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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended: September 30, 2014

 

¨ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                      to                     

Commission File Number: 0-26001

 

 

Hudson City Bancorp, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   22-3640393

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

West 80 Century Road

Paramus, New Jersey

  07652
(Address of Principal Executive Offices)   (Zip Code)

(201) 967-1900

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of November 3, 2014, the registrant had 528,764,950 shares of common stock, $0.01 par value, outstanding.

 

 

 


Table of Contents

Table of Contents

 

     Page
Number
 

PART I – FINANCIAL INFORMATION

  

Item 1. – Financial Statements

  

Consolidated Statements of Financial Condition – September 30, 2014 (Unaudited) and December  31, 2013

     5   

Consolidated Statements of Income (Unaudited) – For the three and nine months ended September  30, 2014 and 2013

     6   

Consolidated Statements of Comprehensive Income (Loss) (Unaudited) – For the three and nine months ended September 30, 2014 and 2013

     7   

Consolidated Statements of Changes in Shareholders’ Equity (Unaudited) – For the nine months ended September 30, 2014 and 2013

     8   

Consolidated Statements of Cash Flows (Unaudited) – For the nine months ended September  30, 2014 and 2013

     9   

Notes to Unaudited Consolidated Financial Statements

     10   

Item 2. – Management’s Discussion and Analysis of Financial Condition and Results of Operations

     41   

Item 3. – Quantitative and Qualitative Disclosures About Market Risk

     78   

Item 4. – Controls and Procedures

     85   

PART II – OTHER INFORMATION

  

Item 1. – Legal Proceedings

     85   

Item 1A. – Risk Factors

     86   

Item 2. – Unregistered Sales of Equity Securities and Use of Proceeds

     86   

Item 3. – Defaults Upon Senior Securities

     86   

Item 4. – Mine Safety Disclosures

     86   

Item 5. – Other Information

     87   

Item 6. – Exhibits

     87   

SIGNATURES

     88   

 

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Table of Contents

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains certain “forward looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 which may be identified by the use of such words as “may,” “believe,” “expect,” “anticipate,” “consider,” “should,” “plan,” “estimate,” “predict,” “continue,” “probable,” and “potential” or the negative of these terms or other comparable terminology. Examples of forward-looking statements include, but are not limited to, estimates with respect to the financial condition, results of operations and business of Hudson City Bancorp, Inc. and Hudson City Bancorp, Inc.’s strategies, plans, objectives, expectations and intentions, and other statements contained in this Quarterly Report on Form 10-Q that are not historical facts. These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors (many of which are beyond our control) that could cause actual results to differ materially from future results expressed or implied by such forward-looking statements. These factors include, but are not limited to:

 

    the timing and occurrence or non-occurrence of events may be subject to circumstances beyond our control;

 

    there may be increases in competitive pressure among financial institutions or from non-financial institutions;

 

    changes in the interest rate environment may reduce interest margins or affect the value of our investments;

 

    changes in deposit flows, loan demand or real estate values may adversely affect our business;

 

    changes in accounting principles, policies or guidelines may cause our financial condition to be perceived differently;

 

    general economic conditions, including unemployment rates, either nationally or locally in some or all of the areas in which we do business, or conditions in the securities markets or the banking industry may be less favorable than we currently anticipate;

 

    legislative or regulatory changes including, without limitation, the provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Reform Act”), and any actions regarding foreclosures may adversely affect our business;

 

    enhanced regulatory scrutiny may adversely affect our business and increase our cost of operation;

 

    applicable technological changes may be more difficult or expensive than we anticipate;

 

    success or consummation of new business initiatives may be more difficult or expensive than we anticipate;

 

    litigation or matters before regulatory agencies, whether currently existing or commencing in the future, may delay the occurrence or non-occurrence of events longer than we anticipate;

 

    the risks associated with adverse changes to credit quality, including changes in the level of loan delinquencies and non-performing assets and charge-offs, the length of time our non-performing assets remain in our portfolio and changes in estimates of the adequacy of the allowance for loan losses;

 

    difficulties associated with achieving or predicting expected future financial results;

 

    our ability to restructure our balance sheet, diversify our funding sources and access the capital markets;

 

    our ability to comply with the terms of the Memoranda of Understanding with the Office of the Comptroller of the Currency (the “OCC”) and the Board of Governors of the Federal Reserve System (the “FRB”);

 

    our ability to pay dividends, repurchase our outstanding common stock or execute capital management strategies each of which requires the approval of the OCC and the FRB;

 

    the effects of changes in existing U.S. government or U.S. government sponsored mortgage programs;

 

    the risk of an economic slowdown that would adversely affect credit quality and loan originations;

 

    the potential impact on our operations and customers resulting from natural or man-made disasters;

 

   

the actual results of the pending merger (the “Merger”) with Wilmington Trust Corporation (“WTC”), a wholly owned subsidiary of M&T Bank Corporation (“M&T”) could vary materially as a result of a number of

 

Page 3


Table of Contents
 

factors, including the possibility that various closing conditions for the transaction may not be satisfied or waived, and the Merger Agreement (as defined below) with M&T could be terminated under certain circumstances;

 

    the outcome of any judicial decision related to the settlement of existing class action lawsuits related to the Merger;

 

    further delays in closing the Merger, including the possibility that the Merger may not be completed prior to the end of the extension period previously agreed to with M&T; and

 

    difficulties and delays in the implementation of our Strategic Plan (as defined below) in the event the Merger is further delayed or is not completed.

Our ability to predict results or the actual effects of our plans or strategies is inherently uncertain. As such, forward-looking statements can be affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties. Consequently, no forward-looking statement can be guaranteed. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect conditions only as of the date of this filing. We do not intend to update any of the forward-looking statements after the date of this Form 10-Q or to conform these statements to actual events.

As used in this Form 10-Q, unless we specify otherwise, “Hudson City Bancorp,” “Company,” “we,” “us,” and “our” refer to Hudson City Bancorp, Inc., a Delaware corporation. “Hudson City Savings” and “Bank” refer to Hudson City Savings Bank, a federal stock savings bank and the wholly-owned subsidiary of Hudson City Bancorp.

 

Page 4


Table of Contents

PART I – FINANCIAL INFORMATION

Item 1. – Financial Statements

Hudson City Bancorp, Inc. and Subsidiary

Consolidated Statements of Financial Condition

 

     September 30,
2014
    December 31,
2013
 
(In thousands, except share and per share amounts)    (unaudited)        

Assets:

    

Cash and due from banks

   $ 109,294      $ 133,665   

Federal funds sold and other overnight deposits

     5,570,103        4,190,809   
  

 

 

   

 

 

 

Total cash and cash equivalents

     5,679,397        4,324,474   

Securities available for sale:

    

Mortgage-backed securities

     4,792,901        7,167,555   

Investment securities

     2,101,679        297,283   

Securities held to maturity:

    

Mortgage-backed securities (fair value of $1,529,967 at September 30, 2014 and $1,888,823 at December 31, 2013)

     1,435,674        1,784,464   

Investment securities (fair value of $42,045 at September 30, 2014 and $42,727 at December 31, 2013)

     39,011        39,011   
  

 

 

   

 

 

 

Total securities

     8,369,265        9,288,313   

Loans

     22,271,805        24,112,829   

Net deferred loan costs

     102,063        105,480   

Allowance for loan losses

     (242,212     (276,097
  

 

 

   

 

 

 

Net loans

     22,131,656        23,942,212   

Federal Home Loan Bank of New York stock

     320,753        347,102   

Foreclosed real estate, net

     78,514        70,436   

Accrued interest receivable

     44,200        52,887   

Banking premises and equipment, net

     59,324        65,353   

Goodwill

     152,109        152,109   

Other assets

     325,907        364,468   
  

 

 

   

 

 

 

Total Assets

   $ 37,161,125      $ 38,607,354   
  

 

 

   

 

 

 

Liabilities and Shareholders’ Equity:

    

Deposits:

    

Interest-bearing

   $ 19,322,569      $ 20,811,108   

Noninterest-bearing

     650,578        661,221   
  

 

 

   

 

 

 

Total deposits

     19,973,147        21,472,329   

Repurchase agreements

     6,150,000        6,950,000   

Federal Home Loan Bank of New York advances

     6,025,000        5,225,000   
  

 

 

   

 

 

 

Total borrowed funds

     12,175,000        12,175,000   

Accrued expenses and other liabilities

     197,405        217,449   
  

 

 

   

 

 

 

Total liabilities

     32,345,552        33,864,778   
  

 

 

   

 

 

 

Common stock, $0.01 par value, 3,200,000,000 shares authorized; 741,466,555 shares issued; 528,764,950 and 528,419,170 shares outstanding at September 30, 2014 and December 31, 2013

     7,415        7,415   

Additional paid-in capital

     4,750,497        4,743,388   

Retained earnings

     1,942,454        1,883,754   

Treasury stock, at cost; 212,701,605 and 213,047,385 shares at September 30, 2014 and December 31, 2013

     (1,709,641     (1,712,107

Unallocated common stock held by the employee stock ownership plan

     (181,706     (186,210

Accumulated other comprehensive income, net of tax

     6,554        6,336   
  

 

 

   

 

 

 

Total shareholders’ equity

     4,815,573        4,742,576   
  

 

 

   

 

 

 

Total Liabilities and Shareholders’ Equity

   $ 37,161,125      $ 38,607,354   
  

 

 

   

 

 

 

See accompanying notes to unaudited consolidated financial statements.

 

Page 5


Table of Contents

Hudson City Bancorp, Inc. and Subsidiary

Consolidated Statements of Income

(Unaudited)

 

     For the Three Months Ended
September 30,
     For the Nine Months Ended
September 30,
 
     2014     2013      2014     2013  
     (In thousands, except share data)  

Interest and Dividend Income:

         

First mortgage loans

   $ 241,637      $ 266,324       $ 741,900      $ 844,571   

Consumer and other loans

     2,155        2,377         6,632        7,693   

Mortgage-backed securities held to maturity

     9,399        17,382         30,738        61,992   

Mortgage-backed securities available for sale

     25,284        33,534         94,369        102,496   

Investment securities held to maturity

     585        585         1,755        1,756   

Investment securities available for sale

     1,764        795         3,478        5,498   

Dividends on Federal Home Loan Bank of New York stock

     3,409        3,466         10,903        11,190   

Federal funds sold and other overnight deposits

     3,387        1,835         9,589        4,676   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total interest and dividend income

     287,620        326,298         899,364        1,039,872   
  

 

 

   

 

 

    

 

 

   

 

 

 

Interest Expense:

         

Deposits

     39,950        44,021         120,761        139,764   

Borrowed funds

     142,732        142,864         423,647        423,459   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total interest expense

     182,682        186,885         544,408        563,223   
  

 

 

   

 

 

    

 

 

   

 

 

 

Net interest income

     104,938        139,413         354,956        476,649   

Provision for Loan Losses

     (3,500     4,000         (3,500     36,500   
  

 

 

   

 

 

    

 

 

   

 

 

 

Net interest income after provision for loan losses

     108,438        135,413         358,456        440,149   
  

 

 

   

 

 

    

 

 

   

 

 

 

Non-Interest Income:

         

Service charges and other income

     1,631        2,815         5,091        7,753   

Gain on securities transactions, net

     22,307        10,641         57,789        17,824   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total non-interest income

     23,938        13,456         62,880        25,577   
  

 

 

   

 

 

    

 

 

   

 

 

 

Non-Interest Expense:

         

Compensation and employee benefits

     32,669        34,802         98,685        99,016   

Net occupancy expense

     9,068        9,383         28,212        27,916   

Federal deposit insurance assessment

     11,825        18,850         38,835        62,525   

Other expense

     16,483        15,453         57,134        46,907   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total non-interest expense

     70,045        78,488         222,866        236,364   
  

 

 

   

 

 

    

 

 

   

 

 

 

Income before income tax expense

     62,331        70,381         198,470        229,362   

Income Tax Expense

     25,205        27,647         79,641        89,975   
  

 

 

   

 

 

    

 

 

   

 

 

 

Net income

   $ 37,126      $ 42,734       $ 118,829      $ 139,387   
  

 

 

   

 

 

    

 

 

   

 

 

 

Basic Earnings Per Share

   $ 0.07      $ 0.09       $ 0.24      $ 0.28   
  

 

 

   

 

 

    

 

 

   

 

 

 

Diluted Earnings Per Share

   $ 0.07      $ 0.09       $ 0.24      $ 0.28   
  

 

 

   

 

 

    

 

 

   

 

 

 

Weighted Average Number of Common Shares Outstanding:

         

Basic

     499,225,954        497,954,146         498,840,849        497,669,445   

Diluted

     500,258,664        498,313,185         499,781,385        497,864,749   

See accompanying notes to unaudited consolidated financial statements.

 

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Table of Contents

Hudson City Bancorp, Inc. and Subsidiary

Consolidated Statements of Comprehensive Income (Loss)

(Unaudited)

 

     For the Three Months
Ended September 30,
 
     2014     2013  
     (In thousands)  

Net income

   $ 37,126      $ 42,734   

Other comprehensive income (loss), net of tax:

    

Net unrealized gains (losses) on securities:

    

Net unrealized losses on securities available for sale arising during period, net of tax benefit of $4,822 for 2014 and $841 for 2013

     (6,982     (1,217

Reclassification adjustment for realized gains in net income, net of tax expense of $8,508 for 2014

     (12,320     —     

Postretirement benefit pension plans:

    

Amortization of net loss arising during period, net of tax expense of $329 for 2014 and $739 for 2013

     475        1,070   

Amortization of prior service cost included in net periodic pension cost, net of tax benefit of $135 for 2014 and $123 for 2013

     (198     (178
  

 

 

   

 

 

 

Other comprehensive loss

     (19,025     (325
  

 

 

   

 

 

 

Total comprehensive income

   $ 18,101      $ 42,409   
  

 

 

   

 

 

 

 

     For the Nine Months
Ended September 30,
 
     2014     2013  
     (In thousands)  

Net income

   $ 118,829      $ 139,387   

Other comprehensive income (loss), net of tax:

    

Net unrealized gains (losses) on securities:

    

Net unrealized gains (losses) on securities available for sale arising during period, net of tax (expense) benefit of $(19,824) for 2014 and $58,223 for 2013

     28,845        (84,306

Reclassification adjustment for realized gains in net income, net of tax expense of $20,250 for 2014 and $2,934 for 2013

     (29,460     (4,249

Postretirement benefit pension plans:

    

Amortization of net loss arising during period, net of tax expense of $985 for 2014 and $2,218 for 2013

     1,426        3,211   

Amortization of prior service cost included in net periodic pension cost, net of tax benefit of $408 for 2014 and $370 for 2013

     (593     (535
  

 

 

   

 

 

 

Other comprehensive income (loss)

     218        (85,879
  

 

 

   

 

 

 

Total comprehensive income

   $ 119,047      $ 53,508   
  

 

 

   

 

 

 

See accompanying notes to unaudited consolidated financial statements.

 

Page 7


Table of Contents

Hudson City Bancorp, Inc. and Subsidiary

Consolidated Statements of Changes in Shareholders’ Equity

(Unaudited)

 

     For the Nine Months
Ended September 30,
 
             2014                     2013          
     (In thousands, except per share data)  

Common Stock

   $ 7,415      $ 7,415   
  

 

 

   

 

 

 

Additional paid-in capital:

    

Balance at beginning of year

     4,743,388        4,730,105   

Stock benefit plan expense

     8,660        7,392   

Tax benefit from stock plans

     63        218   

Allocation of ESOP stock

     2,482        1,872   

Vesting of deferred stock unit awards

     (4,096     —     
  

 

 

   

 

 

 

Balance at end of period

     4,750,497        4,739,587   
  

 

 

   

 

 

 

Retained Earnings:

    

Balance at beginning of year

     1,883,754        1,798,430   

Net income

     118,829        139,387   

Dividends paid on common stock ($0.12 and $0.16 per share, respectively)

     (60,146     (79,605

Exercise of stock options

     17        (381
  

 

 

   

 

 

 

Balance at end of period

     1,942,454        1,857,831   
  

 

 

   

 

 

 

Treasury Stock:

    

Balance at beginning of year

     (1,712,107     (1,713,895

Purchase of vested stock awards surrendered for withholding taxes

     (1,726     —     

Exercise of stock options

     96        1,788   

Deferred stock unit awards granted

     4,096        —     
  

 

 

   

 

 

 

Balance at end of period

     (1,709,641     (1,712,107
  

 

 

   

 

 

 

Unallocated common stock held by the ESOP:

    

Balance at beginning of year

     (186,210     (192,217

Allocation of ESOP stock

     4,504        4,505   
  

 

 

   

 

 

 

Balance at end of period

     (181,706     (187,712
  

 

 

   

 

 

 

Accumulated other comprehensive income (loss):

    

Balance at beginning of year

     6,336        69,970   

Other comprehensive income (loss), net of tax

     218        (85,879
  

 

 

   

 

 

 

Balance at end of period

     6,554        (15,909
  

 

 

   

 

 

 

Total Shareholders’ Equity

   $ 4,815,573      $ 4,689,105   
  

 

 

   

 

 

 

See accompanying notes to unaudited consolidated financial statements.

 

Page 8


Table of Contents

Hudson City Bancorp, Inc. and Subsidiary

Consolidated Statements of Cash Flows

(Unaudited)

 

     For the Nine Months
Ended September 30,
 
     2014     2013  
     (In thousands)  

Cash Flows from Operating Activities:

    

Net income

   $ 118,829      $ 139,387   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation, accretion and amortization expense

     29,466        93,827   

Provision for loan losses

     (3,500     36,500   

Gains on securities transactions, net

     (57,789     (17,824

Share-based compensation, including committed ESOP shares

     15,646        13,769   

Deferred tax expense

     14,410        2,659   

Decrease in accrued interest receivable

     8,687        23,247   

Decrease in other assets

     23,838        358,574   

(Decrease) increase in accrued expenses and other liabilities

     (20,044     5,108   
  

 

 

   

 

 

 

Net Cash Provided by Operating Activities

     129,543        655,247   
  

 

 

   

 

 

 

Cash Flows from Investing Activities:

    

Originations of loans

     (950,650     (2,853,266

Purchases of loans

     (149,861     (74,160

Principal payments on loans

     2,859,965        5,323,886   

Principal collection of mortgage-backed securities held to maturity

     204,769        741,429   

Proceeds from sales of mortgage backed securities held to maturity

     151,473        160,905   

Principal collection of mortgage-backed securities available for sale

     946,959        1,917,199   

Purchases of mortgage-backed securities available for sale

     (94,422     (1,671,343

Proceeds from sales of mortgage backed securities available for sale

     1,535,456        —     

Proceeds from sales of investment securities available for sale

     —          412,886   

Purchases of investment securities available for sale

     (1,800,687     (298,017

Redemption of Federal Home Loan Bank of New York stock

     26,349        9,365   

Purchases of premises and equipment, net

     (2,494     (265

Net proceeds from sale of foreclosed real estate

     59,401        52,275   
  

 

 

   

 

 

 

Net Cash Provided by Investment Activities

     2,786,258        3,720,894   
  

 

 

   

 

 

 

Cash Flows from Financing Activities:

    

Net decrease in deposits

     (1,499,182     (1,404,186

Dividends paid

     (60,146     (79,605

Purchase of vested stock awards surrendered for withholding taxes

     (1,726     —     

Exercise of stock options

     113        1,407   

Tax benefit from stock plans

     63        218   
  

 

 

   

 

 

 

Net Cash Used in Financing Activities

     (1,560,878     (1,482,166
  

 

 

   

 

 

 

Net Increase in Cash and Cash Equivalents

     1,354,923        2,893,975   

Cash and Cash Equivalents at Beginning of Year

     4,324,474        827,968   
  

 

 

   

 

 

 

Cash and Cash Equivalents at End of Period

   $ 5,679,397      $ 3,721,943   
  

 

 

   

 

 

 

Supplemental Disclosures:

    

Interest paid

   $ 546,469      $ 560,678   
  

 

 

   

 

 

 

Loans transferred to foreclosed real estate

   $ 93,083      $ 93,524   
  

 

 

   

 

 

 

Income tax payments

   $ 59,894      $ 88,190   
  

 

 

   

 

 

 

Income tax refunds

   $ 460      $ 364,925   
  

 

 

   

 

 

 

See accompanying notes to unaudited consolidated financial statements.

 

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Table of Contents

Notes to Unaudited Consolidated Financial Statements

1.    Organization

Hudson City Bancorp is a Delaware corporation and is the savings and loan holding company for Hudson City Savings Bank and its subsidiaries. As a savings and loan holding company, Hudson City Bancorp is subject to the supervision and examination of the FRB. Hudson City Savings is a federally chartered stock savings bank subject to supervision and examination by the OCC.

On August 27, 2012, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with M&T and WTC. The Merger Agreement provides that, upon the terms and subject to the conditions set forth therein, the Company will merge with and into WTC, with WTC continuing as the surviving entity.

Subject to the terms and conditions of the Merger Agreement, in the Merger, Hudson City Bancorp shareholders will have the right to receive with respect to each of their shares of common stock of the Company, at their election (but subject to proration and adjustment procedures), 0.08403 of a share of common stock, or cash having a value equal to the product of 0.08403 multiplied by the average closing price of the M&T Common Stock for the ten days immediately prior to the completion of the Merger. The Merger Agreement also provides that at the closing of the Merger, 40% of the outstanding shares of Hudson City Bancorp common stock will be converted into the right to receive cash and the remainder of the outstanding shares of Hudson City Bancorp common stock will be converted into the right to receive shares of M&T common stock.

