Item 1. Business
General
In 2003, NewAlliance was organized as a Delaware business corporation in connection with the conversion of NewAlliance Bank (the “Bank”), formerly New Haven Savings Bank, from mutual to capital stock form, which became effective on April 1, 2004. The Bank’s conversion resulted in the Company owning all of the Bank’s outstanding capital stock. The Bank is now a wholly-owned subsidiary of the Company, a bank holding company regulated by the Federal Reserve Board. On April 1, 2004, the Bank changed its name to NewAlliance Bank. The Bank was founded in 1838 as a Connecticut-chartered mutual savings bank and is regulated by the State of Connecticut Department of Banking and the FDIC.
By assets, NewAlliance is the third largest banking institution headquartered in Connecticut and the fourth largest based in New England with consolidated assets of $9.03 billion and stockholders’ equity of $1.46 billion at December 31, 2010. NewAlliance delivers financial services to individuals, families and businesses throughout Connecticut and Western Massachusetts. NewAlliance Bank provides commercial banking, retail banking, consumer financing, trust and investment services through 88 banking offices, 100 ATMs and its internet website (www.newalliancebank.com). NewAlliance common stock is traded on the New York Stock Exchange under the symbol “NAL”.
Pending Merger
On August 18, 2010, the Company entered into an agreement and plan of merger with First Niagara Financial Group, Inc. (“First Niagara”), pursuant to which the Company will merge with and into First Niagara (the “Merger”). The Merger was approved by the Company’s shareholders and First Niagara’s shareholders at special meetings of shareholders held on December 20, 2010. Pending and subject to the receipt of all required regulatory approvals, the Merger is expected to close in the second quarter of 2011. See “Item 1A
Item 1A. Risk Factors
An investment in our common stock involves certain risks inherent to our business. The material risks and uncertainties that management believes affect the Company are described below. To understand these risks and to evaluate an investment in our common stock, you should read this entire report, including the following risk factors.
If any of the following risks actually occur, the Company’s financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of the Company’s common stock could decline significantly.
Changes in interest rates and spreads could have a negative impact on earnings and results of operations, which could have a negative impact on the value of NewAlliance stock.
NewAlliance’s earnings and financial condition are dependent to a large degree upon net interest income, which is the difference between interest earned from loans and investments and interest paid on deposits and borrowings. The narrowing of interest rate spreads, meaning the difference between interest rates earned on loans and investments and the interest rates paid on deposits and borrowings, could adversely affect NewAlliance’s earnings, unrealized gains and financial condition. The Company cannot predict with certainty or control changes in interest rates. Regional and local economic conditions and the policies of regulatory authorities, including monetary policies of the Federal Reserve Board, affect interest income and interest expense. The Company has ongoing policies and procedures designed to manage the risks associated with changes in market interest rates.
However, changes in interest rates still may have an adverse effect on NewAlliance’s profitability. For example, high interest rates could also affect the amount of loans that we originate, because higher rates could cause customers to apply for fewer mortgages, or cause depositors to shift funds from accounts that have a comparatively lower rate, to accounts with a higher rate or experience customer attrition due to competitor pricing. If the cost of interest-bearing deposits increases at a rate greater than the yields on interest-earning assets increase, net interest income will be negatively affected. Changes in the asset and liability mix may also affect net interest income. Similarly, lower interest rates cause higher yielding assets to prepay and floating or adjustable rate assets to reset to lower rates. If the Bank is not able to reduce its funding costs sufficiently, due to either competitive factors or the maturity schedule of existing liabilities, then the Bank’s net interest margin will decline.
Credit market conditions may impact NewAlliance’s investments.
Significant credit market anomalies may impact the valuation and liquidity of the Company’s investment securities. The problems of numerous financial institutions have reduced market liquidity, increased normal bid-asked spreads and increased the uncertainty of market participants. Such illiquidity could reduce the market value of the Company’s investments, even those with no apparent credit exposure. The valuation of the Company’s investments requires judgment and as market conditions change investment values may also change.
Weakness in the markets for residential or commercial real estate could reduce NewAlliance’s net income and profitability.
Softening residential housing markets, increasing delinquency and default rates and constrained secondary credit markets have been affecting the mortgage industry generally. NewAlliance’s financial results may be adversely affected by changes in real estate values. The effects of ongoing mortgage market challenges, combined with the ongoing correction in residential real estate market prices and reduced levels of home sales, could result in further price reductions in single family home values, adversely affecting the value of collateral securing mortgage loans held, mortgage loan originations and gains on sale of mortgage loans. Continued declines in real estate values and home sales volumes, and financial stress on borrowers as a result of job losses, or other factors, could have further adverse effects on borrowers that result in higher delinquencies and greater charge-offs in future periods, which would adversely affect NewAlliance’s financial condition or results of operations.
NewAlliance may experience higher levels of loan losses due to current economic conditions.
The current economic conditions have led to declines in collateral values and stress on the cash flows of borrowers. Therefore, NewAlliance’s allowance for loan losses may need to be increased, or may be deemed insufficient by various regulatory agencies. Such agencies may require the Bank to recognize an increase to the allowance for loan losses. Any increases in the allowance for loan losses will result in a decrease in net income and, possibly capital, and may have a material adverse effect on NewAlliance’s financial condition and results of operations. See the sections titled “Allowance for Loan Losses” and “Classification of Assets and Loan Review” in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operation, located elsewhere in the Report for further discussion related to the process for determining the appropriate level of the allowance for loan losses.
If the goodwill that the Company has recorded in connection with its acquisitions becomes impaired, it could have a negative impact on the Company’s profitability.
Applicable accounting standards require that the purchase method of accounting be used for all business combinations. Under purchase accounting, if the purchase price of an acquired company exceeds the fair value of the company’s net assets, the excess is
carried on the acquirer’s balance sheet as goodwill. At December 31, 2010, the Company had approximately $527.2 million of goodwill on its balance sheet. Companies must evaluate goodwill for impairment at least annually. Write-downs of the amount of any impairment, if necessary, are to be charged to the results of operations in the period in which the impairment occurs. There can be no assurance that future evaluations of goodwill will not result in findings of impairment and related write-downs, which may have a material adverse effect on NewAlliance’s financial condition and results of operations.
The impact on the Company and the Bank of enacted legislation, in particular the Dodd-Frank Act and its implementing regulations cannot be predicted at this time.
Recently enacted and potential financial regulatory reforms could have a significant impact on our business, financial condition and results of operations. On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) into law. The Dodd-Frank Act is expected to have a broad impact on the financial services industry, including significant regulatory and compliance changes. Many of the requirements called for in the Dodd-Frank Act will be implemented over time and most will be subject to implementing regulations over the course of several years. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies and through regulations, the full extent of the impact such requirements will have on our operations is unclear. The changes resulting from the Dodd-Frank Act may impact the profitability of business activities, require changes to certain business practices, impose more stringent capital, liquidity and leverage requirements or otherwise adversely affect our business.
Strong competition within NewAlliance’s market areas may limit growth and profitability.
Competition in the banking and financial services industry is intense. In our market areas, we compete with commercial banks, savings institutions, mortgage brokerage firms, credit unions, finance companies, mutual funds, insurance companies, and brokerage and investment banking firms operating locally and elsewhere. Larger banking institutions have become increasingly active in our market areas. Many of these competitors have substantially greater resources and lending limits than we have and may offer certain services that we do not or cannot efficiently provide. Our profitability depends upon our continued ability to successfully compete in our market areas. The greater resources and deposit and loan products offered by some of our competitors may limit our ability to grow profitably.
NewAlliance is subject to extensive government regulation and supervision.
NewAlliance, primarily through NewAlliance Bank 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, not stockholders. These regulations affect the Company’s lending practices, capital structure, investment practices, dividend policy and growth, among other things. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect the Company in substantial and unpredictable ways. Such changes could subject the Company to additional costs, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. 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. While NewAlliance has policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur. See the section captioned “Regulation and Supervision” in Item 1 of this report for further information.
NewAlliance may not pay you dividends if NewAlliance is not able to receive dividends from its subsidiary, NewAlliance Bank.
Cash dividends from NewAlliance Bank and our liquid assets are our principal sources of funds for paying cash dividends on our common stock. Unless we receive dividends from NewAlliance Bank or choose to use our liquid assets, we may not be able to pay dividends. NewAlliance Bank’s ability to pay us dividends is subject to its ability to earn net income and to meet certain regulatory requirements.
NewAlliance’s stock price can be volatile.
NewAlliance’s stock price can fluctuate widely in response to a variety of factors including:
•
actual or anticipated variations in quarterly operating results;
•
recommendations by securities analysts;
•
new technology used, or services offered, by competitors;
•
significant business combinations, strategic partnerships, joint ventures or capital commitments by or involving the Company or the Company’s competitors;
•
operating and stock price performance of other companies that investors deem comparable to NewAlliance;
•
news reports relating to trends, concerns and other issues in the financial services industry;
•
changes in government regulations; and
•
geopolitical conditions such as acts or threats of terrorism or military conflicts.
General market fluctuations, industry factors and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes, credit loss trends or currency fluctuations could also cause NewAlliance’s stock price to decrease regardless of the Company’s operating results.
NewAlliance may not be able to attract and retain skilled people.
NewAlliance’s success depends, in large part, on its ability to attract and retain key people. Competition for the best people in most activities engaged in by the Company can be intense and we may not be able to hire people or to retain them. The unexpected loss of services of one or more of the Company’s key personnel could have a material adverse impact on the business because of their skills, knowledge of the market, years of industry experience and the difficulty of promptly finding qualified replacement personnel.
NewAlliance continually encounters technological change.
The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology can increase efficiency and enable financial institutions to better serve customers and to reduce costs. However, some new technologies needed to compete effectively result in incremental operating costs. The Company’s future success depends, in part, upon its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in operations. Many of the Company’s competitors have substantially greater resources to invest in technological improvements. The Company may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to its customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on the Company’s business and, in turn, its financial condition and results of operations.
NewAlliance’s controls and procedures may fail or be circumvented.
Management regularly reviews and updates the Company’s internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of the controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on the Company’s business, results of operations and financial condition.
Customer information may be obtained and used fraudulently.
Risk of theft of customer information resulting from security breaches by third parties or the lack of controls by third party vendors exposes the Company to reputation risk and potential monetary loss. The Company has exposure to fraudulent use of our customer’s personal information resulting from its general business operations through loss or theft of the information and through customer use of financial instruments, such as debit cards.
Changes in accounting standards can materially impact NewAlliance’s financial statements.
NewAlliance’s accounting policies and methods are fundamental to how the Company records and reports its financial condition and results of operations. From time to time, the Financial Accounting Standards Board or regulatory authorities change the financial accounting and reporting standards that govern the preparation of our financial statements. These changes can be hard to predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in the Company restating prior period financial statements.
Changes and interpretations of tax laws and regulations may adversely impact NewAlliance’s financial statements.
Local, state or federal tax authorities may interpret tax laws and regulations differently than NewAlliance and challenge tax positions that NewAlliance has taken on its tax returns. This may result in the disallowance of deductions or differences in the timing of deductions and result in the payment of additional taxes, interest or penalties that could materially affect NewAlliance’s performance.
Unpredictable catastrophic events could have a material adverse effect on NewAlliance Bank.
The occurrence of catastrophic events such as hurricanes, pandemic disease, windstorms, floods, severe winter weather or other catastrophes could adversely affect NewAlliance’s business and, in turn, its financial condition or results of operations. This may result in a significant number of employees that are unavailable to perform critical operating functions at either their regular worksite or the disaster recovery worksite. Unpredictable natural and other disasters could have an adverse effect on the Company in that such events could materially disrupt its operations or the ability or willingness of its customers to access the financial services offered by NewAlliance Bank.
The merger agreement may be terminated in accordance with its terms and the merger may not be completed.
The majority of the conditions to fulfill the completion of the merger have been completed with the exception of regulatory approvals and the continued accuracy of the representations and warranties by both parties and the performance by both parties of their covenants and agreements, and the receipt by both parties of legal opinions from their respective tax counsels.
In addition, certain circumstances exist whereby NewAlliance may choose to terminate the merger agreement, including if First Niagara’s share price declines to below $10.22 (subject to customary anti-dilution adjustments) as of the first date when all regulatory approvals for the merger have been received, combined with such decline being at least 20% greater than a corresponding decline in the value of the NASDAQ Bank Index. If this situation occurs, the agreement allows First Niagara the ability to make an adjustment to the exchange ratio, pursuant to a specified formula, to cure any shortfall caused by the decline in share price as previously described. There can be no assurance that the conditions to closing of the merger will be fulfilled or that the merger will be completed.
Termination of the merger agreement could negatively impact NewAlliance.
If the merger agreement is terminated, there may be various consequences, including:
•
NewAlliance’s businesses may have been adversely impacted by the failure to pursue other beneficial opportunities due to the focus of management on the merger, without realizing any of the anticipated benefits of completing the merger; and
•
the market price of NewAlliance common stock might decline to the extent that the current market price reflects a market assumption that the merger will be completed.
If the merger agreement is terminated and NewAlliance’s board of directors seeks another merger or business combination, NewAlliance stockholders cannot be certain that NewAlliance will be able to find a party willing to offer equivalent or more attractive consideration than the consideration First Niagara has agreed to provide in the merger.
NewAlliance will be subject to business uncertainties and contractual restrictions while the merger is pending.
Uncertainty about the effect of the merger on employees and customers may have an adverse effect on NewAlliance. These uncertainties may impair NewAlliance’s ability to attract, retain and motivate key personnel until the merger is completed, and could cause customers and others that deal with NewAlliance to seek to change existing business relationships with NewAlliance. Retention of certain employees may be challenging during the pendency of the merger, as certain employees may experience uncertainty about their future roles. In addition, the merger agreement restricts NewAlliance from making certain acquisitions and taking other specified actions until the merger occurs without the consent of First Niagara. These restrictions may prevent NewAlliance from pursuing attractive business opportunities that may arise prior to the completion of the merger.
The merger agreement limits NewAlliance’s ability to pursue alternatives to the merger.
The merger agreement contains “no-shop” provisions that, subject to limited exceptions, limit NewAlliance’s ability to initiate, solicit, encourage or knowingly facilitate any inquiries or competing third-party proposals, or engage in any negotiations, or provide any confidential information, or have any discussions with any person relating to a proposal to acquire all or a significant part of NewAlliance. In addition, NewAlliance has agreed to pay First Niagara a termination fee in the amount of $60 million in the event that First Niagara terminates the merger agreement for certain reasons. These provisions might discourage a potential competing acquirer that might have an interest in acquiring all or a significant part of NewAlliance from considering or proposing that acquisition even if it were prepared to pay consideration with a higher per share market price than that proposed in the merger, or might result in a potential competing acquirer’s proposing to pay a lower per share price to acquire NewAlliance than it might otherwise have proposed to pay.
Settlement agreement related to lawsuits filed against NewAlliance challenging the merger is not approved, and an adverse judgment in such lawsuits or any future similar lawsuits may prevent the merger from becoming effective or from becoming effective within the expected timeframe.
NewAlliance, the members of the NewAlliance board of directors, certain NewAlliance officers, First Niagara and Merger Sub are named as defendants in a number of purported class action lawsuits brought by various NewAlliance stockholders, both in the Superior Court of New Haven County in Connecticut and in the Court of Chancery in the State of Delaware, challenging the proposed merger and seeking, among other things, to enjoin the defendants from completing the merger on the agreed-upon terms and rescission of the merger to the extent it has been completed. In December 2010, the parties reached an agreement in principle to resolve these actions and the settlement contemplated by the agreement has been submitted to the Connecticut court for approval. Immediately following final approval by the Connecticut court, the parties to the Delaware actions shall dismiss those actions with prejudice.
One of the conditions to the closing of the merger is that no judgment, decree, injunction or other order (whether temporary or permanent) that prohibits the completion of the merger be in effect. As such, if any plaintiff were successful in obtaining an injunction prohibiting the NewAlliance or First Niagara defendants from completing the merger on the agreed upon terms, then such injunction may prevent the merger from becoming effective or from becoming effective within the expected timeframe.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
The Company conducts business from its executive offices at 195 Church Street, New Haven, Connecticut and its 76 banking offices located in Connecticut and 12 banking offices located in Massachusetts. Of the 88 banking offices, 30 are owned and 58 are leased. Lease expiration dates range from 3 months to 18 years with renewal options of 5 to 32 years.
The following table sets forth certain information with respect to our offices:
The total net book value of properties and equipment at December 31, 2010 was $59.7 million. For additional information regarding our premises and equipment and lease obligations, see Notes 6 and 14 of the Notes to Consolidated Financial Statements.
Item 3.
Item 3. Legal Proceedings
In the ordinary course of business, we are involved in various threatened and pending legal proceedings. We believe that we are not a party to any pending legal, arbitration, or regulatory proceedings that would have a material adverse impact on our financial results or liquidity. Certain legal proceedings in which we are involved are described below:
On or about August 20, 2010, a lawsuit was filed by Stanley P. Kops against NewAlliance and its directors in the Connecticut Superior Court for the Judicial District of New Haven (NNH-CV10-6013984) challenging the proposed merger between NewAlliance and First Niagara. The purported class action alleges that the NewAlliance board of directors breached its fiduciary duties to NewAlliance stockholders by failing to maximize stockholder value in approving the merger agreement with First Niagara and that NewAlliance and First Niagara aided and abetted this alleged breach of fiduciary duty.
Since the first action was commenced, nine additional lawsuits have been filed against NewAlliance, First Niagara, Merger Sub, and/or the NewAlliance directors and certain officers of NewAlliance. The plaintiffs in the additional lawsuits are: Southwest Ohio Regional Council of Carpenters Pension Plan (NNH-CV10-6014110); Cynthia J. Kops (NNH-CV10-6014155); Joseph Caldarella (NNH-CV10-6014192); Michael Rubin (NNH-CV10-6014328); Arlene H. Levine and Gertrude M. Nitkin (NNH-CV10-6014477); Port Authority of Alleghany County Retirement & Disability Allowance Plan for Employees Represented by Local 85 of the Amalgamated Transit Union (NN-CV10-6014634); Alan Kahn (Case No. 5785); Moses Eilenberg (Case No. 5796); and Erie County Employees’ Retirement System (Case No. 5831). The latter three lawsuits were filed in the Court of Chancery of the State of Delaware and the remainder were filed in the Connecticut Superior Court. The claims in the nine additional lawsuits are substantially the same as the claims in the first lawsuit and seek, among other things, to enjoin the proposed merger on the agreed upon terms. Certain of the new actions, however, also seek attorneys’ and experts’ fees and actual and punitive damages if the merger is completed.
On September 28, 2010, the three Delaware actions were consolidated into In re NewAlliance Bancshares, Inc. Shareholders Litigation (No. 5785-VCP), and the plaintiffs in the consolidated action filed an amended complaint which adds allegations challenging the accuracy of disclosures in the preliminary Form S-4, a motion to preliminarily enjoin the defendants from taking any action to consummate the merger and a motion seeking expedited discovery. On October 22, the court granted the plaintiffs’ motion for expedited discovery and tentatively scheduled a preliminary injunction hearing for December 1, 2010.
On October 19, 2010, the seven Connecticut actions were transferred to the complex litigation docket in the Judicial District of Stamford. The cases were consolidated on October 20 and, on October 22, the plaintiffs filed an amended complaint which adds allegations challenging the accuracy of disclosure in the preliminary Form S-4. The plaintiffs in the Connecticut actions also have indicated that they intend to seek a preliminary injunction and expedited discovery.
On October 18 and 19, 2010, the Company and other defendants filed motions in the seven Connecticut actions and in the consolidated Delaware action requesting that the courts direct the plaintiffs in all the actions to confer and agree on a single forum in which to litigate their claims, or if the plaintiffs are unable to agree, that the courts confer and designate a single forum, and that the cases in the other forum be stayed. The defendants’ motions are pending.
On December 6, 2010, the parties to the Connecticut and Delaware actions reached an agreement in principle to resolve the Connecticut Action and the Delaware Action. Part of that agreement was that the defendants would not object to the payment of plaintiffs’ attorney fees up to $750,000. The settlement contemplated by the agreement has been submitted to the Connecticut court for approval. Immediately following final approval by the Connecticut court of the settlement, the parties to the Delaware actions shall dismiss those actions with prejudice. As part of the settlement, the defendants deny all allegations of wrongdoing and deny that the disclosures in the joint proxy/statement prospectus were inadequate but have agreed to provide supplemental disclosures. These supplemental disclosures were provided in the Company’s Current Report on Form 8-K, filed on December 6, 2010. The settlement will not affect the timing of the merger or the amount of consideration to be paid in the merger. There are no injunction proceedings pending at this time.
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
Market Information
The Company’s common stock is traded on the New York Stock Exchange under the symbol “NAL”. The following table sets forth the high and low closing prices of our common stock and the dividends declared per share of common stock for the periods indicated.
On February 24, 2011, the closing price for the Company’s common stock was $15.55.
Holders
As of January 31, 2011, there were 104,988,327 shares of common stock outstanding, which were held by approximately 9,272 holders of record. The number of stockholders of record was determined by American Stock Transfer and Trust Company. Such number of record holders does not reflect the number of persons or entities holding stock in nominee name through banks, brokerage firms, and other nominees.
Dividends
The Company began paying quarterly dividends in 2004 on its common stock and paid its 27th consecutive dividend on February 15, 2011. This was most likely the last dividend to be paid by NewAlliance due to the merger with First Niagara which is anticipated to close early in the second quarter of 2011. The Company’s ability to pay dividends depends on a number of factors, however, including the ability of the Bank to pay dividends to the Company under federal laws and regulations, and as a result there can be no assurance that dividends will continue to be paid in the future. See the section captioned “Regulation and Supervision” in Item 1 of this report for further information.
Recent Sales of Unregistered Securities; Use of Proceeds From Registered Securities
None.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
The following table sets forth information about the Company’s stock repurchases for the three months ended December 31, 2010.
On January 31, 2006, a second stock repurchase plan was announced and provides for the repurchase of up to 10.0 million shares of common stock of the Company. There is no set expiration date for this plan, however, the Company is precluded from repurchasing its outstanding common stock under the terms of the merger agreement with First Niagara.
(1)
Shares represent common stock withheld by the Company to satisfy tax withholding requirements on the vesting of shares under the Company’s benefit plans.
Stock Performance Graph
The following graph compares the cumulative total return on NewAlliance Bancshares common stock over the last five fiscal years, as reported by the NYSE through December 31, 2010, with (i) the cumulative total return on the S&P 500 Index and (ii) the cumulative total return on the SNL Thrift Index for the period.
This graph assumes the investment of $100 on December 31, 2005 in our common stock, the S&P 500 Index and the SNL Thrift Index and assumes that dividends are reinvested.
COMPARISON OF CUMULATIVE TOTAL RETURN
AMONG NEWALLIANCE BANCSHARES,
S&P 500 INDEX AND SNL THRIFT INDEX
Item 6.
Item 6. Selected Financial Data
The following tables contain certain information concerning the financial position and results of operations of the Company at the dates and for the periods indicated. This information should be read in conjunction with the Consolidated Financial Statements and related notes.
In August 2010, the Company entered into an agreement and plan of merger with First Niagara with an anticipated closing date early in the second quarter of 2011. The pending merger has lead to significant increases in the Company’s merger related charges in 2010.
In July 2007, a restructuring of part of the available-for-sale securities portfolio was completed. A recognized loss in the amount of $28.3 million, or $18.4 million net of tax, was recorded to non-interest income as a result of this restructuring. Selected Financial Data includes the effect of this transaction at and for the year ended December 31, 2007.
(1)
Loans are stated at their principal amounts outstanding, net of deferred loan fees and costs and net unamortized premium on acquired loans.
(2)
Nonperforming loans include all loans 90 days or more past due, restructured loans due to a weakening in the financial condition of the borrower and other loans which have been identified by the Company as presenting uncertainty with respect to the collectability of principal or interest. All of the Company’s nonperforming loans do not accrue interest.
(3)
Nonperforming assets consist of nonperforming loans and other real estate owned.
(4)
Performance ratios are based on average daily balances during the periods indicated and are annualized where appropriate. Regulatory Capital Ratios and Asset Quality Ratios are end-of-period ratios.
(5)
Interest rate spread represents the difference between the weighted average yield on average interest-bearing assets and the weighted average cost of average interest-bearing liabilities.
(6)
Net interest margin represents net interest income as a percentage of average interest-earning assets.
(7)
No tax equivalent adjustments were made due to the fact that ratio would not be materially different.
(8)
In light of diversity in presentation among financial institutions, the methodologies for determining the non-GAAP financial measures listed may vary significantly.
(9)
The efficiency ratio represents the ratio of non-interest expenses, net of OREO expenses, to the sum of net interest income before provision for loan losses and non-interest income, excluding security and limited partnership gains or losses. The efficiency ratio is not a financial measurement required by accounting principles generally accepted in the United States of America. However, the efficiency ratio is used by management in its assessment of financial performance specifically as it relates to non-interest expense control and also believes such information is useful to investors in evaluating company performance.
(10)
The tangible common equity ratio excludes goodwill and identifiable intangible assets. The ratio is not a financial measurement required by accounting principles generally accepted in the United States of America. However, management believes such information is useful to analyze the relative strength of NewAlliance’s capital position and is useful to investors in evaluating Company performance due to the importance that analysts placed on this ratio since the introduction of the Troubled Asset Relief Program.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help the reader understand NewAlliance Bancshares, Inc., our operations and our present business environment. We believe transparency and clarity are the primary goals of successful financial reporting. We remain committed to increasing the transparency of our financial reporting, providing our stockholders with informative financial disclosures and presenting an accurate view of our financial disclosures and presenting an accurate view of our financial position and operating results.
