding such date, except for performance-based awards with a market condition. The grant date fair values of performance-based awards that vest based on a market condition are determined by a third party specialist using a Monte Carlo valuation model.
On January 26, 2021, the Board of Directors approved the Valley National Bancorp 2021 Incentive Compensation Plan (the 2021 Plan). The 2021 Plan is subject to approval by Valley shareholders at the Annual Meeting of Shareholders on April 19, 2021. The 2021 Plan would authorize the Committee to issue up to 9 million shares to Valley's employees and directors. Awards under the 2021 Plan will be granted in substantially the same manner as the 2016 Plan. The 2021 Plan is described in more detail in Valley's 2021 definitive proxy statement.
Valley recorded total stock-based compensation expense of $16.5 million, $15.0 million and $19.5 million for the years ended December 31, 2020, 2019 and 2018, respectively. The stock-based compensation expense for 2020, 2019 and 2018 included $1.5 million, $2.1 million and $4.3 million, respectively, related to stock awards granted to retirement eligible employees. In 2020 and 2019, compensation expense for these awards was amortized monthly over a one year period after the grant date. Prior to 2019, award grantees who were eligible for retirement did not have a service period requirement and the expense was immediately recognized. The fair values of all other stock awards are expensed over the shorter of the vesting or required service period. As of December 31, 2020, the unrecognized amortization expense for all stock-based compensation totaled approximately $17.8 million and will be recognized over an average remaining vesting period of approximately 1.76 years.
Restricted Stock Units (RSUs). Restricted stock units are awarded as (1) performance-based RSUs and (2) time-based RSUs. Performance based RSUs vest based on (i) growth in tangible book value per share plus dividends and (ii) total shareholder return as compared to our peer group. The performance based RSUs "cliff" vest after three years based on the cumulative performance of Valley during that time period. Generally, time-based RSUs vest ratably one-third each year over a three-year vesting period. The RSUs earn dividend equivalents (equal to cash dividends paid on Valley's common share) over the applicable performance or service period. Dividend equivalents, per the terms of the agreements, are accumulated and paid to the grantee at the vesting date, or forfeited if the applicable performance or service conditions are not met. The grant date fair value of the performance-based RSUs was $10.82, $10.43 and $12.36 per share for the years ended December 31, 2020, 2019, and 2018, respectively. The grant date fair value of time-based RSUs was $10.29 and $10.32 for the years ended December 31, 2020 and 2019, respectively. Valley did not award time-based restricted stock units during 2018.
The following table sets forth the changes in RSUs outstanding for the years ended December 31, 2020, 2019 and 2018:
Restricted Stock. Restricted stock is awarded to key employees providing for the immediate award of our common stock subject to certain vesting and restrictions under the 2016 Plan. Compensation expense is measured based on the grant-date fair value of the shares.
The following table sets forth the changes in restricted stock awards (RSAs) outstanding for the years ended December 31, 2020, 2019 and 2018:
Valley did not award any shares of restricted stock during 2020 and 2019. Included in the RSAs granted (in the table above) during 2018 are 60 thousand shares issued to Valley directors, which are fully vested.
Stock Options. The fair value of each option granted on the date of grant is estimated using a binomial option pricing model. The fair values are estimated using assumptions for dividend yield based on the annual dividend rate; the stock volatility, based on Valley’s historical and implied stock price volatility; the risk-free interest rates, based on the U.S. Treasury constant maturity bonds, in effect on the actual grant dates, with a remaining term approximating the expected term of the options; and expected exercise term calculated based on Valley’s historical exercise experience.
The following table summarizes stock options activity as of December 31, 2020, 2019 and 2018 and changes during the years ended on those dates:
The following table summarizes information about stock options outstanding and exercisable at December 31, 2020:
INCOME TAXES (Note 13)
Income tax expense for the years ended December 31, 2020, 2019 and 2018 consisted of the following:
The tax effects of temporary differences that gave rise to the significant portions of the deferred tax assets and liabilities as of December 31, 2020 and 2019 were as follows:
Valley's federal net operating loss carryforwards totaled approximately $64.1 million at December 31, 2020 and expire during the period from 2029 through 2034. Valley's capital loss carryforwards totaled $3.1 million at December 31, 2020 and expire at December 31, 2023. State net operating loss carryforwards totaled approximately $92.2 million at December 31, 2020 and expire during the period from 2029 through 2038.
Based upon taxes paid and projections of future taxable income over the periods in which the net deferred tax assets are deductible, management believes that it is more likely than not that Valley will realize the benefits, net of an immaterial valuation allowance, of these deductible differences and loss carryforwards.
Reconciliation between the reported income tax expense and the amount computed by multiplying consolidated income before taxes by the statutory federal income tax rate of 21 percent for the years ended December 31, 2020, 2019, and 2018 were as follows:
We invest in certain tax-advantaged investments that support qualified affordable housing projects, community development and, prior to 2019, renewable energy resources. Our investments in these projects are designed to generate a return primarily through the realization of federal and state income tax credits, and other tax benefits, over specified time periods. Third parties perform diligence on these investments for us on which we rely both at inception and on an on-going basis. We are subject to the risk that previously recorded tax credits, which remain subject to recapture by taxing authorities based on compliance features required to be met at the project level, may fail to meet certain government compliance requirements and may not be able to be realized.