On April 12, 2013, M&T and the Company announced that additional time would be required to obtain a regulatory determination on the applications necessary to complete the proposed Merger. On April 13, 2013, M&T and the Company entered into Amendment No. 1 to the Merger Agreement (“Amendment No. 1”). Amendment No. 1, among other things, extended the date after which either party may elect to terminate the Merger Agreement from August 27, 2013 to January 31, 2014. On December 17, 2013, M&T and the Company announced that they entered into Amendment No. 2 to the Merger Agreement (“Amendment No. 2”). Amendment No. 2 extends the date after which either party may terminate the Merger Agreement if the Merger has not yet been completed from January 31, 2014 to December 31, 2014, and provides that the Company may terminate the Merger Agreement at any time if it reasonably determines that M&T is unlikely to be able to obtain the requisite regulatory approvals in time to permit the closing to occur on or prior to December 31, 2014. Amendment No. 2 also permits the Company to take certain interim actions without the prior approval of M&T, including with respect to the Bank’s conduct of business, implementation of its strategic plan, retention incentives and certain other matters with respect to Bank personnel, prior to the completion of the Merger. While M&T and the Company extended the date after which either party may elect to terminate the Merger Agreement from January 31, 2014 to December 31, 2014, there can be no assurances that the Merger will be completed by that date or that the Company will not exercise its right to terminate the Merger Agreement in accordance with its terms.

The Merger Agreement, as amended by Amendment No. 1, was approved by the shareholders of both Hudson City Bancorp and M&T. The Merger is subject to the receipt of regulatory approvals and the satisfaction of other customary closing conditions.

On March 30, 2012, the Bank entered into a Memorandum of Understanding with the OCC (the “Bank MOU”), which is substantially similar to and replaced the MOU the Bank entered into with our former regulator, the Office of Thrift Supervision (the “OTS”), on June 24, 2011. In accordance with the Bank MOU, the Bank has adopted and has implemented enhanced operating policies and procedures, that are

 

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Table of Contents

Notes to Unaudited Consolidated Financial Statements

 

intended to enable us to continue to: (a) reduce our level of interest rate risk, (b) reduce our funding concentration, (c) diversify our funding sources, (d) enhance our liquidity position, (e) monitor and manage loan modifications and (f) maintain our capital position in accordance with our existing capital plan. In addition, we developed a written strategic plan (the “Strategic Plan”) for the Bank which establishes objectives for the Bank’s overall risk profile, earnings performance, growth and balance sheet mix and to enhance our enterprise risk management program. The Strategic Plan includes initiatives such as secondary mortgage market operations, commercial real estate lending, the introduction of small business banking products and developing a more robust suite of consumer banking products. These initiatives require significant lead time for full implementation and roll out to our customers.

The Company entered into a separate Memorandum of Understanding with the FRB (the “Company MOU”) on April 24, 2012, which is substantially similar to and replaced the MOU the Company entered into with our former regulator, the OTS, on June 24, 2011. In accordance with the Company MOU, the Company must, among other things support the Bank’s compliance with the Bank MOU. The Company MOU also requires the Company to: (a) obtain approval from the FRB prior to receiving a capital distribution from the Bank or declaring a dividend to shareholders, and (b) obtain approval from the FRB prior to repurchasing or redeeming any Company stock or incurring any debt with a maturity of greater than one year. In accordance with the Company MOU, the Company submitted a comprehensive Capital Plan and a comprehensive Earnings Plan to the FRB. These agreements will remain in effect until modified or terminated by the OCC (with respect to the Bank MOU) and the FRB (with respect to the Company MOU).

2.    Basis of Presentation

The accompanying consolidated financial statements include the accounts of Hudson City Bancorp and its wholly-owned subsidiary, Hudson City Savings.

In our opinion, all the adjustments (consisting of normal and recurring adjustments) necessary for a fair presentation of the consolidated financial condition and consolidated results of operations for the unaudited periods presented have been included. The results of operations and other data presented for the nine months ended September 30, 2014 are not necessarily indicative of the results of operations that may be expected for the year ending December 31, 2014. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the statements of financial condition and the results of operations for the period. Actual results could differ from these estimates.

The allowance for loan losses (“ALL”) is a material estimate that is particularly susceptible to near-term change. The current economic environment has increased the degree of uncertainty inherent in this material estimate. In addition, bank regulators, as an integral part of their supervisory function, periodically review our ALL. These regulatory agencies have the ability to require us, as they can require all banks, to increase our provision for loan losses or to recognize further charge-offs based on their judgments, which may be different from ours. Any increase in the ALL required by these regulatory agencies could adversely affect our financial condition and results of operations.

The goodwill impairment analysis depends on the use of estimates and assumptions which are highly sensitive to, among other things, market interest rates and are therefore subject to change in the near-term. Goodwill is tested for impairment at least annually and is considered impaired if the carrying value of goodwill exceeds its implied fair value. Similar to the calculation of goodwill in a business combination, the implied fair value of goodwill is determined by measuring the excess of the fair value of the reporting

 

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Table of Contents

Notes to Unaudited Consolidated Financial Statements

 

unit over the aggregate estimated fair values of individual assets, liabilities and identifiable intangibles as if the reporting unit was being acquired at the impairment test date. The estimation of the fair value of the Company is based on, among other things, the market price of our common stock. In addition, the fair value of the individual assets, liabilities and identifiable intangibles are determined using estimates and assumptions that are highly sensitive to market interest rates. These estimates and assumptions are subject to change in the near-term and may result in the impairment in future periods of some or all of the goodwill on our balance sheet.

Certain information and note disclosures usually included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) for the preparation of the Form 10-Q. The consolidated financial statements presented should be read in conjunction with Hudson City Bancorp’s audited consolidated financial statements and notes to consolidated financial statements included in Hudson City Bancorp’s 2013 Annual Report on Form 10-K.

3.    Earnings Per Share

The following is a summary of our earnings per share calculations and reconciliation of basic to diluted earnings per share.

 

     For the Three Months
Ended September 30
     For the Nine Months
Ended September 30
 
     2014     2013      2014     2013  
     (In thousands, except share data)  

Net income

   $ 37,126      $ 42,734       $ 118,829      $ 139,387   

Less: Income allocated to participating securities

     (113     —           (289     —     
  

 

 

   

 

 

    

 

 

   

 

 

 

Net income available to common shareholders

   $ 37,013      $ 42,734       $ 118,540      $ 139,387   
  

 

 

   

 

 

    

 

 

   

 

 

 

Basic weighted average common shares outstanding

     499,225,954        497,954,146         498,840,849        497,669,445   

Effect of dilutive common stock equivalents

     1,032,710        359,039         940,536        195,304   
  

 

 

   

 

 

    

 

 

   

 

 

 

Diluted weighted average common shares outstanding

     500,258,664        498,313,185         499,781,385        497,864,749   
  

 

 

   

 

 

    

 

 

   

 

 

 

Basic EPS

   $ 0.07      $ 0.09       $ 0.24      $ 0.28   

Diluted EPS

   $ 0.07      $ 0.09       $ 0.24      $ 0.28   

Common stock equivalents for both the three and nine months ended September 30, 2014 exclude outstanding options to purchase 21,191,643 shares of the Company’s common stock as their inclusion would be anti-dilutive. Common stock equivalents for both the three and nine months ended September 30, 2013 exclude outstanding options to purchase 25,351,142 shares of common stock as their inclusion would be anti-dilutive.

 

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Notes to Unaudited Consolidated Financial Statements

 

4.    Securities

The amortized cost and estimated fair market value of investment securities and mortgage-backed securities available-for-sale at September 30, 2014 and December 31, 2013 are as follows:

 

     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Estimated
Fair Market
Value
 
            (In thousands)        

September 30, 2014

          

Investment Securities:

          

United States government-sponsored enterprises debt

   $ 2,099,020       $ 361       $ (4,906   $ 2,094,475   

Equity securities

     6,873         331         —          7,204   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total investment securities available for sale

   $ 2,105,893       $ 692       $ (4,906   $ 2,101,679   
  

 

 

    

 

 

    

 

 

   

 

 

 

Mortgage-backed securities:

          

GNMA pass-through certificates

   $ 669,744       $ 20,359       $ (537   $ 689,566   

FNMA pass-through certificates

     2,674,849         38,189         (19,329     2,693,709   

FHLMC pass-through certificates

     1,387,892         25,706         (3,972     1,409,626   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total mortgage-backed securities available for sale

   $ 4,732,485       $ 84,254       $ (23,838   $ 4,792,901   
  

 

 

    

 

 

    

 

 

   

 

 

 

December 31, 2013

          

Investment securities:

          

United States government-sponsored enterprises debt

   $ 298,190       $ —         $ (7,996   $ 290,194   

Equity securities

     6,873         216         —          7,089   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total investment securities available for sale

   $ 305,063       $ 216       $ (7,996   $ 297,283   
  

 

 

    

 

 

    

 

 

   

 

 

 

Mortgage-backed securities:

          

GNMA pass-through certificates

   $ 788,504       $ 17,775       $ (1,396   $ 804,883   

FNMA pass-through certificates

     3,879,723         50,800         (39,800     3,890,723   

FHLMC pass-through certificates

     2,396,085         46,300         (8,947     2,433,438   

FHLMC and FNMA – REMICs

     38,220         291         —          38,511   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total mortgage-backed securities available for sale

   $ 7,102,532       $ 115,166       $ (50,143   $ 7,167,555   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

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Table of Contents

Notes to Unaudited Consolidated Financial Statements

 

The amortized cost and estimated fair market value of investment securities and mortgage-backed securities held to maturity at September 30, 2014 and December 31, 2013 are as follows:

 

     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Estimated
Fair Market
Value
 
            (In thousands)        

September 30, 2014

          

Investment securities:

          

United States government-sponsored enterprises debt

   $ 39,011       $ 3,034       $ —        $ 42,045   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total investment securities held to maturity

   $ 39,011       $ 3,034       $ —        $ 42,045   
  

 

 

    

 

 

    

 

 

   

 

 

 

Mortgage-backed securities:

          

GNMA pass-through certificates

   $ 56,312       $ 1,696       $ —        $ 58,008   

FNMA pass-through certificates

     331,999         23,846         (3     355,842   

FHLMC pass-through certificates

     967,648         64,616         —          1,032,264   

FHLMC and FNMA – REMICs

     79,715         4,140         (2     83,853   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total mortgage-backed securities held to maturity

   $ 1,435,674       $ 94,298       $ (5   $ 1,529,967   
  

 

 

    

 

 

    

 

 

   

 

 

 

December 31, 2013

          

Investment securities:

          

United States government-sponsored enterprises debt

   $ 39,011       $ 3,716       $ —        $ 42,727   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total investment securities held to maturity

   $ 39,011       $ 3,716       $ —        $ 42,727   
  

 

 

    

 

 

    

 

 

   

 

 

 

Mortgage-backed securities:

          

GNMA pass-through certificates

   $ 63,070       $ 2,260       $ —        $ 65,330   

FNMA pass-through certificates

     402,848         25,103         (1     427,950   

FHLMC pass-through certificates

     1,123,029         66,816         (1     1,189,844   

FHLMC and FNMA – REMICs

     195,517         10,182         —          205,699   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total mortgage-backed securities held to maturity

   $ 1,784,464       $ 104,361       $ (2   $ 1,888,823   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

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Table of Contents

Notes to Unaudited Consolidated Financial Statements

 

The following tables summarize the fair values and unrealized losses of our securities held to maturity and available-for-sale with an unrealized loss at September 30, 2014 and December 31, 2013, segregated between securities that had been in a continuous unrealized loss position for less than twelve months or longer than twelve months at the respective dates.

 

     Less Than 12 Months     12 Months or Longer     Total  
     Fair Value      Unrealized
Losses
    Fair Value      Unrealized
Losses
    Fair Value      Unrealized
Losses
 
                  (In thousands)               

September 30, 2014

               

Held to maturity:

               

FNMA pass-through certificates

   $ 202       $ (2   $ 92       $ (1   $ 294       $ (3

FHLMC and FNMA – REMIC’s

     685         (2     —           —          685         (2
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total temporarily impaired securities held to maturity

     887         (4     92         (1     979         (5
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Available for sale:

               

United States government-sponsored enterprises debt

   $ 848,130       $ (950   $ 195,872       $ (3,956   $ 1,044,002       $ (4,906

GNMA pass-through certificates

     7,369         (9     17,328         (528     24,697         (537

FNMA pass-through certificates

     137,319         (376     794,916         (18,953     932,235         (19,329

FHLMC pass-through certificates

     206,777         (1,042     156,719         (2,930     363,496         (3,972
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total temporarily impaired securities available for sale

     1,199,595         (2,377     1,164,835         (26,367     2,364,430         (28,744
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 1,200,482       $ (2,381   $ 1,164,927       $ (26,368   $ 2,365,409       $ (28,749
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

December 31, 2013

               

Held to maturity:

               

FNMA pass-through certificates

   $ —         $ —        $ 65       $ (1   $ 65       $ (1

FHLMC pass-through certificates

     166         (1     —           —          166         (1
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total temporarily impaired securities held to maturity

     166         (1     65         (1     231         (2
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Available for sale:

               

United States government-sponsored enterprises debt

   $ 290,194       $ (7,996   $ —         $ —        $ 290,194       $ (7,996

GNMA pass-through certificates

     35,971         (1,396     —           —          35,971         (1,396

FNMA pass-through certificates

     1,478,488         (39,800     —           —          1,478,488         (39,800

FHLMC pass-through certificates

     434,059         (8,947     —           —          434,059         (8,947
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total temporarily impaired securities available for sale

     2,238,712         (58,139     —           —          2,238,712         (58,139
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 2,238,878       $ (58,140   $ 65       $ (1   $ 2,238,943       $ (58,141
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

The unrealized losses of our held to maturity and available-for-sale securities are primarily due to the changes in market interest rates subsequent to purchase. At September 30, 2014, a total of 63 securities were in an unrealized loss position compared to 82 at December 31, 2013. We do not consider these investments to be other-than-temporarily impaired at September 30, 2014 and December 31, 2013 since the decline in market value is attributable to changes in interest rates and not credit quality. In addition, the Company does not intend to sell and does not believe that it is more likely than not that we will be required to sell these investments until there is a full recovery of the unrealized loss, which may be at maturity. As a result no impairment loss was recognized during the nine months ended September 30, 2014.

 

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Table of Contents

Notes to Unaudited Consolidated Financial Statements

 

The amortized cost and estimated fair market value of our securities held to maturity and available-for-sale at September 30, 2014, by contractual maturity, are shown below. The table does not include the effect of prepayments or scheduled principal amortization. The expected maturity may differ from the contractual maturity because issuers may have the right to call or prepay obligations. Equity securities have been excluded from this table.

 

     Amortized Cost         
     Mortgage-backed
securities
     Investment
securities
     Estimated
Fair Market
Value
 
     (In thousands)  

September 30, 2014

        

Held to Maturity:

        

Due in one year or less

   $ 14       $ —         $ 14   

Due after one year through five years

     2,772         —           2,869   

Due after five years through ten years

     39,200         —           41,266   

Due after ten years

     1,393,688         39,011         1,527,863   
  

 

 

    

 

 

    

 

 

 

Total held to maturity

   $ 1,435,674       $ 39,011       $ 1,572,012   
  

 

 

    

 

 

    

 

 

 

Available for Sale:

        

Due after one year through five years

   $ —         $ 2,099,020       $ 2,094,475   

Due after five years through ten years

     16,307         —           17,973   

Due after ten years

     4,716,178         —           4,774,928   
  

 

 

    

 

 

    

 

 

 

Total available for sale

   $ 4,732,485       $ 2,099,020       $ 6,887,376   
  

 

 

    

 

 

    

 

 

 

Sales of mortgage-backed securities held-to-maturity amounted to $143.4 million for the nine months ended September 30, 2014, resulting in a realized gain of $8.1 million. Sales of mortgage-backed securities held-to-maturity amounted to $149.6 million for the nine months ended September 30, 2013, resulting in a realized gain of $10.6 million. The sales of the held-to-maturity securities were made after the Company had collected at least 85% of the initial principal balance.

Sales of mortgage-backed securities available-for-sale amounted to $1.49 billion for the nine months ended September 30, 2014, resulting in a realized gain of $49.7 million. There were no sales of mortgage-backed securities available-for-sale for the nine months ended September 30, 2013.

There were no sales of investment securities available-for-sale or held to maturity for the nine months ended September 30, 2014. There were sales of $405.7 million of investment securities available-for-sale during the nine months ended September 30, 2013 resulting in a realized gain of $7.2 million. There were no sales of investment securities held to maturity during the nine months ended September 30, 2013. Gains and losses on the sale of all securities are determined using the specific identification method.

5.    Stock Repurchase Programs

Pursuant to our stock repurchase programs, shares of Hudson City Bancorp common stock may be purchased in the open market or through other privately negotiated transactions, depending on market conditions. The repurchased shares are held as treasury stock for general corporate use. In accordance with the terms of the Company MOU, future share repurchases must be approved by the FRB. In addition, pursuant to the terms of the Merger Agreement, we may not repurchase shares of Hudson City Bancorp common stock without the consent of M&T. We did not purchase any of our common shares pursuant to the repurchase programs during the nine months ended September 30, 2014. Included in

 

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Table of Contents

Notes to Unaudited Consolidated Financial Statements

 

treasury stock are vested shares related to stock awards that were surrendered for withholding taxes. These shares are included in purchases of vested stock awards surrendered for withholding taxes in the consolidated statements of cash flows and amounted to 175,111 shares for the nine months ended September 30, 2014. There were no shares surrendered for withholding taxes for the nine months ended September 30, 2013. As of September 30, 2014, there remained 50,123,550 shares that may be purchased under the existing stock repurchase programs.

6.    Loans and Allowance for Loan Losses

Loans at September 30, 2014 and December 31, 2013 are summarized as follows:

 

     September 30, 2014      December 31, 2013  
     (In thousands)  

First mortgage loans:

     

One- to four-family

     

Amortizing

   $ 18,333,026       $ 19,518,912   

Interest-only

     3,074,839         3,648,732   

FHA/VA

     645,500         704,532   

Multi-family and commercial

     17,451         25,671   

Construction

     177         294   
  

 

 

    

 

 

 

Total first mortgage loans

     22,070,993         23,898,141   
  

 

 

    

 

 

 

Consumer and other loans:

     

Fixed – rate second mortgages

     76,065         86,079   

Home equity credit lines

     105,099         108,550   

Other

     19,648         20,059   
  

 

 

    

 

 

 

Total consumer and other loans

     200,812         214,688   
  

 

 

    

 

 

 

Total loans

   $ 22,271,805       $ 24,112,829   
  

 

 

    

 

 

 

There were no loans held for sale at September 30, 2014 and December 31, 2013.

The following tables present the composition of our loan portfolio by credit quality indicator at the dates indicated:

 

Credit Risk Profile based on Payment Activity

 
     (In thousands)  
     One-to four- family
first mortgage loans
     Other first
Mortgages
     Consumer and Other      Total
Loans
 
     Amortizing      Interest-only      Multi-family
and
Commercial
     Construction      Fixed-rate
second
mortgages
     Home Equity
credit lines
     Other         

September 30, 2014

                       

Performing

   $ 18,237,532       $ 2,966,441       $ 16,407       $ —         $ 74,502       $ 100,389       $ 16,695       $ 21,411,966   

Non-performing

     740,994         108,398         1,044         177         1,563         4,710         2,953         859,839   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 18,978,526       $ 3,074,839       $ 17,451       $ 177       $ 76,065       $ 105,099       $ 19,648       $ 22,271,805   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2013

                       

Performing

   $ 19,319,959       $ 3,513,504       $ 22,482       $ —         $ 84,667       $ 104,655       $ 18,318       $ 23,063,585   

Non-performing

     903,485         135,228         3,189         294         1,412         3,895         1,741         1,049,244   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 20,223,444       $ 3,648,732       $ 25,671       $ 294       $ 86,079       $ 108,550       $ 20,059       $ 24,112,829   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

Notes to Unaudited Consolidated Financial Statements

 

Credit Risk Profile by Internally Assigned Grade

 
     (In thousands)  
     One-to four- family
first mortgage loans
     Other first
Mortgages
     Consumer and Other      Total
Loans
 
     Amortizing      Interest-only      Multi-family
and
Commercial
     Construction      Fixed-rate
second
mortgages
     Home Equity
credit lines
     Other         

September 30, 2014

                       

Pass

   $ 18,024,644       $ 2,939,979       $ 10,460       $ —         $ 73,692       $ 97,994       $ 15,478       $ 21,162,247   

Special mention

     97,649         9,505         698         —           367         300         1,217         109,736   

Substandard

     856,233         125,355         6,293         177         2,006         6,805         2,953         999,822   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 18,978,526       $ 3,074,839       $ 17,451       $ 177       $ 76,065       $ 105,099       $ 19,648       $ 22,271,805   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2013

                       

Pass

   $ 19,218,917       $ 3,480,909       $ 15,281       $ —         $ 84,233       $ 102,364       $ 17,157       $ 22,918,861   

Special mention

     108,957         19,866         980         —           129         875         45         130,852   

Substandard

     895,570         147,957         9,410         294         1,717         5,311         2,857         1,063,116   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 20,223,444       $ 3,648,732       $ 25,671       $ 294       $ 86,079       $ 108,550       $ 20,059       $ 24,112,829   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Loan classifications are defined as follows:

 

    Pass – These loans are protected by the current net worth and paying capacity of the obligor (or guarantors, if any) or by the fair value, less cost to acquire and sell, of any underlying collateral in a timely manner.

