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EX-32 - EXHIBIT 32 - VALLEY NATIONAL BANCORPvly-9302016ex32.htm
EX-31.2 - EXHIBIT 31.2 - VALLEY NATIONAL BANCORPvly-9302016ex312.htm
EX-31.1 - EXHIBIT 31.1 - VALLEY NATIONAL BANCORPvly-9302016ex311.htm
EX-10.1 - EXHIBIT 10.1 - VALLEY NATIONAL BANCORPexhibit101rudyschupp.htm


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 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, 2016
OR
¨

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 1-11277 
 
 

VALLEY NATIONAL BANCORP
(Exact name of registrant as specified in its charter)
 
 
New Jersey
 
22-2477875
(State or other jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification Number)
 
 
1455 Valley Road
Wayne, NJ
 
07470
(Address of principal executive office)
 
(Zip code)
973-305-8800
(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 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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one):
Large accelerated filer
x
Accelerated filer
¨
 
 
 
 
Non-accelerated filer
¨ (Do not check if a smaller reporting company)
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
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. Common Stock (no par value), of which 254,529,715 shares were outstanding as of November 3, 2016
 




TABLE OF CONTENTS
 
 
 
Page
Number
PART I
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
PART II
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 6.
 
 


1




PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
VALLEY NATIONAL BANCORP
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(in thousands, except for share data)
 
September 30,
2016
 
December 31,
2015
Assets
(Unaudited)
 
 
Cash and due from banks
$
238,664

 
$
243,575

Interest bearing deposits with banks
160,462

 
170,225

Investment securities:
 
 
 
Held to maturity (fair value of $1,891,982 at September 30, 2016 and $1,621,039 at December 31, 2015)
1,845,151

 
1,596,385

Available for sale
1,276,709

 
1,506,861

Total investment securities
3,121,860

 
3,103,246

Loans held for sale (includes fair value of $27,868 at September 30, 2016 and $16,832 at December 31, 2015 for loans originated for sale)
202,369

 
16,382

Loans
16,634,135

 
16,043,107

Less: Allowance for loan losses
(110,697
)
 
(106,178
)
Net loans
16,523,438

 
15,936,929

Premises and equipment, net
294,165

 
298,943

Bank owned life insurance
390,600

 
387,542

Accrued interest receivable
63,815

 
63,554

Goodwill
689,589

 
686,339

Other intangible assets, net
44,038

 
48,882

Other assets
639,453

 
656,999

Total Assets
$
22,368,453

 
$
21,612,616

Liabilities
 
 
 
Deposits:
 
 
 
Non-interest bearing
$
5,092,740

 
$
4,914,285

Interest bearing:
 
 
 
Savings, NOW and money market
8,759,562

 
8,181,362

Time
3,119,881

 
3,157,904

Total deposits
16,972,183

 
16,253,551

Short-term borrowings
1,433,356

 
1,076,991

Long-term borrowings
1,450,818

 
1,810,728

Junior subordinated debentures issued to capital trusts
41,536

 
41,414

Accrued expenses and other liabilities
213,487

 
222,841

Total Liabilities
20,111,380

 
19,405,525

Shareholders’ Equity
 
 
 
Preferred stock (no par value, authorized 30,000,000 shares; issued 4,600,000 shares at September 30, 2016 and December 31, 2015)
111,590

 
111,590

Common stock (no par value, authorized 332,023,233 shares; issued 254,492,480 shares at September 30, 2016 and 253,787,561 shares at December 31, 2015)
89,007

 
88,626

Surplus
1,937,572

 
1,927,399

Retained earnings
153,531

 
125,171

Accumulated other comprehensive loss
(34,343
)
 
(45,695
)
Treasury stock, at cost (30,574 common shares at September 30, 2016)
(284
)
 

Total Shareholders’ Equity
2,257,073

 
2,207,091

Total Liabilities and Shareholders’ Equity
$
22,368,453

 
$
21,612,616

See accompanying notes to consolidated financial statements.

2




VALLEY NATIONAL BANCORP
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
(in thousands, except for share data)
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
Interest Income
 
 
 
 
 
 
 
Interest and fees on loans
$
171,143

 
$
157,141

 
$
506,640

 
$
465,787

Interest and dividends on investment securities:
 
 
 
 
 
 
 
Taxable
14,232

 
12,148

 
42,487

 
39,313

Tax-exempt
4,023

 
3,593

 
11,447

 
10,800

Dividends
1,612

 
1,658

 
4,408

 
5,013

Interest on federal funds sold and other short-term investments
193

 
150

 
846

 
516

Total interest income
191,203

 
174,690

 
565,828

 
521,429

Interest Expense
 
 
 
 
 
 
 
Interest on deposits:
 
 
 
 
 
 
 
Savings, NOW and money market
10,165

 
5,587

 
29,369

 
17,493

Time
9,412

 
9,535

 
28,220

 
25,637

Interest on short-term borrowings
3,545

 
126

 
8,537

 
427

Interest on long-term borrowings and junior subordinated debentures
13,935

 
25,482

 
45,948

 
75,649

Total interest expense
37,057

 
40,730

 
112,074

 
119,206

Net Interest Income
154,146

 
133,960

 
453,754

 
402,223

Provision for credit losses
5,840

 
94

 
8,069

 
4,594

Net Interest Income After Provision for Credit Losses
148,306

 
133,866

 
445,685

 
397,629

Non-Interest Income
 
 
 
 
 
 
 
Trust and investment services
2,628

 
2,450

 
7,612

 
7,520

Insurance commissions
4,580

 
4,119

 
14,133

 
12,454

Service charges on deposit accounts
5,263

 
5,241

 
15,460

 
15,794

(Losses) gains on securities transactions, net
(10
)
 
157

 
258

 
2,481

Fees from loan servicing
1,598

 
1,703

 
4,753

 
4,948

Gains on sales of loans, net
4,823

 
2,014

 
9,723

 
3,034

Gains (losses) on sales of assets, net
310

 
(558
)
 
1,009

 
(77
)
Bank owned life insurance
1,683

 
1,806

 
5,464

 
5,188

Change in FDIC loss-share receivable
(313
)
 
(55
)
 
(872
)
 
(3,380
)
Other
4,291

 
4,042

 
13,025

 
11,802

Total non-interest income
24,853

 
20,919

 
70,565

 
59,764

Non-Interest Expense
 
 
 
 
 
 
 
Salary and employee benefits expense
58,107

 
54,315

 
174,438

 
165,601

Net occupancy and equipment expense
20,658

 
21,526

 
65,615

 
65,858

FDIC insurance assessment
4,804

 
4,168

 
14,998

 
11,972

Amortization of other intangible assets
2,675

 
2,232

 
8,452

 
6,721

Professional and legal fees
4,031

 
4,643

 
13,398

 
12,043

Amortization of tax credit investments
6,450

 
5,224

 
21,360

 
14,231

Telecommunication expense
2,459

 
2,050

 
7,139

 
6,101

Other
14,084

 
14,494

 
45,896

 
41,655

Total non-interest expense
113,268

 
108,652

 
351,296

 
324,182

Income Before Income Taxes
59,891

 
46,133

 
164,954

 
133,211

Income tax expense
17,049

 
10,179

 
46,898

 
34,925

Net Income
$
42,842

 
$
35,954

 
$
118,056

 
$
98,286

Dividends on preferred stock
1,797

 
2,017

 
5,391

 
2,017

Net Income Available to Common Shareholders
$
41,045

 
$
33,937

 
$
112,665

 
$
96,269

Earnings Per Common Share:
 
 
 
 
 
 
 
Basic
$
0.16

 
$
0.15

 
$
0.44

 
$
0.41

Diluted
0.16

 
0.15

 
0.44

 
0.41

Cash Dividends Declared per Common Share
0.11

 
0.11

 
0.33

 
0.33

Weighted Average Number of Common Shares Outstanding:
 
 
 
 
 
 
Basic
254,473,994

 
232,737,953

 
254,310,769

 
232,548,840

Diluted
254,940,307

 
232,780,219

 
254,698,593

 
232,565,695

See accompanying notes to consolidated financial statements.

