ITEM 1 - BUSINESS
General
Hudson Valley Holding Corp. (the “Company”) is a New York corporation founded in 1982. The Company is registered as a bank holding company under the Bank Holding Company Act of 1956.
The Company provides financial services through its wholly-owned subsidiary, Hudson Valley Bank, N.A. (“HVB” or “the Bank”), a national banking association established in 1972, with operational headquarters in Westchester County, New York. New York National Bank, (“NYNB”), a national banking association which the Company acquired effective January 1, 2006, was merged into HVB effective March 1, 2010. NYNB currently operates as a division of HVB. HVB has 18 branch offices in Westchester County, New York, 5 in Manhattan, New York, 4 in Bronx County, New York, 1 in Rockland County, New York, 1 in Queens County, New York, 1 in Kings County, New York, 5 in Fairfield County, Connecticut and 1 in New Haven County Connecticut.
The Company provides investment management services through a wholly-owned subsidiary of HVB, A.R. Schmeidler & Co., Inc. (“ARS”), a money management firm, thereby generating fee income. ARS has offices at 500 Fifth Avenue in Manhattan, New York.
We derive substantially all of our revenue and income from providing banking and related services to businesses, professionals, municipalities, not-for-profit organizations and individuals within our market area. See “Our Market Area.”
Our principal executive offices are located at 21 Scarsdale Road, Yonkers, New York 10707.
Our principal customers are businesses, professionals, municipalities, not-for-profit organizations and individuals. Our strategy is to operate community-oriented banking institutions dedicated to providing personalized service to customers and focusing on products and services for selected segments of the market. We believe that our ability to attract and retain customers is due primarily to our focused approach to our markets, our personalized and professional services, our product offerings, our experienced staff, our knowledge of our local markets and our ability to provide responsive solutions to customer needs. We provide these products and services to a diverse range of customers and do not rely on a single large depositor for a significant percentage of deposits. We anticipate that we will continue to expand in our current market and surrounding area by acquiring other banks and related businesses, adding staff and continuing to open new branch offices and loan production offices.
Forward-Looking Statements
The Company has made in this Annual Report on Form 10-K various forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 with respect to earnings, credit quality and other financial and business matters for periods subsequent to December 31, 2010. These statements may be identified by such forward-looking terminology as “expect”, “may”, “will”, “anticipate”, “continue”, “believe” or similar statements or variations of such terms. The Company cautions that these forward-looking statements are subject to numerous assumptions, risks and uncertainties, and that statements relating to subsequent periods increasingly are subject to greater uncertainty because of the increased likelihood of changes in underlying factors and assumptions. Actual results could differ materially from 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 disclosed in this Annual Report on Form 10-K include, but are not limited to, statements regarding:
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further increases in our non-performing loans and allowance for loan losses;
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our ability to manage our commercial real estate portfolio;
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the future performance of our investment portfolio;
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our opportunities for growth, our plans for expansion (including opening new branches) and the competition we face in attracting and retaining customers;
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economic conditions generally and in our market area in particular, which may affect the ability of borrowers to repay their loans and the value of real property or other property held as collateral for such loans;
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demand for our products and services;
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possible impairment of our goodwill and other intangible assets;
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our ability to manage interest rate risk;
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the regulatory environment in which we operate, our regulatory compliance and future regulatory requirements;
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our intention and ability to maintain regulatory capital above the levels required by the Office of the Comptroller of the Currency (the “OCC”) for the Bank and the levels required for us to be “well-capitalized”, or such higher capital levels as may be required;
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proposed legislative and regulatory action affecting us and the financial services industry;
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legislative and regulatory actions (including the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act and related regulations) subject us to additional regulatory oversight which may result in increased compliance costs and/or require us to change our business model;
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future Federal Deposit Insurance Corporation (“FDIC”) special assessments or changes to regular assessments;
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our ability to raise additional capital in the future;
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potential liabilities under federal and state environmental laws; and
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limitations on dividends payable by the Company or the Bank.
We assume no obligation for updating any such forward-looking statements at any given time.
Subsidiaries of the Bank and the Company
In 1993, HVB formed a wholly-owned subsidiary, Sprain Brook Realty Corp., primarily for the purpose of holding property obtained by HVB through foreclosure in its normal course of business.
In 1997, HVB formed a subsidiary (of which it owns more than 99 percent of the voting stock), Grassy Sprain Real Estate Holdings, Inc., a real estate investment trust, primarily for the purpose of acquiring and managing a portfolio of mortgage-backed securities, loans collateralized by real estate and other investment securities previously owned by HVB.
In 2001, HVB began originating lease financing transactions through a wholly owned subsidiary, HVB Leasing Corp.
In 2002, HVB formed two wholly-owned subsidiaries. HVB Realty Corp. owns and manages five branch locations in Yonkers, New York and HVB Employment Corp. leases certain branch staff to HVB.
In 2004, HVB acquired for cash A.R. Schmeidler & Co., Inc. as a wholly-owned subsidiary in a transaction accounted for as a purchase. This money management firm provides investment management services to its customers thereby generating fee income.
In 1997, NYNB formed a wholly-owned subsidiary, 369 East 149th Street Corp., primarily for the purpose of owning and operating certain commercial real estate property of which NYNB is a tenant.
In 2008, NYNB formed a wholly-owned subsidiary, 369 East Realty Corp., primarily for the purpose of holding property obtained by NYNB through foreclosure in its normal course of business.
In January 2010, the Company formed a wholly owned subsidiary, HVHC Risk Management Corp, which is a captive insurance company which underwrites certain insurance coverage for HVB and its subsidiary companies.
In February 2010, HVB formed three wholly owned subsidiaries. HVB Properties Corp. owns and manages two of HVB’s branches. HVB Fleet Services Corp. owns and manages company owned automobiles. 21 Scarsdale Road Corp. owns and manages the HVB headquarters buildings.
In February 2010, NYNB formed a wholly owned subsidiary, 2256 Second Avenue Corp., which owns and manages the Second Avenue branch in Manhattan, New York.
As a result of the merger of HVB and NYNB, effective March 1, 2010, all subsidiaries of NYNB became subsidiaries of HVB.
The Company has no separate operations or revenues apart from HVHC Risk Management Corp. and HVB and its subsidiaries.
Employees
At December 31, 2010, we employed 438 full-time employees and 40 part-time employees. We provide a variety of benefit plans, including group life, health, dental, disability, retirement and stock option plans. We consider our employee relations to be satisfactory.
Our Market Area
The banking and financial services business in our market area is highly competitive. Due to their proximity to and location within New York City, our branches compete with regional banks, as well as many other non-bank financial institutions. A number of these banks are larger than we are and are increasing their efforts to serve smaller commercial borrowers. Many of these competitors, by virtue of their size and resources, may enjoy efficiencies and competitive advantages over us in pricing, delivery and marketing of their products and services. We believe that, despite the continued growth of large institutions and the potential for large out-of-area banking and financial institutions to enter our market area, there will continue to be opportunities for efficiently-operated, service-oriented, well-capitalized, community-based banking organizations to grow by serving customers that are not well served by larger institutions or do not wish to bank with such large institutions.
Westchester County is a suburban county located in the northern sector of the New York metropolitan area. It has a large and varied economic base containing many corporate headquarters, research facilities, manufacturing firms as well as well-developed trade and service sectors. The median household income, based on 2009 census data, was $79,585. The County’s 2009 per capita income of $47,204 placed Westchester County among the highest of the nation’s counties. In December 2010, the County’s unemployment rate was 6.9 percent, as compared to New York State at 8.1 percent and the United States at 9.1 percent. The County has over 100,000 businesses, which form a large portion of our current and potential customer base. We continue to evaluate expansion opportunities in Westchester County.
New York City, which borders Westchester County, is the nation’s financial capital and the home of more than 8 million individuals representing virtually every race and nationality. According to the 2008 census data, the median household income in the city was $50,173, while the per capita income was $30,337. This places New York City in the top ranks of cities across the United States. In December 2010, New York City’s unemployment rate was 8.6%. The city also has a vibrant and diverse business community with more than 106,000 businesses and professional service firms. New York City is comprised of five counties or boroughs: Bronx, Kings (Brooklyn), New York (Manhattan), Queens and Richmond (Staten Island).
New York City has many attractive attributes and we believe that there is an opportunity for community banks to service our niche markets of businesses and professionals very effectively. We expanded into the New York City market with the opening of our first branch in the Bronx in 1999. Subsequent expansion in this borough was accomplished with the opening of a second branch in 2002, the addition of two additional branches as a result of the acquisition of NYNB in 2006, and a third branch in 2010. The two branches acquired with NYNB were consolidated into one branch in 2010. We entered the Manhattan market with the opening of a full-service branch in the Lincoln Building in 2002 and followed by the openings of three additional branches in 2004, 2005 and 2008. The NYNB acquisition also provided an additional Manhattan branch location. In 2008, we opened our first branch in the borough of Brooklyn. We continue to evaluate additional expansion opportunities in New York City.
We expanded into Rockland County, New York, by opening a full service branch in New City, New York in February 2007. Rockland County, New York, a suburban county, borders Westchester County, New York to the west. Rockland County’s 2009 per capita income was $34,071. In December 2010, the County’s unemployment rate was 6.9%. We believe Rockland County offers attractive opportunities for us to develop new customers within our niche markets of businesses, professionals and not-for-profit organizations.
We expanded our branch network into Fairfield County, Connecticut with the opening of a full-service branch in, Stamford, Connecticut in December 2007. We subsequently expanded our presence in Fairfield County to five full service locations with the additions of branch offices in Westport, Greenwich and Fairfield in 2008 and Stratford in 2009. Fairfield County, Connecticut, a suburban county, borders Westchester County, New York to the east. The County’s 2009 per capita income was $48,394. In December 2010, the County’s unemployment rate was 7.9% as
compared to the state of Connecticut’s unemployment rate of 8.6%. Fairfield County has very similar attributes to Westchester County, New York, where we have had success in attracting and retaining customers.
We expanded into New Haven County, Connecticut in 2009 with the opening of a full service branch in Milford. New Haven County, Connecticut borders Fairfield County to the east and is a mixed urban and suburban county. In December 2010, the County’s unemployment rate was 9.6%. We continue to explore additional opportunities for expansion in the Connecticut market.
Competition
The banking and financial services business in our market area is highly competitive. There are approximately 150 banking institutions with 2,510 branch banking offices in our Westchester County, Rockland County, Fairfield County, Connecticut and New York City market area. These banking institutions had deposits of approximately $542 billion as of June 30, 2008 according to Federal Deposit Insurance Corporation (“FDIC”) data. Our branches compete with local offices of large New York City commercial banks due to their proximity to and location within New York City. Other financial institutions, such as mutual funds, finance companies, factoring companies, mortgage bankers and insurance companies, also compete with us for both loans and deposits. We are smaller in size than most of our competitors. In addition, many non-bank competitors are not subject to the same extensive federal regulations that govern bank holding companies and federally insured banks.
Competition for depositors’ funds and for credit-worthy loan customers is intense. A number of larger banks are increasing their efforts to serve smaller commercial borrowers. Competition among financial institutions is based upon interest rates and other credit and service charges, the quality of service provided, the convenience of banking facilities, the products offered and, in the case of larger commercial borrowers, relative lending limits.
Federal legislation permits adequately capitalized bank holding companies to expand across state lines to offer banking services. In view of this, it is possible for large organizations to enter many new markets, including our market area. Many of these competitors, by virtue of their size and resources, may enjoy efficiencies and competitive advantages over us in pricing, delivery and marketing of their products and services.
In response to competition, we have focused our attention on customer service and on addressing the needs of businesses, professionals and not-for-profit organizations located in the communities in which we operate. We emphasize community relations and relationship banking. We believe that, despite the continued growth of large institutions and the potential for large out-of-area banking and financial institutions to enter our market area, there will continue to be opportunities for efficiently-operated, service-oriented, well-capitalized, community-based banking organizations to grow by serving customers that are not served well by larger institutions or do not wish to bank with such large institutions.
Our strategy is to increase earnings through growth within our existing market. Our primary market area, which includes Westchester County, Rockland County and New York City in the State of New York, and Fairfield County and New Haven County in the State of Connecticut, has a high concentration of the types of customers that we desire to serve. We expect to continue to expand by opening new full-service banking facilities and loan production offices, by expanding deposit gathering and loan originations in our market area, by enhancing and expanding computerized and telephonic products, by diversifying our products and services, by acquiring other banks and related businesses and through strategic alliances and contractual relationships.
During the past five years, we have focused on maintaining existing customer relationships and adding new relationships by providing products and services that meet these customers’ needs. The focus of our products and services continues to be businesses, professionals, not-for-profit organizations and municipalities. We have expanded our market to additional sections of Westchester County and New York City and further expanded to include sections of Rockland County, New York, Fairfield County, Connecticut and New Haven County, Connecticut. We have opened or acquired seventeen new facilities during the past five years, three in Westchester County, New York, seven in New York City, one in Rockland County, New York, five in Fairfield County, Connecticut and one in New Haven County, Connecticut. We anticipate opening at least one additional facility during 2011. We expect to continue to open additional facilities in the future. We have invested in technology based products and services to meet customer needs. In addition, we have expanded products and services in our deposit gathering and lending programs, and our offering of investment management and trust services. As a result, our total assets have grown nearly 50 percent during this five year period.
Lending
We engage in a variety of lending activities which are primarily categorized as real estate, commercial and industrial, individual and lease financing. At December 31, 2010, gross loans totaled $1,732.3 million. Gross loans were comprised of the following loan types:
At December 31, 2010, HVB’s lending limit to one borrower under applicable regulations was approximately $39.7 million.
In managing our loan portfolios, we focus on:
(i) the application of established underwriting criteria,
(ii)
the establishment of individual internal comfort levels of lending authority below HVB’s legal lending authority,
(iii)
the involvement by senior management and the Board of Directors in the loan approval process for designated categories, types or amounts of loans,
(iv) an awareness of concentration by industry or collateral, and
(v) the monitoring of loans for timely payment and to seek to identify potential problem loans.
We utilize our Credit Department to assess acceptable and unacceptable credit risks based upon established underwriting criteria. We utilize our loan officers, branch managers and Credit Department to identify changes in a borrower’s financial condition that may affect the borrower’s ability to perform in accordance with loan terms. Lending policies and procedures place an emphasis on assessing a borrower’s income and cash flow as well as collateral values. Further, we utilize systems and analysis which assist in monitoring loan delinquencies. We utilize our loan officers, Asset Recovery Department and legal counsel in collection efforts on past due loans. Additional collateral or guarantees may be requested where delinquencies remain unresolved.
An independent qualified loan review firm reviews loans in our portfolios and confirms a risk grading to each reviewed loan. Loans are reviewed based upon the type of loan, the collateral for the loan, the amount of the loan and any other pertinent information. The loan review firm reports directly to the Audit Committee of the Board of Directors.
In addition, we have participated in loans originated by various other financial institutions within the normal course of business and within standard industry practices.
See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Loan Portfolio” for further information related to our portfolio and lending activities.
Deposits
We offer deposit products ranging in maturity from demand-type accounts to certificates of deposit with maturities of up to 5 years. Deposits are generally derived from customers within our primary marketplace. We solicit only certain types of deposits from outside our market area, primarily from certain professionals and government agencies. We also utilize brokered certificates of deposits as a source of funding and to manage interest rate risk.
We set deposit rates to remain generally competitive with other financial institutions in our market, although we do not generally seek to match the highest rates paid by competing institutions. We have established a process to review interest rates on all deposit products and, based upon this process, update our deposit rates weekly. This process also established a procedure to set deposit interest rates on a relationship basis and to periodically review these deposit rates. Our Asset/Liability Management Policy and our Liquidity Policy set guidelines to manage overall interest rate risk and liquidity. These guidelines can affect the rates paid on deposits. Deposit rates are reviewed under these policies periodically since deposits are our primary source of liquidity.
We offer deposit pick up services for certain business customers. We have 27 automated teller machines, or ATMs, at various locations, which generate activity fees based on use by other banks’ customers.
For more information regarding our deposits, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Deposits.”
Portfolio Management Services
We provide investment management services to our customers and others through a subsidiary, A. R. Schmeidler & Co., Inc. The acquisition of this firm has allowed us to expand our investment management services to customers and to expand revenue by offering such services. We anticipate that we will continue to expand this line of business.
Other Services
We also provide a software application to a limited number of customers designed to meet the specific administrative needs of bankruptcy trustees through a marketing and licensing agreement with the application vendor. We have no current plans to expand this line of business.
Segments
We maintain only one business segment which is discussed in more detail in Notes 1 and 15 to the financial statements included elsewhere herein.
Supervision and Regulation
Banks and bank holding companies are extensively regulated under both federal and state law. We have set forth below brief summaries of various aspects of the supervision and regulation of the Banks. These summaries do not purport to be complete and are qualified in their entirety by reference to applicable laws, rules and regulations.
As a bank holding company, we are regulated by and subject to the supervision of the Board of Governors of the Federal Reserve System (the “FRB”) and are required to file with the FRB an annual report and such other information as may be required. The FRB has the authority to conduct examinations of the Company as well.
The Bank Holding Company Act of 1956 (the “BHC Act”) limits the types of companies which we may acquire or organize and the activities in which they may engage. In general, a bank holding company and its subsidiaries are prohibited from engaging in or acquiring control of any company engaged in non-banking activities unless such activities are so closely related to banking or managing and controlling banks as to be a proper incident thereto. Activities determined by the FRB to be so closely related to banking within the meaning of the BHC Act include operating a mortgage company, finance company, credit card company, factoring company, trust company or savings association; performing certain data processing operations; providing limited securities brokerage services; acting as an investment or financial advisor; acting as an insurance agent for certain types of credit-related insurance; leasing personal property on a full-payout, non-operating basis; providing tax planning and preparation service; operating a collection agency; and providing certain courier services. The FRB also has determined that certain other activities, including real estate brokerage and syndication, land development, property management and underwriting of life insurance unrelated to credit transactions, are not closely related to banking and therefore are not proper activities for a bank holding company.
The BHC Act requires every bank holding company to obtain the prior approval of the FRB before acquiring substantially all the assets of, or direct or indirect ownership or control of more than five percent of the voting shares of, any bank. Subject to certain limitations and restrictions, a bank holding company, with the prior approval of the FRB, may acquire an out-of-state bank.
In November 1999, Congress amended certain provisions of the BHC Act through passage of the Gramm-Leach-Bliley Act. Under this legislation, a bank holding company may elect to become a “financial holding company” and thereby engage in a broader range of activities than would be permissible for traditional bank holding companies. In order to qualify for the election, all of the depository institution subsidiaries of the bank holding company must be well capitalized and well managed, as defined under FRB regulations, and all such subsidiaries must have achieved a rating of “satisfactory” or better with respect to meeting community credit needs. Pursuant to the Gramm-Leach-Bliley Act, financial holding companies are permitted to engage in activities that are “financial
in nature” or incidental or complementary thereto, as determined by the FRB. The Gramm-Leach-Bliley Act identifies several activities as “financial in nature”, including, among others, insurance underwriting and agency activities, investment advisory services, merchant banking and underwriting, and dealing in or making a market in securities. The Company owns a financial subsidiary, A.R. Schmeidler & Co., Inc.
We believe we meet the regulatory criteria that would enable us to elect to become a financial holding company. At this time, we have determined not to make such an election, although we may do so in the future.
The Gramm-Leach-Bliley Act also makes it possible for entities engaged in providing various other financial services to form financial holding companies and form or acquire banks. Accordingly, the Gramm-Leach-Bliley Act makes it possible for a variety of financial services firms to offer products and services comparable to the products and services we offer.
There are various statutory and regulatory limitations regarding the extent to which present and future banking subsidiaries of the Company can finance or otherwise transfer funds to the Company or its non-banking subsidiaries, whether in the form of loans, extensions of credit, investments or asset purchases, including regulatory limitation on the payment of dividends directly or indirectly to the Company from the Bank. Federal bank regulatory agencies also have the authority to limit further the Bank’s payment of dividends based on such factors as the maintenance of adequate capital for such subsidiary bank, which could reduce the amount of dividends otherwise payable. Under applicable banking statutes, at December 31, 2010, the Bank could have declared additional dividends of approximately $3.9 million to the Company without prior regulatory approval.
Under the policy of the FRB, the Company is expected to act as a source of financial strength to its banking subsidiaries and to commit resources to support its banking subsidiaries in circumstances where we might not do so absent such policy. In addition, any subordinated loans by the Company to its banking subsidiaries would also be subordinate in right of payment to depositors and obligations to general creditors of such subsidiary banks. The Company currently has no loans to the Bank.
The FRB has established capital adequacy guidelines for bank holding companies that are similar to the FDIC capital requirements for the Bank described below. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Capital Resources” and Note 10 to the Consolidated Financial Statements. The Company and HVB are subject to various regulatory capital guidelines. To be considered “well capitalized,” an institution must generally have a leverage ratio of at least 5 percent, a Tier 1 ratio of 6 percent and a total capital ratio of 10 percent. As a result of the increase in our non-performing loans, the high percentage of commercial real estate loans in our loan portfolio, and the increased potential for further possible deterioration in our loans, as of October 13, 2009 we were required by the OCC to maintain at the Bank, by no later than December 31, 2009, a total risk-based capital ratio of at least 12.0% (compared to 10.0% for a well capitalized bank), a Tier 1 risk-based capital ratio of at least 10.0% (compared to 6.0% for a well capitalized bank), and a Tier 1 leverage ratio of at least 8.0% (compared to 5.0% for a well capitalized bank). In October 2009 we raised approximately $93.3 million through an offering of our common stock and accordingly, at December 31, 2009, the Bank’s total risk-based capital ratio, Tier 1 risk-based capital ratio and Tier 1 leverage ratio were 12.7%, 11.4% and 8.4%, respectively. At December 31, 2010, the Bank’s total risk-based capital ratio, Tier 1 risk-based capital ratio and Tier 1 leverage ratio were 14.0%, 12.8% and 8.8%, respectively. Management intends to conduct the affairs of the Company and its subsidiary Bank so as to maintain a strong capital position in the future.
Basel III
In December 2010, the Basel Committee released its final framework for strengthening international capital and liquidity regulation, now officially identified by the Basel Committee as “Basel III”. Basel III, when implemented by the U.S. banking agencies and fully phased-in, will require bank holding companies and their bank subsidiaries to maintain substantially more capital, with a greater emphasis on common equity.
The Basel III final capital framework, among other things, (i) introduces as a new capital measure “Common Equity Tier 1” (“CET1”), (ii) specifies that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting specified requirements, (iii) defines CET1 narrowly by requiring that most adjustments to regulatory capital measures be made to CET1 and not to the other components of capital and (iv) expands the scope of the adjustments as compared to existing regulations.
When fully phased in on January 1, 2019, Basel III requires banks to maintain (i) as a newly adopted international standard, a minimum ratio of CET1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% CET1 ratio as that buffer is phased in, effectively resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7%), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio as that buffer is phased in, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation), (iii) a minimum ratio of Total (that is, Tier 1 plus Tier 2) capital to risk-weighted assets of at least 8.0%, plus the capital conservation buffer (which is added to the 8.0% total capital ratio as that buffer is phased in, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation) and (iv) as a newly adopted international standard, a minimum leverage ratio of 3%, calculated as the ratio of Tier 1 capital to balance sheet exposures plus certain off-balance sheet exposures (computed as the average for each quarter of the month-end ratios for the quarter).
Basel III also provides for a “countercyclical capital buffer,” generally to be imposed when national regulators determine that excess aggregate credit growth becomes associated with a buildup of systemic risk, that would be a CET1 add-on to the capital conservation buffer in the range of 0% to 2.5% when fully implemented (potentially resulting in total buffers of between 2.5% and 5%). The aforementioned capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of CET1 to risk-weighted assets above the minimum but below the conservation buffer (or below the combined capital conservation buffer and countercyclical capital buffer, when the latter is applied) will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall.
The implementation of the Basel III final framework will commence January 1, 2013. On that date, banking institutions will be required to meet the following minimum capital ratios:
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3.5% CET1 to risk-weighted assets.
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4.5% Tier 1 capital to risk-weighted assets.
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8.0% Total capital to risk-weighted assets.
The Basel III final framework provides for a number of new deductions from and adjustments to CET1. These include, for example, the requirement that mortgage servicing rights, deferred tax assets dependent upon future taxable income and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such categories in the aggregate exceed 15% of CET1.
Implementation of the deductions and other adjustments to CET1 will begin on January 1, 2014 and will be phased-in over a five-year period (20% per year). The implementation of the capital conservation buffer will begin on January 1, 2016 at 0.625% and be phased in over a four-year period (increasing by that amount on each subsequent January 1, until it reaches 2.5% on January 1, 2019).
The U.S. banking agencies have indicated informally that they expect to propose regulations implementing Basel III in mid-2011 with final adoption of implementing regulations in mid-2012. Notwithstanding its release of the Basel III framework as a final framework, the Basel Committee is considering further amendments to Basel III, including the imposition of additional capital surcharges on globally systemically important financial institutions. In addition to Basel III, Dodd-Frank requires or permits the Federal banking agencies to adopt regulations affecting banking institutions’ capital requirements in a number of respects, including potentially more stringent capital requirements for systemically important financial institutions. Accordingly, the regulations ultimately applicable to the Company may be substantially different from the Basel III final framework as published in December 2010. Requirements to maintain higher levels of capital or to maintain higher levels of liquid assets could adversely impact the Corporation’s net income and return on equity.
The Dodd-Frank Wall Street Reform and Consumer Protection Act of
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) was signed into law on July 21, 2010. Generally, the Act is effective the day after it was signed into law, but different effective dates apply to specific sections of the law. The Act, among other things:
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Directs the Federal Reserve to issue rules which are expected to limit debit-card interchange fees;
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After a three-year phase-in period which begins January 1, 2013, removes trust preferred securities as a permitted component of Tier 1 capital for bank holding companies with assets of $15 billion or more, however, bank holding companies with assets of less than $15 billion will be permitted to include trust preferred securities that were issued before May 19, 2010 as Tier 1 capital;
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Provides for increases in the minimum reserve ratio for the deposit insurance fund from 1.15 percent to 1.35 percent and changes the basis for determining FDIC premiums from deposits to assets;
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Creates a new Consumer Financial Protection Bureau that will have rulemaking authority for a wide range of consumer protection laws that would apply to all banks and would have broad powers to supervise and enforce consumer protection laws;
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Requires public companies to give shareholders a non-binding vote on executive compensation at their first annual meeting following enactment and at least every three years thereafter and on “golden parachute” payments in connection with approvals of mergers and acquisitions unless previously voted on by shareholders;
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Authorizes the SEC to promulgate rules that would allow shareholders to nominate their own candidates using a company’s proxy materials;
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Directs federal banking regulators to promulgate rules prohibiting excessive compensation paid to executives of depository institutions and their holding companies with assets in excess of $1 billion, regardless of whether the company is publicly traded or not;
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Prohibits a depository institution from converting from a state to a federal charter or vice versa while it is the subject of a cease and desist order or other formal enforcement action or a memorandum of understanding with respect to a significant supervisory matter unless the appropriate federal banking agency gives notice of conversion to the federal or state authority that issued the enforcement action and that agency does not object within 30 days;
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Changes standards for Federal preemption of state laws related to federally chartered institutions and their subsidiaries;
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Provides mortgage reform provisions regarding a customer’s ability to repay, requiring the ability to repay for variable-rate loans to be determined by using the maximum rate that will apply during the first five years of the loan term, and making more loans subject to provisions for higher cost loans, new disclosures, and certain other revisions;
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Creates a Financial Stability Oversight Council that will recommend to the Federal Reserve increasingly strict rules for capital, leverage, liquidity, risk management and other requirements as companies grow in size and complexity;
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Makes permanent the $250 thousand limit for federal deposit insurance and provides unlimited federal deposit insurance through December 31, 2012 for non-interest bearing demand transaction accounts at all insured depository institutions; and
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Repeals the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transactions and other accounts.
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Authorizes de novo interstate branching, subject to non-discriminatory state rules, such as home office protection.
The Dodd-Frank Act contains numerous other provisions affecting financial institutions of all types, many of which may have an impact on our operating environment in substantial and unpredictable ways. Consequently, the Dodd-Frank Act is likely to increase our cost of doing business, it may limit or expand our permissible activities, and it may affect the competitive balance within our industry and market areas. The nature and extent of future legislative and regulatory changes affecting financial institutions, including as a result of the Dodd-Frank Act, is very unpredictable at this time. Our management is actively reviewing the provisions of the Dodd-Frank Act, many of which are phased-in over time, and assessing its probable impact on our business, financial condition, and results of operations. However, the ultimate effect of the Dodd-Frank Act on the financial services industry in general, and us in particular, is uncertain at this time.
Emergency Economic Stabilization Act of 2008
In response to the financial crisis affecting the banking system and financial markets, on October 3, 2008, the Emergency Economic Stabilization Act of 2008 (“EESA”) was signed into law and established the Troubled Asset Relief Program (“TARP”). As part of TARP, the Treasury established the Capital Purchase Program (“CPP”) to provide up to $700 billion of funding to eligible financial institutions through the purchase of capital stock and other financial instruments for the purpose of stabilizing and providing liquidity to the U.S. financial markets. In connection with EESA, there have been numerous actions by the Federal Reserve Board, Congress, the Treasury, the FDIC, the SEC and others to further the economic and banking industry stabilization efforts under EESA. The Company elected not to participate in the CPP.