 

    Special Mention – These loans have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of repayment prospects.

 

    Substandard – These loans are inadequately protected by the current net worth and paying capacity of the obligor or by the collateral pledged, if any. Assets so classified must have a well-defined weakness, or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected.

 

    Doubtful – These loans have all the weaknesses inherent in a loan classified substandard with the added characteristic that the weaknesses make the full recovery of our principal balance highly questionable and improbable on the basis of currently known facts, conditions, and values. The likelihood of a loss on an asset or portion of an asset classified Doubtful is high. Its classification as Loss is not appropriate, however, because pending events are expected to materially affect the amount of loss.

 

    Loss – These loans are considered uncollectible and of such little value that a charge-off is warranted. This classification does not necessarily mean that an asset has no recovery or salvage value; but rather, there is much doubt about whether, how much, or when the recovery will occur.

We evaluate the classification of our one-to four-family mortgage loans, consumer loans and other loans primarily on a pooled basis by delinquency. Loans that are past due 60 to 89 days are classified as special mention and loans that are past due 90 days or more as well as impaired loans are classified as substandard. We obtain updated valuations for one- to four- family mortgage loans by the time a loan becomes 180 days past due. If necessary, we charge-off an amount to reduce the carrying value of the loan to the value of the underlying property, less estimated selling costs. Since we record the charge-off when we receive the updated valuation, we typically do not have any residential first mortgages classified as doubtful or loss. We evaluate troubled debt restructurings individually, as well as multi-family, commercial and construction loans when they become 120 days past due and base our classification on the debt service capability of the underlying property as well as secondary sources of repayment such as the borrower’s and any

 

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Table of Contents

Notes to Unaudited Consolidated Financial Statements

 

guarantor’s ability and willingness to provide debt service. Residential mortgage loans that are classified as troubled debt restructurings are individually evaluated for impairment based on the present value of each loan’s expected future cash flows.

Originating loans secured by residential real estate is our primary business. Our financial results may be adversely affected by changes in prevailing economic conditions, either nationally or in our local New Jersey and metropolitan New York market areas, including decreases in real estate values, adverse employment conditions, the monetary and fiscal policies of the federal and state government and other significant external events. As a result of our lending practices, we have a concentration of loans secured by real property located primarily in New Jersey, New York and Connecticut (the “New York metropolitan area”). At September 30, 2014, approximately 84.6% of our total loans are in the New York metropolitan area.

Included in our loan portfolio at September 30, 2014 and December 31, 2013 are $3.07 billion and $3.65 billion, respectively, of interest-only one-to four- family residential mortgage loans. These loans are originated as adjustable-rate mortgage (“ARM”) loans with initial terms of five, seven or ten years with the interest-only portion of the payment based upon the initial loan term, or offered on a 30-year fixed-rate loan with interest-only payments for the first 10 years of the obligation. At the end of the initial 5-, 7- or 10-year interest-only period, the loan payment will adjust to include both principal and interest and will amortize over the remaining term so the loan will be repaid at the end of its original life. We had $108.4 million and $135.2 million of non-performing interest-only one-to four-family residential mortgage loans at September 30, 2014 and December 31, 2013, respectively.

In addition to our full documentation loan program, prior to January 2014, we originated loans to certain eligible borrowers as reduced documentation loans. We discontinued our reduced documentation loan program in January 2014 in order to comply with the Consumer Financial Protection Bureau’s (the “CFPB”) new requirements to validate a borrower’s ability to repay and the corresponding safe harbor for loans that meet the requirements for a “qualified mortgage”. Loans that were eligible for reduced documentation processing were ARM loans, interest-only first mortgage loans and 10-, 15-, 20- and 30-year fixed-rate loans to owner-occupied primary and second home applicants. These loans were available in amounts up to 65% of the lower of the appraised value or purchase price of the property. Generally the maximum loan amount for reduced documentation loans was $750,000 and these loans were subject to higher interest rates than our full documentation loan products. Reduced documentation loans have an inherently higher level of risk compared to loans with full documentation. Reduced documentation loans represent 21.7% of our one- to four-family first mortgage loans at September 30, 2014. Included in our loan portfolio at September 30, 2014 are $4.11 billion of amortizing reduced documentation loans and $666.5 million of reduced documentation interest-only loans as compared to $4.27 billion and $826.5 million, respectively, at December 31, 2013. Non-performing loans at September 30, 2014 include $171.1 million of amortizing reduced documentation loans and $39.0 million of interest-only reduced documentation loans as compared to $182.9 million and $48.8 million, respectively, at December 31, 2013.

 

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Table of Contents

Notes to Unaudited Consolidated Financial Statements

 

The following table is a comparison of our delinquent loans by class as of the dates indicated:

 

     30-59 Days      60-89 Days      90 Days
or more
     Total
Past Due
     Current
Loans
     Total
Loans
     90 Days or
more and
accruing (1)
 
     (In thousands)  

At September 30, 2014

                    

One- to four-family first mortgages:

                    

Amortizing

   $ 250,083       $ 121,237       $ 740,994       $ 1,112,314       $ 17,866,212       $ 18,978,526       $ 28,242   

Interest-only

     42,769         10,168         108,398         161,335         2,913,504         3,074,839         —     

Multi-family and commercial mortgages

     1,143         4,548         1,044         6,735         10,716         17,451         —     

Construction loans

     —           —           177         177         —           177         —     

Consumer and other loans:

              —           —              —     

Fixed-rate second mortgages

     675         367         1,563         2,605         73,460         76,065         —     

Home equity lines of credit

     875         300         4,710         5,885         99,214         105,099         —     

Other

     110         1,217         2,953         4,280         15,368         19,648         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 295,655       $ 137,837       $ 859,839       $ 1,293,331       $ 20,978,474       $ 22,271,805       $ 28,242   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

At December 31, 2013

  

One- to four-family first mortgages:

                    

Amortizing

   $ 274,303       $ 132,910       $ 903,485       $ 1,310,698       $ 18,912,746       $ 20,223,444       $ 132,844   

Interest-only

     34,277         21,283         135,228         190,788         3,457,944         3,648,732         —     

Multi-family and commercial mortgages

     1,384         5,983         3,189         10,556         15,115         25,671         —     

Construction loans

     —           —           294         294         —           294         —     

Consumer and other loans:

                    

Fixed-rate second mortgages

     484         129         1,412         2,025         84,054         86,079         —     

Home equity lines of credit

     1,389         1,163         3,895         6,447         102,103         108,550         —     

Other

     58         45         1,741         1,844         18,215         20,059         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 311,895       $ 161,513       $ 1,049,244       $ 1,522,652       $ 22,590,177       $ 24,112,829       $ 132,844   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Loans that are past due 90 days or more and still accruing interest are loans that are guaranteed by the FHA.

During the third quarter of 2014, we sold a pool of non-performing residential mortgage loans guaranteed by the FHA with an aggregate unpaid principal balance of $112.1 million to the financial institution that originally sold the loans to the Bank. The sale of the non-performing loan pool was in accordance with the repurchase right with respect to loans that become non-performing that the financial institution exercised pursuant to the terms of the original sale and servicing agreement between the Bank and the financial institution. As consideration for the sale of the non-performing loans, the Bank received from the financial institution an amount equal to 100% of the outstanding unpaid principal balance of the loans, plus all accrued and unpaid interest on the loans. The Bank may sell additional loans to the financial institution in the future, in the event the financial institution exercises its repurchase right with respect to any additional non-performing FHA loans.

 

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Table of Contents

Notes to Unaudited Consolidated Financial Statements

 

The following table presents the geographic distribution of our loan portfolio as a percentage of total loans and of our non-performing loans as a percentage of total non-performing loans:

 

     At September 30, 2014     At December 31, 2013  
           Non-performing           Non-performing  
     Total loans     Loans     Total loans     Loans  

New Jersey

     42.3     42.0     42.5     44.2

New York

     27.7        27.6        27.1        24.1   

Connecticut

     14.6        8.1        14.9        8.0   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total New York metropolitan area

     84.6        77.7        84.5        76.3   
  

 

 

   

 

 

   

 

 

   

 

 

 

Pennsylvania

     4.9        1.7        4.9        2.4   

Massachusetts

     2.0        2.1        1.8        1.6   

Virginia

     1.7        1.9        1.8        2.3   

Maryland

     1.7        5.0        1.7        4.7   

Illinois

     1.6        4.9        1.6        4.8   

All others

     3.5        6.7        3.7        7.9   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Outside New York metropolitan area

     15.4        22.3        15.5        23.7   
  

 

 

   

 

 

   

 

 

   

 

 

 
     100.0     100.0     100.0     100.0
  

 

 

   

 

 

   

 

 

   

 

 

 

The following is a summary of loans, by class, on which the accrual of income has been discontinued and loans that are contractually past due 90 days or more but have not been classified as non-accrual at September 30, 2014 and December 31, 2013:

 

     September 30,
2014
     December 31,
2013
 
     (In thousands)  

Non-accrual loans:

     

One-to four-family amortizing loans

   $ 712,752       $ 770,641   

One-to four-family interest-only loans

     108,398         135,228   

Multi-family and commercial mortgages

     1,044         3,189   

Construction loans

     177         294   

Fixed-rate second mortgages

     1,563         1,412   

Home equity lines of credit

     4,710         3,895   

Other loans

     2,953         1,741   
  

 

 

    

 

 

 

Total non-accrual loans

     831,597         916,400   

Accruing loans delinquent 90 days or more (1)

     28,242         132,844   
  

 

 

    

 

 

 

Total non-performing loans

   $ 859,839       $ 1,049,244   
  

 

 

    

 

 

 

 

(1) Loans that are past due 90 days or more and still accruing interest are loans that are insured by the FHA.

The total amount of interest income on non-accrual loans that would have been recognized during the first nine months of 2014, if interest on all such loans had been recorded based upon original contract terms, amounted to approximately $38.9 million as compared to $44.8 million for the same period in 2013. Hudson City Savings is not committed to lend additional funds to borrowers on non-accrual status.

 

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Table of Contents

Notes to Unaudited Consolidated Financial Statements

 

Non-performing loans exclude troubled debt restructurings that are accruing and have been performing in accordance with the terms of their restructure agreement for at least six months. The following table presents information regarding loans modified in a troubled debt restructuring at September 30, 2014 and December 31, 2013:

 

     September 30,
2014
     December 31,
2013
 
     (In thousands)  

Troubled debt restructurings:

     

Current

   $ 126,409       $ 108,413   

30-59 days

     25,100         19,931   

60-89 days

     15,513         17,407   

90 days or more

     161,380         176,797   
  

 

 

    

 

 

 

Total troubled debt restructurings

   $ 328,402       $ 322,548   
  

 

 

    

 

 

 

The following table presents loan portfolio class modified as troubled debt restructurings at September 30, 2014 and December 31, 2013. The pre-restructuring and post-restructuring outstanding recorded investments disclosed in the table below represent the loan carrying amounts immediately prior to the restructuring and the carrying amounts at September 30, 2014 and December 31, 2013:

 

     September 30, 2014      December 31, 2013  
     Number
of
Contracts
     Pre-restructuring
Outstanding
Recorded
Investment
     Post-restructuring
Outstanding
Recorded
Investment
     Number
of
Contracts
     Pre-restructuring
Outstanding
Recorded
Investment
     Post-restructuring
Outstanding
Recorded
Investment
 
     (Dollars in thousands)  

Troubled debt restructurings:

                 

One-to four- family first mortgages:

                 

Amortizing

     960       $ 337,994       $ 289,430         933       $ 318,908       $ 281,481   

Interest-only

     57         33,198         29,752         55         35,226         31,564   

Multi-family and commercial mortgages

     2         7,911         4,744         2         7,029         7,029   

Consumer and other loans

     38         4,740         4,476         24         2,672         2,474   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     1,057       $ 383,843       $ 328,402         1,014       $ 363,835       $ 322,548   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

Notes to Unaudited Consolidated Financial Statements

 

Loans evaluated for impairment include loans classified as troubled debt restructurings and non-performing multi-family, commercial and construction loans. The following table presents our loans evaluated for impairment by class at the date indicated as well as the related allowance for loan losses based on the impairment analysis:

 

     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
     Interest
Income
Recognized
 
     (In thousands)  

September 30, 2014

              

One-to four-family amortizing loans

   $ 289,430       $ 334,515       $ —         $ 293,097       $ 5,801   

One-to four-family interest-only loans

     29,752         33,857         —           29,900         659   

Multi-family and commercial mortgages

     5,154         8,543         1         6,416         276   

Construction loans

     177         292         —           293         —     

Consumer and other loans

     4,149         4,476         327         4,520         78   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 328,662       $ 381,683       $ 328       $ 334,226       $ 6,814   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2013

              

One-to four-family amortizing loans

   $ 281,481       $ 319,783       $ —         $ 301,291       $ 7,013   

One-to four-family interest-only loans

     31,564         35,924         —           33,398         854   

Multi-family and commercial mortgages

     8,002         9,289         414         8,307         368   

Construction loans

     181         294         113         295         —     

Consumer and other loans:

     2,411         2,474         63         2,575         108   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 323,639       $ 367,764       $ 590       $ 345,866       $ 8,343   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The following table presents the activity in our ALL for the periods indicated:

 

     For the Three Months
Ended September 30,
    For the Nine Months
Ended September 30,
 
     2014     2013     2014     2013  
     (In thousands)  

Balance at beginning of period

   $ 255,011      $ 297,288      $ 276,097      $ 302,348   
  

 

 

   

 

 

   

 

 

   

 

 

 

Charge-offs

     (16,510     (18,049     (48,752     (66,331

Recoveries

     7,211        7,768        18,367        18,490   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs

     (9,299     (10,281     (30,385     (47,821
  

 

 

   

 

 

   

 

 

   

 

 

 

Provision for loan losses

     (3,500     4,000        (3,500     36,500   
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 242,212      $ 291,007      $ 242,212      $ 291,007   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

Page 23


Table of Contents

Notes to Unaudited Consolidated Financial Statements

 

The following table presents the activity in our ALL by portfolio segment.

 

     One-to four-
Family
Mortgages
    Multi-
family and
Commercial
Mortgages
    Construction     Consumer
and Other
Loans
    Total  
     (In thousands)  

Balance at December 31, 2013

   $ 271,261      $ 805      $ 113      $ 3,918      $ 276,097   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Provision for loan losses

     (5,411     2,030        2        (121     (3,500

Charge-offs

     (45,562     (2,515     (115     (560     (48,752

Recoveries

     17,922        —          —          445        18,367   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs

     (27,640     (2,515     (115     (115     (30,385
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2014

   $ 238,210      $ 320      $ —        $ 3,682      $ 242,212   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loan portfolio:

        

Balance at September 30, 2014

        

Individually evaluated for impairment

   $ 319,182      $ 5,155      $ 177      $ 4,476      $ 328,990   

Collectively evaluated for impairment

     21,734,183        12,296        —          196,336        21,942,815   

Allowance

        

Individually evaluated for impairment

   $ 18,433      $ 1      $ —        $ 327      $ 18,761   

Collectively evaluated for impairment

     219,777        319        —          3,355        223,451   

Historically, our primary lending emphasis has been the origination and purchase of one- to four-family first mortgage loans on residential properties and, to a lesser extent, second mortgage loans on one- to four-family residential properties resulting in a loan concentration in residential first mortgage loans at September 30, 2014. As a result of our lending practices, we also have a concentration of loans secured by real property located primarily in New Jersey, New York and Connecticut. As of September 30, 2014, approximately 84.6% of our total loans are in the New York metropolitan area. Additionally, the states of Pennsylvania, Massachusetts, Virginia, Maryland and Illinois, accounted for 4.9%, 2.0%, 1.7%, 1.7%, and 1.6%, respectively of total loans. The remaining 3.5% of the loan portfolio is secured by real estate primarily in the remainder of our lending markets. Based on the composition of our loan portfolio, we believe the primary risks inherent in our portfolio relate to the conditions in our lending market areas including economic conditions, unemployment levels, rising interest rates and a decline in real estate market values. Any one or a combination of these adverse trends may adversely affect our loan portfolio resulting in increased delinquencies, non-performing assets, charge-offs and future levels of loan loss provisions. We consider these trends in market conditions in determining the ALL.

Due to the nature of our loan portfolio, our evaluation of the adequacy of our ALL is performed primarily on a “pooled” basis. Each quarter we prepare an analysis which categorizes the entire loan portfolio by certain risk characteristics such as loan type (fixed and variable one- to four-family, interest-only, reduced documentation, multi-family, commercial, construction, etc.), loan source (originated or purchased) and payment status (i.e., current or number of days delinquent). Loans with known potential losses are categorized separately. We assign estimated loss factors to the payment status categories on the basis of our assessment of the potential risk inherent in each loan type. These factors are periodically reviewed for appropriateness giving consideration to our loss experience, delinquency trends, portfolio growth and environmental factors such as the status of the regional economy and housing market, in order to ascertain that the loss factors cover probable and estimable losses inherent in the portfolio. We define our loss experience on non-performing loans as the ratio of the excess of the loan balance (including selling costs) over the updated collateral value to the principal balance of loans for which we have updated valuations. We obtain updated collateral values by the time a loan becomes 180 days past due and on an annual basis thereafter for as long as the loan remains non-performing. Based on our analysis, our loss experience on our non-performing one- to four-family first mortgage loans was approximately 12.5% at September 30, 2014 compared to 13.6% at December 31, 2013.

 

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Table of Contents

Notes to Unaudited Consolidated Financial Statements

 

One-to four-family mortgage loans that are individually evaluated for impairment consist primarily of troubled debt restructurings. If our evaluation indicates that the loan is impaired, we record a charge-off for the amount of the impairment. Loans that were individually evaluated for impairment, but would otherwise be evaluated on a pooled basis, are included in the collective evaluation if the individual evaluation indicated no impairment existed. This collective evaluation of one-to four-family mortgage loans that were also individually evaluated for impairment (but for which no impairment existed) resulted in an ALL of $18.4 million at September 30, 2014, which is intended to capture the risk that the net present value calculation did not account for such as changes in collateral, unemployment and other environmental factors.

The ultimate ability to collect the loan portfolio is subject to changes in the real estate market and future economic conditions. Economic conditions in our primary market area continued to improve modestly during the third quarter of 2014 as evidenced by increased levels of home sale activity, higher real estate valuations and a decrease in the unemployment rate which, while improving, remains elevated. We continue to closely monitor the local and national real estate markets and other factors related to risks inherent in our loan portfolio.

Although we believe that we have established and maintained the ALL at adequate levels, additions may be necessary if future economic and other conditions differ substantially from the current operating environment. While we continue to adhere to prudent underwriting standards, we are geographically concentrated in the New York metropolitan area of the United States and, therefore, are not immune to negative consequences arising from overall economic weakness and, in particular, a sharp downturn in the housing industry. Decreases in real estate values could adversely affect the value of property used as collateral for our loans. No assurance can be given in any particular case that our loan-to-value ratios will provide full protection in the event of borrower default. Adverse changes in the economy and increases in the unemployment rate may have a negative effect on the ability of our borrowers to make timely loan payments, which would have an adverse impact on our earnings. An increase in loan delinquencies would decrease our net interest income and may adversely impact our loss experience on non-performing loans which may result in an increase in the loss factors used in our quantitative analysis of the ALL, causing increases in our provision and ALL. Although we use the best information available, the level of the ALL remains an estimate that is subject to significant judgment and short-term change.

We obtain updated collateral values by the time a loan becomes 180 days past due and then annually thereafter. If the estimated fair value of the collateral (less estimated selling costs) is less than the recorded investment in the loan, we charge-off an amount to reduce the loan to the fair value of the collateral less estimated selling costs. As a result, certain losses inherent in our non-performing loans are being recognized as charge-offs which may result in a lower ratio of the ALL to non-performing loans. Net charge-offs amounted to $30.4 million for the nine months ended September 30, 2014 as compared to $47.8 million for the corresponding period in 2013.

 

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Notes to Unaudited Consolidated Financial Statements

 

7.    Borrowed Funds

Borrowed funds at September 30, 2014 and December 31, 2013 are summarized as follows:

 

     September 30, 2014     December 31, 2013  
     Principal      Weighted
Average
Rate
    Principal      Weighted
Average
Rate
 
     (Dollars in thousands)  

Securities sold under agreements to repurchase:

          

FHLB

   $ —           —     $ 800,000         4.53

Other financial institutions

     6,150,000         4.44        6,150,000         4.44   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total securities sold under agreements to repurchase

     6,150,000         4.44        6,950,000         4.45   

Advances from the FHLB

     6,025,000         4.75        5,225,000         4.77   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total borrowed funds

   $ 12,175,000         4.59   $ 12,175,000         4.59
  

 

 

      

 

 

    

Accrued interest payable

   $ 65,575         $ 64,061      

The average balances of borrowings and the maximum amount outstanding at any month-end are as follows:

 

     At or For the Nine
Months Ended
September 30, 2014
    At or For the
Year Ended
December 31, 2013
 
     (Dollars in thousands)  

Repurchase Agreements:

    

Average balance outstanding during the period

   $ 6,317,033      $ 6,950,000   
  

 

 

   

 

 

 

Maximum balance outstanding at any month-end during the period

   $ 6,950,000      $ 6,950,000   
  

 

 

   

 

 

 

Weighted average rate during the period

     4.43     4.51
  

 

 

   

 

 

 

FHLB Advances:

    

Average balance outstanding during the period

   $ 5,857,967      $ 5,225,000   
  

 

 

   

 

 

 

Maximum balance outstanding at any month-end during the period

   $ 6,025,000      $ 5,225,000   
  

 

 

   

 

 

 

Weighted average rate during the period

     4.76     4.84
  

 

 

   

 

 

 

 

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Notes to Unaudited Consolidated Financial Statements

 

At September 30, 2014, $3.33 billion of our borrowed funds may be put back to us at the discretion of the lender. At that date, borrowed funds had scheduled maturities and potential put dates as follows:

 

     Borrowings by Scheduled
Maturity Date
    Borrowings by Earlier of Scheduled
Maturity or Next Potential Put Date
 

Year

   Principal      Weighted
Average
Rate
        Principal          Weighted
Average Rate
 
     (Dollars in thousands)  

2014

   $ —           —     $ 3,125,000         4.45

2015

     75,000         4.62        275,000         4.10   

2016

     3,925,000         4.92        3,925,000         4.92   

2017

     2,475,000         4.39        200,000         4.04   

2018

     700,000         3.65        500,000         3.54   

2019

     1,725,000         4.62        1,325,000         4.69   

2020

     3,275,000         4.53        2,825,000         4.52   
  

 

 

      

 

 

    

Total

   $ 12,175,000         4.59   $ 12,175,000         4.59
  

 

 

      

 

 

    

During the first quarter of 2014, we modified $800.0 million of FHLB repurchase agreements to be FHLB advances. This reduced our collateral requirements related to the repurchase agreements, which use securities as collateral. FHLB advances are secured by a blanket lien on our loan portfolio. The modification resulted in an increase of six basis points in the weighted average cost of the borrowings that were modified.