3




VALLEY NATIONAL BANCORP
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
(in thousands)
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
Net income
$
42,842

 
$
35,954

 
$
118,056

 
$
98,286

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Unrealized gains and losses on available for sale securities
 
 
 
 
 
 
 
Net gains arising during the period
4,902

 
4,586

 
12,550

 
2,677

Less reclassification adjustment for net losses (gains) included in net income
6

 
(91
)
 
(162
)
 
(1,445
)
Total
4,908

 
4,495

 
12,388

 
1,232

Non-credit impairment losses on available for sale securities
 
 
 
 
 
 
 
Net change in non-credit impairment losses on securities
(74
)
 
252

 
168

 
(200
)
Less reclassification adjustment for accretion of credit impairment losses included in net income
(50
)
 
(267
)
 
(336
)
 
(371
)
Total
(124
)
 
(15
)
 
(168
)
 
(571
)
Unrealized gains and losses on derivatives (cash flow hedges)
 
 
 
 
 
 
 
Net gains (losses) on derivatives arising during the period
1,735

 
(6,163
)
 
(6,939
)
 
(10,291
)
Less reclassification adjustment for net losses included in net income
2,095

 
772

 
5,943

 
2,714

Total
3,830

 
(5,391
)
 
(996
)
 
(7,577
)
Defined benefit pension plan
 
 
 
 
 
 
 
Amortization of net loss
42

 
119

 
128

 
359

Total other comprehensive income (loss)
8,656

 
(792
)
 
11,352

 
(6,557
)
Total comprehensive income
$
51,498

 
$
35,162

 
$
129,408

 
$
91,729

See accompanying notes to consolidated financial statements.


4




VALLEY NATIONAL BANCORP
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(in thousands)
 
Nine Months Ended
September 30,
 
2016
 
2015
Cash flows from operating activities:
 
 
 
Net income
$
118,056

 
$
98,286

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
18,593

 
15,213

Stock-based compensation
7,382

 
6,512

Provision for credit losses
8,069

 
4,594

Net amortization of premiums and accretion of discounts on securities and borrowings
14,152

 
17,595

Amortization of other intangible assets
8,452

 
6,721

Gains on securities transactions, net
(258
)
 
(2,481
)
Proceeds from sales of loans held for sale
337,069

 
94,342

Gains on sales of loans, net
(9,723
)
 
(3,034
)
Originations of loans held for sale
(342,989
)
 
(86,274
)
(Gains) losses on sales of assets, net
(1,009
)
 
77

FDIC loss-share receivable (excluding reimbursements)
872

 
3,380

Net change in:
 
 
 
Trading securities

 
14,233

Fair value of borrowings hedged by derivative transactions
6,646

 
3,270

Cash surrender value of bank owned life insurance
(5,464
)
 
(5,188
)
Accrued interest receivable
(261
)
 
(199
)
Other assets
(2,170
)
 
(33,555
)
Accrued expenses and other liabilities
(9,888
)
 
12,490

Net cash provided by operating activities
147,529

 
145,982

Cash flows from investing activities:
 
 
 
Net loan originations
(182,893
)
 
(486,862
)
Loans purchased
(593,769
)
 
(1,066,934
)
Investment securities held to maturity:
 
 
 
Purchases
(502,833
)
 
(201,681
)
Sales

 
11,666

Maturities, calls and principal repayments
243,764

 
321,771

Investment securities available for sale:
 
 
 
Purchases
(557,978
)
 
(38,819
)
Sales
2,081

 
14,022

Maturities, calls and principal repayments
800,967

 
115,397

Death benefit proceeds from bank owned life insurance
2,406

 

Proceeds from sales of real estate property and equipment
18,243

 
10,510

Purchases of real estate property and equipment
(17,155
)
 
(23,139
)
Reimbursements from the FDIC
269

 
2,835

Net cash used in investing activities
(786,898
)
 
(1,341,234
)
Cash flows from financing activities:
 
 
 
Net change in deposits
718,632

 
465,747

Net change in short-term borrowings
356,365

 
156,160

Proceeds from issuance of long-term borrowings, net
385,000

 
98,930

Repayments of long-term borrowings
(749,000
)
 
(100,000
)
Proceeds from issuance of preferred stock, net

 
111,590

Cash dividends paid to preferred shareholders
(5,391
)
 
(2,017
)
Cash dividends paid to common shareholders
(83,821
)
 
(76,671
)
Purchase of common shares to treasury
(1,700
)
 
(2,108
)
Common stock issued, net
4,610

 
4,993

Net cash provided by financing activities
624,695

 
656,624

Net change in cash and cash equivalents
(14,674
)
 
(538,628
)
Cash and cash equivalents at beginning of year
413,800

 
830,407

Cash and cash equivalents at end of period
$
399,126

 
$
291,779


5





VALLEY NATIONAL BANCORP
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(in thousands)

 
Nine Months Ended
September 30,
 
2016
 
2015
Supplemental disclosures of cash flow information:
 
 
 
Cash payments for:
 
 
 
Interest on deposits and borrowings
$
115,253

 
$
121,907

Federal and state income taxes
24,464

 
49,932

Supplemental schedule of non-cash investing activities:
 
 
 
Transfer of loans to other real estate owned
$
7,611

 
$
8,711

Transfer of loans to loans held for sale
174,501

 

See accompanying notes to consolidated financial statements.







 




6




VALLEY NATIONAL BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Basis of Presentation
The unaudited consolidated financial statements of Valley National Bancorp, a New Jersey corporation (Valley), include the accounts of its commercial bank subsidiary, Valley National Bank (the “Bank”), and all of Valley’s direct or indirect wholly-owned subsidiaries. All inter-company transactions and balances have been eliminated. The accounting and reporting policies of Valley conform to U.S. generally accepted accounting principles (U.S. GAAP) and general practices within the financial services industry. In accordance with applicable accounting standards, Valley does not consolidate statutory trusts established for the sole purpose of issuing trust preferred securities and related trust common securities.
In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly Valley’s financial position, results of operations and cash flows at September 30, 2016 and for all periods presented have been made. The results of operations for the three and nine months ended September 30, 2016 are not necessarily indicative of the results to be expected for the entire fiscal year.
In preparing the unaudited consolidated financial statements in conformity with U.S. GAAP, management has made estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated statements of financial condition and results of operations for the periods indicated. Material estimates that are particularly susceptible to change are: the allowance for loan losses; the evaluation of goodwill and other intangible assets, and investment securities for impairment; fair value measurements of assets and liabilities; and income taxes. Estimates and assumptions are reviewed periodically and the effects of revisions are reflected in the consolidated financial statements in the period they are deemed necessary. While management uses its best judgment, actual amounts or results could differ significantly from those estimates. The current economic environment has increased the degree of uncertainty inherent in these material estimates.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP and industry practice have been condensed or omitted pursuant to rules and regulations of the SEC. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in Valley’s Annual Report on Form 10-K for the year ended December 31, 2015.
In August 2016, we elected to prepay $405 million of FHLB borrowings with various maturity dates in 2018. The prepaid borrowings with a total average cost of 3.69 percent were funded with a new fixed-rate five-year FHLB advance totaling $405 million. The transaction was accounted for as a debt modification under U.S. GAAP. As a result, the new advance has an adjusted annual interest rate of 2.51 percent, after amortization of prepayment penalties totaling $20 million paid to the FHLB.
Note 2. Business Combinations

On January 4, 2016, Masters Coverage Corp., an all-line insurance agency that is a wholly-owned subsidiary of the Bank, acquired certain assets of an independent insurance agency located in New York. The purchase price totaled approximately $1.4 million in cash and future cash consideration. The transaction generated goodwill and other intangible assets totaling $701 thousand and $660 thousand, respectively.

On December 1, 2015, Valley completed its acquisition of CNLBancshares, Inc. (CNL) and its wholly-owned subsidiary, CNLBank, headquartered in Orlando, Florida, a commercial bank with approximately $1.6 billion in assets, $825 million in loans, and $1.2 billion in deposits and 16 branch offices on the date of its acquisition by Valley. The common shareholders of CNL received 0.705 of a share of Valley common stock for each CNL share they owned prior to the merger. The total consideration for the acquisition was approximately $230 million, consisting of 20.6 million shares of Valley's common stock.