Temporary Liquidity Guarantee Program
On November 21, 2008, the Board of Directors of the FDIC adopted a final rule relating to the Temporary Liquidity Guarantee Program (“TLG Program”), Under the TLG Program (as amended on March 17, 2009 the FDIC has (i) guaranteed through the earlier of maturity or December 31, 2012, certain newly issued senior unsecured debt issued by participating institutions on or after October 14, 2008, and before October 31, 2009 (the “Debt Guarantee Program”) and (ii) provide full FDIC deposit insurance coverage for non-interest bearing transaction deposit accounts, Negotiable Order of Withdrawal (“NOW”) accounts paying less than or equal to 0.5 percent interest per annum and Interest on Lawyers Trust Accounts (“IOLTAs”) held at participating FDIC- insured institutions through June 30, 2010 (the “TAG Program”). On April 13, 2010, the FDIC announced a second extension of the TAG Program until December 31, 2010. Coverage under the TLG Program was available for the first 30 days without charge. The fee assessment for coverage of senior unsecured debt ranges from 50 basis points to 100 basis points per annum, depending on the initial maturity of the debt. The fee assessment for deposit insurance coverage ranges from 15 to 25 basis points based upon the Bank’s CAMELS rating by the OCC on amounts in covered accounts exceeding $250,000.
We elected to participate in both the Debt Guarantee Program and the TAG Program. We have not issued debt under the Debt Guarantee Program.
The Dodd-Frank Wall Street Reform and Consumer Protection Act included a two-year extension of the TAG Program, though the extension does not apply to all accounts covered under the original program. The extension through December 31, 2012 applies only to non-interest bearing transaction accounts and IOLTAs. Beginning January 1, 2011, NOW accounts will no longer be eligible for the unlimited guarantee. Unlike the original TAG Program, which allowed banks to opt in, the extended program will apply at all FDIC-insured institutions and will no longer be funded by separate premiums. The FDIC will account for the additional TAG insurance coverage in determining the amount of the general assessment it charges under the risk-based assessment system.
Regulation of HVB
The Bank is subject to the supervision of, and to regular examination by, the OCC. Various laws and the regulations thereunder applicable to the Company and the Bank impose restrictions and requirements in many areas, including capital requirements, the maintenance of reserves, establishment of new offices, the making of loans and investments, consumer protection, employment practices, bank acquisitions and entry into new types of business. There are various legal limitations, including Sections 23A and 23B of the Federal Reserve Act, which govern the extent to which a bank subsidiary may finance or otherwise supply funds to its holding company or its holding company’s non-bank subsidiaries. Under federal law, no bank subsidiary may, subject to certain limited exceptions, make loans or extensions of credit to, or investments in the securities of, its parent or the non-bank subsidiaries of its parent (other than direct subsidiaries of such bank which are not financial subsidiaries) or take their securities as collateral for loans to any borrower. The Bank is also subject to collateral security requirements for any loans or extensions of credit permitted by such exceptions.
Dividend Limitations
The Company is a legal entity separate and distinct from its subsidiaries. The Company’s revenues (on a parent company only basis) result in substantial part from dividends paid by the Bank. The Bank’s dividend payments, without prior regulatory approval, are subject to regulatory limitations. Under the National Bank Act, dividends may be declared only if, after payment thereof, capital would be unimpaired and remaining surplus would equal
100 percent of capital. Moreover, a national bank may declare, in any one year, dividends only in an amount aggregating not more than the sum of its net profits for such year and its retained net profits for the preceding two years. In addition, the bank regulatory agencies have the authority to prohibit the Bank from paying dividends or otherwise supplying funds to the Company if the supervising agency determines that such payment would constitute an unsafe or unsound banking practice. Under applicable banking statutes, at December 31, 2010, the Bank could have declared additional dividends of approximately $3.9 million to the Company without prior regulatory approval.
Capital Standards
The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), defines specific capital categories based upon an institution’s capital ratios. The capital categories, in declining order, are: (i) well capitalized; (ii) adequately capitalized; (iii) undercapitalized; (iv) significantly undercapitalized; and (v) critically undercapitalized. Under FDICIA and the FDIC’s prompt corrective action rules, the FDIC may take any one or more of the following actions against an undercapitalized bank: restrict dividends and management fees, restrict asset growth and prohibit new acquisitions, new branches or new lines of business without prior FDIC approval. If a bank is significantly undercapitalized, the FDIC may also require the bank to raise capital, restrict interest rates a bank may pay on deposits, require a reduction in assets, restrict any activities that might cause risk to the bank, require improved management, prohibit the acceptance of deposits from correspondent banks and restrict compensation to any senior executive officer. When a bank becomes critically undercapitalized, (i.e., the ratio of tangible equity to total assets is equal to or less than 2 percent), the FDIC must, within 90 days thereafter, appoint a receiver for the bank or take such action as the FDIC determines would better achieve the purposes of the law. Even where such other action is taken, the FDIC generally must appoint a receiver for a bank if the bank remains critically undercapitalized during the calendar quarter beginning 270 days after the date on which the bank became critically undercapitalized.
The OCC’s standard regulations implementing these provisions of FDICIA provide that an institution will be classified as “well capitalized” if it (i) has a total risk-based capital ratio of at least 10.0 percent, (ii) has a Tier 1 risk-based capital ratio of at least 6.0 percent, (iii) has a Tier 1 leverage ratio of at least 5.0 percent, and (iv) meets certain other requirements. An institution will be classified as “adequately capitalized” if it (i) has a total risk-based capital ratio of at least 8.0 percent, (ii) has a Tier 1 risk-based capital ratio of at least 4.0 percent, (iii) has a Tier 1 leverage ratio of (a) at least 4.0 percent or (b) at least 3.0 percent if the institution was rated 1 in its most recent examination, and (iv) does not meet the definition of “well capitalized.” An institution will be classified as “undercapitalized” if it (i) has a total risk-based capital ratio of less than 8.0 percent, (ii) has a Tier 1 risk-based capital ratio of less than 4.0 percent, or (iii) has a Tier 1 leverage ratio of (a) less than 4.0 percent or (b) less than 3.0 percent if the institution was rated 1 in its most recent examination. An institution will be classified as “significantly undercapitalized” if it (i) has a total risk-based capital ratio of less than 6.0 percent, (ii) has a Tier 1 risk-based capital ratio of less than 3.0 percent, or (iii) has a Tier 1 leverage ratio of less than 3.0 percent. An institution will be classified as “critically undercapitalized” if it has a tangible equity to total assets ratio that is equal to or less than 2.0 percent. An insured depository institution may be deemed to be in a lower capitalization category if it receives an unsatisfactory examination rating. Similar categories apply to bank holding companies.
As a result of the increase in our non-performing loans, the high percentage of commercial real estate loans in our loan portfolio, and the increased potential for further possible deterioration in our loans, as of October 13, 2009 we were required by the OCC to maintain at the Bank, by no later than December 31, 2009, a total risk-based capital ratio of at least 12.0% (compared to 10.0% for a well capitalized bank), a Tier 1 risk-based capital ratio of at least 10.0% (compared to 6.0% for a well capitalized bank), and a Tier 1 leverage ratio of at least 8.0% (compared to 5.0% for a well capitalized bank). In October 2009 we raised approximately $93.3 million through an offering of our common stock and accordingly, at December 31, 2009, the Bank’s total risk-based capital ratio, Tier 1 risk-based capital ratio and Tier 1 leverage ratio were 12.7%, 11.4% and 8.4%, respectively. At December 31, 2010, the Bank’s total risk-based capital ratio, Tier 1 risk-based capital ratio and Tier 1 leverage ratio were 14.0%, 12.8% and 8.8%, respectively.
In addition, significant provisions of FDICIA required federal banking regulators to impose standards in a number of other important areas to assure bank safety and soundness, including internal controls, information
systems and internal audit systems, credit underwriting, asset growth, compensation, loan documentation and interest rate exposure.
See Note 10 to the Consolidated Financial Statements.
Insurance of Deposit Account
The Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund of the Federal Deposit Insurance Corporation (“FDIC”). The Deposit Insurance Fund is the successor to the Bank Insurance Fund and the Savings Association Insurance Fund, which were merged in 2006. Under the FDIC’s risk-based system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and certain other factors with less risky institutions paying lower assessments on their deposits.
On November 12, 2009, the FDIC issued a final rule that required insured depository institutions to prepay, on December 30, 2009, their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012, together with their quarterly risk-based assessment for the third quarter 2009. The Bank paid approximately $13.4 million, in assessments as of December 31, 2009 of which approximately $12.5 million was recorded as a prepaid asset. Prepaid assessments are to be applied against the actual quarterly assessments until exhausted, and may not be applied to any special assessments that may occur in the future. Any unused prepayments will be returned to the Bank on June 30, 2013. The balance of the prepaid FDIC assessment fees at December 31, 2010 was $8.8 million.
In November 2010, as required by the Dodd-Frank Act, the FDIC proposed to revise the assessment base to consist of average consolidated total assets during the assessment period minus the average tangible equity during the assessment period. In addition, the proposed revisions would eliminate the adjustment for secured borrowings and make certain other changes to the impact of unsecured borrowings and brokered deposits on an institution’s deposit insurance assessment. The proposed rule also revises the assessment rate schedule to provide assessments ranging from 5 to 45 basis points. No assurance can be given as to the final form of the proposed regulations or its impact on the Bank.
As previously noted above, the Dodd-Frank Act makes permanent the $250 thousand limit for federal deposit insurance and provides unlimited federal deposit insurance through December 31, 2012 for non-interest bearing demand transaction accounts and IOLTAs at all insured depository institutions.
The FDIC has authority to further increase insurance assessments. A significant increase in insurance premiums may have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what insurance assessment rates will be in the future.
Loans to Related Parties
The Bank’s authority to extend credit to its directors, executive officers and 10 percent stockholders, as well as to entities controlled by such persons, is currently governed by the requirements of the National Bank Act, Sarbanes-Oxley Act and Regulation O of the FRB thereunder. Among other things, these provisions require that extensions of credit to insiders (i) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with other persons not related to the lender and that do not involve more than the normal risk of repayment or present other unfavorable features and (ii) not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of the Bank’s capital. In addition, extensions of credit in excess of certain limits must be approved by the Bank’s Board of Directors. Under the Sarbanes-Oxley Act, the Company and its subsidiaries, other than the Bank, may not extend or arrange for any personal loans to its directors and executive officers.
FIRREA
Under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”), a depository institution insured by the FDIC can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with (i) the default of a commonly controlled FDIC-insured depository institution or (ii) any assistance provided by the FDIC to a commonly controlled FDIC-insured depository institution in danger of default. These provisions have commonly been referred to as FIRREA’s “cross guarantee” provisions. Further, under
FIRREA, the failure to meet capital guidelines could subject a bank to a variety of enforcement remedies available to federal regulatory authorities.
FIRREA also imposes certain independent appraisal requirements upon a bank’s real estate lending activities and further imposes certain loan-to-value restrictions on a bank’s real estate lending activities. The bank regulators have promulgated regulations in these areas.
Community Reinvestment Act and Fair Lending Developments
Under the Community Reinvestment Act (“CRA”), as implemented by Interagency Appraisal and Evaluation guidelines, the Bank has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of our entire community, including low and moderate income neighborhoods. The CRA does not prescribe specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the regulatory agencies, in connection with its examination of a bank, to assess the institution’s record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such institution. FIRREA amended the CRA to require public disclosure of an institution’s CRA rating and require the regulatory agencies to provide a written evaluation of an institution’s CRA performance utilizing a four-tiered descriptive rating system. Institutions are evaluated and rated by the regulatory agencies as “Outstanding”, “Satisfactory”, “Needs to Improve” or “Substantial Non Compliance.” Failure to receive at least a “Satisfactory” rating may inhibit an institution from undertaking certain activities, including acquisitions of other financial institutions, which require regulatory approval based, in part, on CRA Compliance considerations. As of its last CRA examination in March 2010, the Bank received a rating of “Satisfactory.”
USA Patriot Act
The USA Patriot Act of 2001, signed into law on October 26, 2001, enhances the powers of domestic law enforcement organizations and makes numerous other changes aimed at countering the international terrorist threat to the security of the United States. Title III of the legislation most directly affects the financial services industry. It is intended to enhance the federal government’s ability to fight money laundering by monitoring currency transactions and suspicious financial activities. The USA Patriot Act has significant implications for depository institutions and other businesses involved in the transfer of money. Under the USA Patriot Act, a financial institution must establish due diligence policies, procedures and controls reasonably designed to detect and report money laundering through correspondent accounts and private banking accounts. Financial institutions must follow regulations adopted by the Treasury Department to encourage financial institutions, their regulatory authorities, and law enforcement authorities to share information about individuals, entities, and organizations engaged in or suspected of engaging in terrorist acts or money laundering activities. Financial institutions must follow regulations adopted by the Treasury Department setting forth minimum standards regarding customer identification. These regulations require financial institutions to implement reasonable procedures for verifying the identity of any person seeking to open an account, maintain records of the information used to verify the person’s identity, and consult lists of known or suspected terrorists and terrorist organizations provided to the financial institution by government agencies. Every financial institution must establish anti-money laundering programs, including the development of internal policies and procedures, designation of a compliance officer, employee training, and an independent audit function. The passage of the USA Patriot Act has increased our compliance activities, but has not otherwise affected our operations.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley Act”) added new legal requirements for public companies affecting corporate governance, accounting and corporate reporting.
The Sarbanes-Oxley Act provides for, among other things:
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a prohibition on personal loans made or arranged by the issuer to its directors and executive officers (except for loans made by a bank subject to Regulation O);
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independence requirements for audit committee members;
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independence requirements for company auditors;
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certification of financial statements within the Annual Report on Form 10-K and Quarterly Reports on Form 10-Q by the chief executive officer and the chief financial officer;
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the forfeiture by the chief executive officer and the chief financial officer of bonuses or other incentive-based compensation and profits from the sale of an issuer’s securities by such officers in the twelve month period following initial publication of any financial statements that later require restatement due to corporate misconduct;
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disclosure of off-balance sheet transactions;
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two-business day filing requirements for insiders filing on Form 4;
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disclosure of a code of ethics for financial officers and filing a Current Report on Form 8-K for a change in or waiver of such code;
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the reporting of securities violations “up the ladder” by both in-house and outside attorneys;
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restrictions on the use of non-GAAP financial measures in press releases and SEC filings;
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the formation of a public accounting oversight board;
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various increased criminal penalties for violations of securities laws; and
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an assertion by management with respect to the effectiveness of internal control over financial reporting.
Governmental Monetary Policy
Our business and earnings depend in large part on differences in interest rates. One of the most significant factors affecting our earnings is the difference between (1) the interest rates paid by us on our deposits and other borrowings (liabilities) and (2) the interest rates received by us on loans made to our customers and securities held in our investment portfolios (assets). The value of and yield on our assets and the rates paid on our liabilities are sensitive to changes in prevailing market rates of interest. Therefore, our earnings and growth will be influenced by general economic conditions, the monetary and fiscal policies of the federal government, including the Federal Reserve System, whose function is to regulate the national supply of bank credit in order to influence inflation and overall economic growth. Its policies are used in varying combinations to influence overall growth of bank loans, investments and deposits and may also affect interest rates charged on loans, earned on investments or paid for deposits.
In view of changing conditions in the national and local economies, we cannot predict possible future changes in interest rates, deposit levels, loan demand, or availability of investment securities and the resulting effect our business or earnings.
Investment Advisers Act of 1940
A.R. Schmeidler & Co., Inc., is a money manager registered as an investment adviser under the federal Investment Advisers Act of 1940. ARS and its representatives are also registered under the laws of various states regulating investment advisers and their representatives. Regulation under the Investment Advisers Act requires the filing and updating of a Form ADV, filed with the Securities and Exchange Commission. The Investment Advisers Act regulates, among other things, the fees that may be charged to advisory clients, the custody of client funds, relationships with brokers and the maintenance of books and records.
Available Information
We make available free of charge on our website (http://www.hudsonvalleybank.com) our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports, as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission. We provide electronic or paper copies of filings free of charge upon request.
ITEM 1A
ITEM 1A - RISK FACTORS
Risks Related to Our Business
Further increases in our nonperforming loans may occur and adversely affect our results of operations and financial condition.
As a result of the effects of the recent economic downturn, we are facing higher levels of delinquencies in our loans. At December 31, 2010 and 2009, our non-accrual loans totaled $43.7 million and $50.6 million, or 2.5% and 2.8% of the loan portfolio, respectively. At December 31, 2010 and 2009, our nonperforming assets (which include non-accrual loans, accruing loans 90 days or more past due and foreclosed real estate, also called other real estate owned) totaled $56.3 million and $66.7 million, or 2.1% and 2.5% of total assets, respectively. In addition, we had $21.0 million and $32.0 million of accruing loans that were 31-89 days delinquent at December 31, 2010 and 2009, respectively and $7.8 million on non-performing loans held for sale at December 31, 2010.
Until economic and market conditions improve, we expect to continue to incur additional losses relating to an increase in non-performing loans. Our non-performing assets adversely affect our net income in various ways. First, we do not record interest income on non-accrual loans or other real estate owned, thereby adversely affecting our income and increasing our loan administration costs. Second, when we take collateral in foreclosures and similar proceedings, we are required to mark the related loan to the then fair market value of the collateral, which may result in a loss. Third, these loans and other real estate owned also increase our risk profile and the capital our regulators believe is appropriate in light of such risks. Adverse changes in the value of our problem assets, or the underlying collateral, or in these borrowers’ performance or financial conditions, whether or not due to economic and market conditions beyond our control, could adversely affect our business, results of operations and financial condition. In addition, the resolution of nonperforming assets requires significant commitments of time from management and our directors, which can be detrimental to the performance of their other responsibilities. There can be no assurance that we will not experience further increases in nonperforming loans in the future, or that our nonperforming assets will not result in further losses in the future.
A further downturn in the market areas we serve could increase our credit risk associated with our loan portfolio, as it could have a material adverse effect on both the ability of borrowers to repay loans as well as the value of the real property or other property held as collateral for such loans. Further deterioration of our loan portfolio will likely cause a significant increase in nonperforming loans, which would have an adverse impact on our results of operations and financial condition. There can be no assurance that we will not experience further increases in nonperforming loans in the future.
As regulated entities, the Company and the Bank are subject to extensive supervision and prudential regulation, including maintaining certain capital requirements, which may limit their operations and potential growth. Failure to meet any such requirements would subject us to regulatory action.
The Company is supervised by the Federal Reserve and the Bank is supervised by the OCC. As such, each is subject to extensive supervision and prudential regulation, including risk-based and leverage capital requirements. The Company and the Bank must maintain certain risk-based and leverage capital ratios as required by the Federal Reserve or the OCC, respectively, that may change depending upon general economic conditions and the particular condition, risk profile and growth plans of the Company and the Bank.
In today’s economic and regulatory environment, banking regulators, including the OCC, continue to direct greater scrutiny to banks with higher levels of commercial real estate loans like us. As a general matter, such banks, including the Bank, are expected to maintain higher capital levels as well as other measures due to commercial real estate lending growth and exposures. As a result of the higher levels of our non-performing loans, the high percentage of commercial real estate loans in our loan portfolio, and the increased potential for further possible deterioration in our loans, since December 31, 2009 we have been required by the OCC to maintain at the Bank, by no later than December 31, 2009, a total risk-based capital ratio of at least 12.0% (compared to 10.0% for a well capitalized bank), a Tier 1 risk-based capital ratio of at least 10.0% (compared to 6.0% for a well capitalized bank), and a Tier 1 leverage ratio of at least 8.0% (compared to 5.0% for a well capitalized bank). At December 31, 2010, the Bank’s total risk-based capital ratio, Tier 1 risk-based capital ratio and Tier 1 leverage ratio were 14.0%, 12.8% and 8.8%, respectively, and the Company’s total risk-based capital ratio, Tier 1 risk-based capital ratio and Tier 1 leverage ratio were 15.2%, 13.9% and 9.6%, respectively.
If we do not maintain these higher capital levels we may be subject to enforcement actions. More generally, compliance with capital requirements may limit loan growth or other operations that require the use of capital and could adversely affect our ability to expand or maintain present business levels.
If we fail to meet any regulatory capital requirement or are otherwise deemed to be operating in an unsafe and unsound manner or in violation of law, we may be subject to a variety of informal or formal remedial measures and enforcement actions. Such informal remedial measures and enforcement actions may include a memorandum of understanding which is initiated by the regulator and outlines an institution’s agreement to take specified actions within specified time periods to correct violations of law or unsafe and unsound practices. In addition, as part of our regular examination process, regulators may advise us to operate under various restrictions as a prudential matter. Any of these restrictions, in whatever manner imposed, could have a material adverse effect on our business and results of operations.
In addition to informal remedial actions, we may also be subject to formal enforcement actions. Failure to comply with an informal enforcement action could cause us to be subject to formal enforcement actions. Formal enforcement actions include written agreements, cease and desist orders, the imposition of substantial fines and other civil penalties and, in the most severe cases, the termination of deposit insurance or the appointment of a conservator or receiver for our bank subsidiary. Furthermore, if the Bank fails to meet any regulatory capital requirement, it will be subject to the prompt corrective action framework of the Federal Deposit Insurance Corporation Improvements Act of 1991, which imposes progressively more restrictive constraints on operations, management and capital distributions as the capital category of an institution declines, up to and including, ultimately, the appointment of a conservator or receiver. A failure to meet regulatory capital requirements could also subject us to capital raising requirements. Additional capital raisings would be dilutive to holders of our common stock. See “Risk Factors - Risks Relating to Our Common Stock” for more information.
Any remedial measure or enforcement action, whether formal or informal, could impose restrictions on our ability to operate our business and adversely affect our prospects, financial condition or results of operations. In addition, any formal enforcement action could harm our reputation and our ability to retain and attract customers and impact the trading price of our common stock.
Further increases to the allowance for loan losses may cause our earnings to decrease.
In determining our loan loss reserves for each quarter, we make various assumptions and judgments about the future performance of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of loans. In determining the amount of the allowance for loan losses, we rely on loan quality reviews, past experience, and an evaluation of economic conditions, among other factors. If our assumptions prove to be incorrect, our allowance for credit losses may not be sufficient to cover losses inherent in our loan portfolio, resulting in additions to the allowance and a corresponding decrease in income. In addition, bank regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or loan charge-offs. Any increase in our allowance for loan losses or loan charge-offs as required by these regulatory authorities or otherwise could have a material adverse effect on our results of operations or financial condition.
Our concentration of commercial real estate loans has resulted in increased loan losses and could result in further increases in future periods.
Commercial real estate is cyclical and poses risks of loss to us due to concentration levels and similar risks of the asset. Of our loan portfolio, 46.0% was concentrated in commercial real estate loans as of December 31, 2010 and 43.1% as of December 31, 2009. As discussed above, banking regulators direct greater scrutiny to banks with higher levels of commercial real estate loans. Due to the high percentage of commercial real estate loans in our loan portfolio, we are among the banks subject to greater regulatory scrutiny of their activities.
We have significant exposure to commercial real estate in our loan portfolio and have substantially increased our provision for loan losses primarily because of an increase in expected losses relating to adverse economic conditions, particularly in the real estate market in our primary lending areas. During 2010, we added $46.5 million in provision for loan losses compared to $24.3 million in 2009 and $11.0 million in 2008, in part reflecting collateral evaluations in response to recent changes in the market values of real estate development loans. We may be required to add additional provision for loan loss in 2011.
Given our high concentration in commercial real estate and the greater scrutiny directed to this asset class by banking regulators, our regulators may impose specific concentration limits on our lending activity in this area in the future. Such limitations may restrict our business opportunities and adversely affect our operating results. In addition, further deterioration in our loan portfolio, including further declines in the market values of real estate supporting certain commercial real estate loans, would result in further provisions for loan losses in future periods, which would have a material adverse affect on our business and results of operations.
Declines in value may adversely impact the carrying amount of our investment portfolio and result in other-than-temporary impairment charges.
As of December 31, 2010, we owned pooled trust preferred debt securities with an aggregate book value of $11.6 million and an unrealized loss of approximately $8.0 million. As a result of recent adverse economic banking conditions, we incurred pretax impairment charges to earnings on these securities of approximately $2.6 million in 2010, $5.5 million in 2009 and $1.1 million during 2008. We may be required to record additional impairment charges on these pooled trust preferred debt securities or other of our investment securities if they suffer a decline in value that is considered other-than-temporary. Numerous factors, including lack of liquidity for resales of certain investment securities, absence of reliable pricing information for investment securities, adverse changes in business climate or adverse actions by regulators could have a negative impact on the valuation of our investment portfolio in future periods. If an impairment charge is significant enough, it could affect the ability of the Bank to upstream dividends to us, which could have a material adverse effect on our liquidity and our ability to pay dividends to stockholders, and could also negatively impact our regulatory capital ratios and result in us not being classified as “well capitalized” for regulatory purposes.
A prolonged or worsened downturn in the economy in general and the real estate market in our key market areas in particular would adversely affect our loan portfolio and our growth potential.
Our primary lending market area is Westchester County, New York and New York City and to an increasing extent, Rockland County, New York and Fairfield County and New Haven County, Connecticut, with a primary focus on businesses, professionals and not-for-profit organizations located in this area. Accordingly, the asset quality of our loan portfolio largely depends upon the area’s economy and real estate markets. The Bank’s primary lending market area and asset quality have been adversely affected by the current economic downturn. A prolonged or worsened downturn in the economy in our primary lending area would adversely affect our asset quality, operations and limit our future growth potential.
In particular, a downturn in our local real estate market could negatively affect our business because a significant portion (approximately 88% as of December 31, 2010) of our loans are secured, either on a primary or secondary basis, by real estate. Our ability to recover on defaulted loans by selling the real estate collateral would then be diminished and we would be more likely to suffer losses on defaulted loans. The Bank’s loans have already been adversely affected by the current decline in the real estate market. Continuation or worsening of such conditions could have additional negative effects on our business in the future.
A downturn in the real estate market could also result in lower customer demand for real estate loans. This could in turn result in decreased profits as our alternative investments, such as securities, generally yield less than real estate loans.
Difficult market conditions have adversely affected our industry.
Substantial declines in the real estate markets over the past two years, with falling prices and increasing foreclosures, unemployment and under-employment, have negatively impacted the credit performance of real estate related loans and resulted in significant write-downs of asset values by financial institutions. These write-downs have caused many financial institutions to seek additional capital, to reduce or eliminate dividends, to merge with larger and stronger institutions and, in some cases, to fail. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced or ceased providing funding to borrowers, including to other financial institutions. This market turmoil and tightening of credit have led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and widespread reduction of business activity generally. A worsening of these conditions
would likely exacerbate the adverse effects of these difficult market conditions on us and others in the financial institutions industry.
As a result of the foregoing, there is a potential for new laws and regulations regarding lending and funding practices and liquidity and capital standards, and financial institution regulatory agencies are now expected to be very aggressive in responding to concerns and trends identified in examinations, including the more frequent issuance of informal remedial measures and formal enforcement orders. These negative developments in the financial services industry and the impact of new legislation in response to those developments could negatively impact our operations by restricting our business operations, including our ability to originate loans and work with borrowers to collect loans, and adversely impact our financial performance.
Higher FDIC deposit insurance premiums and assessments could adversely affect our financial condition.
FDIC insurance premiums increased substantially in 2009 and we may have to pay significantly higher FDIC premiums in the future. Market developments have significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured deposits. The FDIC adopted a revised risk-based deposit insurance assessment schedule on February 27, 2009, which raised regular deposit insurance premiums. On May 22, 2009, the FDIC also implemented a five basis point special assessment of each insured depository institution’s total assets minus Tier 1 capital as of June 30, 2009, but no more than 10 basis points times the institution’s assessment base for the second quarter of 2009, collected by the FDIC on September 30, 2009. The amount of this special assessment for HVB and NYNB was $1.2 million. Additional special assessments may be imposed by the FDIC for future quarters at the same or higher levels.
In addition, the FDIC adopted a rule that required insured depository institutions, including our Bank subsidiaries, to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012. The prepaid assessments were collected on December 30, 2009. The total prepaid assessments for HVB and NYNB was $12.5 million, which was recorded as a prepaid expense (asset) as of December 30, 2009. As of December 31, 2009 and each quarter thereafter, HVB (for itself and as successor to NYNB) would record an expense for its regular quarterly assessment for the quarter and an offsetting credit to the prepaid assessment until the asset is exhausted.
The Dodd-Frank Act made the FDIC’s TAG Program mandatory for all FDIC-insured banks. This additional insurance coverage will be accounted for by likely increases in general assessment charges under its risk-based assessment system. These changes, along with the use of all of our remaining FDIC insurance assessment credits in early 2009, may cause the premiums charged by the FDIC to increase. These actions could significantly increase our noninterest expense in 2011 and in future periods.
A substantial decline in the value of our Federal Home Loan Bank of New York common stock may adversely affect our financial condition.
We own common stock of the Federal Home Loan Bank of New York (“FHLB”), in order to qualify for membership in the Federal Home Loan Bank system, which enables us to borrow funds under the Federal Home Loan Bank advance program. The amount of FHLB common stock we own fluctuates in relation to the amount of our borrowing from the FHLB. As of December 31, 2010 the carrying value of our FHLB common stock was $7.0 million. In an extreme situation, it is possible that the capitalization of a Federal Home Loan Bank, including the FHLB, could be substantially diminished or reduced to zero. If this occurs, it may adversely affect our results of operations and financial condition.
Certain of our goodwill and intangible assets may become impaired in the future.
We test our goodwill and intangible assets for impairment on a periodic basis. It is possible that future impairment testing could result in a value of our goodwill and intangibles which may be less than the carrying value and, as a result, may adversely affect our financial condition and results of operations. If we determine that impairment exists at a given time, our earnings and the book value of the related goodwill and intangibles will be reduced by the amount of the impairment.
The opening of new branches could reduce our profitability.
We have expanded our branch network by opening new branches. We intend to continue our branch expansion strategy by opening new branches, which requires us to incur a number of up-front expenses associated with the leasing and build-out of the space to be occupied by the branch, the staffing of the branch and similar matters. These expenses are typically greater than the income generated by the branch until it builds up its customer base, which, depending on the branch, could take 18 months or more. In opening branches in a new locality, we may also encounter problems in adjusting to local market conditions, such as the inability to gain meaningful market share and the stronger than expected competition. Numerous factors contribute to the performance of a new branch, such as a suitable location, qualified personnel, and an effective marketing strategy.
Our income is sensitive to changes in interest rates.