The Bank had two collateralized borrowings in the form of repurchase agreements totaling $100.0 million with Lehman Brothers, Inc. that were secured by mortgage-backed securities with an amortized cost of approximately $114.1 million. The trustee for the liquidation of Lehman Brothers, Inc. (the “Trustee”) notified the Bank in the fourth quarter of 2011 that it considered our claim to be a non-customer claim, which has a lower payment preference than a customer claim and that the value of such claim is approximately $13.9 million representing the excess of the fair value of the collateral over the $100.0 million repurchase price. At that time we established a reserve of $3.9 million against the receivable balance at December 31, 2011. On June 25, 2013, the Bankruptcy Court affirmed the Trustee’s determination that the repurchase agreements did not entitle the Bank to customer status and on February 26, 2014, the U.S. District Court upheld the Bankruptcy Court’s decision that our claim should be treated as a non-customer claim. As a result, we increased our reserve by $3.0 million to $6.9 million against the receivable balance during the first quarter of 2014. During the third quarter of 2014, the Bank received a partial payment on our non-customer claim of $2.4 million reducing the claim amount to $11.4 million as of September 30, 2014.

 

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Table of Contents

Notes to Unaudited Consolidated Financial Statements

 

8.    Goodwill and Other Intangible Assets

Goodwill and other intangible assets amounted to $152.6 million and were recorded as a result of Hudson City Bancorp’s acquisition of Sound Federal Bancorp, Inc. (“Sound Federal”) in 2006.

The first step (“Step 1”) used to identify potential impairment involves comparing each reporting unit’s estimated fair value to its carrying amount, including goodwill. As a community-oriented bank, substantially all of the Company’s operations involve the delivery of loan and deposit products to customers and these operations constitute the Company’s only segment for financial reporting purposes. If the estimated fair value of a reporting unit exceeds its carrying amount, goodwill is not considered to be impaired. If the carrying amount exceeds the estimated fair value, there is an indication of potential impairment and the second step (“Step 2”) is performed to measure the amount. Step 2 involves calculating an implied fair value of goodwill for each reporting unit for which impairment was indicated in Step 1. The implied fair value of goodwill is determined in a manner similar to the amount of goodwill calculated in a business combination by measuring the excess of the estimated fair value of the reporting unit, as determined in Step 1, over the aggregate estimated fair values of the individual assets, liabilities, and identifiable intangibles, as if the reporting unit was being acquired at the impairment test date. We perform our goodwill impairment analysis annually and also perform interim impairment reviews if certain triggering events occur which may indicate that the fair value of goodwill is less than the carrying value. Subsequent reversal of goodwill impairment losses is not permitted.

We performed our annual goodwill impairment analysis as of June 30, 2014 and concluded that goodwill was not impaired. In addition, we do not believe that any events, circumstances or triggering events occurred during the third quarter of 2014 which would have indicated that goodwill and other intangible assets required reassessment. Therefore, we did not recognize any impairment of goodwill or other intangible assets during 2014.

The estimation of the fair value of the Company requires the use of estimates and assumptions that results in a greater degree of uncertainty. In addition, the estimated fair value of the Company is based on, among other things, the market price of our common stock as calculated per the terms of the Merger. As a result of the current volatility in market and economic conditions, these estimates and assumptions are subject to change in the near-term and may result in the impairment in future periods of some or all of the goodwill on our balance sheet.

9.    Fair Value Measurements

a) Fair Value Measurements

We use fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. We did not have any liabilities that were measured at fair value at September 30, 2014 and December 31, 2013. Our securities available-for-sale are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record at fair value other assets or liabilities on a non-recurring basis, such as foreclosed real estate owned, certain impaired loans and goodwill. These non-recurring fair value adjustments generally involve the write-down of individual assets due to impairment losses.

 

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Table of Contents

Notes to Unaudited Consolidated Financial Statements

 

In accordance with ASC Topic 820, Fair Value Measurements and Disclosures, we group our assets at fair value in three levels, based on the markets in which the assets are traded and the reliability of the assumptions used to determine fair value. These levels are:

 

    Level 1 – Valuation is based upon quoted prices for identical instruments traded in active markets.

 

    Level 2 – Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market.

 

    Level 3 – Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect our own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include the use of option pricing models, discounted cash flow models and similar techniques. The results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset or liability.

We base our fair values on the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date. ASC Topic 820 requires us to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

Assets that we measure on a recurring basis are limited to our available-for-sale securities portfolio. Our available-for-sale portfolio is carried at estimated fair value with any unrealized gains and losses, net of taxes, reported as accumulated other comprehensive income or loss in shareholders’ equity. Substantially all of our available-for-sale portfolio consists of mortgage-backed securities and investment securities issued by U.S. government-sponsored entities (the “GSEs”). The fair values for substantially all of these securities are obtained monthly from an independent nationally recognized pricing service. On a monthly basis, we assess the reasonableness of the fair values obtained by reference to a second independent nationally recognized pricing service. Based on the nature of our securities, our independent pricing service provides us with prices which are categorized as Level 2 since quoted prices in active markets for identical assets are generally not available for the majority of securities in our portfolio. Various modeling techniques are used to determine pricing for our mortgage-backed securities, including option pricing and discounted cash flow models. The inputs to these models include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. On an annual basis, we obtain the models, inputs and assumptions utilized by our pricing service and review them for reasonableness. We also own equity securities with a carrying value of $7.2 million and $7.1 million at September 30, 2014 and December 31, 2013, respectively, for which fair values are obtained from quoted market prices in active markets and, as such, are classified as Level 1.

 

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Table of Contents

Notes to Unaudited Consolidated Financial Statements

 

The following table provides the level of valuation assumptions used to determine the carrying value of our assets measured at fair value on a recurring basis at September 30, 2014 and December 31, 2013.

 

            Fair Value Measurements at September 30, 2014 using  

Description

   Carrying
Value
     Quoted Prices in Active
Markets for Identical
Assets (Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable Inputs
(Level 3)
 
                   (In thousands)         

Available for sale debt securities:

           

Mortgage-backed securities

   $ 4,792,901       $ —         $ 4,792,901       $ —     

U.S. government-sponsored enterprises debt

     293,809         —           293,809         —     

U.S. Treasury securities

     1,800,666         —           1,800,666         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available for sale debt securities

     6,887,376         —           6,887,376         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Available for sale equity securities:

           

Financial services industry

   $ 7,204       $ 7,204       $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available for sale equity securities

     7,204         7,204         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available for sale securities

   $ 6,894,580       $ 7,204       $ 6,887,376       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

 

            Fair Value at December 31, 2013 using  

Description

   Carrying
Value
     Quoted Prices in Active
Markets for Identical
Assets (Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable Inputs
(Level 3)
 
                   (In thousands)         

Available for sale debt securities:

           

Mortgage-backed securities

   $ 7,167,555       $ —         $ 7,167,555       $ —     

U.S. government-sponsored enterprises debt

     290,194         —           290,194         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available for sale debt securities

   $ 7,457,749       $ —         $ 7,457,749       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Available for sale equity securities:

           

Financial services industry

   $ 7,089       $ 7,089       $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available for sale equity securities

     7,089         7,089         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available for sale securities

   $ 7,464,838       $ 7,089       $ 7,457,749       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Assets that were measured at fair value on a non-recurring basis at September 30, 2014 and December 31, 2013 were limited to non-performing commercial and construction loans that are collateral dependent, troubled debt restructurings and foreclosed real estate. Loans evaluated for impairment in accordance with Financial Accounting Standards Board (“FASB”) guidance amounted to $329.0 million and $324.2 million at September 30, 2014 and December 31, 2013, respectively. Based on this evaluation, we established an ALL of $328,000 and $590,000 for those same respective periods. These impaired loans are individually assessed to determine that the loan’s carrying value is not in excess of the fair value of the collateral, less estimated selling costs or the present value of the loan’s expected future cash flows. Impaired loans for which the carrying value exceeded the fair value and which are recorded at fair value

 

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Table of Contents

Notes to Unaudited Consolidated Financial Statements

 

at September 30, 2014 and December 31, 2013 amounted to $155.8 million and $138.2 million, respectively. Loans that were individually evaluated for impairment, but would otherwise be evaluated on a pooled basis, are included in the collective evaluation if the individual evaluation indicated no impairment existed. This collective evaluation of one-to four-family mortgage loans that were also individually evaluated for impairment (but for which no impairment existed) resulted in an ALL of $18.4 million at September 30, 2014 and $25.0 million at December 31, 2013. For impaired loans that are secured by real estate, fair value is estimated through current appraisals, where practical, or an inspection and a comparison of the property securing the loan with similar properties in the area by either a licensed appraiser or real estate broker and, as such, are classified as Level 3.

Foreclosed real estate represents real estate acquired as a result of foreclosure or by deed in lieu of foreclosure and is carried at the lower of cost or fair value less estimated selling costs. Fair value is estimated through current appraisals, where practical, or an inspection and a comparison of the property securing the loan with similar properties in the area by either a licensed appraiser or real estate broker and, as such, foreclosed real estate properties are classified as Level 3. Foreclosed real estate consisted primarily of one-to four-family properties and amounted to $78.5 million and $70.4 million at September 30, 2014 and December 31, 2013, respectively. Foreclosed real estate for which the carrying value exceeded fair value and which are recorded at fair value at September 30, 2014 and December 31, 2013 amounted to $22.0 million and $16.9 million, respectively.

The following table provides the level of valuation assumptions used to determine the carrying value, included in the Consolidated Statements of Financial Condition, of our assets measured at fair value on a non-recurring basis at September 30, 2014 and December 31, 2013.

 

     Fair Value Measurements at September 30, 2014 using         

Description

   Quoted Prices in Active
Markets for Identical
Assets (Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable Inputs
(Level 3)
     Total
Gains
(Losses)
 
            (In thousands)                

Impaired loans

   $ —         $ —         $ 155,798       $ (5,565

Foreclosed real estate

     —           —           21,998         (5,930
     Fair Value Measurements at December 31, 2013 using         

Description

   Quoted Prices in Active
Markets for Identical
Assets (Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable Inputs
(Level 3)
     Total
Gains
(Losses)
 
            (In thousands)                

Impaired loans

   $ —         $ —         $ 138,171       $ (3,100

Foreclosed real estate

     —           —           16,867         (5,370

 

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Table of Contents

Notes to Unaudited Consolidated Financial Statements

 

The following table presents quantitative information about Level 3 fair value measurements for financial assets measured at fair value on a non-recurring basis at September 30, 2014.

 

     September 30, 2014

Description

   Fair Value      Valuation Technique    Significant Unobservable Input    Range
of
Inputs
     (Dollars in thousands)

Impaired loans

   $ 155,798       Net Present Value
Appraisal Value
   Discount rate

Discount for costs to sell
Adjustment for differences between
comparable sales.

   Varies

13.0%

 

Varies

Foreclosed real estate

     21,998       Appraisal Value    Discount for costs to sell
Adjustment for differences between
comparable sales.
   13.0%

 

Varies

b) Fair Value Disclosures

The fair value of financial instruments represents the estimated amounts at which the asset or liability could be exchanged in a current transaction between willing parties, other than in a forced liquidation sale. These estimates are subjective in nature, involve uncertainties and matters of judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Further, certain tax implications related to the realization of the unrealized gains and losses could have a substantial impact on these fair value estimates and have not been incorporated into any of the estimates.

Cash and due from Banks

Carrying amounts of cash, due from banks and federal funds sold are considered to approximate fair value (Level 1).

Securities held to maturity

The fair values for our securities held to maturity are obtained from an independent nationally recognized pricing service utilizing similar modeling techniques and assumptions as used for our securities available-for-sale which are measured at fair value on a recurring basis (Level 2).

FHLB Stock

The carrying value of FHLB stock equals cost. The fair value of FHLB stock is based on redemption at par value (Level 1).

Loans

The fair value of one- to four-family mortgages and home equity loans are generally estimated using the present value of expected future cash flows, assuming future prepayments and using market rates for new loans with comparable credit risk. Published pricing in the secondary and securitization markets was also utilized to assist in the fair value of the loan portfolio (Level 3). The valuation of our loan portfolio is consistent with accounting guidance but does not fully incorporate the exit price approach.

 

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Table of Contents

Notes to Unaudited Consolidated Financial Statements

 

Deposits

For deposit liabilities payable on demand, the fair value is the carrying value at the reporting date (Level 1). For time deposits the fair value is estimated by discounting estimated future cash flows using currently offered rates (Level 2).

Borrowed Funds

The fair value of fixed-maturity borrowed funds is estimated by discounting estimated future cash flows using currently offered rates (Level 2). Structured borrowed funds are valued using an option valuation model which uses assumptions for anticipated calls of borrowings based on market interest rates and weighted-average life (Level 2).

Off-balance Sheet Financial Instruments

There is no material difference between the fair value and the carrying amounts recognized with respect to our off-balance sheet loan commitments (Level 3). The fair value of our loan commitments is immaterial to our financial condition.

Other important elements that are not deemed to be financial assets or liabilities and, therefore, not considered in these estimates include the value of Hudson City Savings’ retail branch delivery system, its existing core deposit base and banking premises and equipment.

The estimated fair values of financial instruments are summarized as follows:

 

     September 30, 2014      December 31, 2013  
     Carrying
Amount
     Estimated
Fair Value
     Carrying
Amount
     Estimated
Fair Value
 
     (In thousands)  
Assets:            

Cash and due from banks

   $ 109,294       $ 109,294       $ 133,665       $ 133,665   

Federal funds sold and other overnight deposits

     5,570,103         5,570,103         4,190,809         4,190,809   

Investment securities held to maturity

     39,011         42,045         39,011         42,727   

Investment securities available for sale

     2,101,679         2,101,679         297,283         297,283   

Federal Home Loan Bank of New York stock

     320,753         320,753         347,102         347,102   

Mortgage-backed securities held to maturity

     1,435,674         1,529,967         1,784,464         1,888,823   

Mortgage-backed securities available for sale

     4,792,901         4,792,901         7,167,555         7,167,555   

Loans

     22,131,656         23,538,290         23,942,212         25,245,987   
Liabilities:            

Deposits

     19,973,147         20,049,666         21,472,329         21,590,537   

Borrowed funds

     12,175,000         13,562,030         12,175,000         13,621,332   

10.    Postretirement Benefit Plans

We maintain non-contributory retirement and post-retirement plans to cover employees hired prior to August 1, 2005, including retired employees, who have met the eligibility requirements of the plans. Benefits under the qualified and non-qualified defined benefit retirement plans are based primarily on years of service and compensation. Funding of the qualified retirement plan is actuarially determined on an annual basis. It is our policy to fund the qualified retirement plan sufficiently to meet the minimum requirements set forth in the Employee Retirement Income Security Act of 1974. The non-qualified retirement plan, which is maintained for certain employees, is unfunded.

 

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Table of Contents

Notes to Unaudited Consolidated Financial Statements

 

In 2005, we limited participation in the non-contributory retirement plan and the post-retirement benefit plan to those employees hired on or before July 31, 2005. We also placed a cap on paid medical expenses at the 2007 rate, beginning in 2008, for those eligible employees who retire after December 31, 2005. As part of our acquisition of Sound Federal in 2006, participation in the Sound Federal retirement plans and the accrual of benefits for such plans were frozen as of the acquisition date.

The components of the net periodic expense for the plans were as follows:

 

     For the Three Months Ended September 30,  
     Retirement Plans     Other Benefits  
     2014     2013     2014     2013  
     (In thousands)  

Service cost

   $ 1,130      $ 1,293      $ 246      $ 327   

Interest cost

     2,326        2,121        554        527   

Expected return on assets

     (3,609     (3,244     —          —     

Amortization of:

        

Net loss

     617        1,511        187        298   

Unrecognized prior service cost

     58        90        (391     (391
  

 

 

   

 

 

   

 

 

   

 

 

 

Net periodic benefit cost

   $ 522      $ 1,771      $ 596      $ 761   
  

 

 

   

 

 

   

 

 

   

 

 

 
     For the Nine Months Ended September 30,  
     Retirement Plans     Other Benefits  
     2014     2013     2014     2013  
     (In thousands)  

Service cost

   $ 3,392      $ 3,879      $ 738      $ 981   

Interest cost

     6,978        6,363        1,662        1,581   

Expected return on assets

     (10,827     (9,732     —          —     

Amortization of:

        

Net loss

     1,850        4,533        561        894   

Unrecognized prior service cost

     173        270        (1,174     (1,173
  

 

 

   

 

 

   

 

 

   

 

 

 

Net periodic benefit cost

   $ 1,566      $ 5,313      $ 1,787      $ 2,283   
  

 

 

   

 

 

   

 

 

   

 

 

 

We made no contributions to the pension plans during the first nine months of 2014 or 2013.

 

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Notes to Unaudited Consolidated Financial Statements

 

11.    Other Comprehensive Income (Loss)

The changes in accumulated other comprehensive income (loss) by component, net of tax, is as follows:

 

     Unrealized gains
(losses) on securities
available for sale
    Postretirement
Benefit Plans
    Total  
     (In thousands)  

Balance at December 31, 2013

   $ 33,944      $ (27,608   $ 6,336   
  

 

 

   

 

 

   

 

 

 

Other comprehensive income before reclassifications

     28,845        —          28,845   

Amounts reclassified from accumulated other comprehensive income (loss)

     (29,460     833        (28,627
  

 

 

   

 

 

   

 

 

 

Other comprehensive (loss) income

     (615     833        218   
  

 

 

   

 

 

   

 

 

 

Balance at September 30, 2014

   $ 33,329      $ (26,775   $ 6,554   
  

 

 

   

 

 

   

 

 

 

Balance at December 31, 2012

   $ 122,630      $ (52,660   $ 69,970   
  

 

 

   

 

 

   

 

 

 

Other comprehensive loss before reclassifications

     (84,306     —          (84,306

Amounts reclassified from accumulated other comprehensive income (loss)

     (4,249     2,676        (1,573
  

 

 

   

 

 

   

 

 

 

Other comprehensive (loss) income

     (88,555     2,676        (85,879
  

 

 

   

 

 

   

 

 

 

Balance at September 30, 2013

   $ 34,075      $ (49,984   $ (15,909
  

 

 

   

 

 

   

 

 

 

The following table presents the reclassification adjustment out of accumulated other comprehensive income (loss) included in net income and the corresponding line item on the consolidated statements of operations for the periods indicated:

 

Details about Accumulated Other Comprehensive Income
Components

   Amounts Reclassified
from Accumulated Other
Comprehensive Income
    Line Item in the Statement of Income
(In thousands)    For the Three Months
Ended September 30,
    For the Nine Months
Ended September 30,
     
     2014     2013     2014     2013      

Securities available for sale:

          

Net realized gain on securities available for sale

   $ (20,828   $ —        $ (49,710   $ (7,183   Gain on securities transaction, net

Income tax expense

     8,508        —          20,250        2,934      Income tax expense
  

 

 

   

 

 

   

 

 

   

 

 

   

Net of income tax expense

     (12,320     —          (29,460     (4,249  
  

 

 

   

 

 

   

 

 

   

 

 

   

Amortization of postretirement benefit pension plans:

          

Net actuarial loss

   $ 804      $ 1,809      $ 2,411      $ 5,429      (a)

Prior service cost

     (333     (301     (1,001     (905   (a)
  

 

 

   

 

 

   

 

 

   

 

 

   

Total before income tax expense

     471        1,508        1,410        4,524     

Income tax expense

     (194     (616     (577     (1,848   Income tax expense
  

 

 

   

 

 

   

 

 

   

 

 

   

Net of income tax expense

     277        892        833        2,676     
  

 

 

   

 

 

   

 

 

   

 

 

   

Total reclassifications

   $ (12,043   $ 892      $ (28,627   $ (1,573  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

(a) These items are included in the computation of net period pension cost. See Postretirement Benefit Plans footnote for additional disclosure.