7




During the first quarter of 2016, Valley revised the estimated fair values of the acquired assets as of the acquisition date as the result of additional information obtained. The adjustments mostly related to the fair value of certain purchased credit-impaired (PCI) loans, core deposit intangibles and time deposits which, on a combined basis, resulted in a $2.5 million increase in goodwill (see Note 10 for amount of goodwill as allocated to Valley's business segments). If additional information (that existed at the date of close) becomes available, the fair value estimates for acquired assets and assumed liabilities are subject to change for up to one year after the closing date of the CNL acquisition.
Note 3. Earnings Per Common Share
The following table shows the calculation of both basic and diluted earnings per common share for the three and nine months ended September 30, 2016 and 2015.
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
 
(in thousands, except for share data)
Net income available to common shareholders
$
41,045

 
$
33,937

 
$
112,665

 
$
96,269

Basic weighted average number of common shares outstanding
254,473,994

 
232,737,953

 
254,310,769

 
232,548,840

Plus: Common stock equivalents
466,313

 
42,266

 
387,824

 
16,855

Diluted weighted average number of common shares outstanding
254,940,307

 
232,780,219

 
254,698,593

 
232,565,695

Earnings per common share:
 
 
 
 
 
 
 
Basic
$
0.16

 
$
0.15

 
$
0.44

 
$
0.41

Diluted
0.16

 
0.15

 
0.44

 
0.41


Common stock equivalents represent the dilutive effect of additional common shares issuable upon the assumed vesting or exercise, if applicable, of performance-based restricted stock units, common stock options and warrants to purchase Valley’s common shares. Common stock options and warrants with exercise prices that exceed the average market price of Valley’s common stock during the periods presented have an anti-dilutive effect on the diluted earnings per common share calculation and therefore are excluded from the diluted earnings per share calculation. Anti-dilutive common stock options and warrants equaled approximately 4.6 million shares for both the three and nine months ended September 30, 2016 and 5.0 million shares for both the three and nine months ended September 30, 2015.

8




Note 4. Accumulated Other Comprehensive Loss

The following table presents the after-tax changes in the balances of each component of accumulated other comprehensive loss for the three and nine months ended September 30, 2016. 

 
Components of Accumulated Other Comprehensive Loss
 
Total
Accumulated
Other
Comprehensive
Loss
 
Unrealized Gains
and Losses on
Available for Sale
(AFS) Securities
 
Non-credit
Impairment
Losses on
AFS Securities
 
Unrealized Gains
and (Losses) on
Derivatives
 
Defined
Benefit
Pension Plan
 
 
(in thousands)
Balance at June 30, 2016
$
2,144

 
$
(564
)
 
$
(22,470
)
 
$
(22,109
)
 
$
(42,999
)
Other comprehensive income (loss) before reclassifications
4,902

 
(74
)
 
1,735

 

 
6,563

Amounts reclassified from other comprehensive income (loss)
6

 
(50
)
 
2,095

 
42

 
2,093

Other comprehensive income (loss), net
4,908

 
(124
)
 
3,830

 
42

 
8,656

Balance at September 30, 2016
$
7,052

 
$
(688
)
 
$
(18,640
)
 
$
(22,067
)
 
$
(34,343
)

 
Components of Accumulated Other Comprehensive Loss
 
Total
Accumulated
Other
Comprehensive
Loss
 
Unrealized Gains
and Losses on
Available for Sale
(AFS) Securities
 
Non-credit
Impairment
Losses on
AFS Securities
 
Unrealized Gains
and (Losses) on
Derivatives
 
Defined
Benefit
Pension Plan
 
 
(in thousands)
Balance at December 31, 2015
$
(5,336
)
 
$
(520
)
 
$
(17,644
)
 
$
(22,195
)
 
$
(45,695
)
Other comprehensive income (loss) before reclassifications
12,550

 
168

 
(6,939
)
 

 
5,779

Amounts reclassified from other comprehensive income (loss)
(162
)
 
(336
)
 
5,943

 
128

 
5,573

Other comprehensive income (loss), net
12,388

 
(168
)
 
(996
)
 
128

 
11,352

Balance at September 30, 2016
$
7,052

 
$
(688
)
 
$
(18,640
)
 
$
(22,067
)
 
$
(34,343
)


9




The following table presents amounts reclassified from each component of accumulated other comprehensive loss on a gross and net of tax basis for the three and nine months ended September 30, 2016 and 2015
 
 
Amounts Reclassified from
Accumulated Other Comprehensive Loss
 
 
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
Components of Accumulated Other Comprehensive Loss
 
2016
 
2015
 
2016
 
2015
 
Income Statement
Line Item
 
 
(in thousands)
 
 
Unrealized gains (losses) on AFS securities before tax
 
$
(10
)
 
$
157

 
$
258

 
$
2,481

 
(Losses) gains on securities transactions, net
Tax effect
 
4

 
(66
)
 
(96
)
 
(1,036
)
 
 
Total net of tax
 
(6
)
 
91

 
162

 
1,445

 
 
Non-credit impairment losses on AFS securities before tax:
 
 
 
 
 
 
 
 
 
 
Accretion of credit loss impairment due to an increase in expected cash flows
 
87

 
458

 
576

 
636

 
Interest and dividends on  investment securities (taxable)
Tax effect
 
(37
)
 
(191
)
 
(240
)
 
(265
)
 
 
Total net of tax
 
50

 
267

 
336

 
371

 
 
Unrealized losses on derivatives (cash flow hedges) before tax
 
(3,578
)
 
(1,323
)
 
(10,146
)
 
(4,651
)
 
Interest expense
Tax effect
 
1,483

 
551

 
4,203

 
1,937

 
 
Total net of tax
 
(2,095
)
 
(772
)
 
(5,943
)
 
(2,714
)
 
 
Defined benefit pension plan:
 
 
 
 
 
 
 
 
 
 
Amortization of net loss
 
(71
)
 
(205
)
 
(215
)
 
(616
)
 
*
Tax effect
 
29

 
86

 
87

 
257

 
 
Total net of tax
 
(42
)
 
(119
)
 
(128
)
 
(359
)
 
 
Total reclassifications, net of tax
 
$
(2,093
)
 
$
(533
)
 
$
(5,573
)
 
$
(1,257
)
 
 
 
*
Amortization of net loss is included in the computation of net periodic pension cost.

10




Note 5. New Authoritative Accounting Guidance

Accounting Standards Update (ASU) No. 2016-15, "Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments" clarifies on how certain cash receipts and cash payments should be classified and presented in the statement of cash flow. The ASU No. 2016-15 includes guidance on eight cash flow classification issues. ASU No. 2016-15 is effective for fiscal years beginning after December 15, 2017 and is not expected to have a significant impact on Valley's consolidated financial statements.

ASU No. 2016-13, "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments" amends the accounting guidance on the impairment of financial instruments. The ASU No. 2016-13 adds to U.S. GAAP an impairment model (known as the current expected credit loss (CECL) model) that is based on expected losses rather than incurred losses. Under the new guidance, an entity is required to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. ASU No. 2016-13 is effective for Valley for reporting periods beginning January 1, 2020. Management is currently evaluating the impact of the ASU No. 2016-13 on Valley’s consolidated financial statements.

ASU No. 2016-09, "Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting" simplifies several aspects of the stock compensation guidance in Topic 718 and other related guidance. The amendments focus on income tax accounting upon vesting or exercise of share-based payments, award classification, liability classification exception for statutory tax withholding requirements, estimating forfeitures, and cash flow presentation. ASU No. 2016-09 is effective for annual periods beginning after December 15, 2017, and interim periods within annual periods beginning after December 15, 2018 with an early adoption permitted. ASU No. 2016-09 is not expected to have a significant impact on Valley's consolidated financial statements.