In accordance with Section 404 of the Sarbanes-Oxley Act of 2002, our management, including our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of our internal control over financial reporting and concluded that such control was effective as of December 31, 2010. Management’s report on the effectiveness of our internal control over financial reporting is included in Item 8, Financial Statements and Supplementary Data, of this report.
MD&A is provided as a supplement to-and should be read in conjunction with-our Consolidated Financial Statements and the accompanying notes thereto contained in Item 8, Financial Statements and Supplementary Data, of this report. This overview summarizes the MD&A, which includes the following sections:
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Our Business - a general description of our business.
•
Critical Accounting Estimates - a discussion of accounting estimates that require critical judgments and estimates.
•
Recent Accounting Estimates - a discussion of recently adopted accounting pronouncements or changes.
•
Operation Results - an analysis of our Company’s consolidated results of operations for the three years presented in our Consolidated Financial Statements.
•
Financial Condition, Liquidity and Capital Resources - an overview of financial condition, contractual obligations and liquidity and capital resources.
Our Business
General
By assets, NewAlliance is the third largest banking institution headquartered in Connecticut and the fourth largest based in New England with consolidated assets of $9.03 billion and stockholders’ equity of $1.46 billion at December 31, 2010. Its business philosophy is to operate as a community bank with local decision-making authority. NewAlliance delivers financial services to individuals, families and businesses throughout Connecticut and Western Massachusetts. NewAlliance Bank provides commercial banking, retail banking, consumer financing, trust and investment services through 88 banking offices, 100 ATMs and its internet website (www.newalliancebank.com). NewAlliance common stock is traded on the New York Stock Exchange under the symbol “NAL”.
NewAlliance has a relentless commitment to improve the financial well-being of the people and businesses in the markets we serve, and to invest in the communities where they reside and work. We accomplish this by operating a community banking business model with a commitment to be a leader in our markets by seeking to continually deliver superior value to our customers, shareholders, employees and communities.
The Company’s results of operations depend primarily on net interest income, which is the difference between the income earned on its loan and securities portfolios and its cost of funds, consisting of the interest paid on deposits and borrowings. Results of operations are also affected by the Company’s provision for loan losses, income and expenses pertaining to other real estate owned, gains and losses from sales of loans and securities and non-interest income and expenses. Non-interest income primarily consists of fee income from depositors and wealth management services and increases in cash surrender value of bank owned life insurance (“BOLI”). Non-interest expenses consist principally of compensation and employee benefits, occupancy, data processing, amortization of acquisition related intangible assets, marketing, professional services, FDIC insurance assessments and other operating expenses.
Results of operations are also significantly affected by general economic and competitive conditions and changes in interest rates as well as government policies and actions of regulatory authorities. Future changes in applicable laws, regulations or government policies may materially affect the Company.
Critical Accounting Estimates
Our Consolidated Financial Statements are prepared in accordance with GAAP. In connection with the preparation of our financial statements, we are required to make assumptions and estimates about future events, and apply judgments that affect the reported amounts of assets, liabilities, revenue, expenses and the related disclosures. We base our assumptions, estimates and judgments on historical experience, current trends and other factors that management believes to be relevant at the time our Consolidated Financial Statements are prepared. On a regular basis, management reviews the accounting policies, assumptions, estimates and judgments to ensure that our financial statements are presented fairly and in accordance with GAAP. However, because future events and their effects cannot be determined with certainty, actual results could differ from our assumptions and estimates, and such differences could be material.
Our significant accounting policies are discussed in Note 1, of the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this report. Management believes that the following accounting estimates are the most critical to aid in fully understanding and evaluating our reported financial results, and they require management’s most difficult, subjective or complex judgments, resulting from the need to make estimates about the effect of matters that are inherently uncertain. Management has reviewed these critical accounting estimates and related disclosures with the Audit Committee of our Board.
Other-Than-Temporary Impairment of Investments
Critical Estimates
Judgment and Uncertainties
Effect if Actual Results Differ from Assumptions
Our investment securities portfolio is comprised of available-for-sale and held-to-maturity investments. The available-for-sale portfolio is carried at estimated fair value, with any unrealized gains or losses, net of taxes, reported as accumulated other comprehensive income or loss in stockholders’ equity. The held-to-maturity portfolio is carried at amortized cost. Management determines the classification of a security at the time of its purchase.
We conduct a periodic review of our investment securities portfolio to determine if the value of any security has declined below its cost or amortized cost, and whether such decline is other-than-temporary. If such decline is deemed other-than-temporary for debt securities, the security is written down to a new cost basis and the amount of impairment related to the credit loss component would be reported within non-interest income in the consolidated statement of income while the remaining amount would be recognized in other comprehensive income. For equity securities, the entire other-than-temporary would be considered credit related and would be recorded in earnings.
During 2010, we recorded other-than-temporary credit impairment charges on a security which totaled $1.2 million. At December 31, 2010, we have net unrealized gains on our available-for-sale portfolio of $35.5 million comprised of gains in the amount of $64.0 million and losses of $28.5 million. In the held-to-maturity portfolio, we have net unrealized gains of $9.4 million comprised of $9.4 million in gains and $48,000 in losses. For further discussion on other-than-temporary impairment of investments, see the “Investment Securities” section on page 43 of Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations as well as Note 4 of the Notes to Consolidated Financial Statements.
Significant judgment is involved in determining when a decline in fair value is other-than-temporary. The factors considered by management include, but are not limited to:
Adverse changes in management’s assessment of the factors used to determine that a security was not other-than-temporarily impaired could lead to additional impairment charges. Conditions affecting a security that we determined to be temporary could become other than temporary and warrant an impairment charge. Additionally, a security that had no apparent risk could be affected by a sudden or acute market condition and necessitate an impairment charge.
The Company has one security that is currently valued at 30.0% or more below book value that is not considered other than temporarily impaired. At December 31, 2010, this security has a fair value of $2.3 million compared to a book value of $4.7 million.
• Percentage and length of time by which an issue is below book value;
• Financial condition and near-term prospects of the issuer including their ability to meet contractual obligations in a timely manner;
• Ratings of the security;
• Whether the decline in fair value appears to be issuer specific or, alternatively, a reflection of general market or industry conditions;
• Whether the decline is due to interest rates and spreads or credit risk;
• The value of underlying collateral; and
• Our intent and ability to retain the investment for a period of time sufficient to allow for the anticipated recovery in market value or more likely than not will be required to sell a debt security before its anticipated recovery which may be until maturity.
Goodwill and Identifiable Intangible Assets
Critical Estimates
Judgment and Uncertainties
Effect if Actual Results Differ from Assumptions
We evaluate goodwill and identifiable intangible assets for impairment annually or whenever events or changes in circumstances indicate the carrying value of the goodwill or identifiable intangible assets may not be recoverable. We complete our impairment evaluation by performing internal valuation analyses, considering other publicly available market information and using an independent valuation firm, as appropriate.
In the first quarter of fiscal 2010, we completed our annual impairment testing of goodwill using an independent valuation firm, and determined there was no impairment. Through year end, no events or circumstances subsequent to the annual testing date indicate that the carrying value of the Company’s goodwill may not be recoverable, therefore, no interim testing was required.
The carrying value of goodwill and identifiable intangible assets at December 31, 2010, was $527.2 million and $27.5 million, respectively. For further discussion on goodwill and identifiable intangible assets, see the “Goodwill and Intangible Assets” section on page 54 of Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations as well as Note 7 of the Notes to Consolidated Financial Statements.
Fair value was determined using widely accepted valuation techniques, including estimated future cash flows, comparable transactions, control premium and market peers. These types of analyses contain uncertainties because they require management to make assumptions and to apply judgment to estimate industry economic factors and the profitability of future business strategies. It is our policy to conduct impairment testing based on our current business strategy in light of present industry and economic conditions, as well as future expectations.
If actual results are not consistent with our estimates or assumptions, we may be exposed to an impairment charge that could be material. Management has evaluated the effect of lowering the estimated fair value of the reporting unit and determined that fair value would have to decline more than 10% before Step 2 of the impairment analysis would be required under accounting guidance for goodwill impairment.
Allowance for Loan Losses
Critical Estimates
Judgment and Uncertainties
Effect if Actual Results Differ from Assumptions
It is the policy of NewAlliance to maintain an allowance for loan losses that equals management’s best estimate of probable credit losses that are inherent in the portfolio at the balance sheet date.
Management follows a guiding principle that the level of the reserve should be directionally consistent with asset quality indicators. The adequacy of the allowance for loan losses is determined based upon a detailed evaluation of the portfolio and sub-portfolios through a process which considers numerous factors, including levels and direction of delinquencies, historical loss rates over the business cycle, non-performing loans and assets, risk ratings, estimated credit losses using both internal and external portfolio reviews, current economic and market conditions, concentrations, portfolio volume and mix, changes in underwriting and experience of staff.
The allowance for loan losses is reviewed and approved by the Board of Directors on a quarterly basis. For further discussion on the allowance for loan losses, see the “Allowance for Loan Losses” section on page 52 of Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations as well as Note 7 of the Notes to Consolidated Financial Statements.
We determine the adequacy of the allowance for loan losses by analyzing and estimating losses inherent in the portfolio. The allowance for loan losses contains uncertainties because the calculation requires management to use historical information as well as current economic data to make judgments on the adequacy of the allowance. As the allowance is affected by changing economic conditions and various external factors, it may impact the portfolio in a way currently unforeseen.
Adverse changes in management’s assessment of the factors used to determine the allowance for loan losses could lead to additional provisions. Actual loan losses could differ materially from management’s estimates if actual losses and conditions differ significantly from the assumptions utilized. These factors and conditions include general economic conditions within NewAlliance’s market, trends within industries, real estate and other collateral values, interest rates and the financial condition of the individual borrower. While management believes that it has established adequate specific and general allowances for probable losses on loans, there can be no assurance that the regulators, in reviewing the Company’s loan portfolio, will not request an increase in the allowance for losses, thereby negatively affecting the Company’s financial condition and results of operations.
Income Taxes
Deferred Tax Assets and Liabilities
Critical Estimates
Judgment and Uncertainties
Effect if Actual Results Differ from Assumptions
Management uses the asset and liability method of accounting for income taxes in which deferred tax assets and liabilities are established for the temporary differences between the financial reporting basis and the tax basis of the Company’s asset and liabilities. The realization of the net deferred tax asset generally depends upon future levels of taxable income and the existence of prior years’ taxable income, to which “carryback” refund claims could be made. A valuation allowance is maintained for deferred tax assets that we estimate are more likely than not to be unrealizable based on available evidence at the time the estimate is made.
Each quarter, we reevaluate our estimate related to the valuation allowance, including our assumptions about future profitability. At December 31, 2010 and December 31, 2009, our valuation allowance was $23.2 million and $21.6 million, respectively, of which $22.1 million and $20.1 million, respectively, was established against the net state deferred tax asset as a result of the implementation of a Connecticut passive investment company and is not a result of assumptions about future profitability.
Because of a review of the factors discussed above related to the adequacy of the valuation allowance, our income tax expense for the year-ended December 31, 2010 included a decrease in the valuation allowance attributable to capital losses of $406,000. The decrease was mainly due to additional capital gains incurred in 2010. For further discussion on our deferred taxes and valuation allowance, see Note 13 of the Notes to Consolidated Financial Statements.
Significant management judgment is required in determining income tax expense and deferred tax assets and liabilities. Some judgments are subjective and involve estimates and assumptions about matters that are inherently uncertain. In determining the valuation allowance, we use historical and forecasted future operating results, based upon approved business plans, including a review of the eligible carryforward periods, tax planning opportunities and other relevant considerations. Management believes that the accounting estimate related to the valuation allowance is a critical accounting estimate because the underlying assumptions can change from period to period. For example, tax law changes or variances in future projected operating performance could result in a change in the valuation allowance.
Should actual factors and conditions differ materially from those used by management, the actual realization of net deferred tax assets or deferred tax liabilities could differ materially from the amounts recorded in the financial statements. If we were not able to realize all or part of our net deferred tax assets in the future, an adjustment to our deferred tax assets valuation allowance would be charged to income tax expense in the period such determination was made. We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to calculate our income taxes.
Tax Contingencies
Critical Estimates
Judgment and Uncertainties
Effect if Actual Results Differ from Assumptions
We regularly face challenges from domestic tax authorities regarding the amount of taxes due. These challenges include questions regarding the timing and amount of deductions and the allocation of income among various tax jurisdictions. At any one time, multiple tax years are subject to audit by the various tax authorities. In evaluating the exposures associated with our various tax filing positions, we record reserves for probable exposures. A number of years may elapse before a particular matter, for which we have established a reserve, is audited and fully resolved or clarified. We adjust our tax contingencies reserve and income tax provision in the period in which actual results of a settlement with tax authorities differs from our established reserve, the statute of limitations expires for the relevant tax authority to examine the tax position or when more information becomes available. For further discussion on current tax examinations, see Note 13 of Notes to Consolidated Financial Statements.
Our tax contingencies reserve contains uncertainties because management is required to make assumptions and to apply judgment to estimate the exposures associated with our various filing positions.
Our effective income tax rate is also affected by changes in tax law, entry into new tax jurisdictions, the level of earnings and the results of tax audits.
We believe that our tax reserves reflect the probable outcomes of known contingencies. Although we think that our estimates and judgments discussed herein are reasonable, actual results may differ, which could be material to our financial statements. To the extent we prevail in matters for which reserves have been established, or are required to pay amounts in excess of our reserves, our effective income tax rate in a given financial statement period could be materially affected. An unfavorable tax settlement would require use of our cash and would result in an increase in our effective income tax rate in the period of resolution. A favorable tax settlement would generally be recognized as a reduction in our effective income tax rate.
Pension and Other Post Retirement Benefits
Critical Estimates
Judgment and Uncertainties
Effect if Actual Results Differ from Assumptions
Pension costs and liabilities are dependent on assumptions used in calculating such amounts. Management uses key assumptions that include discount rates, expected return on plan assets, benefits earned, interest costs, mortality rates, increases in compensation, and other factors. The two most critical assumptions-estimated return on plan assets and the discount rate-are important elements of plan expense and asset/liability measurements. These critical assumptions are evaluated at least annually on a plan basis. Other assumptions are evaluated periodically and are updated to reflect actual experience and expectations for the future. Actual results in any given year will often differ from actuarial assumptions because of economic and other factors, and in accordance with U.S. GAAP the impact of these differences is accumulated and amortized over future periods.
The discount rate assumptions used to measure the postretirement benefit obligations is set by reference to published high-quality bond indices, as well as certain yield curves. The Company used the Citigroup Pension Liability Index as a benchmark. A higher discount rate decreases the present value of benefit obligations and decreases pension expense.
The expected rate of return on plan assets is based on current and expected asset allocations, as well as the long-term historical risks and returns with each asset class within the plan portfolio. A lower expected rate of return on plan assets increases pension costs. For further discussion on pension and other post retirement benefits, see Note 11 of the Notes to Consolidated Financial Statements.
To reflect market interest rate conditions in calculating the projected benefit obligation, the pension discount rate was decreased from 5.85% at December 31, 2009 to 5.35% at December 31, 2010, and the postretirement discount rate decreased from 5.50% to 4.85% at each of these periods.
An expected rate of return on plan assets of 7.50% and 7.75% was utilized at December 31, 2010 and 2009, respectively.
While management believes that the assumptions used are appropriate, differences in actual experience or changes in assumptions may affect future pension or other postretirement obligations and expense. Continued volatility in pension expense is expected as assumed investment returns vary from actual.
A 25 basis point decrease in the discount rate would have increased annual pension expense by $333,000, while a 25 basis point increase in the discount rate would have decreased annual pension expense by $318,000.
A 25 basis point decrease or increase in the expected return on assets would have increased or decreased annual pension expense, respectively, by $219,000.
Recent Accounting Changes
We have adopted the following new accounting pronouncements and authoritative guidance during 2010. Except as indicated, the adoption of the following pronouncements did not have a material impact on the Company’s consolidated financial statements.
FASB ASU 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. This guidance is intended to improve the transparency of financial reporting by requiring enhanced disclosures about a bank’s allowance for loan losses and the credit quality of its financing receivables (generally defined as loans and leases). The primary goal of the disclosure requirements is to provide more information about the credit risk in a bank’s portfolio of loans and how that risk is analyzed and assessed in arriving at the allowance for loan loss.
FASB ASU 2010-06, Improving Disclosures about Fair Value Measurements. This guidance amends Topic 820, Fair Value Measurements and Disclosures. The guidance requires additional disclosures about fair value measurements including transfer in and out of Levels 1 and 2 and higher levels of disaggregation for the different types of financial instruments. For the reconciliation of Level 3 fair values measurements, information about purchases, sales, issuances and settlements should be presented separately.
FASB ASU 2009-16, an update to Topic 860 - Transfer of Financial Assets. This guidance requires entities to provide more information about sales of securitized financial assets and similar transactions, particularly if the seller retains some risk in the assets. The guidance eliminates the concept of a qualifying special-purpose entity, changes the requirements for the derecognition of financial assets, and enhances the disclosure requirements for sellers of the assets.
FASB ASU No. 2009-17, an update to Topic 810 - Consolidations. The guidance requires an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity (which would result in the enterprise being deemed the primary beneficiary of that entity and, therefore, obligated to consolidate the variable interest entity in its financial statements); to require ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity; to revise guidance for determining whether an entity is a variable interest entity; and to require enhanced disclosures that will provide more transparent information about an enterprise’s involvement with a variable interest entity.
FASB ASU 2010-09, an update to Topic 855 - Subsequent Events. The guidance updates certain recognition and disclosure requirements. Among other things, this guidance retracts, for public entities, the requirement to disclose the date through which subsequent events have been evaluated and whether that date is the date the financial statements were issued or were available to be issued.
Operating Results
Table 1: Summary Income Statements
Earnings Summary
Comparison of 2010 and 2009
The Company, for 2010, achieved record net income of $58.0 million, or $0.59 per diluted share; attained $9.03 billion in total assets; originated a record $2.16 billion in loans and preserved credit quality. These results were the culmination of NewAlliance’s continued focus on strong banking fundamentals and successful achievement of its priorities to sustain net revenue momentum, continue deposit growth and improve operating leverage.
As shown in Table 1, net income increased $11.5 million, or $0.12 per share, over the year ended 2009. This was primarily due to the increase in net interest income of $31.1 million, or 15.3%, as the Company significantly reduced its cost of funds while growing lending and deposit relationships. The Company’s net interest margin increased 34 basis points to 3.02% from 2.68% for the years ended December 31, 2010 and 2009, respectively and the interest rate spread increased 46 basis points to 2.75% for the year ended December 31, 2010. The increase in net interest income was partially offset by increases in non-interest expenses, primarily merger related charges of $12.2 million and income tax expense. Merger related charges are attributable to the First Niagara transaction, which also contributed $3.7 million to the increase in income tax expense. The remaining increase in income tax expense of $4.0 million was due to the higher income earned in 2010.
Comparison of 2009 and 2008
The year 2009 was one of continued stress on the banking system, where raising capital and controlling credit costs were top priorities for the industry. Assisted by numerous Government programs, the longest and deepest economic downturn since the 1930’s appears to have abated. However, continued credit market tightness, damage to household balance sheets and lack of job security are tempering the economic recovery. NewAlliance leveraged its position of financial and credit strength and proceeded aggressively to take deposit market share, build revenue momentum and take advantage of disruption in the marketplace.
As shown in Table 1, earnings per share for the year ended December 31, 2009 increased $0.02 over the same period in 2008 primarily due to a substantial reduction in our cost of funds while gaining deposit market share, predominantly core deposits, gains on sales of mortgage-backed securities and residential mortgages. These were the main drivers behind the increases in net interest income before provision and non-interest income of $13.1 million and $3.4 million, respectively. Additionally, these increases more than offset the $4.6 million increase in the provision for loan losses due to the economic environment and loan net charge-offs, the increase in operating expenses of $5.7 million, largely due to the FDIC special assessment of $3.9 million and a $5.1 million increase in income tax expense due to higher net income along with an increase in the effective tax rate.
Average Balances, Interest and Average Yields/Cost
Table 2 below sets forth certain information concerning average interest-earning assets and interest-bearing liabilities and their associated yields or rates for the periods indicated. The average yields and costs are derived by dividing income or expenses by the average balances of interest-earning assets or interest-bearing liabilities, respectively, for the periods shown and reflect annualized yields and costs. Average balances are computed using daily balances. Yields and amounts earned include loan fees and fair value adjustments related to acquired loans. Loans held for sale and nonaccrual loans have been included in interest-earning assets for purposes of these computations. Interest on nonaccrual loans has been included only to the extent reflected in the Consolidated Statements of Income. Unrealized gain or losses on available-for-sale investment securities are excluded from average yield calculations.
Table 2: Average Balance Sheets for the Years Ended December 31, 2010, 2009 and 2008
Net Interest Income Analysis
Net interest income is the amount that interest and fees on earning assets (loans and investments) exceeds the cost of funds, primarily interest paid to the Company’s depositors and interest on external borrowings. Net interest margin is the difference between the income on earning assets and the cost of interest-bearing funds as a percentage of earning assets.
Comparison of 2010 and 2009
As shown in Tables 2 and 3, net interest income increased $31.1 million for the year ended December 31, 2010 compared to the same period ended December 31, 2009. The increase was primarily due to: a) repricing or maturing interest-bearing liabilities outpacing interest-earning assets during the period, thereby allowing us to reduce our cost of funds at a faster pace and b) the average balance of interest-earning assets outpacing the growth in interest-bearing liabilities by $64.8 million and c) the shift in the mix of funding sources from higher cost time deposits and borrowings to core interest and non-interest bearing deposits which was a factor in reducing the cost of funds. The net interest margin increased 34 basis points for the year ended December 31, 2010 from the 2009 comparative period. The net interest margin for the years ended December 31, 2010 and 2009 was 3.02% and 2.68%, respectively.
Interest and dividend income decreased $21.0 million to $350.8 million at December 31, 2010 compared to $371.8 million at December 31, 2009 primarily due to lower asset yields. Partially offsetting the net decrease in asset yields, was growth in interest-earning assets with average balances increasing $156.8 million from the same period a year ago due to the loan and investment portfolios. The decline of 37 basis points in the average yield was due to lower market interest rates and, to a lesser extent, the increased level of nonperforming loans. The increase in organic loans and investment securities helped to relieve some of the interest rate pressure as the Company, with ready liquidity, was able to grow these portfolios. The interest income decline in the loan portfolio related to the average balance was primarily due to the decrease in the average balance of the purchased loan portfolio.
The decrease in income attributable to the loan portfolio was $6.4 million, of which $9.9 million was due to lower yields, partially offset by an increase of $3.5 million due to net average balance growth. The increase in interest income attributable to the average balance was primarily in commercial real estate loans and asset based lending, partially offset by continued declines in the purchased
residential loan portfolio. The decline in the average yield of 19 basis points was primarily in organic residential mortgage loans as homeowners have been taking advantage of refinancing opportunities at lower rates throughout 2009 and 2010. Loan yields have also been negatively impacted by the increase in nonperforming loans of $24.4 million from December 2009.
Earnings on the investment securities portfolio decreased $14.4 million primarily due to the decline in the average yield. The low level of market interest rates has pushed the average yield down 75 basis points resulting in a decline in interest income of $19.4 million.
The cost of funds for the year ended December 31, 2010 decreased $52.1 million, or 30.9% to $116.5 million, compared to $168.6 million for the same period a year ago. The decrease in the cost of funds was primarily due to a shift to a more favorable funding mix and our focus on pricing discipline which resulted in the cost of funds being reduced by 83 basis points.
The cost of deposits for the year ended December 31, 2010 decreased $30.1 million to $50.6 million, compared to $80.7 million for the same period a year ago, primarily resulting from the Company’s diligence in bringing deposit costs down while continuing to increase core deposit balances. While the average interest-bearing deposit balances increased $240.3 million, deposit costs declined $30.1 million. The Company experienced a decrease of $30.6 million in deposit interest expense due to a reduction of 76 basis points on the average rate paid and was attributable across all deposit categories. Deposit interest expense increased $574,000 due to the net increase of the average balance of interest-bearing core deposits of $381.2 million, partially offset by a decrease of $140.9 million in the average time deposit balances. Through our continued emphasis on building core deposit relationships and migration from maturing time deposits as they repriced at reduced rates, the Company has been able to grow core deposit average balances. The main driver of this growth has been money market accounts with an average balance increase of $360.8 million. Additionally, when combined with the decline in the average rate paid of 61 basis points, interest expense decreased by $64,000 for this product.
A further benefit of the low interest rate environment has been the decline in the average rate paid on borrowings from the Federal Home Loan Bank (“FHLB”). FHLB advances and other borrowing costs decreased $21.7 million due to the decline in the average rate paid of 87 basis points. Supported by the growth in deposits, the Company was able to pay down higher cost borrowings as they mature or replace them with new advances at substantially lower rates and reduce its overall reliance on borrowings.
Comparison of 2009 and 2008
As shown in Table 2 and 3, net interest income for the year ended December 31, 2009 was $203.2 million, an increase of $13.1 million from December 31, 2008. The net interest margin increased seven basis points to 2.68% for the year ended December 31, 2009 as compared to the year ended December 31, 2008. This increase was a net result of the loss of the FHLB Boston dividend and a reduction in interest-earning asset yields that were more than offset by the reduction in the costs of interest-bearing liabilities.