Our profitability, like that of most banking institutions, depends to a large extent upon our net interest income. Net interest income is the difference between interest income received on interest-earning assets, including loans and securities, and the interest paid on interest-bearing liabilities, including deposits and borrowings. Accordingly, our results of operations and financial condition depend largely on movements in market interest rates and our ability to manage our assets and liabilities in response to such movements. Management estimates that, as of December 31, 2010, a 200 basis point increase in interest rates would result in a 1.3% increase in net interest income and a 100 basis point decrease would result in a 1.6% decrease in net interest income.
In addition, changes in interest rates may result in an increase in higher cost deposit products within our existing portfolios, as well as a flow of funds away from bank accounts into direct investments (such as U.S. Government and corporate securities and other investment instruments such as mutual funds) to the extent that we may not pay rates of interest competitive with these alternative investments.
We may need to raise additional capital in the future and such capital may not be available when needed or at all.
We may need to raise additional capital in the future to provide us with sufficient capital resources and liquidity to meet our commitments and business needs. Our ability to raise additional capital, if needed, will depend on, among other things, conditions in the capital markets at that time, which are outside of our control, and our financial performance. We cannot assure you that such capital will be available to us on acceptable terms or at all. Our inability to raise sufficient additional capital on acceptable terms when needed could adversely affect our businesses, financial condition and results of operations.
Our markets are intensely competitive, and our principal competitors are larger than us.
We face significant competition both in making loans and in attracting deposits. This competition is based on, among other things, interest rates and other credit and service charges, the quality of services rendered, the convenience of the banking facilities, the range and type of products offered and the relative lending limits in the case of loans to larger commercial borrowers. Our market area has a very high density of financial institutions, many of which are branches of institutions that are significantly larger than we are and have greater financial resources and higher lending limits than we do. Many of these institutions offer services that we do not or cannot provide. Nearly all such institutions compete with us to varying degrees.
Our competition for loans comes principally from commercial banks, savings banks, savings and loan associations, credit unions, mortgage banking companies, insurance companies and other financial service companies. Our most direct competition for deposits has historically come from commercial banks, savings banks, savings and loan associations, and money market funds and other securities funds offered by brokerage firms and other similar financial institutions. We face additional competition for deposits from non-depository competitors such as the mutual fund industry, securities and brokerage firms, and insurance companies. Competition may increase in the future as a result of recently proposed regulatory changes in the financial services industry.
Impact of inflation and changing prices
The consolidated financial statements and notes thereto incorporated by reference herein have been prepared in accordance with GAAP, which requires the measurement of financial position and operating results in terms of historical dollar amounts or estimated fair value without considering the changes in the relative purchasing power of
money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, nearly all of our assets and liabilities are monetary in nature. As a result, interest rates have a greater impact on our performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods and services.
Extensive Regulation and Supervision.
The Company, primarily through its principal subsidiary and certain non-bank subsidiaries, is subject to extensive federal and state regulation and supervision. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds and the banking system as a whole. Such laws are not designed to protect the Company’s stockholders. These regulations affect the Company’s lending practices, capital structure, investment practices, dividend policy and growth, among other things. The Company is also subject to a number of Federal laws, which, among other things, require it to lend to various sectors of the economy and population, and establish and maintain comprehensive programs relating to anti-money laundering and customer identification. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on the Company’s business, financial condition and results of operations. The Company’s compliance with certain of these laws will be considered by banking regulators when reviewing bank merger and bank holding company acquisitions.
The Dodd-Frank Wall Street Reform and Consumer Protection Act May Affect Our Business Activities, Financial Position and Profitability By Increasing Our Regulatory Compliance Burden and Associated Costs, Placing Restrictions on Certain Products and Services, and Limiting Our Future Capital Raising Strategies.
On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law by the President of the United States. The Dodd-Frank Act implements significant changes in financial regulation and will impact all financial institutions, including the Company and the Bank. Among the Dodd-Frank Act’s significant regulatory changes, it creates a new financial consumer protection agency, known as the Bureau of Consumer Financial Protection (the “Bureau”), that is empowered to promulgate new consumer protection regulations and revise existing regulations in many areas of consumer protection. The Bureau has exclusive authority to issue regulations, orders and guidance to administer and implement the objectives of federal consumer protection laws. The Bureau will also have the ability to participate, with the OCC, in our consumer compliance examinations. Moreover, the Dodd-Frank Act permits states to adopt stricter consumer protection laws and authorizes state attorney generals’ to enforce consumer protection rules issued by the Bureau. The Dodd-Frank Act also restricts the authority of the Comptroller of the Currency to preempt state consumer protection laws applicable to national banks, such as the Bank, and may affect the preemption of state laws as they affect subsidiaries and agents of national banks, changes the scope of federal deposit insurance coverage, and potentially increases the FDIC assessment payable by the Bank. We expect that the Bureau and certain other provisions in the Dodd-Frank Act will significantly increase our regulatory compliance burden and costs and may restrict the financial products and services we offer to our customers.
Because many of the Dodd-Frank Act’s provisions require regulatory rulemaking, we are uncertain as to the impact that some of the provisions of the Dodd-Frank Act will have on the Company and the Bank and cannot provide assurance that the Dodd-Frank Act will not adversely affect our financial condition and results of operations for other reasons.
Technological change may affect our ability to compete.
The banking industry continues to undergo rapid technological changes, with frequent introductions of new technology-driven products and services. In addition to improving customer services, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend, in part, on our ability to address the needs of customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. There can be no assurance that we will be able to effectively implement new technology-driven products and services or be successful in marketing such products and services to the public.
In addition, because of the demand for technology-driven products, banks are increasingly contracting with outside vendors to provide data processing and core banking functions. The use of technology-related products, services, delivery channels and processes exposes a bank to various risks, particularly transaction, strategic, reputation and compliance risks. There can be no assurance that we will be able to successfully manage the risks associated with our increased dependency on technology.
Changes in Accounting Policies or Accounting Standards.
The Company’s accounting policies are fundamental to understanding its financial results and condition. Some of these policies require use of estimates and assumptions that may affect the value of the Company’s assets or liabilities and financial results. The Company identified its accounting policies regarding the allowance for loan losses, security valuations, goodwill and other intangible assets, and income taxes to be critical because they require management to make difficult, subjective and complex judgments about matters that are inherently uncertain. Under each of these policies, it is possible that materially different amounts would be reported under different conditions, using different assumptions, or as new information becomes available.
From time to time the Financial Accounting Standards Board (“FASB”) and the Securities and Exchange Commission (“SEC”) change their guidance governing the form and content of the Company’s external financial statements. In addition, accounting standard setters and those who interpret U.S. generally accepted accounting principles (“GAAP”), such as the FASB, SEC, banking regulators and the Company’s outside auditors, may change or even reverse their previous interpretations or positions on how these standards should be applied. Such changes are expected to continue, and may accelerate as the FASB and International Accounting Standards Board have reaffirmed their commitment to achieving convergence between U.S. GAAP and International Financial Reporting Standards. Changes in U.S. GAAP and changes in current interpretations are beyond the Company’s control, can be hard to predict and could materially impact how the Company reports its financial results and condition. In certain cases, the Company could be required to apply a new or revised guidance retroactively or apply existing guidance differently (also retroactively) which may result in the Company restating prior period financial statements for material amounts. Additionally, significant changes to U.S. GAAP may require costly technology changes, additional training and personnel, and other expenses that will negatively impact our results of operations.
We may incur liabilities under federal and state environmental laws with respect to foreclosed properties.
Approximately 88% of the loans held by the Company as of December 31, 2010 were secured, either on a primary or secondary basis, by real estate. Approximately half of these loans were commercial real estate loans, with most of the remainder being for single or multi-family residences. We currently own seven properties acquired in foreclosure, totaling $11.0 million. Under federal and state environmental laws, we could face liability for some or all of the costs of removing hazardous substances, contaminants or pollutants from properties we acquire on foreclosure. While other persons might be primarily liable, such persons might not be financially solvent or able to bear the full cost of the clean-up. It is also possible that a lender that has not foreclosed on property but has exercised unusual influence over the borrower’s activities may be required to bear a portion of the clean-up costs under federal or state environmental laws.
We Are Subject to Environmental Liability Risk Associated With Lending Activities.
A significant portion of our loan portfolio is secured by real property. During the ordinary course of business, we may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require us to incur substantial expenses and may materially reduce the affected property’s value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. Although we have policies and procedures to perform an environmental review prior to originating certain commercial real estate loans, as well as before initiating any foreclosure action on real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on our financial condition and results of operations.
Risks Relating to Our Common Stock
Market conditions and other factors may affect the value of our common stock.
The trading price of the shares of our common stock will depend on many factors, which may change from time to time, including:
•
conditions in the credit, mortgage and housing markets, the markets for securities relating to mortgages or housing, and developments with respect to financial institutions generally;
•
interest rates;
•
the market for similar securities;
•
government action or regulation;
•
general economic conditions or conditions in the financial markets;
•
our past and future dividend practice; and
•
our financial condition, performance, creditworthiness and prospects.
Accordingly, the shares of common stock that an investor purchases may trade at a price lower than that at which they were purchased.
There may be future dilution of our common stock.
The Company is currently authorized to issue up to 25 million shares of common stock, of which 17,665,908 shares were outstanding as of December 31, 2010, and up to 15 million shares of preferred stock, of which no shares are outstanding. The Company’s certificate of incorporation authorizes the Board of Directors to, among other things, issue additional shares of common or preferred stock, or securities convertible or exchangeable into common or preferred stock, without stockholder approval. We may issue such additional equity or convertible securities to raise additional capital in connection with acquisitions, as part of our employee and director compensation or otherwise. The issuance of any additional shares of common or preferred stock or convertible securities could substantially dilute holders of our common stock. Moreover, to the extent that we issue restricted stock, stock options, or warrants to purchase our common stock in the future and those stock options or warrants are exercised or the restricted stock vests, our stockholders may experience further dilution. Holders of our shares of common stock have no preemptive rights that entitle them to purchase their pro rata share of any offering of shares of any class or series and, therefore, such sales or offerings could result in increased dilution to our stockholders.
We may further reduce or eliminate the cash dividend on our common stock.
We reduced our total per share dividend in 2010 to $0.65 per share. Holders of our common stock are only entitled to receive such cash dividends as our Board of Directors may declare out of funds legally available for such payments. Although we have historically declared cash dividends on our common stock, we are not required to do so and may further reduce or eliminate our common stock cash dividend in the future. This could adversely affect the market price of our common stock. Also, as a bank holding company, the Company’s ability to declare and pay dividends depends on certain federal regulatory considerations, including the guidelines of the Federal Reserve regarding capital adequacy and dividends.
Government regulation restricts our ability to pay cash dividends.
Dividends from the Bank are the only current significant source of cash for the Company. There are various statutory and regulatory limitations regarding the extent to which the Bank can pay dividends or otherwise transfer funds to the Company. Federal bank regulatory agencies also have the authority to limit further the Bank’s payment of dividends based on such factors as the maintenance of adequate capital for the Bank, which could reduce the amount of dividends otherwise payable. We paid a cash dividend to our stockholders of $0.65 per share in 2010 and $1.15 per share in 2009 (adjusted for subsequent stock dividends). We currently expect to pay substantially reduced per share dividends in 2011. Under applicable banking statutes, at December 31, 2010, the Bank could have declared dividends of approximately $3.9 million to the Company without prior regulatory approval. No assurance can be given that the Bank will have the profitability necessary to permit the payment of dividends in the future; therefore, no assurance can be given that the Company would have any funds available to pay dividends to stockholders.
Federal bank regulators require us to maintain certain levels of regulatory capital. The failure to maintain these capital levels or to comply with applicable laws, regulations and supervisory agreements could subject us to a variety of informal and formal enforcement actions. Moreover, dividends can be restricted by any of our regulatory authorities if the agency believes that our financial condition warrants such a restriction.
The Company’s ability to declare and pay dividends is restricted under the New York Business Corporation Law, which provides that dividends may only be paid by a corporation out of its surplus.
The Federal Reserve issued a supervisory letter dated February 24, 2009 to bank holding companies that contains guidance on when the board of directors of a bank holding company should eliminate, defer or severely limit dividends including, for example, when net income available for stockholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends. The letter also contains guidance on the redemption of stock by bank holding companies which urges bank holding companies to advise the Federal Reserve of any such redemption or repurchase of common stock for cash or other value which results in the net reduction of a bank holding company’s capital during the quarter.
In the event of a liquidation or reorganization of the Bank, the ability of holders of debt and equity securities of the Company to benefit from the distribution of assets from the Bank upon any such liquidation or reorganization would be subordinate to prior claims of creditors of the Bank (including depositors), except to the extent that the Company’s claim as a creditor may be recognized. The Company is not currently a creditor of the Bank.
Our common stock price may fluctuate due to the potential sale of stock by our existing stockholders.
We are aware that several of our large stockholders may in the future liquidate some or all of their shares of Company common stock for estate planning and other reasons. In addition, other stockholders may sell their shares of common stock from time to time on the NASDAQ Global Select Market or otherwise. As a result, substantial amounts of our common stock are eligible for future sale. While we cannot predict either the magnitude or the timing of such sales, if a large number of common shares are sold during a short time frame, it may have the effect of reducing the market price of our common stock.
Our earnings may be subject to increased volatility.
Our earnings may experience volatility as a result of several factors. These factors include, among others:
•
a continuation of the current economic downturn, or further adverse economic developments;
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instability in the financial markets;
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our inability to generate or maintain creditworthy customer relationships in our primary markets;
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unexpected increases in operating costs, including special assessments for FDIC insurance;
•
further credit deterioration in our loan portfolio or unanticipated credit deterioration, or defaults by our loan customers;
•
credit deterioration or defaults by issuers of securities within our investment portfolio; or
•
a decrease in our common stock price below its book value potentially impacting the valuation of our goodwill.
If any one or more of these events occur, we may experience significant declines in our net interest margin and non-interest income, or we may be required to record substantial charges to our earnings, including increases in the provision for loan losses, credit-related impairment on securities (both permanent and other-than-temporary), and impairment on goodwill and other intangible assets, in future periods.
Our certificate of incorporation, the New York Business Corporation Law and federal banking laws and regulations may prevent a takeover of our company.
Provisions of the Company’s certificate of incorporation, the New York Business Corporation Law and federal banking laws and regulations, including regulatory approval requirements, could make it more difficult for a third party to acquire us, even if doing so would be perceived to be beneficial to our stockholders. The combination of these provisions may inhibit a non-negotiated merger or other business combination, which, in turn, could adversely affect the market price of our common stock.
ITEM 1B
ITEM 1B - UNRESOLVED STAFF COMMENTS
None.
ITEM 2
ITEM 2 - PROPERTIES
Our principal executive offices, including administrative and operating departments, are located at 21 Scarsdale Road, Yonkers, New York, in premises we own. HVB’s main branch is located at 1055 Summer Street, Stamford, Connecticut, in premises we lease.
HVB operates 36 branches. HVB owns the following branch locations :
HVB leases the following branch locations:
Of the above leased properties, 4 properties located in Bronx, White Plains, New Rochelle and New York, New York, have lease terms that expire within the next 2 years. We currently expect to renew the leases of each of these properties.
A. R. Schmeidler & Co., Inc is located at 500 Fifth Avenue, New York, New York in leased premises.
We currently operate 27 ATM machines, 24 of which are located in the Banks’ facilities. Three ATMs are located at off-site locations: St. Joseph’s Hospital, Yonkers, College of Mount Saint Vincent, Riverdale, New York, and Concordia College, Bronxville, New York.
In our opinion, the premises, fixtures and equipment are adequate and suitable for the conduct of our business. All facilities are well maintained and provide adequate parking.
ITEM 3
ITEM 3 - LEGAL PROCEEDINGS
Various claims and lawsuits are pending against the Company and its subsidiaries in the ordinary course of business. In the opinion of management, resolution of each matter is not expected to have a material effect on the financial condition or results of operations of the Company and its subsidiaries.
ITEM 4
ITEM 4 - (REMOVED AND RESERVED)
PART II
ITEM 5
ITEM 5 - MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock was held of record as of March 1, 2011 by approximately 894 registered shareholders. Our common stock trades on the NASDAQ Global Select Market under the symbol “HUVL”. Trading in this market is limited. Prior to our listing on the NASDAQ Global Select Market on September 21, 2009, our common stock traded sporadically on the OTC Bulletin Board. We historically created a secondary market for our stock by issuing offers to repurchase shares from any stockholder based on the appraised value of the Company. However we have discontinued this program.
The table below sets forth the price range of our common stock since being listed on the NASDAQ Global Select Market on September 21, 2009. Prices have been adjusted to reflect the 10% stock dividend to shareholders in December 2010.
(1) Prior to the fourth quarter of 2009, there was no established public trading market for the Company’s common stock.
In 1998, the Board of Directors of the Company adopted a policy of paying quarterly cash dividends to holders of its common stock. Quarterly cash dividends were paid as follows: In 2010, $0.21 per share to shareholders of record on February 11 and May 10, $0.09 per share to shareholders of record on August 9 and $0.14 per share to shareholders of record on November 8. In 2009, $0.38 per share to shareholders of record on February 13, $0.33 per share to shareholders of record on May 22, $0.25 per share to shareholders of record on August 21 and $0.19 per share to shareholders of record on November 13. Dividends per share have been adjusted to reflect the 10 percent stock dividends to shareholders in December 2010 and 2009.
Stock dividends of 10 percent each (one share for every 10 outstanding shares) were declared by the Company for shareholders of record on November 29, 2010 and December 7, 2009.
Any funds which the Company may require in the future to pay cash dividends, as well as various Company expenses, are expected to be obtained by the Company chiefly in the form of cash dividends from HVB and secondarily from sales of common stock pursuant to the Company’s stock option plan. The ability of the Company to declare and pay dividends in the future will depend not only upon its future earnings and financial condition, but also upon the future earnings and financial condition of the Bank and its ability to transfer funds to the Company in the form of cash dividends and otherwise. See further discussion in “Supervision and Regulation” under Item 1 of this Annual Report on Form 10-K. The Company is a separate and distinct legal entity from HVB. The Company’s right to participate in any distribution of the assets or earnings of HVB is subordinate to prior claims of creditors of HVB.
The Company sold 3,993,395 shares of common stock at an issue price of $25.00 per share in an underwritten common stock offering during the fourth quarter of 2009. Net proceeds from the offering were $93.3 million. In conjunction with this common stock offering, the Company listed its common stock on the NASDAQ Global Select Market under the symbol “HUVL”. Concurrent with listing its common stock on the NASDAQ, the Company lifted all restrictions on transferability of its common stock that previously applied to certain shareholders and a majority of the shares outstanding. A total of $59.0 million of the net proceeds from this offering was contributed to HVB and NYNB during 2010 and 2009 increasing the Banks’ capital ratios, as required of the Banks’ by the OCC, to levels in excess of “well capitalized” levels generally applicable to banks under current regulations. See further discussion in
“Supervision and Regulation” under Item 1 of this Annual Report on Form 10-K. The remaining net proceeds of this offering are available for general corporate purposes. There were no sales of common stock by the Company during the fourth quarter of 2010.
There were no purchases made by the Company of its common stock during the year ended December 31, 2010.
Stockholder Return Performance Graph
The following graph compares the Company’s total stockholder return for the years 2006, 2007, 2008, 2009 and 2010 based on prices as reported on the over-the-counter bulletin board and as reported on the NASDAQ Global Select Market effective with the Company’s listing in September 2009, with (1) the Russell 2000 and (2) the SNL $1 billion to $5 billion Bank Index.
Total Return Performance
The graph assumes $100 was invested on December 31, 2005 and dividends were reinvested. Returns are market capitalization weighted.
ITEM 6
ITEM 6 - SELECTED FINANCIAL DATA
The following table sets forth selected historical consolidated financial data for the years ended and as of the dates indicated. The selected historical consolidated financial data as of December 31, 2010 and 2009, and for the years ended December 31, 2010, 2009 and 2008, are derived from our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The selected historical consolidated financial data as of December 31, 2008, 2007 and 2006 and for the years ended December 31, 2007 and 2006 are derived from our consolidated financial statements that are not included in this Annual Report on Form 10-K. Share and per share data have been restated to reflect the effects of 10 percent stock dividends issued in 2010, 2009, 2008 and 2007. The information set forth below should be read in conjunction with the consolidated financial statements and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this Annual Report on Form 10-K.
Financial Ratios
Significant ratios of the Company for the periods indicated are as follows:
(1)
Adjusted average stockholders’ equity excludes unrealized gains, net of tax, of $3,078 and $981 in 2010 and 2009, respectively and unrealized losses, net of tax, of $2,955, $4,521 and $7,846 in 2008, 2007 and 2006, respectively. Management believes this alternate presentation more closely reflects actual performance, as it is more consistent with the Company’s stated asset/liability management strategies, which have not resulted in significant realization of temporary market gains or losses on securities available for sale which were primarily related to changes in interest rates. As noted in the Company’s 2011 Proxy Statement, which is incorporated herein by reference, net income as a percentage of adjusted average stockholders’ equity is one of several factors utilized by management to determine total compensation.
ITEM 7
ITEM 7 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This section presents discussion and analysis of the Company’s consolidated financial condition at December 31, 2010 and 2009, and consolidated results of operations for each of the three years in the period ended December 31, 2010. The Company is consolidated with its wholly-owned subsidiaries Hudson Valley Bank, N.A. and its subsidiaries (collectively “HVB” or “the Bank”) and HVHC Risk Management Corp. This discussion and analysis should be read in conjunction with the financial statements and supplementary financial information contained elsewhere in this Annual Report on Form 10-K.
Overview of Management’s Discussion and Analysis
This overview is intended to highlight selected information included in this Annual Report on Form 10-K. It does not contain sufficient information for a complete understanding of the Company’s financial condition and operating results and, therefore, should be read in conjunction with this entire Annual Report on Form 10-K.
The Company derives substantially all of its revenue from providing banking and related services to businesses, professionals, municipalities, not-for profit organizations and individuals within its market area, primarily Westchester County and Rockland County, New York, portions of New York City and Fairfield County and New Haven County, Connecticut. The Company’s assets consist primarily of loans and investment securities, which are funded by deposits, borrowings and capital. The primary source of revenue is net interest income, the difference between interest income on loans and investments, and interest expense on deposits and borrowed funds. The Company’s basic strategy is to grow net interest income and non interest income by the retention of its existing customer base and the expansion of its core businesses and branch offices within its current market and surrounding areas. Considering current economic conditions, the Company’s primary market risk exposures are interest rate risk, the risk of deterioration of market values of collateral supporting the Company’s loan portfolio, particularly commercial and residential real estate and potential risks associated with the impact of regulatory changes that may take place in reaction to current conditions in the financial system. Interest rate risk is the exposure of net interest income to changes in interest rates. Commercial and residential real estate are the primary collateral for the majority of Company’s loans.
The wide ranging economic downturn, which began in 2008 and continued throughout 2009 and 2010, has had extremely negative effects on all financial sectors both domestic and foreign. Perhaps the most severe impact of this downturn has been felt by the real estate industry, which is a major source of both the deposit and loan businesses of the Company. Although recent indications suggest that the economic decline has begun to turn around, the Company expects this recovery to be slow and expects to continue to experience some negative pressure from these adverse conditions into the first quarter of 2011 and beyond.
Net income for 2010 was $5.1 million or $0.29 per diluted share, a decrease of $13.9 million or 73.2 percent compared to $19.0 million or $1.37 per diluted share in 2009. The overall decline in earnings in 2010, compared to 2009, resulted primarily from significant increases in the provision for loan losses which totaled $46.5 million for the year ended December 31, 2010, compared to $24.3 million for the prior year period. Earnings were also adversely affected by real estate owned valuation provisions of $1.4 million and $0.6 million, respectively, in the second and third quarters of 2010. These provisions are reflective of continued weakness in the overall economy which has resulted in the Company’s decision to follow a more aggressive strategy for problem asset resolution further discussed below.
Total loans decreased $84.2 million during the year ended December 31, 2010. This decline resulted from a number of factors including decreased loan demand, charge-offs, pay downs of existing loans and the transfer of $21.9 million of nonperforming loans to the loans held-for-sale category. The Company recognized $46.2 million of net charge-offs during 2010. Despite the weakness in loan demand, and the continuation of pressure on overall asset quality caused by the ongoing effects of the economic downturn, the Company continues to provide lending availability to both new and existing customers.
Overall asset quality continued to be adversely affected by the current state of the economy and the real estate market. Nonperforming assets, which include nonaccrual loans, accruing loans delinquent over 90 days and other
real estate owned, decreased to $56.3 million at December 31, 2010, compared to $66.7 million at December 31, 2009. The decrease included the transfer of $21.9 million of nonperforming loans to the loans held-for-sale category. The Company has continued to experience a slowdown in payments of certain loans, such as construction loans, whose repayment is often dependent on sales of completed properties, as well as increases in delinquent and nonperforming loans in other sectors of the loan portfolio, all of which have been adversely impacted by the economic downturn and decline in the real estate market. These conditions have resulted in severe declines in the demand for and values of virtually all commercial and residential real estate properties. These declines, together with the limited availability of residential mortgage financing, resulted in continued downward pressure on the overall asset quality of the Company’s loan portfolio during 2010. In addition, recent significant increases in filings of bankruptcy and foreclosure proceedings have overloaded the court systems and have resulted in what the Company believes to be unacceptable delays in attempts to obtain title to real estate and other collateral through conventional foreclosure.
As a result of above factors, since the second quarter of 2010, the Company has followed a more aggressive strategy for resolving problem assets. As part of the revised resolution strategy, the Company has reevaluated each problem loan and has made a determination of net realizable value based on management’s estimation of the best possible outcome considering the individual characteristics of each asset against the likelihood of resolution with the current borrower, expectations for resolution through the court system, or other available market opportunities. The severity of the decline in real estate values has provided new market opportunities for the disposition of distressed assets as investors search for yield in the current low interest rate environment and our more aggressive policy has begun to take advantage of those opportunities. As part of this revised strategy, during the third quarter of 2010, the Company transferred twenty five loans totaling $21.9 million to the loans held-for-sale category. Partial charge-offs of these loans to adjust their carrying amount to estimated fair value accounted for $14.1 million of the $46.2 million of net charge-offs recorded during the full year of 2010. Approximately $14.1 million of these loans were sold in December of 2010 without further loss. The remaining $7.8 million are expected to be disposed of in the first or second quarters of 2011. As noted above, despite recent indications suggesting that the economic decline may have begun to turn around, the Company expects any recovery to be slow and expects to continue to experience some negative pressure from these adverse conditions into the first quarter of 2011 and beyond.
Total deposits increased $61.8 million during the year ended December 31, 2010, as the Company continued to experience significant growth in new customers both in existing branches and new branches added during the last two years. Overall deposit growth was partially offset by planned reductions in certain non-core deposit balances. Proceeds from deposit growth were used to reduce maturing term borrowings or were retained in liquid investments, principally interest earning bank deposits.
As a result of the aforementioned activity in the Company’s core businesses of loans and deposits and other asset/liability management activities, tax equivalent basis net interest income declined by $4.6 million or 3.9 percent to $113.8 million for the year ended December 31, 2010, compared to $118.4 million for the year ended December 31, 2009. The effect of the adjustment to a tax equivalent basis was $3.1 million in 2010 and $4.1 million in 2009.
Non interest income was $13.7 million in 2010, an increase of $3.2 million or 30.5 percent, compared to $10.5 million in 2009. The increase was partially due to an increase in investment advisory fees. Fee income from this source increased primarily as a result of the effects of recent improvement in both domestic and international equity markets. Assets under management were approximately $1.5 billion at December 31, 2010 and $1.3 billion at December 31, 2009. The overall increases in non interest income also included growth in deposit service charges. Non interest income also included recognized pre-tax impairment charges on securities available for sale of $2.6 million in 2010 and $5.5 million in 2009. The impairment charges were related to the Company’s investments in pooled trust preferred securities. Non interest income for 2010 and 2009 also included $2.0 million and $0.3 million of valuation losses on other real estate owned.
Non interest expense was $74.1 million for both 2010 and 2009. Increases in non interest expense resulting from the Company’s continued investment in its branch offices, technology and personnel to accommodate growth, the expansion of services and products available to new and existing customers and the upgrading of certain internal processes were more than offset by cost saving measures implemented by the Company during 2009 and 2010. In
addition, 2010 reflected significantly lower FDIC deposit insurance premiums. Additional premiums imposed by the FDIC in 2009 to replenish shortfalls in the FDIC Insurance Fund were not imposed to the same degree in 2010. However, additional premium increases and special assessments may continue to be imposed by the FDIC in the future. Decreases resulting from the lower FDIC premiums and other cost saving measures were offset by significant increases in costs related to problem loan resolutions and other real estate owned.
The Company uses a simulation analysis to estimate the effect that specific movements in interest rates would have on net interest income. Excluding the effects of planned growth and anticipated new business, the simulation analysis at December 31, 2010 shows the Company’s net interest income decreasing slightly if rates fall and increasing slightly if rates rise.
The Company has established specific policies and operating procedures governing its liquidity levels to address future liquidity needs, including contingent sources of liquidity. While the current adverse economic situation has put pressure on the availability of liquidity in the marketplace, the Company believes that its present liquidity and borrowing capacity are sufficient for its current business needs. In addition, the Company and the Bank are subject to various regulatory capital guidelines. In today’s economic and regulatory environment the OCC, which is the primary federal regulator of the Bank, has directed greater scrutiny to banks with higher levels of commercial real estate loans. During the fourth quarter of 2009, the OCC required HVB to maintain, by December 31, 2009, a total risk-based capital ratio of at least 12.0%, a Tier 1 risk-based capital ratio of at least 10.0%, and a Tier 1 leverage ratio of at least 8.0%. These capital levels are in excess of “well capitalized” levels generally applicable to banks under current regulations. To meet these increased capital ratios and to support future growth, the Company successfully raised a net $93.3 million in an underwritten common stock offering in the fourth quarter of 2009. As of December 31, 2010, and 2009, the Company and HVB exceeded all required regulatory capital levels.