 

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Notes to Unaudited Consolidated Financial Statements

 

12.    Stock-Based Compensation

Stock Option Plans

A summary of the changes in outstanding stock options is as follows:

 

     For the Nine Months Ended September 30,  
     2014      2013  
     Number of
Stock
Options
    Weighted
Average
Exercise
Price
     Number of
Stock
Options
    Weighted
Average
Exercise
Price
 

Outstanding at beginning of period

     25,402,955      $ 13.02         27,775,857      $ 12.97   

Exercised

     (11,900     9.50         (222,510     6.32   

Forfeited

     (2,804,799     11.92         (2,150,392     12.97   
  

 

 

      

 

 

   

Outstanding at end of period

     22,586,256      $ 13.16         25,402,955      $ 13.02   
  

 

 

      

 

 

   

In June 2006, our shareholders approved the Hudson City Bancorp, Inc. 2006 Stock Incentive Plan (the “2006 SIP”) authorizing us to grant up to 30,000,000 shares of common stock. In July 2006, the Compensation Committee of the Board of Directors of Hudson City Bancorp (the “Committee”), authorized grants to each non-employee director, executive officers and other employees to purchase shares of the Company’s common stock, pursuant to the 2006 SIP. Grants of stock options made through December 31, 2010 pursuant to the 2006 SIP amounted to 23,120,000 options at an exercise price equal to the fair value of our common stock on the grant date of the respective options, based on quoted market prices. Of these options, 6,067,500 had vesting periods ranging from one to five years and an expiration period of ten years. The remaining 17,052,500 shares had vesting periods ranging from two to three years if certain financial performance measures were met. The financial performance measures for each of these awards, other than the performance stock options granted in 2010 (“2010 option grants”), have been met, so we have recorded compensation expense for these awards accordingly. One of the two performance measures related to the 2010 option grants was not met so the Company recorded expense for only half of the 2010 option grants. The options that did not vest are reflected as forfeitures in 2013 in the table above.

In April 2011, our shareholders approved the Hudson City Bancorp, Inc. Amended and Restated 2011 Stock Incentive Plan (the “2011 SIP”) authorizing us to grant up to 28,750,000 shares of common stock including 2,070,000 shares remaining under the 2006 SIP. During 2011, the Committee authorized stock option grants (the “2011 option grants”) pursuant to the 2011 SIP for 1,618,932 options at an exercise price equal to the fair value of our common stock on the grant date, based on quoted market prices. Of these options, 1,308,513 will vest between April 2014 and July 2014 if certain financial performance measures are met and employment continues through the vesting date (the “2011 Performance Options”). The remaining 310,419 options vested in April 2012. The 2011 option grants have an expiration period of ten years. The performance measures for the 2011 Performance Options have been met and we have recorded compensation expense for those grants accordingly.

Compensation expense related to our outstanding stock options amounted to $10,000 and $262,000 for the three months ended September 30, 2014 and 2013, respectively and $282,000 and $930,000 for the nine months ended September 30, 2014 and 2013, respectively.

 

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Notes to Unaudited Consolidated Financial Statements

 

Stock Unit Awards

Hudson City Bancorp granted stock unit awards to a newly appointed member of the Board of Directors in July 2010. These awards were for a value of $250,000 which was converted to common stock equivalents (stock units) of 20,661 shares. These units vested over a three-year period upon continued service through the annual vesting dates and will be settled in shares of our common stock following the director’s departure from the Board of Directors.

Stock unit awards were also made in 2011 (the “2011 stock unit awards”) pursuant to the 2011 SIP for a total value of $9.7 million, or stock units of 1,004,230 shares. 2011 stock unit awards to employees vested on continued service through the third anniversary of the awards, and our attainment of certain financial performance measures as certified by the Committee. A portion of these awards were settled in shares of our common stock upon vesting, and the remainder will be settled in shares of our common stock on the sixth anniversary of the awards. 2011 stock unit awards to directors vested on continued service through the first anniversary of the award, and are settled in shares of our common stock following the director’s departure from the Board of Directors.

Stock unit awards were made in 2012 (the “2012 stock unit awards”) pursuant to the 2011 SIP for a total of $12.7 million, or stock units of 1,768,681 shares. The 2012 stock unit awards to employees vest if service continues through the third anniversary of the awards and certain financial performance measures are met. The 2012 stock unit awards include stock units of 974,528 shares that will be settled, if vested, in shares of our common stock on the third and sixth anniversaries of the awards. The 2012 stock unit awards also included variable performance stock units (“VPUs”) of 718,826 shares which will be settled, if vested, in shares of our common stock on the third anniversary of the awards. Half of each VPU award is conditioned on the ranking of the total shareholder return of the Company’s common stock over the calendar years 2012 to 2014 against the total shareholder return of a peer group of 50 companies and the other half was conditioned on the Company’s attainment of return on tangible equity measures for the calendar year 2012. Based on the level of performance of each award, between 0% and 150% of the VPUs may vest. The market condition requirements are reflected in the grant date fair value of the award, and the compensation expense for the award will be recognized regardless of whether the market conditions are met. Based on performance through December 31, 2012, the Company has determined that no more than 60.25% of the VPUs subject to the return on tangible equity condition may vest upon continued service through their vesting dates.

The remaining 75,327 2012 stock unit awards, which were granted to outside directors, vested in April 2013 and will be settled upon the director’s resignation from the Board of Directors. Expense for the stock unit awards is recognized over their vesting period and is based on the fair value of our common stock on each stock unit grant date, based on quoted market prices.

Stock unit awards were made in 2013 (the “2013 stock unit awards”) pursuant to the 2011 SIP for a total of $13.8 million, or stock units of 1,672,639 shares. The 2013 stock unit awards include 1,480,100 shares granted to employees in June 2013 that will be settled, if vested, in shares of our common stock on the third and sixth anniversaries of the awards. These awards vest in annual installments, subject to continued service through January 1, 2014, 2015 and 2016 and the attainment of certain financial performance measures. Attainment of these measures was certified by the Committee in 2014. The Committee specifically reserved its rights to reduce the number of shares covered by the 2013 stock unit awards to senior executives on or before certification of the performance goals if the Committee determined, in its discretion, that prevailing circumstances warrant such a reduction. The Committee

 

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Notes to Unaudited Consolidated Financial Statements

 

exercised this discretion in the first quarter of 2014 resulting in the forfeiture of stock units representing 323,550 shares. The 2013 stock unit awards also include 138,800 shares which were granted in March 2013 that will be settled in shares of our common stock on each vesting date. These awards vest in annual installments, subject to continued service through March 19, 2014, 2015 and 2016. The remaining 53,739 2013 stock unit awards, which were granted to outside directors, vested on continued service through April 2014 and will be settled upon such director’s resignation from the Board of Directors. These awards will be settled, if vested, in shares of our common stock on the final vesting date.

Stock unit awards were made in March 2014 (the “2014 stock unit awards”) pursuant to the 2011 SIP for a total of $13.9 million, or stock units of 1,417,951 shares. The 2014 stock unit awards include 1,363,740 shares granted to employees in March 2014 that will be settled, if vested, in shares of our common stock on the third and sixth anniversaries of the awards. These awards vest in annual installments, subject to continued service through January 1, 2015, 2016 and 2017 and our achievement of certain financial performance measures. The remaining 53,851 stock unit awards, which were granted to outside directors, vest on continued service through March 2015 and will be settled upon such director’s resignation from the Board of Directors. These awards will be settled, if vested, in shares of our common stock on the final vesting date.

Total compensation expense for stock unit awards amounted to $2.5 million and $3.2 million for the three months ended September 30, 2014 and 2013, respectively, and $8.3 million and $6.5 million for the nine months ended September 30, 2014 and 2013, respectively.

13.    Recent Accounting Pronouncements

In August 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-14, “Receivables – Troubled Debt Restructurings by Creditors”. The amendment requires that a mortgage loan be derecognized and that a separate other receivable be recognized upon foreclosure if the following conditions are met, (1) the loan has a government guarantee that is not separable from the loan before foreclosure; (2) at the time of foreclosure, the creditor has the intent to convey the real estate property to the guarantor and make a claim on the guarantee, and the creditor has the ability to recover under that claim; and (3) at the time of foreclosure, any amount of the claim that is determined on the basis of the fair value of the real estate is fixed. Upon foreclosure, the separate other receivable should be measured based on the amount of the loan balance (principal and interest) expected to be recovered from the guarantor. The amendments in ASU 2014-14 are effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2014. Early adoption is permitted. This guidance is not expected to have a material impact on our financial condition or results of operations.

In June 2014, the FASB issued ASU 2014-12, “Stock Compensation – Accounting for Share-Based Payments When the Terms of an Award Provide that a Performance Target Could Be Achieved after the Requisite Service Period”. The amendment applies to reporting entities that grant their employees share-based payments in which the terms of the award provide that a performance target can be achieved after the requisite service period. A reporting entity should apply existing guidance in ASC Topic 718 as it relates to awards with performance conditions that affect vesting to account for such awards. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. If the performance target becomes probable of being achieved before the end of the requisite service period, the remaining unrecognized compensation cost should be recognized prospectively over the remaining requisite service period. The total amount of

 

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Notes to Unaudited Consolidated Financial Statements

 

compensation cost recognized during and after the requisite service period should reflect the number of awards that are expected to vest and should be adjusted to reflect those awards that ultimately vest. The requisite service period ends when the employee can cease rendering service and still be eligible to vest in the award if the performance target is achieved. As indicated in the definition of vest, the stated vesting period (which includes the period in which the performance target could be achieved) may differ from the requisite service period. The amendments in ASU 2014-12 are effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2014. Early adoption is permitted. This guidance is not expected to have a material impact on our financial condition or results of operations.

In June 2014, the FASB issued ASU 2014-11, “Transfers and Servicing – Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures”. The amendments in this Update require that repurchase-to-maturity transactions be accounted for as secured borrowings consistent with the accounting for other repurchase agreements. In addition, the amendments require separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty (a repurchase financing), which will result in secured borrowing accounting for the repurchase agreement. The amendments require an entity to disclose information about transfers accounted for as sales in transactions that are economically similar to repurchase agreements, in which the transferor retains substantially all of the exposure to the economic return on the transferred financial asset throughout the term of the transaction. In addition the amendments require disclosure of the types of collateral pledged in repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions and the tenor of those transactions. The amendments in ASU 2014-11 are effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2014, and the disclosure for repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions accounted for as secured borrowings is required to be presented for annual periods beginning after December 15, 2014, and for interim periods beginning after March 15, 2015. This guidance is not expected to have a material impact on our financial condition or results of operations.

In January 2014, the FASB issued ASU 2014-04, “Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40) Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure,” which applies to all creditors who obtain physical possession of residential real estate property collateralizing a consumer mortgage loan in satisfaction of a receivable. The amendments in this update clarify when an in substance repossession or foreclosure occurs and requires disclosure of both (1) the amount of foreclosed residential real estate property held by a creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The amendments in ASU 2014-04 are effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2014. Early adoption is permitted and entities can elect to adopt a modified retrospective transition method or a prospective transition method. This guidance is not expected to have a material impact on our financial condition or results of operations.

14.    Legal Matters

Since the announcement of the Merger, eighteen putative class action complaints have been filed in the Court of Chancery, Delaware against Hudson City Bancorp, its directors, M&T, and WTC challenging the Merger. Six putative class actions challenging the Merger have also been filed in the Superior Court for Bergen County, Chancery Division, of New Jersey (the “New Jersey Court”). The lawsuits generally allege, among other things, that the Hudson City Bancorp directors breached their fiduciary duties to

 

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Notes to Unaudited Consolidated Financial Statements

 

Hudson City Bancorp’s public shareholders by approving the Merger at an unfair price, that the Merger was the product of a flawed sales process, and that Hudson City Bancorp and M&T filed a misleading and incomplete Form S-4 with the SEC in connection with the proposed transaction. All 24 lawsuits seek, among other things, to enjoin completion of the Merger and an award of costs and attorneys’ fees. Certain of the actions also seek an accounting of damages sustained as a result of the alleged breaches of fiduciary duty and punitive damages.

On April 12, 2013, the defendants entered into a memorandum of understanding (the “MOU”) with the plaintiffs regarding the settlement of all of the actions described above (collectively, the “Actions”).

Under the terms of the MOU, Hudson City Bancorp, M&T, the other named defendants, and all the plaintiffs have reached an agreement in principle to settle the Actions and release the defendants from all claims relating to the Merger, subject to approval of the New Jersey Court. Pursuant to the MOU, Hudson City Bancorp and M&T agreed to make available additional information to Hudson City Bancorp shareholders. The additional information was contained in a Supplement to the Joint Proxy Statement filed with the SEC as an exhibit to a Current Report on Form 8-K dated April 12, 2013. In addition, under the terms of the MOU, plaintiffs’ counsel also has reserved the right to seek an award of attorneys’ fees and expenses. If the New Jersey Court approves the settlement contemplated by the MOU, the Actions will be dismissed with prejudice. The settlement will not affect the Merger consideration to be paid to Hudson City Bancorp’s shareholders in connection with the proposed Merger. In the event the New Jersey Court approves an award of attorneys’ fees and expenses in connection with the settlement, such fees and expenses shall be paid by Hudson City Bancorp, its successor in interest, or its insurers.

Hudson City Bancorp, M&T, and the other defendants deny all of the allegations in the Actions and believe the disclosures in the Joint Proxy Statement are adequate under the law. Nevertheless, Hudson City Bancorp, M&T, and the other defendants have agreed to settle the Actions in order to avoid the costs, disruption, and distraction of further litigation.

 

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Item 2. – Management’s Discussion and Analysis of Financial Condition and Results of Operations

Executive Summary

During the first nine months of 2014, we continued to focus on our consumer-oriented business model through the origination of one- to four-family mortgage loans. We have traditionally funded this loan production with customer deposits and borrowings. Market interest rates remained at historically low levels during the first nine months of 2014 which provided limited opportunities for the reinvestment of repayments received on our mortgage-related assets which account for 82.5% of our average interest-earning assets for the nine months ended September 30, 2014. As a result, we continued to reduce the size of our balance sheet and we continue to carry an elevated level of short-term liquid assets. Federal funds and other overnight deposits amounted to $5.57 billion, or 15.0%, of total assets at September 30, 2014. In addition, we have $1.80 billion of U.S. Treasury securities that had a weighted-average life of 1.4 years at the time of purchase and an average yield of 0.34%. We believe that while carrying this level of short-term liquid assets adversely impacts our current earnings, it better positions our balance sheet for future strategic initiatives such as a balance sheet restructuring. Our total assets decreased $1.45 billion, or 3.8%, to $37.16 billion at September 30, 2014 from $38.61 billion at December 31, 2013.

Our results of operations depend primarily on net interest income, which, in part, is a direct result of the market interest rate environment. Net interest income is the difference between the interest income we earn on our interest-earning assets, primarily mortgage loans, mortgage-backed securities and investment securities, and the interest we pay on our interest-bearing liabilities, primarily time deposits, interest-bearing transaction accounts and borrowed funds. Net interest income is affected by the shape of the market yield curve, the timing of the placement and repricing of interest-earning assets and interest-bearing liabilities on our balance sheet, the prepayment rate on our mortgage-related assets and the puts of our borrowings. Our results of operations may also be affected significantly by general and local economic and competitive conditions, particularly those with respect to changes in market interest rates, credit quality, government policies and actions of regulatory authorities. Our results of operations are also affected by the market price of our stock, as the expense of our employee stock ownership plan is related to the current price of our common stock.

The Federal Open Market Committee of the Board of Governors of the Federal Reserve System (the “FOMC”) noted that economic activity is expanding at a moderate pace. Labor market conditions improved somewhat further with solid job gains and a lower unemployment rate. A range of labor market indicators suggests that underutilization of labor resources is gradually diminishing. Household spending is rising moderately and business fixed investment is advancing, while the recovery in the housing sector remains slow. The national unemployment rate decreased to 5.9% in September 2014 from 6.7% in December 2013 and from 7.2% in September 2013. The FOMC decided to maintain the overnight lending target rate at zero to 0.25% during the third quarter of 2014.

The FOMC judged that there has been a substantial improvement in the outlook for the labor market since the inception of its current asset purchase program. Moreover, the FOMC continues to see sufficient underlying strength in the broader economy to support ongoing progress toward maximum employment in a context of price stability. Accordingly, the FOMC decided to conclude its asset purchase program in October 2014. The FOMC is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction.

 

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Net interest income decreased $34.5 million, or 24.7%, to $104.9 million for the third quarter of 2014 from $139.4 million for the third quarter of 2013 reflecting the overall decrease in the average balance of interest-earning assets and interest-bearing liabilities, the continued low interest rate environment and a continued increase in the average balance of short-term liquid assets, including U.S. Treasury securities and Federal funds sold and other overnight deposits. Our interest rate spread decreased to 0.88% for the third quarter of 2014 as compared to 1.00% for the linked second quarter of 2014 and 1.22% for the third quarter of 2013. Our net interest margin was 1.18% for the third quarter of 2014 as compared to 1.29% for the linked second quarter of 2014 and 1.48% for the third quarter of 2013.

Net interest income decreased $121.6 million, or 25.5%, to $355.0 million for the first nine months of 2014 as compared to $476.6 million for the first nine months of 2013. Our interest rate spread decreased 40 basis points to 1.01% for the nine months ended September 30, 2014 as compared to 1.41% for the nine months ended September 30, 2013. Our net interest margin decreased 36 basis points to 1.29% for the nine months ended September 30, 2014 as compared to 1.65% for the nine months ended September 30, 2013.

The decrease in our interest rate spread and net interest margin for the three and nine month periods ended September 30, 2014 is primarily due to repayments of higher yielding assets due to the low interest rate environment. The decrease is also due to an increase in the average balance of Federal funds and other overnight deposits and U.S. Treasury securities which yield 0.25% and 0.34%, respectively.

Market interest rates on mortgage-related assets remained at near-historic lows primarily due to the FRB’s program to purchase mortgage-backed securities to keep mortgage rates low and provide stimulus to the housing markets. Given the current market environment and our concerns about taking on additional interest rate risk, we expect to continue to reduce the size of our balance sheet in the near term.

During the third quarter of 2014, we sold a pool of non-performing residential mortgage loans guaranteed by the FHA with an aggregate principal balance of $112.1 million back to the financial institution that originally sold the loans to the Bank. The sale of the non-performing loan pool was in accordance with the repurchase right with respect to loans that become non-performing that the financial institution exercised pursuant to the terms of the original sale and servicing agreement between the Bank and the financial institution. As consideration for the sale of the non-performing loans, the Bank received from the financial institution an amount equal to 100% of the outstanding unpaid principal balance of the loans, plus all accrued and unpaid interest on the loans. The Bank may sell additional loans to the financial institution in the future, in the event the financial institution exercises its repurchase right with respect to any additional non-performing FHA loans.

We recorded a net credit provision for loan losses of $3.5 million during the third quarter of 2014. The provision for loan losses decreased $7.5 million and $40.0 million for the quarter and nine months ended September 30, 2014, respectively, as compared to the same respective periods in 2013. The net credit provision for loan losses was primarily due to a decrease in non-performing loans and early stage delinquent loans. The decline in non-performing loans was due to the sale of a pool of non-performing FHA loans, along with improving economic conditions particularly in the housing and labor markets. Early stage loan delinquencies (defined as loans that are 30 to 89 days delinquent) decreased $39.9 million to $433.5 million at September 30, 2014 from $473.4 million at December 31, 2013. Non-performing loans, defined as non-accrual loans and accruing loans delinquent 90 days or more, amounted to $859.8 million at September 30, 2014 as compared to $1.05 billion at December 31, 2013. The ratio of non-performing loans to total loans was 3.86% at September 30, 2014 as compared to 4.35% at December 31, 2013 and

 

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4.36% at September 30, 2013. Notwithstanding the decrease in non-performing loans, the foreclosure process and the time to complete a foreclosure, continues to be prolonged, especially in New York and New Jersey where 69.6% of our non-performing loans are located at September 30, 2014. This protracted foreclosure process delays our ability to resolve non-performing loans through the sale of the underlying collateral and our ability to maximize any recoveries.

Total non-interest income was $23.9 million for the third quarter of 2014 as compared to $13.5 million for the third quarter of 2013. Included in non-interest income for the third quarter of 2014 were $22.3 million in gains from the sale of $644.2 million of mortgage-backed securities. Gains on the sales of securities amounted to $10.6 million in the third quarter of 2013. The remainder of non-interest income is primarily made up of service fees and charges on deposit and loan accounts.

Total non-interest income was $62.9 million for the first nine months of 2014 as compared to $25.6 million for the same period in 2013. Included in non-interest income for the first nine months of 2014 were $57.8 million in gains from the sale of $1.63 billion of mortgage-backed securities. Gains on the sales of securities amounted to $17.8 million for the nine months ended September 30, 2013.

We sold these mortgage-backed securities during the first nine months of 2014 to take advantage of current market demand and prices.

Total non-interest expense decreased $8.5 million to $70.0 million for the third quarter of 2014 as compared to $78.5 million for the third quarter of 2013. This decrease was due to a $7.1 million decrease in Federal deposit insurance expense and a $2.1 million decrease in compensation and employee benefits expense partially offset by a $1.0 million increase in other non-interest expense.

Total non-interest expense decreased $13.5 million to $222.9 million for the nine months ended September 30, 2014 as compared to $236.4 million for the nine months ended September 30, 2013. This decrease was due to a $23.7 million decrease in Federal deposit insurance expense partially offset by a $10.2 million increase in other non-interest expense.

Net loans decreased to $22.13 billion at September 30, 2014 as compared to $23.94 billion at December 31, 2013 due primarily to a decrease in loan production. During the first nine months of 2014, our loan production (originations and purchases) amounted to $1.10 billion as compared to $2.93 billion for the same period in 2013. Loan production was offset by principal repayments of $2.86 billion during the first nine months of 2014, as compared to principal repayments of $5.32 billion for the first nine months of 2013. The decrease in loan repayments is primarily due to reduced refinancing activity.