Interest and dividend income decreased $27.4 million to $371.8 million at December 31, 2009 compared to $399.2 million at December 31, 2008 comprising of a decrease of $40.9 million due to rate, offset by a $13.5 million increase due to volume. The decline in rate was primarily due to a) newly originated loans and adjustable or variable rate loans that were reset at reduced rates due to the rate cuts imposed by the FRB throughout 2008, b) the absence of a quarterly dividend from the FHLB Boston and c) a decline in the average yield in the investment securities portfolio due to a decline in market interest rates resulting from the current economic conditions. Loan yields have also been negatively impacted to a lesser extent by the increase in nonperforming loans. Investment growth helped to mitigate the effect of the rate decline on interest income as the average balance increase of $302.5 million accounted for approximately $13.0 million of the increase to interest income. Due to the growth in core deposits the Company has expanded the securities portfolio primarily with purchases of adjustable rate mortgage-backed securities. The average balance of the loan portfolio increased $10.0 million for the period, which includes an increase of $23.1 million in the average balance of loans held for sale. Given the economic and market conditions that have beset the industry over the last year, there have been fewer commercial originations that met our underwriting criteria and although residential mortgage originations were relatively strong, approximately half were originated at fixed rates and sold in the secondary market.
The cost of funds for the year ended December 31, 2009 decreased $40.5 million, or nearly 20.0% to $168.6 million, compared to $209.1 million for the same period a year ago. The Company’s continued strategy during this period was to reduce deposit costs and focus on the growth of core interest and non-interest-bearing deposits. The result was a decrease of $24.0 million in deposit interest expense due to changes in the mix of deposits with net average balance growth of $451.0 million and a decrease of 85 basis points on the average rate paid. This decrease in deposit interest expense was primarily in time deposits, which decreased $18.4 million due to the declines in the average balances and average rate paid of $201.9 million and 69 basis points, respectively. Through targeted marketing campaigns and migration from maturing time deposits as they repriced at reduced rates, the Company was able to grow core deposit average balances by a total of $652.9 million. The main driver of core deposit growth was savings and money market accounts with an average balance increase of $498.7 million $158.8 million, respectively. Additionally, when combined with the
decline in the average rate paid of 95 basis points on savings and 63 basis points on money market, interest expense decreased by $5.3 million during this period for these products.
A further benefit of the core deposit growth was a substantial reduction in and reliance on borrowings from the FHLB. FHLB advances and other borrowing costs decreased $14.1 million due to the decline in the average balance and the average rate paid on FHLB advances of $184.6 million and 29 basis points, respectively. The Company was able to replace maturing advances with new advances at substantially lower rates or payoff maturing advances.
Rate/Volume Analysis
The following table presents the extent to which changes in interest rates and changes in volume of interest-earning assets and interest-bearing liabilities have affected the Company’s interest income and interest expense during the periods indicated. Information is provided in each category with respect to: (i) changes attributable to changes in volume (changes in volume multiplied by prior rate); (ii) changes attributable to changes in rate (changes in rate multiplied by prior volume); and (iii) the net change. The changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate.
Table 3: Rate/Volume Analysis
Provision for Loan Losses
The provision for loan losses (“provision”) is based on management’s periodic assessment of the adequacy of the loan loss allowance which, in turn, is based on such interrelated factors as the composition of the loan portfolio and its inherent risk characteristics, the level of nonperforming loans and charge-offs, both current and historic, local economic and credit conditions, the direction of real estate values, and regulatory guidelines. The provision is charged against earnings in order to maintain an allowance for loan losses that reflects management’s best estimate of probable losses inherent in the loan portfolio at the balance sheet date.
Management performs a monthly review of the loan portfolio, and based on this review determines the level of the provision necessary to maintain an adequate allowance for loan losses. Management recorded a provision of $17.0 million for the year ended December 31, 2010. The primary factors that influenced management’s decision to record this provision were: a) the increase in non-performing loans of $24.4 million, or 48.3%, b) continuing trends in delinquencies, c) net charge-offs of $14.2 million and d) the
ongoing support of estimated credit losses embedded in the portfolio. Further details about nonperforming loans can be found in the “Asset Quality” and “Allowance for Loan Losses” sections beginning on page 49. Future provisions may be deemed necessary if economic conditions do not improve or continue to deteriorate. A provision of $18.0 million and $13.4 million was recorded for the years ended December 31, 2009 and 2008, respectively.
At December 31, 2010, the allowance for loan losses was $55.2 million, which represented 1.08% of total loans and 73.75% of nonperforming loans. In comparison, the allowance for loan losses was $52.5 million at December 31, 2009 representing 1.10% of total loans and 103.87% of nonperforming loans. See the “Asset Quality” and “Allowance for Loan Losses” sections located on pages 49-54 for further information regarding the Company’s credit quality.
Table 4: Non-Interest Income
Non-Interest Income Analysis
The Company has two primary sources of non-interest income: (a) banking services related to loans, deposits and other core customer activities typically provided through the branch network as well as merchant services and (b) financial services, comprised of trust, investment and insurance products and brokerage and investment advisory services. The principal categories of non-interest income are shown in Table 4.
Comparison of 2010 and 2009
As displayed in Table 4, non-interest income increased $1.9 million to $61.2 million for the year ended December 31, 2010 from the prior year period. The drivers of the increase were depositor service charges, loan and servicing income, trust fees, BOLI and net gain on limited partnerships. These increases were partially offset by decreases in investment management, brokerage and insurance fees, net security gains and mortgage banking and loan sale income.
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Depositor service charges increased due to merchant services income and check card fees. Growth of fee income is attributable to an increase in consumer spending and the growth in retail and business core deposit accounts. The increase in depositor service charges was partially offset by a decline in check fees primarily due to the negative impact of the new federal banking regulations which restricted overdraft fees. These new rules, which became effective on July 1, 2010, prohibit financial institutions from charging customers fees for paying overdrafts on automated teller machine and debit card transactions, unless a consumer consents to the overdraft service for those types of transactions. The Company expects that it will have lower fees in 2011 due to the full year impact of these new rules.
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Loan and servicing income increased primarily as a result of a prior year write-down of approximately $520,000 on the Bank’s mortgage servicing asset as well as increased prepayment fees and an increase in fees associated with the commercial finance lending business, which was established in the fourth quarter of 2009.
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Trust fees increased due to the overall improvement in market conditions during the period. For the year ended December 31, 2010, average assets under management were consistently ahead of 2009, and averaged $1.03 billion compared to $942.0 million for the prior year period, a 10% overall increase, further supporting the growth in revenue year over year.
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BOLI income increased as the Company recorded a gain of approximately $2.6 million related to tax-exempt life insurance proceeds. This increase was partially offset by a decline in the average yield earned as a result of current market interest rates and a reduction in the BOLI asset.
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Net gain on limited partnerships increased $4.6 million due primarily to the net increase in the carrying value on certain limited partnerships. A $3.6 million increase in the carrying value and a realized gain of $529,000 resulted from the June 2010 initial public offering (“IPO”) of an underlying portfolio company in a limited partnership. The realized gain represents the Company’s allocated income on 25.0% of the shares sold by the partnership in the IPO. The increase in the carrying value was due to the year to date equity method adjustment for the remaining shares. The Company does not expect the value of the underlying portfolio company to increase at the 2010 rate in 2011. The net increase in 2010 compares to a net loss and an impairment write down recorded in the prior year period.
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Investment management, brokerage and insurance fee income decreased due to the low interest rate environment as well as customer preference for deposit products over other investment alternatives.
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Net gain on securities decreased $4.8 million due to higher prior year gains recorded on the sale of mortgage-backed securities. The net gain of $1.2 million recorded in 2010 was due to the sale of residential mortgage-backed securities and gains recognized on the call of U.S. Agency notes and preferred stock. These gains were partially offset by impairment write-downs on an investment in a pooled trust preferred security based on cash flow analyses. Residential mortgage-backed securities were sold during the current year to reduce pre-payment buy-out risk. Further information related to the impairment can be found in Footnote 4 of the Notes to Consolidated Financial Statements.
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Mortgage origination activity and loan sale income decreased due to a lower number of mortgage loans originated for sale and sold in the secondary market and the effect of originations that were in the pipeline under commitments to be sold at December 31, 2010, compared to December 31, 2009. Mortgage loans originated for sale totaled $355.8 million and $475.9 million for the years ended December 31, 2010 and 2009, respectively.
Comparison of 2009 and 2008
As displayed in Table 4, non-interest income increased $3.4 million to $59.2 million for the year ended December 31, 2009 from the prior year period. The main drivers of the increase were mortgage origination activity and loan sale income and net gain on securities. These increases were partially offset by decreases in BOLI, investment management, brokerage and insurance fees, trust fees and other income.
•
Mortgage origination activity and loan sale income increased $4.0 million due to a greater number of mortgage loans originated for sale and sold in the secondary market during the year and the effect of originations that were in the pipeline at December 31, 2009 under commitments to be sold. The increased origination activity was driven by the low interest rate environment and the continued dislocation in the credit markets which has reduced the number of competitors in the short term.
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Net gain on securities increased due to the gains recorded on the sale of mortgage-backed securities. These securities were sold at a premium and were sold in order to reduce prepayment risk, to reduce high price premium risk and to fund the pay-off of maturing FHLB advances primarily earlier in the year. The increase in the net gain on securities is also due to the prior year impairment charges related to an investment in a trust preferred equity security in a regional bank and two preferred equity securities issued by Freddie Mac and Lehman Brothers. Partially offsetting the net gain on the sale of investments was other-than-temporary impairments recorded against the Company’s investment in an adjustable rate mortgage mutual fund and a pooled trust preferred security.
•
Trust fees declined primarily due to a decrease in the year-to-date average assets under management. The assets under management declined primarily as a result of the decline in the market value of the assets, which caused the reduction in the amount of management fees earned. Assets under management began to rebound in the second half of the year evidenced by the market improvement.
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Investment management, brokerage and insurance fees declined due to prevailing depressed market conditions and the ongoing lack of consumer confidence in longer-term investment choices.
•
BOLI income decreased due to a decline in the average yield earned as a result of current market interest rates.
•
Net gain on limited partnerships decreased due to the net loss of $575,000 recorded on limited partnerships during 2009 due to the decline in the fair-value of the underlying investments compared to a net loss of $30,000 recorded in 2008.
•
The decline in other income was primarily due to a decrease of approximately $380,000 in amounts earned on the outstanding balances of bank checks processed by a third-party vendor due to the decline in market interest rates and the prior year receipt of approximately $500,000 from the partial redemption of the Company’s stake in Visa Inc., following Visa’s initial public offering.
Non-Interest Expense Analysis
Comparison of 2010 and 2009
As displayed in Table 5, non-interest expense increased $14.8 million to $187.0 million for the year ended December 31, 2010 from $172.2 million for the same period a year ago. The main driver of the increase was merger related charges of $12.2 million, followed by salaries and employee benefits, other expense and advertising, public relations and sponsorships, partially offset by a decrease in occupancy, outside services, amortization of identifiable intangible assets and FDIC insurance premiums.
•
Merger related charges increased due primarily to legal, investment banking and compensation expenses associated with the proposed First Niagara acquisition of the Company. Certain existing compensation benefits for executive officers were accelerated, including severance, restricted stock and performance-based share awards. The accelerated benefits would have otherwise been paid or the awards would have vested upon the consummation of the merger.
•
Salaries and employee benefits increased mainly as a result of a) general merit increases and increased bonus accruals, b) additions to the management team and the commercial finance lending business c) increases in restricted stock and option expense due to additional grant awards, d) increased expense for the Company’s pension due to changes in assumptions for 2010 and e) a decrease in deferred direct loan origination salary costs due to a decline in the number of residential and commercial loan originations. These increases were partially offset by severance recorded in 2009.
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Other expense increased in various categories including OREO expense, telephone and supplies as well as an increase in other losses and expense related to a sales and use tax audit.
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Advertising, public relations and sponsorships increased primarily due to advertising expenses associated with new marketing campaigns. These campaigns include expenses associated with TV commercials, radio, print and online advertising, branch merchandising and collateral pieces and select sponsorships.
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FDIC insurance premium expense decreased $2.9 million primarily due to the special assessment of $4.0 million during the second quarter of 2009. The decrease was partially offset by an increase of approximately one basis point in the base assessment rate for 2010, compared to 2009 based on new assessment rates implemented by the FDIC in April 2009. Additionally, the Bank was able to offset some of the first quarter 2009 assessment costs through the exhaustion of the one-time credit established by the FDIC Reform Act of 2005.
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Outside services decreased primarily due to prior year consulting costs for a performance optimization project, partially offset by an increase in data processing fees.
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Amortization of identifiable intangible assets decreased due to less amortization on core deposit intangibles from using the accelerated method of accounting, therefore, there was more amortization expense in 2009 compared to 2010.
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Occupancy expenses declined primarily due to reduced maintenance costs throughout the branch network.
Comparison of 2009 and 2008
As displayed in Table 5, non-interest expense increased $5.6 million to $172.2 million for the year ended December 31, 2009 from $166.6 million for the same period a year ago. The main driver of the increase was the FDIC insurance premium. There was also an increase in outside services; however, there was a reduction in expenses associated with the majority of all other non-interest expense categories.
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FDIC insurance premium expense increased $9.8 million from 2008 due to: a) a seven basis point increase in the assessment rate in the first quarter of 2009 and an additional two basis point increase in the assessment rate bringing the rate to fourteen basis points for the second quarter through the remainder of 2009, b) the exhaustion of the Company’s one-time credit established by the Federal Deposit Insurance Reform Act of 2005 in the first quarter of 2009 and c) the special assessment in the second quarter of 2009 of $3.9 million imposed by the FDIC to provide for replenishment of the Deposit Insurance Fund. In addition, the FDIC required institutions to prepay their regular risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011, and 2012 on December 30, 2009 which amounted to approximately $27.5 million. Included in the prepaid assessment was approximately $1.7 million, which was recorded as expense in 2009.
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Outside services increased primarily due to consulting costs associated with strategic planning initiatives and mortgage consulting costs.
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Salaries and employee benefits decreased as a result of reduced stock option expense as the majority of options granted to date became fully vested on December 31, 2008 and a decrease in restricted stock expense due to the retirement of executive officers in 2009 and 2008. Salary expense also decreased due to a prior year severance payment for an executive who is no longer with the Company, which was partially offset by current year severance payments.
Partially offsetting the decreases were increased bonus accruals, an increase in pension plan expense due to the decline in the value of the pension assets and changes in assumptions for 2009 and additional expense in 2009 related to the Supplemental Executive Retirement Plan (“SERP”) of approximately $1.9 million resulting from the retirement of an executive officer in May 2009 and an unfavorable change in the discount rate associated with the measurement of the plan at December 31, 2009.
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Advertising, public relations and sponsorships declined primarily due to a reduction in expenses related to various media advertising and bonus campaigns to promote an array of business and consumer products.
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Furniture and fixture expense decreased primarily due to a decline in depreciation expenses for various hardware and software that have been fully depreciated, i.e., branch and corporate telephone and computer systems.
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Amortization of identifiable intangible assets decreased due to less amortization on core deposit intangibles from using the accelerated method of accounting whereas there was more amortization expense in 2008 compared to 2009.
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Other expenses decreased due to reductions in general operating expenses partially offset by an increase in other real estate owned expenses as a result of the increased number of foreclosed properties.
Income Tax Expense
Income tax expense for 2010, 2009 and 2008 was $33.5 million, $25.8 million and $20.7 million, respectively. The effective tax rates for the years ended 2010, 2009 and 2008 were 36.6%, 35.7%, and 31.4% respectively.
The change in the effective tax rate for the year ended December 31, 2010 in comparison to the year ended December 31, 2009 was due to an increase in 2010 of estimated non-deductible excess remuneration pursuant to Internal Revenue Code Section 162(m), offset by the increase in 2010 of favorable permanent differences, including bank-owned life insurance income and tax exempt obligations.
The change in the effective tax rate for the year ended December 31, 2009 in comparison to the year ended December 31, 2008 was due to an additional state tax liability as a result of new Massachusetts legislation enacted in 2008 but effective in 2009, an increase in 2009 of estimated non-deductible excess remuneration pursuant to Internal Revenue Code Section 162(m), the reduction in 2009 of favorable permanent differences, including bank-owned life insurance income and the dividends received deduction, and the
recognition in 2008 of the reversal of $991,000 of unrecognized tax benefits for tax positions of prior years resulting from the settlement of the IRS audit in the first quarter of 2008.
NewAlliance continually monitors and evaluates the potential impact of current events and circumstances on the estimates used in the analysis of its income tax positions, and accordingly, NewAlliance’s effective tax rate may fluctuate in the future. NewAlliance evaluates its income tax positions based on tax laws and appropriate regulations and financial reporting considerations, and records adjustments as appropriate. This evaluation takes into consideration the status of current taxing authorities’ examinations of NewAlliance’s tax returns and recent positions taken by the taxing authorities on similar transactions, if any. Accordingly, the results of these examinations may alter the timing or amount of taxable income or deductions taken by the Company.
Financial Condition, Liquidity and Capital Resources
Financial Condition Summary
From December 31, 2009 to December 31, 2010, total assets increased approximately $593.5 million mainly due to increases in investments and loans. Liabilities increased $569.5 million due to increases in both deposits and borrowings. Stockholders’ equity increased $24.0 million to $1.46 billion due primarily to net income for the year ended December 31, 2010 and the impact of the release of restricted stock. These increases are partially offset by dividends declared and treasury shares acquired.
Investment Securities
The Company maintains an investment securities portfolio that is primarily structured to provide a source of liquidity for operating needs, to generate interest income and to provide a means to balance interest-rate sensitivity. The securities portfolio is managed in accordance with regulatory guidelines and established internal corporate investment policies. The following table sets forth certain financial information regarding the amortized cost and fair value of the Company’s investment portfolio at the dates indicated.
Table 6: Investment Securities
At December 31, 2010, the Company had total investments of $2.83 billion, or 31.3%, of total assets. The increase of $259.1 million, from $2.57 billion at December 31, 2009 was primarily the result of purchasing
U.S. Government agency obligations and held to maturity residential mortgage-backed securities, partially offset by a decrease in available for sale residential
mortgage-backed securities. The Company’s increase in the investment portfolio was funded primarily by the growth in deposits and short-term borrowings. While the Company prefers lending as the primary use of its excess cash flows, the investment portfolio serves a secondary role in generating revenue while managing interest-rate risk and liquidity.
The available for sale and held to maturity securities portfolios are primarily composed of mortgage-backed securities. At December 31, 2010, mortgage-backed securities comprised 78.0% and 97.0% of the total available for sale and held to maturity securities portfolios, respectively, the majority of which are issued by Fannie Mae and Freddie Mac. The duration of the mortgage-backed securities portfolio was 2.34 years at December 31, 2010 compared to 1.62 years at December 31, 2009.
The Company’s underlying investment strategy has been to purchase FNMA and FHLMC short-term sequential collateralized mortgage obligations, agency hybrid adjustable rate mortgage backed securities and seasoned 15 and 20 year Government Sponsored Enterprise (“GSE”) fixed rate mortgage-backed securities. The Company has focused on the purchases of these securities due to their attractive spreads versus funding costs and for their monthly cash flows that provide the Company with liquidity. This strategy is also supplemented with select purchases of bullet, callable and step-up coupon agency debentures. The average life for mortgage-backed securities, when purchased, would range between two and four years and the maturity dates for Agency obligations would range between one and seven years depending upon the rate structure of the bond.
FASB guidance requires the Company to designate its securities as held to maturity, available for sale or trading depending on the Company’s intent regarding its investments at the time of purchase. The Company does not currently maintain a portfolio of trading securities. As of December 31, 2010, $2.55 billion, or 90.2% of the portfolio, was classified as available for sale and $275.9 million of the portfolio was classified as held to maturity. The Company believes that the high concentration of securities available for sale allows flexibility in the day-to-day management of the overall investment portfolio, consistent with the objectives of optimizing profitability and mitigating interest rate risk. Securities available for sale are carried at estimated fair value. Additional information about fair value measurements can be found in Note 15 of the Notes to Consolidated Financial Statements.
During the three months ended December 31, 2010, September 30, 2010 and June 30, 2010, a pooled trust preferred security, which had a previous credit related impairment charge during 2009, was deemed to have additional credit related OTTI loss in the amounts of $250,000, $378,000 and $552,000, respectively. These credit related impairments were based on further declines in expected cash flows and were reclassified from other comprehensive income as they were previously recognized as non-credit related. Management utilizes nine cash flow scenarios received quarterly from the underwriter to analyze this security for potential OTTI. The nine scenarios cover various default rates, recovery rates and prepayment options over different time periods. Two of the nine cash flow analyses continue to indicate impairment over the life of the security, the driver of which is the recovery rate, modeled at 0%. Past history of the security indicates that there have not been any recoveries to date from securities that have defaulted. Based on these factors, management recorded a credit related impairment totaling $1.2 million during 2010. The credit impairments represent the average loss of the two negative cash flow analyses at each period. At December 31, 2010, the pooled trust preferred security had an amortized cost and fair value of approximately $247,000 and $221,000, respectively. There is no intent to sell nor is it more likely than not that the Company will be required to sell this security.
The net unrealized gain on securities classified as available for sale as of December 31, 2010 was $35.5 million compared to an unrealized gain of $45.8 million as of December 31, 2009. The depreciation in the market value of securities available for sale was primarily due to the decrease in the fair value of mortgage-backed securities due to the increase in LIBOR/Swap rates and treasury rates and the tightening in mortgage spreads. Partially offsetting the decrease in the fair value of the mortgage-backed securities was an increase in the fair value of the auction rate certificates as they were tendered at par and the trust preferred equity securities which have experienced improvement in market value. The changes in unrealized gains and losses on the investment portfolio were also due to credit spreads, liquidity and fluctuations in market interest rates during the period.
The net unrealized gain on residential mortgage-backed securities is primarily from agency mortgage-backed securities issued by FNMA and FHLMC resulting from the general decline in interest rates and the tightening in mortgage-backed security spreads since date of purchase. Although the Federal Reserve Bank mortgage-backed securities purchase program ended on March 31, 2010, mortgage rates and spreads continue to remain at relatively low levels.
The unrealized loss on private label residential mortgage-backed securities is primarily concentrated in one BBB rated private-label mortgage-backed security which is substantially paid down, well seasoned and of an earlier vintage that has not been significantly affected by high delinquency levels or vulnerable to lower collateral coverage as seen in later issued pools. Widening in non-agency mortgage spreads since the date purchased is the primary factor for the unrealized losses reported on private label residential mortgage-backed securities. None of the securities are backed by subprime mortgage loans and none have suffered losses. Other than the BBB rated security, there is one security rated AA and the remaining securities are AAA rated. Management’s review concluded that the private-label mortgage-backed securities are not other-than-temporarily impaired.
The unrealized losses on other bonds and obligations primarily relates to a position in an adjustable rate mortgage mutual fund. During 2009, the Company recorded an OTTI loss of $816,000 on this adjustable rate mortgage mutual fund due to a decrease in the credit quality of the security coupled with a loss recognized by the fund. As of December 31, 2010, the investment carries a market value to book value ratio of 82.66%, a weighted average underlying investment credit rating of AAA and it continues to pay normal monthly dividends. There is no intent to sell nor is it more likely than not that the Company will be required to sell this security and management has therefore concluded that the fund experienced no further OTTI in the twelve months ended December 31, 2010.
Trust preferred securities are comprised of two pooled trust preferreds with an amortized cost of $4.9 million, one of which is rated BB and the other is rated CC at December 31, 2010. During 2009, the Company recorded a credit related impairment of $581,000 on the CC rated pooled trust preferred security based on a cash flow analysis and subsequent credit related impairments of $1.2 million during the twelve months ended December 31, 2010 as discussed above. The remaining $42.7 million of trust preferred securities are comprised of twelve “individual names” issues with the following ratings: $15.6 million rated A- to A, $25.6 million rated BBB- to BBB+ and $0.5 million rated BB. The unrealized losses reported for trust preferred securities relate to the financial and liquidity stresses in the fixed income markets and in the banking sector and are not reflective of individual stresses in the individual company names. The ratings on all of the issues with the exception of the CC rated pooled security have improved or remained the same since December 31, 2009. Additionally, there have not been any disruptions in the cash flows of these securities and all are currently paying the contractual principal and interest payments. A detailed review of the two pooled trust preferreds and the “individual names” trust preferred equity securities was completed by management. This review included an analysis of collateral reports, cash flows, stress default levels and financial ratios of the underlying issuers. Management concluded that after the OTTI loss recorded on the CC rated pooled trust preferred security, these securities are not other-than-temporarily impaired.
Management has performed a review of all investments with unrealized losses and determined that no other investments had credit related other-than-temporary impairment. The Company has no intent to sell nor is it more likely than not that the Company will be required to sell any of these securities within the time necessary to recover the unrealized losses which may be until maturity. The Company does not plan on investing in securities backed by subprime mortgage collateral.
The following table sets forth certain information regarding the carrying value, weighted average yield and contractual maturities of the Company’s investment portfolio as of December 31, 2010. In the case of mortgage-backed securities, the table shows the securities by their contractual maturities; however, there are scheduled principal payments and there will be unscheduled prepayments prior to their contractual maturity. Income on obligations of states and political subdivisions are taxable and no yield adjustment for dividend receivable deduction is made because it is not material.
Table 7: Investment Maturities Schedule
Lending Activities
The Company originates residential real estate loans secured by one- to four-family residences, commercial real estate loans, residential and commercial construction loans, commercial loans, multi-family loans, home equity lines of credit and fixed rate loans and other consumer loans throughout the States of Connecticut and Massachusetts. Additionally, within the residential real estate loan category are loans with property locations spread throughout the United States, as a result of the Company’s residential real estate loan purchase program.
The following table summarizes the composition of the Company’s total loan portfolio as of the dates presented:
Table 8: Loan Portfolio Analysis
As shown in Table 8, gross loans were $5.09 billion, up $329.2 million, at December 31, 2010 from year-end 2009. The Company experienced an increase in most loan categories due to reduced interest rate levels.