We previously invested in mobile solar generators sold and leased back by DC Solar and its affiliates (DC Solar). DC Solar had its assets frozen in December 2018 by the U.S. Department of Justice. DC Solar and related entities are in Chapter 7 bankruptcy. A group of investors who purchased mobile solar generators from, and leased them back to, DC Solar, including us received tax credits for making these renewable resource investments. During the fourth quarter 2019, several of the co- conspirators pleaded guilty to fraud in the on-going federal investigation. Based upon this information, Valley deemed that its tax positions related to the DC Solar funds did not meet the more likely than not recognition threshold in Valley's tax reserve assessment at December 31, 2019. The principals pled guilty to fraud in early 2020.
As of December 31, 2020 and 2019, Valley believes that it was fully reserved for the renewable energy tax credits and other tax benefits previously recognized from the investments in the DC Solar funds plus interest. Valley will continue to evaluate all its existing tax positions, however, cannot provide assurance that it will not recognize additional tax provisions related to this uncertain tax liability in the future.
A reconciliation of Valley’s gross unrecognized tax benefits for 2020, 2019 and 2018 is presented in the table below:
The entire balance of unrecognized tax benefits, if recognized, would favorably affect Valley's effective income tax rate. It is reasonably possible that the liability for unrecognized tax benefits could increase or decrease in the next twelve months due to completion of tax authorities’ exams or the expiration of statutes of limitations. Management estimates that the liability for unrecognized tax benefits could decrease by $3.5 million within the next twelve months. Valley’s policy is to report interest and penalties, if any, related to unrecognized tax benefits in income tax expense. Valley accrued approximately $7.6 million and
$6.1 million of interest expense associated with Valley’s uncertain tax positions at December 31, 2020 and 2019, respectively. There was no interest expense accrued for uncertain tax positions during the year ended December 31, 2018.
Valley monitors its tax positions for the underlying facts, circumstances, and information available including the federal investigation of DC Solar and changes in tax laws, case law and regulations that may necessitate subsequent de-recognition of previous tax benefits.
Valley files income tax returns in the U.S. federal and various state jurisdictions. With few exceptions, Valley is no longer subject to U.S. federal and state income tax examinations by tax authorities for years before 2017. Valley is under examination by the IRS and also under routine examination by various state jurisdictions, and we expect the examinations to be completed within the next 12 months. Valley has considered, for all open audits, any potential adjustments in establishing our reserve for unrecognized tax benefits as of December 31, 2020.
TAX CREDIT INVESTMENTS (Note 14)
Valley’s tax credit investments are primarily related to investments promoting qualified affordable housing projects, and other investments related to community development and renewable energy sources. Some of these tax-advantaged investments support Valley’s regulatory compliance with the Community Reinvestment Act. Valley’s investments in these entities generate a return primarily through the realization of federal income tax credits, and other tax benefits, such as tax deductions from operating losses of the investments, over specified time periods. These tax credits and deductions are recognized as a reduction of income tax expense.
Valley’s tax credit investments are carried in other assets on the consolidated statements of financial condition. Valley’s unfunded capital and other commitments related to the tax credit investments are carried in accrued expenses and other liabilities on the consolidated statements of financial condition. Valley recognizes amortization of tax credit investments, including impairment losses, within non-interest expense in the consolidated statements of income using the equity method of accounting. After initial measurement, the carrying amounts of tax credit investments with non-readily determinable fair values are increased to reflect Valley's share of income of the investee and are reduced to reflect its share of losses of the investee, dividends received and other-than-temporary impairments, if applicable. See the "Impairment Analysis" section below.
The following table presents the balances of Valley’s affordable housing tax credit investments, other tax credit investments, and related unfunded commitments at December 31, 2020 and 2019:
The following table presents other information relating to Valley’s affordable housing tax credit investments and other tax credit investments for the years ended December 31, 2020, 2019 and 2018:
Impairment Analysis
An impairment loss is recognized when the fair value of the tax credit investment is less than its carrying value. The determination of whether a decline in value of a tax credit investment is other-than-temporary requires significant judgment and is performed separately for each investment. The tax credit investments are reviewed for impairment quarterly, or whenever events or changes in circumstances indicate that the carrying amount of the investment might not be recoverable. These circumstances can include, but are not limited to, the following factors:
•Evidence that Valley does not have the ability to recover the carrying amount of the investment;
•The inability of the investee to sustain earnings;
•A current fair value of the investment based upon cash flow projections that is less than the carrying amount; and
•Change in the economic or technological environment that could adversely affect the investee’s operations
On a quarterly basis, Valley obtains financial reporting on its underlying tax credit investment assets for each fund from the fund manager who is independent of Valley and the Fund Sponsor. The financial reporting is reviewed for deterioration in the financial condition of the fund, the level of cash flows and any significant losses or impairment charges. Valley also regularly reviews the condition and continuing prospects of the underlying operations of the investment with the fund manager, including any observations from site visits and communications with the Fund Sponsor, if available. Annually, Valley obtains the audited financial statements prepared by an independent accounting firm for each investment, as well as the annual tax returns. Generally, none of the aforementioned review factors are individually conclusive and the relative importance of each factor will vary based on facts and circumstances. However, the longer the expected period of recovery, the stronger and more objective the positive evidence needs to be in order to overcome the presumption that the impairment is other than temporary. If management determines that a decline in value is other than temporary per its quarterly and annual reviews, including current probable cash flow projections, the applicable tax credit investment is written down to its estimated fair value through an impairment charge to earnings, which establishes the new cost basis of the investment.
During the first quarter 2019, Valley determined that future cash flows related to the remaining investments in three federal renewable energy tax credit funds sponsored by DC Solar (previously reported in other tax credit investments, net) were not probable based upon new information available, including the sponsor’s bankruptcy proceedings which were reclassified to Chapter 7 from Chapter 11 in late March 2019. As a result, Valley recognized impairment charge for the entire aggregate unamortized investment of $2.4 million for the first quarter 2019, which is included within amortization of tax credit investments for the year ended December 31, 2019.