ASU No. 2016-02, “Leases (Topic 842)” requires the recognition of a right of use asset and related lease liability by lessees for leases classified as operating leases under current GAAP. Topic 842, which replaces the current guidance under Topic 840, retains a distinction between finance leases and operating leases. The recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee also will not significantly change from current GAAP. For leases with a term of 12 months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize right of use assets and lease liabilities. Topic 842 will be effective for Valley for reporting periods beginning January 1, 2019, with an early adoption permitted. Valley must apply a modified retrospective transition approach for the applicable leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Management is currently evaluating the impact of Topic 842 on Valley’s consolidated financial statements.

ASU No. 2016-01, “Financial Instruments - Overall (Subtopic 825-10) - Recognition and Measurement of Financial Assets and Financial Liabilities” requires that: (i) equity investments with readily determinable fair values must be measured at fair value with changes in fair value recognized in net income, (2) equity investments without readily determinable fair values must be measured at either fair value or at cost adjusted for changes in observable prices minus impairment. Changes in value under either of these methods would be recognized in net income, (3) entities that record financial liabilities at fair value due to a fair value option election must recognize changes in fair value in other comprehensive income if it is related to instrument-specific credit risk, and (4) entities must assess whether a valuation allowance is required for deferred tax assets related to available-for-sale debt securities. ASU No. 2016-01 is effective for Valley for reporting periods beginning January 1, 2018 and is not expected to have a material effect on Valley’s consolidated financial statements.

ASU No. 2015-07, "Fair Value Measurement (Topic 820) - Disclosure for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent)", which removes the requirement to categorize within the fair value hierarchy all investments for which the fair value is measured using the net asset value per share practical

11




expedient. ASU No. 2015-07 also removes the requirement to make certain disclosures for all investments that are eligible to be measured at fair value using the net asset value per share practical expedient. ASU No. 2015-07 began effective for Valley for reporting periods after January 1, 2016 and did not have an impact on Valley's fair value measurement disclosures at Note 6.

ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)" implements a common revenue standard that clarifies the principles for recognizing revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In 2016, the Financial Accounting Standards Board issued ASU No. 2016-08, “Revenue from Contracts with Customers (Topic 606) - Principal versus Agent Considerations (Reporting Revenue Gross versus Net)” and ASU No. 2016-10, “Revenue from Contracts with Customers (Topic 606) - Identifying Performance Obligations and Licensing,” to further clarify the new guidance under Topic 606. ASU No. 2014-09 and its aforementioned amendments are effective on January 1, 2018. Management is currently evaluating the new revenue guidance but does not expect it to have a significant impact on Valley’s consolidated financial statements.
Note 6. Fair Value Measurement of Assets and Liabilities

Accounting Standards Codification (ASC) Topic 820, “Fair Value Measurements and Disclosures,” establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:
 
Level 1
Unadjusted exchange quoted prices in active markets for identical assets or liabilities, or identical liabilities traded as assets that the reporting entity has the ability to access at the measurement date.
 
Level 2
Quoted prices in markets that are not active, or inputs that are observable either directly or indirectly (i.e., quoted prices on similar assets), for substantially the full term of the asset or liability.
 
Level 3
Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).


12




Assets and Liabilities Measured at Fair Value on a Recurring and Non-recurring Basis

The following tables present the assets and liabilities that are measured at fair value on a recurring and nonrecurring basis by level within the fair value hierarchy as reported on the consolidated statements of financial condition at September 30, 2016 and December 31, 2015. The assets presented under “nonrecurring fair value measurements” in the table below are not measured at fair value on an ongoing basis but are subject to fair value adjustments under certain circumstances (e.g., when an impairment loss is recognized). 
 
September 30,
2016
 
Fair Value Measurements at Reporting Date Using:
 
Quoted Prices
in Active Markets
for Identical
Assets (Level 1)
 
Significant
Other
Observable Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
(in thousands)
Recurring fair value measurements:
 
Assets
 
 
 
 
 
 
 
Investment securities:
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
U.S. Treasury securities
$
51,791

 
$
51,791

 
$

 
$

U.S. government agency securities
24,097

 

 
24,097

 

Obligations of states and political subdivisions
125,290

 

 
125,290

 

Residential mortgage-backed securities
966,638

 

 
956,266

 
10,372

Trust preferred securities
8,156

 

 
6,131

 
2,025

Corporate and other debt securities
80,567

 
17,579

 
62,988

 

Equity securities
20,170

 
536

 
19,634

 

Total available for sale
1,276,709

 
69,906

 
1,194,406

 
12,397

Loans held for sale (1)
27,868

 

 
27,868

 

Other assets (2)
46,019

 

 
46,019

 

Total assets
$
1,350,596

 
$
69,906

 
$
1,268,293

 
$
12,397

Liabilities
 
 
 
 
 
 
 
Other liabilities (2)
$
72,672

 
$

 
$
72,672

 
$

Total liabilities
$
72,672

 
$

 
$
72,672

 
$

Non-recurring fair value measurements:
 
 
 
 
 
 
 
Collateral dependent impaired loans (3)
$
2,214

 
$

 
$

 
$
2,214

Loan servicing rights
7,358

 

 

 
7,358

Foreclosed assets (4)
1,711

 

 

 
1,711

Total
$
11,283

 
$

 
$

 
$
11,283


13




 
 
 
Fair Value Measurements at Reporting Date Using:
 
December 31,
2015
 
Quoted Prices
in Active Markets
for Identical
Assets (Level 1)
 
Significant
Other
Observable Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
(in thousands)
Recurring fair value measurements:
 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
 
Investment securities:
 
 
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
U.S. Treasury securities
$
549,473

 
$
549,473

 
$

 
$

U.S. government agency securities
29,963

 

 
29,963

 

Obligations of states and political subdivisions
124,966

 

 
124,966

 

Residential mortgage-backed securities
696,428

 

 
684,777

 
11,651

Trust preferred securities
8,404

 

 
6,262

 
2,142

Corporate and other debt securities
77,552

 
17,710

 
59,842

 

Equity securities
20,075

 
1,198

 
18,877

 

Total available for sale
1,506,861

 
568,381

 
924,687

 
13,793

Loans held for sale (1)
16,382

 

 
16,382

 

Other assets (2)
33,774

 

 
33,774

 

Total assets
$
1,557,017

 
$
568,381

 
$
974,843

 
$
13,793

Liabilities
 
 
 
 
 
 
 
Other liabilities (2)
$
50,844

 
$

 
$
50,844

 
$

Total liabilities
$
50,844

 
$

 
$
50,844

 
$

Non-recurring fair value measurements:
 
 
 
 
 
 
 
Collateral dependent impaired loans (3)
$
15,427

 
$

 
$

 
$
15,427

Loan servicing rights
2,571

 

 

 
2,571

Foreclosed assets (4)
16,672

 

 

 
16,672

Total
$
34,670

 
$

 
$

 
$
34,670

 
(1)
Loans held for sale carried at fair value (which consist of residential mortgages) had contractual unpaid principal balances totaling approximately $27.0 million and $16.1 million at September 30, 2016 and December 31, 2015, respectively.
(2)
Derivative financial instruments are included in this category.
(3)
Excludes PCI loans.
(4)
Includes covered (i.e., subject to loss-sharing agreements with the FDIC) other real estate owned totaling $200 thousand and $4.2 million at September 30, 2016 and December 31, 2015, respectively.









14




The changes in Level 3 assets measured at fair value on a recurring basis for the three and nine months ended September 30, 2016 and 2015 are summarized below: 
 
Available for Sale Securities
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
 
(in thousands)
Balance, beginning of the period
$
13,101

 
$
14,712

 
$
13,793

 
$
19,309

Total net losses included in other comprehensive income for the period
(212
)
 
(26
)
 
(283
)
 
(908
)
Sales

 

 

 
(2,675
)
Settlements
(492
)
 
(340
)
 
(1,113
)
 
(1,380
)
Balance, end of the period
$
12,397

 
$
14,346

 
$
12,397

 
$
14,346


No changes in unrealized gains or losses on Level 3 securities were included in earnings during the three and nine months ended September 30, 2016 and 2015. There were no transfers of assets into or out of Level 3, or between Level 1 and Level 2, during the three and nine months ended September 30, 2016 and 2015.