Total mortgage-backed securities decreased $2.72 billion to $6.23 billion at September 30, 2014 from $8.95 billion at December 31, 2013. The decrease was due primarily to securities sales of $1.63 billion and repayments of $1.15 billion of mortgage-backed securities during the first nine months of 2014. We sold these mortgage-backed securities to take advantage of current market demand and prices.

Total investment securities increased $1.80 billion to $2.14 billion at September 30, 2014 as compared to $336.3 million at December 31, 2013. The increase was due primarily to purchases of $1.80 billion of U.S. Treasury securities with an average life of 1.4 years which are used as collateral for our outstanding borrowings.

 

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Total liabilities decreased $1.51 billion, or 4.5%, to $32.35 billion at September 30, 2014 from $33.86 billion at December 31, 2013. The decrease in total liabilities reflected a decrease in total deposits while total borrowed funds remained unchanged.

On August 27, 2012, the Company entered into the Merger Agreement with M&T and WTC, pursuant to which the Company will merge with and into WTC, with WTC continuing as the surviving entity. As part of the Merger, the Bank will merge with and into Manufacturers and Traders Trust Company.

Subject to the terms and conditions of the Merger Agreement, in the Merger, Hudson City Bancorp shareholders will have the right to receive with respect to each of their shares of common stock of the Company, at their election (but subject to proration and adjustment procedures), 0.08403 of a share of common stock, or cash having a value equal to the product of 0.08403 multiplied by the average closing price of the M&T common stock for the ten days immediately prior to the completion of the Merger. The Merger Agreement also provides that at the closing of the Merger, 40% of the outstanding shares of Hudson City common stock will be converted into the right to receive cash and the remainder of the outstanding shares of Hudson City common stock will be converted into the right to receive shares of M&T common stock.

On two occasions, M&T and the Company announced that additional time would be required to obtain a regulatory determination on the applications necessary to complete the proposed Merger. Most recently, on December 17, 2013, M&T and the Company announced that they entered into Amendment No. 2 to the Merger Agreement. Amendment No. 2 further extends the date after which either party may terminate the Merger Agreement if the Merger has not yet been completed from January 31, 2014 to December 31, 2014, and provides that the Company may terminate the Merger Agreement at any time if it reasonably determines that M&T is unlikely to be able to obtain the requisite regulatory approvals of the Merger to permit the closing to occur on or prior to December 31, 2014. Amendment No. 2 also permits the Company to take certain interim actions, including with respect to our conduct of business, implementation of our Strategic Plan, retention incentives and certain other matters with respect to our personnel, prior to the completion of the Merger. While Amendment No. 2 extends the date after which either party may elect to terminate the Merger Agreement from January 31, 2014 to December 31, 2014, there can be no assurances that the Merger will be completed by that date or that the Company will not exercise its right to terminate the Merger Agreement in accordance with its terms.

As part of our Strategic Plan, we are continuing to explore ways to reduce our interest rate risk while strengthening our balance sheet, which includes the implementation of our commercial real estate (“CRE”) lending initiative. Under this initiative, the Bank will initially participate in syndicated CRE and multi-family mortgage loan deals. The Bank has developed a detailed project plan for the CRE initiative and the Bank originated its first CRE participation loan for $25.0 million in October 2014. As part of our Strategic Plan, we may also further restructure our balance sheet during 2014. The Company previously completed a series of restructuring transactions in 2011 that reduced higher-cost structured borrowings on the Company’s balance sheet. Management is continuing to consider a variety of different restructuring alternatives, including whether to restructure all or various portions of our borrowed funds and various alternatives for replacement funding. No decision has been made at this time regarding the timing, structure and scope of any restructuring transaction. Decisions regarding any restructuring transaction are dependent upon, among other things, market interest rates, overall economic conditions and the status of the Merger. We expect a restructuring to result in a net loss and reduction of shareholder equity, though we also expect an improvement in net interest margin and future earnings prospects. Any restructuring will focus on the prospects for long-term overall earnings stability and growth. Any restructuring will likely reduce our excess cash position, but will not adversely affect the liquidity we need to operate in a safe and sound manner.

 

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The Bank is currently subject to the Bank MOU. In accordance with the Bank MOU, the Bank has adopted and has implemented enhanced operating policies and procedures that are intended to continue to (a) reduce our level of interest rate risk, (b) reduce our funding concentration, (c) diversify our funding sources, (d) enhance our liquidity position, (e) monitor and manage loan modifications and (f) maintain our capital position in accordance with our existing capital plan. In addition, we developed the Strategic Plan which establishes objectives for the Bank’s overall risk profile, earnings performance, growth and balance sheet mix and to enhance our enterprise risk management program.

The Company is currently subject to the Company MOU. In accordance with the Company MOU, the Company must, among other things support the Bank’s compliance with the Bank MOU. The Company MOU also requires the Company to: (a) obtain approval from the FRB prior to receiving a capital distribution from the Bank or declaring a dividend to shareholders and (b) obtain approval from the FRB prior to repurchasing or redeeming any Company stock or incurring any debt with a maturity of greater than one year. In accordance with the Company MOU, the Company submitted a comprehensive Capital Plan and a comprehensive Earnings Plan to the FRB. These agreements will remain in effect until modified or terminated by the OCC (with respect to the Bank MOU) and the FRB (with respect to the Company MOU).

Comparison of Financial Condition at September 30, 2014 and December 31, 2013

Total assets decreased $1.45 billion, or 3.8%, to $37.16 billion at September 30, 2014 from $38.61 billion at December 31, 2013. The decrease in total assets reflected a $2.72 billion decrease in total mortgage-backed securities and a $1.81 billion decrease in net loans, partially offset by a $1.36 billion increase in cash and cash equivalents and a $1.80 billion increase in investment securities.

Total cash and cash equivalents increased $1.36 billion to $5.68 billion at September 30, 2014 as compared to $4.32 billion at December 31, 2013. This increase is primarily due to repayments on mortgage-related assets and the lack of attractive reinvestment opportunities in the current low interest rate environment as available short term reinvestment opportunities continue to carry low yields, and medium and longer term opportunities available to us carry significant duration risk at relatively low yields. We have maintained lower deposit rates to allow a reduction in our deposits to help alleviate the pressure created by our increasing cash position. Accordingly, we have used a portion of our excess cash inflows to fund these deposit reductions.

Net loans decreased to $22.13 billion at September 30, 2014 as compared to $23.94 billion at December 31, 2013 due primarily to a decrease in loan production. During the first nine months of 2014, our loan production (originations and purchases) amounted to $1.10 billion as compared to $2.93 billion for the same period in 2013. Loan production was offset by principal repayments of $2.86 billion during the first nine months of 2014, as compared to principal repayments of $5.32 billion for the first nine months of 2013. The decrease in loan repayments is due primarily to reduced refinancing activity.

The decline in loan production during the first nine months of 2014 as compared to the same period in 2013 reflects our limited appetite for adding long-term fixed-rate mortgage loans to our portfolio in the current low market interest rate environment. In addition, loan production has been impacted by the new qualified mortgage regulations issued by the Consumer Financial Protection Bureau (the “CFPB”). Effective in January 2014, we discontinued our reduced documentation loan program in order to comply

 

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with the new requirements to validate a borrower’s ability to repay and the corresponding safe harbor for loans that meet the requirements for a “qualified mortgage.” During 2013, 22% of our total loan production consisted of reduced documentation loans to borrowers with acceptable credit and larger down payments resulting in loss ratios similar to our full documentation portfolio.

Our first mortgage loan production during the first nine months of 2014 was substantially all in one- to four-family mortgage loans. Approximately 80.3% of mortgage loan production for the first nine months of 2014 were variable-rate loans as compared to approximately 76.7% for the corresponding period in 2013. Fixed-rate mortgage loans accounted for 54.0% of our first mortgage loan portfolio at September 30, 2014 as compared to 55.4% at December 31, 2013.

Our ALL amounted to $242.2 million at September 30, 2014 and $276.1 million at December 31, 2013. Non-performing loans amounted to $859.8 billion, or 3.86% of total loans, at September 30, 2014 as compared to $1.05 billion, or 4.35% of total loans, at December 31, 2013.

Total mortgage-backed securities decreased $2.72 billion to $6.23 billion at September 30, 2014 from $8.95 billion at December 31, 2013. The decrease was due primarily to securities sales of $1.63 billion and repayments of $1.15 billion of mortgage-backed securities during the first nine months of 2014. We sold the mortgage-backed securities to take advantage of current market demand and prices. The proceeds from the sales have been invested primarily in short-term liquid assets. While this further increases our levels of low-yielding liquid assets, we believe this positions our balance sheet for future strategic initiatives such as a balance sheet restructuring.

Total investment securities increased $1.80 billion to $2.14 billion at September 30, 2014 as compared to $336.3 million at December 31, 2013. The increase was due primarily to purchases of $1.80 billion of U.S. Treasury securities with an average life of 1.4 years which are used as collateral for our outstanding borrowings.

Total liabilities decreased $1.51 billion, or 4.5%, to $32.35 billion at September 30, 2014 from $33.86 billion at December 31, 2013. The decrease in total liabilities primarily reflected a decrease in total deposits of $1.50 billion, while total borrowed funds remained unchanged.

Total deposits decreased $1.50 billion, or 7.0%, to $19.97 billion at September 30, 2014 from $21.47 billion at December 31, 2013. The decrease in total deposits reflected a $779.8 million decrease in our money market accounts and a $646.0 million decrease in our time deposit accounts. The decrease in our money market and time deposit accounts was due to our decision to maintain lower deposit rates that allow us to manage deposit levels at a time when there are limited investment opportunities with attractive yields to reinvest the funds received from payment activity on mortgage-related assets. We had 135 banking offices at both September 30, 2014 and December 31, 2013.

Borrowings amounted to $12.18 billion at both September 30, 2014 and December 31, 2013. At September 30, 2014, we had $3.33 billion of borrowed funds with put dates within one year, all of which can be put back to the Company quarterly. If interest rates were to decrease, or remain consistent with current rates, we believe these borrowings would likely not be put back and our average cost of existing borrowings would not decrease even as market interest rates decrease. Conversely, if interest rates increase we believe these borrowings would likely be put back at their next put date and our cost to replace these borrowings would increase. However, we believe, given current market conditions, that the likelihood that a significant portion of these borrowings would be put back will not increase substantially unless interest rates were to increase by at least 250 basis points.

 

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Total shareholders’ equity increased $73.0 million to $4.82 billion at September 30, 2014 as compared to $4.74 billion at December 31, 2013. The increase was primarily due to net income of $118.8 million partially offset by cash dividends paid to common shareholders of $60.1 million.

As of September 30, 2014, there remained 50,123,550 shares that may be purchased under our existing stock repurchase programs. We did not repurchase any shares of our common stock during the third quarter of 2014 pursuant to our repurchase programs. Pursuant to the Company MOU, any future share repurchases must be approved by the FRB. In addition, pursuant to the terms of the Merger Agreement, we may not repurchase shares of Hudson City Bancorp common stock without the consent of M&T. At September 30, 2014, our capital ratios were in excess of the applicable regulatory requirements to be considered well-capitalized. See “Liquidity and Capital Resources.”

At September 30, 2014, our shareholders’ equity to asset ratio was 12.96% compared with 12.28% at December 31, 2013. Our book value per share, using the period-end number of outstanding shares, less purchased but unallocated employee stock ownership plan shares and less purchased but unvested recognition and retention plan shares, was $9.65 at September 30, 2014 and $9.52 at December 31, 2013. Our tangible book value per share, calculated by deducting goodwill and the core deposit intangible from shareholders’ equity, was $9.34 as of September 30, 2014 and $9.21 at December 31, 2013.

 

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Comparison of Operating Results for the Three-Month Periods Ended September 30, 2014 and 2013

Average Balance Sheet. The following table presents the average balance sheets, average yields and costs and certain other information for the three months ended September 30, 2014 and 2013. The table presents the annualized average yield on interest-earning assets and the annualized average cost of interest-bearing liabilities. We derived the yields and costs by dividing annualized income or expense by the average balance of interest-earning assets and interest-bearing liabilities, respectively, for the periods shown. We derived average balances from daily balances over the periods indicated. Interest income includes fees that we considered to be adjustments to yields. Yields on tax-exempt obligations were not computed on a tax equivalent basis. Nonaccrual loans were included in the computation of average balances and therefore have a zero yield. The yields set forth below include the effect of deferred loan origination fees and costs, and purchase discounts and premiums that are amortized or accreted to interest income.

 

     For the Three Months Ended September 30,  
     2014     2013  
     Average
Balance
     Interest      Average
Yield/
Cost
    Average
Balance
     Interest      Average
Yield/
Cost
 
     (Dollars in thousands)  

Assets:

                

Interest-earnings assets:

                

First mortgage loans, net (1)

   $ 22,348,498       $ 241,637         4.32   $ 24,383,366       $ 266,324         4.37

Consumer and other loans

     203,068         2,155         4.24        221,737         2,377         4.29   

Federal funds sold and other overnight deposits

     5,331,249         3,387         0.25        3,223,431         1,835         0.23   

Mortgage-backed securities at amortized cost

     6,683,978         34,683         2.08        9,971,361         50,916         2.04   

Federal Home Loan Bank stock

     326,866         3,409         4.17        347,102         3,466         3.99   

Investment securities, at amortized cost

     1,688,757         2,349         0.56        344,135         1,380         1.60   
  

 

 

    

 

 

      

 

 

    

 

 

    

Total interest-earning assets

     36,582,416         287,620         3.14        38,491,132         326,298         3.39   
  

 

 

    

 

 

      

 

 

    

 

 

    

Noninterest-earnings assets (4)

     885,898              976,062         
  

 

 

         

 

 

       

Total Assets

   $ 37,468,314            $ 39,467,194         
  

 

 

         

 

 

       

Liabilities and Shareholders’ Equity:

                

Interest-bearing liabilities:

                

Savings accounts

     1,048,986         397         0.15        990,581         376         0.15   

Interest-bearing transaction accounts

     2,134,535         1,435         0.27        2,224,661         1,613         0.29   

Money market accounts

     4,537,454         2,269         0.20        5,712,302         2,803         0.19   

Time deposits

     11,859,805         35,849         1.20        12,768,104         39,229         1.22   
  

 

 

    

 

 

      

 

 

    

 

 

    

Total interest-bearing deposits

     19,580,780         39,950         0.81        21,695,648         44,021         0.80   
  

 

 

    

 

 

      

 

 

    

 

 

    

Repurchase agreements

     6,150,000         69,563         4.43        6,950,000         79,059         4.45   

Federal Home Loan Bank of New York advances

     6,025,000         73,169         4.75        5,225,000         63,805         4.78   
  

 

 

    

 

 

      

 

 

    

 

 

    

Total borrowed funds

     12,175,000         142,732         4.59        12,175,000         142,864         4.59   
  

 

 

    

 

 

      

 

 

    

 

 

    

Total interest-bearing liabilities

     31,755,780         182,682         2.26        33,870,648         186,885         2.17   
  

 

 

    

 

 

      

 

 

    

 

 

    

Noninterest-bearing liabilities:

                

Noninterest-bearing deposits

     662,752              647,121         

Other noninterest-bearing liabilities

     203,458              245,583         
  

 

 

         

 

 

       

Total noninterest-bearing liabilities

     866,210              892,704         
  

 

 

         

 

 

       

Total liabilities

     32,621,990              34,763,352         

Shareholders’ equity

     4,846,324              4,703,842         
  

 

 

         

 

 

       

Total Liabilities and Shareholders’ Equity

   $ 37,468,314            $ 39,467,194         
  

 

 

         

 

 

       

Net interest income/net interest rate spread (2)

      $ 104,938         0.88         $ 139,413         1.22   
     

 

 

         

 

 

    

Net interest-earning assets/net interest margin (3)

   $ 4,826,636            1.18   $ 4,620,484            1.48
  

 

 

         

 

 

       

Ratio of interest-earning assets to interest-bearing liabilities

           1.15x              1.14x   

 

(1) Amount includes deferred loan costs and non-performing loans and is net of the allowance for loan losses.
(2) Determined by subtracting the annualized weighted average cost of total interest-bearing liabilities from the annualized weighted average yield on total interest-earning assets.
(3) Determined by dividing annualized net interest income by total average interest-earning assets.
(4) Includes the average balance of principal receivable related to FHLMC mortgage-backed securities of $45.1 million and $108.0 million for the quarters ended September 30, 2014 and 2013, respectively.

 

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General. Net income was $37.1 million for the third quarter of 2014 as compared to $42.7 million for the third quarter of 2013. Both basic and diluted earnings per common share were $0.07 for the third quarter of 2014 as compared to both basic and diluted earnings per share of $0.09 for the third quarter of 2013. For the third quarter of 2014, our annualized return on average shareholders’ equity was 3.06% as compared to 3.63% for the corresponding period in 2013. Our annualized return on average assets for the third quarter of 2014 was 0.40% as compared to 0.43% for the third quarter of 2013. The decrease in the annualized return on average equity and assets is primarily due to the decrease in net income during the third quarter of 2014.

Interest and Dividend Income. Total interest and dividend income for the third quarter of 2014 decreased $38.7 million, or 11.9%, to $287.6 million from $326.3 million for the third quarter of 2013. The decrease in total interest and dividend income was due to a $1.91 billion decrease in the average balance of total interest-earning assets during the third quarter of 2014 to $36.58 billion from $38.49 billion for the third quarter of 2013 as well as a decrease in the annualized weighted-average yield on total interest earning assets. The decrease in the average balance of total interest-earning assets for the third quarter of 2014 as compared to the third quarter of 2013 was due primarily to repayments of mortgage-related assets as a result of the low interest rate environment and our decision not to reinvest in low yielding, long term assets. In addition, we sold mortgage-backed securities with a carrying value of $644.2 million during the third quarter of 2014.

The annualized weighted-average yield on total interest-earning assets was 3.14% for the third quarter of 2014 as compared to 3.39% for the third quarter of 2013. The decrease in the annualized weighted average yield of interest-earning assets was due to lower market interest rates earned on mortgage-related assets. The decrease was also due to a $2.11 billion increase in the average balance of Federal funds sold and other overnight deposits to $5.33 billion with an average yield of 0.25% and an increase of $1.34 billion in the average balance of investment securities with an annualized weighted-average yield of 0.56% during the third quarter of 2014.

Interest on first mortgage loans decreased $24.7 million, or 9.3%, to $241.6 million for the third quarter of 2014 from $266.3 million for the third quarter of 2013. The decrease in interest on first mortgage loans was primarily due to a $2.03 billion decrease in the average balance of first mortgage loans to $22.35 billion for the third quarter of 2014 from $24.38 billion for the same quarter in 2013. The decrease in interest income on first mortgage loans was also due to a 5 basis point decrease in the annualized weighted-average yield to 4.32% for the third quarter of 2014 from 4.37% for the third quarter of 2013.

The decrease in the average yield earned on first mortgage loans during the third quarter of 2014 was due to repayments of higher-yielding loans. Consequently, the average yield on our loan portfolio continued to decline during the third quarter of 2014. The decrease in the average balance of first mortgage loans was due to a decrease in our loan production reflecting our limited appetite for adding long-term mortgage loans to our portfolio in the current low interest rate environment and also the impact of the CFPB’s new ability to repay and qualified mortgage regulations, which went into effect in January 2014. During the first nine months of 2014, our loan production (originations and purchases) amounted to $1.10 billion as compared to $2.93 billion for the same period in 2013. Loan production was offset by principal repayments of $2.86 billion for the first nine months of 2014 as compared to $5.32 billion for the same period in 2013.

Interest on consumer and other loans decreased $222,000 to $2.2 million for the third quarter of 2014 from $2.4 million for the third quarter of 2013 due to a decrease in the average balance of consumer and other loans. The average balance of consumer and other loans decreased $18.6 million to $203.1 million

 

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for the third quarter of 2014 from $221.7 million for the third quarter of 2013 and the average yield earned decreased 5 basis points to 4.24% from 4.29% for those same respective periods. The average balance of consumer loans decreased as consumer loans is not a business that we actively pursue. The decrease in the annualized weighted-average yield is a result of current market interest rates.

Interest on mortgage-backed securities decreased $16.2 million to $34.7 million for the third quarter of 2014 from $50.9 million for the third quarter of 2013. This decrease was due primarily to a $3.29 billion decrease in the average balance of mortgage-backed securities to $6.68 billion for the third quarter of 2014 from $9.97 billion for the third quarter of 2013. This was partially offset by an increase in the annualized weighted-average yield of mortgage-backed securities to 2.08% for the third quarter of 2014 as compared to 2.04% for third quarter of 2013.

The decrease in the average balance of mortgage-backed securities was due to sales of mortgage-backed securities as well as principal repayments during 2013 and the first nine months of 2014. During the nine months ended September 30 2014, we sold $1.63 billion of mortgage-backed securities to realize gains that would likely decrease as market interest rates increase and as the outstanding principal balance of these securities decreases due to repayments.

Interest on investment securities increased $969,000 to $2.3 million for the third quarter of 2014 as compared to $1.4 million for the third quarter of 2013. This increase was due primarily to a $1.34 billion increase in the average balance of investment securities to $1.69 billion for the third quarter of 2014 as compared to $344.1 million for the third quarter of 2013. This was partially offset by a decrease in the annualized weighted-average yield to 0.56% for the third quarter of 2014 from 1.60% for the third quarter of 2013.