Residential real estate loans continue to represent the largest segment of the Company’s loan portfolio as of December 31, 2010, comprising 49.8% of total loans. The increase of $138.8 million from December 31, 2009 was primarily due to origination volume partially offset by the net impact of prepayments. The Company had significant originations of both adjustable and fixed rate mortgages of $1.3 billion during the year, with approximately $946.6 million originated for portfolio and the remainder sold in the secondary market. The Company currently sells the majority of all originated fixed rate residential real estate loans with terms of 15 years or more. During the third quarter of 2009 the Company began to retain in its portfolio 30 year jumbo fixed rate residential mortgage originations and in 2010 the Company originated and retained $135.8 million of these mortgages. The strong mortgage origination activity resulted from low market interest rates, competitive pricing and increased marketing campaigns. The residential real estate loan portfolio has a weighted average FICO score of 750 and a current estimated weighted loan to value ratio of 62%. Included in residential real estate is a purchased portfolio, which is made up of prime loans individually re-underwritten by the Company to our underwriting criteria, and includes adjustable-rate and 10 and 15 year fixed-rate residential real estate loans with property locations throughout the United States with no significant exposure in any particular state. At December 31, 2010 the Company’s purchased portfolio had an outstanding balance of approximately $352.5 million with the largest concentration in our footprint of Connecticut and Massachusetts at 19.0%, followed by New York at 14.4% and California at 12.4%.
Commercial real estate loans increased $128.2 million from December 31, 2009, as the Bank has experienced increased demand in refinancing commercial real estate loans. Mid-sized businesses continue to look to regional community banks for relationship banking and personalized lending services. The commercial construction portfolio of $110.5 million includes $23.6 million of loans to commercial borrowers for residential housing development, of which approximately $9.0 million are for condominium projects. The decrease in commercial construction is mainly the result of transfers of construction to permanent loans to the commercial real estate portfolio as well as a drop in residential housing development loans.
The Company originates loans with interest reserves on certain commercial construction credits depending on various factors including, but not limited to, quality of credit, interest rate and project type. At December 31, 2010 the Company has five performing commercial construction loan relationships representing approximately 4.0% of the total commercial real estate portfolio balance with outstanding interest reserves of approximately $1.5 million.
Commercial business loans decreased $12.6 million from December 31, 2009 while commercial finance loans increased $111.8 million from December 31, 2009. As of December 31, 2010, the asset based lending portfolio was $113.7 million or 2.2% of total loans. The Company remains an active commercial lender and will continue promoting strong business development efforts to obtain new business banking relationships, while maintaining strong credit quality and profitability. We believe that our status as a healthy regional community bank focused on relationship banking bodes well for us to retain customers and to be a potential source of credit for new businesses.
Home equity loans and lines of credit decreased $33.3 million from December 31, 2009 to December 31, 2010. The Company continues to offer competitive pricing and is committed to growing this loan segment while maintaining credit quality. However, as a result of the continuing interest rate environment and general economic conditions, consumer demand has shifted to residential mortgages and away from home equity products, contributing to the year-to-date decline in the portfolio. The weighted average FICO score and current estimated weighted combined loan to value ratio for home equity loans and lines of credit is 749 and 67%, respectively. Lending has been from organic originations in the Company’s market area, none of which is subprime.
Selected Loan Maturities
The following table shows the contractual maturity of the Company’s construction and commercial business loan portfolios at December 31, 2010.
Table 9: Contractual Maturities and Interest Rate Sensitivity of Selected Loan Categories
Higher-Risk Loans
The loan portfolio segments that we consider to be higher risk are construction loans to commercial developers for residential development and a small segment of our residential real estate loans. The Company has a carrying value of $23.6 million of commercial construction loans for residential development. All of these loans are collateralized and carry a reserve allocation of $2.0 million. This segment has total delinquencies of $2.4 million, all of which are in the over 90 day category.
Within the residential portfolio, management uses an early warning technique to more closely monitor credit deterioration and potential nonperforming loans. The Company uses a matrix to identify where the concentration of outstanding loans fall in the risk continuum. This matrix is constructed using estimated current loan-to-value ranges (current balance LTV adjusted for estimated appreciation or depreciation in the appraised value) and the latest available FICO score ranges (rescored quarterly). The Company considers loans with an estimated current loan-to-value ratio above 80% and a FICO score less than 620 to be higher-risk. Once identified, the higher-risk loans are then reviewed by the Special Assets department to determine what, if any, action should be taken to mitigate possible loss exposure. At December 31, 2010, higher-risk loans comprised approximately $59.6 million, or 2.4% of the residential real estate portfolio.
Additionally, the Company also tracks loans that have a FICO score that has declined 20 points or more and are below 660. As of December 31, 2010 loans meeting this criteria represent approximately $55.0 million, or 2.4% of the residential portfolio.
The estimated current LTV is determined using several methods including the Case-Schiller composite home price index, the National Association of Realtors quarterly report on MSA-level house price averages, and an automated valuation random sampling across vintages and regions. Updated appraisals are generally obtained at 90 days past due or at any point management determines that full repayment of the loan is unlikely.
Asset Quality
Loans are placed on nonaccrual if collection of principal or interest in full is in doubt, if the loan has been restructured, or if any payment of principal or interest is past due 90 days or more. A loan may be returned to accrual status if it has demonstrated sustained contractual performance or if all principal and interest amounts contractually due are reasonably assured of repayment within a reasonable period.
As displayed in Table 10, nonperforming assets at December 31, 2010 increased to $78.4 million compared to $54.2 million at December 31, 2009. The increase is primarily due to loans secured by residential one-to-four family loans and commercial real estate loans, partially offset by a decline in commercial business and commercial construction loans.
The increase in nonperforming residential loans of $15.5 million was due to current economic conditions including factors such as continued high unemployment rates and softness in the real estate market impacting customer’s ability to make loan payments. There are 218 loans in the residential nonperforming category totaling $46.6 million, representing 1.84% of the total residential portfolio, just over half of which have property locations in Connecticut and Massachusetts. The Company routinely updates FICO scores and LTV ratios and continues to originate loans with superior credit characteristics. Through continued heightened account monitoring, collections and workout efforts, the Bank is committed to mortgage solution programs to assist homeowners to remain in their homes. As has been its practice historically, the Company does not originate subprime loans. Included in nonperforming residential loans are approximately $5.2 million in restructured loans which have been modified from their original contractual terms.
In the course of resolving nonperforming loans, the Bank may choose to restructure the contractual terms of certain real estate loans. Contractual terms may be modified to fit the ability of the borrower to repay in line with their current financial status which may be a reduction in interest rate to market rate or below, a change in the term, movement of the past due amounts to the back end of the loan or refinance. Loans are placed on nonaccrual status upon being restructured, even if they were not previously on nonaccrual status. The Bank’s policy to restore a loan to performing status includes the receipt of regular payments, generally for a period of six months. Over the past two years, the Company has restructured approximately 30 residential and six commercial real estate loans.
General adverse economic pressure, including softness in the real estate markets, continues to be the main driver of the increase in nonperforming commercial real estate loans. This increase primarily relates to four loans totaling $10.2 million which have been restructured and are performing in accordance with restructured terms. These loans are expected to return to full performing status by mid-2011. As of December 31, 2010, the construction to permanent segment of commercial construction loans had no delinquencies or nonaccruals.
While the economic data indicates the worst of the recession is over, if unfavorable general economic, employment and real estate market conditions persist or deteriorate further, there will be added stress on our loan portfolios. The Company believes, however, that its historical practice of prudent underwriting, the relatively modest size of its residential construction portfolio and strong average FICO scores combined with low weighted average loan to value ratios associated with its residential portfolio are significant advantages in keeping asset quality manageable. Nonperforming loans as a percent of total loans outstanding at December 31, 2010 were 1.47%, compared to 1.06% at December 31, 2009.
Table 10: Nonperforming Assets
(1) Nonperforming loans include all loans 90 days or more past due, restructured loans due to a weakening in the financial condition of the borrower and other loans for which have been identified by the Company as presenting uncertainty with respect to the collectability of principal or interest. The Company’s nonperforming loans do not accrue interest.
(2) Total loans are stated at their principal amounts outstanding, net of deferred loan fees and costs and net unamortized premium on acquired loans.
The following tables set forth delinquencies for 30-89 days and 90 days or more in the Company’s loan portfolio as of the dates indicated:
Table 11: Loan Delinquencies
(1) The table of delinquencies does not include guaranteed U.S. Government Certificates totaling $902,000 and $3.2 million at December 31, 2010 and 2009, respectively. At December 31, 2010, total delinquencies were in the 30-89 day category, where as $2.8 million was 30- 89 days delinquent and $477,000 was delinquent 90 days or more and non-accruing at December 31, 2009. The delinquent loans to total loans ratio, including these loans would be 0.40% for 30-89 days at December 31, 2010 and 0.54% and 1.07%, for the 30 - 89 days and 90 days or more categories, respectively, at December 31, 2009.
Other Real Estate Owned
The Company classifies property acquired through foreclosure or acceptance of a deed-in-lieu of foreclosure as other real estate owned in its financial statements. When a property is placed in other real estate owned, the excess of the loan balance over the estimated fair market value of the collateral, based on a recent appraisal, is charged to the allowance for loan losses. Estimated fair value usually represents the sales price a buyer would be willing to pay on the basis of current market conditions, including normal loan terms from other financial institutions, less the estimated costs to sell the property. Management inspects all other real estate owned properties periodically. Subsequent writedowns in the carrying value of other real estate owned are charged to expense if the carrying value exceeds the estimated fair value. At December 31, 2010, the Company had $3.5 million in other real estate owned. Due to current market conditions the Company does expect foreclosure activity to increase moderately in 2011.
Classification of Assets and Loan Review
An internal risk rating system is used to monitor and evaluate the credit risk inherent in the commercial, commercial real estate and commercial construction loan portfolios. Under our internal risk rating system, we currently identify criticized loans as “special mention,” “substandard,” “doubtful” or “loss”. On a quarterly basis, a Criticized Asset Committee composed of senior officers meets to review Criticized Asset Reports on commercial, commercial real estate and commercial construction loans that are risk rated special mention, substandard, or doubtful. The reports and the committee focus on the current status, strategy, financial data, and appropriate risk rating of the criticized loan. The internal risk ratings are subject to change based on the committee’s review and approval. In addition to the internal review, semi-annually, the Bank engages a third party to conduct a review of the commercial, commercial real estate and commercial construction loan portfolios. The primary purpose of the third party review is to evaluate the loan portfolio with respect to the risk rating profiles. Differences between the third party review and the internal risk ratings are discussed and rating classifications are adjusted accordingly.
At December 31, 2010, commercial, commercial real estate and commercial construction loans classified as substandard (both accruing and nonaccruing) totaled $73.5 million, and consisted of $39.9 million in commercial real estate loans, $19.0 million in construction lines and $14.6 million in commercial loans. Included in loans classified as substandard are $23.8 million of loans that are considered impaired and carry a specific reserve of $1.8 million. Impaired loans are measured based on either collateral values supported by appraisals, observed market prices or where potential losses have been identified and reserved accordingly. Special mention loans totaled $130.6 million, and consisted of $64.1 million of commercial real estate loans, $12.3 million in construction lines and $54.2 million of commercial loans. There were three loans totaling $647,000 classified as doubtful at December 31, 2010.
At December 31, 2009, loans classified as substandard (both accruing and nonaccruing) totaled $75.5 million, and consisted of $32.1 million in commercial real estate loans, $22.3 million in construction lines and $21.1 million in commercial loans. Special mention loans totaled $148.7 million, and consisted of $88.7 million of commercial real estate loans, $16.7 million in construction lines and $43.3 million of commercial loans. There were no loans classified as doubtful at December 31, 2009.
The Company evaluates its nonperforming residential real estate loans for impairment based on a review of current collateral values. At December 31, 2010, the Company’s nonperforming residential real estate loans were evaluated and of the $46.6 million nonperforming loans, $19.4 million were identified as requiring a specific reserve allocation which totaled $1.7 million. The Company also monitors credit deterioration in potential nonperforming residential real estate loans using current estimated loan-to-value ranges and the latest available FICO scores as described above in the Higher Risk Loans section.
Allowance For Loan Losses
The Board of Directors and management of the Company are committed to the establishment and maintenance of an adequate allowance for loan losses, determined in accordance with GAAP. Our approach is to follow the most recent guidelines that have been provided by our regulators. Management believes that the methodology it employs to develop, monitor and support the allowance for loan losses is consistent with those guidelines.
While management believes that it has established adequate specific and general allowances for probable losses on loans, there can be no assurance that the regulators, in reviewing the Company’s loan portfolio, will not request an increase in the allowance for losses, thereby negatively affecting the Company’s financial condition and earnings. Moreover, actual losses may be dependent upon future events and, as such, further additions to the allowance for loan losses may become necessary.
The allowance for loan losses is established through provisions for loan losses based on management’s on-going evaluation of the risks inherent in the Company’s loan portfolio. Charge-offs against the allowance for loan losses are taken on loans when it is determined that the collection of loan principal is unlikely. Recoveries made on loans that have been charged-off are credited to the allowance for loan losses.
The allowance for loan losses and the provision are determined based upon a detailed evaluation of the portfolio and sub-portfolios through a process which considers numerous factors, including levels and direction of delinquencies, nonperforming loans, risk ratings, estimated credit losses using both internal and external portfolio reviews, current economic and market conditions, concentrations, industry data, peer comparisons, portfolio volume and mix, changes in underwriting, experience of staff, and historical loss rates over the business cycle.
The Bank evaluates the allowance for loan loss requirements through an analysis of all impaired loans in accordance with impairment guidance within FASB ASC 310 -Receivables, with the balance of the portfolios, not impaired, analyzed under the guidelines of FASB ASC 450 - Contingencies, using a measurement of estimated credit losses based on historical loss rates adjusted for qualitative and environmental factors. The qualitative and environmental factors include but are not limited to 1) estimated embedded losses in non-performing loans and criticized loans not impaired 2) estimated losses in high risk residential mortgages and home equity loans
and lines of credit 3) increased portfolio delinquencies 4) changes in risk ratings and 5) macro economic conditions, including unemployment, consumer confidence, and continued softness in the real estate market.
In establishing an acceptable range of losses for the total portfolio, the Bank considers a high and low range of losses and a historical net loss rate analysis on individual loan portfolios. The loan loss allowance allocations as of December 31, 2010 are between these high and low ranges, as shown below in Table 13. The unallocated reserve increased slightly to $2.7 million, or 4.8% of the total reserve, and is for inherent losses, yet unidentified due to the current state of the economy. The 4.8% allocation is on the high side of management’s established range of 1% to 5%, however, is appropriate based on the current economic environment. The provision and allowance for loan losses are then reviewed and approved by the Company’s Board of Directors on a quarterly basis.
The following table sets forth activity in the Company’s allowance for loan losses for the periods indicated:
Table 12: Schedule of Allowance for Loan Losses
At December 31, 2010, the Company’s loan loss allowance was $55.2 million, or 1.08% of total loans as compared to a loan loss allowance of $52.5 million, or 1.10% of total loans at December 31, 2009. The relatively small increase in the allowance and ratio to total loans can, in part, be attributable to a favorable change in the portfolio mix as new loan growth has been primarily real estate and commercial finance loans which generally carry a lower risk of loss, and the balance of higher risk loans have been declining. This is demonstrated by the general reserve analysis for non-impaired loans in accordance with accounting guidance for contingencies. At December 31, 2010, the allowance for non-impaired loans to total non-impaired loans was virtually even with the prior year at 0.96% and 0.98%, respectively.
In the latter part of 2007, deteriorating market conditions began affecting loan portfolios. These conditions have continued to persist, although lessening as time passes. As displayed in Table 12, the Company recorded net charge-offs of $14.2 million during the year ended December 31, 2010, compared to net charge-offs of $15.4 million for the year ended December 31, 2009. The majority of the charge-offs in the residential category were adjustments based on current appraisals which continue to show the depression in home values while persistent adverse economic pressures are affecting charge-off levels in the commercial real estate, commercial construction and commercial business portfolios. As a result of the net loan growth, higher nonaccrual and delinquent loans, adversely classified loan indicators and net charge-offs, a provision for loan losses of $17.0 million was recorded for the year ended December 31, 2010 compared to $18.0 million for the same period in 2009.
The allowance for loan losses to nonperforming loans ratio at December 31, 2010 was 73.75% compared to 103.87% at December 31, 2009. As shown in Table 10, nonperforming loans include $15.4 million and $4.4 million of troubled debt restructured loans at December 31, 2010 and 2009, respectively, which are performing in accordance with their restructured terms but generally remain in nonaccrual status for at least six months. This ratio has declined because growth in the allowance is not proportionate to growth in nonperforming loans as the result of the following:
1) The majority of the Company’s nonperforming loans are secured by real estate collateral and while the entire loan is classified as nonperforming, only the amount of estimated losses would have been captured in the allowance for loan losses. Nonperforming residential and commercial real estate loans total $46.6 million and $18.8 million, respectively at December 31, 2010, however, the risk of loss is only $3.2 million;
2) Growth in nonperforming loans has been concentrated in real estate loans in which a significant loss in event of default is relatively low. Nonperforming residential and commercial real estate loans increased $15.5 million and $12.6 million, respectively, compared to the total increase in nonperforming loans of $24.4 million;
3) Certain nonperforming loans have already been partially charged-off to the expected net realizable value or have been restructured and, although performing, remain in nonaccrual status for a period of at least six months; and
4) A portion of the allowance is to cover losses established under FASB ASC 450,Contingencies, for performing loans. The increase in total loans since December 31, 2009 has been concentrated in well secured mortgage and asset based loans. Additionally, there has been a continued reduction in the construction loan portfolio.
The following table sets forth the Company’s allowance by loan category and the percent of the loans to total loans in each of the categories listed at the dates indicated:
Table 13: Allocation of Allowance for Loan Losses
The Company continues to maintain a well secured portfolio of loans which is regularly reviewed, and as it is related to impaired loans, reserved for or written down in a timely manner. This is evidenced by our low annual net charge-offs of 29 basis points for the year ended December 31, 2010 compared to 32 basis points in the prior year. The allowance at December 31, 2010 continues to represent a significant multiple of our actual net charge-off history and based on the existing loan portfolio profile, no material changes in loss performance is anticipated. Further, a portion of our nonperforming assets and delinquencies represents $15.4 million in already written down troubled debt restructurings, an increase of $12.1 million from the prior year end, which are performing per the restructured terms yet remain classified as nonaccrual per management’s policies. It is anticipated that these restructured loans will return to (full) performing status by mid-2011. Therefore, and although certain asset quality indicators have worsened, management believes that the allowance for loan losses is adequate and represents the best estimate of probable losses inherent in the loan portfolio.
Goodwill and Intangible Assets
At December 31, 2010, the Company had intangible assets of $554.7 million, a decrease of $7.8 million, from $562.5 million at December 31, 2009. The decrease is due to year-to-date amortization expense for core deposit and customer relationship intangibles.
Identifiable intangible assets are amortized on a straight-line or accelerated basis, over their estimated lives. Management assesses the recoverability of intangible assets subject to amortization whenever events or changes in circumstances indicate that their carrying value may not be recoverable. If the carrying amount exceeds fair value an impairment charge is recorded to income. Goodwill is not amortized, but instead is reviewed for impairment on an annual basis and more frequently if circumstances exist that indicate a possible reduction in the fair value of the business below its carrying value. For purposes of goodwill impairment evaluation, the Bank is identified as the reporting unit.
The Company engaged an external third party to assist with the annual test for goodwill impairment during the first quarter of 2010. The analysis performed evaluated the fair value of the reporting unit using a combination of four valuation methodologies including; the Public Market Peers approach, the Comparable Transactions approach, the Control Premium approach and a Discounted Cash Flow approach. Based on the analysis, the Company concluded that the reporting unit was not at risk of failing Step 1 of the impairment test; therefore, an impairment charge was not deemed necessary. No events or circumstances subsequent to the analysis through December 31, 2010 indicate that the carrying value of the Company’s goodwill may not be recoverable.
Sources of Funds
Cash flows from deposits, loan and mortgage-backed securities repayments, securities sales proceeds and maturities, borrowings and earnings are the primary sources of the Company’s funds available for use in its lending and investment activities and in meeting its operational needs. While scheduled loan and securities repayments are a relatively stable source of funds, deposit flows and loan and investment security prepayments are influenced by prevailing interest rates and local and economic conditions and are inherently uncertain. The borrowings primarily include FHLB advances and repurchase agreement borrowings. See Note 11 of Notes to Consolidated Financial Statements contained elsewhere within this Report for further borrowings information.
The Company attempts to control the flow of funds in its deposit accounts according to its need for funds and the cost of alternative sources of funding. A Loan and Deposit Pricing Committee meets weekly to determine pricing and marketing initiatives. Actions of the committee influence the flow of funds primarily by the pricing of deposits, which is affected to a large extent by competitive factors in its market area and asset/liability management strategies.
Deposits
The Company receives retail and commercial deposits through its main office and 87 other banking offices throughout Connecticut (76 locations) and Massachusetts (12 locations). Customer deposits generated through the NewAlliance banking network are the largest source of funds used to support asset growth. Deposit customers can access their accounts in a variety of ways including branch banking, ATM’s, internet banking or telephone banking. Effective advertising, direct mail, well-designed product offerings, customer service and competitive pricing policies have been successful in attracting and retaining deposits. A key strategic objective is to grow the base of checking customers by retaining existing relationships while attracting new customers. The deposit base provides a source of funding for the bank as well as an ongoing stream of fee revenue. The Company offers a wide variety of deposit accounts including checking, savings and certificate of deposit accounts that meet the needs of both the consumer and business customers.
Table 14: Deposits
As displayed in Table 14, deposits increased $215.3 million compared to December 31, 2009. The Company’s strategy has been to increase core deposits and reduce rates paid on interest bearing deposits, particularly on time deposits, in order to improve the net interest margin and the interest rate spread while continuing to build core relationships. Through well-designed product offerings and sales efforts, the Company has been able to grow core deposits by $182.3 million, or 5.1%, particularly through the Company’s money market and demand products which have grown $229.1 million and $83.3 million, respectively since year end 2009. The Company has executed several marketing programs, including telephone and direct mail campaigns to retain and grow valued, higher-balance deposit customer relationships through the cross-sell strategy of offering our highest tier of banking products - Premium Alliance and Platinum Alliance Checking and their companion accounts - Premium and Platinum Savings and Premium and Platinum Money Market. Also, and keeping in line with the Company’s overall deposit strategy throughout the year, the Company has reduced its cost of interest bearing deposits, which has led to decreases in savings deposits of $137.8 million. However, the Company was able to retain a portion of these deposit accounts through our premium level money market products that offer competitive interest rates.
The Company had $556.7 million in time deposits of $100,000 or more outstanding as of December 31, 2010, maturing as follows:
Table 15: Time Deposit Maturities of $100,000 or more
Borrowings
NewAlliance uses various types of short-term and long-term borrowings to meet funding needs. While customer deposits remain the primary source of funding loan originations, management uses short-term and long-term borrowings as a supplementary funding source for loan growth and liquidity needs when the cost of these funds are favorable compared to alternative funding, including deposits.
The Company is a member of the FHLB Boston regional bank which is part of the FHLB. Members are required to retain capital stock in the FHLB Boston and borrowings are collateralized by certain home mortgages and securities of the U.S. Government and its agencies. The Company’s borrowing capacity at the FHLB Boston is determined by the amount of FHLB Boston capital stock owned by the Company and the amount of loan and investment assets pledged to the FHLB Boston by the Company as collateral.
The following table summarizes the Company’s recorded borrowings at December 31, 2010.
Table 16: Borrowings
(1) Includes fair value adjustments on acquired borrowings, in accordance with purchase accounting standards of $1.9 million and $3.1 million at December 31, 2010 and December 31, 2009, respectively.
(2) The trusts were organized to facilitate the issuance of “trust preferred” securities. The Company acquired these subsidiaries when it acquired Alliance Bancorp of New England, Inc. and Westbank Corporation, Inc. The affiliated trusts are wholly-owned subsidiaries of the Company and the payments of these securities are irrevocably and unconditionally guaranteed by the Company.
The acquisition fair value adjustments (premiums) are being amortized as an adjustment to interest expense on borrowings over their remaining term using the level yield method.
Table 16 above summarizes the Company’s recorded borrowings of $2.24 billion at December 31, 2010 an increase of $352.7 million from the balance recorded at December 31, 2009, mainly in FHLB advances. The increase in FHLB advances represents the Company taking advantage of reduced rates offered by the FHLB for advances that were competitive with current market deposit rates. Combined with the growth in our core deposits, the advances assist the Company with the growth in our loan portfolio, to invest in securities and meet other liquidity needs, while effectively managing interest rate risk. At December 31, 2010, all of the Company’s outstanding FHLB advances were at fixed rates ranging from 0.31% to 8.17%.
The decrease of $5.5 million in repurchase agreements is primarily due to a decline in commercial customer repurchase agreements which fluctuate based on the operating needs of the customers and due to the low levels of market interest rates, some customer balances shifted to demand deposit and savings products.
Stockholders’ Equity
Total stockholders’ equity equaled $1.46 billion at December 31, 2010, an increase of $24.0 million compared to $1.43 billion at December 31, 2009. The increase was primarily due to year to date earnings of $58.0 million and the impact of the release of restricted stock. The increase in equity was partially offset by the acquisition of treasury stock totaling $13.3 million and $27.9 million for the payment of cash dividends declared on our common stock during the year ended December 31, 2010. For information regarding our compliance with applicable capital requirements, see “Liquidity and Capital Position” below.
Dividends declared for both of the year to date periods ended December 31, 2010 and December 31, 2009 were $0.28 per share. On January 25, 2011, the Company declared a $0.07 per share cash dividend payable on February 15, 2011 to shareholders of record on February 4, 2011. This was the Company’s 27th consecutive quarterly dividend payment. Book value per share amounted to $13.90 and $13.53 at December 31, 2010 and December 31, 2009, respectively, and tangible book value amounted to $8.62 and $8.23 at the same dates, respectively.