Critical Accounting Policies
Application of Critical Accounting Policies - The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. The Company’s significant accounting policies are more fully described in Note 1 to the Consolidated Financial Statements. Certain accounting policies require management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reporting period. On an on-going basis, management evaluates its estimates and assumptions, and the effects of revisions are reflected in the financial statements in the period in which they are determined to be necessary. The accounting policies described below are those that most frequently require management to make estimates and judgements, and therefore, are critical to understanding the Company’s results of operations. Senior management has discussed the development and selection of these accounting estimates and the related disclosures with the Audit Committee of the Company’s Board of Directors.
Securities - Securities are classified as either available for sale, representing securities the Company may sell in the ordinary course of business, or as held to maturity, representing securities that the Company has determined that it is more likely than not that it would not be required to sell prior to maturity or recovery of cost. Securities available for sale are reported at fair value with unrealized gains and losses (net of tax) excluded from operations and reported in other comprehensive income. Securities held to maturity are stated at amortized cost. Interest income includes amortization of purchase premium and accretion of purchase discount. The amortization of premiums and accretion of discounts is determined by using the level yield method. Securities are not acquired for purposes of engaging in trading activities. Realized gains and losses from sales of securities are determined using the specific identification method. The Company regularly reviews declines in the fair value of securities below their costs for purposes of determining whether such declines are other-than-temporary in nature. In estimating other-than-temporary impairment (“OTTI”), management considers adverse changes in expected cash flows, the length of time and extent that fair value has been less than cost and the financial condition and near term prospects of the issuer. The Company also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of these criteria is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as
follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) OTTI related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis.
Allowance for Loan Losses - The Company maintains an allowance for loan losses to absorb probable losses incurred in the loan portfolio based on ongoing quarterly assessments of the estimated losses. The Company’s methodology for assessing the appropriateness of the allowance consists of a specific component for identified problem loans, and a formula component which addresses historical loan loss experience together with other relevant risk factors affecting the portfolio.
The specific component incorporates the results of measuring impaired loans as required by the “Receivables” topic of the FASB Accounting Standards Codification. These accounting standards prescribe the measurement methods, income recognition and disclosures related to impaired loans. A loan is recognized as impaired when it is probable that principal and/or interest are not collectible in accordance with the loan’s contractual terms. In addition, a loan which has been renegotiated with a borrower experiencing financial difficulties for which the terms of the loan have been modified with a concession that the Company would not otherwise have granted are considered troubled debt restructurings and are also recognized as impaired. A loan is not deemed to be impaired if there is a short delay in receipt of payment or if, during a longer period of delay, the Company expects to collect all amounts due including interest accrued at the contractual rate during the period of delay. Measurement of impairment can be based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price or the fair value of the collateral, if the loan is collateral dependent. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant change. If the fair value of an impaired loan is less than the related recorded amount, a specific valuation component is established within the allowance for loan losses or, if the impairment is considered to be permanent, a partial charge-off is recorded against the allowance for loan losses. Individual measurement of impairment does not apply to large groups of smaller balance homogenous loans that are collectively evaluated for impairment such as portions of the Company’s portfolios of home equity loans, real estate mortgages, installment and other loans.
The formula component is calculated by first applying historical loss experience factors to outstanding loans by type. This component is then adjusted to reflect additional risk factors not addressed by historical loss experience. These factors include the evaluation of then-existing economic and business conditions affecting the key lending areas of the Company and other conditions, such as new loan products, credit quality trends (including trends in nonperforming loans expected to result from existing conditions), collateral values, loan volumes and concentrations, specific industry conditions within portfolio segments that existed as of the balance sheet date and the impact that such conditions were believed to have had on the collectibility of the loan portfolio. Senior management reviews these conditions quarterly. Management’s evaluation of the loss related to each of these conditions is quantified by loan type and reflected in the formula component. The evaluations of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty due to the subjective nature of such evaluations and because they are not identified with specific problem credits.
Actual losses can vary significantly from the estimated amounts. The Company’s methodology permits adjustments to the allowance in the event that, in management’s judgment, significant factors which affect the collectibility of the loan portfolio as of the evaluation date have changed.
Management believes the allowance for loan losses is the best estimate of probable losses which have been incurred as of December 31, 2010. There is no assurance that the Company will not be required to make future adjustments to the allowance in response to changing economic conditions, particularly in the Company’s service area, since the majority of the Company’s loans are collateralized by real estate. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on their judgments at the time of their examinations.
Other Real Estate Owned (“OREO”) - Real estate properties acquired through loan foreclosure are recorded at estimated fair value, net of estimated selling costs, at time of foreclosure establishing a new cost basis. Credit losses arising at the time of foreclosure are charged against the allowance for loan losses. Subsequent valuations are
periodically performed by management and the carrying value is adjusted by a charge to expense to reflect any subsequent declines in the estimated fair value. Routine holding costs are charged to expense as incurred.
Goodwill and Other Intangible Assets - Goodwill and identified intangible assets with indefinite useful lives are not subject to amortization. Identified intangible assets that have finite useful lives are amortized over those lives by a method which reflects the pattern in which the economic benefits of the intangible asset are used up. All goodwill and identified intangible assets are subject to impairment testing on an annual basis, or more often if events or circumstances indicate that impairment may exist. If such testing indicates impairment in the values and/or remaining amortization periods of the intangible assets, adjustments are made to reflect such impairment. The Company’s impairment evaluations as of December 31, 2010 and December 31, 2009 did not indicate impairment of its goodwill or identified intangible assets.
Income Taxes - Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period the change is enacted.
Results of Operations for Each of the Three Years in the Period Ended December 31, 2010
Summary of Results
The Company reported net income of $5.1 million in 2010, a decrease of $13.9 million or 73.2 percent compared to $19.0 million in 2009, which decreased $11.9 million or 38.5 percent compared to $30.9 million in 2008. The decrease in 2010 net income, compared to 2009, reflected a significantly higher provision for loan losses, lower net interest income and slightly higher noninterest expense, partially offset by higher non interest income and a lower effective tax rate. The decrease in 2009 net income, compared to 2008, reflected a significantly higher provision for loan losses, higher noninterest expense including significantly higher FDIC deposit insurance premiums and lower non interest income, partially offset by higher net interest income and a lower effective tax rate. Provisions for loan losses totaled $46.5 million, $24.3 million and $11.0 million in 2010, 2009 and 2008 respectively. Non interest income includes $2.6 million, $5.5 million and $1.5 million of pretax recognized impairment charges related to certain securities in the Company’s investment portfolio in 2010, 2009 and 2008, respectively. Non interest income also includes $2.0 million and $0.3 million of valuation losses on other real estate owned in 2010 and 2009, respectively. Non interest expense includes $4.7 million, $5.5 million and $0.9 million of FDIC deposit insurance premiums in 2010, 2009 and 2008, respectively. The significantly higher levels of the provisions for loan losses, recognized impairment charges, valuation losses on other real estate owned and FDIC deposit insurance premiums in 2010 and 2009, compared to 2008, are a direct result of the significantly negative effects that the ongoing economic downturn has had on the performance and collateral values of the Company’s loan portfolios, the underlying credit and marketability of certain securities in its investment portfolio, and the overall performance of the financial services industry in general.
Diluted earnings per share were $0.29 in 2010, a decrease of $1.08 or 78.8 percent compared to $1.37 in 2009, which decreased $0.90 or 39.6 percent compared to $2.27 in 2008. These changes are a direct result of the changes in net income in the respective years compared to the prior year period. Prior period per share amounts have been adjusted to reflect the 10 percent stock dividend distributed in December 2010. Returns on average stockholders’ equity and average assets were 1.7 percent and 0.2 percent for 2010, compared to 8.7 percent and 0.7 percent in 2009 and 14.8 percent and 1.3 percent in 2008. Returns on adjusted average stockholders’ equity were 1.8 percent, 8.8 percent and 14.6 percent in 2010, 2009 and 2008, respectively. Adjusted average stockholders’ equity excludes the effects of net unrealized gains, net of tax of $3,078 and $981 and unrealized losses, net of tax, of $2,955 on securities available for sale in 2010, 2009 and 2008, respectively. The annualized return on adjusted average stockholders’ equity is, under SEC regulations, a non-GAAP financial measure. Management believes that this non-GAAP financial measures more closely reflects actual performance, as it is more consistent with the Company’s stated asset/liability management strategies, which do not contemplate significant realization of market gains or
losses on securities available for sale which were primarily related to changes in interest rates or illiquidity in the marketplace.
Net interest income for 2010 was $110.7 million, a decrease of $3.6 million or 3.1 percent compared to $114.3 million in 2009, which increased $4.3 million or 3.9 percent compared to $110.0 million in 2008. The 2010 decrease compared to 2009 was primarily due to a decrease in the tax equivalent basis net interest margin to 4.36% from 4.90%, partially offset by $193.2 million growth in the average balance of interest earning assets which was in excess of the $85.0 million growth in the average balance of interest bearing liabilities. The 2010 decrease in the tax equivalent basis net interest margin, compared to the prior year, resulted primarily from the effects significant increases in the average balance of low yielding interest bearing deposits in banks as a percentage of interest earning assets resulting primarily from weak loan demand, the completion of a planned reduction of the Company’s investment portfolio and the effects of maturing, higher yielding loans and investments being renewed or replaced in a significantly lower interest rate environment. The 2009 increase over 2008 was primarily due to $187.3 million growth in the average balance of interest earning assets which was in excess of the $143.4 million growth in the average balance of interest bearing liabilities, partially offset by a reduction in the tax equivalent basis net interest margin to 4.90% in 2009 from 5.14% in 2008. The 2009 decrease in the tax equivalent basis net interest margin, compared to the prior year, was primarily as a result of a slight reduction in the incremental spread between interest earning assets and interest bearing liabilities, partially offset by a $43.9 million increase in the excess of interest earning assets over interest bearing liabilities. The 2009 increase in the average balance of interest earning assets reflected growth in loans and short-term funds, partially offset by a planned reduction in investments. The 2009 increase in interest bearing liabilities reflected growth in deposits, partially offset by a planned reduction in short-term and other borrowed funds.
The provision for loan losses for 2010 was $46.5 million compared to $24.3 million in 2009 and $11.0 million in 2008. The significant increases in 2010 and 2009, compared to their respective prior year periods is primarily directly related to negative effects on the loan portfolio of conditions resulting from the ongoing crisis in the financial markets. As a result of the severe economic downturn, the Company has experienced significant levels of delinquent and nonperforming loans and a continuation of the slowdowns in repayments and declines in the loan-to-value ratios on existing loans which began in the second half of 2008 and has continued throughout 2009 and 2010. These conditions, together with the shortage of available residential mortgage financing, have put downward pressure on the overall asset quality of virtually all financial institutions, including the Company. In addition since the second quarter of 2010, the Company has followed the more aggressive strategy for resolving problem assets including the transfer of $21.9 million of nonperforming loans, to the held-for-sale category. The Company believes that the overall revised strategy will continue to address new and existing problem loans in the most appropriate and timely manner given current conditions in the economy.
Non interest income increased $3.2 million or 30.5 percent to $13.7 million in 2010 compared to $10.5 million in 2009, which decreased $8.1 million or 43.5 percent compared to $18.6 million in 2008. The increase of noninterest income in 2010, compared to the prior year period, was primarily due to increases in investment advisory fees of A.R. Schmeidler & Co., Inc., growth in deposit activity and other service fees and a decrease in recognized impairment charges on securities available-for-sale, partially offset by an increase in valuation losses on other real estate owned. The Company’s non interest income decreased in 2009, compared to the prior year period, primarily as a result of a significant increase in recognized impairment charges on securities available-for-sale and a significant decrease in investment advisory fees, partially offset by a decline in deposit activity and other service income. Investment advisory fee income experienced significant declines beginning in the fourth quarter of 2008 and continued to decline during the first half of 2009 as a result of significant declines in both domestic and international equity markets. Although there was significant improvement in the financial markets in late 2009 and 2010, continued improvement and the continued acquisition of new customers will be necessary for this source of non interest income to return to past levels. The Company recorded pre-tax recognized impairment charges on securities available-for-sale of $2.6 million, $5.5 million and $1.5 million in 2010, 2009 and 2008, respectively. Other dispositions of securities available for sale resulted in net realized gains of $0.2 million, $0.1 million and $0.1 million in 2010, 2009 and 2008, respectively. The sales were conducted as part of the Company’s ongoing asset/liability management process. Non interest income also includes $2.0 million and $0.3 million of valuation losses on other real estate owned in 2010 and 2009, respectively.
Non interest expense was $74.1 million for both 2010 and 2009. The 2009 amount reflected an increase of $3.0 million or 4.2 percent compared to $71.1 million in 2008. Increases in 2010 non interest expense resulting from the Company’s continued investment in its branch offices, technology and personnel to accommodate growth, the expansion of services and products available to new and existing customers and the upgrading of certain internal processes were more than offset by cost saving measures implemented by the Company during 2009 and 2010. In addition, 2010 reflected significantly lower FDIC deposit insurance premiums compared to 2009. Additional premiums imposed by the FDIC in 2009 to replenish shortfalls in the FDIC Insurance Fund were not imposed to the same degree in 2010. However, additional premium increases and special assessments may continue to be imposed by the FDIC in the future. Decreases resulting from the lower FDIC premiums and other cost saving measures were offset by significant increases in costs related to problem loan resolutions and other real estate owned. Increases in 2009 resulting from the Company’s continued investment in its branch offices, technology and personnel to accommodate growth in loans and deposits, the expansion of services and products available to new and existing customers and the upgrading of certain internal processes were effectively offset by significant other cost saving measures implemented by the Company during the year, including the elimination of all 2009 incentive compensation and bonuses for employees of the Bank. However, overall 2009 non interest expense increased, compared to the prior year period, primarily due to aforementioned significant increase in FDIC deposit premiums.
The effective tax rate in 2010 decreased to (37.9) percent, compared to 27.8 percent in 2009 and 33.6 percent in 2008. The tax benefit recorded in 2010 resulted from the effects of tax-exempt income exceeding taxable income for the year primarily due to the significant 2010 loan loss provision. The 2009 decrease, compared to the prior year period, was primarily as a result of tax-exempt income constituting a greater percentage of pretax income due to the significant increase in the loan loss provision and recognized impairment charges on securities available for sale.
Average Balances and Interest Rates
The following table sets forth the daily average balances of interest earning assets and interest bearing liabilities for each of the last three years as well as total interest and corresponding yields and rates.
(1)
Excludes unrealized gains (losses) on securities available for sale. Management believes that this presentation more closely reflects actual performance, as it is more consistent with the Company’s stated asset/liability management strategies, which have not resulted in significant realization of temporary market gains or losses on securities available for sale which were primarily related to changes in interest rates. Effects of these adjustments are presented in the table below.
(2)
Includes loans classified as non-accrual.
(3)
The data contained in the table has been adjusted to a tax equivalent basis, based on the Company’s federal statutory rate of 35 percent. Management believes that this presentation provides comparability of net interest income and net interest margin arising from both taxable and tax-exempt sources and is consistent with industry practice and SEC rules. Effects of these adjustments are presented in the table below.
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
Average Balances and Interest Rates
Non-GAAP disclosures
Interest Differential
The following table sets forth the dollar amount of changes in interest income, interest expense and net interest income between the years ended December 31, 2010 and 2009, and the years ended December 31, 2009 and 2008, on a tax equivalent basis.
(1)
Changes attributable to both rate and volume are allocated between the rate and volume variances based upon their absolute relative weights to the total change.
Net Interest Income
Net interest income, the difference between interest income and interest expense, is the most significant component of the Company’s consolidated earnings. During the three year period ended December 31, 2010, the overall economic picture, both globally and in the Company’s market area, has been one of historic low interest rates, severe economic downturn in virtually every sector of the economy, sharp declines in asset values particularly in the commercial and residential real estate sectors, weak loan demand and shrinking margins. The Company’s overall asset quality has continued to be adversely affected by the current state of the economy. During 2010 and 2009, the Company has experienced significant levels of delinquent and nonperforming loans and a continuation of the slowdowns in repayments and declines in the loan-to-value ratios on existing loans which began in the second half of 2008. Changes in the levels of nonperforming loans have a direct impact on net interest income. While there are recent signs that the economic downturn has begun to reverse, the Company expects some continued downward pressure on net interest income for the near future as a result of ongoing lag effect of these conditions.
The Company has made efforts throughout this period of severe economic uncertainty and low interest rates to minimize the impact on its net interest income by appropriately repositioning its securities portfolio and funding
sources while maintaining prudence and awareness of the potential consequences that the current economic crisis could have on its asset quality and interest rate risk profiles. During 2010 and 2009, the Company was able to repay maturing long-term borrowings, all of its brokered certificates of deposit and non-customer related short-term borrowings with liquidity provided primarily by core deposit growth and planned utilization of run-off from our investment securities. Additional liquidity from deposit growth was retained in the Company’s short-term liquidity portfolios, available to fund future loan growth. With interest rates remaining at historically low levels, this increase in liquidity contributed to margin compression. Also during 2010 and 2009, the Company increased the number of loans originated with interest rate floors and, as part of the continuation of a planned reduction of the Company’s investment portfolio, targeting cash flow from maturing investment securities to fund current and future loan growth. These actions were conducted partially in reaction to severely declining interest rates. The Company’s ability to make changes in its asset mix allows management to capitalize on more desirable yields, as available, on various interest earning assets. Management believes that the result of these efforts has enabled the Company, given the difficulties being encountered in the current economic crisis, to maximize the effective repositioning of its portfolios from both asset and interest rate risk perspectives.
Net interest income, on a tax equivalent basis, decreased $4.6 million or 3.9 percent to $113.8 million in 2010, compared to $118.4 million in 2009, which increased $3.7 million or 3.2 percent from $114.7 million in 2008. The decrease in 2010, compared to 2009, primarily resulted from a decrease in the tax equivalent basis net interest margin to 4.36 percent in 2010 from 4.90 percent in 2009, partially offset by an increase of $108.2 million or 14.3 percent in the excess of adjusted average interest earning assets over average interest bearing liabilities to $867.4 million in 2010 from $759.2 million in 2009. The increase in 2009, compared to 2008, primarily resulted from an increase of $43.9 million or 6.1 percent in the excess of adjusted average interest earning assets over interest bearing liabilities to $759.2 million in 2009 from $715.3 million in 2008, partially offset by a decrease in the tax equivalent basis net interest margin to 4.90 percent in 2009 from 5.14 percent in 2008. For purposes of the financial information included in this section, the Company adjusts average interest earning assets to exclude the effects of unrealized gains and losses on securities available for sale and adjusts net interest income to a tax equivalent basis. Management believes that this alternate presentation more closely reflects actual performance, as it is consistent with the Company’s stated asset/liability management strategies. The effects of these non-GAAP adjustments to tax equivalent basis net interest income and adjusted average assets are included in the table presented in “Average Balances and Interest Rates” section herein.
Interest income is determined by the volume of and related rates earned on interest earning assets. Volume decreases in loans and investments and a lower average yield on interest earning assets, partially offset by volume increases in interest earning deposits and Federal funds sold resulted in lower interest income in 2010, compared to 2009. A volume decrease in investments and a lower average yield on interest earning assets, partially offset by volume increases in loans, Federal funds sold and interest earning deposits resulted in slightly lower interest income in 2009, compared to 2008. Adjusted average interest earning assets in 2010 increased $193.2 million or 8.0 percent to $2,610.6 million from $2,417.4 million in 2009, which increased $187.3 million or 8.4 percent from $2,230.1 million in 2008.
Loans are the largest component of interest earning assets. Net loans decreased $83.4 million or 4.7 percent to $1,689.2 million at December 31, 2010 from $1,772.6 million at December 31, 2009, which increased $95.0 million or 5.7 percent from $1,677.6 million at December 31, 2008. Average net loans decreased $25.1 million or 1.4 percent to $1,714.3 million in 2010 from $1,739.4 million in 2009, which increased $256.2 million or 17.3 percent from $1,483.2 million in 2008. The decrease in average net loans in 2010, compared to 2009 resulted from insufficient loan demand to offset payoffs and pay downs, significant charge-offs taken during the year and sales of other nonperforming loans, partially offset by significant growth in the multi-family sector of the portfolio. The increase in average net loans during 2009, compared to 2008, reflected the Company’s continuing emphasis on making new loans, expansion of loan production capabilities and more effective market penetration. The average yield on loans was 6.28 percent in 2010, compared to 6.36 percent in 2009 and 7.12 percent in 2008. As a result, interest income on loans decreased in 2010, compared to 2009, due to lower volume and lower interest rates, and interest income on loans increased in 2009, compared to 2008, due to higher volume, partially offset by lower interest rates.
Total securities, including Federal Home Loan Bank (“FHLB”) stock and excluding net unrealized gains and losses, decreased $66.4 million or 12.5 percent to $464.1 million at December 31, 2010 from $530.5 million at December 31, 2009, which decreased $166.3 million or 23.9 percent from $696.8 million at December 31, 2008. Average total securities, including FHLB stock and excluding net unrealized gains and losses, decreased $81.8 million or 13.7 percent to $516.8 million in 2010 from $598.6 million in 2009, which decreased $118.1 million or 16.5 percent from $716.7 million in 2008. The decreases in average total securities in 2010 and 2009, compared to their respective prior year periods, resulted primarily from a planned reduction in the portfolio conducted by the Company as part of its ongoing asset/liability management efforts. During 2010, cash flow from maturing investments was either redeployed into new mortgage backed securities, or retained in interest bearing bank balances to fund future loan growth. The decrease in average total securities in 2010 compared to 2009 reflects volume decreases in U.S. Treasury and Agency securities, mortgage-backed securities including collateralized mortgage obligations, obligations of state and political subdivisions and FHLB stock, partially offset by a volume increase in other securities. The average tax equivalent basis yield on securities was 4.44 percent for 2010 compared to 4.99 percent in 2009. As a result, tax equivalent basis interest income on securities decreased in 2010, compared to 2009, due to lower volume and lower interest rates. During 2009, management utilized cash flow from maturing investments to fund loan growth and to reduce short-term and other borrowings. The decrease in average total securities in 2009 compared to 2008 reflects volume decreases in U.S. Treasury and Agency securities, mortgage-backed securities including collateralized mortgage obligations, obligations of state and political subdivisions, FHLB stock and other securities. The average tax equivalent basis yield on securities was 4.99 percent for 2009 compared to 5.32 percent in 2008. As a result, tax equivalent basis interest income on securities decreased in 2009, compared to 2008, due to lower volume and lower interest rates. Increases and decreases in average FHLB stock results from purchases or redemptions of stock in order to maintain required levels to support FHLB borrowings.
Interest expense is a function of the volume of, and rates paid for, interest bearing liabilities, comprised of deposits and borrowings. Interest expense decreased $4.6 million or 20.6 percent to $17.7 million in 2010 from $22.3 million in 2009, which decreased $7.8 million or 25.9 percent from $30.1 million in 2008. Average interest bearing liabilities increased $85.0 million or 5.1 percent to $1,743.2 million in 2010 from $1,658.2 million in 2009, which increased $143.4 million or 9.5 percent from $1,514.8 million in 2008.
The increase in average interest bearing liabilities in 2010, compared to 2009, was due to volume increases in money market deposits, savings deposits and checking with interest, partially offset by volume decreases in time deposits, short-term borrowings and other borrowed funds. The Company continued to experience significant growth in new customers both in existing branches and new branches added during the last two years. Proceeds from deposit growth were used to reduce maturing term borrowings or were retained in liquid investments, principally interest earning bank deposits. The average interest rate paid on interest bearing liabilities was 1.01 percent in 2010, compared to 1.35 percent in 2009. As a result of these factors, interest expense was lower in 2010, compared to 2009, due to lower interest rates, partially offset by higher volume.
The increase in average interest bearing liabilities in 2009, compared to 2008, was due to volume increases in interest bearing demand deposits, partially offset by volume decreases in securities sold under repurchase agreements and other short-term borrowings and other borrowings, and a slight volume decrease in time deposits. The increases in average interest bearing demand deposits include approximately $101 million of growth which resulted from the transfer of certain money market mutual fund investments of existing customers to interest bearing demand deposits. This transfer was primarily due to the increase in FDIC insurance coverage of certain deposit products which was part of the legislation enacted in response to the current economic crisis. In addition to above mentioned deposit growth, the Company experienced significant growth in new customers both in existing branches and new branches added during 2008 and 2009. Overall deposit growth in 2009 was partially offset by some declines in balances of existing customers, primarily those customers directly involved in or supported by the real estate industry. Proceeds from deposit growth were used primarily to reduce long term and short term debt and to fund loan growth. The decreases in average short-term and other borrowings in 2009, compared to 2008, resulted from management’s decision to utilize cash flow from deposit growth and maturing investment securities to reduce borrowings as part of the Company’s ongoing asset/liability management efforts. The average interest rate paid on interest bearing liabilities was 1.35 percent in 2009, compared to 1.99 percent in 2008. As a result of these factors,
interest expense on average interest bearing liabilities was lower in 2009, compared to the prior year period due to lower interest rates, partially offset by higher volume.
Average non interest bearing demand deposits increased $69.3 million or 10.3 percent to $745.3 million in 2010 from $676.0 million in 2009, which increased $50.4 million or 8.1 percent from $625.6 million in 2008. Non interest bearing demand deposits are an important component of the Company’s ongoing asset liability management, and also have a direct impact on the determination of net interest income.
The interest rate spread on a tax equivalent basis for each of the three years in the period ended December 31, 2010 is as follows:
In 2010 and 2009, the interest rate spreads decreased reflecting greater increases in interest rates on interest bearing liabilities compared to interest rates on interest earning assets. Management cannot predict what impact market conditions will have on its interest rate spread and future compression in net interest rate spread may occur.
Provision for Loan Losses
The provision for loan losses in 2010 was $46.5 million compared to $24.3 million in 2008 and $11.0 million in 2008. The significant increases in 2010 and 2009, compared to their respective prior years, are directly related to negative effects on the Company’s loan portfolio of conditions resulting from the ongoing crisis in the financial markets. In addition, the 2010 increase, compared to 2009, partially resulted from a decision by the Company to implement a more aggressive workout strategy for the resolution of problem assets in light of a sluggish economic recovery, continued weakness in local real estate activity and market values and growing difficulty in resolving problem loans in a timely fashion through traditional foreclosure proceedings due to increased bankruptcy filings and overcrowded court systems. Continuation or worsening of such conditions could result in additional significant provisions for loan losses in the future.
Non Interest Income
Non interest income increased $3.2 million or 30.5 percent to $13.7 million in 2010 compared to $10.5 million in 2009, which decreased $8.1 million or 43.5 percent compared to $18.6 million in 2008. The increase in 2010, compared to the prior year period, was primarily due to an increase in investment advisory fees of A.R. Schmeidler & Co., Inc. and also reflects growth in deposit activity and other service fees and a decrease in recognized impairment charges on securities available for sale, partially offset by an increase in valuation losses on other real estate owned and a slight decrease in other income. The decrease in 2009, compared to the prior year period, was primarily the result of a significant increase in impairment charges related to the Company’s investment in certain pooled trust preferred securities and a sharp decrease in investment advisory fees. The above mentioned changes in investment advisory fees, impairment charges on securities and valuation losses on other real estate owned are directly related to the current economic crisis, which has had significant negative effects on the financial services industry, the real estate industry and the domestic and international equity markets.
Service charges increased by $0.7 million or 11.9 percent to $6.6 million in 2010 compared to $5.9 million in 2009, which decreased slightly by $0.1 million or 1.7 percent from $6.0 million in 2008. The 2010 increase, compared to 2009, was primarily due to growth service charges related to new products introduced in 2009 and 2010. The 2009 decrease, compared to 2008, resulted primarily from increases in fees related to growth in deposits being offset by declines in activity fees on existing deposits.
Investment advisory fees increased $1.4 million or 18.2 percent to $9.1 million in 2010 from $7.7 million in 2009, which decreased $3.5 million or 31.3 percent from $11.2 million in 2008. The 2010 increase, compared to 2009, was due to a net increase in assets under management from existing customers, addition of new customers and net increases in asset value. Fee income from this source, however, experienced sharp declines beginning in the
fourth quarter of 2008 and continued to decline during the first half of 2009 as a result of the effects of significant declines in both domestic and international equity markets which resulted in the sharp decline in fees in 2009, compared to 2008. Although there has been recent improvement in the financial markets, continued improvement and the acquisition of new customers will be necessary for this source of non interest income to return to past levels.
The Company recognized impairment charges on securities available for sale of $2.6 million, $5.5 million and $0.6 million for the years ended December 31, 2010, 2009 and 2008 respectively. The entire 2010 and 2009 charges and $1.1 million of the 2008 charge related to the Company’s investments in certain pooled trust preferred securities. These securities are primarily backed by U.S. financial institutions many of which are experiencing severe financial difficulties as a result of the current economic downturn. Continuation of these conditions may result in additional impairment charges on these securities in the future. The Company has decided to hold its investments in trust preferred securities as it does not believe that the current market quotes for these investments are indicative of their underlying value. The $0.4 million remainder of the 2008 impairment charge was related to the Company’s investment in a mutual fund. This investment was sold in April 2008 without additional loss. Other dispositions of securities available for sale resulted in net realized gains of $0.2 million, $0.1 million and $0.1 million in 2010, 2009 and 2008, respectively. The sales were conducted as part of the Company’s ongoing asset/liability management process. Non interest income also includes $2.0 million and $0.3 million of valuation losses on other real estate owned in 2010 and 2009, respectively. These valuation losses are a direct result of the significantly negative effects that the ongoing economic downturn has had on the values of the Company’s real estate related assets.
Other income decreased $0.2 million or 7.7 percent to $2.4 million in 2010 from $2.6 million in 2009, which decreased $0.3 million or 10.3 percent from $2.9 million in 2008. The decrease in 2010, compared to 2009, resulted from decreases in income on bank owned life insurance, rental income and miscellaneous customer fees, partially offset by increases in debit card income. The decrease in 2009, compared to 2008, resulted primarily from a decrease in miscellaneous service fees and rental income, partially offset by increases in income from bank owned life insurance and debit card income.