COMMITMENTS AND CONTINGENCIES (Note 15)
Financial Instruments with Off-balance Sheet Risk
In the ordinary course of business in meeting the financial needs of its customers, Valley, through its subsidiary Valley National Bank, is a party to various financial instruments, which are not reflected in the consolidated financial statements. These financial instruments include standby and commercial letters of credit, unused portions of lines of credit and
commitments to extend various types of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amounts recognized in the consolidated financial statements. The commitment or contract amount of these instruments is an indicator of the Bank’s level of involvement in each type of instrument as well as the exposure to credit loss in the event of non-performance by the other party to the financial instrument. The Bank seeks to limit any exposure of credit loss by applying the same credit policies in making commitments, as it does for on-balance sheet lending facilities.
The following table provides a summary of financial instruments with off-balance sheet risk at December 31, 2020 and 2019:
Obligations to advance funds under commitments to extend credit, including commitments under unused lines of credit, are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have specified expiration dates, which may be extended upon request, or other termination clauses and generally require payment of a fee. These commitments do not necessarily represent future cash requirements as it is anticipated that many of these commitments will expire without being fully drawn upon. The Bank’s lending activity for outstanding loan commitments is primarily to customers within the states of New Jersey, New York, and Florida.
Standby letters of credit represent the guarantee by the Bank of the obligations or performance of the bank customer in the event of the default of payment or nonperformance to a third party beneficiary.
Loan sale commitments represent contracts for the sale of residential mortgage loans to third parties in the ordinary course of the Bank’s business. These commitments require the Bank to deliver loans within a specific period to the third party. The risk to the Bank is its non-delivery of loans required by the commitment, which could lead to financial penalties. The Bank has not defaulted on its loan sale commitments.
Derivative Instruments and Hedging Activities
Valley is exposed to certain risks arising from both its business operations and economic conditions. Valley principally manages its exposure to a wide variety of business and operational risks through management of its core business activities. Valley manages economic risks, including interest rate and liquidity risks, primarily by managing the amount, sources, and duration of its assets and liabilities and, from time to time, the use of derivative financial instruments. Specifically, Valley enters into derivative financial instruments to manage exposures that arise from business activities that result in the payment of future known and uncertain cash amounts, the value of which are determined by interest rates. Valley’s derivative financial instruments are used to manage differences in the amount, timing, and duration of Valley’s known or expected cash receipts and its known or expected cash payments related to assets and liabilities as outlined below.
Cash Flow Hedges of Interest Rate Risk. Valley’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, Valley uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the payment of either fixed or variable-rate amounts in exchange for the receipt of variable or fixed-rate amounts from a counterparty.
At December 31, 2020, Valley had 10 interest rate swap agreements, with a total notional amount of $1.1 billion, to hedge the changes in cash flows associated with certain short-term FHLB advances and brokered deposits. Valley is required to pay fixed-rates of interest ranging from 0.05 percent to 0.67 percent and receives variable rates of interest that reset quarterly based on three-month LIBOR. Expiration dates for the swaps range from April 2021 to August 2022.
Fair Value Hedges of Fixed Rate Assets and Liabilities. Valley is exposed to changes in the fair value of certain of its fixed rate assets or liabilities due to changes in benchmark interest rates based on one-month LIBOR. From time to time, Valley uses interest rate swaps to manage its exposure to changes in fair value. Interest rate swaps designated as fair value hedges
involve the receipt of variable rate payments from a counterparty in exchange for Valley making fixed rate payments over the life of the agreements without the exchange of the underlying notional amount. For derivatives that are designated and qualify as fair value hedges, the gain or loss on the derivative as well as the loss or gain on the hedged item attributable to the hedged risk are recognized in earnings. Valley includes the gain or loss on the hedged items in the same income statement line item as the loss or gain on the related derivatives.
Valley's one interest rate swap used to hedge the change in the fair value of a commercial loan matured in November 2020. Valley did not have any fair value hedges at December 31, 2020.
Non-designated Hedges. Derivatives not designated as hedges may be used to manage Valley’s exposure to interest rate movements or to provide service to customers but do not meet the requirements for hedge accounting under U.S. GAAP. Derivatives not designated as hedges are not entered into for speculative purposes. Valley executes interest rate swaps with commercial lending customers to facilitate their respective risk management strategies. These interest rate swaps with customers are simultaneously offset by interest rate swaps that Valley executes with a third party, such that Valley minimizes its net risk exposure resulting from such transactions. As these interest rate swaps do not meet the strict hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings.
Valley sometimes enters into risk participation agreements with external lenders where the banks are sharing their risk of default on the interest rate swaps on participated loans. Valley either pays or receives a fee depending on the participation type. Risk participation agreements are credit derivatives not designated as hedges. Credit derivatives are not speculative and are not used to manage interest rate risk in assets or liabilities. Changes in the fair value in credit derivatives are recognized directly in earnings. At December 31, 2020, Valley had 26 credit swaps with an aggregate notional amount of $221.1 million related to risk participation agreements.
At December 31, 2020, Valley had two "steepener" swaps with a total current notional amount of $10.4 million where the receive rate on the swap mirrors the pay rate on the brokered deposits. The rates paid on these types of hybrid instruments are based on a formula derived from the spread between the long and short ends of the constant maturity swap (CMS) rate curve. Although these types of instruments do not meet the hedge accounting requirements, the change in fair value of both the bifurcated derivative and the stand-alone swap tend to move in opposite directions with changes in three-month LIBOR rate and therefore provide an effective economic hedge.