There have been no material changes in the valuation methodologies used at September 30, 2016 from December 31, 2015.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following valuation techniques were used for financial instruments measured at fair value on a recurring basis. All the valuation techniques described below apply to the unpaid principal balance,excluding any accrued interest or dividends at the measurement date. Interest income and expense are recorded within the consolidated statements of income depending on the nature of the instrument using the effective interest method based on acquired discount or premium.

Available for sale securities.

All U.S. Treasury securities, certain corporate and other debt securities, and certain common and preferred equity securities are reported at fair value utilizing Level 1 inputs. The majority of other investment securities are reported at fair value utilizing Level 2 inputs. The prices for these instruments are obtained through an independent pricing service or dealer market participants with whom Valley has historically transacted both purchases and sales of investment securities. Prices obtained from these sources include prices derived from market quotations and matrix pricing. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. Management reviews the data and assumptions used in pricing the securities by its third party provider to ensure the highest level of significant inputs are derived from market observable data. For certain securities, the inputs used by either dealer market participants or an independent pricing service may be derived from unobservable market information (Level 3 inputs). In these instances, Valley evaluates the appropriateness and quality of the assumption and the resulting price. In addition, Valley reviews the volume and level of activity for all available for sale and trading securities and attempts to identify transactions which may not be orderly or reflective of a significant level of activity and volume. For securities meeting these criteria, the quoted prices received from either market participants or an independent pricing service may be adjusted, as necessary, to estimate fair value and this results in fair values based on Level 3 inputs. In determining fair value, Valley utilizes unobservable inputs which reflect Valley’s own assumptions about the inputs that market participants would use in pricing each security. In developing its assertion of market participant assumptions, Valley utilizes the best information that is both reasonable and available without undue cost and effort.


15




In calculating the fair value for the available for sale securities under Level 3, Valley prepared present value cash flow models for certain private label mortgage-backed securities. The cash flows for the residential mortgage-backed securities incorporated the expected cash flow of each security adjusted for default rates, loss severities and prepayments of the individual loans collateralizing the security.

The following table presents quantitative information about Level 3 inputs used to measure the fair value of these securities at September 30, 2016
Security Type
Valuation
Technique
 
Unobservable
Input
 
Range
 
Weighted
Average
 
 
 
 
 
 
 
 
Private label mortgage-backed securities
Discounted cash flow
 
Prepayment rate
 
       4.8-20.9%
 
12.3
%
 
 
 
Default rate
 
   3.8-27.0
 
9.1

 
 
 
Loss severity
 
 45.3-66.7
 
60.6


Significant increases or decreases in any of the unobservable inputs in the table above in isolation would result in a significantly lower or higher fair value measurement of the securities. Generally, a change in the assumption used for the default rate is accompanied by a directionally similar change in the assumption used for the loss severity and a directionally opposite change in the assumption used for prepayment rates.

For the Level 3 available for sale private label mortgage-backed securities (consisting of 4 securities), cash flow assumptions incorporated independent third party market participant data based on vintage year for each security. The discount rate utilized in determining the present value of cash flows for the mortgage-backed securities was arrived at by combining the yield on orderly transactions for similar maturity government sponsored mortgage-backed securities with (i) the historical average risk premium of similar structured private label securities, (ii) a risk premium reflecting current market conditions, including liquidity risk, and (iii) if applicable, a forecasted loss premium derived from the expected cash flows of each security. The estimated cash flows for each private label mortgage-backed security were then discounted at the aforementioned effective rate to determine the fair value. The quoted prices received from either market participants or independent pricing services are weighted with the internal price estimate to determine the fair value of each instrument.

For the Level 3 available for sale one pooled trust preferred security, the resulting estimated future cash flow was discounted at a yield determined by reference to similarly structured securities for which observable orderly transactions occurred. The discount rate was applied using a pricing matrix based on credit, security type and maturity characteristics to determine the fair value. The fair value calculation is received from an independent valuation adviser. In validating the fair value calculation from an independent valuation adviser, Valley reviews the accuracy of the inputs and the appropriateness of the unobservable inputs utilized in the valuation to ensure the fair value calculation is reasonable from a market participant perspective.

Loans held for sale. The conforming residential mortgage loans originated for sale are reported at fair value using Level 2 inputs. The fair values were calculated utilizing quoted prices for similar assets in active markets. To determine these fair values, the mortgages held for sale are put into multiple tranches, or pools, based on the coupon rate and maturity of each mortgage. The market prices for each tranche are obtained from both Fannie Mae and Freddie Mac. The market prices represent a delivery price, which reflects the underlying price each institution would pay Valley for an immediate sale of an aggregate pool of mortgages. The market prices received from Fannie Mae and Freddie Mac are then averaged and interpolated or extrapolated, where required, to calculate the fair value of each tranche. Depending upon the time elapsed since the origination of each loan held for sale, non-performance risk and changes therein were addressed in the estimate of fair value based upon the delinquency data provided to both Fannie Mae and Freddie Mac for market pricing and changes in market credit spreads. Non-performance risk did not materially impact the fair value of mortgage loans held for sale at September 30, 2016 and December 31, 2015 based on the short duration these assets were held, and the high credit quality of these loans.


16




Derivatives. Derivatives are reported at fair value utilizing Level 2 inputs. The fair value of Valley’s derivatives are determined using third party prices that are based on discounted cash flow analysis using observed market inputs, such as the LIBOR and Overnight Index Swap rate curves. The fair value of mortgage banking derivatives, consisting of interest rate lock commitments to fund residential mortgage loans and forward commitments for the future delivery of such loans (including certain loans held for sale at September 30, 2016 and December 31, 2015), is determined based on the current market prices for similar instruments provided by Fannie Mae and Freddie Mac. The fair values of most of the derivatives incorporate credit valuation adjustments, which consider the impact of any credit enhancements to the contracts, to account for potential nonperformance risk of Valley and its counterparties. The credit valuation adjustments were not significant to the overall valuation of Valley’s derivatives at September 30, 2016 and December 31, 2015.

Assets and Liabilities Measured at Fair Value on a Non-recurring Basis

The following valuation techniques were used for certain non-financial assets measured at fair value on a nonrecurring basis, including non-performing loans held for sale carried at estimated fair value (less selling costs) when less than the unamortized cost, impaired loans reported at the fair value of the underlying collateral, loan servicing rights, other real estate owned and other repossessed assets, which are reported at fair value upon initial recognition or subsequent impairment as described below.

Impaired loans. Certain impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from the collateral and are commonly referred to as “collateral dependent impaired loans.” Collateral values are estimated using Level 3 inputs, consisting of individual appraisals that are significantly adjusted based on certain discounting criteria. At September 30, 2016, appraisals were discounted based on specific market data by location and property type. During the quarter ended September 30, 2016, collateral dependent impaired loans were individually re-measured and reported at fair value through direct loan charge-offs to the allowance for loan losses and/or a specific valuation allowance allocation based on the fair value of the underlying collateral. The collateral dependent loan charge-offs to the allowance for loan losses totaled $3.7 million and $366 thousand for the three months ended September 30, 2016 and 2015, respectively, and $4.7 million and $3.0 million for the nine months ended September 30, 2016 and 2015, respectively. At September 30, 2016, collateral dependent impaired loans with a total recorded investment of $2.6 million were reduced by specific valuation allowance allocations totaling $350 thousand to a reported total net carrying amount of $2.2 million.

Loan servicing rights. Fair values for each risk-stratified group of loan servicing rights are calculated using a fair value model from a third party vendor that requires inputs that are both significant to the fair value measurement and unobservable (Level 3). The fair value model is based on various assumptions, including but not limited to, prepayment speeds, internal rate of return (“discount rate”), servicing cost, ancillary income, float rate, tax rate, and inflation. The prepayment speed and the discount rate are considered two of the most significant inputs in the model. At September 30, 2016, the fair value model used prepayment speeds (stated as constant prepayment rates) from 0 percent up to 24 percent and a discount rate of 8.0 percent for the valuation of the loan servicing rights. A significant degree of judgment is involved in valuing the loan servicing rights using Level 3 inputs. The use of different assumptions could have a significant positive or negative effect on the fair value estimate. Impairment charges are recognized on loan servicing rights when the amortized cost of a risk-stratified group of loan servicing rights exceeds the estimated fair value. Valley recorded no net impairment charges on its loan servicing rights for the three months ended September 30, 2016 and net impairment charges totaling $457 thousand for the nine months ended September 30, 2016. Valley recorded net recoveries of impairment charges totaling $48 thousand and $209 thousand for three and nine months ended September 30, 2015, respectively.