Non Interest Expense
Non interest expense was $74.1 million, $74.1 million and $71.1 million for the years ended December 31, 2010, 2009 and 2008, respective. Increases in non interest expense resulting from the Company’s continued investment in its branch offices, technology and personnel to accommodate growth, the expansion of services and products available to new and existing customers and the upgrading of certain internal processes were more than offset by cost saving measures implemented by the company during 2009 and 2010. The Company’s efficiency ratio (a lower ratio indicates greater efficiency) which compares non interest expense to total adjusted revenue (taxable equivalent net interest income, plus non interest income, excluding gain or loss on securities transactions) was 56.2 percent in 2010, compared to 55.2 percent in 2009 and 52.8 percent in 2008.
Salaries and employee benefits, the largest component of non interest expense, decreased $0.2 million or 0.5 percent to $38.5 million in 2010 from $38.7 million in 2009, which was a decrease of $3.2 million or 7.6 percent from $41.9 million in 2008. The decrease in 2010 resulted from the planned reduction in certain staffing levels and a reduction in employee retirements plans partially offset by increased incentive compensation. The decrease in 2009 resulted from decreased incentive compensation and the reduction of certain benefits which were partially offset by additional staff requirements which resulted from the opening of new branches.
Occupancy expense increased $0.1 million or 1.2 percent to $8.4 million in 2010 from $8.3 million in 2009 which increased $0.8 million or 10.7 percent from $7.5 million in 2008. The increases in both 2010 and 2009 reflect increased costs related to the opening of new branch offices and also included rising costs on leased facilities, real estate taxes, utility costs, maintenance costs and other costs to operate the Company’s facilities.
Professional services increased $0.8 million or 18.2 percent to $5.2 million in 2010 from $4.4 million in 2009, which was a $0.1 million or 2.3 percent increase from $4.3 million for 2008. The increase in 2010 was primarily due to costs related to the formation of a new subsidiary, expenses related to the operational merger of New York National Bank into HVB and the engagement of consultants to assist with new systems implementations and certain personnel related projects. The slight increase in 2009 was related to a core processing study.
Equipment expense decreased $0.4 million or 9.1 percent to $4.0 million in 2010 from $4.4 million in 2009, which was an increase of $0.2 million or 4.8 percent from $4.2 million in 2008. The 2010 decrease reflects reduced equipment rental costs and cost saving measures implemented in late 2009. The 2009 increase reflects increased maintenance expense for the Company’s equipment and offices due to higher costs and the addition of new branch offices.
Business development expense was $2.0 million at December 31, 2010 which was unchanged as compared to $2.0 million in 2009, which was a $0.1 million or 4.8 percent decrease from $2.1 million in 2008. The 2009 decrease was due to a decreased participation in public relations events and a reduction in annual report expenses.
The assessment of the Federal Deposit Insurance Corporation (“FDIC”) was $4.7 million for 2010, $5.5 million in 2009 and $0.9 million for 2008. The 2010 decrease was due to additional premiums that were imposed by the FDIC, during 2009, to replenish shortfalls in the FDIC Insurance Fund which resulted from the current economic crisis.
Other operating expenses, as reflected in the following table increased 4.2 percent in 2010 and increased 5.6 percent in 2009.
The 2010 increases reflect higher loan expenses, including increased expenses related to properties held as other real estate owned and increased loan collection costs, increased costs related to couriers and higher outside service fees. The 2010 decreases reflect lower stationary and printing costs, lower communications expense and lower insurance costs.
The 2009 increases reflect higher loan expenses, including increased expenses related to properties held as other real estate owned and increased loan collection costs and higher outside service fees. The 2009 decreases reflect lower stationary and printing costs, lower communications expense, lower courier costs due to greater efficiencies gained due to a change in service providers and decreased participation in meetings and seminars.
Income Taxes
Income taxes (benefits) of $(1.4) million, $7.3 million and $15.6 million were recorded in 2010, 2009, and 2008, respectively. The Company is currently subject to a statutory Federal tax rate of 35 percent, a New York State tax rate of 7.1 percent plus a 17 percent surcharge, a Connecticut State tax rate of 7.5 percent, and a New York City tax rate of approximately 9 percent. The Company’s overall effective tax rate was (37.9) percent in 2010, 27.8 percent in 2009 and 33.6 percent in 2008. The tax benefit in 2010 and the decrease in the overall effective tax rate in 2009, compared to 2008, resulted primary from tax-exempt income exceeding book pre-tax income in 2010 and representing a larger percentage of book pre-tax income in 2009, compared to 2008.
In the normal course of business, the Company’s Federal, New York State and New York City corporation tax returns are subject to audit. The Company is currently open to audit by the Internal Revenue Service under the statute of limitations for years after 2006. The Company is currently undergoing an audit by New York State for years 2005 through 2007. This audit has not yet been completed, however, no significant issues have as yet been raised. Other pertinent tax information is set forth in the Notes to Consolidated Financial Statements included elsewhere herein.
Financial Condition at December 31, 2010 and 2009
Cash and Due from Banks
Cash and due from banks was $284.2 million at December 31, 2010, an increase of $117.2 million or 70.2 percent from $167.0 million at December 31, 2009. Included in cash and due from banks is interest earning deposits of $258.3 million at December 31, 2010 and $127.7 million at December 31, 2009. The increase was a result of deposit growth and loan paydowns which have not yet been deployed into investments or loans.
Federal Funds Sold
Federal funds sold totaled $72.1 million at December 31, 2010, an increase of $20.2 million or 38.9 percent from $51.9 million at December 31, 2009. The increase resulted from timing differences in the redeployment of available funds into loans and longer term investments and volatility in certain deposit types and relationships.
Securities Portfolio
Securities are selected to provide safety of principal, liquidity, pledging capabilities (to collateralize certain deposits and borrowings), income and to leverage capital. The Company’s investment strategy focuses on maximizing income while providing for safety of principal, maintaining appropriate utilization of capital, providing adequate liquidity to meet loan demand or deposit outflows and to manage overall interest rate risk. The Company selects individual securities whose credit, cash flow, maturity and interest rate characteristics, in the aggregate, affect the stated strategies.
The securities portfolio consists of various debt and equity securities totaling $459.9 million, $522.3 million and $671.4 million and FHLB stock totaling $7.0 million, $8.5 million and $20.5 million at December 31, 2010, 2009, and 2008, respectively.
Securities are classified as either available for sale, representing securities the Company may sell in the ordinary course of business, or as held to maturity, representing securities the Company has the ability and positive intent to hold until maturity. Securities available for sale are reported at fair value with unrealized gains and losses (net of tax) excluded from operations and reported in other comprehensive income. Securities held to maturity are stated at amortized cost. The available for sale portfolio totaled $443.7 million, $500.6 million and $642.4 million at December 31, 2010, 2009 and 2008 respectively. The held to maturity portfolio totaled $16.3 million, $21.7 million and $29.0 million at December 31, 2010, 2009 and 2008, respectively.
Average aggregate securities and FHLB stock represented 19.8 percent, 24.8 percent and 32.1 percent of average interest earning assets in 2010, 2009 and 2008, respectively. Emphasis on the securities portfolio will continue to be an important part of the Company’s investment strategy. The size of the securities portfolio will depend on loan and deposit growth, the level of capital and the Company’s ability to take advantage of leveraging opportunities.
The following table sets forth the amortized cost, gross unrealized gains and losses and the estimated fair value of securities classified as available for sale and held to maturity at December 31:
(000’s)
(000’s)
(000’s)
The following table presents the amortized cost of securities at December 31, 2010, distributed based on contractual maturity or earlier call date for securities expected to be called, and weighted average yields computed on a tax equivalent basis. Mortgage-backed securities which may have principal prepayments are distributed to a maturity category based on estimated average lives. Actual maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
Obligations of U.S. Treasury and government agencies principally include U.S. Treasury securities and debentures and notes issued by the FHLB, Fannie Mae, and Freddie Mac. The total balances held of such securities classified as available for sale decreased $2.0 million to $3.0 million as of December 31, 2010, from $5.0 million as of December 31, 2009, which decreased $40.4 million from $45.4 million at December 31, 2008. The 2010 decrease resulted from maturities of $42.0 million which were partially offset by purchases of $40.0 million. The 2009 decrease resulted from maturities and calls of $246.1 million and other decreases of $0.2 million, partially offset by purchases of $205.9 million.
The Company invests in mortgage-backed securities, including CMO’s that are primarily issued by the Government National Mortgage Association (“GNMA”), Fannie Mae, Freddie Mac and, to a lesser extent from time to time, such securities issued by others. GNMA securities are backed by the full faith and credit of the U.S. Treasury, assuring investors of receiving all of the principal and interest due from the mortgages backing the securities. Fannie Mae and Freddie Mac guarantee the payment of interest at the applicable certificate rate and the full collection of the mortgages backing the securities; however, such securities are not backed by the full faith and credit of the U.S. Treasury.
Mortgage-backed securities, including CMO’s, classified as available for sale decreased $6.9 million to $309.5 million as of December 31, 2010 from $316.4 million as of December 31, 2009 which decreased $57.7 million from $374.1 million at December 31, 2008. The 2010 decrease was due to principal paydowns of $138.8 million and sales of $4.9 million which were partially offset by purchases of $136.3 million and other changes of $0.5 million. The 2009 decrease was due to principal paydowns of $157.9 million, sales of $6.8 million, partially offset by purchases of $106.2 million and other increases of $0.8 million. The sales were conducted as a result of management’s efforts to reposition the portfolio during the periods of changing economic conditions and interest rates.
Mortgage-backed securities, including CMO’s, classified as held to maturity totaled $11.1 million at December 31, 2010 which was a decrease of $5.4 million from $16.5 million as of December 31, 2009, which was a decrease of $7.4 million from $23.9 million as of December 31, 2008. The 2010 decrease was due to principal paydowns of $5.4. The decrease in 2009 was due to principal paydowns of $7.3 million and other changes of $0.1 million. There were no adjustable rate mortgage-backed securities classified as held to maturity at December 31, 2010, 2009 and 2008.
At December 31, 2010 and 2009, fixed rated mortgage-backed securities, including CMO’s, classified as available for sale totaled $303.6 million and $304.4 million, respectively. During 2010, principal paydowns of $137.8 million were partially offset by purchases of $136.3 million and other increases of $0.9 million. During 2009, principal paydowns of $155.7 million and sales of $1.3 million were partially offset by purchases of $101.2 million and other increases of $0.4 million. At December 31, 2010 and 2009, variable rate mortgaged backed securities classified as available for sale totaled $5.9 million and $12.0 million, respectively. In 2010, the decrease was due to sales of $4.8 million, principal paydowns of $1.0 million and other decreases of $0.2 million. In 2009, sales of $5.5 million and principal paydowns of $2.2 million were partially offset by purchases of $5.0 million and other changes of $0.4 million.
Obligations of states and political subdivisions classified as available for sale decreased $48.2 million to $116.1 million at December 31, 2010, from $164.3 million at December 31, 2009, which decreased $37.2 million from $201.5 million at December 31, 2008. The 2010 decrease resulted from maturities and calls of $69.2, sales of $16.9 million and other decreases of $1.6 million which was partially offset by purchases of $39.5 million. The 2009 decrease resulted from maturities and calls of $53.5 million and sales of $2.0 million which was partially offset by purchases of $13.1 million and other increases of $5.2 million. Obligations of states and political subdivisions classified as held to maturity totaled $5.1 million at December 31, 2010, 2009 and 2008. The obligations at year end 2009 were comprised of approximately 82 percent for New York State political subdivisions and 18 percent for a variety of other states and their subdivisions all with diversified final maturities. The Company considers such securities to have favorable tax equivalent yields and further utilizes such securities for their favorable income tax treatment.
Other debt securities classified as available for sale decreased $0.4 million to $4.4 million at December 31, 2010 from $4.8 million at December 31, 2009, which decreased $6.8 million from $11.6 million at December 31, 2008. The 2010 decrease was due to other decreases of $0.4 million and maturities and calls of $0.2 million partially
offset by payments in kind of $0.2 million. The 2009 decrease was due to other changes of $7.0 million partially offset by payments in kind of $0.2 million. Included in other changes was a $5.5 million pretax impairment charge related to the Company’s investment in pooled trust preferred securities and an additional $1.5 million of unrealized losses on pooled trust preferred securities. These pooled trust preferred securities, which had a cost basis of $11.6 million and $13.8 million as of December 31, 2010 and 2009, respectively, have suffered severe declines in estimated fair value as a result of both illiquidity in the marketplace and severe declines in the credit ratings of a number of issuing banks underlying these securities. The Company has recognized $2.6 million impairment charges over the past twelve months, related to its investments in pooled trust preferred securities. Management cannot predict what effect that continuation of such conditions could have on potential future value or whether there will be additional impairment charges related to these securities.
Mutual funds and other equities classified as available for sale totaled $10.7 million at December 31, 2010, which increased $0.6 million from $10.1 million at December 31, 2009, which was an increase of $0.4 million from $9.7 million at December 31, 2008. The 2010 increase was due to purchases of $1.0 million was partially offset by other decreases of $0.4 million and maturities and calls of $0.1 million. There were no mutual funds or other equities classified as held to maturity during 2010, 2009 or 2008.
The Company invests in FHLB stock and other securities which are rated with an investment grade by nationally recognized credit rating organizations. As a matter of policy, the Company invests in non-rated securities, on a limited basis, when the Company is able to satisfy itself as to the underlying credit. These non-rated securities outstanding at December 31, 2010 totaled approximately $5.8 million comprised primarily of obligations of municipalities located within the Company’s market area. The Bank, as a member of the FHLB, invests in stock of the FHLB as a prerequisite to obtaining funding under various advance programs offered by the FHLB. The Bank must purchase additional shares of FHLB stock to obtain increases in such borrowings.
The Company continues to exercise a conservative approach to investing by purchasing high credit quality investments with various maturities and cash flows to provide for liquidity needs and prudent asset liability management. The Company’s securities portfolio provides for a significant source of income, liquidity and is utilized in managing Company-wide interest rate risk. These securities are used to collateralize borrowings and deposits to the extent required or permitted by law. Therefore, the securities portfolio is an integral part of the Company’s funding strategy.
Except for securities of the U.S. Treasury and government agencies, there were no obligations of any single issuer which exceeded ten percent of stockholders’ equity at December 31, 2010.
Loan Portfolio
Real Estate Loans: Real estate loans are comprised primarily of loans collateralized by interim and permanent commercial mortgages, construction mortgages and residential mortgages including home equity loans. The Company originates these loans primarily for its portfolio, although a portion of its residential real estate loans, in addition to meeting the Company’s underwriting criteria, comply with nationally recognized underwriting criteria (“conforming loans”) and can be sold in the secondary market.
Commercial real estate loans are offered by the Company on a fixed or variable rate basis generally with up to 10 year terms. Amortizations generally range up to 25 years. The Company also originates 15 year fixed rate self-amortizing commercial mortgages.
In underwriting commercial real estate loans, the Company evaluates both the prospective borrower’s ability to make timely payments on the loan and the value of the property securing the loan. The Company generally utilizes licensed or certified appraisers, previously approved by the Company, to determine the estimated value of the property. Commercial mortgages are generally underwritten for up to 75% of the value of the property depending on the type of the property. The Company generally requires lease assignments where applicable. Repayment of such loans may be negatively impacted should the borrower default or should there be a substantial decline in the value of the property securing the loan, or a decline in general economic conditions.
Where the owner occupies the property, the Company also evaluates the business’s ability to repay the loan on a timely basis. In addition, the Company may require personal guarantees, lease assignments and/or the guarantee of the operating company when the property is owner occupied. These types of loans may involve greater risks than other types of lending, because payments on such loans are often dependent upon the successful operation of the
business involved, therefore, repayment of such loans may be negatively impacted by adverse changes in economic conditions affecting the borrowers’ business.
Construction loans are short-term loans (generally up to 18 months) secured by land for both residential and commercial development. The loans are generally made for acquisition and improvements. Funds are disbursed as phases of construction are completed. The majority of these loans are made with variable rates of interest, although some fixed rate financing is provided. The loan amount is generally limited to 55% to 70% of completed value, depending on the type of property. Most non-residential construction loans require pre-approved permanent financing or pre-leasing by the company or another bank providing the permanent financing. The Company funds construction of single family homes and commercial real estate, when no contract of sale exists, based upon the experience of the builder, the financial strength of the owner, the type and location of the property and other factors. Construction loans are generally personally guaranteed by the principal(s). Repayment of such loans may be negatively impacted by the builders’ inability to complete construction, by a downturn in the new construction market, by a significant increase in interest rates or by a decline in general economic conditions.
Residential real estate loans are offered by the Company with terms of up to 30 years and loan to value ratios of up to 70%. Repayment of such loans may be negatively impacted should the borrower default, should there be a significant decline in the value of the property securing the loan or should there be a decline in general economic conditions.
The Company offers a variety of home equity line of credit products. These products include credit lines on primary residences, vacation homes and 1-4 unit residential investment properties. A low cost option is available to qualified borrowers who intend to actively utilize the lines. Depending on the product, loan amounts of $50,000 to $2,000,000 are available for terms ranging from 5 years to 25 years with various repayment terms. Required combined maximum loan to value ratios range from 60% to 70%, and the lines generally have interest rates ranging from the prime rate minus 1% (Prime Rate as published in the Wall Street Journal) to prime rate plus 1.5%, subject to certain interest rate floors.
The Company does not originate loans similar to payment option loans or loans that allow for negative interest amortization. The Company does not engage in sub-prime lending nor does it offer loans with low “teaser” rates or high loan-to-value ratios to sub-prime borrowers.
Commercial and Industrial Loans: The Company’s commercial and industrial loan portfolio consists primarily of commercial business loans and lines of credit to businesses and professionals. These loans are usually made to finance the purchase of inventory, new or used equipment or other short or long-term working capital purposes. These loans are generally secured by corporate assets, often with real estate as secondary collateral, but are also offered on an unsecured basis. These loans generally have variable rates of interest. Commercial loans, for the purpose of purchasing equipment and/or inventory, are usually written for terms of 1 to 5 years with, exceptionally, longer terms. In granting this type of loan, the Company primarily looks to the borrower’s cash flow as the source of repayment with collateral and personal guarantees, where obtained, as a secondary source. The Company generally requires a debt service coverage ratio of at least 125%. Commercial loans are often larger and may involve greater risks than other types of loans offered by the Company. Payments on such loans are often dependent upon the successful operation of the underlying business involved and, therefore, repayment of such loans may be negatively impacted by adverse changes in economic conditions, management’s inability to effectively manage the business, claims of others against the borrower’s assets which may take priority over the Company’s claims against assets, death or disability of the borrower or loss of market for the borrower’s products or services.
Loans to Individuals and Leasing: The Company offers installment loans and reserve lines of credit to individuals. Installment loans are limited to $50,000 and lines of credit are generally limited to $5,000. These loans have terms up to 5 years with fixed or variable rates of interest. The rate of interest is dependent on the term of the loan and the type of collateral. The Company does not place an emphasis on originating these types of loans.
The Company also originates lease financing transactions. These transactions are primarily conducted with businesses, professionals and not-for-profit organizations and provide financing principally for office equipment, telephone systems, computer systems, energy saving improvements and other special use equipment. The terms vary depending on the equipment being leased, but are generally 3 to 5 years. The interest rate is dependent on the term of the lease, the type of collateral, and the overall credit of the customer.
Average net loans decreased $25.1 million or 1.4 percent to $1,714.3 million in 2010 from $1,739.4 million in 2009, which increased $256.2 million or 17.3 percent from $1,483.2 million in 2008. Gross loans decreased $84.1 million or 4.6 percent to $1,732.3 million at December 31, 2010 from $1,816.4 million at December 31, 2009, which increased $111.1 million or 6.5 percent from $1,705.3 million at December 31, 2008. The changes in gross loans resulted primarily from:
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Increases of $12.7 million and $140.7 million in 2010 and 2009, respectively, in commercial real estate mortgages. The increases were due to increased activity in commercial mortgages,
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Decrease of $81.3 million and an increase of $0.9 million in 2010 and 2009, respectively, in construction loans. The decrease in 2010 was due to increased payoffs, charge-offs and a lower volume of originations. The increase in 2009 resulted from a slightly higher volume of originations.
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Increases in residential real estate mortgages of $12.8 million and $45.1 million in 2010 and 2009, respectively, primarily as a result of increased activity principally in multi-family loans,
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Decreases of $29.6 million and $83.2 million in 2010 and 2009, respectively, in commercial and industrial loans. The decreases were primarily the result of lower loan volume due to the ongoing economic crisis.
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Increases of $6.3 million and $5.5 million in 2010 and 2009, respectively in other loans, and
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Decrease of $5.0 million and an increase of $2.3 million in 2010 and 2009, respectively, in lease financings.
Major classifications of loans, at December 31 are as follows:
The Company’s primary lending emphasis is for loans to businesses and developers, primarily in the form of commercial and multi-family residential real estate mortgages, construction loans, and commercial and industrial loans, including lines of credit. The Company will continue to emphasize these types of loans, which will enable the Company to meet the borrowing needs of businesses in the communities it serves. These loans are made at both fixed rates of interest and variable or floating rates of interest, generally based upon the Prime Rate as published in the Wall Street Journal. At December 31, 2010, the Company had total gross loans with fixed rates of interest of $1,173.8 million, or 67.8 percent of total loans, and total gross loans with variable or floating rates of interest of $558.5 million, or 32.2 percent of total loans, as compared to $1,134.1 million or 62.4 percent of total loans in fixed rate loans and $682.3 million or 37.6 percent of total loans in variable or floating rate loans at December 31, 2009.
At December 31, 2010 and 2009, the Company had approximately $195.1 million and $274.8 million, respectively, of committed but unissued lines of credit, commercial mortgages, construction loans and commercial and industrial loans.
The following table presents the maturities of loans outstanding at December 31, 2010 excluding loans to individuals, real estate mortgages (other than construction loans) and lease financings, and the amount of such loans by maturity date that have pre-determined interest rates and the amounts that have floating or adjustable rates.
It is the Company’s policy to discontinue the accrual of interest on loans when, in the opinion of management, a reasonable doubt exists as to the timely collectibility of the amounts due. Regulatory requirements generally prohibit the accrual of interest on certain loans when principal or interest is due and remains unpaid for 90 days or more, unless the loan is both well secured and in the process of collection.
The following table summarizes the Company’s non-accrual loans, loans past due 90 days or more, Other Real Estate Owned (“OREO”) and related interest income not recorded on non-accrual loans as of and for the years ended December 31:
There was no interest income on non-accrual loans included in net income for the years ended December 31, 2010, 2009 and 2008, respectively.
The following table is a summary of nonperforming assets as of December 31:
Non-accrual commercial real estate loans decreased $5.7 million to $15.3 million at December 31, 2010 from $21.0 million at December 31, 2009 which was an increase of $18.8 million from $2.2 million at December 31, 2008. The 2010 decrease resulted from the charge-off of twenty three loans totaling $12.8 million, the transfer of twelve loans totaling $9.5 million to loans held for sale, principal payments of $2.7 million, and the transfer of two loans totaling $2.5 million to other real estate owned. These decreases were partially offset by the transfer to non-accrual of 27 loans totaling $21.8 million. The 2009 increase resulted from the addition of seventeen loans totaling $30.3 million which was partially offset by the transfer of one loan totaling $6.0 million to other real estate owned, the charge-off of two loans totaling $2.8 million and principal payments of $2.7 million.
Non-accrual construction loans increased $5.6 million to $15.7 million at December 31, 2010 from $10.1 million at December 31, 2009, which was an increase of $7.3 million from $2.8 million at December 1, 2008. The 2010 increase resulted from the transfer of twenty one loans totaling $38.4 to non-accrual status. The increase was partially offset by the charge-off of twenty one loans totaling $17.0 million, the transfer of nine loans totaling $9.6 million to loans held for sale, principal payments of $2.5 million and the transfer of four loans totaling $3.7 million to other real estate owned. The 2009 increase resulted from the transfer of sixteen loans totaling
$14.7 million to non-accrual which was partially offset by the return of three loans totaling $3.9 million to accruing status, the transfer of two loans totaling $2.4 million to other real estate owned and the charge-off of four loans totaling $1.1 million.
Non-accrual residential real estate loans decreased $7.9 million to $7.7 million at December 31, 2010 from $15.6 million at December 31, 2009 which was an increase of $11.0 million from $4.6 million at December 31, 2008. The 2010 decrease was due to the charge-off of twenty five loans totaling $14.7 million, principal payments of $5.5 million, the transfer of four loans totaling $2.7 million to loans held for sale and the transfer of three loans totaling $4.0 million to other real estate owned. These decreases were partially offset by the transfer of twenty eight loans totaling $19.0 million to non-accrual. The 2009 increase resulted from the transfer of seventeen loans totaling $16.1 million to non-accrual, which was partially offset by principal payments of $2.4 million, the return of three loans totaling $1.5 million to accruing status and the charge-off of five loans totaling $1.2 million.
Non-accrual commercial and industrial loans increased $0.8 million to $4.6 million at December 31, 2010 from $3.8 million at December 31, 2009 which was an increase of $2.2 million from $1.6 million at December 31, 2008. The 2010 increase resulted from the transfer of twenty nine loans totaling $4.2 million which was partially offset by the charge-off of thirty loans totaling $2.8 million, the return of one loan totaling $0.4 million to accrual status, the transfer of one loan totaling $0.1 million to other real estate owned and principal payments of $0.1 million. The 2009 increase resulted from the transfer of thirty eight loans totaling $6.8 million to non-accrual which was partially offset by the charge off of thirty four loans totaling $4.4 million and principal payments of $0.1 million.
Non-accrual loans to individuals increased $0.3 million to $0.4 million at December 31, 2010 from $0.1 million at December 31, 2009 which was an increase of $0.1 million from December 31, 2008. The 2010 increase resulted from the transfer of seventeen loans totaling $1.3 million which was partially offset by the charge-off of fifteen loans totaling $1.0 million. The 2009 increase resulted from the transfer of eighteen loans totaling $0.2 million to non-accrual which were partially offset by the charge-off of sixteen loans totaling $0.1 million.
Loans past due 90 days or more and still accruing were $1.6 million, $6.9 million and $7.0 million at December 31, 2010, 2009 and 2008, respectively. In addition, we had $21.0 million, $32.0 million and $17.1 million of accruing loans that were 31-89 days delinquent at December 31, 2010, 2009 and 2008, respectively.
Other real estate owned increased $1.8 million to $11.0 million at December 31, 2010, which was an increase of $3.7 million to $9.2 million at December 31, 2009 from $5.5 million in 2008. The 2010 increase was due to the addition of six properties totaling $10.3 million which were partially offset by the sale of three properties totaling $6.6 million and a $1.9 million loss on the sale of one property. The 2009 increase was due to the addition of three properties totaling $8.4 million which was partially offset by the sale of two properties totaling $3.4 million and writedowns of $1.3 million.
The increase in nonperforming assets for 2010, compared to their respective prior year periods, has primarily resulted from the effects of the current severe economic downturn. During 2010 and 2009, the Company experienced severe increases in delinquent and nonperforming loans and a continuation of the slowdowns in repayment and declines in loan-to-value ratios on existing loans which began in the second half of 2008. The severity of the economic downturn during 2009 extended well beyond the sub-prime lending issue, and has resulted in severe declines in the demand for and values of virtually all commercial and residential real estate properties. These declines, together with the present shortage of available mortgage financing, have put downward pressure on overall asset quality of virtually all financial institutions, including the Company’s. Continuation or worsening of such conditions would have additional significant adverse effects on asset quality in the future.
At December 31, 2010, the Company had no commitments to lend additional funds to customers with non-accrual or restructured loan balances. Non-accrual loans decreased $6.9 million to $43.7 million at December 31, 2010, compared to $50.6 million at December 31, 2009, which increased $39.3 million compared to $11.3 million at December 31, 2008. Net income is adversely impacted by the level of non-accrual loans and other nonperforming assets caused by the deterioration of the borrowers’ ability to meet scheduled interest and principal payments. In addition to forgone revenue, the Company must increase the level of provision for loan losses, incur higher collection costs and other costs associated with the management and disposition of foreclosed properties.
In accordance with the “Receivables” Topic of the FASB Accounting Standards Codification, which establishes the accounting treatment of impaired loans, loans totaling $49.6 million, $50.6 million and $11.3 million at December 31, 2010, 2009 and 2008, respectively, have been measured based on the estimated fair value of the collateral since these loans are all collateral dependent. At December 31, 2010 and 2009, the total allowance for loan loss allocated to impaired loans and other identified loan problems was $0.9 million and $3.6 million, respectively. At December 31, 2008 there was no allowance for loan losses specifically allocated to impaired and other identified problem loans. The average recorded investment in impaired loans for the years ended December 31, 2010, 2009 and 2008 was approximately $64.4 million, $35.0 million and $12.3 million, respectively. Loans which have been renegotiated with a borrower experiencing financial difficulties for which the terms of the loan have been modified with a concession that the Company would not otherwise have granted are considered to be troubled debt restructurings (“TDRs”) and are included in impaired loans. Impaired loans as of December 31, 2010 and 2009 included $17.2 million and $0.6 million, respectively, of loans considered to be TDRs. At December 31, 2010, one TDR with a carrying amount of $5.9 million was on accrual status and performing in accordance with its modified terms. All other TDRs as of December 31, 2010 and 2009 were on nonaccrual status. There were no TDRs at December 31, 2008. Other pertinent data related to the Company’s loan portfolio are contained in Note 4 to the Company’s consolidated financial statements presented in this Form 10-K.