Valley regularly enters into mortgage banking derivatives which are non-designated hedges. These derivatives include interest rate lock commitments provided to customers to fund certain residential mortgage loans to be sold into the secondary market and forward commitments for the future delivery of such loans. Valley enters into forward commitments for the future delivery of residential mortgage loans when interest rate lock commitments are entered into in order to economically hedge the effect of future changes in interest rates on Valley’s commitments to fund the loans as well as on its portfolio of mortgage loans held for sale.
Amounts included in the consolidated statements of financial condition related to the fair value of Valley’s derivative financial instruments were as follows:
(1) Other contracts include risk participation agreements.
The Chicago Mercantile Exchange and London Clearing House variation margins are classified as a single-unit of account with the cash flow hedges and over-the-counter (OTC) non-designated derivative instruments. As a result, the fair value of the designated cash flow interest rate swaps assets and designated and non-designated interest rate swaps liabilities were reduced by variation margin treated as settlement of the related derivatives fair values for legal and accounting purposes as required by central clearing houses and reported in the table above on a net basis at December 31, 2020 and 2019.
Gains (losses) included in the consolidated statements of income and in other comprehensive income (loss), on a pre-tax basis, related to interest rate derivatives designated as hedges of cash flows were as follows:
The net gains or losses related to cash flow hedge ineffectiveness were immaterial during the years ended December 31, 2020, 2019 and 2018. The accumulated net after-tax losses related to effective cash flow hedges included in accumulated other comprehensive loss were $4.0 million and $3.7 million at December 31, 2020 and 2019, respectively.
Amounts reported in accumulated other comprehensive loss related to cash flow interest rate derivatives are reclassified to interest expense as interest payments are made on the hedged variable interest rate liabilities. Valley estimates that $3.4 million will be reclassified as an increase to interest expense in 2021.
Gains (losses) included in the consolidated statements of income related to interest rate derivatives designated as hedges of fair value were as follows:
The following table presents the hedged items related to interest rate derivatives designated as hedges of fair value and the cumulative basis fair value adjustment included in the net carrying amount of the hedged items at December 31, 2020 and 2019:
Net losses included in the consolidated statements of income related to derivative instruments not designated as hedging instruments were as follows:
Fee income related to derivative interest rate swaps executed with commercial loan customers totaled $59.0 million, $33.4 million and $16.4 million for the years ended December 31, 2020, 2019 and 2018, respectively.
Collateral Requirements and Credit Risk Related Contingency Features. By using derivatives, Valley is exposed to credit risk if counterparties to the derivative contracts do not perform as expected. Management attempts to minimize counterparty credit risk through credit approvals, limits, monitoring procedures and obtaining collateral where appropriate. Credit risk exposure associated with derivative contracts is managed at Valley in conjunction with Valley’s consolidated counterparty risk management process. Valley’s counterparties and the risk limits monitored by management are periodically reviewed and approved by the Board of Directors.
Valley has agreements with its derivative counterparties providing that if Valley defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then Valley could also be declared in default on its derivative counterparty agreements. Additionally, Valley has an agreement with several of its derivative counterparties that contains provisions that require Valley’s debt to maintain an investment grade credit rating from each of the major credit rating agencies from which it receives a credit rating. If Valley’s credit rating is reduced below investment grade, or such rating is withdrawn or suspended, then the counterparty could terminate the derivative positions and Valley would be required to settle its obligations under the agreements. As of December 31, 2020, Valley was in compliance with all of the provisions of its derivative counterparty agreements. As of December 31, 2020, the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements was $152.8 million. Valley has derivative counterparty agreements that require minimum collateral posting thresholds for certain counterparties.
BALANCE SHEET OFFSETTING (Note 16)
Certain financial instruments, including certain OTC derivatives (mostly interest rate swaps) and repurchase agreements (accounted for as secured long-term borrowings), may be eligible for offset in the consolidated statements of financial condition and/or subject to master netting arrangements or similar agreements. OTC derivatives include interest rate swaps executed and settled bilaterally with counterparties without the use of an organized exchange or central clearing house (presented in the table below). The credit risk associated with bilateral OTC derivatives is managed through obtaining collateral and enforceable master netting agreements.
Valley is party to master netting arrangements with its financial institution counterparties; however, Valley does not offset assets and liabilities under these arrangements for financial statement presentation purposes. The master netting arrangements provide for a single net settlement of all swap agreements, as well as collateral, in the event of default on, or termination of, any one contract. Collateral, usually in the form of cash or marketable investment securities, is posted by the counterparty with net liability positions in accordance with contract thresholds. Master repurchase agreements which include “right of set-off” provisions generally have a legally enforceable right to offset recognized amounts. In such cases, the collateral would be used to settle the fair value of the repurchase agreement should Valley be in default. Total amount of collateral held or pledged can not exceed the net derivative fair values with the counterparty.
The table below presents information about Valley’s financial instruments that are eligible for offset in the consolidated statements of financial condition as of December 31, 2020 and 2019.
(1) Cash collateral pledged to our counterparties in relation to market value exposures of OTC derivative contracts in a liability position.
(2) Represents the fair value of non-cash pledged investment securities.
REGULATORY AND CAPITAL REQUIREMENTS (Note 17)
Valley’s primary source of cash is dividends from the Bank. Valley National Bank, a national banking association, is subject to certain restrictions on the amount of dividends that it may declare without prior regulatory approval. In addition, the dividends declared cannot be in excess of the amount which would cause the subsidiary bank to fall below the minimum required for capital adequacy purposes.