Foreclosed assets. Certain foreclosed assets (consisting of other real estate owned and other repossessed assets), upon initial recognition and transfer from loans, are re-measured and reported at fair value through a charge-off to the allowance for loan losses based upon the fair value of the foreclosed assets. The fair value of a foreclosed asset, upon initial recognition, is typically estimated using Level 3 inputs, consisting of an appraisal that is adjusted based on certain discounting criteria, similar to the criteria used for impaired loans described above. The appraisals of foreclosed assets were adjusted up to 4.8 percent at September 30, 2016. At September 30, 2016, foreclosed assets

17




included $1.7 million of assets that were measured at fair value upon initial recognition or subsequently re-measured during the quarter ended September 30, 2016. The foreclosed assets charge-offs to the allowance for loan losses totaled $245 thousand and $629 thousand for the three months ended September 30, 2016 and 2015, respectively and $1.2 million and $1.5 million for nine months ended September 30, 2016 and 2015, respectively. The re-measurement of foreclosed assets at fair value subsequent to their initial recognition resulted in net loss within non-interest expense of $34 thousand and $1.3 million for the three months ended September 30, 2016 and 2015, respectively and $946 thousand and $1.8 million for nine months ended September 30, 2016 and 2015, respectively.
 
Other Fair Value Disclosures

ASC Topic 825, “Financial Instruments,” requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis.

The fair value estimates presented in the following table were based on pertinent market data and relevant information on the financial instruments available as of the valuation date. These estimates do not reflect any premium or discount that could result from offering for sale at one time the entire portfolio of financial instruments. Because no market exists for a portion of the financial instruments, fair value estimates may be based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Fair value estimates are based on existing balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. For instance, Valley has certain fee-generating business lines (e.g., its mortgage servicing operation, trust and investment management departments) that were not considered in these estimates since these activities are not financial instruments. In addition, the tax implications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.


18




The carrying amounts and estimated fair values of financial instruments not measured and not reported at fair value on the consolidated statements of financial condition at September 30, 2016 and December 31, 2015 were as follows: 
 
Fair Value
Hierarchy
 
September 30, 2016
 
December 31, 2015
 
Carrying
Amount
 
Fair Value
 
Carrying
Amount
 
Fair Value
 
 
 
(in thousands)
Financial assets
 
 
 
 
 
 
 
 
 
Cash and due from banks
Level 1
 
$
238,664

 
$
238,664

 
$
243,575

 
$
243,575

Interest bearing deposits with banks
Level 1
 
160,462

 
160,462

 
170,225

 
170,225

Investment securities held to maturity:
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
Level 1
 
138,866

 
154,042

 
138,978

 
149,483

U.S. government agency securities
Level 2
 
11,549

 
12,106

 
12,859

 
13,130

Obligations of states and political subdivisions
Level 2
 
568,212

 
595,525

 
504,865

 
527,263

Residential mortgage-backed securities
Level 2
 
1,030,165

 
1,046,387

 
852,289

 
855,272

Trust preferred securities
Level 2
 
59,800

 
45,726

 
59,785

 
46,437

Corporate and other debt securities
Level 2
 
36,559

 
38,196

 
27,609

 
29,454

Total investment securities held to maturity
 
 
1,845,151

 
1,891,982

 
1,596,385

 
1,621,039

Net loans
Level 3
 
16,523,438

 
16,511,137

 
15,936,929

 
15,824,475

Accrued interest receivable
Level 1
 
63,815

 
63,815

 
63,554

 
63,554

Federal Reserve Bank and Federal Home Loan Bank stock (1)
Level 1
 
162,584

 
162,584

 
145,068

 
145,068

Financial liabilities
 
 
 
 
 
 
 
 
 
Deposits without stated maturities
Level 1
 
13,852,302

 
13,852,302

 
13,095,647

 
13,095,647

Deposits with stated maturities
Level 2
 
3,119,881

 
3,148,902

 
3,157,904

 
3,203,389

Short-term borrowings
Level 1
 
1,433,356

 
1,433,356

 
1,076,991

 
1,076,991

Long-term borrowings
Level 2
 
1,450,818

 
1,612,654

 
1,810,728

 
1,945,741

Junior subordinated debentures issued to capital trusts
Level 2
 
41,536

 
43,751

 
41,414

 
44,127

Accrued interest payable (2)
Level 1
 
9,931

 
9,931

 
13,110

 
13,110

 
(1)
Included in other assets.
(2)
Included in accrued expenses and other liabilities.

The following methods and assumptions were used to estimate the fair value of other financial assets and financial liabilities in the table above:

Cash and due from banks and interest bearing deposits with banks. The carrying amount is considered to be a reasonable estimate of fair value because of the short maturity of these items.

Investment securities held to maturity. Fair values are based on prices obtained through an independent pricing service or dealer market participants with whom Valley has historically transacted both purchases and sales of investment securities. Prices obtained from these sources include prices derived from market quotations and matrix pricing. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things (Level 2 inputs). Additionally, Valley reviews the volume and level of activity for all classes of held to maturity securities and attempts to identify transactions which may not be orderly or reflective of a significant level of activity and volume. For securities meeting these criteria, the quoted prices received from either market participants or an independent pricing service

19




may be adjusted, as necessary. If applicable, the adjustment to fair value is derived based on present value cash flow model projections prepared by Valley utilizing assumptions similar to those incorporated by market participants.

Loans. Fair values of loans are estimated by discounting the projected future cash flows using market discount rates that reflect the credit and interest-rate risk inherent in the loan. The discount rate is a product of both the applicable index and credit spread, subject to the estimated current new loan interest rates. The credit spread component is static for all maturities and may not necessarily reflect the value of estimating all actual cash flows re-pricing. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. Fair values estimated in this manner do not fully incorporate an exit-price approach to fair value, but instead are based on a comparison to current market rates for comparable loans.

Accrued interest receivable and payable. The carrying amounts of accrued interest approximate their fair value due to the short-term nature of these items.

Federal Reserve Bank and Federal Home Loan Bank stock. Federal Reserve Bank and FHLB stock are non-marketable equity securities and are reported at their redeemable carrying amounts, which approximate fair value.

Deposits. The carrying amounts of deposits without stated maturities (i.e., non-interest bearing, savings, NOW, and money market deposits) approximate their estimated fair value. The fair value of time deposits is based on the discounted value of contractual cash flows using estimated rates currently offered for alternative funding sources of similar remaining maturity.

Short-term and long-term borrowings. The carrying amounts of certain short-term borrowings, including securities sold under agreements to repurchase and FHLB borrowings (and from time to time, federal funds purchased) approximate their fair values because they frequently re-price to a market rate. The fair values of other short-term and long-term borrowings are estimated by obtaining quoted market prices of the identical or similar financial instruments when available. When quoted prices are unavailable, the fair values of the borrowings are estimated by discounting the estimated future cash flows using current market discount rates of financial instruments with similar characteristics, terms and remaining maturity.

Junior subordinated debentures issued to capital trusts. The fair value of debentures issued to capital trusts is estimated utilizing the income approach, whereby the expected cash flows, over the remaining estimated life of the security, are discounted using Valley’s credit spread over the current yield on a similar maturity of U.S. Treasury security or the three-month LIBOR for the variable rate indexed debentures (Level 2 inputs). The credit spread used to discount the expected cash flows was calculated based on the median current spreads for all fixed and variable publicly traded trust preferred securities issued by banks.