The Company performs extensive ongoing asset quality monitoring by both internal and independent loan review functions. In addition, the Company conducts timely remediation and collection activities through a network of internal and external resources which include an internal asset recovery department, real estate and other loan workout attorneys and external collection agencies. In addition, during the second quarter of 2010, the Company decided to implement a more aggressive workout strategy for the resolution of problem assets in light of a sluggish economic recovery, continued weakness in local real estate activity and market values and growing difficulty in resolving problem loans in a timely fashion through traditional foreclosure proceedings due to increased bankruptcy filings and overcrowded court systems. See “Allowance for Loan Losses” below for further discussion of this strategy. Management believes that these efforts are appropriate for accomplishing either successful remediation or maximizing collections related to nonperforming assets.
Allowance for Loan Losses
The Company maintains an allowance for loan losses to absorb probable losses incurred in the loan portfolio based on ongoing quarterly assessments of the estimated losses. The Company’s methodology for assessing the appropriateness of the allowance consists of a specific component for identified problem loans and a formula component to consider historical loan loss experience and additional risk factors affecting the portfolio.
A summary of the components of the allowance for loan losses, changes in the components and the impact of charge-offs/recoveries on the resulting provision for loan losses for the dates indicated is as follows:
The formula component is calculated by first applying historical loss experience factors to outstanding loans by type, excluding loans for which a specific allowance has been determined. This component is then adjusted to reflect additional risk factors not addressed by historical loss experience. These factors include the evaluation of then-existing economic and business conditions affecting the key lending areas of the Company and other conditions, such as new loan products, credit quality trends (including trends in nonperforming loans expected to result from existing conditions), collateral values, loan volumes and concentrations, specific industry conditions within portfolio segments that existed as of the balance sheet date and the impact that such conditions were believed to have had on the collectibility of the loan portfolio. Senior management reviews these conditions quarterly. Management’s evaluation of the loss related to these conditions is quantified by loan type and reflected in the formula component. The evaluations of the incurred loss with respect to these conditions is subject to a higher degree of uncertainty due to the subjective nature of such evaluations and because they are not identified with specific problem credits.
The specific component of the allowance for loan losses is the result of our analysis of impaired loans and our determination of the amount required to reduce the carrying amount of such loans to estimated fair value. Accordingly, such allowance is dependent on the particular loans and their characteristics at each measurement date, not necessarily the total amount of such loans. The Company usually records partial charge-offs as opposed to specific reserves for impaired loans that are real estate collateral dependent and for which independent appraisals have determined the fair value of the collateral to be less than the carrying amount of the loan. In 2010, the Company decided to implement a more aggressive workout strategy for the resolution of problem assets in light of a sluggish economic recovery, continued weakness in local real estate activity and market values and growing difficulty in resolving problem loans in a timely fashion through traditional foreclosure proceedings due to increased bankruptcy filings and overcrowded court systems. The severity of the decline in real estate values has provided new market opportunities for the disposition of distressed assets as investors search for yield in the current low interest rate environment and our more aggressive policy may be able to take advantage of those opportunities. As part of the revised resolution strategy, the Company has reevaluated each problem loan and has made a determination of net realizable value based on management’s estimation of the best probable outcome considering the individual characteristics of each asset against the likelihood of resolution with the current borrower, expectations for resolution through the court system, or other available market opportunities including potential loan sales. The effects of this new strategy are reflected in significant 2010 charge-offs, as well as in a $3.0 million increase in the formula component of the allowance at December 31, 2010 compared to December 31, 2009. The reduction in the specific component at December 31, 2010 resulted from partial charge-offs taken during 2010 on loans with specific reserves at December 31, 2009. On September 30, 2010, the Company transferred $21.9 million of nonperforming loans to the loans held for sale category. During the fourth quarter of 2010, a significant portion of the sale had been completed, leaving a balance of $7.1 million in “Nonperforming loans held for sale” in the December 31, 2010 Consolidated Balance Sheet. Loans held for sale are carried at the lower of cost or fair value. At December 31, 2010, the Company had $0.9 million of specific reserves allocated to three impaired loans. There were $3.6 million of specific reserves allocated to seven impaired loans as of December 31, 2009. The Company’s analyses as of December 31, 2010 and December 31, 2009 indicated that impaired loans were principally real estate collateral dependent and that, with the exception of those loans for which specific reserves were assigned, there was sufficient underlying collateral value or guarantees to indicate expected recovery of the carrying amount of the loans.
The changes in the formula component of the allowance for loan losses are the result of the application of historical loss experience to outstanding loans by type. Loss experience for each year is based upon average charge-off experience for the prior three year period by loan type. The formula component is then adjusted to reflect changes in other relevant factors affecting loan collectibility. Management periodically adjusted the formula component to an amount that, when considered with the specific component, represented its best estimate of probable losses in the loan portfolio as of each balance sheet date. The following are the major add-on factors which affected the changes in the formula component of the allowance for loan losses each year:
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Economic and business conditions - The volatility in energy costs and the cost of raw materials used in construction, the demand for and value of real estate, the primary collateral for the Company’s loans, and the level of real estate taxes within the Company’s market area, together with the general state of the economy, trigger economic uncertainty. While there continue to be some recent signs of increased activity in the real estate sectors of the market, persistent negative effects from the unprecedented economic downturn experienced in 2009 and 2008 have continued to negatively affect the cash flow of many of the Company’s customers in 2010. In addition, significant increases in filings of bankruptcy and foreclosure proceedings have overloaded the court systems and have resulted in what the Company believes to be unacceptable delays in attempts to obtain title to real estate and other collateral through conventional foreclosure which has resulted in the Company considering alternate strategies for problem loan resolution including loan sales. Although current indicators show that the economic downturn may have begun to turn around, recovery is expected to be a slow process. Also, despite evidence of recent improvement, there has been continued volatility in housing prices and the availability of mortgage financing continues to be limited. After considering the significant increase in the historical loss factor resulting from the impact of 2010 net charge-offs, the Company has continued to include an additional factor for adverse economic and business conditions in the determination of the formula component of the allowance. The aforementioned factors
were reduced slightly during 2010 from December 2009 levels due to management’s judgment of limited improvement in major economic indicators, and have remained unchanged since then, due to the continuing lag effect of the economic downturn offsetting the improvements in the economic indicators.
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Concentration - The primary collateral for the Company’s loans is real estate, particularly commercial real estate. The economic downturn has had a severe negative effect on activity and values throughout the real estate industry, which has heightened risk associated with this concentration. Therefore, consideration of the changes in levels of risk associated with concentrations resulting from adverse conditions in the marketplace is part of the determination of the formula component of the allowance. As result of charge-offs, paydowns and reduced production of new loans, concentrations in construction loans have been significantly reduced, and concentrations in commercial real estate loans have grown slightly. After considering the significant increase in the historical loss factor resulting from 2010 net charge-offs and the overall reduction in total construction loans, in the third quarter the Company slightly reduced the additional factor for concentrations in construction compared to December 2009. The additional factor for concentration in commercial real estate was maintained at the December 2009 level as there was no significant change in the concentration.
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Collateral Values - Real estate loans in general have taken on a heightened degree of risk during the recent economic downturn. Underlying values of real estate have generally declined throughout 2010 both nationally and within our local market area. Construction loans, in particular, have a higher degree of risk than other types of loans which the Company makes, since repayment of the loans is generally dependent on the borrowers’ ability to successfully construct and sell or lease completed properties. After considering the significant increase in the historical loss factor resulting from 2010 net charge-offs, the Company increased the additional factor for real estate values on construction loans and commercial real estate loans in the first two quarters of 2010. This increase was designed at that time to reflect significant valuation adjustments expected to result from the loan sale being contemplated as part of the Company’s more aggressive strategy on loan resolution which began in the second quarter of 2010. Upon completion of partial charge-offs related to the valuation adjustments related to the sale, the additional factors were reduced in the third quarter, and maintained for the remainder of the 2010 at a level slightly above the amounts of December 2009. The additional factor for residential real estate values had been higher than that for commercial real estate in December 2009 as the impact of the financial downturn on the Company’s residential portfolio had been felt earlier in the cycle. The additional factor however was increased in the second quarter of 2010 as certain nonperforming residential loans were also being considered for sale. Upon completion of partial charge-offs related to the sale, the additional factor was reduced in the third quarter, and maintained for the remainder of 2010 at the December 2009 level.
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Asset quality - Changes in the amount of nonperforming loans, classified loans, delinquencies, and the results of the Company’s periodic loan review process are also considered in the process of determining the formula component. During the year ended December 31, 2010, the lagging effects of the economic downturn within the economy and our local market area have had negative effects on the Company’s loans. Significant charge-offs have continued to increase the historical loss factor used for determination of the formula component of the allowance, and continued additions to nonperforming assets and fluctuating delinquency, have added additional economic uncertainty, although the Company has experienced some recent improvement in overall delinquencies. After considering the significant increase in the historical loss factor resulting from 2010 net charge-offs, in the third quarter of 2010 the Company reduced the additional factors for charge-offs compared to December 31, 2009 as management believes the impact of the level of charge-offs recorded in 2010 have had more than a sufficient impact on the historical loss factor. This level was maintained for the remainder of 2010. The additional factors for delinquency and extension risk were generally reduced slightly below December 2009 levels by the third quarter of 2010, reflective of general improvement in delinquency levels after the aggressive resolution strategy implemented in the second quarter. This level was maintained in the fourth quarter as there was no evidence to warrant further adjustment to the factor after considering the combination of the increase in the historical loss factor and the changes in the delinquency pipeline.
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Nature of Portfolio Volume - We purchase loan participations from a number of banks, including some outside our primary market area. While we review each loan and make our own determination regarding whether to participate in the loan, we rely on the other bank’s knowledge of their customer and marketplace.
Due to the severely negative impact that the recent economic downturn has had on the financial services industry, risk associated with participation with other financial institutions has increased. The Company also recognizes potential risk differentials between different types of collateral within portfolios. Owner occupied versus non owner occupied real estate and primary versus secondary liens are examples. The potential impact of these factors on any probable losses with respect to nature of portfolio volume is considered in the determination of the formula component of the allowance for loan losses. Despite the significant increase in the historical loss factor resulting from 2010 net charge-offs, the Company has maintained or, in the case of the additional factor for Commercial Real Estate, slightly reduced the additional factors for nature of portfolio volume compared to December 31, 2009 in the determination of the formula component of the allowance, as it does not believe that there has been significant changes in these risk factors during 2010.
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Economic and business conditions - The volatility in energy costs and the cost of raw materials used in construction, the demand for and value of real estate, the primary collateral for the Company’s loans, and the level of real estate taxes within the Company’s market area, together with the general state of the economy, trigger economic uncertainty. During 2009, these factors generally continued to worsen, particularly in the second quarter. Although there may be indications that the economic downturn has bottomed out, we believe any economic recovery will be a slow process. In addition, during the fourth quarter of 2008 and continuing through 2009, housing prices have significantly declined and the availability of mortgage financing continues to be limited. We have considered these trends in determining the formula component of the allowance for loan losses.
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Concentration - The primary collateral for the Company’s loans is real estate, particularly commercial real estate. The current economic downturn has had a severely negative effect on activity and values throughout the real estate industry, which has heightened risk associated with this concentration. Therefore, consideration of the changes in levels of risk associated with concentrations resulting from adverse conditions in the marketplace is part of the determination of the formula component of the allowance.
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Credit risk - Construction loans currently have a higher degree of risk than other types of loans which the Company makes, since repayment of the loans is generally dependent on the borrowers’ ability to successfully construct and sell or lease completed properties. Changes in concentration and the associated changes in various risk factors are considered in the determination of the formula component of the allowance. During the year ended December 31, 2009, the market for new construction has continued to slow significantly in the Company’s primary market area. Houses are taking longer to sell and prices have declined. We have considered these trends in determining the formula component of the allowance for loan losses.
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Asset quality - Changes in the amount of nonperforming loans, classified loans, delinquencies, and the results of the Company’s periodic loan review process are also considered in the process of determining the formula component. During the year ended December 31, 2009, nonperforming assets and delinquencies increased substantially. We believe the overall increase in nonperforming assets in 2009 is due to lagging effects of the economic downturn within the economy and our local market area.
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Loan Participations - We purchase loan participations from a number of banks, including some outside our primary market area. While we review each loan and make our own determination regarding whether to participate in the loan, we rely on the other bank’s knowledge of their customer and marketplace. Since many of these relationships are new, we do not yet have an established record of performance and, therefore, any probable losses with respect to these new loan participation relationships is considered in the determination of the formula component of the allowance for loan losses
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Economic and business conditions - The volatility in energy costs and the cost of raw materials used in construction, the demand for and value of real estate, the primary collateral for the Company’s loans, and the level of real estate taxes within the Company’s market area, together with the general state of the economy, trigger economic uncertainty. During the year ended December 31, 2008, these factors have generally
worsened. Further deterioration in the economy in general and business conditions in the Company’s primary market area continue. During the fourth quarter, housing prices have significantly declined and the availability of mortgage financing is limited. We have considered these trends in determining the formula component of the allowance for loan losses.
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Credit risk - Construction loans currently have a higher degree of risk than other types of loans which the Company makes, since repayment of the loans is generally dependent on the borrowers’ ability to successfully construct and sell or lease completed properties. Changes in concentration and the associated changes in various risk factors are considered in the determination of the formula component of the allowance. During the year ended December 31, 2008, the market for new construction has slowed significantly in the Company’s primary market area. Houses are taking longer to sell and prices have declined. We have considered these trends in determining the formula component of the allowance for loan losses.
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Asset quality - Changes in the amount of nonperforming loans, classified loans, delinquencies, and the results of the Company’s periodic loan review process are also considered in the process of determining the formula component. During the year ended December 31, 2008, nonperforming assets increased. We believe this increase is due to current trends within the economy and our local market area.
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Loan Participations - We will purchase loan participations from a number of banks, including some outside our primary market area. While we review each loan and make our own determination regarding whether to participate in the loan, we rely on the other bank’s knowledge of their customer and marketplace. Since many of these relationships are new, we do not yet have an established record of performance and, therefore, any probable losses with respect to these new loan participation relationships is considered in the determination of the formula component of the allowance for loan losses.
A summary of the allowance for loan losses for each of the prior five years ended December 31, is as follows:
In determining the allowance for loan losses, in addition to historical loss experience and the other relevant factors disclosed above, management considers changes in net charge-offs during the year.
The distribution of our allowance for loan losses at the years ended December 31, is summarized as follows:
Actual losses can vary significantly from the estimated amounts. The Company’s methodology permits adjustments to the allowance in the event that, in management’s judgment, significant factors which affect the collectibility of the loan portfolio as of the evaluation date have changed. By assessing the estimated losses probable in the loan portfolio on a quarterly basis, the Bank is able to adjust specific and probable loss estimates based upon any more recent information that has become available. Other pertinent information related to the Company’s
allowance for loan losses is contained in Note 4 to the Company’s consolidated financial statements presented in this Form 10-K.
Management believes the allowance for loan losses is the best estimate of probable losses which have been incurred as of December 31, 2010. There is no assurance that the Company will not be required to make future adjustments to the allowance in response to changing economic conditions or regulatory examinations.
The Company recorded a provision for loan losses of $46.5 million during 2010, $24.3 million for 2009 and $11.0 million in 2008. The provision for loan losses is charged to income to bring the Company’s allowance for loan losses to a level deemed appropriate by management based on the factors previously discussed under “Allowance for Loan Losses.”
Deposits
The Company’s fundamental source of funds supporting interest earning assets is deposits, consisting of non interest bearing demand deposits, checking with interest, money market, savings and various forms of time deposits. The maintenance of a strong deposit base is key to the development of lending opportunities and creates long term customer relationships, which enhance the ability to cross sell services. Depositors include businesses, professionals, municipalities, not-for-profit organizations and individuals. To meet the requirements of a diverse customer base, a full range of deposit instruments are offered, which has allowed the Company to maintain and expand its deposit base despite intense competition from other banking institutions and non-bank financial service providers.
Total deposits at December 31, 2010 increased $61.8 million or 2.8 percent to $2,234.4 million, from $2,172.6 million at December 31, 2009, which increased $333.3 million or 18.1 percent from $1,839.3 million at December 31, 2008. In 2009, approximately $101 million of this growth resulted from the transfer of certain money market mutual fund investments of existing customers to interest bearing demand deposits. This transfer was primarily due to the recent increase in FDIC insurance coverage of certain deposit products which was part of the legislation enacted in response to the current economic crisis. In addition to the above mentioned deposit growth, the Company also experienced significant growth in new customers both in existing branches and new branches added during 2009 and 2010. This growth was partially offset by some declines in balances of existing customers, primarily those customers directly involved in or supported by the real estate industry. Proceeds from deposit growth were used primarily to reduce long term and short term borrowings and to fund loan growth. The Company had no brokered certificates of deposit at December 31, 2010 and December 31, 2009.
The following table presents a summary of deposits at December 31:
At December 31, 2010 and 2009, certificates of deposit including other time deposits of $100,000 or more totaled $188.3 million and $206.0 million, respectively. At December 31, 2010 and 2009 such deposits classified by time remaining to maturity were as follows:
Time deposits of over $100,000, including municipal CD’s, decreased $0.3 million at December 31, 2010 and decreased $11.7 million at December 31, 2009, respectively, compared to the prior year end balances. These CD’s are primarily short term and are acquired on a bid basis. Time deposits of over $100,000 generally have maturities of 7 to 180 days.
The Company also utilizes wholesale borrowings, brokered deposits and other sources of funds interchangeably with time deposits in excess of $100,000 depending upon availability and rates paid for such funds at any point in time. Due to the generally short maturity of these funding sources, the Company can experience higher volatility of interest margins during periods of both rising and declining interest rates. At December 31, 2010 and 2009, the Company had no brokered deposits.
The following table summarizes the average amounts and rates of various classifications of deposits for the periods indicated:
Average deposits outstanding increased $243.7 million or 11.7 percent to $2,322.2 million in 2010 from $2,078.5 million in 2009, which increased $301.5 million or 17.0 percent from $1,777.0 million in 2008.
Average non interest bearing deposits increased $69.3 million or 10.3 percent to $745.3 million in 2010 from $676.0 in 2009 which increased $50.4 million or 8.1 percent from $625.6 million in 2008. These increases reflect the Company’s continuing emphasis on developing this funding source. Average interest bearing deposits in 2010 increased $174.4 million or 12.4 percent reflecting increases in money market accounts, checking with interest accounts and savings accounts partially offset by decreases in time deposits. Average interest bearing deposits in 2009 increased $251.1 million or 21.8 percent reflecting increases in checking with interest accounts, money market accounts, and time deposits partially offset by decreases in savings accounts.
Average money market deposits increased $139.4 million or 17.7 percent in 2010 and $144.5 million or 22.5 percent in 2009, due in part to new customer accounts, increased activity in existing accounts, and the addition of new branches.
Average checking with interest deposits increased $82.0 million or 32.8 percent in 2010 and increased $100.5 million or 67.1 percent in 2009. These increases were due to new account activity and increased activity in existing accounts. The increased activity in existing accounts, particularly in 2009, resulted partially from the increase in FDIC insurance coverage of certain deposit products which was part of legislation enacted in response to the ongoing economic crisis.
Average time deposits decreased $60.8 million or 23.1 percent in 2010 and $0.4 million or 0.2 percent in 2009. The decreases in both 2010 and 2009 were due to decreased activity in existing accounts due to the current low interest rate environment.
Average savings deposit balances increased $13.8 million or 13.6 percent in 2010 and increased $6.5 million or 6.8 percent in 2009. The increases in both 2010 and 2009 were a result of new customer accounts, increased activity in existing accounts and the addition of new branches.
Borrowings
The Company’s borrowings with original maturities of one year or less totaled $36.6 million and $53.1 million at December 31, 2010 and 2009, respectively. Such short-term borrowings consisted of $36.1 million of customer repurchase agreements and note options on Treasury, tax and loan of $0.5 million at December 31, 2010 and $52.6 million of customer repurchase agreements, and note options on Treasury, tax and loan of $0.5 million at December 31, 2009. The decrease was due to reductions in overnight borrowings as a result of deposit growth and runoff of the securities portfolio in excess of loan growth. Other borrowings totaled $87.8 million and $123.8 million at December 31, 2010 and 2009, respectively, which consisted of fixed rate borrowings of $66.5 million and $102.5 million from the FHLB with initial stated maturities of five or ten years and one to four year call options and non callable FHLB borrowings of $21.3 million and $21.3 million at December 31, 2010 and 2009, respectively. The callable borrowings from FHLB mature beginning in 2010 through 2016. The FHLB has the right to call all of such borrowings at various dates in 2010 and quarterly thereafter. A non callable borrowing of $1.3 million matures in 2027 and a non callable borrowing of $20.0 million matures in 2011. Our FHLB term borrowings are subject to prepayment penalties under certain circumstances in the event of prepayment.
Interest expense on all borrowings totaled $5.5 million, $7.7 million and $11.0 million in 2010, 2009 and 2008, respectively. As of December 31, 2010 and 2009, these borrowings were collateralized by loans and securities with an estimated fair value of $267.0 million and $206.0 million, respectively.
The following table summarizes the average balances, weighted average interest rates and the maximum month-end outstanding amounts of the Company’s borrowings for each of the years set forth below:
HVB is a member of the FHLB. As a member, HVB is able to participate in various FHLB borrowing programs which require certain investments in FHLB common stock as a prerequisite to obtaining funds. As of December 31,
2010, HVB had short-term borrowing lines with the FHLB of $200 million with no amounts outstanding. These and various other FHLB borrowing programs available to members are subject to availability of qualifying loan and/or investment securities collateral and other terms and conditions.
HVB also has unsecured overnight borrowing lines totaling $70 million with three major financial institutions which were all unused and available at December 31, 2010. In addition, HVB has approved lines under Retail Certificate of Deposit Agreements with three major financial institutions totaling $944 million of which no balances were outstanding as at December 31, 2010. Utilization of these lines are subject to product availability and other restrictions.
Additional liquidity is also provided by the Company’s ability to borrow from the Federal Reserve Bank’s discount window. In response to the current economic crisis, the Federal Reserve Bank has increased the ability of banks to borrow from this source through its Borrower-in-Custody (“BIC”) program, which expanded the types of collateral which qualify as security for such borrowings. HVB has been approved to participate in the BIC program. There were no balances outstanding with the Federal Reserve at December 31, 2010.
As of December 31, 2010, the Company had qualifying loan and investment securities totaling approximately $311.8 million which could be utilized under available borrowing programs thereby increasing liquidity.
Capital Resources
Stockholders’ equity decreased $3.8 million or 1.3 percent to $289.9 million at December 31, 2010 from $293.7 million at December 31, 2009, which increased $86.2 million or 41.5 percent from $207.5 million at December 31, 2008. The 2010 decrease resulted from cash dividends of $11.4 which was partially offset by net income of $5.1 million, net proceeds from exercises of stock options of $0.8 million and an increase of accumulated other comprehensive income of $1.7 million. The 2009 increase resulted from proceeds from a public offering of common stock of $93.3 million, net income of $19.0 million, an increase in accumulated other comprehensive income of $4.4 million and net proceeds from stock options exercised of $0.8 million partially offset by cash dividends paid of $15.7 million and purchases of treasury stock of $15.6 million.
The Company sold 3,993,395 shares of common stock at an issue price of $25.00 per share in an underwritten common stock offering during the fourth quarter of 2009. Net proceeds from the offering were $93.3 million. In conjunction with this common stock offering, the Company listed its common stock on the NASDAQ Global Select Market under the symbol “HUVL”. Concurrent with listing its common stock on the NASDAQ, the Company lifted all restrictions on transferability of its common stock that previously applied to certain shareholders and a majority of the shares outstanding. A total of $59.0 million of the net proceeds from this offering was contributed to HVB increasing the Bank’s capital ratios, as required of the Bank by the OCC, to levels in excess of “well capitalized” levels generally applicable to banks under current regulations. See further discussion in “Supervision and Regulation” under Item 1 of this Annual Report on Form 10-K. The remaining net proceeds of this offering are available for general corporate purposes.
The Company paid its first cash dividend in 1996, and the Board of Directors authorized a quarterly cash dividend policy in the first quarter of 1998. HVB’s payment of dividends to the Company, the Company’s primary source of funds, is subject to limitation by federal and state regulators based on such factors as the maintenance of adequate capital, which could reduce the amount of dividends otherwise payable. See “Business - Supervision and Regulation.”
The various components and changes in stockholders’ equity are reflected in the Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2010, 2009 and 2008 included elsewhere herein.
Management believes that future retained earnings will provide the necessary capital for current operations and the planned growth in total assets.
The Board of Governors of the Federal Reserve System issued a supervisory letter dated February 24, 2009 to bank holding companies that contains guidance on when the board of directors of a bank holding company should eliminate, defer or severely limit dividends including, for example, when net income available for shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the
dividends. The letter also contains guidance on the redemption of stock by bank holding companies which urges bank holding companies to advise the Federal Reserve of any such redemption or repurchase of common stock for cash or other value which results in the net reduction of a bank holding company’s capital during the quarter.
All banks and bank holding companies are subject to risk-based capital guidelines. These guidelines define capital as Tier 1 and Total capital. Tier 1 capital consists of common stockholders’ equity and qualifying preferred stock, less intangibles; and Total capital consists of Tier 1 capital plus the allowance for loan losses up to certain limits, preferred stock and certain subordinated and term-debt securities. The guidelines require a minimum total risk-based capital ratio of 8.0 percent, and a minimum Tier 1 risk-based capital ratio of 4.0 percent. Banks and bank holding companies must also maintain a minimum leverage ratio of 4 percent, which consists of Tier 1 capital based on risk-based capital guidelines, divided by average tangible assets (excluding intangible assets that were deducted to arrive at Tier 1 capital). In today’s economic and regulatory environment, banking regulators, including the OCC, which is the primary federal regulator of the Bank, are directing greater scrutiny to banks with higher levels of commercial real estate loans. Due to the high percentage of commercial real estate loans in our portfolio, we are among the banks subject to such greater regulatory scrutiny. As a result of this concentration, the increase in the level of our non-performing loans, and the potential for further possible deterioration in our loan portfolio, the OCC required HVB to maintain, since December 31, 2009, a total risk-based capital ratio of at least 12.0 percent (compared to 10.0 percent for a well capitalized bank), a Tier 1 risk-based capital ratio of at least 10.0 percent (compared to 6.0 percent for a well capitalized bank), and a Tier 1 leverage ratio of at least 8.0 percent (compared to 5.0 percent for a well capitalized bank). These capital levels are in excess of “well capitalized” levels generally applicable to banks under current regulations.
The capital ratios at December 31, are as follows:
Management intends to conduct the affairs of the Bank so as to maintain a strong capital position in the future.
Liquidity
The Asset/Liability Strategic Committee (“ALSC”) of the Board of Directors of HVB establishes specific policies and operating procedures governing the Company’s liquidity levels and develops plans to address future liquidity needs, including contingent sources of liquidity. The primary functions of asset liability management are to provide safety of depositor and investor funds, assure adequate liquidity and maintain an appropriate balance between interest earning assets and interest bearing liabilities. Liquidity management involves the ability to meet the cash flow requirement of depositors wanting to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. Interest rate sensitivity management seeks to manage fluctuating net interest margins and to enhance consistent growth of net interest income through periods of changing interest rates.
The Company’s liquid assets, at December 31, 2010, include cash and due from banks of $284.2 million and Federal funds sold of $72.1 million. Federal funds sold represents the Company’s excess liquid funds that are invested with other financial institutions in need of funds and which mature daily.
Other sources of liquidity include maturities and principal and interest payments on loans and securities. The loan and securities portfolios provide a constant stream of maturing assets and reinvestable cash flows, which can be converted into cash should the need arise. The ability to redeploy these funds is an important source of medium to long term liquidity. The amortized cost of securities having contractual maturities, expected call dates or average lives of one year or less amounted to $110.1 million at December 31, 2010. This represented 24.1 percent of the amortized cost of the securities portfolio. Excluding installment loans to individuals, real estate loans other than construction loans and lease financing, $257.4 million, or 14.9 percent of loans at December 31, 2010, mature in one year or less. The Company may increase liquidity by selling certain residential mortgages, or exchanging them for mortgage-backed securities that may be sold in the secondary market.
Non interest bearing demand deposits and interest bearing deposits from businesses, professionals, not-for-profit organizations and individuals are a relatively stable, low-cost source of funds. The deposits of the Bank generally have shown a steady growth trend as well as a generally consistent deposit mix. However, there can be no assurance that deposit growth will continue or that the deposit mix will not shift to higher rate products.
The Bank is a member of the FHLB. As such, we are able to participate in various FHLB borrowing programs which require certain investments in FHLB common stock as a prerequisite to obtaining funds. As of December 31, 2010, HVB had short-term borrowing lines with the FHLB of $200 million with no balances outstanding. These and various other FHLB borrowing programs available to members are subject to availability of qualifying loan and/or investment securities collateral and other terms and conditions.
The Bank also has unsecured overnight borrowing lines totaling $70.0 million with three major financial institutions which were all unused and available at December 31, 2010. In addition, HVB has approved lines under Retail Certificate of Deposit Agreements with three major financial institutions totaling approximately $944 million which were also unused and available at December 31, 2010. The retail certificates of deposit lines are subject to product availability and other restrictions.
Additional liquidity is also provided by the Bank’s ability to borrow from the Federal Reserve Bank’s discount window. In response to the current economic crisis, the Federal Reserve Bank has increased the ability of banks to borrow from this source through its Borrower-in-Custody (“BIC”) program, which expanded the types of collateral which qualify as security for such borrowings. The Bank has been approved to participate in the BIC program. There were no amounts outstanding with the Federal Reserve at December 31, 2010.
The various borrowing programs discussed above are subject to certain restrictions and terms and conditions which may include continued availability of such borrowing programs, the Company’s ability to pledge qualifying collateral in sufficient amounts, the Company’s maintenance of capital ratios acceptable to these lenders and other conditions which may be imposed on the Company.
As of December 31, 2010, the Company had qualifying loan and investment securities totaling approximately $311.8 million which could be utilized under available borrowing programs thereby increasing liquidity.