Valley and Valley National Bank are subject to the regulatory capital requirements administered by the Federal Reserve Bank and the OCC. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct significant impact on Valley’s consolidated financial statements. Under capital adequacy guidelines Valley and Valley National Bank must meet specific capital guidelines that involve quantitative measures of Valley’s assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require Valley and Valley National Bank to maintain minimum amounts and ratios of common equity Tier 1 capital, total and Tier 1 capital to risk-weighted assets, and Tier 1 capital to average assets, as defined in the regulations.
Valley is required to maintain a common equity Tier 1 capital to risk-weighted assets ratio of 4.5 percent, Tier 1 capital to risk-weighted assets of 6.0 percent, ratio of total capital to risk-weighted assets of 8.0 percent, and minimum leverage ratio of 4.0 percent, plus a 2.5 percent capital conservation buffer added to the minimum requirements for capital adequacy purposes. As of December 31, 2020 and 2019, Valley and Valley National Bank exceeded all capital adequacy requirements (see table below).
For regulatory capital purposes, in connection with the Federal Reserve Board’s final interim rule as of April 3, 2020, 100 percent of the CECL Day 1 impact to shareholders' equity equaling $28.2 million after-tax will be deferred for a two-year period ending January 1, 2022, at which time it will be phased in on a pro-rata basis over a three-year period ending January 1, 2025. Additionally, 25 percent of the reserve build (i.e., provision for credit losses less net charge-offs) for the year ended December 31, 2020 will be phased in over the same time frame.
The following table presents Valley’s and Valley National Bank’s actual capital positions and ratios under the Basel III risk-based capital guidelines at December 31, 2020 and 2019:
COMMON AND PREFERRED STOCK (Note 18)
Dividend Reinvestment Plan. Valley's transfer agent maintains its dividend reinvestment plan (DRIP) with shares purchased in the open market. The ability to issue authorized and previously unissued common stock or reissue treasury stock as part of Valley's DRIP was terminated effective February 12, 2018. During 2018, 87 thousand common shares were reissued from treasury stock or issued from authorized common shares under the DRIP for net proceeds totaling $1.0 million.
Repurchase Plan. In 2007, Valley’s Board of Directors approved the repurchase of up to 4.7 million of common shares. Purchases of Valley’s common shares may be made from time to time in the open market or in privately negotiated transactions generally not exceeding prevailing market prices. Repurchased shares are held in treasury and are expected to be used for general corporate purposes. Under the repurchase plan, Valley made no purchases of its outstanding shares during the years ended December 31, 2020, 2019 and 2018 in the open market.
Other Stock Repurchases. Valley purchases shares directly from its employees in connection with employee elections to withhold taxes related to the vesting of stock awards. During the years ended December 31, 2020, 2019 and 2018, Valley purchased approximately 510 thousand, 175 thousand and 441 thousand shares, respectively, of its outstanding common stock at an average price of $10.61, $10.45 and $11.83, respectively, for such purpose.
Preferred Stock
Series A Issuance. On June 19, 2015, Valley issued 4.6 million shares of its Fixed-to-Floating Rate Non-Cumulative Perpetual Preferred Stock, Series A, no par value per share, with a liquidation preference of $25 per share. Dividends on the preferred stock accrue and are payable quarterly in arrears, at a fixed rate per annum equal to 6.25 percent from the original issue date to, but excluding, June 30, 2025, and thereafter at a floating rate per annum equal to three-month LIBOR plus a spread of 3.85 percent. The net proceeds from the preferred stock offering totaled $111.6 million. Commencing June 30, 2025, Valley may redeem the preferred shares at the liquidation preference plus accrued and unpaid dividends, subject to certain conditions.
Series B Issuance. On August 3, 2017, Valley issued 4.0 million shares of its Fixed-to-Floating Rate Non-Cumulative Perpetual Preferred Stock, Series B, no par value per share, with a liquidation preference of $25 per share. Dividends on the preferred stock will accrue and be payable quarterly in arrears, at a fixed rate per annum equal to 5.50 percent from the original issuance date to, but excluding, September 30, 2022, and thereafter at a floating rate per annum equal to three-month LIBOR plus a spread of 3.578 percent. The net proceeds from the preferred stock offering totaled $98.1 million. Commencing September 30, 2022, Valley may redeem the preferred shares at the liquidation preference plus accrued and unpaid dividends, subject to certain conditions.
Preferred stock is included in Valley's (additional) Tier 1 capital and total risk-based capital at December 31, 2020 and 2019.
OTHER COMPREHENSIVE INCOME (Note 19)
The following table presents the tax effects allocated to each component of other comprehensive income (loss) for the years ended December 31, 2020, 2019 and 2018. Components of other comprehensive income (loss) include changes in net unrealized gains and losses on debt securities available for sale; unrealized gains and losses on derivatives used in cash flow hedging relationships; and the pension benefit adjustment for the unfunded portion of various employee, officer and director pension plans.
(1) Included in gains (losses) on securities transactions, net.
(2) Included in interest expense.
(3) Included in the computation of net periodic pension cost. See Note 12 for details.