20




Note 7. Investment Securities

Held to Maturity

The amortized cost, gross unrealized gains and losses and fair value of securities held to maturity at September 30, 2016 and December 31, 2015 were as follows: 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
 
(in thousands)
September 30, 2016
 
 
 
 
 
 
 
U.S. Treasury securities
$
138,866

 
$
15,176

 
$

 
$
154,042

U.S. government agency securities
11,549

 
557

 

 
12,106

Obligations of states and political subdivisions:
 
 
 
 
 
 
 
Obligations of states and state agencies
192,735

 
13,353

 

 
206,088

Municipal bonds
375,477

 
13,960

 

 
389,437

Total obligations of states and political subdivisions
568,212

 
27,313

 

 
595,525

Residential mortgage-backed securities
1,030,165

 
17,642

 
(1,420
)
 
1,046,387

Trust preferred securities
59,800

 
28

 
(14,102
)
 
45,726

Corporate and other debt securities
36,559

 
1,637

 

 
38,196

Total investment securities held to maturity
$
1,845,151

 
$
62,353

 
$
(15,522
)
 
$
1,891,982

December 31, 2015
 
 
 
 
 
 
 
U.S. Treasury securities
$
138,978

 
$
10,505

 
$

 
$
149,483

U.S. government agency securities
12,859

 
271

 

 
13,130

Obligations of states and political subdivisions:
 
 
 
 
 
 
 
Obligations of states and state agencies
194,547

 
10,538

 
(10
)
 
205,075

Municipal bonds
310,318

 
11,955

 
(85
)
 
322,188

Total obligations of states and political subdivisions
504,865

 
22,493

 
(95
)
 
527,263

Residential mortgage-backed securities
852,289

 
11,018

 
(8,035
)
 
855,272

Trust preferred securities
59,785

 
36

 
(13,384
)
 
46,437

Corporate and other debt securities
27,609

 
1,894

 
(49
)
 
29,454

Total investment securities held to maturity
$
1,596,385

 
$
46,217

 
$
(21,563
)
 
$
1,621,039


21




The age of unrealized losses and fair value of related securities held to maturity at September 30, 2016 and December 31, 2015 were as follows: 
 
Less than
Twelve Months
 
More than
Twelve Months
 
Total
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
(in thousands)
September 30, 2016
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage-backed securities
$
185,774

 
$
(867
)
 
$
128,211

 
$
(553
)
 
$
313,985

 
$
(1,420
)
Trust preferred securities

 

 
44,344

 
(14,102
)
 
44,344

 
(14,102
)
Total
$
185,774

 
$
(867
)
 
$
172,555

 
$
(14,655
)
 
$
358,329

 
$
(15,522
)
December 31, 2015
 
 
 
 
 
 
 
 
 
 
 
Obligations of states and political subdivisions:
 
 
 
 
 
 
 
 
 
 
 
Obligations of states and state agencies
$
6,837

 
$
(5
)
 
$
1,965

 
$
(5
)
 
$
8,802

 
$
(10
)
Municipal bonds
8,814

 
(72
)
 
10,198

 
(13
)
 
19,012

 
(85
)
Total obligations of states and political subdivisions
15,651

 
(77
)
 
12,163

 
(18
)
 
27,814

 
(95
)
Residential mortgage-backed securities
244,440

 
(2,916
)
 
162,756

 
(5,119
)
 
407,196

 
(8,035
)
Trust preferred securities

 

 
45,047

 
(13,384
)
 
45,047

 
(13,384
)
Corporate and other debt securities
2,951

 
(49
)
 

 

 
2,951

 
(49
)
Total
$
263,042

 
$
(3,042
)
 
$
219,966

 
$
(18,521
)
 
$
483,008

 
$
(21,563
)

The unrealized losses on investment securities held to maturity are primarily due to changes in interest rates (including, in certain cases, changes in credit spreads) and, in some cases, lack of liquidity in the marketplace. Within the held to maturity portfolio, the total number of security positions in an unrealized loss position was 52 at September 30, 2016 and 74 at December 31, 2015.

The unrealized losses within the residential mortgage-backed securities category of the held to maturity portfolio at September 30, 2016 mainly related to certain investment grade securities issued by Ginnie Mae.
The unrealized losses existing for more than twelve months for trust preferred securities at September 30, 2016 primarily related to four non-rated single-issuer trust preferred securities issued by bank holding companies. All single-issuer trust preferred securities classified as held to maturity are paying in accordance with their terms, have no deferrals of interest or defaults and, if applicable, the issuers meet the regulatory capital requirements to be considered “well-capitalized institutions” at September 30, 2016.
Management does not believe that any individual unrealized loss as of September 30, 2016 included in the table above represents other-than-temporary impairment as management mainly attributes the declines in fair value to changes in interest rates and market volatility, not credit quality or other factors. Based on a comparison of the present value of expected cash flows to the amortized cost, management believes there are no credit losses on these securities. Valley does not have the intent to sell, nor is it more likely than not that Valley will be required to sell, the securities contained in the table above before the recovery of their amortized cost basis or maturity.
As of September 30, 2016, the fair value of investments held to maturity that were pledged to secure public deposits, repurchase agreements, lines of credit, and for other purposes required by law, was $860.6 million.

22




The contractual maturities of investments in debt securities held to maturity at September 30, 2016 are set forth in the table below. Maturities may differ from contractual maturities in residential mortgage-backed securities because the mortgages underlying the securities may be prepaid without any penalties. Therefore, residential mortgage-backed securities are not included in the maturity categories in the following summary.  
 
September 30, 2016
 
Amortized
Cost
 
Fair
Value
 
(in thousands)
Due in one year
$
85,384

 
$
85,388

Due after one year through five years
181,107

 
192,968

Due after five years through ten years
369,454

 
398,494

Due after ten years
179,041

 
168,745

Residential mortgage-backed securities
1,030,165

 
1,046,387

Total investment securities held to maturity
$
1,845,151

 
$
1,891,982

Actual maturities of debt securities may differ from those presented above since certain obligations provide the issuer the right to call or prepay the obligation prior to scheduled maturity without penalty.
The weighted-average remaining expected life for residential mortgage-backed securities held to maturity was 6.5 years at September 30, 2016.


23




Available for Sale
The amortized cost, gross unrealized gains and losses and fair value of securities available for sale at September 30, 2016 and December 31, 2015 were as follows: 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
 
(in thousands)
September 30, 2016
 
 
 
 
 
 
 
U.S. Treasury securities
$
51,025

 
$
766

 
$

 
$
51,791

U.S. government agency securities
23,764

 
339

 
(6
)
 
24,097

Obligations of states and political subdivisions:
 
 
 
 
 
 
 
Obligations of states and state agencies
42,466

 
1,091

 
(40
)
 
43,517

Municipal bonds
80,155

 
1,939

 
(321
)
 
81,773

Total obligations of states and political subdivisions
122,621

 
3,030

 
(361
)
 
125,290

Residential mortgage-backed securities
958,531

 
11,021

 
(2,914
)
 
966,638

Trust preferred securities*
10,231

 

 
(2,075
)
 
8,156

Corporate and other debt securities
79,148

 
1,623

 
(204
)
 
80,567

Equity securities
20,522

 
445

 
(797
)
 
20,170

Total investment securities available for sale
$
1,265,842

 
$
17,224

 
$
(6,357
)
 
$
1,276,709

December 31, 2015
 
 
 
 
 
 
 
U.S. Treasury securities
$
551,173

 
$
4

 
$
(1,704
)
 
$
549,473

U.S. government agency securities
29,316

 
665

 
(18
)
 
29,963

Obligations of states and political subdivisions:
 
 
 
 
 
 
 
Obligations of states and state agencies
44,285

 
196

 
(67
)
 
44,414

Municipal bonds
80,717

 
209

 
(374
)
 
80,552

Total obligations of states and political subdivisions
125,002

 
405

 
(441
)
 
124,966

Residential mortgage-backed securities
701,764

 
3,348

 
(8,684
)
 
696,428

Trust preferred securities*
10,458

 

 
(2,054
)
 
8,404

Corporate and other debt securities
78,202

 
1,239

 
(1,889
)
 
77,552

Equity securities
21,022

 
575

 
(1,522
)
 
20,075

Total investment securities available for sale
$
1,516,937

 
$
6,236

 
$
(16,312
)
 
$
1,506,861

 
*
Includes two pooled trust preferred securities, principally collateralized by securities issued by banks and insurance companies, at September 30, 2016 and December 31, 2015.