The Company also has outstanding, at any time, a significant number of commitments to extend credit and provide financial guarantees to third parties. These arrangements are subject to strict credit control assessments. Guarantees specify limits to the Company’s obligations. Because many commitments and almost all guarantees expire without being funded in whole or in part, the contract amounts are not estimates of future cash flows. The Company is also obligated under leases or license agreements for certain of its branches and equipment.
A summary of significant long-term contractual obligations and credit commitments at December 31, 2010 follows:
(1) Interest not included.
FHLB borrowings are presented in the above table by contractual maturity date. The FHLB has rights, under certain conditions, to call $30.0 million of those borrowings as of various dates during 2011 and quarterly thereafter.
The Company pledges certain of its assets as collateral for deposits of municipalities and other deposits allowed or required by law, FHLB and FRB borrowings and repurchase agreements. By utilizing collateralized funding sources, the Company is able to access a variety of cost effective sources of funds. The assets pledged consist of certain loans secured by real estate, U.S. Treasury and government agency securities, mortgage-backed securities, certain obligations of state and political subdivisions and other securities. Management monitors its liquidity requirements by assessing assets pledged, the level of assets available for sale, additional borrowing capacity and other factors. Management does not anticipate any negative impact to its liquidity from its pledging activities.
Another source of funding for the Company is capital market funds, which includes common stock, preferred stock, convertible debentures, retained earnings and long-term debt qualifying as regulatory capital.
Each of the Company’s sources of liquidity is vulnerable to various uncertainties beyond the control of the Company. Scheduled loan and security payments are a relatively stable source of funds, while loan and security prepayments and calls, and deposit flows vary widely in reaction to market conditions, primarily prevailing interest rates. Asset sales are influenced by general market interest rates and other unforeseen market conditions. The Company’s ability to borrow at attractive rates is affected by its financial condition and other market conditions.
Management expects that the Company has and will have sources of liquidity to meet any expected funding needs and also to be responsive to changing interest rate markets.
Quarterly Results of Operations
Set forth below are certain quarterly results of operations for 2010 and 2009 (in thousands except for per share amounts):
Forward-Looking Statements
The Company has made, and may continue to make, various forward-looking statements with respect to earnings, credit quality and other financial and business matters for periods subsequent to December 31, 2010. The Company cautions that these forward-looking statements are subject to numerous assumptions, risks and uncertainties, and that statements relating to subsequent periods increasingly are subject to greater uncertainty because of the increased likelihood of changes in underlying factors and assumptions. Actual results could differ materially from 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 disclosed in this Annual Report on Form 10-K include, but are not limited to, statements regarding:
•
further increases in our non-performing loans and allowance for loan losses;
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our ability to manage our commercial real estate portfolio;
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the future performance of our investment portfolio;
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our opportunities for growth, our plans for expansion (including opening new branches) and the competition we face in attracting and retaining customers;
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economic conditions generally and in our market area in particular, which may affect the ability of borrowers to repay their loans and the value of real property or other property held as collateral for such loans;
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demand for our products and services;
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possible impairment of our goodwill and other intangible assets;
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our ability to manage interest rate risk;
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the regulatory environment in which we operate, our regulatory compliance and future regulatory requirements;
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our intention and ability to maintain regulatory capital above the levels required by the OCC for the Bank and the levels required for us to be “well-capitalized”, or such higher capital levels as may be required;
•
proposed legislative and regulatory action affecting us and the financial services industry;
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legislative and regulatory actions (including the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act and related regulations) subject us to additional regulatory oversight which may result in increased compliance costs and/or require us to change our business model;
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future FDIC special assessments or changes to regular assessments;
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our ability to raise additional capital in the future;
•
potential liabilities under federal and state environmental laws; and
•
limitations on dividends payable by the Company or the Bank.
We assume no obligation for updating any such forward-looking statements at any given time.
ITEM 7A
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the potential for economic losses to be incurred on market risk sensitive instruments arising from adverse changes in market indices such as interest rates, foreign currency exchange rates and commodity prices. Since all Company transactions are denominated in U.S. dollars with no direct foreign exchange or changes in commodity price exposures, the Company’s primary market risk exposure is interest rate risk.
Interest rate risk is the exposure of net interest income to changes in interest rates. Interest rate sensitivity is the relationship between market interest rates and net interest income due to the repricing characteristics of assets and liabilities. If more liabilities than assets reprice in a given period (a liability-sensitive position or “negative gap”), market interest rate changes will be reflected more quickly in liability rates. If interest rates decline, such positions will generally benefit net interest income. Alternatively, where assets reprice more quickly than liabilities in a given period (an asset-sensitive position or “positive gap”), a decline in market rates could have an adverse effect on net interest income. Excessive levels of interest rate risk can result in a material adverse effect on the Company’s future financial condition and results of operations. Accordingly, effective risk management techniques that maintain interest rate risk at prudent levels is essential to the Company’s safety and soundness.
The Company has no financial instruments entered into for trading purposes. Federal funds, both purchases and sales, on which rates change daily, and loans and deposits tied to certain indices, such as the prime rate and federal discount rate, are the most market sensitive and have the most stable fair values. The least sensitive instruments include long-term fixed rate loans and securities and fixed rate savings deposits, which have the least stable fair value. On those types falling between these extremes, the management of maturity distributions is as important as the balances maintained. Management of maturity distributions involve the matching of interest rate maturities, as well as principal maturities, and is a key determinant of net interest income. In periods of rapidly changing interest rates, an imbalance (“gap”) between the rate sensitive assets and liabilities can cause major fluctuations in net interest income and in earnings. Establishing patterns of sensitivity which will enhance future growth regardless of frequent shifts in the market conditions is one of the objectives of the Company’s asset/liability management strategy.
Evaluating the Company’s exposure to changes in interest rates is the responsibility of ALSC and includes assessing both the adequacy of the management process used to control interest rate risk and the quantitative level of exposure. When assessing the interest rate risk management process, the Company seeks to ensure that appropriate policies, procedures, management information systems and internal controls are in place to maintain interest rate risk at appropriate levels. Evaluating the quantitative level of interest rate risk exposure requires the Company to assess the existing and potential future effects of changes in interest rates on its consolidated financial condition, including capital adequacy, earnings, liquidity and asset quality.
The Company uses the simulation analysis to estimate the effect that specific movements in interest rates would have on net interest income. This analysis incorporates management assumptions about the levels of future balance sheet trends, different patterns of interest rate movements, and changing relationships between interest rates (i.e. basis risk). These assumptions have been developed through a combination of historical analysis and future expected pricing behavior. For a given level of market interest rate changes, the simulation can consider the impact of the varying behavior of cash flows from principal prepayments on the loan portfolio and mortgage-backed securities, call activities on investment securities, balance changes on non contractual maturity deposit products (demand deposits, checking with interest, money market and savings accounts), and embedded option risk by taking into account the effects of interest rate caps and floors. The impact of planned growth and anticipated new business activities is not integrated into the simulation analysis. The Company can assess the results of the simulation and, if necessary, implement suitable strategies to adjust the structure of its assets and liabilities to reduce potential unacceptable risks to net interest income. The simulation analysis at December 31, 2010 shows the Company’s net interest income increasing slightly if rates rise and decreasing slightly if rates fall.
The Company’s policy limit on interest rate risk is that if interest rates were to gradually increase or decrease 200 basis points from current rates, the percentage change in estimated net interest income for the subsequent 12 month measurement period should not decline by more than 5.0 percent. Net interest income is forecasted using various interest rate scenarios that management believes are reasonably likely to impact the Company’s financial condition. A base case scenario, in which current interest rates remain stable, is used for comparison to other
scenario simulations. The table below illustrates the estimated exposures under a rising rate scenario and a declining rate scenario calculated as a percentage change in estimated net interest income from the base case scenario, assuming a gradual shift in interest rates for the next 12 month measurement period, beginning December 31, 2010 and 2009.
Beginning on March 31, 2008, a 100 basis point downward change was substituted for the 200 basis point downward scenario previously used, as management believes that a 200 basis point downward change is not a meaningful analysis in light of current interest rate levels. The percentage change in estimated net income in the +200 and −100 basis points scenario is within the Company’s policy limits.
As with any method of measuring interest rate risk, there are certain limitations inherent in the method of analysis presented. Actual results may differ significantly from simulated results should market conditions and management strategies, among other factors, vary from the assumptions used in the analysis. The model assumes that certain assets and liabilities of similar maturity or period to repricing will react the same to changes in interest rates, but, in reality, they may react in different degrees to changes in market interest rates. Specific types of financial instruments may fluctuate in advance of changes in market interest rates, while other types of financial instruments may lag behind changes in market interest rates. Additionally, other assets, such as adjustable-rate loans, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. Furthermore, in the event of a change in interest rates, expected rates of prepayments on loans and securities and early withdrawals from time deposits could deviate significantly from those assumed in the simulation.
One way to minimize interest rate risk is to maintain a balanced or matched interest rate sensitivity position. However, profits are not always maximized by matched funding. To increase net interest earnings, the Company selectively mismatches asset and liability repricing to take advantage of short-term interest rate movements and the shape of the U.S. Treasury yield curve. The magnitude of the mismatch depends on a careful assessment of the risks presented by forecasted interest rate movements. The risk inherent in such a mismatch, or gap, is that interest rates may not move as anticipated.
Interest rate risk exposure is reviewed in quarterly meetings in which guidelines are established for the following quarter and the longer term exposure. The structural interest rate mismatch is reviewed periodically by ALSC and management.
The Company also prepares a static gap analysis. Balance sheet items are appropriately categorized by contractual maturity, expected average lives for mortgage-backed securities, or repricing dates, with prime rate indexed loans and certificates of deposit. Checking with interest accounts, savings accounts, money market accounts and other borrowings constitute the bulk of the floating rate category. The determination of the interest rate sensitivity of non contractual items is arrived at in a subjective fashion. Savings accounts are viewed as a relatively stable source of funds and are therefore classified as intermediate funds.
At December 31, 2010, the “Static Gap” showed a positive cumulative gap of $271.8 million in the one day to one year repricing period, as compared to a positive cumulative gap of $191.6 million at December 31, 2009. The change in the cumulative static gap between December 31, 2010 and December 31, 2009 reflects the results of the Company’s efforts to reposition its portfolios as a result of changes in interest rates and changes to the shape of the yield curve. Management believes that this strategy has enabled the Company to be well positioned for the next cycle of interest rate changes and to address conditions which may arise as a result of the current financial crisis.
ITEM 8
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Directors and Stockholders of
Hudson Valley Holding Corp.
Yonkers, New York
We have audited the accompanying consolidated balance sheets of Hudson Valley Holding Corp. and Subsidiaries as of December 31, 2010 and 2009 and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2010. We also have audited Hudson Valley Holding Corp. and Subsidiaries’ internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Hudson Valley Holding Corp. and Subsidiaries’ management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control Over Financial Reporting located in Item 9A of this accompanying Form 10-K. Our responsibility is to express an opinion on these financial statements and an opinion on the company’s internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. 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 audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
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.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Hudson Valley Holding Corp. and Subsidiaries as of December 31, 2010 and 2009 and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, Hudson Valley Holding Corp. and Subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
/s/ Crowe Horwath LLP
New York, New York
March 16, 2011
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
For the years ended December 31, 2010, 2009 and 2008
Dollars in thousands, except per share amounts
See notes to consolidated financial statements.
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the years ended December 31, 2010, 2009 and 2008
Dollars in thousands
See notes to consolidated financial statements.
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2010 and 2009
Dollars in thousands, except per share and share amounts
See notes to consolidated financial statements.
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
For the years ended December 31, 2010, 2009 and 2008
Dollars in thousands, except share amounts
See notes to consolidated financial statements.
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 2010, 2009 and 2008
Dollars in thousands
See notes to consolidated financial statements.
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Dollars in thousands, except per share and share amounts
1 Summary of Significant Accounting Policies
Description of Operations and Basis of Presentation - The consolidated financial statements include the accounts of Hudson Valley Holding Corp. and its wholly owned subsidiaries, Hudson Valley Bank N.A. (the “Bank” or “HVB”) and HVHC Risk Management Corp (“HVHC RMC”), (collectively the “Company”). The Company offers a broad range of banking and related services to businesses, professionals, municipalities, not-for-profit organizations and individuals. HVB is a national banking association headquartered in Westchester County, New York. As of the date of merger, HVB has 36 branch offices, 18 in Westchester County, New York, 1 in Rockland County, New York, 11 in New York City, 5 in Fairfield County, Connecticut and 1 in New Haven County, Connecticut. The Company also provides investment management services to its customers through its wholly-owned subsidiary, A.R. Schmeidler & Co., Inc. (“ARS”), a Manhattan, New York based money management firm. All inter-company accounts are eliminated. The consolidated financial statements have been prepared in accordance with generally accepted accounting principles. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated balance sheet and income and expenses for the period. Actual results could differ significantly from those estimates. Estimates that are particularly susceptible to significant change in the near term relates to the determination of the allowance for loan losses, fair value of other real estate owned and fair value of financial instruments. In connection with the determination of the allowance for loan losses, management utilizes the work of professional appraisers for significant properties.
Securities - Securities are classified as either available for sale, representing securities the Company may sell in the ordinary course of business, or as held to maturity, representing securities that the Company has determined that it is more likely than not that it would not be required to sell prior to maturity or recovery of cost. Securities available for sale are reported at fair value with unrealized gains and losses (net of tax) excluded from operations and reported in other comprehensive income. Securities held to maturity are stated at amortized cost. Interest income includes amortization of purchase premium and accretion of purchase discount. The amortization of premiums and accretion of discounts is determined by using the level yield method. Securities are not acquired for purposes of engaging in trading activities. Realized gains and losses from sales of securities are determined using the specific identification method. The Company regularly reviews declines in the fair value of securities below their costs for purposes of determining whether such declines are other-than-temporary in nature. In estimating other-than-temporary impairment (“OTTI”), management considers adverse changes in expected cash flows, the length of time and extent that fair value has been less than cost and the financial condition and near term prospects of the issuer. The Company also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of these criteria is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) OTTI related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis.
Loans - Loans are reported at their outstanding principal balance, net of the allowance for loan losses, and deferred loan origination fees and costs. Loan origination fees and certain direct loan origination costs are deferred and recognized over the life of the related loan or commitment as an adjustment to yield, or taken directly into income when the related loan is sold or commitment expires.
Allowance for Loan Losses - The Company maintains an allowance for loan losses to absorb probable losses incurred in the loan portfolio based on ongoing quarterly assessments of the estimated losses. The Company’s methodology for assessing the appropriateness of the allowance consists of a specific component for identified problem loans, and a formula component which addresses historical loan loss experience together with other relevant risk factors affecting the portfolio.
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The specific component incorporates the results of measuring impaired loans as required by the “Receivables” topic of the FASB Accounting Standards Codification. These accounting standards prescribe the measurement methods, income recognition and disclosures related to impaired loans. A loan is recognized as impaired when it is probable that principal and/or interest are not collectible in accordance with the loan’s contractual terms. In addition, a loan which has been renegotiated with a borrower experiencing financial difficulties for which the terms of the loan have been modified with a concession that the Company would not otherwise have granted are considered troubled debt restructurings and are also recognized as impaired. A loan is not deemed to be impaired if there is a short delay in receipt of payment or if, during a longer period of delay, the Company expects to collect all amounts due including interest accrued at the contractual rate during the period of delay. Measurement of impairment can be based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price or the fair value of the collateral, if the loan is collateral dependent. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant change. If the fair value of an impaired loan is less than the related recorded amount, a specific valuation component is established within the allowance for loan losses or, if the impairment is considered to be permanent, a partial charge-off is recorded against the allowance for loan losses. Individual measurement of impairment does not apply to large groups of smaller balance homogenous loans that are collectively evaluated for impairment such as portions of the Company’s portfolios of home equity loans, real estate mortgages, installment and other loans.
The formula component is calculated by first applying historical loss experience factors to outstanding loans by type. The Company uses a three year average loss experience as the starting base for the formula component. This component is then adjusted to reflect additional risk factors not addressed by historical loss experience. These factors include the evaluation of then-existing economic and business conditions affecting the key lending areas of the Company and other conditions, such as new loan products, credit quality trends (including trends in nonperforming loans expected to result from existing conditions), collateral values, loan volumes and concentrations, recent charge-off and delinquency experience, specific industry conditions within portfolio segments that existed as of the balance sheet date and the impact that such conditions were believed to have had on the collectibility of the loan portfolio. Senior management reviews these conditions quarterly. Management’s evaluation of the loss related to each of these conditions is quantified by loan type and reflected in the formula component. The evaluations of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty due to the subjective nature of such evaluations and because they are not identified with specific problem credits.
Actual losses can vary significantly from the estimated amounts. The Company’s methodology permits adjustments to the allowance in the event that, in management’s judgment, significant factors which affect the collectibility of the loan portfolio as of the evaluation date have changed.
Management believes the allowance for loan losses is the best estimate of probable losses which have been incurred as of December 31, 2010. There is no assurance that the Company will not be required to make future adjustments to the allowance in response to changing economic conditions, particularly in the Company’s service area, since the majority of the Company’s loans are collateralized by real estate. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on their judgments at the time of their examinations.
Income Recognition on Loans - Interest on loans is accrued monthly. Net loan origination and commitment fees are deferred and recognized as an adjustment of yield over the lives of the related loans. Loans, including impaired loans, are placed on a non-accrual status when management believes that interest or principal on such loans may not be collected in the normal course of business. When a loan is placed on non-accrual status, all interest previously accrued, but not collected, is reversed against interest income. Interest received on non-accrual loans generally is either applied against principal or reported as interest income, in accordance with management’s judgment as to the collectibility of principal. Loans can be returned to accruing status when they become current as to principal and interest, demonstrate a period of performance under the contractual terms, and when, in management’s opinion, they are estimated to be fully collectible.
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Premises and Equipment - Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets, generally 3 to 5 years for furniture, fixtures and equipment and 31.5 years for buildings. Leasehold improvements are amortized over the lesser of the term of the lease or the estimated useful life of the asset.
Other Real Estate Owned (“OREO”) - Real estate properties acquired through loan foreclosure are recorded at estimated fair value, net of estimated selling costs, at time of foreclosure establishing a new cost basis. Credit losses arising at the time of foreclosure are charged against the allowance for loan losses. Subsequent valuations are periodically performed by management and the carrying value is adjusted by a charge to expense to reflect any subsequent declines in the estimated fair value. Routine holding costs are charged to expense as incurred.
Goodwill and Other Intangible Assets - Goodwill and identified intangible assets with indefinite useful lives are not subject to amortization. Identified intangible assets that have finite useful lives are amortized over those lives by a method which reflects the pattern in which the economic benefits of the intangible asset are used up. All goodwill and identified intangible assets are subject to impairment testing on an annual basis, or more often if events or circumstances indicate that impairment may exist. If such testing indicates impairment in the values and/or remaining amortization periods of the intangible assets, adjustments are made to reflect such impairment. The Company’s impairment evaluations as of December 31, 2010 and December 31, 2009 did not indicate impairment of its goodwill or identified intangible assets.
Income Taxes - Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period the change is enacted.
Stock-Based Compensation - On May 27, 2010, at the Company’s Annual Meeting of Shareholders, the Hudson Valley Holding Corp. 2010 Omnibus Incentive Plan was approved. The purpose of the 2010 Plan is to provide additional incentive to directors, officers, key employees, consultants and advisors of the Company and its subsidiaries. Included in the provisions of the 2010 Plan, the Company may grant eligible employees, including directors, consultants and advisors, incentive stock options, non-qualified stock options, restricted stock awards, restricted stock units, stock appreciation rights, performance awards and other types of awards. The 2010 Plan provides for the issuance of up to 1,100,000 shares of the Company’s common stock. Prior to the adoption of the 2010 Plan, the Company had stock option plans that provided for the granting of options to directors, officers, eligible employees, and certain advisors, based upon eligibility as determined by the Compensation Committee. Under the prior plans options were granted for the purchase of shares of the Company’s common stock at an exercise price not less than the market value of the stock on the date of grant, vested over various periods ranging from immediate to five years from date of grant, and had expiration dates of up to ten years from the date of grant.
Compensation costs relating to share-based payment transactions are recognized in the financial statements with measurement based upon the fair value of the equity or liability instruments issued. Compensation costs related to share based payment transactions are expensed over their respective vesting periods. The fair value (present value of the estimated future benefit to the option holder) of each option grant is estimated on the date of grant using the Black-Scholes option pricing model. See Note 11 “Stock-Based Compensation” herein for additional discussion.
Earnings per Common Share - “Earnings per Share,” topic of the FASB Accounting Standards Codification establishes standards for computing and presenting earnings per share. The statement requires disclosure of basic earnings per common share (i.e. common stock equivalents are not considered) and diluted earnings per common share (i.e. common stock equivalents are considered using the treasury stock method) on the face of the statement of income, along with a reconciliation of the numerator and denominator of basic and diluted earnings per share. Basic earnings per common share are computed by dividing net income by the weighted average number of common
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
shares outstanding during the period. The computation of diluted earnings per common share is similar to the computation of basic earnings per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares, consisting solely of stock options, had been issued.
Weighted average common shares outstanding used to calculate basic and diluted earnings per share were as follows:
In November 2010, December 2009 and December 2008, the Board of Directors of the Company declared 10 percent stock dividends. Share amounts have been retroactively restated to reflect the issuance of the additional shares.
Disclosures About Segments of an Enterprise and Related Information - “Segment Reporting” topic of the FASB Accounting Standards Codification establishes standards for the way business enterprises report information about operating segments and establishes standards for related disclosure about products and services, geographic areas, and major customers. The statement requires that a business enterprise report financial and descriptive information about its reportable operating segments. Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and assess performance. The Company has one operating segment, “Community Banking.”
Bank Owned Life Insurance - The Company has purchased life insurance policies on certain key executives. Bank owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.
Retirement Plans - Pension expense is the net of service and interest cost, return on plan assets and amortization of gains and losses not immediately recognized. Employee 401(k) and profit sharing plan expense is the amount of matching contributions. Supplemental retirement plan expense allocates the benefits over years of service.
Recent Accounting Pronouncements
In June 2009, the FASB amended previous guidance relating to transfers of financial assets and eliminates the concept of a qualifying special purpose entity. This guidance must be applied as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. This guidance must be applied to transfers occurring on or after the effective date. Additionally, on and after the effective date, the concept of a qualifying special-purpose entity is no longer relevant for accounting purposes. Therefore, formerly qualifying special-purpose entities should be evaluated for consolidation by reporting entities on and after the effective date in accordance with the applicable consolidation guidance. The disclosure provisions were also amended and apply to transfers that occurred both before and after the effective date of this guidance. The adoption of this guidance on January 1, 2010 did not have a material effect on the Company’s financial condition and results of operations.
In June 2009, the FASB amended guidance for consolidation of variable interest entity guidance by replacing the quantitative-based risks and rewards calculation for determining which enterprise, if any, has a controlling financial interest in a variable interest entity with an approach focused on identifying which enterprise has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and (1) the obligation to absorb losses of the entity or (2) the right to receive benefits from the entity. Additional disclosures about an enterprise’s involvement in variable interest entities are also required. This guidance is
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. The adoption of this guidance on January 1, 2010 did not have a material effect on the Company’s financial condition and results of operations.
In July 2010, the FASB issued Accounting Standards Update 2010-20 “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses”. This guidance will significantly expand the disclosures that the Company must make about the credit quality of financing receivables and the allowance for credit losses. The objectives of the enhanced disclosures are to provide financial statement users with additional information about the nature of credit risks inherent in the Company’s financing receivables, how credit risk is analyzed and assessed when determining the allowance for credit losses, and the reasons for the change in the allowance for credit losses. The disclosures as of the end of the reporting period are effective for the Company’s interim and annual periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for the Company’s interim and annual periods beginning on or after December 15, 2010. The adoption of this Update requires enhanced disclosures and did not have a material effect on the Company’s financial condition or results of operations.
Other - Certain 2009 amounts have been reclassified to conform to the 2010 presentation.
2 Securities
The following table sets forth the amortized cost, gross unrealized gains and losses and the estimated fair value of securities classified as available for sale and held to maturity at December 31:
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Included in other debt securities are investments in six pooled trust preferred securities with amortized costs and estimated fair values of $11,637 and $3,687, respectively, at December 31, 2010 and $13,823 and $3,938, respectively, at December 31, 2009. These investments represent pooled trust preferred obligations of financial institutions. The value of these investments has been severely negatively affected by the recent downturn in the economy and increased investor concerns about recent and potential future losses in the financial services industry. These investments are rated below investment grade by Moody’s Investor Services at December 31, 2010 with ratings ranging from Caa1 to C. In light of these conditions, these investments were reviewed for other-than-temporary impairment.
In estimating other-than-temporary impairment (“OTTI”) losses, the Company considers: (1) the length of time and extent that fair value has been less than cost, (2) the financial condition and near term prospects of the issuers, (3) whether it is more likely than not that the Company would be required to sell the investments prior to maturity or recovery of cost and (4) evaluation of cash flows to determine if they have been adversely affected.
The Company uses a discounted cash flow (“DCF”) analysis to provide an estimate of an OTTI loss. Inputs to the discount model included known defaults and interest deferrals, projected additional default rates, projected additional deferrals of interest, over-collateralization tests, interest coverage tests and other factors. Expected default and deferral rates were weighted toward the near future to reflect the current adverse economic environment affecting the banking industry. The discount rate was based upon the yield expected from the related securities. Significant inputs to the cash flow models used in determining credit related other-than-temporary impairment losses on pooled trust preferred securities as of December 31, 2010 included the following:
The following table summarizes the change in pretax OTTI credit related losses on securities available for sale for the years end December 31, 2010 and 2009 (in thousands):
During the year ended December 31, 2010, pretax OTTI losses of $2,082, $304, $151, $12 and $3, respectively, were recognized on five pooled trust preferred securities which, prior to the 2010 losses, had book values of $7,455, $2,500, $2,215, $943 and $649, respectively. During the year ended December 31, 2009, pretax OTTI losses of $2,857, $2,633, $4 and $2, respectively, were recognized on four pooled trust preferred securities which, prior to the 2009 losses, had book values of $5,000, $10,000, $939 and $646, respectively. The OTTI losses in 2010 and 2009 resulted from adverse changes in the expected cash flows of the pooled trust preferred securities which indicated that the Company may not recover the entire cost basis of these investments. Continuation or worsening of the current adverse economic conditions may result in further impairment charges in the future.
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
At December 31, 2010, securities having a stated value of approximately $310,000 were pledged to secure public deposits, securities sold under agreements to repurchase and for other purposes as required or permitted by law.
Gross proceeds from sales of securities available for sale were $21,915, $8,750 and $65,506 in 2010, 2009 and 2008, respectively. These sales resulted in gross pretax gains of $280 and gross pretax losses of $112 in 2010, gross pretax gains of $110 and gross pretax losses of $58 in 2009, and gross pretax gains of $148 in 2008. There were no gross losses on sales of securities available for sale in 2008. Applicable income taxes relating to such transactions were $67, $21 and $59 in 2010, 2009, and 2008, respectively.
The Company recorded $2,552, $5,496 and $1,547, respectively, of pretax impairment charges on securities available-for-sale. All of the 2010 and 2009 charges and $1,062 of the 2008 charges were related to the Company’s investments in pooled trust preferred securities. These charges represented approximately 18.5 percent, 33.1 percent and 53.1 percent of the book value of the related investments in 2010, 2009 and 2008, respectively. In 2008, the Company also recorded a pretax impairment charge of $485 related to an investment in a mutual fund. This adjustment represented approximately 2.2 percent of the book value of the related investment. The investment was sold in April 2008 without further loss, due to its inability to meet the Company’s performance expectations. Income tax benefits applicable to impairment charges were $1,051, $2,264 and $714 in 2010, 2009 and 2008, respectively.
The following tables reflect the Company’s investment’s fair value and gross unrealized loss, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position, as of December 31, 2010 and 2009 (in thousands):
December 31,
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
December 31,
The total number of securities in the Company’s portfolio that were in an unrealized loss position was 90 and 162 at December 31, 2010 and December 31, 2009, respectively. The Company has determined that it is more likely than not that it would not be required to sell its securities prior to maturity or to recovery of cost. With the exception of the investment in pooled trust preferred securities discussed above, the Company believes that its securities continue to have satisfactory ratings, are readily marketable and that current unrealized losses are primarily a result of changes in interest rates. Therefore, management does not consider these investments to be other-than-temporarily impaired at December 31, 2010. With regard to the investments in pooled trust preferred securities, the Company has decided to hold these securities as it believes that current market quotes for these securities are not necessarily indicative of their value. The Company has recognized impairment charges on five of the pooled trust preferred securities. Management believes that the remaining impairment in the value of these securities to be primarily related to illiquidity in the market and therefore not credit related at December 31, 2010.
The contractual maturity of all debt securities held at December 31, 2010 is shown below. Actual maturities may differ from contractual maturities because some issuers have the right to call or prepay obligations with or without call or prepayment penalties.
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
3 Credit Commitments and Concentrations of Credit Risk
The Company has outstanding, at any time, a significant number of commitments to extend credit and also provide financial guarantees to third parties. Those arrangements are subject to strict credit control assessments. Guarantees specify limits to the Company’s obligations. The amounts of those loan commitments and guarantees are set out in the following table. Because many commitments and almost all guarantees expire without being funded in whole or in part, the contract amounts are not estimates of future cash flows.
The majority of loan commitments have terms up to one year, with either a floating interest rate or contracted fixed interest rates, generally ranging from 3.25% to 12.00%. Guarantees written generally have terms up to one year.
Loan commitments and guarantees written have off-balance-sheet credit risk because only origination fees and accruals for probable losses are recognized in the balance sheet until the commitments are fulfilled or the guarantees expire. Credit risk represents the accounting loss that would be recognized at the reporting date if counterparties failed completely to perform as contracted. The credit risk amounts are equal to the contractual amounts, assuming that the amounts are fully advanced and that collateral or other security would have no value.
The Company’s policy is to require customers to provide collateral prior to the disbursement of approved loans. For loans and financial guarantees, the Company usually retains a security interest in the property or products financed or other collateral which provides repossession rights in the event of default by the customer.