The following table presents the after-tax changes in the balances of each component of accumulated other comprehensive loss for the years ended December 31, 2020, 2019 and 2018:
PARENT COMPANY INFORMATION (Note 20)
Condensed Statements of Financial Condition
Condensed Statements of Income
Condensed Statements of Cash Flows
BUSINESS SEGMENTS (Note 21)
Valley has four business segments that it monitors and reports on to manage Valley’s business operations. These segments are consumer lending, commercial lending, investment management, and corporate and other adjustments. Valley’s reportable segments have been determined based upon its internal structure of operations and lines of business. Each business segment is reviewed routinely for its asset growth, contribution to income before income taxes and return on average interest earning assets and impairment (if events or circumstances indicate a possible inability to realize the carrying amount). Expenses related to the branch network, all other components of retail banking, along with the back office departments of the Bank are allocated from the corporate and other adjustments segment to each of the other three business segments. Interest expense and internal transfer expense (for general corporate expenses) are allocated to each business segment utilizing a transfer pricing methodology, which involves the allocation of operating and funding costs based on each segment's respective mix of average earning assets and/or liabilities outstanding for the period. The financial reporting for each segment contains allocations and reporting in line with Valley’s operations, which may not necessarily be comparable to any other financial institution. The accounting for each segment includes internal accounting policies designed to measure consistent and reasonable financial
reporting and may result in income and expense measurements that differ from amounts under U.S. GAAP. Furthermore, changes in management structure or allocation methodologies and procedures may result in changes in reported segment financial data.
The consumer lending segment is mainly comprised of residential mortgages and automobile loans, and to a lesser extent, secured personal lines of credit, home equity loans and other consumer loans. The duration of the residential mortgage loan portfolio is subject to movements in the market level of interest rates and forecasted prepayment speeds. The average weighted life of the automobile loans within the portfolio is relatively unaffected by movements in the market level of interest rates. However, the average life may be impacted by new loans as a result of the availability of credit within the automobile marketplace and consumer demand for purchasing new or used automobiles. The consumer lending segment also includes the Wealth Management and Insurance Services Division, comprised of trust, asset management, and insurance services.
The commercial lending segment is mainly comprised of floating rate and adjustable rate commercial and industrial loans and construction loans, as well as fixed rate owner occupied and commercial real estate loans. Due to the portfolio’s interest rate characteristics, commercial lending is Valley’s business segment that is most sensitive to movements in market interest rates.
The investment management segment generates a large portion of Valley’s income through investments in various types of securities and interest-bearing deposits with other banks. These investments are mainly comprised of fixed rate securities and depending on Valley's liquid cash position, federal funds sold and interest-bearing deposits with banks (primarily the Federal Reserve Bank of New York), as part of its asset/liability management strategies. The fixed rate investments are among Valley’s assets that are least sensitive to changes in market interest rates. However, a portion of the investment portfolio is invested in shorter-duration securities to maintain the overall asset sensitivity of Valley’s balance sheet.
The amounts disclosed as “corporate and other adjustments” represent income and expense items not directly attributable to a specific segment, including net securities gains and losses not reported in the investment management segment above, interest expense related to subordinated notes, amortization and impairment of tax credit investments, as well as non-core items, including the loss on extinguishment of debt and merger expenses.
The following tables represent the financial data for Valley’s four business segments for the years ended December 31, 2020, 2019 and 2018:
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors
Valley National Bancorp:
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated statements of financial condition of Valley National Bancorp and subsidiaries (the Company) as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2020, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 26, 2021 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Change in Accounting Principle
As discussed in Note 1 to the consolidated financial statements, the Company has changed its method of accounting for the recognition and measurement of credit losses as of January 1, 2020 due to the adoption of ASC Topic 326, Financial Instruments - Credit Losses.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
Allowance for loan losses evaluated on a collective basis
As discussed in Note 1 to the consolidated financial statements, the Company adopted ASU No. 2016-13, Financial Instruments - Credit Losses (ASC Topic 326), as of January 1, 2020. As discussed in Note 5 to the consolidated financial statements, the Company’s total allowance for loan losses as of December 31, 2020 was $340.2 million, of which $264.4 million related to the loans collectively evaluated for credit losses (the collective ALL). The collective ALL includes the measure of expected credit losses on a collective basis for those loans that share similar risk characteristics. In estimating the collective ALL, the Company uses a transition matrix model which calculates an expected life of loan loss percentage for each loan pool by using probability of default and loss given default metrics.
The metrics are based on the migration of loans from performing to loss by credit quality rating or delinquency categories using life-of-loan analysis periods for each loan portfolio pool, and the severity of loss, based on the aggregate net lifetime losses incurred. The expected credit losses are the product of multiplying the model’s expected life of loan loss percentages by the exposure at default at period end. The model’s expected losses are adjusted for qualitative factors which includes a two-year reasonable and supportable forecast period followed by a one-year period over which estimated losses revert to historical loss experience on a straight-line basis for the remaining life of the loan. The forecasts consist of a multi-scenario economic forecast model which is assigned relative probability weightings. These adjustments are based on qualitative factors not reflected in the quantitative model but are likely to impact the measurement of estimated credit losses.
We identified the assessment of the collective ALL as a critical audit matter. A high degree of audit effort, including specialized skills and knowledge, and subjective and complex auditor judgment was involved in the assessment of the collective ALL. Specifically, the assessment encompassed the evaluation of the collective ALL methodology, including the model and methods used to estimate the (1) life of loan loss percentages and the related significant assumptions, including probability of default, loss given default and credit risk ratings for commercial loans, and (2) the qualitative factors, including the reasonable and supportable economic forecasts and related weightings, and reversion. The assessment also included an evaluation of the conceptual soundness and performance of the methodology utilized to derive the quantitative life of loan loss percentages and qualitative factors and the Company’s procedures to validate the model utilized to produce the lifetime loss estimate. In addition, auditor judgment was required to evaluate the sufficiency of audit evidence obtained.
The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls related to the Company’s measurement of the collective ALL estimate, including controls over the:
•development of the collective ALL methodology
•development of the transition matrix model
•identification and determination of the significant assumptions used in the model
•development and ongoing monitoring of the appropriateness of the reasonable and supportable forecast period
•development of the qualitative factors, including the significant assumptions used in the measurement of the qualitative factors
•procedures performed by the Company to validate the model is fit for use and appropriate to estimate lifetime losses
•periodic testing of loan risk ratings for loan portfolios
•analysis of the collective ALL results, trends and ratios.