Liquidity and Capital Resources
Liquidity is the ability to meet current and future short-term financial obligations. The Company further defines liquidity as the ability to respond to the needs of depositors and borrowers as well as maintaining the flexibility to take advantage of investment opportunities. The Company’s primary sources of funds consist of deposit inflows, loan repayments and sales, maturities, paydowns and sales of investment securities, borrowings from the FHLB and repurchase agreements.
The Company manages liquidity by determining its cash position daily. The Investment Department compiles reports detailing the Company’s cash activity and cash balances occurring at its various correspondents and through its various funding sources. The Investment Department then settles all correspondent and bank accounts by either investing excess funds or borrowing to cover the projected shortfall.
The Company’s most liquid assets are cash and due from banks, short-term investments and debt securities. The levels of these assets are dependent on the Company’s operating, financing, lending and investment activities during any given period. At December 31, 2010, cash and due from banks, short-term investments and debt securities maturing within one year amounted to $390.9 million, or 4.3% of total assets.
Factors affecting liquidity include loan origination volumes, loan prepayment rates, maturity structure of existing loans, core deposit growth levels, time deposit maturity structure and retention, investment portfolio cash flows, the market value of investment securities that can be used to collateralize FHLB advances and repurchase agreements. The liquidity position is influenced by general interest rate levels, economic conditions and competition. For example, as interest rates decline, payments of principal from the loan and mortgage-backed securities portfolio accelerate, as borrowers are more willing to prepay. Additionally, the market value of the securities portfolio generally increases as rates decline, thereby increasing the amount of collateral available for funding purposes.
The Company uses borrowings from the FHLB Boston to fund loan and investment growth while managing interest rate risk and liquidity. At December 31, 2010, total borrowings from the FHLB amounted to $2.11 billion, exclusive of $1.9 million in purchase accounting adjustments, and the Company had the immediate capacity to increase that total to $2.32 billion. Additional borrowing capacity of approximately $1.51 billion would be readily available by pledging eligible investment securities as collateral. Depending on market conditions and the Company’s liquidity and gap position, the Company may continue to borrow from the FHLB or initiate borrowings through the repurchase agreement market. At December 31, 2010 the Company’s repurchase agreement lines of credit with four large broker dealers totaled $200.0 million, $175.0 million of which was available on that date. Agreement terms vary based on the collateral submitted.
NewAlliance’s main source of liquidity at the parent company level is dividends from NewAlliance Bank. The main uses of liquidity are payments of dividends to common stockholders, repurchase of NewAlliance’s common stock and the payment of principal and interest to holders of trust preferred securities. There are certain restrictions on the payment of dividends. See Note 17 of Notes to Consolidated Financial Statements contained elsewhere within this report for further information on dividend restrictions.
At December 31, 2010, the Company had commitments to originate loans, unused outstanding lines of credit and standby letters of credit totaling $1.06 billion. Commitments generally have fixed expiration dates or other termination clauses, therefore, total commitment amounts do not necessarily represent future cash requirements. Management anticipates that it will have sufficient funds available to meet its current loan commitments and contractual obligations. Time deposits maturing within one year from December 31, 2010 amount to $820.2 million. FHLB advances maturing within one year from December 31, 2010 amount to $615.4 million and interest payments of approximately $56.8 million are payable in 2011.
Management believes that the cash and due from banks, short term investments and debt securities maturing within one year, coupled with the borrowing line at the FHLB and the available repurchase agreement lines at selected broker dealers, provide for sufficient liquidity to meet its operating needs. The Company has a liquidity contingency policy in order to respond in a prompt and comprehensive manner to unforeseeable liquidity needs in the event of any severe market or economic shock. The Company believes, however, that due to its credit profile, interest rate risk and overall balance sheet structure that the Company is well positioned to meet potential liquidity risks. If unforeseen market conditions or counterparty risk placed limitations on our ability to borrow from either the FHLB or the repurchase market, the Company would be able to utilize the FRB’s discount window to obtain funds.
The following tables present information indicating various obligations and commitments of the Company as of December 31, 2010 and the respective maturity dates. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any terms or covenants established in the contract and generally have fixed expiration dates or other termination clauses.
Table 17: Contractual Obligations
(1) Secured under a blanket security agreement on qualifying assets, principally mortgage loans.
(2) Represents non-cancelable operating leases for offices.
(3) Represents unrecognized tax benefits with associated interest for which payment dates are undeterminable.
Table 18: Other Commitments
(1) Commitments for loans are extended to customers for up to 180 days after which they expire.
(2) Unadvanced portions of construction loans are available to be drawn on at any time by the borrower for up to 2 years.
(3) Unadvanced portions of home equity loans are available to be drawn on at any time by the borrower for up to 9.5 years. Commercial lines of credit are available to be drawn on at any time by the borrower for up to 1 or 2 years. Commercial finance lines generally range from 2 - 5 years, with an average term of 3 years.
Applicable regulations require the Company and the Bank to satisfy certain minimum capital requirements. At December 31, 2010, the Company and the Bank were in full compliance with all applicable capital requirements and met the FDIC requirements for a well capitalized institution. See Note 17 of Notes to Consolidated Financial Statements contained in Item 8 of this report, and the section titled Regulation and Supervision in Item 1, concerning capital requirements.
Off-Balance Sheet Arrangements
In the normal course of operations, NewAlliance engages in a variety of financial transactions that, in accordance with U.S. GAAP, are not recorded in the financial statements, or are recorded in amounts that differ from the notional amounts. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used for general corporate purposes or for customer needs. Corporate purpose transactions are used to help manage credit, interest rate and liquidity risk or to optimize capital. Customer transactions are used to manage customers’ request for funding.
For the year ended December 31, 2010, NewAlliance did not engage in any off-balance sheet transactions that would have a material effect on its consolidated financial condition.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Management Of Market And Interest Rate Risk
General
Market risk is the exposure to losses resulting from changes in interest rates, foreign currency exchange rates, commodity prices and equity prices. The Company has no foreign currency or commodity price risk. Credit risk related to investment securities is mitigated as the majority are government agency securities. The chief market risk factor affecting financial condition and operating results is interest rate risk. Interest rate risk is the exposure of current and future earnings and capital arising from adverse movements in interest rates and spreads. This risk is managed by periodic evaluation of the interest rate risk inherent in certain balance sheet accounts, determination of the level of risk considered appropriate given the Company’s capital and liquidity requirements, business strategy, performance objectives and operating environment and maintenance of such risks within guidelines approved by the Board of Directors. Through such management, the Company seeks to reduce the vulnerability of its net earnings to changes in interest rates. The Asset/Liability Committee, comprised of numerous senior executives, is responsible for managing interest rate risk. On a quarterly basis, the Board of Directors reviews the Company’s gap position and interest rate sensitivity exposure described below and Asset/Liability Committee minutes detailing the Company’s activities and strategies, the effect of those strategies on the Company’s operating results, interest rate risk position and the effect changes in interest rates would have on the Company’s net interest income. The extent of movement of interest rates is an uncertainty that could have a negative impact on earnings.
The principal strategies used to manage interest rate risk include (i) emphasizing the origination, purchase and retention of adjustable rate loans, and the origination and purchase of loans with maturities matched with those of the deposits and borrowings funding the loans, (ii) investing in debt securities with relatively short maturities and/or average lives and (iii) classifying a significant portion of its investment portfolio as available for sale so as to provide sufficient flexibility in liquidity management. By its strategy of limiting the Bank’s risk to rising interest rates, the Bank is also limiting the benefit of falling interest rates.
The Company employs two approaches to interest rate risk measurement; gap analysis and income simulation analysis.
Gap Analysis
The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are “interest rate sensitive” and by monitoring a bank’s interest rate sensitivity “gap.” An asset or liability is deemed to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. The “interest rate sensitivity gap” is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within that same time period. At December 31, 2010, the Company’s cumulative one-year interest rate gap (which is the difference between the amount of interest-earning assets maturing or repricing within one year and interest-bearing liabilities maturing or repricing within one year), was positive $438.5 million, or positive 4.86% of total assets. The Bank’s approved policy limit is plus or minus 20%. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. During a period of rising interest rates, a negative gap would tend to adversely affect net interest income while a positive gap would tend to result in an increase in net interest income. Conversely, during a period of falling interest rates, a negative gap would tend to result in an increase in net interest income while a positive gap would tend to adversely affect net interest income.
The following table sets forth the Company’s cumulative maturity distribution of interest-earning assets and interest-bearing liabilities at December 31, 2010, interest rate sensitivity gap, cumulative interest rate sensitivity gap, cumulative interest rate sensitivity gap ratio, and cumulative interest-earning assets as a percentage of cumulative interest-bearing liabilities ratio. This table indicates the time periods in which interest-earning assets and interest-bearing liabilities will mature or may reprice in accordance with their contractual terms. Assumptions are made on the rate of prepayment of principal on loans and investment securities and on the sensitivity of accounts with indeterminate maturity dates. However, this table does not necessarily indicate the impact of general interest rate movements on the Company’s net interest yield because the repricing of various categories of assets and liabilities is discretionary and is subject to competitive and other pressures. Additionally, certain assets, such as adjustable rate loans, have features that restrict changes in interest rates both on a short-term basis and over the life of the asset. Further, in the event of changes in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in the gap analysis, so that when interest rates rise, the gap becomes more negative, and when interest rates fall, the gap becomes more positive. As a result, various assets and liabilities indicated as repricing within the same time period may, in fact, reprice at different times and at different rate levels. It should also be noted that this table reflects certain assumptions regarding the categorization of assets and liabilities and represents a one-day position; in fact, variations occur daily as management adjusts interest rate sensitivity throughout the year.
Interest Rate Sensitivity Gap
Income Simulation Analysis
Income simulation analysis considers the maturity and repricing characteristics of assets and liabilities, as well as the relative sensitivities of these balance sheet components over a range of interest rate scenarios. Tested scenarios include instantaneous rate shocks, rate ramps over a six-month or one-year period, static rates, non-parallel shifts in the yield curve and a forward rate scenario. These simulation analyses are used to measure the exposure of net interest income to changes in interest rates over a specified time horizon, usually a three-year period. Simulation analysis involves projecting a future balance sheet structure and interest income and expense under the various rate scenarios. The Company’s internal guidelines on interest rate risk specify that for a range of interest rate scenarios, the estimated net interest margin over the next 12 months should decline by less than 10% as compared to the forecasted net interest margin in the base case scenario. However, in practice, interest rate risk is managed well within these 10% guidelines.
For the base case rate scenario the yield curve as of December 31, 2010 was utilized. This yield curve was utilized due to continued uncertainty regarding the strength of the recovering economy as well as due to the comments from various FRB officials that interest rates would likely remain flat for an extended period. As of December 31, 2010, the Company’s estimated exposure as a percentage of estimated net interest income for the next twelve-month period as compared to the forecasted net interest income in the base case scenario are as follows:
As of December 31, 2010, a downward rate shock of 25 basis points was a realistic representation of the risk of falling rates as the FRB has reduced the overnight lending rate target to a range between 0.00% and 0.25%. For an increase in rates, an upward rate shock of 100 basis points is also a relevant representation of potential risk given the recent beginnings of an economic rebound due to the past reductions in the federal funds rate, the benefits of the extension of the personal and business tax rate reductions and the expansion of the FRB’s balance sheet.
Based on the scenarios above, net interest income would increase slightly in the 12-month period after an upward movement in rates, and would decrease slightly after a downward movement in rates. Computation of prospective effects of hypothetical interest rate changes are based on a number of assumptions including the level of market interest rates, the degree to which non-maturity deposits react to changes in market rates, the expected prepayment rates on loans and investments, the degree to which early withdrawals occur
on time deposits and other deposit flows. As a result, these computations should not be relied upon as indicative of actual results. Further, the computations do not reflect any actions that management may undertake in response to changes in interest rates.
Item 8.
Item 8. Financial Statements and Supplementary Data
For the Company’s Consolidated Financial Statements, see index on page 63.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
The Company’s management, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) or Rule 15d-15(e) under the Exchange Act) as of December 31, 2010. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective.
Disclosure controls and procedures are our controls and other procedures that are designed to ensure that the information required to be disclosed by us in our reports filed or submitted under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in our reports filed under the Exchange Act is accumulated and communicated to our management, including the principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure for the year ending December 31, 2010.
In addition, based on that evaluation, no change in the Company’s internal control over financial reporting occurred during the fourth quarter ended December 31, 2010 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
The Company’s independent registered public accounting firm has issued a report on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2010. The report, which expresses an unqualified opinion on the effective operation of the Company’s internal control over financial reporting as of December 31, 2010, is included on page 65 of this Form 10-K.
Item 9A(T). Controls and Procedures
Not applicable
Item 9B.
Item 9B. Other Information
None
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
The information required by this Item is incorporated into this Form 10-K by reference to the Company’s Form 10-K/A, to be filed within 120 days following December 31, 2010.
Item 11.
Item 11. Executive Compensation
The information required by this Item is incorporated into this Form 10-K by reference to the Company’s Form 10-K/A, to be filed within 120 days following December 31, 2010.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this Item is incorporated into this Form 10-K by reference to the Company’s Form 10-K/A, to be filed within 120 days following December 31, 2010.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this Item is incorporated into this Form 10-K by reference to the Company’s Form 10-K/A, to be filed within 120 days following December 31, 2010.
Item 14.
Item 14. Principal Accountant Fees and Services
The information required by this Item is incorporated into this Form 10-K by reference to the Company’s Form 10-K/A, to be filed within 120 days following December 31, 2010.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a)(1) Financial Statements
The following Consolidated Financial Statements of NewAlliance Bancshares and subsidiaries are filed as part of this document under Item 8:
- Management’s Report on Internal Control over Financial Reporting
- Report of Independent Registered Public Accounting Firm
- Consolidated Balance Sheets as of December 31, 2010 and 2009
- Consolidated Statements of Income for the Years Ended December 31, 2010, 2009 and 2008
- 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
(a)(2) Financial Statement Schedules
Financial Statement Schedules have been omitted because they are not applicable or the required information is shown in the Consolidated Financial Statements or notes thereto.
Index to Consolidated Financial Statements Page
Management’s Report on Internal Control Over Financial Reporting
Report of Independent Registered Public Accounting Firm
Consolidated Financial Statements
Consolidated Balance Sheets as of December 31, 2010 and 2009
Consolidated Statements of Income for the Years Ended December 31, 2010, 2009 and 2008
Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended December 31, 2010, 2009 and
Consolidated Statements of Cash Flows for the Years Ended December 31, 2010, 2009 and 2008
Notes to Consolidated Financial Statements
Management’s Report on Internal Control Over Financial Reporting
NewAlliance Bancshares, Inc.
The management of NewAlliance Bancshares, Inc. (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting. The 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 in the United States of America.
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 accounting principles generally accepted in the United States of America, 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, based on the framework set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control - Integrated Framework. Based on that assessment, management concluded that, as of December 31, 2010, the Company’s internal control over financial reporting is effective based on the criteria established in Internal Control - Integrated Framework.
The effectiveness of the Company’s internal control over financial reporting as of December 31, 2010, has been audited by PricewaterhouseCoopers, LLP, an independent registered public accounting firm, as stated in their report appearing on page 65, which expresses an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2010.
Peyton R. Patterson
Glenn I. MacInnes
Chairman of the Board, President and
Executive Vice President and Chief
Chief Executive Officer
Financial Officer
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of NewAlliance Bancshares, Inc.
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, consolidated statements of changes in stockholders’ equity and consolidated statements of cash flows present fairly, in all material respects, the financial position of NewAlliance Bancshares, Inc. and its subsidiaries at December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company 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). The Company’s 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 the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on these financial statements and on the Company’s internal control over financial reporting based on our integrated 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.
As discussed in Note 2 to the consolidated financial statements, the Company changed the manner in which it accounts for their split-dollar life insurance arrangements and defined benefit and other postretirement plans in 2008 upon the adoption of new accounting pronouncements.
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. Management’s assessment and our audit of NewAlliance Bancshares, Inc.’s internal control over financial reporting also included controls over the preparation of financial statements in accordance with the instructions to the Consolidated Financial Statements for Bank Holding Companies (Form FR Y-9C) to comply with the reporting requirements of Section 112 of the Federal Deposit Insurance Corporation Improvement Act (FDICIA). A 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.
PricewaterhouseCoopers LLP
Hartford, Connecticut
February 28, 2011
NewAlliance Bancshares, Inc.
Consolidated Balance Sheets
NewAlliance Bancshares, Inc.
Consolidated Statements of Income
NewAlliance Bancshares, Inc.
Consolidated Statements of Changes in Stockholders’ Equity
NewAlliance Bancshares, Inc.
Consolidated Statements of Cash Flows
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
1.
Summary of Significant Accounting Policies
Financial Statement Presentation
The consolidated financial statements of NewAlliance Bancshares, Inc. (the “Company”) have been prepared in conformity with accounting principles generally accepted in the United States of America. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. All significant intercompany transactions and balances have been eliminated in consolidation. Amounts in prior period financial statements are reclassified whenever necessary to conform to the current year presentation.
The preparation of the consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant near-term change relate to the determination of the allowance for loan losses, the obligation and expense for pension and other postretirement benefits, and estimates used to evaluate asset impairment including investment securities, income tax contingencies and deferred tax assets and liabilities and the recoverability of goodwill and other intangible assets.
Management has determined that no subsequent events have occurred following the balance sheet date of December 31, 2010, which require recognition or disclosure in the financial statements.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash on hand and due from banks and short-term investments with original maturities of three months or less. At December 31, 2010, included in the balance of cash and due from banks were cash on hand of $108.5 million, which includes required reserves in the form of deposits with the Federal Reserve Bank (“FRB”) of approximately $36.7 million. Short-term investments included money market funds of $25.0 million at December 31, 2010.
Investment Securities
Marketable equity and debt securities are classified as either trading, available for sale, or held to maturity (applies only to debt securities). Management determines the appropriate classifications of securities at the time of purchase. At December 31, 2010 and 2009, the Company had no debt or equity securities classified as trading. Held to maturity securities are debt securities for which the Company has the ability and intent to hold until maturity. All other securities not included in held to maturity are classified as available for sale. Held to maturity securities are recorded at amortized cost, adjusted for the amortization or accretion of premiums or discounts. Available for sale securities are recorded at fair value. Unrealized gains and losses, net of the related tax effect, on available for sale securities are excluded from earnings and are reported in accumulated other comprehensive income, a separate component of equity, until realized. Further information relating to the fair value of securities can be found within Note 4 of the Notes to Consolidated Financial Statements.
Premiums and discounts on debt securities are amortized or accreted into interest income over the term of the securities using the level yield method. In accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“FASB ASC”) 320 - Debt and Equity Securities, a decline in market value of a debt security below amortized cost that is deemed other than temporary is charged to earnings for the credit related other than temporary impairment (“OTTI”) resulting in the establishment of a new cost basis for the security, while the non-credit related OTTI is recognized in other comprehensive income (“OCI”) if there is no intent to sell or will not be required to sell the security. If an equity security is deemed other-than-temporarily impaired, the full impairment is considered to be credit-related and a charge to earnings would be recorded. Gains and losses on sales of securities are recognized at the time of sale on a specific identification basis and are recorded in other non-interest income as net gain or loss on securities.
Federal Home Loan Bank of Boston stock
As a member of the Federal Home Loan Bank of Boston, (“FHLB Boston”), the Bank is required to hold a certain amount of FHLB Boston stock. This stock is considered to be a non-marketable equity security reported at cost. The level of stock purchases is determined by the Bank’s advances outstanding and the amount of residential mortgage assets on the Bank’s balance sheet. The shares can only be purchased and sold between the FHLB Boston and the Company at a par value of $100 per share.
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
Loans Held for Sale
The Company currently sells the majority of originated fixed rate residential real estate loans with terms of 15 years and over. Mortgage loans held for sale are carried at fair value. Fair value is estimated using quoted loan market prices provided by government-sponsored entities of Federal National Mortgage Association (“FNMA”) and Federal Home Loan Mortgage Corporation (“FHLMC”). Further information regarding the fair value measurement of mortgage loans held for sale can be found in Note 15 of the Notes to Consolidated Financial Statements. Residential loans are sold by the Company without recourse. The Company currently sells these loans servicing released.
The Company is also involved in the Small Business Administration (“SBA”) loan secondary market. The Company currently sells the guaranteed portion of SBA loans that meet certain criteria and retains the unguaranteed portion and the right to service the sold portion of the loan in its portfolio. Such loans are included in loans held for sale on the balance sheet upon origination. SBA loans held for sale are valued at the lower of cost (less principal payments received and net of deferred fees and costs) or estimated fair value. Fair value is estimated using quoted market prices from a secondary market broker. All other loan originations are classified as loans not held for resale.
Loans Receivable
Loans are stated at their principal amounts outstanding, net of deferred loan fees and costs and fair value adjustments for loans acquired.
The Company’s loan portfolio segments are residential, commercial real estate, commercial construction, commercial and industrial, commercial finance and consumer loans. Commercial construction includes classes for commercial real estate construction and residential development. The consumer segment consists of classes for home equity loans and equity lines of credit and other consumer loans.
Certain direct loan origination fees and costs and fair value adjustments to acquired loans are recognized over the lives of the related loans as an adjustment of interest using the level yield method. When loans are prepaid, sold or participated out, the unamortized portion is recognized as income or expense at that time.
The policy for determining past due or delinquency status for all loan portfolio segments is based on the number of days past due or the contractual terms of the loan.
Interest on loans is credited to income as earned based on the rate applied to principal amounts outstanding. Loans are placed on nonaccrual status when timely collection of principal or interest in accordance with contractual terms is in question. The Company’s policy is to discontinue the accrual of interest on all loan segments when principal or interest payments become 90 days delinquent or sooner if management concludes that circumstances indicate borrowers may be unable to meet contractual principal or interest payments.
The Company performs a quarterly analysis of impaired loans for the commercial loan segments to include those loans risk rated substandard or worse, whose balance is $250,000 or greater. Additionally, the Company analyzes all residential and consumer loans for possible impairment when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement.
If a residential or consumer loan is in non-accrual or is considered to be impaired, cash payments are applied first to interest income and then as a reduction of principal as specified in the contractual agreement, unless the collection of the remaining principal amount due is considered doubtful. However, if the residential or consumer loan has also been written down the payments are instead applied to principal until the remaining principal amount due is expected to be collected.
For the commercial portfolio segments, if a loan is in non-accrual cash payments are applied first to interest income and then as a reduction of principal as specified in the contractual agreement, unless the collection of the remaining principal amount due is considered doubtful. However, if the loan is considered impaired then interest payments are applied to principal until the remaining principal amount due is expected to be collected.
For residential, consumer and commercial loans if the collection of the remaining principal amount due is considered doubtful, then cash payments received would be applied first solely to principal until the remaining principal amount due is expected to be collected and then as a recovery of any charge-off, if applicable, followed by recording interest income. If ultimately collected, such interest for all loan segments is credited to income when received. Loans are removed from nonaccrual status when they become current as to principal and interest and when, in the opinion of management concern no longer exists as to the collectability of principal and interest.
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
Allowance for Loan Losses
The adequacy of the allowance for loan losses is regularly evaluated by management. Factors considered in evaluating the adequacy of the allowance include previous loss experience, current economic conditions and their effect on borrowers, the performance of individual loans in relation to contract terms, and other pertinent factors. The provision for loan losses charged to expense is based upon management’s judgment of the amount necessary to maintain the allowance at a level adequate to absorb probable losses inherent in the loan portfolio. Loan losses are charged against the allowance when management believes the collectability of the principal balance outstanding is unlikely. The Bank evaluates the allowance for loan loss requirements through separate analyses of its impaired and non-impaired loans.
Impaired loans are analyzed in accordance with impairment guidance within FASB ASC 310 - Receivables, for which there is a specific allocation of the allowance for loans losses. A loan is considered to be impaired when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. When the measurement of the impaired loan is less than the recorded investment in the loan, the impairment is recorded through a valuation allowance. Further information relating to impaired loans for which there is an allowance for loan loss allocation can be found in Note 5 of the Notes to Consolidated Financial Statement.
The balance of the portfolio, the non-impaired loans, are analyzed under the guidelines of FASB ASC 450 - Contingencies, using a measurement of estimated credit losses based on historical loss rates adjusted for qualitative and environmental factors. The qualitative and environmental factors include but are not limited to 1) estimated embedded losses in non-performing loans and criticized loans not impaired 2) estimated losses in high risk residential mortgages and home equity loans and lines of credit 3) increased portfolio delinquencies 4) changes in risk ratings and 5) macro economic conditions, including unemployment, consumer confidence, and current real estate market conditions.
Residential loans and consumer loans, which primarily consist of home equity loans and lines of credit are first reviewed for impairment based on current information and events. The analysis to measure impairment is based on the loans observable market price, or the fair value of the collateral less costs to sell. A reserve is created if the measure of the impaired loan is less than the recorded investment in the loan. The Bank then considers other qualitative and environmental factors, including but not limited to the levels and trends in delinquencies, levels and trends in charge-offs and recoveries, trends in volume and terms of loans, current economic and market conditions, changes in underwriting and historical loss rates. Charge-offs against the allowance for loan losses are taken on loans when the Bank determines that the collection of the full loan balance is unlikely.
Commercial real estate, commercial construction and commercial business and commercial finance loans are first reviewed for impairment based on current information and events. The analysis to measure impairment will use one of the following; the present value of expected future cash flows, the loans observable market price, or the fair value of the collateral less costs to sell. A reserve is created if the measure of the impaired loans is less than the recorded investment in the loans. The Bank then considers other qualitative and environmental factors, including but not limited to levels and trends in delinquencies, levels and trends in charge-offs and recoveries, trends in volume and terms of loans, current economic and market conditions, changes in underwriting, levels of criticized and classified assets and risk ratings, internal and external portfolio reviews and historical loss rates. Charge-offs against the allowance for loan losses are taken on loans when the Bank determines that the collection of the full loan balance is unlikely.