The increase in the average balance of investment securities for the quarter ended September 30, 2014 was due to the purchase of $1.80 billion of U.S. Treasury securities during the first nine months of 2014. The decrease in the average yield earned on investment securities is due to the yield earned on the U.S. Treasury securities purchased which was 0.34%.

Interest on Federal funds sold and other overnight deposits amounted to $3.4 million for the third quarter of 2014 as compared to $1.8 million for the third quarter of 2013. The increase in interest income on Federal funds sold and other overnight deposits was primarily due to an increase in the average balance of Federal funds sold and other overnight deposits. The average balance of Federal funds sold and other overnight deposits amounted to $5.33 billion for the third quarter of 2014 as compared to $3.22 billion for the third quarter of 2013. The yield earned on Federal funds sold and other overnight deposits was 0.25% for the 2014 third quarter and 0.23% for the 2013 third quarter.

The increase in the average balance of Federal funds sold and other overnight deposits for the third quarter of 2014 was due primarily to repayments and sales of mortgage-related assets and our low appetite for adding long-term fixed-rate mortgage loans to our portfolio in the current low interest rate environment.

Interest Expense. Total interest expense for the quarter ended September 30, 2014 decreased $4.2 million, or 2.2%, to $182.7 million from $186.9 million for the quarter ended September 30, 2013. This decrease was primarily due to a $2.11 billion decrease in the average balance of total interest-bearing liabilities to $31.76 billion for the quarter ended September 30, 2014 from $33.87 billion for the quarter ended September 30, 2013. This was offset by an increase in the annualized weighted-average cost of total interest-bearing liabilities which was 2.26% for the quarter ended September 30, 2014 as compared to 2.17% for the quarter ended September 30, 2013. The decrease in the average balance of total interest-bearing liabilities was due entirely to a decrease in the average balance of total deposits.

 

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The increase in the average cost of interest-bearing liabilities during the third quarter of 2014 was due to a decrease in the average balance of interest-bearing deposits which have a lower weighted-average cost than our borrowed funds, the average balances of which remained unchanged. Interest-bearing deposits accounted for 62% of interest-bearing liabilities for the three months ended September 30, 2014 as compared to 64% for the same period in 2013.

Interest expense on deposits decreased $4.0 million, or 9.1%, to $40.0 million for the third quarter of 2014 from $44.0 million for the third quarter of 2013. The decrease is primarily due to a $2.12 billion decrease in the average balance of interest-bearing deposits to $19.58 billion for the third quarter of 2014 from $21.70 billion for the third quarter of 2013. The annualized weighted-average cost of interest-bearing deposits was 0.81% for the third quarter of 2014 as compared to 0.80% for the third quarter of 2013.

Interest expense on our time deposit accounts decreased $3.4 million to $35.8 million for the third quarter of 2014 as compared to $39.2 million for the third quarter of 2013. This decrease was due to a $908.3 million decrease in the average balance of time deposit accounts to $11.86 billion for the third quarter of 2014 from $12.77 billion for the same period in 2013. The decrease was also due to a 2 basis point decrease in the annualized weighted-average cost to 1.20% for the third quarter of 2014 compared with 1.22% for the third quarter of 2013 as maturing time deposits were renewed or replaced by new time deposits at lower rates. The decline in the average balance of our time deposits reflects our decision to maintain lower deposit rates to continue our balance sheet reduction.

Interest expense on money market accounts decreased $534,000 to $2.3 million for the third quarter of 2014 from $2.8 million for the third quarter of 2013. This was due primarily to a $1.17 billion decrease in the average balance of money market accounts to $4.54 billion for the third quarter of 2014 from $5.71 billion for the third quarter of 2013. The annualized weighted-average cost of money market accounts was 0.20% for the third quarter of 2014 as compared to 0.19% for the third quarter of 2013.

Interest expense on borrowed funds decreased slightly to $142.7 million for the third quarter of 2014 from $142.9 million for the third quarter of 2013. The annualized weighted-average cost of borrowed funds was 4.59% for both the quarter ended September 30, 2014 and for the quarter ended September 30, 2013. The average balance of borrowings was unchanged for both comparative periods.

At September 30, 2014 we had $3.33 billion of borrowings with put dates within one year. We believe, given current market conditions, that the likelihood that a significant portion of these borrowings would be put back will not increase substantially unless interest rates were to increase by at least 250 basis points. See “Liquidity and Capital Resources.”

Net Interest Income. Net interest income decreased $34.5 million, or 24.7%, to $104.9 million for the third quarter of 2014 from $139.4 million for the third quarter of 2013 reflecting the overall decrease in the average balance of interest-earning assets and interest-bearing liabilities, the continued low interest rate environment and a continued increase in the average balance of short-term liquid assets, including U.S. Treasury securities and Federal funds sold and other overnight deposits. Our interest rate spread decreased to 0.88% for the third quarter of 2014 as compared to 1.22% for the third quarter of 2013. Our net interest margin was 1.18% for the third quarter of 2014 as compared to 1.48% for the third quarter of 2013.

 

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The decreases in our interest rate spread and net interest margin for the third quarter of 2014 as compared to the third quarter of 2013 are primarily due to repayments of higher yielding assets due to the low interest rate environment. The decrease in the annualized weighted average yield of interest-earning assets was due to lower market interest rates earned on mortgage-related assets. The decrease was also due to a $2.11 billion increase in the average balance of Federal funds sold and other overnight deposits to $5.33 billion with an average yield of 0.25% and an increase of $1.34 billion in investment securities with an annualized weighted-average yield of 0.56% during the third quarter of 2014 during this same period, all of which caused our average yield on interest earning assets to decline while the average cost of interest bearing liabilities rose slightly. The compression of our net interest margin and the reduction in the size of our balance sheet may result in a decline in our net interest income in future periods.

Provision for Loan Losses. We recorded a net credit provision for loan losses of $3.5 million for the quarter ended September 30, 2014 as compared to a provision for loan losses of $4.0 million for the quarter ended September 30, 2013. The ALL amounted to $242.2 million at September 30, 2014 as compared to $276.1 million at December 31, 2013 and $291.0 million at September 30, 2013. The net credit provision for loan losses and the decline in the ALL were primarily due to a decrease in non-performing loans and early stage delinquent loans. The decline in non-performing loans was primarily due to the sale of a pool of non-performing FHA loans as well as improving economic conditions, particularly in the housing and labor markets. The decline in the ALL also reflects improving home prices and economic conditions and a decrease in the size of the loan portfolio. See “Critical Accounting Policies – Allowance for Loan Losses.”

During the third quarter of 2014, we sold a pool of non-performing residential mortgage loans guaranteed by the FHA with an aggregate unpaid principal balance of $112.1 million to the financial institution that originally sold the loans to the Bank. The sale of the non-performing loan pool was in accordance with the repurchase right with respect to loans that become non-performing that the financial institution exercised pursuant to the terms of the original sale and servicing agreement between the Bank and the financial institution. As consideration for the sale of the non-performing loans, the Bank received from the financial institution an amount equal to 100% of the outstanding unpaid principal balance of the loans, plus all accrued and unpaid interest on the loans. The Bank may sell additional loans to the financial institution in the future, in the event the financial institution exercises its repurchase right with respect to any additional non-performing FHA loans.

Our primary lending emphasis is the origination and purchase of one- to four-family first mortgage loans on residential properties and, to a lesser extent, second mortgage loans on one- to four-family residential properties. Our loan production is primarily concentrated in one- to four-family mortgage loans with original loan-to-value (“LTV”) ratios of less than 80%. For the first nine months of 2014, the average LTV ratio for our first mortgage loan originations was 61.5%. The weighted average LTV ratio for our one-to four-family mortgage loan portfolio was 56.5% at September 30, 2014, using the appraised value of the collateral property at the time of origination. The value of the property used as collateral for our loans is dependent upon local market conditions. As part of our estimation of the ALL, we monitor changes in the values of homes in each market using indices published by various organizations. Based on our analysis of the data for the third quarter of 2014, we concluded that home values in our primary lending markets have increased approximately 4% since the third quarter of 2013.

Economic conditions in our primary market area continued to improve modestly during the first nine months of 2014 as evidenced by increased levels of home sale activity, higher real estate valuations and a decrease in the unemployment rate which, while improving, remains elevated. We continue to closely monitor the local and national real estate markets and other factors related to risks inherent in our loan portfolio.

 

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Non-performing loans amounted to $859.8 million at September 30, 2014 as compared to $1.05 billion at December 31, 2013 and $1.07 billion at September 30, 2013. Excluding the impact of the FHA loan sale, non-performing loans further declined during the quarter from $896.1 million at June 30, 2014 to $859.8 million at September 30, 2014. Non-performing loans at September 30, 2014 included $849.4 million of one- to four-family first mortgage loans as compared to $1.04 billion at December 31, 2013 and $1.06 billion at September 30, 2013. The ratio of non-performing loans to total loans was 3.86% at September 30, 2014 as compared to 4.35% at December 31, 2013 and 4.36% at September 30, 2013. Loans delinquent 30 to 59 days amounted to $295.7 million at September 30, 2014 as compared to $311.9 million at December 31, 2013 and $318.8 million at September 30, 2013. Loans delinquent 60 to 89 days amounted to $137.8 million at September 30, 2014 as compared to $161.5 million at December 31, 2013 and $154.6 million at September 30, 2013. Accordingly, total early stage delinquencies (loans 30 to 89 days past due) decreased $39.9 million to $433.5 million at September 30, 2014 from $473.4 million at December 31, 2013 and decreased $39.9 million from $473.4 million at September 30, 2013. Foreclosed real estate amounted to $78.5 million at September 30, 2014 as compared to $70.4 million at December 31, 2013, and $65.7 million at September 30, 2013. As a result of our underwriting policies, our borrowers typically have a significant amount of equity, at the time of origination, in the underlying real estate that we use as collateral for our loans. Due to the ability of real estate values to fluctuate, the LTV ratios based on appraisals obtained at time of origination do not necessarily indicate the extent to which we may incur a loss on any given loan that may go into foreclosure.

At September 30, 2014, the ratio of the ALL to non-performing loans was 28.17% as compared to 26.31% at December 31, 2013 and 27.17% at September 30, 2013. The ratio of the ALL to total loans was 1.09% at September 30, 2014 as compared to 1.15% at December 31, 2013 and 1.19% at September 30, 2013. Changes in the ratio of the ALL to non-performing loans are not, absent other factors, an indication of the adequacy of the ALL since there is not necessarily a direct relationship between changes in various asset quality ratios and changes in the ALL, non-performing loans and losses we may incur on our loan portfolio. A loan generally becomes non-performing when the borrower experiences financial difficulty. In many cases, the borrower also has a second mortgage or home equity loan on the property. In substantially all of these cases, we do not hold the second mortgage or home equity loan as that is not a business we have actively pursued.

We obtain updated collateral values by the time a loan becomes 180 days past due and annually thereafter. If the estimated fair value of the collateral (less estimated selling costs) is less than the recorded investment in the loan, we charge-off an amount to reduce the loan to the fair value of the collateral less estimated selling costs. As a result, certain losses inherent in our non-performing loans are being recognized as charge-offs which may result in a lower ratio of the ALL to non-performing loans. Charge-offs, net of recoveries amounted to $9.3 million for the third quarter of 2014 as compared to $10.3 million for the third quarter of 2013. Write-downs and net gains or losses on the sale of foreclosed real estate amounted to a net gain of $2.0 million for the third quarter of 2014 as compared to a net gain of $346,000 for the third quarter of 2013. The results of our reappraisal process, our recent charge-off history and our loss experience related to the sale of foreclosed real estate are considered in the determination of the ALL. Our loss experience on the sale of foreclosed real estate, calculated without regard for previous charge-offs and write-downs, was 12.8% for the nine months ended September 30, 2014 as compared to 17.8% for the nine months ended September 30, 2013.

As part of our estimation of the ALL, we monitor changes in the values of homes in each market using indices published by various organizations including the FHFA and Case Shiller. Our Asset Quality

 

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Committee (“AQC”) uses these indices and a stratification of our loan portfolio by state as part of its quarterly determination of the ALL. We do not apply different loss factors based on geographic locations since, at September 30, 2014, 84.6% of our loan portfolio and 77.7% of our non-performing loans are located in the New York metropolitan area. We obtain updated collateral values by the time a loan becomes 180 days past due and annually thereafter, which we believe identifies potential charge-offs more accurately than a house price index that is based on a wide geographic area and includes many different types of houses. However, we use house price indices to identify geographic trends in housing markets to determine if an overall adjustment to the ALL is required based on loans we have in those geographic areas and to determine if changes in the loss factors used in the ALL quantitative analysis are necessary. Our quantitative analysis of the ALL accounts for increases in non-performing loans by applying progressively higher risk factors to loans as they become more delinquent.

Due to the nature of our loan portfolio, our evaluation of the adequacy of our ALL is performed primarily on a “pooled” basis. Each quarter we prepare an analysis which categorizes the entire loan portfolio by certain risk characteristics such as loan type (fixed and variable one- to four-family, interest-only, reduced documentation, multi-family, commercial, construction, etc.), loan source (originated or purchased) and payment status (i.e., current or number of days delinquent). Loans with known potential losses are categorized separately. We assign estimated loss factors to the payment status categories on the basis of our assessment of the potential risk inherent in each loan type. These factors are periodically reviewed for appropriateness giving consideration to our loss experience, delinquency trends, portfolio growth and environmental factors such as the status of the regional economy and housing market, in order to ascertain that the loss factors cover probable and estimable losses inherent in the portfolio. We define our loss experience on non-performing loans as the ratio of the excess of the loan balance (including selling costs) over the updated collateral value to the principal balance of loans for which we have updated valuations. We obtain updated collateral values by the time a loan becomes 180 days past due and on an annual basis thereafter for as long as the loan remains non-performing. Based on our analysis, our loss experience on our non-performing one- to four-family first mortgage loans was approximately 12.5% for the twelve months ended September 30, 2014 compared to 13.6% for the twelve months ended December 31, 2013. Our loss experience analysis excludes the effect of the sale of FHA loans.

In addition to our loss experience, we also use environmental factors and qualitative analyses to determine the adequacy of our ALL. This analysis includes further evaluation of economic factors, such as trends in the unemployment rate, as well as a ratio analysis to evaluate the overall measurement of the ALL, a review of delinquency ratios, net charge-off ratios and the ratio of the ALL to both non-performing loans and total loans. The qualitative review is used to reassess the overall determination of the ALL and to ensure that directional changes in the ALL and the provision for loan losses are supported by relevant internal and external data.

We consider the average LTV of our non-performing loans and our total portfolio in relation to the overall changes in house prices in our lending markets when determining the ALL. This provides us with a “macro” indication of the severity of potential losses that might be expected. Since substantially all our portfolio consists of first mortgage loans on residential properties, the LTV is particularly important to us when a loan becomes non-performing. The weighted average LTV ratio in our one- to four-family mortgage loan portfolio at September 30, 2014 was 56.5%, using the appraised value of the collateral property at the time of origination. Based on the valuation indices, house prices have declined in the New York metropolitan area, where 77.7% of our non-performing loans were located at September 30, 2014, by approximately 18% from the peak of the market in 2006 through July 2014 and by 16% nationwide

 

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during that period. The average LTV ratio of our non-performing loans was approximately 68.3% at September 30, 2014 using appraised values at the time of origination. Changes in house values may affect our loss experience which may require that we change the loss factors used in our quantitative analysis of the ALL. There can be no assurance whether significant further declines in house values may occur and result in higher loss experience and increased levels of charge-offs and loan loss provisions.

Net charge-offs amounted to $9.3 million for the third quarter of 2014 as compared to net charge-offs of $10.3 million for the third quarter of 2013. Net charge-offs as a percentage of average loans was 0.17% for both the quarters ended September 30, 2014 and 2013.

Due to the unprecedented level of foreclosures and the desire by many states to slow the foreclosure process, we continue to experience a time frame to repayment or foreclosure of up to 48 months from the initial non-performing period. These delays have impacted our level of non-performing loans as these loans take longer to migrate to real estate owned and ultimate disposition. In addition, the highly publicized foreclosure issues that have affected the nation’s largest mortgage loan servicers has resulted in greater court and state attorney general scrutiny, and the time to complete a foreclosure continues to be prolonged, especially in New York and New Jersey where 69.6% of our non-performing loans are located. If real estate prices do not continue to improve or begin to decline, this extended time may result in further charge-offs. We continue to closely monitor the property values underlying our non-performing loans during this timeframe and take appropriate charge-offs when the loan balances exceed the underlying property values.

Commercial and construction loans evaluated for impairment amounted to $5.3 million, $8.7 million and $8.7 million at September 30, 2014, December 31, 2013 and September 30, 2013, respectively. Based on this evaluation, we established an ALL of $1,500 for these loans classified as impaired at September 30, 2014 as compared to $527,000 at December 31, 2013 and $527,000 at September 30, 2013.

Although we believe that we have established and maintained the ALL at adequate levels, additions may be necessary if future economic and other conditions differ substantially from the current operating environment. Changes in our loss experience on non-performing loans, the loss factors used in our quantitative analysis of the ALL and continued increases in overall loan delinquencies can have a significant impact on our need for increased levels of loan loss provisions in the future. Although we use the best information available, the level of the ALL remains an estimate that is subject to significant judgment and short-term change. See “Critical Accounting Policies.”

Non-Interest Income. Total non-interest income was $23.9 million for the third quarter of 2014 as compared to $13.5 million for the third quarter of 2013. Included in non-interest income for the third quarter of 2014 were $22.3 million in gains from the sale of $644.2 million of mortgage-backed securities. Gains on the sales of securities amounted to $10.6 million in the third quarter of 2013. We sold these mortgage-backed securities to realize gains that would likely decrease as market interest rates increase and as the outstanding principal balance of these securities decreases due to repayments. The remainder of non-interest income is primarily made up of service fees and charges on deposit and loan accounts.

Non-Interest Expense. Total non-interest expense decreased $8.5 million to $70.0 million for the third quarter of 2014 as compared to $78.5 million for the third quarter of 2013. This decrease was due to a $7.1 million decrease in Federal deposit insurance expense and a $2.1 million decrease in compensation and employee benefits partially offset by a $1.0 million increase in other non-interest expense.

 

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Compensation and employee benefit costs decreased $2.1 million, or 6.0%, to $32.7 million for the third quarter of 2014 as compared to $34.8 million for the same period in 2013. The decrease in compensation and employee benefit costs is primarily due to a $2.1 million decrease in compensation expense and a $1.3 million decrease in postretirement benefit costs, partially offset by increases of $904,000 in medical plan expenses and $504,000 in stock benefit plan expense. The decrease in compensation expense is a result of a reduced number of employees and lower expenses for the executive officer annual incentive plan. The increase in stock benefit plan expense was due primarily to an increase in the market price of our common stock. At September 30, 2014, we had 1,515 full-time equivalent employees as compared to 1,525 at September 30, 2013.

For the quarter ended September 30, 2014, Federal deposit insurance expense decreased $7.1 million, or 37.6%, to $11.8 million from $18.9 million for the quarter ended September 30, 2013. The decrease in Federal deposit insurance expense for the quarter ended September 30, 2014 is primarily due to a reduction in the size of our balance sheet and a decrease in our assessment rate.

Other non-interest expense increased $1.0 million to $16.5 million for the quarter ended September 30, 2014 as compared to $15.5 million for the third quarter of 2013. This increase was due primarily to increases of $1.1 million in foreclosed real estate expenses and $1.5 million in professional service fees, partially offset by a $1.7 million increase in net gains and write-downs on foreclosed real estate.

The increase in professional service fees is due primarily to fees related to the use of consultants to assist the Company in preparing its capital stress tests and capital plan as well as the use of consultants to supplement staffing during the pendency of the Merger with M&T.

Included in other non-interest expense were net gains of $2.0 million resulting from write-downs on foreclosed real estate and net gains on the sale of foreclosed real estate for the third quarter of 2014 as compared to a net gain of $346,000 for the third quarter of 2013. We sold 69 properties during the third quarter of 2014 and had 222 properties in foreclosed real estate with a carrying value of $78.5 million, 45 of which were under contract to sell as of September 30, 2014. For the third quarter of 2013, we sold 61 properties and had 180 properties in foreclosed real estate with a carrying value of $65.7 million, of which 23 were under contract to sell as of September 30, 2013.

Income Taxes. Income tax expense amounted to $25.2 million for the third quarter of 2014 as compared to income tax expense of $27.7 million for the corresponding period in 2013. Our effective tax rate for the third quarter of 2014 was 40.44% compared with 39.28% for the third quarter of 2013.

 

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Comparison of Operating Results for the Nine-Month Periods Ended September 30, 2014 and 2013

Average Balance Sheet. The following table presents the average balance sheets, average yields and costs and certain other information for the nine months ended September 30, 2014 and 2013. The table presents the annualized average yield on interest-earning assets and the annualized average cost of interest-bearing liabilities. We derived the yields and costs by dividing annualized income or expense by the average balance of interest-earning assets and interest-bearing liabilities, respectively, for the periods shown. We derived average balances from daily balances over the periods indicated. Interest income includes fees that we considered to be adjustments to yields. Yields on tax-exempt obligations were not computed on a tax equivalent basis. Nonaccrual loans were included in the computation of average balances and therefore have a zero yield. The yields set forth below include the effect of deferred loan origination fees and costs, and purchase discounts and premiums that are amortized or accreted to interest income.