We evaluated the Company’s process to develop the collective ALL estimate by testing certain sources of data, factors, and assumptions that the Company used, and considered the relevance and reliability of such data, factors and assumptions. In addition, we involved credit risk professionals with specialized skills and knowledge, who assisted in:
•evaluating the Company’s collective ALL methodology for compliance with U.S. generally accepted accounting principles
•evaluating the judgments made by the Company relative to the development and performance monitoring of the transition matrix model used to calculate the life of loan loss percentage by comparing them to Company-specific metrics and trends and the applicable industry and regulatory practices
•testing the conceptual soundness and performance of the transition matrix model by inspecting the model documentation and model validation documentation to determine whether the model is suitable for the intended use
•evaluating the economic forecast scenarios and related weightings by comparing them to the Company’s business environment and relevant industry practices
•testing the reasonable and supportable forecast period and reversion period to evaluate the length of each period by comparison to specific portfolio risk characteristics and trends
•determining whether the loan portfolio is segmented by similar risk characteristics by comparing to the Company’s business environment and relevant industry practices
•testing individual credit risk ratings for a selection of commercial loans by evaluating the financial performance of the borrower, sources of repayment and any relevant guarantees or underlying collateral
•evaluating the methodology used to develop the qualitative factor framework and the effect of those factors on the collective ALL by comparing the qualitative factors to the specific portfolio risk characteristics, trends and relevant industry practices and identified limitations of the underlying quantitative models.
We also assessed the sufficiency of the audit evidence obtained related to the collective ALL by evaluating the cumulative results of the audit procedures, qualitative aspects of the Company’s accounting practices and potential bias in the accounting estimate.
Goodwill impairment assessment of the Company’s reporting units
As discussed in Notes 1 and 8 to the consolidated financial statements, the carrying value of the Company’s goodwill balance is $1.4 billion as of December 31, 2020. The Company’s goodwill is not amortized but is subject to annual tests for impairment in the second quarter, or more often, if events or circumstances indicate it may be impaired. The Company elected to perform a quantitative impairment test for its annual assessment in the second quarter which compared the fair value of each of the reporting units with their carrying amounts, including goodwill. If the fair value of each of the reporting units exceeded its carrying amounts, the goodwill of the reporting unit was not impaired. An impairment loss is recognized if the carrying value of the net assets assigned to the reporting units exceeds the fair value, with the impairment charge not to exceed the amount of goodwill recorded. Fair value is determined using market multiples and certain discounted cash flow analyses. Factors that may materially affect the fair value estimate include, among others, changes in discount rates, terminal values and specific industry or market sector conditions.
We identified the measurement of the fair value of each of the reporting units in the Company’s annual goodwill impairment assessment as a critical audit matter. A high degree of audit effort, including specialized skills and knowledge, and subjective and complex auditor judgement was involved in performing procedures over the individual reporting unit estimated cash flows and related key assumptions, which included the discount rate and the terminal value growth rate used in the discounted cash flow analyses. The key assumptions were challenging to test as they represented subjective determinations of future market and economic conditions that were also more sensitive to variation. Minor changes in these assumptions could have had a significant effect on the Company’s measurement of the fair value of the reporting units and the impairment assessment of the carrying value of the goodwill.
The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls related to the Company’s determination of the estimated fair value of the reporting units in the annual goodwill impairment assessment, including controls over the selection and development of key assumptions used in the discounted cash flow analyses. We involved valuation professionals with specialized skill and knowledge, who assisted in:
•evaluating the Company’s fair value methodology for the reporting units for compliance with U.S. generally accepted accounting principles
•evaluating the Company’s discount rate by comparing it against a discount rate range that was independently developed using publicly available data for comparable entities
•evaluating the Company’s terminal value growth rate by comparing it against an average growth rate range that was independently developed using publicly available economic and industry data for comparable entities
•developing an independent estimate of the reporting units’ fair value using the reporting units’ cash flow forecast and an independently developed discount rate and compared our estimate of fair value to the Company’s fair value estimate
•reconciling the Company’s estimated fair value to its market capitalization as of the measurement date and evaluating the implied control premium for alignment with industry standards.
/s/ KPMG LLP
We have served as the Company’s auditor since 2008.
Short Hills, New Jersey
February 26, 2021
Item 9.
Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A.Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Valley maintains disclosure controls and procedures which, consistent with Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended, are defined to mean controls and other procedures that are designed to ensure that information required to be disclosed in the reports that Valley files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and to ensure that such information is accumulated and communicated to Valley’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Valley’s management, with the participation of the Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of Valley’s disclosure controls and procedures. Based on such evaluation, Valley’s Chief Executive Officer and Chief Financial Officer have concluded that such disclosure controls and procedures were effective as of December 31, 2020 (the end of the period covered by this Annual Report on Form 10-K).
Valley’s management, including the Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls over financial reporting will prevent all errors and all fraud. A system of internal control, no matter how well conceived and operated, provides reasonable, not absolute, assurance that the objectives of the system of internal control are met. The design of a system of internal control reflects resource constraints and the benefits of controls must be considered relative to their costs. Because there are inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Valley have been or will be detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns occur because of a simple error or mistake. Controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of internal control is based in part upon certain assumptions about the likelihood of future events. There can be no assurance that any design will succeed in achieving its stated goals under all future conditions; over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with the policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
Management’s Report on Internal Control over Financial Reporting
Valley’s management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. Valley’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles and includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
As of December 31, 2020, management assessed the effectiveness of Valley’s internal control over financial reporting based on the criteria for effective internal control over financial reporting established in Internal Control-Integrated Framework (2013), issued by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission. Management’s assessment included an evaluation of the design of Valley’s internal control over financial reporting and testing of the operating
effectiveness of its internal control over financial reporting. Management reviewed the results of its assessment with the Audit Committee.