Concentrations of credit risk (whether on or off-balance-sheet) arising from financial instruments exist in relation to certain groups of customers. A group concentration arises when a number of counterparties have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions. The Company does not have a significant exposure to any individual customer or counterparty. A geographic concentration arises because the Company operates principally in Westchester County and Bronx County, New York. Loans and credit commitments collateralized by real estate including all loans where real estate is either primary or secondary collateral are as follows:
The credit risk amounts represent the maximum accounting loss that would be recognized at the reporting date if counterparties failed completely to perform as contracted and any collateral or security proved to have no value. The Company has in the past experienced little difficulty in accessing collateral when required.
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
4 Loans
The loan portfolio is comprised of the following:
The Company has established credit policies applicable to each type of lending activity in which it engages. The Banks evaluate the credit worthiness of each customer and extends credit based on credit history, ability to repay and market value of collateral. The customers’ credit worthiness is monitored on an ongoing basis. Additional collateral is obtained when warranted. Real estate is the primary form of collateral. Other important forms of collateral are bank deposits and marketable securities. While collateral provides assurance as a secondary source of repayment, the Company ordinarily requires the primary source of payment to be based on the borrower’s ability to generate continuing cash flows.
A summary of the activity in the allowance for loan losses follows:
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table presents the allowance for loan losses and the recorded investment in loans by portfolio segment for the year ended December 31, 2010:
The recorded investment in impaired loans was $49,555 and $50,589 at December 31, 2010 and 2009, respectively, for which specific reserves of $892 and $3,574, respectively, had been established. The Company classifies all loans considered to be troubled debt restructurings (“TDRs”) as impaired. Impaired loans as of December 31, 2010 and 2009 included $17,236 and $640, respectively, of loans considered to be TDRs. At December 31, 2010, one TDR with a carrying amount of $5,871 was on accrual status and performing in accordance with its modified terms. All other TDRs as of December 31, 2010 and 2009 were on nonaccrual status. The fair value of impaired loans was determined using either the fair value of the underlying collateral of the loan or by an analysis of the expected cash flows related to the loan.
The average investment in impaired loans during 2010 and 2009 was $64,390 and $34,970, respectively.
Impaired loans at December 31, 2010 were as follows:
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table presents the allowance for loan losses and the recorded investment in loans by portfolio segment based on impairment method for the year ended December 31, 2010.
Non-accrual loans at December 31, 2010, 2009 and 2008 are summarized as follows:
There was no income recorded on non-accrual loans during the years ended December 31, 2010, 2009 and 2008.
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table presents the recorded investments in non-accrual loans and loans past due 90 days and still accruing by class of loans as of December 31:
The following table presents the recorded investments in past due loans as of December 31, 2010 by class of loans:
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Loans made directly or indirectly to employees, directors or principal shareholders were approximately $37,681 and $36,336 at December 31, 2010 and 2009, respectively. During 2010, new loans granted to these individuals totaled $7,418 and payments and decreases due to changes in board composition totaled $6,073.
The Company categorizes loans into risk categories based on relevant information about the ability of the borrowers to service their debt such as; value of underlying collateral, current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes non-homogeneous loans individually and classifies them as to credit risk. This analysis is performed on a quarterly basis. The Company uses the following definitions for risk ratings.
Special Mention - Loans classified as special mention have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of repayment prospects for the asset or in the institution’s credit position at some future date.
Substandard - Loans classified as substandard asset are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified must have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the bank will sustain some loss if the deficiencies are not corrected.
Doubtful - Loans classified as doubtful have all the weaknesses inherent in one classified as substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions and values, highly questionable and improbable.
Loans not meeting the above criteria that are analyzed individually as part of the above described process are considered to be pass rated loans.
The following table presents the risk category by class of loans as of December 31, 2010 of non-homogeneous loans individually classified as to credit risk as of the most recent analysis performed:
Loans not individually rated, primarily consisting of certain 1-4 family residential mortgages and home equity lines of credit, are evaluated for risk in groups of homogeneous loans. The primary risk characteristic evaluated on these pools is payment history.
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table presents the delinquency categories by class of loans for loans evaluated for risk in groups of homogeneous loans.
Loans Held for Sale
During 2010, the Company transferred $21,864 of nonperforming loans to the held-for-sale category. This transfer was part of the Company’s implementation of a more aggressive workout strategy in reaction to the severity of the current economic crisis. The Company sold $14,053 of these loans in the fourth quarter of 2010. The remaining $7,811 are recorded at their fair value and are reflected as “Nonperforming loans held for sale” on the Consolidated Balance Sheet as of December 31, 2010.
5 Premises and Equipment
A summary of premises and equipment follows:
Depreciation and amortization expense totaled $3,993, $3,864 and $3,554 in 2010, 2009 and 2008, respectively.
6 Goodwill and Other Intangible Assets
In the fourth quarter 2004, the Company acquired A.R. Schmeidler & Co., Inc. in a transaction accounted for as an asset purchase for tax purposes. In connection with this acquisition, the Company recorded customer relationship intangible assets of $2,470 and non-compete provision intangible assets of $516, which have amortization periods of 13 years and 7 years, respectively. Deferred tax benefits have been provided for the tax effect of temporary differences in the amortization periods of these identified intangible assets for book and tax purposes.
Also, at the time of this acquisition, the Company recorded $4,492 of goodwill. In accordance with the terms of the acquisition agreement, the Company made additional performance-based payments over the five years subsequent to the acquisition. These additional payments, which totaled $17,995, were accounted for as additional purchase price and, as a result, goodwill related to the acquisition was increased. The deferred income tax effects related to timing differences between the book and tax bases of identified intangible assets and goodwill deductible for tax purposes are included in net deferred tax assets in the Company’s Consolidated Balance Sheets.
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
On January 1, 2006, the Company acquired NYNB in a tax-free stock purchase transaction. In connection with this acquisition the Company recorded a core deposit premium intangible asset of $3,907 and a related deferred tax liability of $1,805. The core deposit premium has an estimated amortization period of 7 years. Also in connection with this acquisition, the Company recorded $1,528 of goodwill.
The following table sets forth the gross carrying amount and accumulated amortization for each of the Company’s intangible assets subject to amortization as of December 31, 2010 and 2009.
Intangible assets amortization expense was $822 for 2010, 2009 and 2008. The estimated annual intangible assets amortization expense in each of the five years subsequent to December 31, 2010 is as follows:
Changes in the carrying amount of goodwill for the years ended December 31 are as follows:
Cumulative deferred tax on goodwill deductible for tax purposes was $2,446 and $1,690 at December 31, 2010 and 2009, respectively.
7 Deposits
The following table presents a summary of deposits at December 31:
The Company had no brokered deposits at December 31, 2010 or 2009.
At December 31, 2010 and 2009, certificates of deposits, including other time deposits of $100,000 or more, totalled $188,348 and $206,048, respectively.
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Scheduled maturities of time deposit for the next five years were as follows:
8 Borrowings
The Company’s borrowings with original maturities of one year or less totaled $35,594 and $53,121 at December 31, 2010 and 2009, respectively. Such short-term borrowings consisted of $35,129 of customer repurchase agreements and note options on Treasury, tax and loan of $465 at December 31, 2010 and $52,604 of customer repurchase agreements, and note options on Treasury, tax and loan of $517 at December 31, 2009. The decrease was due to reductions in overnight borrowings as a result of deposit growth and runoff off the securities portfolio in excess of loan growth. Other borrowings totaled $87,751 million and $123,782 at December 31, 2010 and 2009, respectively, which consisted of fixed rate borrowings of $66,451 and $102,482 from the FHLB with initial stated maturities of five or ten years and one to four year call options and non callable FHLB borrowings of $21,300 and $21,300 at December 31, 2010 and 2009, respectively. The callable borrowings from FHLB mature beginning in 2010 through 2016. The FHLB has the right to call all of such borrowings at various dates in 2010 and quarterly thereafter. A non callable borrowing of $1,300 matures in 2027 and a non callable borrowing of $20,000 matures in 2011. Our FHLB term borrowings are subject to prepayment penalties under certain circumstances in the event of prepayment.
Interest expense on all borrowings totaled $5,476, $7,709 and $11,048 in 2010, 2009 and 2008, respectively. As of December 31, 2010 and 2009, these borrowings were collateralized by loans and securities with an estimated fair value of $267,000 and $206,000, respectively.
The following table summarizes the average balances, weighted average interest rates and the maximum month-end outstanding amounts of the Company’s borrowings for each of the years:
HVB is a member of the FHLB. As a member, HVB is able to participate in various FHLB borrowing programs which require certain investments in FHLB common stock as a prerequisite to obtaining funds. As of December 31, 2010, HVB had short-term borrowing lines with the FHLB of $200 million with no amounts outstanding. These and various other FHLB borrowing programs available to members are subject to availability of qualifying loan and/or investment securities collateral and other terms and conditions.
HVB also has unsecured overnight borrowing lines totaling $70 million with three major financial institutions which were all unused and available at December 31, 2010. In addition, HVB has approved lines under Retail
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Certificate of Deposit Agreements with three major financial institutions totaling $944 million of which no balances were outstanding as at December 31, 2010. Utilization of these lines are subject to product availability and other restrictions.
Additional liquidity is also provided by the Company’s ability to borrow from the Federal Reserve Bank’s discount window. In response to the current economic crisis, the Federal Reserve Bank has increased the ability of banks to borrow from this source through its Borrower-in-Custody (“BIC”) program, which expanded the types of collateral which qualify as security for such borrowings. HVB has been approved to participate in the BIC program. There were no balances outstanding with the Federal Reserve at December 31, 2010.
As of December 30, 2010, the Company had qualifying loan and investment securities totaling approximately $312 million which could be utilized under available borrowing programs thereby increasing liquidity.
The various borrowing programs discussed above are subject to certain restrictions and terms and conditions which may include continued availability of such borrowing programs, the Company’s ability to pledge qualifying collateral in sufficient amounts, the Company’s maintenance of capital ratios acceptable to these lenders and other conditions which may be imposed on the Company.
9 Income Taxes
A reconciliation of the income tax provision and the amount computed using the federal statutory rate is as follows:
The components of the provision for income taxes (benefit) are as follows:
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The tax effect of temporary differences giving rise to the Company’s deferred tax assets and liabilities are as follows:
In the normal course of business, the Company’s Federal, New York State and New York City Corporation tax returns are subject to audit. The Company is currently open to audit by the Internal Revenue Service under the statute of limitations for years after 2005. The Company is currently undergoing an audit by New York State 2005 through 2007. This audit has not yet been completed, however, no significant issues have as yet been raised.
The Company follows the “Income Taxes” topic of the FASB Accounting Standard Codification which prescribes a recognition threshold and measurement attribute criteria for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return as well as guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.
The Company has performed an evaluation of its tax positions and has concluded that as of December 31, 2010, there were no significant uncertain tax positions requiring additional recognition in its financial statements and does not believe that there will be any material changes in its unrecognized tax positions over the next 12 months.
The Company’s policy is to recognize interest and penalties related to unrecognized tax benefits as a component of income tax expense. There were no accruals for interest or penalties during the years ended December 31, 2010 and 2009.
10 Stockholders’ Equity
The Company and the Bank are subject to various regulatory capital requirements administered by the Federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the financial statements of the Company and the Bank. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. Quantitative measures established by regulation to ensure capital adequacy require the Company and HVB to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined).
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. In today’s economic and regulatory environment, banking regulators, including the OCC, which is the primary federal regulator of the Bank, are directing greater scrutiny to banks with higher levels of commercial real estate loans. Due to the high percentage of commercial real estate loans in our portfolio, we are among the banks subject to such greater regulatory scrutiny. As a result of this concentration, the increase in the level of our non-performing loans, and the potential for further deterioration in our loan portfolio, the OCC required HVB to maintain, by December 31, 2009, a total risk-based capital ratio of at least 12.0 percent (compared to 10.0 percent for a well capitalized bank), a Tier 1 risk-based capital ratio of at least 10.0 percent (compared to 6.0 percent for a well capitalized bank), and a Tier 1 leverage ratio of at least 8.0 percent (compared to 5.0 percent for a well capitalized bank.) These capital requirements are in excess of “well capitalized” levels generally applicable to banks under current regulations. To meet these new higher capital requirements, in October, 2009 the Company raised approximately $93.3 million through an offering of its common stock.
The following summarizes the capital requirements and capital position at December 31, 2010 and 2009:
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Management believes, as of December 31, 2010 and 2009, that the Company and the Bank met all capital adequacy requirements to which they are subject.
In addition, pursuant to Rule 15c3-1 of the Securities and Exchange Commission, ARS is required to maintain minimum “net capital” as defined under such rule. As of December 31, 2010 ARS exceeded its minimum capital requirement.
Stock Dividend
In November 2010 and December 2009 the Board of Directors of the Company declared 10 percent stock dividends. Share and per share amounts have been retroactively restated to reflect the issuance of the additional shares.
11 Stock-Based Compensation
In accordance with the provisions of the Hudson Valley Holding Corp. 2010 Omnibus Incentive Plan, approved by the Company’s shareholders on May 27, 2010, the Company may grant eligible employees, including directors, consultants and advisors, incentive stock options, non-qualified stock options, restricted stock awards, restricted stock units, stock appreciation rights, performance awards and other types of awards. The 2010 Plan provides for the issuance of up to 1,100,000 shares of the Company’s common stock. Prior to the 2010 Plan, the Company had stock option plans that provided for the granting of options to directors, officers, eligible employees, and certain advisors, based upon eligibility as determined by the Compensation Committee. Under the prior plans, options were granted for the purchase of shares of the Company’s common stock at an exercise price not less than the market value of the stock on the date of grant, vested over various periods ranging from immediate to five years from date of grant, and had expiration dates up to ten years from the date of grant. The Company estimates that more than 75% of options granted under the prior plans will vest. Compensation costs relating to stock-based payment transactions are recognized in the financial statements with measurement based upon the fair value of the equity or liability instruments issued. Compensation costs related to share based payment transactions are expensed over their respective vesting periods. There were no stock-based compensation awards granted under either the 2010 Plan or the prior plans during the year ended December 31, 2010.
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table summarizes stock option activity for 2010. Shares and per share amounts have been adjusted to reflect the effect of the 10% stock dividend in 2010.
(1)
The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on December 31, 2010. This amount changes based on changes in the market value of the Company’s stock.
The following table summarizes the range of exercise prices of the Company’s stock options outstanding and exercisable at December 31, 2010:
The fair value (present value of the estimated future benefit to the option holder) of each option grant is estimated on the date of grant using the Black-Scholes option pricing model. There were no stock options granted in the years ended December 31, 2010 and 2009. The following table illustrates the assumptions used in the valuation model for activity during the year ended December 31, 2008.
The expected volatility is based on historical volatility. The risk-free interest rates for periods within the contractual life of the awards are based on the U.S. Treasury yield curve in effect at the time of the grant. The expected life is based on historical exercise experience.
The per share weighted average fair value of options granted during the year ended December 31, 2008 was $3.96. Compensation expense of $148, $254 and $596 related to the Company’s stock option plans was included in
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
net income for the years ended December 30, 2010, 2009 and 2008, respectively. The total tax benefit related thereto was $6, $8 and $144, respectively. Unrecognized compensation expense related to non-vested share-based compensation granted under the Company’s stock option plans totaled $245 at December 31, 2010. This expense is expected to be recognized over a weighted-average period of 1.3 years.
12 Fair Value
The Company follows the “Fair Value Measurement and Disclosures” topic of the FASB Accounting Standards Codification which requires additional disclosures about the Company’s assets and liabilities that are measured at fair value and establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
A description of the valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. While management believes the Company’s valuation methodologies are appropriate and consistent with other financial institutions, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.
The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges, which is a Level 1 input, or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities, which is a Level 2 input.
The Company’s available for sale securities at December 31, 2010 and 2009 include several pooled trust preferred instruments. The recent severe downturn in the overall economy and, in particular, in the financial services industry has created a situation where significant observable inputs (Level 2) are not readily available for these securities. As an alternative, the Company combined Level 2 input of market yield requirements of similar instruments together with certain Level 3 assumptions addressing the impact of current market illiquidity to estimate the fair value of these instruments - See Note 2 “Securities” for further discussion of pooled trust preferred securities.
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Assets and liabilities measured at fair value are summarized below:
(1)
Impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from the collateral. Collateral values are estimated using Level 2 and Level 3 inputs which include independent appraisals and internally customized discounting criteria. The recorded investment in impaired loans subject to fair value reporting on December 31, 2010 was $19,486 for which a specific allowance of $892 has been established within the allowance for loan losses. The fair values were based on internally customized discounting criteria of the collateral and thus classified as Level 3 fair values.
(2)
Loans held for sale are reported at lower of cost or fair value. Fair value is based on average bid indicators received from third parties expected to participate in the loans sales.
(3)
Other real estate owned is reported at fair value less anticipated costs to sell. Fair value is based on third party or internally developed appraisals which, considering the assumptions in the valuation, are considered Level 2 or Level 3 inputs. The fair value of other real estate owned at December 31, 2010 was derived by management from appraisals which used various assumptions and were discounted as necessary, resulting in a Level 3 classification.
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(1)
Impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from the collateral. Collateral values are estimated using Level 2 and Level 3 inputs which include independent appraisals and internally customized discounting criteria. The recorded investment in impaired loans subject to fair value measurement on December 31, 2009 was $20,494 for which a specific allowance of $3,573 has been established within the allowance for loan losses.
(2)
Other real estate owned is reported at fair value less anticipated costs to sell. Fair value is based on third party or internally developed appraisals which, considering the assumptions in the valuation, are considered Level 2 or Level 3 inputs. The fair value of other real estate owned at December 31, 2009 was derived by management from appraisals which used various assumptions and were discounted as necessary, resulting in a Level 3 classification.
The table below presents a reconciliation and income statement classification of gains and losses for securities available for sale measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2010 and 2009:
(1)
Reported under “Unrealized (loss) gain on securities available for sale arising during the period”.
(2)
Reported under “Recognized impairment charge on securities available for sale, net”.
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
13 Benefit Plans
The Hudson Valley Bank Employees’ Defined Contribution Pension Plan covers substantially all employees. In 2010, there were no pension costs accrued and charged to current operations. Pension costs accrued and charged to current operations included 2.5 percent of each participant’s earnings in 2009 and 5 percent of each participant’s earnings in 2008. Pension costs charged to other operating expenses totaled approximately $387 and $1,066 in 2009 and 2008, respectively.
The Hudson Valley Bank Employees’ Savings Plan covers substantially all employees. The Company matches 25 percent of employee contributions annually, up to 4 percent of base salary. Savings Plan costs charged to expense totaled approximately $170, $170 and $166 in 2010, 2009 and 2008, respectively.
The Company’s matching contribution under the Employees’ Savings Plan as well as its contribution to the Defined Contribution Pension Plan is in the form of cash. Neither plan holds any shares of the Company’s stock.
Additional retirement benefits are provided to certain officers and directors of HVB pursuant to unfunded supplemental plans. Costs for the supplemental pension plans totaled $1,299, $2,123 and $1,103 in 2010, 2009 and 2008, respectively. The Company uses a December 31 measurement date for the supplemental plans and makes contributions to the plans only as benefit payments become due. In the fourth quarter of 2010, one employee was added to the officers’ supplemental plan resulting in an additional $24 of expense for the year. Also during 2010, two directors included in the directors’ supplemental retirement plan elected to retire. In accordance with the terms of the plan, one retiring director began receiving monthly benefits beginning in June 2010 and the other elected a lump sum payment which was paid in December 2010. Activity in the officers’ supplemental plan during 2009 included the addition of one employee to the plan in the second quarter and, in the fourth quarter, the election of one participant to retire early at a reduced benefit as permitted by the plan. In addition, during the fourth quarter of 2009, the Company amended the officers’ supplemental plan to establish a maximum salary on which benefits under the plan can be determined. The net effect of the 2009 activity and amendment was a $923 decrease in the projected benefit obligation of the plan as of December 31, 2009, and a $414 increase in 2009 expense related to the plan. The expense increase was primarily related to the accrual of prior service cost of the employee added to the plan in the second quarter. In late 2008, HVB amended the directors’ supplemental retirement plan by freezing benefits to a level equal to vested benefits, as defined, as of December 31, 2008. This amendment resulted in a pretax reduction of the accrued benefit liability of $861 of which $669 is included as a reduction of directors’ pension expense included in Professional Services in the Consolidated Statement of Income, and $192 is included as part of the accrued benefit liability adjustment in the Consolidated Statement of Comprehensive Income.
The following tables set forth the status of the Company’s supplemental plans as of December 31:
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Amounts recognized in accumulated comprehensive income at December 31 consist of:
The accumulated benefit obligation was $10,658 and $10,321 at December 31, 2010 and 2009, respectively.
The estimated net loss and prior service costs that will be amortized from accumulated other comprehensive income into net periodic benefit cost in 2010 are $558 and $(233).
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid:
14 Commitments, Contingent Liabilities and Other Disclosures
The Company is obligated under leases for certain of its branches and equipment. Minimum rental commitments for bank premises and equipment under noncancelable operating leases are as follows:
Rent expense for premises and equipment was $3,533, $3,462 and $3,097 in 2010, 2009 and 2008, respectively.
In the normal course of business, there are various outstanding commitments and contingent liabilities which are not reflected in the consolidated balance sheets. No losses are anticipated as a result of these transactions.
In the ordinary course of business, the Company is party to various legal proceedings, none of which, in the opinion of management, will have a material effect on the Company’s consolidated financial position or results of operations.
Cash Reserve Requirements
HVB is required to maintain average reserve balances under the Federal Reserve Act and Regulation D issued thereunder. Such reserves totaled $13,082 at December 31, 2010.
Restrictions on Funds Transfers
There are various restrictions which limit the ability of a bank subsidiary to transfer funds in the form of cash dividends, loans or advances to the parent company. Under federal law, the approval of the primary regulator is required if dividends declared by a bank in any year exceed the net profits of that year, as defined, combined with the retained net profits for the two preceding years. Under applicable banking statutes, at December 31, 2010, HVB could have declared additional dividends of $3,901 to the Company without prior regulatory approval.
15 Segment Information
The Company has one reportable segment, “Community Banking.” All of the Company’s activities are interrelated, and each activity is dependent and assessed based on how each of the activities of the Company
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
supports the others. For example, commercial lending is dependent upon the ability of the Company to fund itself with retail deposits and other borrowings and to manage interest rate and credit risk. This situation is also similar for consumer and residential mortgage lending. Accordingly, all significant operating decisions are based upon analysis of the Company as one operating segment or unit.
The Company operates only in the U.S. domestic market, primarily in the New York metropolitan area. For the years ended December 31, 2010, 2009 and 2008, there is no customer that accounted for more than 10% of the Company’s revenue.
16 Fair Value of Financial Instruments
The “Financial Instruments” topic of the FASB Accounting Standards Codification requires the disclosure of the estimated fair value of certain financial instruments. These estimated fair values as of December 31, 2010 and 2009 have been determined using available market information and appropriate valuation methodologies. Considerable judgment is required to interpret market data to develop estimates of fair value. The estimates presented are not necessarily indicative of amounts the Company could realize in a current market exchange. The use of alternative market assumptions and estimation methodologies could have had a material effect on these estimates of fair value.
Carrying amount and estimated fair value of financial instruments, not previously presented, at December 31, 2010 and 2009 were as follows:
The estimated fair value of the indicated items was determined as follows:
Financial assets for which carrying value approximates fair value - The estimated fair value approximates carrying amount because of the immediate availability of these funds or based on the short maturities and current rates for similar deposits. Cash and due from banks as well as Federal funds sold are reported in this line item.
Held to maturity securities and accrued interest - The fair value of securities held to maturity was estimated based on quoted market prices or dealer quotations. Accrued interest is stated at its carrying amounts which approximates fair value.
FHLB Stock - It is not practicable to determine its fair value due to restrictions placed on its transferability.
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Loans and accrued interest - The fair value of loans was estimated by discounting projected cash flows at the reporting date using current rates for similar loans. Accrued interest is stated at its carrying amount which approximates fair value.
Deposits with no stated maturity and accrued interest - The estimated fair value of deposits with no stated maturity and accrued interest, as applicable, are considered to be equal to their carrying amounts.
Time deposits and accrued interest - The fair value of time deposits has been estimated by discounting projected cash flows at the reporting date using current rates for similar deposits. Accrued interest is stated at its carrying amount which approximates fair value.
Securities sold under repurchase agreements and other short-term borrowings and accrued interest - The estimated fair value of these instruments approximate carrying amount because of their short maturities and variable rates. Accrued interest is stated at its carrying amount which approximates fair value.
Other borrowings and accrued interest - The fair value of callable FHLB advances was estimated by discounting projected cash flows at the reporting date using the rate applicable to the projected call date option. Accrued interest is stated at its carrying amount which approximates fair value.
17 Condensed Financial Information of Hudson Valley Holding Corp.
(Parent Company Only)
Condensed Balance Sheets
December 31, 2010 and 2009
Dollars in thousands
Condensed Statements of Income
For the years ended December 31, 2010, 2009 and 2008
Dollars in thousands
HUDSON VALLEY HOLDING CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Condensed Statements of Cash Flows
For the years ended December 31, 2010, 2009 and 2008
Dollars in thousands
ITEM 9
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Our disclosure controls and procedures are designed to ensure that information the Company must disclose in its reports filed or submitted under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized, and reported on a timely basis. Any controls and procedures, no matter how well designed and operated, can only provide reasonable assurance of achieving the desired control objectives. We carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of December 31, 2010. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of December 31, 2010, the Company’s disclosure controls and procedures were effective in bringing to their attention on a timely basis information required to be disclosed by the Company in reports that the Company files or submits under the Exchange Act. Also, during the year ended December 31, 2010, there has not been any change that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
The management of the Company 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 and Exchange Act of 1934. The Company’s internal control over financial reporting is 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.
The Company’s internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) 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 (iii) 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.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2010. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control-Integrated Framework. Based on our assessment and those criteria, management concluded that the Company maintained effective internal control over financial reporting as of December 31, 2010.
The Company’s independent registered public accounting firm has issued their report on the effectiveness of the Company’s internal control over financial reporting. That report is included under the heading, Report of Independent Registered Public Accounting Firm.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information set forth under the captions “Nominees for the Board of Directors”, “Executive Officers”, “Corporate Governance” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the 2011 Proxy Statement is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information set forth under the caption “Executive Compensation” in the 2011 Proxy Statement is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT, AND RELATED STOCKHOLDER MATTERS
The information set forth under the captions “Outstanding Equity Awards at Fiscal Year End” and “Security Ownership of Certain Beneficial Owners and Management” in the 2011 Proxy Statement is incorporated herein by reference.
The following table sets forth information regarding the Company’s Stock Option Plans as of December 31, 2010:
All equity compensation plans have been approved by the Company’s stockholders. Additional details related to the Company’s equity compensation plans are provided in Notes 10 and 11 to the Company’s consolidated financial statements presented in this Form 10-K.
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 Relationships and Related Transactions” and “Corporate Governance” in the 2011 Proxy Statement is incorporated herein by reference.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information set forth under the caption “Independent Registered Public Accounting Firm Fees” in the 2011 Proxy Statement and is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
1. Financial Statements
The following financial statements of the Company are included in this document in Item 8 - Financial Statements and Supplementary Data:
•
Report of Independent Registered Public Accounting Firm
•
Consolidated Statements of Income for the Years Ended December 31, 2010, 2009 and 2008
•
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2010, 2009 and 2008
•
Consolidated Balance Sheets at December 31, 2010 and 2009
•
Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended December 31, 2010, 2009 and 2008
•
Consolidated Statements of Cash Flows for the Years Ended December 31, 2010, 2009 and 2008
•
Notes to Consolidated Financial Statements
2. Financial Statement Schedules
Financial Statement Schedules have been omitted because they are not applicable or the required information is shown elsewhere in the document in the Financial Statements or Notes thereto, or in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
3. Exhibits Required by Securities and Exchange Commission Regulation S-K
* Management contract and compensatory plan or arrangement
(1)
Incorporated herein by reference in this document to the Form 10-K filed on March 11, 2005
(2)
Incorporated herein by reference in this document to the Form 10-Q filed on August 9, 2006
(3)
Incorporated herein by reference in this document to the Form 10-K filed on March 15, 2007
(4)
Incorporated herein by reference in this document to the Form 10-Q filed October 20, 2009
(5)
Incorporated herein by reference in this document to the Form 8-K filed on April 28, 2010
(6)
Incorporated herein by reference in this document to the Form 10-K filed on March 16, 2009
(7)
Incorporated herein by reference in this document to the Form 10-K filed on March 16, 2010
(8)
Incorporated herein by reference in this document to the Form 8-K filed on June 1, 2010
(9)
Filed herewith
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.
HUDSON VALLEY HOLDING CORP.
March 16, 2011
By:
/s/ James J. Landy
James J. Landy
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on March 16, 2011 by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
/s/ James J. Landy
James J. Landy
President, Chief Executive Officer and Director
/s/ Stephen R. Brown
Stephen R. Brown
Senior Executive Vice President, Chief Financial Officer, Treasurer and Director
(Principal Financial Officer)
John P. Cahill
John P. Cahill
Director
/s/ William E. Griffin
William E. Griffin
Chairman of the Board and Director
/s/ Mary Jane Foster
Mary Jane Foster
Director
/s/ Gregory F. Holcombe
Gregory F. Holcombe
Director
/s/ Adam Ifshin
Adam Ifshin
Director
/s/ Michael J. Maloney
Michael J. Maloney
Executive Vice President, Chief Banking
Officer of the Bank and Director
/s/ Angelo R. Martinelli
Angelo R. Martinelli
Director
John A. Pratt Jr.
John A. Pratt Jr.
Director
Cecile D. Singer
Cecile D. Singer
Director
/s/ Craig S. Thompson
Craig S. Thompson
Director
/s/ Andrew J. Reinhart
Andrew J. Reinhart
First Senior Vice President and Controller
(Principal Accounting Officer)