 

     For the Nine Months Ended September 30,  
     2014     2013  
     Average
Balance
     Interest      Average
Yield/
Cost
    Average
Balance
     Interest      Average
Yield/
Cost
 
     (Dollars in thousands)  

Assets:

                

Interest-earnings assets:

                

First mortgage loans, net (1)

   $ 22,985,919       $ 741,900         4.30   $ 25,251,005       $ 844,571         4.46

Consumer and other loans

     207,508         6,632         4.26        232,984         7,693         4.40   

Federal funds sold and other overnight deposits

     5,073,555         9,589         0.25        2,618,817         4,676         0.24   

Mortgage-backed securities at amortized cost

     7,579,455         125,107         2.20        9,988,792         164,488         2.20   

Federal Home Loan Bank stock

     337,229         10,903         4.31        350,429         11,190         4.26   

Investment securities, at amortized cost

     862,341         5,233         0.81        439,080         7,254         2.20   
  

 

 

    

 

 

      

 

 

    

 

 

    

Total interest-earning assets

     37,046,007         899,364         3.24        38,881,107         1,039,872         3.57   
  

 

 

    

 

 

      

 

 

    

 

 

    

Noninterest-earnings assets (4)

     899,033              1,120,881         
  

 

 

         

 

 

       

Total Assets

   $ 37,945,040            $ 40,001,988         
  

 

 

         

 

 

       

Liabilities and Shareholders’ Equity:

                

Interest-bearing liabilities:

                

Savings accounts

     1,038,745         1,168         0.15      $ 978,388         1,482         0.20   

Interest-bearing transaction accounts

     2,164,280         4,554         0.28        2,243,344         5,601         0.33   

Money market accounts

     4,856,430         7,108         0.20        6,143,355         12,356         0.27   

Time deposits

     12,093,884         107,931         1.19        12,888,825         120,325         1.25   
  

 

 

    

 

 

      

 

 

    

 

 

    

Total interest-bearing deposits

     20,153,339         120,761         0.80        22,253,912         139,764         0.84   
  

 

 

    

 

 

      

 

 

    

 

 

    

Repurchase agreements

     6,317,033         212,293         4.43        6,950,000         234,396         4.45   

Federal Home Loan Bank of New York advances

     5,857,967         211,354         4.76        5,225,000         189,063         4.77   
  

 

 

    

 

 

      

 

 

    

 

 

    

Total borrowed funds

     12,175,000         423,647         4.59        12,175,000         423,459         4.59   
  

 

 

    

 

 

      

 

 

    

 

 

    

Total interest-bearing liabilities

     32,328,339         544,408         2.23        34,428,912         563,223         2.16   
  

 

 

    

 

 

      

 

 

    

 

 

    

Noninterest-bearing liabilities:

                

Noninterest-bearing deposits

     593,170              578,883         

Other noninterest-bearing liabilities

     206,070              262,631         
  

 

 

         

 

 

       

Total noninterest-bearing liabilities

     799,240              841,514         
  

 

 

         

 

 

       

Total liabilities

     33,127,579              35,270,426         

Shareholders’ equity

     4,817,461              4,731,562         
  

 

 

         

 

 

       

Total Liabilities and Shareholders’ Equity

   $ 37,945,040            $ 40,001,988         
  

 

 

         

 

 

       

Net interest income/net interest rate spread (2)

      $ 354,956         1.01         $ 476,649         1.41   
     

 

 

         

 

 

    

Net interest-earning assets/net interest margin (3)

   $ 4,717,668            1.29   $ 4,452,195            1.65
  

 

 

         

 

 

       

Ratio of interest-earning assets to interest-bearing liabilities

           1.15           1.13

 

(1) Amount includes deferred loan costs and non-performing loans and is net of the allowance for loan losses.
(2) Determined by subtracting the annualized weighted average cost of total interest-bearing liabilities from the annualized weighted average yield on total interest-earning assets.
(3) Determined by dividing annualized net interest income by total average interest-earning assets.
(4) Includes the average balance of principal receivable related to FHLMC mortgage-backed securities of $45.9 million and $99.6 million for the nine months ended September 30, 2014 and 2013, respectively.

 

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General. Net income was $118.8 million for the nine months ended September 30, 2014 as compared to net income of $139.4 million for the nine months ended September 30, 2013. Both basic and diluted earnings per common share were $0.24 for the nine months ended September 30, 2014 as compared to both basic and diluted earnings per share of $0.28 for the nine months ended September 30, 2013. For the nine months ended September 30, 2014, our annualized return on average shareholders’ equity was 3.29%, compared with 3.93% for the nine months ended September 30, 2013. Our annualized return on average assets for the nine months ended September 30, 2014 was 0.42% as compared to 0.46% for the nine months ended September 30, 2013.

Interest and Dividend Income. Total interest and dividend income for the nine months ended September 30, 2014 decreased $140.5 million, or 13.5%, to $899.4 million from $1.04 billion for the nine months ended September 30, 2013. The decrease in total interest and dividend income was primarily due to a decrease in the average balance of total interest-earning assets of $1.83 billion, or 4.7%, to $37.05 billion for the nine months ended September 30, 2014 from $38.88 billion for the nine months ended September 30, 2013. The decrease in total interest and dividend income was also due to a decrease of 33 basis points in the annualized weighted-average yield on total interest-earning assets to 3.24% for the nine months ended September 30, 2014 from 3.57% for the nine months ended September 30, 2013. The decrease in the average balance of total interest-earning assets was due primarily to repayments of mortgage-related assets during the first nine months of 2014 as a result of the low interest rate environment and our decision not to reinvest in low yielding, long term assets. The decrease in the annualized weighted-average yield of interest-earning assets was due to lower market interest rates earned on mortgage-related assets and a $2.45 billion increase in the average balance of Federal funds and other overnight deposits which had an average yield of 0.25% during the nine months ended September 30, 2014 and a $423.2 million increase in the average balance of investment securities with an annualized weighted-average yield of 0.81% for the nine months ended September 30, 2014.

For the nine months ended September 30, 2014, interest on first mortgage loans decreased $102.7 million, or 12.2%, to $741.9 million from $844.6 million for the nine months ended September 30, 2013. This was primarily due to a $2.26 billion decrease in the average balance of first mortgage loans to $22.99 billion for the nine months ended September 30, 2014 from $25.25 billion for the nine months ended September 30, 2013. The decrease in interest income on mortgage loans was also due to a 16 basis point decrease in the annualized weighted-average yield to 4.30% for the nine months ended September 30, 2014 from 4.46% for the nine months ended September 30, 2013.

The decrease in the annualized weighted-average yield earned on first mortgage loans during the nine months ended September 30, 2014 was due to repayments of higher-yielding loans. Consequently, the average yield on our loan portfolio continued to decline during the first nine months of 2014.

Interest on consumer and other loans decreased $1.1 million to $6.6 million for the nine months ended September 30, 2014 from $7.7 million for the nine months ended September 30, 2013. The average balance of consumer and other loans decreased $25.5 million to $207.5 million for the first nine months of 2014 from $233.0 million for the first nine months of 2013 and the annualized weighted-average yield earned decreased 14 basis points to 4.26% from 4.40% for those same respective periods. The average balance of consumer loans decreased as consumer loans is not a business that we actively pursue. The decrease in the annualized weighted-average yield is a result of current market interest rates.

Interest on mortgage-backed securities decreased $39.4 million to $125.1 million for the nine months ended September 30, 2014 from $164.5 million for the nine months ended September 30, 2013. This

 

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decrease was due primarily to a $2.41 billion decrease in the average balance of mortgage-backed securities to $7.58 billion during the first nine months of 2014 from $9.99 billion for the first nine months of 2013. The annualized weighted-average yield of mortgage-backed securities was 2.20% for both the nine months ended September 30, 2014 and 2013.

The decrease in the average balance of mortgage-backed securities during the nine month period ended September 30, 2014 was due to sales of mortgage-backed securities and principal repayments. During the first nine months of 2014, we sold $1.63 billion of mortgage-backed securities to realize gains that would decrease as market interest rates increase and as repayments reduced the outstanding principal balance on these securities.

For the nine months ended September 30, 2014, interest on investment securities decreased $2.1 million to $5.2 million as compared to $7.3 million for the nine months ended September 30, 2013. This decrease was due to a decrease of 139 basis points in the annualized weighted-average yield to 0.81% for the first nine months of 2014 from 2.20% for the same period in 2013. This decrease was partially offset by an increase of $423.2 million in the average balance of investment securities to $862.3 million for the first nine months of 2014 as compared to $439.1 million for the first nine months of 2013.

The increase in the average balance of investment securities during the nine month period ended September 30, 2014 was due to the purchase of $1.80 billion of U.S. Treasury securities during the first nine months of 2014. The decrease in the annualized weighted-average yield earned on investment securities during this same period is due to the yield earned on the U.S. Treasury securities purchased which was 0.34%.

Dividends on FHLB stock decreased $287,000 or 2.6%, to $10.9 million for the nine months ended September 30, 2014 from $11.2 million for the nine months ended September 30, 2013. The decrease was primarily due to a $13.2 million decrease in the average balance of FHLB stock to $337.2 million for the first nine months of 2014 as compared to $350.4 million for the first nine months of 2013. The annualized weighted-average dividend yield earned on FHLB stock was 4.31% for the nine months ended September 30, 2014 as compared to 4.26% for the same period in 2013.

Interest on Federal funds sold and other overnight deposits amounted to $9.6 million for the nine months ended September 30, 2014 as compared to $4.7 million for the nine months ended September 30, 2013 due primarily to an increase in the average balance of Federal funds sold and other overnight deposits. The average balance of Federal funds sold and other overnight deposits amounted to $5.07 billion for the first nine months of 2014 as compared to $2.62 billion for the same period in 2013. The yield earned on Federal funds and other overnight deposits was 0.25% for the nine months ended September 30, 2014 and 0.24% for the same period in 2013, respectively.

The increase in the average balance of Federal funds sold and other overnight deposits for the nine month period ended September 30, 2014 was due primarily to repayments and sales of mortgage-related assets and our low appetite for adding long-term fixed-rate mortgage loans to our portfolio in the current low interest rate environment.

Interest Expense. For the nine months ended September 30, 2014, total interest expense decreased $18.8 million, or 3.3%, to $544.4 million from $563.2 million for the nine months ended September 30, 2013. This decrease was primarily due to a $2.10 billion, or 6.1%, decrease in the average balance of total interest-bearing liabilities to $32.33 billion for the nine months ended September 30, 2014 compared with $34.43 billion for the nine months ended September 30, 2013. This was partially offset by an

 

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increase in the annualized weighted-average cost of total interest-bearing liabilities to 2.23% for the nine months ended September 30, 2014 as compared to 2.16% for the nine months ended September 30, 2013. The decrease in the average balance of total interest-bearing liabilities was due entirely to a decrease in the average balance of total deposits.

The increase in the average cost of interest-bearing liabilities during the nine months ended September 30, 2014 was due to a decrease in the average balance of interest-bearing deposits which have a lower weighted-average cost than our borrowed funds, the average balances of which remained unchanged. Interest-bearing deposits accounted for 62% of interest-bearing liabilities for the nine months ended September 30, 2014 as compared to 65% for the same respective period in 2013.

Interest expense on deposits decreased $19.0 million, or 13.6%, to $120.8 million for the nine months ended September 30, 2014 from $139.8 million for the nine months ended September 30, 2013. The decrease is primarily due to a $2.10 billion decrease in the average balance of interest-bearing deposits to $20.15 billion for the first nine months of 2014 from $22.25 billion for the first nine months of 2013. The decrease is also due to a decrease in the average cost of interest-bearing deposits of 4 basis points to 0.80% for the first nine months of 2014 from 0.84% for the first nine months of 2013.

Interest expense on our time deposit accounts decreased $12.4 million to $107.9 million for the nine months ended September 30, 2014 as compared to $120.3 million for the nine months ended September 30, 2013. This decrease was due to a $794.9 million decrease in the average balance of time deposit accounts to $12.09 billion for the nine months ended September 30, 2014 from $12.89 billion for the same period in 2013. The decrease was also due to a 6 basis point decrease in the annualized weighted-average cost to 1.19% for the nine months ended September 30, 2014 compared with 1.25% for the nine months ended September 30, 2013 as maturing time deposits were renewed or replaced by new time deposits at lower rates. The decline in the average balance of our time deposits reflects our decision to maintain lower deposit rates to continue our balance sheet reduction.

Interest expense on money market accounts decreased $5.3 million to $7.1 million for the nine months ended September 30, 2014 from $12.4 million for the nine months ended September 30, 2013. This decrease was due to a decrease in the annualized weighted-average cost of 7 basis points to 0.20% for the nine months ended September 30, 2014 from 0.27% for the nine months ended September 30, 2013. This decrease was also the result of a $1.28 billion decrease in the average balance of money market accounts to $4.86 billion for the nine months ended September 30, 2014 from $6.14 billion for the nine months ended September 30, 2013.

Interest expense on our interest-bearing transaction accounts decreased $1.0 million to $4.6 million for the nine months ended September 30, 2014 from $5.6 million for the same period in 2013. The decrease is due to a 5 basis point decrease in the annualized weighted-average cost to 0.28% for the nine months ended September 30, 2014 as compared to 0.33% for the same period in 2013. The decrease was also the result of $79.1 million decrease in the average balance to $2.16 billion for the nine months ended September 30, 2014 as compared to $2.24 billion for the same period in 2013.

The decrease in the average cost of deposits for the first nine months of 2014 reflected lower market interest rates and our decision to maintain lower deposit rates to continue our balance sheet reduction.

For the nine months ended September 30, 2014 interest expense on borrowed funds was $423.6 million as compared to $423.5 million for the nine months ended September 30, 2013. The average cost of borrowed funds was 4.59% for both the nine months ended September 30, 2014 and 2013. The average balance of borrowings was unchanged for both comparative periods.

 

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Borrowings amounted to $12.18 billion at September 30, 2014 with an average cost of 4.59%. There are no scheduled maturities for 2014.

Net Interest Income. Net interest income decreased $121.6 million, or 25.5%, to $355.0 million for the first nine months of 2014 as compared to $476.6 million for the first nine months of 2013. Our interest rate spread decreased 40 basis points to 1.01% for the nine months ended September 30, 2014 as compared to 1.41% for the nine months ended September 30, 2013. Our net interest margin decreased 36 basis points to 1.29% for the nine months ended September 30, 2014 as compared to 1.65% for the nine months ended September 30, 2013. The decreases in our interest rate spread and net interest margin for the nine months ended September 30, 2014 was primarily due to repayments of higher yielding assets due to the low interest rate environment. The decrease is also due to an increase in the average balance of Federal funds and other overnight deposits and U.S. Treasury securities which yield 0.25% and 0.34%, respectively.

Provision for Loan Losses. We recorded a net credit provision for loan losses of $3.5 million during the third quarter of 2014 after recording no provision for loan losses in each of the first and second quarters of 2014, resulting in a decrease of $40.0 million for the nine months ended September 30, 2014 as compared to the same period in 2013. The ALL amounted to $242.2 million at September 30, 2014 and $276.1 million at December 31, 2013. The net credit provision for loan losses and the decline in the ALL were primarily due to a decrease in non-performing loans and early stage delinquencies. The decline in non-performing loans was primarily due to the sale of a pool of non-performing FHA loans as well as improving economic conditions, particularly in the housing and labor markets. The decline in the ALL reflects improving home prices and economic conditions, a decrease in the size of the loan portfolio and a decrease in the amount of total delinquent loans. We recorded our provision for loan losses during the first nine months of 2014 based on our ALL methodology that considers a number of quantitative and qualitative factors, including the amount of non-performing loans, the loss experience of our non-performing loans, recent collateral valuations, conditions in the real estate and housing markets, current economic conditions, particularly continued elevated levels of unemployment, and growth or shrinkage in the loan portfolio. See “Comparison of Operating Results for the Three Months Ended September 30, 2014 and 2013 – Provision for Loan Losses.”

Non-Interest Income. Total non-interest income was $62.9 million for the first nine months of 2014 as compared to $25.6 million for the same period in 2013. Included in non-interest income for the first nine months of 2014 were $57.8 million in gains from the sale of $1.63 billion of mortgage-backed securities. Gains on the sales of securities amounted to $17.8 million for the nine months ended September 30, 2013.

Non-Interest Expense. Total non-interest expense amounted to $222.9 million for the nine months ended September 30, 2014 as compared to $236.4 million for the nine months ended September 30, 2013. This decrease was due to a $23.7 million decrease in Federal deposit insurance expense and a $331,000 decrease in compensation and employee benefit expense, partially offset by a $10.2 million increase in other non-interest expense.

Compensation and employee benefit costs decreased $331,000 to $98.7 million for the first nine months of 2014 as compared to $99.0 million for the same period in 2013. The decrease in compensation and employee benefit costs is primarily due to decreases of $4.1 million in pension plan expense and $4.0 million in compensation expense. The decreases were partially offset by increases of $3.6 million in stock benefit plan expense and $3.8 million in medical plan expenses. The decrease in pension plan expense was due primarily to a decrease in the amortization of net actuarial losses during the nine months ended September 30, 2014 as compared to the same period in 2013. The decrease in compensation expense is a result of a reduced number of employees and lower expenses for the executive officer annual incentive plan.

 

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For the nine months ended September 30, 2014 Federal deposit insurance expense decreased $23.7 million, or 37.9%, to $38.8 million from $62.5 million for the nine months ended September 30, 2013. This decrease was due primarily to a reduction in the size of our balance sheet and a decrease in our assessment rate.

For the nine months ended September 30, 2014, other non-interest expense increased $10.2 million to $57.1 million as compared to $46.9 million for the same period in 2013. This increase was due to a $5.5 million increase in professional fees, a $3.3 million increase in foreclosed property expenses and a $3.0 million increase in our reserve related to our claim against the Lehman Brothers, Inc. estate.

The increase in professional fees is due primarily to fees related to the use of consultants to assist the Company in preparing its capital stress tests and capital plan as well as the use of consultants to supplement staffing during the pendency of the Merger.

The Bank had two collateralized borrowings in the form of repurchase agreements totaling $100.0 million with Lehman Brothers, Inc. that were secured by mortgage-backed securities with an amortized cost of approximately $114.1 million. The trustee for the liquidation of Lehman Brothers, Inc. (the “Trustee”) notified the Bank in the fourth quarter of 2011 that it considered our claim to be a non-customer claim, which has a lower payment preference than a customer claim and that the value of such claim is approximately $13.9 million representing the excess of the fair value of the collateral over the $100.0 million repurchase price. At that time we established a reserve of $3.9 million against the receivable balance at December 31, 2011. On June 25, 2013, the Bankruptcy Court affirmed the Trustee’s determination that the repurchase agreements did not entitle the Bank to customer status and on February 26, 2014, the U.S. District Court upheld the Bankruptcy Court’s decision that our claim should be treated as a non-customer claim. As a result, we increased our reserve by $3.0 million to $6.9 million against the receivable balance during the first quarter of 2014. During the third quarter of 2014, the Bank received a partial payment on our non-customer claim of $2.4 million reducing the claim amount to $11.4 million as of September 30, 2014.

Included in other non-interest expense were net gains of $2.7 million resulting from write-downs on foreclosed real estate and net gains on the sale of foreclosed real estate for the nine months ended September 30, 2014 as compared to a net gain of $753,000 for the comparable period in 2013. We sold 185 properties during the first nine months of 2014 as compared to 152 properties for the same period in 2013. Expenses associated with foreclosed real estate were $13.6 million and $10.3 million for the nine months ended September 30, 2014 and 2013, respectively.

Income Taxes. Income tax expense amounted to $79.6 million for the nine months ended September 30, 2014 compared with income tax expense of $90.0 million for the nine months ended September 30, 2013. Our effective tax rate for the nine months ended September 30, 2014 was 40.13% compared with 39.23% for the nine months ended September 30, 2013.

On March 31, 2014, New York tax legislation was signed into law in connection with the approval of the New York State 2014-2015 budget that will generally become effective on January 1, 2015. Portions of the new legislation will result in significant changes in the method of calculation of income taxes for banks and thrifts operating in New York State, including changes to (1) future period tax rates and (2) rules related to the sourcing of revenue. At this time, we expect the changes to the New York tax code

 

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will cause our effective tax rate to increase. The amount of such increase will depend on the amount of revenues that are sourced to New York State under the new legislation, which can be expected to fluctuate over time. The changes in the tax code had an immaterial effect on the carrying value of the Company’s net deferred tax asset at March 31, 2014 (the date the legislation was signed into law).

 

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Asset Quality

Credit Quality

Historically, our primary lending emphasis has been the origination and purchase of one- to four-family first mortgage loans on residential properties. Our lending market areas generally consist of those states that are east of the Mississippi River and as far south as South Carolina. Loans located outside of the New York metropolitan area were part of our loan purchases. Our loan purchase activity has declined significantly as sellers from whom we have historically purchased loans are either retaining these loans in their portfolios or selling them to the GSEs.

The following table presents the composition of our loan portfolio in dollar amounts and in percentages of the total portfolio at the dates indicated:

 

     September 30, 2014     December 31, 2013  
     Amount     Percent
of Total
    Amount     Percent
of Total
 
     (Dollars in thousands)  

First mortgage loans:

        

One- to four-family:

        

Amortizing

   $ 18,333,026        82.31   $ 19,518,912        80.95

Interest-only

     3,074,839        13.81        3,648,732        15.13   

FHA/VA

     645,500        2.90        704,532        2.92   

Multi-family and commercial

     17,451        0.08        25,671        0.11   

Construction

     177        —          294        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total first mortgage loans

     22,070,993        99.10        23,898,141        99.11   
  

 

 

   

 

 

   

 

 

   

 

 

 

Consumer and other loans