Based on this assessment, management determined that, as of December 31, 2020, Valley’s internal control over financial reporting was effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles.
KPMG LLP, the independent registered public accounting firm that audited Valley’s December 31, 2020 consolidated financial statements included in this Annual Report on Form 10-K, has issued an audit report expressing an opinion on the effectiveness of Valley’s internal control over financial reporting as of December 31, 2020. The report is included in this item under the heading “Report of Independent Registered Public Accounting Firm.”
Changes in Internal Control over Financial Reporting
Beginning January 1, 2020, Valley adopted ASU No. 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”. Valley implemented changes to the policies, processes, and controls over the estimation of the allowance for credit losses to support the adoption of ASU No. 2016-13. Many of the controls that existed under the incurred model remained unchanged under the new standard. New controls were established over the review of economic forecasting projections obtained externally. Except as related to the adoption of ASU No. 2016-13, Valley’s CEO and CFO have also concluded that there have not been any changes in Valley’s internal control over financial reporting in the year ended December 31, 2020 that have materially affected, or are reasonably likely to materially affect, Valley’s internal control over financial reporting.
Valley has not experienced any material impact to Valley’s internal controls over financial reporting due to the fact that most of Valley’s employees responsible for financial reporting are working remotely during the COVID-19 pandemic. Valley is continually monitoring and assessing the impact of the COVID-19 pandemic on Valley’s internal controls over financial reporting to minimize the impact to their design and operating effectiveness.
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors
Valley National Bancorp:
Opinion on Internal Control Over Financial Reporting
We have audited Valley National Bancorp and subsidiaries’ (the Company) internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated statements of financial condition of the Company as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2020, and the related notes (collectively, the consolidated financial statements), and our report dated February 26, 2021 expressed an unqualified opinion on those consolidated financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ KPMG LLP
Short Hills, New Jersey
February 26, 2021
Item 9B.
Item 9B.Other Information
Not applicable.
PART III
Item 10.
Item 10.Directors, Executive Officers and Corporate Governance
Certain information regarding executive officers is included under the section captioned “ Information about our Executive Officers” in Item 1 of this report. The information set forth under the captions “Director Information” and “Corporate Governance” in the 2021 Proxy Statement is incorporated herein by reference.
The information set forth under the captions “Director Compensation”, “Compensation Committee Interlocks and Insider Participation” and “Executive Compensation” in the 2021 Proxy Statement is incorporated herein by reference.
Item 12.
Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters
The information set forth under the captions “Equity Compensation Plan Information” and “Stock Ownership of Management and Principal Shareholders” in the 2021 Proxy Statement is incorporated herein by reference.
Item 13.
Item 13.Certain Relationships and Related Transactions, and Director Independence
The information set forth under the captions “Compensation Committee Interlocks and Insider Participation”, “Certain Transactions with Management” and “Corporate Governance” in the 2021 Proxy Statement is incorporated herein by reference.
Item 14.
Item 14.Principal Accountant Fees and Services
The information set forth under the caption “Ratification of Appointment of Independent Registered Public Accounting Firm” in the 2021 Proxy Statement is incorporated herein by reference.
PART IV
Item 15.
Item 15.Exhibits and Financial Statement Schedules
(a)Financial Statements and Schedules:
The following financial statements and supplementary data are filed as part of this annual report:
All financial statement schedules are omitted because they are either inapplicable or not required, or because the required information is included in the consolidated financial statements or notes thereto.
(b)Exhibits (numbered in accordance with Item 601 of Regulation S-K):
(3)Articles of Incorporation and By-laws:
(4)Instruments Defining the Rights of Security Holders:
(10) Material Contracts:
B.Severance Agreement dated January 24, 2017 between Valley, Valley National Bank and Gerald H. Lipkin, which replaced in full all predecessor severance and guaranteed retirement agreements, incorporated herein by reference to Exhibit 10.1 to the Registrant’s Form 8-K Current Report filed on January 26, 2017 (applicable only to Gerald H. Lipkin guaranteed retirement agreement) +
(21)List of Subsidiaries as of December 31, 2020:
(23)Consent of KPMG LLP.*
(24)Power of Attorney of Certain Directors and Officers of Valley.*
(31.1)Certification of Ira Robbins, Chairman of the Board, President and Chief Executive Officer of the Company, pursuant to Securities Exchange Rule 13a-14(a).*
(31.2)Certification of Michael D. Hagedorn, Senior Executive Vice President and Chief Financial Officer of the Company, pursuant to Securities Exchange Rule 13a-14(a).*
(32)Certification, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, signed by Ira Robbins, Chairman of the Board, President and Chief Executive Officer of the Company and Michael D. Hagedorn, Senior Executive Vice President and Chief Financial Officer of the Company.*
(101)Interactive Data File (XBRL Instance Document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document) *
(104)Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101) *
*Filed herewith.
+Management contract and compensatory plan or arrangement.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
VALLEY NATIONAL BANCORP
By: /s/ IRA ROBBINS
Ira Robbins, Chairman of the Board, President
and Chief Executive Officer
By: /s/ MICHAEL D. HAGEDORN
Michael D. Hagedorn,
Senior Executive Vice President
and Chief Financial Officer
Dated: February 26, 2021
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated:
*