While management uses the best available information to recognize losses on loans, future additions to the allowance for loan losses may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based on their judgments about information available to them at the time of their examinations.
The allowance is an estimate, and ultimate losses may vary from management’s estimate. Changes in the estimate are recorded in the results of operations in the period in which they become known, along with provisions for estimated losses incurred during that period. There have been no changes in accounting policies or methodology related to the allowance calculation from the prior period.
Loan Servicing Rights
The Company capitalizes servicing rights for loans sold based on the relative fair value which is allocated between the servicing rights and the loans (without servicing rights).
The cost basis of loan servicing rights is amortized on a level yield basis over the period of estimated net servicing revenue and such amortization is included in the consolidated statement of income as a reduction of loan servicing fee income. Servicing rights are evaluated for impairment by comparing their aggregate carrying amount to their fair value. The fair value of loan servicing rights is estimated using a present value cash flow model. The most important assumptions used in the valuation model are the anticipated rate
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
of loan prepayments and discount rates. All assumptions are based on standards used by market participants. An independent appraisal of the fair value of the Company’s loan servicing rights is obtained as necessary, but at least annually and is used by management to evaluate the reasonableness of the fair value estimates. For interim quarters, management analyzes the current variables and assesses the need for an independent appraisal. Impairment is recognized as an adjustment to loan and servicing income.
Premises and Equipment
Premises and equipment are carried at cost less accumulated depreciation and amortization. Depreciation and amortization are computed on the straight-line method using the estimated lives of the assets. Estimated lives are 5 to 40 years for building and improvements and 3 to 10 years for furniture, fixtures and equipment. Amortization of leasehold improvements is calculated on a straight-line basis over the terms of the related leases or the life of the asset, whichever is shorter. The cost of maintenance and repairs is charged to expense as incurred, whereas significant renovations are capitalized.
Bank Owned Life Insurance
Bank owned life insurance (“BOLI”) represents life insurance on certain employees who have consented to allow the Bank to be the beneficiary of those policies. BOLI is recorded as an asset at cash surrender value. Increases in the cash value of the policies, as well as insurance proceeds received, are recorded in other non-interest income and are not subject to income tax. Management reviews the financial strength of the insurance carriers on a quarterly basis and BOLI with any individual carrier is limited to 15% of capital plus reserves.
Goodwill and Identifiable Intangible Assets
The assets (including identifiable intangible assets) and liabilities acquired in a business combination are recorded at fair value at the date of acquisition. Goodwill is recognized for the excess of the acquisition cost over the fair values of the net assets acquired and is not subsequently amortized. Identifiable intangible assets are subsequently amortized on a straight-line or accelerated basis, over their estimated lives. Management assesses the recoverability of goodwill at least on an annual basis and all intangible assets whenever events or changes in circumstances indicate that their carrying value may not be recoverable. If carrying amount exceeds fair value an impairment charge is recorded to income.
Income Taxes
The Company files a consolidated federal tax return and various combined and separate Company state tax returns. The Company uses the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are established for the temporary differences between the financial reporting basis and the tax basis of the Company’s assets and liabilities. Deferred tax assets are also recognized for available tax carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to be in effect when temporary differences and carryforwards are realized or settled.
The deferred tax asset is subject to reduction by a valuation allowance in certain circumstances. This valuation allowance is recognized if, based on an analysis of available evidence, management determines that it is more likely than not that some portion or all of the deferred tax asset will not be realized. The valuation allowance is subject to ongoing adjustment based on changes in circumstances that affect management’s judgment about the realization of the deferred tax asset. Adjustments to increase or decrease the valuation allowance are charged or credited, respectively, to income tax expense or in certain limited circumstances to equity.
Income tax expense includes the amount of taxes payable for the current year, and the deferred tax benefit or expense for the period. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income tax expense in the period that includes the enactment date.
The Company is required to make a determination of an inventory of tax positions (federal and state) for which the sustainability of the position, based upon the technical merits, is uncertain. The Company regularly evaluates all tax positions taken and the likelihood of those positions being sustained. If management is highly confident that the position will be allowed and there is a greater than 50% likelihood that the full amount of the tax position will be ultimately realized, the company recognizes the full benefit associated with the tax position. Additionally, interest and penalties related to uncertain tax positions are included as a component of income tax expense.
Trust Assets
The Bank had approximately $1.03 billion of assets under management at December 31, 2010 and 2009 in a fiduciary or agency capacity for customers. These assets are not included in the accompanying consolidated financial statements since they are not owned by the Bank. Trust income primarily consists of management fees based on the assets under management.
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
Pension and Other Postretirement Benefit Plans
The Company has a noncontributory pension plan covering substantially all employees who meet certain age and length of service requirements and who were employed by the Company prior to January 1, 2008. Pension costs related to this plan are based upon actuarial computations of current and future benefits for employees based on years of service and the employee’s highest career earnings over a five-year consecutive period. Costs are charged to non-interest expense and are funded in accordance with requirements of the Employee Retirement Income Security Act and the Pension Protection Act of 2006. Contributions are intended to provide not only for benefits attributed to service to date, but also for those expected to be earned in the future.
In addition to the qualified plan, the Company has supplemental retirement plans for certain key officers. These plans, which are nonqualified, were designed to offset the impact of changes in the pension plan that limit benefits for highly compensated employees under qualified pension plans.
The Company also accrues costs related to postretirement healthcare and life insurance benefits, which recognizes costs over the employee’s period of active employment.
The discount rate is set for the retirement plans by reference to high quality long-term fixed income instrument yields. The discount rates were determined by applying the estimated cash flows of the Company’s retirement plans to the Citigroup Pension Liability Yield Curve. The Moody’s Aa long-term corporate bond index was also reviewed as a benchmark. The expected long-term rate of return on the assets held in our defined pension plan is based on market and economic conditions, the Plan’s asset allocation and other factors.
Based on our review of rates at December 31, 2010, separate discount rates were chosen for each type of benefit plan for the measurement of benefit obligations to better represent the actual plans. Discount rates as of December 31, 2010 were 5.35% for the defined benefit plan, 4.85% for the postretirement plan and 5.25% for the supplemental executive retirement benefit plan. As of December 31, 2009, the discount rates were 5.85% for the defined benefit plan, 5.50% for the postretirement plan and 5.75% for the supplemental executive retirement benefit plan. The expected long-term rate of return on the pension plan assets was 7.50% and 7.75% for December 31, 2010 and 2009, respectively. Under the provisions in FASB ASC 715, Compensation - Retirement Benefits, changes in the fair value of plan assets and the benefit obligation are recognized, net of tax, as an adjustment to other comprehensive income.
Stock-Based Compensation
The Company accounts for stock option and restricted stock awards in accordance with FASB ASC 718, Compensation - Stock Compensation. Pursuant to this guidance, the fair value of stock option and restricted stock awards, measured at grant date, is amortized to compensation expense on a straight-line basis over the vesting period.
Repurchase Agreements
Repurchase agreements are accounted for as secured borrowings since the Company maintains effective control over the transferred securities and the transfer meets the other criteria for such accounting. Securities are sold to a counterparty with an agreement to repurchase the same or substantially the same security at a specified price and date. The Company has repurchase agreements with commercial or municipal customers that are offered as a business banking service. Customer repurchase agreements are for a term of one day and are backed by the purchasers’ interest in certain U.S. Treasury Notes or other U.S. Government securities. The Company also has a single dealer repurchase agreement that was initiated as a means to manage the Company’s interest rate risk. The dealer repurchase agreement was issued for a term of five years and matures in 2012. The dealer repurchase agreement is collateralized by U.S. Government mortgage-backed securities. Obligations to repurchase securities sold are reflected as a liability in the Consolidated Balance Sheets. The Company does not record transactions of repurchase agreements as sales. The securities underlying the repurchase agreements remain in the available-for-sale investment securities portfolio.
Merger Related Charges
The Company accounts for acquisitions in accordance with FASB ASC 805, Business Combinations. Costs that do not meet the conditions for inclusion in the allocation of acquisition cost, costs for contemplated acquisitions and recurring costs related to prior acquisitions are expensed as incurred and are reported in non-interest expense as Merger Related Charges. These charges consist primarily of consulting, legal, system conversion, printing and advertising costs associated with acquired companies, acquisition targets and potential acquisition targets. Additionally, merger related charges in 2010 include costs associated with the impending acquisition of the Company by First Niagara Financial Group, Inc. (“First Niagara”), primarily consisting of legal, investment banking and compensation expenses.
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
Related Party Transactions
Directors and executive officers of the Company and its subsidiaries and their associates have been customers of and have had transactions with the Company, and management expects that such persons will continue to have such transactions in the future. See Note 5 of the Notes to Consolidated Financial Statements for further information with respect to loans to related parties.
Comprehensive Income
The purpose of reporting comprehensive income is to report a measure of all changes in an entity that result from recognized transactions and other economic events of the period other than transactions with owners in their capacity as owners. Comprehensive income includes net income and certain changes in capital that are not recognized in the statement of income (such as changes in net unrealized gains and losses on securities available for sale). The Company has reported comprehensive income for the years ended December 31, 2010, 2009 and 2008 in the Consolidated Statement of Changes in Stockholders’ Equity. The components of comprehensive income are presented in Note 18 of the Notes to Consolidated Financial Statements.
Segment Reporting
The Company’s only business segment is Community Banking. During the years ended 2010, 2009 and 2008 this segment represented all the revenues and income of the consolidated group and therefore, is the only reported segment as defined by FASB ASC 820, Segment Reporting.
Earnings Per Share
Basic earnings per share (“EPS”) excludes dilution and is calculated by dividing net income available to common stockholders by the weighted-average number of shares of common stock outstanding during the period. Diluted EPS is computed in a manner similar to that of basic EPS except that the weighted-average number of common shares outstanding is increased to include the number of incremental common shares (computed using the treasury stock method) that would have been outstanding if all potentially dilutive common shares (such as stock options and unvested restricted stock) were issued during the period. Unallocated common shares held by the Employee Stock Ownership Plan (“ESOP”) are not included in the weighted-average number of common shares outstanding for either basic or diluted earnings per share calculations.
Earnings per share for the years ended December 31, 2010, 2009 and 2008, can be found in Note 19 of the Notes to Consolidated Financial Statements.
2.
Agreement and Plan of Merger
On August 18, 2010, the Company entered into a merger agreement whereby First Niagara will acquire the Company in a stock and cash transaction valued at $1.5 billion. If the merger agreement is approved and the merger is subsequently completed, NewAlliance will become a direct, wholly owned subsidiary of First Niagara. The shares of NewAlliance common stock owned by each NewAlliance stockholder will be converted, at the election of such stockholder, but subject to certain agreed adjustment, election and allocations procedures, into the right to receive one of the following:
•
for each NewAlliance share owned by such stockholder, $14.28 in cash, without interest (the “Cash Consideration”);
•
for each NewAlliance share owned by such stockholder, 1.10 shares of First Niagara common stock (the “Stock Consideration”); or
•
a combination of the Cash Consideration and the Stock Consideration.
As a result of the elective option, the acquisition consideration each Company shareholder elects to receive may be adjusted as necessary so that 86% of NewAlliance common stock will be converted to First Niagara common stock.
As a result of the merger, NewAlliance stockholders who receive Stock Consideration will become stockholders of First Niagara.
The Merger Agreement has been unanimously approved by the board of directors of each of the Company and First Niagara. The merger was approved by the Company’s shareholders at a special meeting of shareholders held on December 20, 2010. Subject to regulatory approvals and other customary closing conditions, the parties anticipate completing the merger early in the second quarter of 2011.
First Niagara is a Delaware corporation that provides a wide range of retail and commercial banking as well as other financial services. As of December 31, 2010, First Niagara had approximately $21.1 billion of assets, $13.1 billion in deposits and 257 branch locations across Upstate New York and Pennsylvania.
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
3.
Changes in Accounting Principles and Effects of New Accounting Pronouncements
Receivables (Topic 310)
In January 2011, the FASB issued Accounting Standards Update (“ASU”) No. 2011-01, Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20. The amendments in this update temporarily delay the effective date of disclosures about troubled debt restructurings in ASU 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. The effective date for the troubled debt restructuring disclosures will be aligned with the effective date for new guidance for determining what constitutes a troubled debt restructuring. Currently, that guidance is anticipated to be effective for interim and annual periods ending after June 15, 2011. The adoption of ASU No. 2011-01 will not have a material impact on the financial statements as it impacts disclosures only.
In July 2010, the FASB issued ASU No. 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. The statement is intended to improve the transparency of financial reporting by requiring enhanced disclosures about a bank’s allowance for loan losses and the credit quality of its financing receivables (generally defined as loans and leases). The primary goal of the disclosure requirements is to provide more information about the credit risk in a bank’s portfolio of loans and how that risk is analyzed and assessed in arriving at the allowance for loan loss. The guidance is effective for public entities for annual and interim reporting periods ending on or after December 15, 2010. The adoption of ASU No. 2010-06 on December 31, 2010 did not have a material impact on the financial statements as it only impacted disclosures.
Business Combinations (Topic 805)
In December 2010, the FASB issued ASU 2010-29, Disclosure of Supplementary Pro Forma Information for Business Combinations. The objective of this update is to address diversity in practice about the interpretation of the pro forma revenue and earnings disclosure requirements for business combinations. The amendments in this update specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting only. This update also expands supplemental pro forma disclosures under Topic 805. These amendments are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. The adoption of ASU No. 2010-29 will not have an impact on the financial statements as it affects disclosures only and will apply prospectively to future business combinations.
Intangibles - Goodwill and Other (Topic 350)
In December 2010, the FASB issued ASU 2010-28, When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts. The objective of this update is to address questions about entities with reporting units with zero or negative carrying amounts because some entities concluded that Step 1 of the test is passed in those circumstances because the fair value of their reporting unit will generally be greater than zero. The amendments in this update modify Step 1 of the goodwill impairment test for reporting with zero or negative carrying amounts. The amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. The Company’s reporting unit for goodwill impairment testing is greater than zero, therefore, ASU No. 2010-28 will not apply and there will be no impact on the financial statements.
Fair Value Measurements and Disclosures (Topic 820)
In February 2010, the FASB issued ASU No. 2010-06, Improving Disclosures about Fair Value Measurements. The amendment to Topic 820, Fair Value Measurements and Disclosures, requires additional disclosures about fair value measurements including transfer in and out of Levels 1 and 2 and higher levels of disaggregation for the different types of financial instruments. For the reconciliation of Level 3 fair values measurements, information about purchases, sales, issuances and settlements should be presented separately. The guidance was effective for annual and interim reporting periods beginning after December 15, 2009, except for the disclosure of information about sales, issuances and settlements on a gross basis for assets and liabilities classified as level 3, which is effective for reporting periods beginning after December 15, 2010. The adoption of ASU No. 2010-06 on January 1, 2010 did not have a material impact on the financial statements as it impacts disclosures only.
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
Investments - Debt and Equity Securities (Topic 320)
In April 2009, the FASB issued new guidance on the Recognition and Presentation of Other-Than-Temporary Impairments (FASB ASC 320-10), which amends FASB ASC 320, Investments - Debt and Equity Securities, to make the other-than-temporary impairment (“OTTI”) guidance more operational and to improve the presentation of other-than-temporary impairments in the financial statements. This guidance replaced the existing requirement that the entity’s management assert it has both the intent and ability to hold an impaired debt security until recovery with a requirement that management assert it does not have the intent to sell the security, and it is more likely than not it will not have to sell the security before recovery of its cost basis. When an other-than-temporary impairment exists under this stated assertion, the amount of impairment related to the credit loss component would be recognized in earnings while the remaining amount would be recognized in other comprehensive income. This guidance provides increased disclosure about the credit and noncredit components of impaired debt securities that are not expected to be sold and also requires increased and more frequent disclosures regarding expected cash flows, credit losses, and an aging of securities with unrealized losses. Although this amendment does not result in a change in the carrying amount of debt securities, it does require that the portion of an other-than-temporary impairment not related to a credit loss for a held-to-maturity security be recognized in a new category of other comprehensive income and be amortized over the remaining life of the debt security as an increase in the carrying value of the security. This new guidance does not amend existing recognition and measurement guidance for other-than-temporary impairments of equity securities. This guidance was effective for interim and annual periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The Company did not elect early application and the adoption resulted in a $1.0 million cumulative effect adjustment, net of taxes, to increase retained earnings and decrease accumulated other comprehensive income as of April 1, 2009 for the non-credit component of debt securities for which an other-than-temporary impairment was previously recognized. Refer to Note 4 of the Notes to Consolidated Financial Statements for further information on the Company’s adoption of this guidance.
Transfers of Financial Assets (Topic 860)
In December 2009, the FASB issued ASU No. 2009-16 codifying the new guidance issued in June 2009 regarding the Transfer of Financial Assets. This guidance requires entities to provide more information about sales of securitized financial assets and similar transactions, particularly if the seller retains some risk in the assets. The guidance eliminates the concept of a qualifying special-purpose entity, changes the requirements for the derecognition of financial assets, and enhances the disclosure requirements for sellers of the assets. This guidance was effective for the fiscal year beginning after November 15, 2009. The adoption of ASU No. 2009-16 on January 1, 2010 did not have a material impact on the financial statements.
Consolidation (Topic 810)
In December 2009, the FASB issued ASU No. 2009-17 codifying the new guidance issued in June 2009 regarding Consolidations. The guidance requires an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity (which would result in the enterprise being deemed the primary beneficiary of that entity and, therefore, obligated to consolidate the variable interest entity in its financial statements); to require ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity; to revise guidance for determining whether an entity is a variable interest entity; and to require enhanced disclosures that will provide more transparent information about an enterprise’s involvement with a variable interest entity. The guidance was effective for interim periods as of the beginning of the first annual reporting period beginning after November 15, 2009. The adoption of ASU No. 2009-17 on January 1, 2010 did not have a material impact on the financial statements.
Subsequent Events (Topic 855)
In February 2010, the FASB issued ASU 2010-09 for amendments to certain recognition and disclosure requirements. Among other things, this guidance retracts, for public entities, the requirement to disclose the date through which subsequent events have been evaluated and whether that date is the date the financial statements were issued or were available to be issued. The portion of the ASU that addresses the disclosure of the date through which subsequent events have been evaluated, and that impacts the Company, was effective upon issuance.
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
The securities portfolio is reviewed on a monthly basis for the presence of other-than-temporary impairment (“OTTI”). In accordance with OTTI guidance issued by the FASB in 2009, credit related OTTI for debt securities is recognized in earnings while non-credit related OTTI is recognized in other comprehensive income (“OCI”) if there is no intent to sell or will not be required to sell the security. If an equity security is deemed other-than-temporarily impaired, the full impairment is considered to be credit-related and a charge to earnings would be recorded.
During the three months ended December 31, 2010, September 30, 2010 and June 30, 2010, a pooled trust preferred security, which had a previous credit related impairment charge during 2009, was deemed to have additional credit related OTTI loss in the amounts of $250,000, $378,000 and $552,000, respectively. These credit related impairments were based on further declines in expected cash flows and were reclassified from other comprehensive income as they were previously recognized as non-credit related. Management utilizes nine cash flow scenarios received quarterly from the underwriter to analyze this security for potential OTTI. The nine scenarios cover various default rates, recovery rates and prepayment options over different time periods. Two of the nine cash flow analyses continue to indicate impairment over the life of the security, the driver of which is the recovery rate, modeled at 0%. Past history of the security indicates that there have not been any recoveries to date from securities that have defaulted. Based on these factors, management recorded a credit related impairment totaling $1.2 million during 2010. The credit impairments represent the average loss of the two negative cash flow analyses at each period. At December 31, 2010, the pooled trust preferred security had an amortized cost and fair value of approximately $247,000 and $221,000, respectively. There is no intent to sell nor is it more likely than not that the Company will be required to sell this security.
The following tables present the fair value of investments with continuous unrealized losses for less than one year and those that have been in a continuous loss position for more than one year as of December 31, 2010 and December 31, 2009. Of the securities summarized, 64 issues have unrealized losses for less than twelve months and 30 have unrealized losses for twelve months or more at December 31, 2010. This compares to a total of 72 issues that had an unrealized loss at December 31, 2009, of which 28 were in a continuous loss position for less than one year and 44 had unrealized losses for more than one year.
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
Management believes that no individual unrealized loss as of December 31, 2010 represents an other-than-temporary impairment, based on its detailed monthly review of the securities portfolio. Among other things, the other-than-temporary impairment review of the investment securities portfolio focuses on the combined factors of percentage and length of time by which an issue is below book value as well as consideration of issuer specific (present value of cash flows expected to be collected, issuer rating changes and trends, credit worthiness and review of underlying collateral), broad market details and the Company’s intent to sell the security or if it is more likely than not that the Company will be required to sell the debt security before recovering its cost. The Company also considers whether the depreciation is due to interest rates or credit risk. The following paragraphs outline the Company’s position related to unrealized losses in its investment securities portfolio at December 31, 2010.
The unrealized losses reported on residential mortgage-backed securities relate to securities issued by FNMA and FHLMC due to changes in market interest rates since the date purchased. The unrealized loss on private label residential mortgage-backed securities is primarily concentrated in one BBB rated private-label mortgage-backed security which is substantially paid down, well seasoned and of an earlier vintage that has not been significantly affected by high delinquency levels or vulnerable to lower collateral coverage as seen in later issued pools. Widening in non-agency mortgage spreads since the date purchased is the primary factor for the unrealized losses reported on private label residential mortgage-backed securities. None of the securities are backed by subprime mortgage loans and none have suffered losses. Other than the BBB rated security, there is one security rated AA and the remaining securities are AAA rated. Management reviewed the above factors and issuer specific data and concluded that the private-label mortgage-backed securities are not other-than-temporarily impaired.
The unrealized loss on other bonds and obligations primarily relates to a position in an adjustable rate mortgage mutual fund. During 2009, the Company recorded an OTTI loss of $816,000 on this adjustable rate mortgage mutual fund due to a decrease in the credit quality of the security coupled with a loss recognized by the fund. As of December 31, 2010, the investment carries a market value to book value ratio of 82.66%, a weighted average underlying investment credit rating of AAA and it continues to pay normal monthly dividends. There is no intent to sell nor is it more likely than not that the Company will be required to sell this security and management has therefore concluded that the fund experienced no further OTTI in the twelve months ended December 31, 2010.
Trust preferred securities include two pooled trust preferreds with an amortized cost of $4.9 million, one of which is rated BB and the other is rated CC at December 31, 2010. During 2009, the Company recorded a credit related impairment of $581,000 on the CC rated pooled trust preferred security based on a cash flow analysis and subsequent credit related impairments of $1.2 million during the twelve months ended December 31, 2010 as discussed above. The remaining $42.7 million of trust preferred securities are comprised of twelve “individual names” issues with the following ratings: $15.6 million rated A to A-, $25.6 million rated BBB- to
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
BBB+ and $1.5 million rated BB. The unrealized losses reported for trust preferred securities relate to the financial and liquidity stresses in the fixed income markets and in the banking sector and are not reflective of individual stresses in the individual company names. The ratings on all of the issues with the exception of the CC rated pooled security have improved or remained the same since December 31, 2009. Additionally, there have not been any disruptions in the cash flows of these securities and all are currently paying the contractual principal and interest payments. A detailed review of the two pooled trust preferreds and the “individual names” trust preferred equity securities was completed by management. This review included an analysis of collateral reports, cash flows, stress default levels and financial ratios of the underlying issuers. Management reviewed the above factors and issuer specific data and concluded that after the OTTI loss recorded on the CC rated pooled trust preferred security, these securities are not other-than-temporarily impaired.
The Company has no intent to sell nor is it more likely than not that the Company will be required to sell any of the securities contained in the table during the period of time necessary to recover the unrealized losses, which may be until maturity.
The following table presents the changes in the credit loss component of the amortized cost of debt securities available for sale that have been written down for other-than-temporary impairment loss and recognized in earnings. The credit loss component represents the difference between the present value of expected future cash flows and the amortized cost basis of the security prior to considering credit losses.
As of December 31, 2010, the amortized cost and fair values of debt securities and short-term obligations, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
Securities with a fair value of approximately $944.5 and $673.8 million at December 31, 2010 and 2009, respectively, were pledged to secure public deposits, repurchase agreements and FHLB borrowings.
Proceeds from sales of available for sale securities for the years ending December 31, 2010, 2009 and 2008 were $55.0 million, $169.5 million and $286.3 million, respectively. The following is a summary of realized gains and losses on sales of securities available for sale during the periods presented:
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
As of December 31, 2010 and 2009, the Company’s residential real estate loan portfolio segment and the majority of the consumer loan portfolio segment, which consists of home equity loans and equity lines of credit are collateralized by one-to-four family homes and condominiums, the majority of which are located in Connecticut and Massachusetts. The commercial real estate loan and commercial construction portfolio segments are collateralized primarily by multi-family, commercial and industrial properties located predominately in Connecticut and Massachusetts. A variety of different assets, including accounts receivable, inventory and property, plant and equipment, collateralize the majority of the commercial and industrial and commercial finance loan portfolio segments. The Company does not originate or directly invest in subprime loans.
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
Loan Delinquencies
The following table provides an age analysis of delinquent loans for the periods presented. Loans that are 90 days or more past due are on nonaccrual status. The Company does not have any loans that are delinquent 90 days or more and still accruing interest.
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
Allowance for Loan Losses
The following table provides a summary of activity in the allowance for loan losses for the periods presented:
The tables below outline the components of the allocation of the allowance for loan losses by portfolio segment:
The Company does not have any loans acquired with deteriorated credit quality.
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
Nonperforming Assets
Nonperforming assets include loans for which the Company does not accrue interest (nonaccrual loans), loans 90 days past due and still accruing interest, restructured loans due to a weakening in the financial condition of the borrower and other real estate owned. There were no accruing loans included in the Company’s nonperforming assets as of December 31, 2010 and 2009. As of December 31, 2010 and 2009, nonperforming assets were:
For the years ended December 31, 2010, 2009 and 2008, had interest been accrued at contractual rates on nonaccrual and restructured loans, such income would have approximated $3.4 million, $2.8 million and $1.6 million, respectively. As of December 31, 2010, 2009 and 2008, no significant additional funds were committed to customers whose loans have been restructured or were nonperforming.
Impaired Loans
As of December 31, 2010, 2009 and 2008, the recorded investment in loans considered to be impaired was $73.3 million, $47.2 million and $22.9 million, respectively. The average recorded investment in impaired loans for the years ended December 31, 2010, 2009 and 2008 was $64.9 million, $47.6 million and $17.3 million, respectively. Interest income recognized on impaired loans was approximately $740,000, $569,000 and $786,000 for the years ended December 31, 2010, 2009 and 2008, respectively. As of December 31, 2010, there were no commitments to lend additional funds for loans considered impaired.
The tables below state the recorded investment for impaired loans for which there is a specific related allowance for loan losses and loans for which there is no related allowance for loan losses as of December 31, 2010. Any impaired loan for which no specific valuation allowance was necessary at December 31, 2010 is the result of either sufficient cash flow or sufficient collateral coverage, or previous charge off amount that reduced the book value of the loan to an amount equal to or below the fair value of the collateral.
Impaired loans are measured based on either collateral values supported by appraisals, observed market prices or where potential losses have been identified and reserved accordingly.
Credit Quality
An internal risk rating system is used to monitor and evaluate the credit risk inherent in the commercial real estate, commercial construction, commercial and industrial and commercial finance loan portfolios. Under our internal risk rating system, we currently identify criticized loans as “special mention,” “substandard,” “doubtful” or “loss”. We use a numerical rating system of 6.0 through 9.0 which align with the federal regulatory risk rating definitions of special mention, substandard, doubtful and loss, respectively. Additionally, the Company has risk rating categories of 1.0 through 5.0 that fall into the federal regulatory risk rating of “pass”. A risk rating of 1.0 is assigned to those loans that are fully secured, while a loan that is rated 5.0 represents moderate risk.
On a quarterly basis, a Criticized Asset Committee composed of senior officers meet to review Criticized Asset Reports on commercial real estate, commercial construction, commercial and industrial and commercial finance loans that are risk rated special mention, substandard, or doubtful. The reports and the committee focus on the current status, strategy, financial data, and appropriate risk rating of the criticized loan. The risk ratings are subject to change based on the committee’s review and approval. In addition to the internal review, semi-annually, the Bank engages a third party to conduct a review of the commercial, commercial real estate and commercial construction loan portfolios. The primary purpose of the third party review is to evaluate the loan portfolio with respect to the risk rating profiles. Rating differences between the third party review and the internal review are discussed and rating classifications are adjusted accordingly.
The table below outlines commercial real estate, commercial real estate construction, residential development, commercial and industrial and commercial finance loans by risk rating:
Within the residential, home equity loan and equity line and other consumer loan portfolios, management uses an early warning technique to more closely monitor credit deterioration and potential nonperforming loans. The Company uses the latest available FICO score ranges (rescored quarterly) as an indicator of the credit quality of the borrower. The Company considers loans with a FICO score less than 620 to be higher-risk. Once identified, the higher-risk loans are then reviewed by the Special Assets Department to determine what, if any, action should be taken to mitigate possible loss exposure.
The table below displays our residential real estate, home equity loans and equity lines of credit and other consumer loans by the FICO scores:
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
The fair value of the capitalized loan servicing rights is approximately $640,000 and $550,000 greater than its carrying value at December 31, 2010 and 2009, respectively. The Company services residential real estate mortgage loans that it has sold without recourse to third parties. Although the Company continues to have a portfolio of serviced residential real estate loans, NewAlliance began selling the majority of residential real estate loans in the secondary market on a servicing released basis in 2007. The Company is also involved in the SBA loan secondary market. The Company currently sells the guaranteed portion of SBA loans that meet certain criteria while retaining the servicing rights. The aggregate of all loans serviced for others approximates $281.6 and $319.6 million as of December 31, 2010 and 2009, respectively.
Related Party Loans
As of December 31, 2010 and 2009, outstanding loans to related parties totaled approximately $89,000 and $91,000, respectively. Related parties include directors and executive officers of the Company and its subsidiaries and their respective affiliates in which they have a controlling interest, immediate family members and owners of 10% or more of the Company’s stock. For the years ended December 31, 2010 and 2009, all related party loans were performing.
Total depreciation and amortization expenses amounted to $6.4 million, $6.3 million and $6.8 million for the years ended December 31, 2010, 2009 and 2008, respectively.
7. Goodwill and Identifiable Intangible Assets
The changes in the carrying amount of goodwill and identifiable intangible assets for the years ended December 31, 2010 and 2009 are summarized as follows:
There were no impairments recorded for goodwill and identifiable intangible assets since inception.
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
The components of identifiable intangible assets are core deposit and customer relationships and had the following balances at December 31, 2010:
As of December 31, 2010 and 2009 time deposits in denominations of $100,000 or more were approximately $556.7 and $478.1 million, respectively. Interest expense paid on these deposits was approximately $10.0 million, $14.2 million and $19.9 million for the years ended December 31, 2010, 2009 and 2008, respectively.
(1) Includes fair value adjustments on acquired borrowings, in accordance with purchase accounting standards of $1.9 million and $3.1 million at December 31, 2010 and December 31, 2009, respectively.
(2) The trusts were organized to facilitate the issuance of “trust preferred” securities. The Company acquired these subsidiaries when it acquired Alliance Bancorp of New England, Inc. and Westbank Corporation, Inc. The affiliated trusts are wholly-owned subsidiaries of the Company and the payments of these securities are irrevocably and unconditionally guaranteed by the Company.
The acquisition fair value adjustments (premiums) are being amortized as an adjustment to interest expense on borrowings over their remaining term using the level yield method.
The following schedule presents the contractual maturities of the Company’s borrowings as of December 31, 2010:
(1) Balances are contractual maturities and exclude $1.9 million in fair value adjustments on acquired balances.
FHLB advances are secured by the Company’s investment in FHLB Boston stock, a blanket security agreement and other eligible investment securities. This agreement requires the Bank to maintain as collateral certain qualifying assets, principally mortgage loans. Investment securities currently maintained as collateral are all U.S. Agency hybrid adjustable rate mortgage-backed securities. At December 31, 2010 and 2009, the Bank was in compliance with the FHLB collateral requirements. At December 31, 2010, the Company could borrow immediately an additional $188.9 million from the FHLB, inclusive of a line of credit of approximately $20.0 million. Additional borrowing capacity of approximately $1.51 billion would be readily available by pledging additional eligible securities as collateral. At December 31, 2010, all of the Company’s $2.11 billion outstanding FHLB advances were at fixed rates ranging from .31% to 8.17%, which includes $300.0 million with original maturity dates of one year or less. The weighted average rate for all FHLB advances at December 31, 2010 was 2.69%. The Company also has borrowing capacity at the FRB’s discount window, which was approximately $90.1 million as of December 31, 2010, all of which was available on that date. Repurchase agreements with commercial or municipal customers or dealer/brokers are secured by the Company’s investment in specific issues of agency mortgage-backed securities and agency obligations in the amount of $118.6 million and $41.5 million, respectively, as of December 31, 2010. Repurchase agreement lines of credit with four large broker-dealers totaled $200.0 million at December 31, 2010, with $175.0 million available.
11. Pension and Other Postretirement Benefit Plans
Defined Benefit and Other Postretirement Plans
The Company provides various defined benefit and other postretirement benefit plans (postretirement health and life insurance benefits) to substantially all employees hired prior to January 1, 2008. The Company also has supplemental retirement plans (the “Supplemental Plans”) that provide benefits for certain key executive officers. Benefits under the supplemental plans are based on a predetermined formula and are reduced by other benefits. The liability arising from these plans is being accrued over the participants’ remaining periods of service so that at the expected retirement dates, the present value of the annual payments will have been expensed.
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
The following table sets forth changes in the benefit obligation, changes in Plan assets and the funded status of the Plans for the periods ended December 31, 2010 and 2009. The table also provides a reconciliation of the Plan’s funded status and the amounts recognized in the Company’s consolidated balance sheets.
The following table presents the amounts recognized in accumulated other comprehensive income that have not yet been recognized as components of net periodic benefit cost as of December 31, 2010 and 2009.
Investment Strategy and Asset Allocations
Plan assets are to be managed within an ERISA framework so as to provide the greatest probability that the following long-term objectives for the qualified pension plan are met in a prudent manner.
•
Ensure that there is an adequate level of assets to support benefit obligations to participants and retirees over the life of the Plan, taking into consideration the nature and duration of Plan liabilities.
•
Maintain liquidity in Plan assets sufficient to cover ongoing benefit payments.
•
Manage volatility of investment results in order to achieve long-term Plan objectives and to minimize level and volatility of pension expenses.
It is recognized that the attainment of these objectives is, for any given time period, largely dictated by the returns available from the capital markets in which Plan assets are invested.
The asset allocation of Plan assets reflects the Company’s long-term return expectations and risk tolerance in meeting the financial objectives of the Plan. Plan assets should be adequately diversified by asset class, sector and industry to reduce the downside risk to total Plan results over short-term time periods, while providing opportunities for long-term appreciation.
Cash held by a particular manager will be viewed as belonging to the asset class in which the manager primarily invests. It is expected that individual managers over time will exceed the median return of the appropriate manager universe composed of professionally managed institutional funds in the same asset class and style.
Rebalancing and Investment of New Contributions
These asset allocation ranges are guidelines and deviations may occur periodically as a result of market movements. In order to balance the benefits of rebalancing with associated transaction costs, assets will be rebalanced if they are outside the range noted above based on quarter-end market values. In addition, the Compensation Committee reserves the right to rebalance at any time it deems necessary and prudent. New contributions to the Plan assets will be invested in a manner that rebalances the Plan assets to the greatest extent possible.
Plan Contributions
The Company plans to contribute $697,000 to the SERP and $318,000 to its other postretirement plan in 2011. The Company does not expect to contribute to the defined benefit pension plan in 2011.
Plan Assets
Fair value estimates are made as of a specific point in time based on the characteristics of the financial instruments and relevant market information. In accordance with FASB ASC 820, the fair value estimates are measured within the fair value hierarchy. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy under FASB ASC 820 are described below:
Basis of Fair Value Measurement
Level 1
Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
Level 2
Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability;
Level 3
Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).
The fair value of the Company’s pension plan assets at December 31, 2010 and 2009 by asset category are listed in the tables below.
Cash and Cash equivalents: Carrying value is assumed to represent fair value for cash and short-term investments.
Equity Securities: Included in this category are exchange-traded common and preferred shares invested in the retail, energy, financial, health care, industrial, technology, materials and utility sectors. The fair value of the securities are based on quoted market prices of identical securities in active markets and therefore are classified as Level 1 in the fair value hierarchy.
Equity Mutual Funds: Fair value of the fund is based upon the fair value of the underlying equity securities. The fair value of the underlying equity securities are based on quoted market prices of identical securities in active markets and therefore are classified as Level 1 in the fair value hierarchy.
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
Fixed Income Mutual Funds: Fair value of the fund is based upon the fair value of the underlying debt securities. The fair value of the underlying debt securities are based on quoted market prices of similar securities or estimated using pricing models (i.e. matrix pricing) using observable market inputs and therefore are classified as Level 2 in the fair value hierarchy.
Interest in Collective Trusts: This category includes investments in equity, fixed income and real estate funds by a collective trust. The fair value of investments in collective trust funds are measured as the fair value of the ownership interest in the fund, which may not always be the fair value of the underlying net assets of the collective investment trust. The net asset value per unit of a collective investment trust is a primary input into the valuation of ownership interest in a collective investment trust. In addition, consideration is given to specific rights or obligations that pertain to the investments. Based on the observability of prices or inputs used to value the underlying portfolio instruments, investments in collective trusts are classified as Level 2 of the fair value hierarchy.
U.S. Government and State Agency Obligations: Included in this category are government and municipal obligations. The U.S. government obligations are measured at fair value based on quoted prices for identical securities in active markets are classified as Level 1 of the fair value hierarchy. The municipal obligations are measured at fair value based on pricing models using benchmark yields and spreads and therefore are classified Level 2 in the fair value hierarchy.
Corporate Obligations: Included in this category are investments in corporate bonds where the fair values are estimated by using pricing models (i.e. matrix pricing) with observable market inputs including recent transactions and/or benchmark yields or quoted prices of securities with similar characteristics and are therefore classified within Level 2 of the valuation hierarchy.
Annuities: This category consists of a guaranteed deposit account issued by Prudential Retirement Insurance and Annuity Company. Classification within the fair value hierarchy is based on the fair value of the underlying investments of the annuity which are primarily comprised of publicly traded and privately placed debt securities, corporate obligations, mortgage backed securities, money market accounts, and equity securities. The fair value of these underlying securities are based on quoted prices in an active market, pricing models, or quoted prices of securities with similar characteristics. The portion of the portfolio with fair values based on pricing models is approximately 95%, comprised of fixed income debt securities and mortgage backed securities. The remaining portion of the portfolio primarily uses quotable market prices for identical securities (i.e. Level 1). As the primary inputs in deriving fair value of the investments in the portfolio are Level 2 inputs, the fair value of the annuity has been classified as Level 2 in the fair value hierarchy.
Savings and Profit Sharing Plans
The NewAlliance Bank 401(k) Savings Plan (the “Savings Plan”) is a tax qualified defined contribution plan with a qualified cash or deferred arrangement under Section 401(k) of the Internal Revenue Code. The Savings Plan currently provides participants with savings and retirement benefits based on employee deferrals of compensation and a matching feature provided through the Company’s ESOP.
There have been no voluntary cash contributions made by the Bank to the Savings Plan maintained for employees meeting certain eligibility requirements for the years ended December 31, 2010, 2009 and 2008.
In connection with its conversion to a state-chartered stock bank, the Company established an employee stock ownership plan (“ESOP”) to provide substantially all employees of the Company the opportunity to also become stockholders. The ESOP borrowed $109.7 million of a $112.0 million line of credit from the Company and used the funds to purchase 7,454,562 shares of common stock in the open market subsequent to the subscription offering. Loan payments are made quarterly principally from the Bank’s discretionary contributions to the ESOP. The unallocated ESOP shares are pledged as collateral on the loan which has a maturity date of March 31, 2034.
At December 31, 2010, the loan had an outstanding balance of $95.1 million and an interest rate of 4.0%. The Company accounts for its ESOP in accordance with FASB ASC 718-40, Compensation - Stock Compensation. Under this guidance, unearned ESOP shares are not considered outstanding for purposes of computing earnings per share and are shown as a reduction of stockholders’ equity as unearned compensation. The Company will recognize compensation cost equal to the fair value of the ESOP shares during the periods in which they are committed to be released. To the extent that the fair value of the Company’s ESOP shares differs from the cost of such shares, this differential will be credited to equity. The Company will receive a tax deduction equal to the cost of the shares released. As the loan is internally leveraged, the loan receivable from the ESOP to the Company is not reported as an asset nor is the debt of the ESOP shown as a liability in the Company’s financial statements. Dividends on unallocated shares are used to pay the ESOP debt. The ESOP compensation expense for the years ended December 31, 2010, 2009, and 2008 was approximately $3.1 million, $2.9 million and $3.2 million, respectively. The amount of loan repayments made by the ESOP is used to reduce the unallocated common stock held by the ESOP.
In April of 2004, the Company also established a supplemental profit sharing plan and a supplemental ESOP (the “Supplemental Savings Plans”) that provide benefits for certain key executive officers, which are unfunded. Compensation expense related to the Supplemental Savings Plans was $203,000, $147,000 and $9,000 for the years ended December 31, 2010, 2009, and 2008, respectively.
Under the terms of the merger agreement with First Niagara, the Company will terminate the ESOP immediately prior to the time the merger becomes effective. The Company will take all necessary actions to extinguish the balance of the ESOP loan as of the merger closing date.
12. Stock-Based Compensation
The Company provides compensation benefits to employees and non-employee directors under its 2005 Long-Term Compensation Plan (the “LTCP”) which was approved by shareholders. The Company accounts for stock-based compensation using the fair value recognition provisions of FASB ASC 718, Compensation - Stock Compensation. Pursuant to this guidance, the fair value of stock option and restricted stock awards, measured at grant date, is amortized to compensation expense on a straight-line basis over the vesting period or over the requisite service period for awards expected to vest.
The LTCP allows for the issuance of up to 11.4 million Options or Stock Appreciation Rights and up to 4.6 million Stock Awards or Performance Awards. During the year ended December 31, 2010, a mix of stock options, restricted stock and performance-based restricted shares were awarded to employees. Due to the terms of the pending acquisition agreement with First Niagara, no further awards will be granted. In December 2010, the Company accelerated the vesting of restricted stock and performance-based share awards for executive officers of the Company that would have otherwise vested upon the consummation of the merger. All remaining outstanding unvested awards will become fully vested upon the effective time of the merger in accordance with the LTCP.
Option Awards
Options awarded to date are for a term of ten years and total approximately 10.0 million shares. The majority of these options were awarded on the original award date of June 17, 2005 and these 2005 option awards had the following vesting schedule: 40% vested at year-end 2005 and 20% vested at year-end 2006, 2007 and 2008, respectively. Subsequent awards have vesting periods of either three or four years. The Company assumed a 2.9% average forfeiture rate on options granted subsequent to June 17, 2005 as the majority of the options were awarded to senior level management. Compensation expense recorded on options for the years ended December 31, 2010, 2009 and 2008 was $576,000, $357,000 and $4.2 million, respectively, or after tax expense of approximately $371,000, $230,000 and $2.8 million, respectively. The Company anticipates it will record expense of $1.5 million in 2011 which factors in the full vesting of outstanding option awards.
Options to purchase 416,568, 473,109 and 124,656 shares were granted to employees during the years ended December 31, 2010, 2009, and 2008, respectively. Using the Black-Scholes option pricing model, the weighted-average grant date fair value was $2.10, $2.31 and $2.21 per share for the options which were granted in 2010, 2009, and 2008, respectively. The weighted-average related assumptions for these periods are presented in the following table.
•
The risk-free interest rate was determined using the U.S. Treasury yield curve in effect at the time of the grant.
•
The dividend yield is calculated on the current dividend and strike price at the time of the grant.
The total fair value of options that vested in 2010, 2009 and 2008 was $490,000, $229,000 and $4.3 million, respectively.
.Restricted Stock and Performance-Based Restricted Stock Awards
To date, approximately 4.0 million shares of restricted stock have been awarded under the LTCP. The majority of these shares were awarded in 2005 and these 2005 awards have a vesting schedule of 15% per year for six years and 10% in the seventh year. Subsequent awards have vesting schedules of three years, four years, or cliff vest after three years. During the years ended December 31, 2010 and 2009, the Company granted approximately 262,000 and 223,000 restricted stock awards, respectively. These awards included approximately 80,000 shares and 65,000 shares of performance-based awards in 2010 and 2009, respectively.
Performance-based restricted stock shares were awarded to executive management and other key members of senior management to encourage decisions with a long-term focus, link pay opportunities with long-term shareholder value creation, enhance the retention power of the Company’s compensation program and balance annual incentive programs to provide award opportunities based on longer-term success. The vesting for these performance-based awards is conditional upon fulfillment of a market condition and on meeting a service period requirement. The actual number of performance shares to be earned will be based on performance criteria over a three-year performance period, which for the 2010 award is May 28, 2010 and ending May 31, 2013 and for the 2009 award is May 29, 2009 through May 31, 2012. The performance shares, if earned, will vest at the end of the three-year period. Performance shares vest based on total shareholder return (“TSR”) (defined as share price appreciation from the beginning of the performance period to the end of the performance period, plus the total dividends paid on the common stock during the period) for the group of banks and thrifts listed on the SNL Thrift Index versus the Company’s TSR (the “TSR Percentage”). A simulation model was used to provide a grant date fair value for the performance-based shares. Expense for the performance-based awards is recognized based on the probability of attaining the performance targets and over the service period similar to the recognition of the expense associated with the other restricted stock awards that only have a service condition. As provided for in the LTCP, shares will vest earlier upon death or disability or in the event of a change of control. In these cases, performance will be calculated and the number of shares pro-rated through the date of termination or change in control.
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
On December 20, 2010, pursuant to applicable agreements and with the consent of First Niagara, the Company and NewAlliance Bank entered into Acknowledgement Agreements with various of its senior officers. The Acknowledgment Agreements provide for the acceleration of certain existing compensation benefits, including the vesting of restricted stock and performance-based share awards that would have otherwise vested upon consummation of the merger.
The unvested time-based restricted stock awards vested as of the close of business on December 20, 2010. The performance-based share awards, which would have been earned in May 2012 and May 2013, were deemed earned as of close of business on December 20, 2010 and were calculated based on the Company’s TSR as of November 30, 2010 and the pro-ration factors that would be applicable as of April 1, 2011. The 2009 awards attained a performance percentage of 131.4% and were pro-rated for 22 months of service, while the 2010 awards attained a performance percentage of 200.0% and were pro-rated for 10 months of service. Expense of $3.5 million resulting from the acceleration of the awards was recognized in 2010.
Total restricted stock compensation expense, including performance shares, for the years ended December 31, 2010, 2009 and 2008 was approximately $10.4 million, $6.1 million and $7.0 million or after tax expense of $9.1 million, $4.8 million and $4.5 million, respectively. The Company anticipates that it will record expense of approximately $3.0 million in 2011, which factors in the full vesting of outstanding stock awards.
The following table summarizes the nonvested restricted stock and performance-based restricted stock awards during the year ended December 31, 2010.
For the years ended December 31, 2010, 2009 and 2008, the provision for income taxes differs from the amount computed by applying the statutory Federal income tax rate of 35% to pre-tax income for the following reasons:
Management believes it is more likely than not that the reversal of deferred tax liabilities and results of future operations will generate sufficient taxable income to realize the deferred tax assets, net of the valuation allowance.
The allocation of deferred tax benefit involving items charged to income, items charged directly to stockholders’ equity and items charged to goodwill are as follows:
The Company has no federal net operating loss carryforwards at December 31, 2010. The Company has state net operating loss carryforwards at December 31, 2010 of $372.5 million which expire between 2020 and 2030. As of December 31, 2010 and 2009, the Company had a valuation allowance of $22.1 million and $20.1 million, respectively, against its state deferred tax asset, including the state net operating loss carryforwards, in connection with the creation of a Connecticut passive investment company pursuant to legislation enacted in 1998. Under this legislation, Connecticut passive investment companies are not subject to the Connecticut Corporate Business Tax and dividends paid by the passive investment company to the Company are exempt from the Connecticut Corporate Business Tax.
The Company has no alternative minimum tax credit carryforwards at December 31, 2010.
The Company has no charitable contribution carryforwards at December 31, 2010. At December 31, 2009, the Company had charitable contribution carryforwards of $198,000 which were fully utilized in 2010. The utilization of charitable contributions for any tax year is limited to 10% of taxable income without regard to charitable contributions, net operating losses, and dividend received deductions. A corporation is permitted to carry over to the five succeeding tax years contributions that exceeded the 10% limitation, but deductions in those years are also subject to the maximum limitation.
The Company has capital loss carryforwards of $1.9 million at December 31, 2010 and 2009. $1.3 million of the carryforward was generated by Westbank Corporation, Inc. (“Westbank”) and expires at the end of 2011. The remainder of carryforwards will primarily expire in 2013 and 2014. Capital losses can only be used to offset capital gains. Excess losses over gains can be carried back three years or carried forward five years. As of December 31, 2010 and December 31, 2009, there is a $1.1 million and a $1.5 million valuation allowance, respectively, for the tax effect of capital loss carryforwards associated with realized and unrealized capital losses on capital assets, of which $482,000 and $462,000, respectively, was recorded as an adjustment to other comprehensive income.
A deferred tax liability has not been recorded for the tax reserve for bad debts of approximately $50.2 million that arose in tax years beginning before December 31, 1987 (the “base year amount”). A deferred tax liability is not recognized for the base year amount unless it becomes apparent that those temporary differences will reverse into taxable income in the foreseeable future. The base year amount will only be recognized into taxable income if the Bank ceases to be a bank or if the Bank makes distributions of property to a shareholder with respect to its stock that is in excess of the Bank’s earnings and profits accumulated in taxable years beginning after December 31, 1951. No deferred tax liability has been established as these two events are not expected to occur in the foreseeable future.
The Company accounts for uncertainty in income taxes in accordance with FASB ASC 740-10. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
Included in the balance at December 31, 2010, are $260,000 of tax positions for which the ultimate deductibility was highly uncertain and for which the disallowance of the tax position would primarily affect the annual effective tax rate. As of December 31, 2010, the Company had accrued approximately $71,000 in interest and penalties.
Included in the balance at December 31, 2009 are $400,000 of tax positions for which the ultimate deductibility is highly uncertain and for which the disallowance of the tax position would primarily affect the annual effective tax rate. The Company recognizes interest and penalties accrued related to unrecognized tax benefits as a component of income tax expense. As of December 31, 2009, the Company had accrued approximately $78,000 in interest and penalties.
The Company anticipates that none of the unrecognized tax benefits as of December 31, 2010 will reverse in the next 12 months due to statute of limitation expirations.
The Company is generally no longer subject to federal, state or local income tax examinations by tax authorities for the years before 2007. In the third quarter of 2008, the IRS commenced an examination of the 2006 and 2007 tax years for Westbank. In the second quarter of 2009, the IRS commenced an examination of the 2006 and 2007 tax years for the Company. Both exams were completed in 2010 and the IRS did not propose any significant adjustments to Westbank’s or the Company’s 2006 and 2007 tax returns.
14. Commitments and Contingencies
Cash and Due from Banks Withdrawal and Usage Restrictions
The Company is required to maintain reserves against its transaction accounts and non-personal time deposits. As of December 31, 2010 and 2009, the Company was required to have deposits at the FRB Boston of approximately $36.7 million and $23.7 million, respectively, to meet these requirements.
Leases
The Company leases certain of its premises and equipment under lease agreements, which expire at various dates through July 31, 2029. The Company has the option to renew certain of the leases at fair rental values. Rental expense was approximately $4.4 million for the years ended December 31, 2010, 2009 and 2008.
Future minimum payments, by fiscal year in the aggregate, under non-cancelable operating leases with initial or remaining terms of one year or more consisted of the following:
Commitments to Extend Credit
The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments consist primarily of commitments to extend credit and standby letters of credit. Commitments to extend credit are agreements to lend to customers as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses that may require payment of a fee. Since many of the commitments could expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. These commitments consist principally of unused commercial and consumer lines of credit. Standby letters of credit generally are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risks associated with commitments to extend credit and standby letters of credit are essentially the same as those involved with extending loans to customers and are subject to normal credit policies. Collateral may be obtained based on management’s assessment of the customer’s creditworthiness.
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
The table below summarizes the Company’s commitments and contingencies discussed above.
Other Commitments
As of December 31, 2010 and 2009, the Company was contractually committed under limited partnership agreements to make additional partnership investments of approximately $1.1 million and $1.5 million, respectively, which constitutes our maximum potential obligation to these partnerships. The Company is obligated to make additional investments in response to formal written requests, rather than a funding schedule. Funding requests are submitted when the partnerships plan to make additional investments.
Legal Proceedings
In the ordinary course of business, we are involved in various threatened and pending legal proceedings. We believe that we are not a party to any pending legal, arbitration, or regulatory proceedings that would have a material adverse impact on our financial results or liquidity. Certain legal proceedings in which we are involved are described below:
On or about August 20, 2010, a lawsuit was filed by Stanley P. Kops against NewAlliance and its directors in the Connecticut Superior Court for the Judicial District of New Haven (NNH-CV10-6013984) challenging the proposed merger between NewAlliance and First Niagara. The purported class action alleges that the NewAlliance board of directors breached its fiduciary duties to NewAlliance stockholders by failing to maximize stockholder value in approving the merger agreement with First Niagara and that NewAlliance and First Niagara aided and abetted this alleged breach of fiduciary duty.
Since the first action was commenced, nine additional lawsuits have been filed against NewAlliance, First Niagara, Merger Sub, and/or the NewAlliance directors and certain officers of NewAlliance. The plaintiffs in the additional lawsuits are: Southwest Ohio Regional Council of Carpenters Pension Plan (NNH-CV10-6014110); Cynthia J. Kops (NNH-CV10-6014155); Joseph Caldarella (NNH-CV10-6014192); Michael Rubin (NNH-CV10-6014328); Arlene H. Levine and Gertrude M. Nitkin (NNH-CV10-6014477); Port Authority of Alleghany County Retirement & Disability Allowance Plan for Employees Represented by Local 85 of the Amalgamated Transit Union (NN-CV10-6014634); Alan Kahn (Case No. 5785); Moses Eilenberg (Case No. 5796); and Erie County Employees’ Retirement System (Case No. 5831). The latter three lawsuits were filed in the Court of Chancery of the State of Delaware and the remainder were filed in the Connecticut Superior Court. The claims in the nine additional lawsuits are substantially the same as the claims in the first lawsuit and seek, among other things, to enjoin the proposed merger on the agreed upon terms. Certain of the new actions, however, also seek attorneys’ and experts’ fees and actual and punitive damages if the merger is completed.
On September 28, 2010, the three Delaware actions were consolidated into In re NewAlliance Bancshares, Inc. Shareholders Litigation (No. 5785-VCP), and the plaintiffs in the consolidated action filed an amended complaint which adds allegations challenging the accuracy of disclosures in the preliminary Form S-4, a motion to preliminarily enjoin the defendants from taking any action to consummate the merger and a motion seeking expedited discovery. On October 22, the court granted the plaintiffs’ motion for expedited discovery and tentatively scheduled a preliminary injunction hearing for December 1, 2010.
On October 19, 2010, the seven Connecticut actions were transferred to the complex litigation docket in the Judicial District of Stamford. The cases were consolidated on October 20 and, on October 22, the plaintiffs filed an amended complaint which adds allegations challenging the accuracy of disclosure in the preliminary Form S-4. The plaintiffs in the Connecticut actions also have indicated that they intend to seek a preliminary injunction and expedited discovery.
On October 18 and 19, 2010, the Company and other defendants filed motions in the seven Connecticut actions and in the consolidated Delaware action requesting that the courts direct the plaintiffs in all the actions to confer and agree on a single forum in which to litigate their claims, or if the plaintiffs are unable to agree, that the courts confer and designate a single forum, and that the cases in the other forum be stayed. The defendants’ motions are pending.
On December 6, 2010, the parties to the Connecticut and Delaware actions reached an agreement in principle to resolve the Connecticut Action and the Delaware Action. Part of the agreement was that the defendants would not object to the payment of plaintiffs’ attorney fees up to $750,000. The settlement contemplated by the agreement will be submitted to the Connecticut court for approval. Immediately following final approval by the Connecticut court of the settlement, the parties to the Delaware actions shall
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
dismiss those actions with prejudice. As part of the settlement, the defendants deny all allegations of wrongdoing and deny that the disclosures in the joint proxy/statement prospectus were inadequate but have agreed to provide supplemental disclosures. These supplemental disclosures were provided in the Company’s Current Report on Form 8-K, filed on December 6, 2010. The settlement will not affect the timing of the merger or the amount of consideration to be paid in the merger. There are no injunction proceedings pending at this time.
15. Fair Value Measurements
Fair value estimates are made as of a specific point in time based on the characteristics of the financial instruments and relevant market information. In accordance with FASB ASC 820, the fair value estimates are measured within the fair value hierarchy. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy under FASB ASC 820 are described below:
Basis of Fair Value Measurement
Level 1
Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;
Level 2
Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability;
Level 3
Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).
When available, quoted market prices are used. In other cases, fair values are based on estimates using present value or other valuation techniques. These techniques involve uncertainties and are significantly affected by the assumptions used and judgments made regarding risk characteristics of various financial instruments, discount rates, estimates of future cash flows, future expected loss experience and other factors. Changes in assumptions could significantly affect these estimates and could be material. Derived fair value estimates may not be substantiated by comparison to independent markets and, in certain cases, could not be realized in an immediate sale of the instrument.
Fair value estimates are based on existing financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not financial instruments. Accordingly, the aggregate fair value amounts presented do not purport to represent the underlying market value of the Company.
Fair Value Option
FASB ASC 825-10 allows for the irrevocable option to elect fair value accounting for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis that may otherwise not be required to be measured at fair value under other accounting standards. The Company elected the fair value option as of January 1, 2009 for its portfolio of mortgage loans held for sale pursuant to forward loan sale commitments originated after January 1, 2009 in order to reduce certain timing differences and better match changes in fair values of the loans with changes in the value of the derivative forward loan sale contracts used to economically hedge them. As a result of the surge of refinances resulting from the drop in mortgage rates within the industry, the balance of loans held for sale and derivative contracts relating to those loans have increased significantly. The fair value option election relating to mortgage loans held for sale did not result in a transition adjustment to retained earnings and instead changes in the fair value have an impact on earnings as a component of noninterest income.
As of December 31, 2010, mortgage loans held for sale pursuant to forward loan sale commitments had a fair value of $41.2 million, which includes a negative fair value adjustment of $838,000. For the twelve months ended December 31, 2010 and 2009, there were net losses from fair value changes of $616,000 and $222,000, respectively. The net losses were recorded to non-interest income as mortgage origination activity and loan sale income. No mortgage loans held for sale were 90 days or more past due as of December 31, 2010.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The following tables detail the financial instruments carried at fair value on a recurring basis as of December 31, 2010 and 2009 and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine the fair value:
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
The following is a description of the valuation methodologies used for instruments measured at fair value.
Securities Available for Sale: Included in the available for sale category are both debt and equity securities. The Company utilizes Interactive Data Corp., a third-party, nationally-recognized pricing service (“IDC”) to estimate fair value measurements for 99.8% of
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
this portfolio. The pricing service evaluates each asset class based on relevant market information considering observable data that may include dealer quotes, reported trades, market spreads, cash flows, the U.S. Treasury yield curve, the LIBOR swap yield curve, trade execution data, market prepayment speeds, credit information and the bond’s terms and conditions, among other things, but these prices are not binding quotes. The fair value prices on all investment securities are reviewed for reasonableness by management through an extensive process. This review process was implemented to determine any unusual market price fluctuations and the analysis includes changes in the LIBOR/swap curve, the treasury curve, mortgage rates and credit spreads as well as a review of the securities inventory list which details issuer name, coupon and maturity date. The review resulted in no adjustments to the IDC pricing as of December 31, 2010. Also, management assessed the valuation techniques used by IDC based on a review of their pricing methodology to ensure proper hierarchy classifications. The Company’s available for sale debt securities include a pooled trust preferred security and an individual named trust preferred security which were not priced by IDC, but rather, were valued through means other than quoted market prices due to the Company’s conclusion that the market for the securities was not active. The fair value for these securities are based on Level 3 inputs in accordance with FASB ASC 820.
The major categories of securities available for sale are:
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Marketable Equity Securities: Included within this category are exchange-traded securities, including common and preferred equity securities, measured at fair value based on quoted prices for identical securities in active markets and therefore meet the Level 1 criteria. Also included are auction rate preferred securities rated AAA, which are priced at par and are classified as Level 2 of the valuation hierarchy.
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Bonds and obligations: Included within this category are highly liquid government obligations and government agency obligations that are measured at fair value based on quoted prices for identical securities in active markets and therefore are classified within Level 1 of the fair value hierarchy. Also included in this category are municipal obligations, corporate obligations and a mortgage mutual fund where the fair values are estimated by using pricing models (i.e. matrix pricing) with observable market inputs including recent transactions and/or benchmark yields or quoted prices of securities with similar characteristics and are therefore classified within Level 2 of the valuation hierarchy.
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Trust preferred equity securities: Included in this category are two pooled trust preferred securities and “individual name” trust preferred securities of financial companies. One of the pooled trust preferred securities of $2.3 million and an individual name trust preferred security of $3.6 million are not priced by IDC, both of which are classified within Level 3 of the valuation hierarchy. The remaining securities are at Level 2 and are priced by IDC based upon matrix pricing factoring in observable benchmark yields and issuer spreads. The Company calculates the fair value of the Level 3 pooled trust preferred security based on a cash flow methodology that uses the Bloomberg A rated bank yield curve to discount the current expected cash flows. In order to derive the fair value of the individual name security, the Company uses the Bloomberg A rated insurance yield curve to discount the current expected cash flows. Additionally, the low level of the three month LIBOR rate, the general widening of credit spreads compared to when these securities were purchased and the reduced level of liquidity in the fixed income markets, were all factors in the determination of the current fair value market price.
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Mortgage-Backed Securities: The Company owns residential mortgage-backed securities. As there are no quoted market prices available, the fair values of mortgage backed securities are based upon matrix pricing factoring in observable benchmark yields and issuer spreads and are therefore classified within Level 2 of the valuation hierarchy.
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Auction Rate Certificates: Through June 30, 2010, the Company owned auction rate certificates which were pools of government guaranteed student loans issued by state student loan departments. At June 30, 2010, these securities were priced at par as the Company tendered its three remaining positions to the underwriter at par as part of their 2008 settlement agreement. Previously, due to the lack of liquidity in the auction rate market, the Company had been obtaining a price from the market maker that factored in credit risk and liquidity premiums to determine a current fair value market price. The auction rate certificates fell into the classification of Level 3 within the fair value hierarchy. These securities were not priced by the pricing service.
Mortgage Loans Held for Sale: Fair values were estimated utilizing quoted prices for similar assets in active markets. Any change in the valuation of mortgage loans held for sale is based upon the change in market interest rates between closing the loan and the measurement date. As the loans are sold in the secondary market, the market prices are obtained from Freddie Mac and represent a delivery price which reflects the underlying price Freddie Mac would pay the Company for an immediate sale on these mortgages.
Derivatives: Derivative instruments related to loans held for sale are carried at fair value. Fair value is determined through quotes obtained from actively traded mortgage markets. Any change in fair value for rate lock commitments to the borrower is based upon
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
the change in market interest rates between making the rate lock commitment and the measurement date and, for forward loan sale commitments to the investor, is based upon the change in market interest rates from entering into the forward loan sales contract and the measurement date. Both the rate lock commitments to the borrowers and the forward loan sale commitments to investors are undesignated derivatives pursuant to the requirements of FASB ASC 815-10, however, the Company has not designated them as hedging instruments. Accordingly, they are marked to fair value through earnings.
At December 31, 2010, the effects of fair value measurements for interest rate lock commitment derivatives and forward loan sale commitments were as follows (mortgage loans held for sale are shown for informational purposes only):
The Company sells the majority of its fixed rate mortgage loans with original terms of 15 years or more on a servicing released basis and receives a servicing released premium upon sale. The servicing value has been included in the pricing of the rate lock commitments and loans held for sale. The Company estimates a fallout rate of approximately 10% based upon historical averages in determining the fair value of rate lock commitments. Although the use of historical averages is based upon unobservable data, the Company believes that this input is insignificant to the valuation and, therefore, has concluded that the fair value measurements meet the Level 2 criteria. The collection of upfront fees from the borrower is the driver of the Company’s low fallout rate. If this practice were to change, the fallout rate would most likely increase and the Company would reassess the significance of the fallout rate on the fair value measurement.
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
The following tables detail the financial instruments carried at fair value on a nonrecurring basis as of December 31, 2010 and December 31, 2009 and indicate the fair value hierarchy of the valuation techniques utilized by the Company to determine the fair value:
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
Loan Servicing Rights: A loan servicing right asset represents the amount by which the present value of the estimated future net cash flows to be received from servicing loans are expected to more than adequately compensate the Company for performing the servicing. The fair value of servicing rights is estimated using a present value cash flow model. The most important assumptions used in the valuation model are the anticipated rate of the loan prepayments and discount rates. Adjustments are only recorded when the discounted cash flows derived from the valuation model are less than the carrying value of the asset. As such, measurement at fair value is on a nonrecurring basis. Although some assumptions in determining fair value are based on standards used by market participants, some are based on unobservable inputs and therefore are classified in Level 3 of the valuation hierarchy.
Other Real Estate Owned: The Company classifies property acquired through foreclosure or acceptance of deed-in-lieu of foreclosure as other real estate owned in its financial statements. Upon foreclosure, the property securing the loan is written down to fair value. The writedown is based upon differences between the appraised value and the book value. Appraisals are based upon observable market data such as comparable sale within the real estate market, however assumptions made in determining comparability are unobservable and therefore these assets are classified as Level 3 within the valuation hierarchy.
Impaired Loans: Impaired loans are measured based on one of three methods: the present value of expected future cash flows discounted at the loan’s original effective interest rate; at the loan’s observable market price: or the fair value of the collateral if the loan is collateral dependent. Consequently, certain impaired loans may be subject to measurement at fair value on a nonrecurring basis and are written down through a valuation allowance within the Bank’s total loan loss reserve allowance. The fair value of these assets are classified within Level 3 of the valuation hierarchy and are estimated based on collateral values supported by appraisals.
Disclosures about Fair Value of Financial Instruments
The following methods and assumptions were used by management to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value.
Cash and cash equivalents: Carrying value is assumed to represent fair value for cash and due from banks and short-term investments, which have original maturities of 90 days or less.
Investment securities: Refer to the above discussion on securities
Federal Home Loan Bank of Boston stock: FHLB Boston stock is a non-marketable equity security which is assumed to have a fair value equal to its carrying value due to the fact that it can only be redeemed back to the FHLB Boston at par value.
Loans held for sale: The fair value of residential mortgage loans held for sale is estimated using quoted market prices provided by government-sponsored entities as described above. The fair value of SBA loans is estimated using quoted market prices from a secondary market broker.
Accrued income receivable: Carrying value is assumed to represent fair value.
Loans: The fair value of the net loan portfolio is determined by discounting the estimated future cash flows using the prevailing interest rates and appropriate credit and prepayment risk adjustments as of period-end at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. The fair value of nonperforming loans is estimated using the Bank’s prior credit experience.
Derivative Assets: Refer to the above discussion on derivatives.
Deposits: The fair value of demand, non-interest bearing checking, savings and certain money market deposits is determined as the amount payable on demand at the reporting date. The fair value of time deposits is estimated by discounting the estimated future cash flows using rates offered for deposits of similar remaining maturities as of period-end.
Borrowed Funds: The fair value of borrowed funds is estimated by discounting the future cash flows using market rates for similar borrowings.
Derivative Liabilities: Refer to the above discussion on derivatives.
The following are the carrying amounts and estimated fair values of the Company’s financial assets and liabilities as of the periods presented:
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
16. Derivative Financial Instruments
The Company accounts for derivatives in accordance with FASB ASC 815, Derivatives and Hedging, which requires that all derivative instruments be recorded on the consolidated balance sheets at their fair values. The Company does not enter into derivative transactions for speculative purposes, does not have any derivatives designated as hedging instruments, nor is party to a master netting agreement as of December 31, 2010.
Loan Commitments and Forward Loan Sale Commitments: The Company enters into interest rate lock commitments with borrowers, to finance residential mortgage loans. Primarily to mitigate the interest rate risk on these commitments, the Company also enters into “mandatory” and “best effort” forward loan sale delivery commitments with investors. The interest rate lock commitments and the forward loan delivery commitments meet the definition of a derivative, however, the Company has not designated them as hedging instruments. Upon closing the loan, the loan commitment expires and the Company records a loan held for sale subject to the same forward loan sale commitment. Prior to January 1, 2009, the Company accounted for loans held for sale at the lower of cost or fair value in accordance with accounting guidance for certain mortgage banking activities. Fluctuations in the fair value of loan commitments, loans held for sale, and forward loan sale commitments generally move in opposite directions, and the net impact of the changes in these valuations on net income is generally inconsequential to the financial statements.
The following table summarizes the Company’s derivative positions at December 31.
(1) An immaterial portion of these amounts was attributable to changes in instrument-specific credit risk.
The following two tables present the fair values of the Company’s derivative instruments and their effect on the Statement of Income:
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
17. Stockholders’ Equity
At December 31, 2010, stockholders’ equity amounted to $1.46 billion, or 16.2% of total assets, compared to $1.43 billion or 17.0% of total assets at December 31, 2009. The Company paid cash dividends of $0.28 per share on common stock during both years ended December 31, 2010 and 2009.
Dividends
The Company and the Bank are subject to dividend restrictions imposed by various regulators. Connecticut banking laws limit the amount of annual dividends that the Bank may pay to the Company to an amount that approximates the Bank’s net income retained for the current year plus net income retained for the two previous years. In addition, the Bank may not declare or pay dividends on, and the Company may not repurchase any of its shares of its common stock if the effect thereof would cause stockholders’ equity to be reduced below applicable regulatory capital maintenance requirements or if such declaration, payment or repurchase would otherwise violate regulatory requirements.
Treasury Shares
Share Repurchase Plan
On January 31, 2006, the Company’s Board of Directors authorized a repurchase plan of up to an additional 10.0 million shares or approximately 10% of the then outstanding Company common stock. Under this plan the Company has repurchased 8,578,062 shares of common stock at a weighted average price of $12.80 per share as of December 31, 2010. During 2010, there were approximately 882,000 shares repurchased. There is no set expiration date for this repurchase plan, however, due to the First Niagara impending acquisition, the Company is not initiating share repurchases.
Other
Upon vesting of shares under the Company’s benefit plans, plan participants may choose to have the Company withhold a number of shares necessary to satisfy tax withholding requirements. The withheld shares are classified as treasury shares by the Company. For the year ended December 31, 2010, approximately 312,000 shares were returned to the Company for this purpose.
Liquidation Account
As part of the conversion to a stock bank on April 1, 2004, the Bank established a liquidation account for the benefit of account holders in an amount equal to the Bank’s capital of $403.8 million as of September 30, 2003. The liquidation account will be maintained for a period of ten years after the conversion for the benefit of those deposit account holders who qualified as eligible
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
account holders at the time of the conversion and who have continued to maintain their eligible deposit balances with the Bank following the conversion. The liquidation account, which totaled $74.5 million at December 31, 2010, is reduced annually by an amount equal to the decrease in eligible deposit balances, notwithstanding any subsequent increases in the account. In the unlikely event of the complete liquidation of the Bank, each eligible deposit account holder will be entitled to receive his/her proportionate interest in the liquidation account, after the payment of all creditors’ claims, but before distributions to the Company as the sole stockholder of the Bank. The Bank may not declare or pay a dividend on its capital stock if its effect would be to reduce the regulatory capital of the Bank below the amount required for the liquidation account.
Regulatory Capital
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 Company’s Consolidated Financial Statements. The regulations require the Bank to meet specific capital adequacy guidelines that involve quantitative measures of the Bank’s assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the banking regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of Total capital and Tier 1 capital to risk weighted assets and of Tier 1 capital to average assets. As of December 31, 2010 and December 31, 2009 the Company and the Bank met all capital adequacy requirements to which it was subject.
As of December 31, 2010, the most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum Total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following table. Management believes that there are no events or conditions, which have occurred subsequent to the notification that would change the Bank’s capital category. The following is a summary of the Company’s and the Bank’s actual capital amounts and ratios as of December 31, 2010 and 2009, compared to the required amounts and ratios for minimum capital adequacy and for classification as a well capitalized institution:
18. Other Comprehensive Income (Loss)
The following table summarizes the components of comprehensive income and other comprehensive income (loss) and the related tax effects for the years ended December 31, 2010, 2010 and 2009.
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
(1 )
Deferred income tax for the years ended December 31, 2010, 2009 and 2008 related to securities gains and losses was a benefit of $3.6 million, an expense of $16.1 million and a benefit of $4.8 million, respectively. Included in deferred income taxes related to securities gains and losses was a change in the valuation allowance of $20,000, $332,000 and $663,000 for the years ended December 31, 2010, 2009 and 2008, respectively, for the tax effects of unrealized capital losses on equity securities. Deferred income tax related to unrecognized pension gains and losses for the years ended December 31, 2010, 2009 and 2008 was an expense of $277,000, $4.1 million and a benefit of $13.4 million, respectively.
(1 )
Not included in the computation of diluted earnings per share because the options’ exercise prices were greater than the average market price of the common shares during the period were options to purchase 143,240, 7,253,647 and 8,339,450 shares of common stock that were outstanding at December 31, 2010, 2009 and 2008, respectively.
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
NewAlliance Bancshares, Inc.
Notes to Consolidated Financial Statements
21. Parent Company Statements
The following represents the Parent Company’s balance sheets as of December 31, 2010 and 2009, and statements of income and cash flows for the years ended December 31, 2010, 2009 and 2008.
10.9.2
Form of Restricted Stock Award Agreement for conversion awards (for employees, including senior officers). Incorporated herein by reference is Exhibit 10.9.2 filed with the Company’s Quarterly Report on Form 10-Q, filed August 9, 2005.
10.10
NewAlliance Bancshares, Inc. 2005 Long-Term Compensation Plan. Incorporated herein by reference is Exhibit 4.3 filed with the Company’s Registration Statement on Form S-8, filed November 4, 2005.
10.11
(Intentionally omitted)
10.12
Form of Indemnification Agreement for Directors and Certain Executive Officers. Incorporated herein by reference is Exhibit 10.12 filed with the Company’s Annual Report on Form 10-K, filed March 1, 2007.
10.13
General Severance Plan. Incorporated herein by reference is Exhibit 10.13 filed with the Company’s Annual Report on Form 10-K, filed February 27, 2009.
10.14
Form of Performance Share Award Agreement (for senior officers). Incorporated herein by reference is Exhibit 10.14 filed with the Company Current Report on Form 8-K, filed June 1, 2009.
10.15
Form of Restricted Stock Award Agreement (for senior officers). Incorporated herein by reference is Exhibit 10.15 filed with the Company Current Report on Form 8-K, filed June 1, 2009.
10.16
Form of Stock Option Award Agreement (for senior officers). Incorporated herein by reference is Exhibit 10.16 filed with the Company Current Report on Form 8-K, filed June 1, 2009.
10.17
Form of Stock Option Agreement for annual awards (for outside directors). Incorporated herein by reference is Exhibit 10.17 filed with the Company’s Annual Report on Form 10-K, filed February 26, 2010.
10.18
Form of Restricted Stock Agreement for annual awards (for outside directors). Incorporated herein by reference is Exhibit 10.18 filed with the Company’s Annual Report on Form 10-K, filed February 26, 2010.
Code of Ethics for Senior Financial Officers. Incorporated herein by reference is Exhibit 14 filed with the Company’s Annual Report on Form 10-KT, filed March 30, 2004.
Subsidiaries of NewAlliance Bancshares, Inc. and NewAlliance Bank. Incorporated herein by reference is Exhibit 21 filed with the Company’s Annual Report on Form 10-K, filed March 1, 2007.
23.1
Consent of PricewaterhouseCoopers LLP (filed herewith).
31.1
Certification of Peyton R. Patterson pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934 (filed herewith).
31.2
Certification of Glenn I. MacInnes pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934 (filed herewith).
32.1
Certification of Peyton R. Patterson pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).
32.2
Certification of Glenn I. MacInnes pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).
The following financial information from NewAlliance Bancshares, Inc.’s annual report on Form 10-K for the year ended December 31, 2010, formatted in XBRL: (i) the Consolidated Statement of Income, (ii) the Consolidated Balance Sheets, (iii) the Consolidated Statement of Changes in Stockholders’ Equity, (iv) the Consolidated Statements of Cash Flows, and (v) the Notes to Consolidated Financial Statements tagged as blocks of text (furnished herewith).