24




The age of unrealized losses and fair value of related securities available for sale at September 30, 2016 and December 31, 2015 were as follows: 
 
Less than
Twelve Months
 
More than
Twelve Months
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
(in thousands)
September 30, 2016
 
 
 
 
 
 
 
 
 
 
 
U.S. government agency securities
$

 
$

 
$
4,197

 
$
(6
)
 
$
4,197

 
$
(6
)
Obligations of states and political subdivisions:
 
 
 
 
 
 
 
 
 
 
 
Obligations of states and state agencies
2,607

 
(40
)
 

 

 
2,607

 
(40
)
Municipal bonds

 

 
11,012

 
(321
)
 
11,012

 
(321
)
Total obligations of states and political subdivisions
2,607

 
(40
)
 
11,012

 
(321
)
 
13,619

 
(361
)
Residential mortgage-backed securities
145,631

 
(566
)
 
138,425

 
(2,348
)
 
284,056

 
(2,914
)
Trust preferred securities

 

 
8,155

 
(2,075
)
 
8,155

 
(2,075
)
Corporate and other debt securities
20,814

 
(7
)
 
15,329

 
(197
)
 
36,143

 
(204
)
Equity securities

 

 
14,998

 
(797
)
 
14,998

 
(797
)
Total
$
169,052

 
$
(613
)
 
$
192,116

 
$
(5,744
)
 
$
361,168

 
$
(6,357
)
December 31, 2015
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury securities
$
548,538

 
$
(1,704
)
 
$

 
$

 
$
548,538

 
$
(1,704
)
U.S. government agency securities
3,489

 
(5
)
 
4,736

 
(13
)
 
8,225

 
(18
)
Obligations of states and political subdivisions:
 
 
 
 
 
 
 
 
 
 
 
Obligations of states and state agencies
24,359

 
(67
)
 

 

 
24,359

 
(67
)
Municipal bonds
38,207

 
(128
)
 
13,551

 
(246
)
 
51,758

 
(374
)
Total obligations of states and political subdivisions
62,566

 
(195
)
 
13,551

 
(246
)
 
76,117

 
(441
)
Residential mortgage-backed securities
293,615

 
(4,147
)
 
164,010

 
(4,537
)
 
457,625

 
(8,684
)
Trust preferred securities

 

 
8,404

 
(2,054
)
 
8,404

 
(2,054
)
Corporate and other debt securities
21,203

 
(471
)
 
36,137

 
(1,418
)
 
57,340

 
(1,889
)
Equity securities

 

 
14,273

 
(1,522
)
 
14,273

 
(1,522
)
Total
$
929,411

 
$
(6,522
)
 
$
241,111

 
$
(9,790
)
 
$
1,170,522

 
$
(16,312
)
The unrealized losses on investment securities available for sale are primarily due to changes in interest rates (including, in certain cases, changes in credit spreads) and, in some cases, lack of liquidity in the marketplace. The total number of security positions in the securities available for sale portfolio in an unrealized loss position at September 30, 2016 was 102 as compared to 291 at December 31, 2015.
The unrealized losses more than twelve months for the residential mortgage-backed securities category of the available for sale portfolio at September 30, 2016 largely related to several investment grade residential mortgage-backed securities mainly issued by Ginnie Mae and three non-investment grade private label mortgage-backed securities that were previously impaired.
The unrealized losses more than twelve months for trust preferred securities at September 30, 2016 in the table above largely relate to 2 pooled trust preferred securities with an amortized cost of $10.2 million and a fair value of $8.2 million. One of the two pooled trust preferred securities had unrealized loss of $1.3 million and an investment grade rating at September 30, 2016.

25





As of September 30, 2016, the fair value of securities available for sale that were pledged to secure public deposits, repurchase agreements, lines of credit, and for other purposes required by law, was $461.5 million.
The contractual maturities of investment securities available for sale at September 30, 2016 are set forth in the following table. Maturities may differ from contractual maturities in residential mortgage-backed securities because the mortgages underlying the securities may be prepaid without any penalties. Therefore, residential mortgage-backed securities are not included in the maturity categories in the following summary.
 
September 30, 2016
 
Amortized
Cost
 
Fair
Value
 
(in thousands)
Due in one year
$
10,549

 
$
10,578

Due after one year through five years
93,945

 
95,479

Due after five years through ten years
122,929

 
125,488

Due after ten years
59,366

 
58,356

Residential mortgage-backed securities
958,531

 
966,638

Equity securities
20,522

 
20,170

Total investment securities available for sale
$
1,265,842

 
$
1,276,709

Actual maturities of debt securities may differ from those presented above since certain obligations provide the issuer the right to call or prepay the obligation prior to scheduled maturity without penalty.
The weighted average remaining expected life for residential mortgage-backed securities available for sale at September 30, 2016 was 9.3 years.
Other-Than-Temporary Impairment Analysis

Valley records impairment charges on its investment securities when the decline in fair value is considered other-than-temporary. Numerous factors, including lack of liquidity for re-sales of certain investment securities; decline in the creditworthiness of the issuer; absence of reliable pricing information for investment securities; adverse changes in business climate; adverse actions by regulators; prolonged decline in value of equity investments; or unanticipated changes in the competitive environment could have a negative effect on Valley’s investment portfolio and may result in other-than-temporary impairment on certain investment securities in future periods. Valley’s investment portfolios include private label mortgage-backed securities, trust preferred securities principally issued by bank holding companies (including two pooled trust preferred securities), corporate bonds, and perpetual preferred and common equity securities issued by banks. These investments may pose a higher risk of future impairment charges by Valley as a result of the unpredictable nature of the U.S. economy and its potential negative effect on the future performance of the security issuers and, if applicable, the underlying mortgage loan collateral of the security.

There were no other-than-temporary impairment losses on securities recognized in earnings for the nine months ended September 30, 2016 and 2015. At September 30, 2016, four previously impaired private label mortgage-backed securities (prior to December 31, 2012) had a combined amortized cost and fair value of $10.8 million and $10.4 million, respectively, while one previously impaired pooled trust preferred security had an amortized cost and fair value of $2.8 million and $2.0 million, respectively. The previously impaired pooled trust preferred security was not accruing interest during the three and nine months ended September 30, 2016 and 2015. Additionally, one previously impaired pooled trust preferred security was sold during the first quarter of 2015 for an immaterial gain. See the table and discussion below for additional information.


26




The following table presents the changes in the credit loss component of cumulative other-than-temporary impairment losses on debt securities classified as either held to maturity or available for sale that Valley has previously recognized in earnings, for which a portion of the impairment loss (non-credit factors) was recognized in other comprehensive income for the three and nine months ended September 30, 2016 and 2015: 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
 
(in thousands)
Balance, beginning of period
$
5,348

 
$
6,387

 
$
5,837

 
$
8,947

Accretion of credit loss impairment due to an increase in expected cash flows
(87
)
 
(458
)
 
(576
)
 
(636
)
Sales

 

 

 
(2,382
)
Balance, end of period
$
5,261

 
$
5,929

 
$
5,261

 
$
5,929


The credit loss component of the impairment loss represents the difference between the present value of expected future cash flows and the amortized cost basis of the security prior to considering credit losses. The beginning balance represents the credit loss component for debt securities for which other-than-temporary impairment occurred prior to each period presented. The credit loss component increases if other-than-temporary impairments (initial and subsequent) are recognized in earnings for credit impaired debt securities. The credit loss component is reduced if (i) Valley receives cash flows in excess of what it expected to receive over the remaining life of the credit impaired debt security, (ii) the security matures, (iii) the security is fully written down, or (iv) Valley sells, intends to sell or believes it will be required to sell previously credit impaired debt securities.
Realized Gains and Losses

Gross gains (losses) realized on sales, maturities and other securities transactions related to investment securities included in earnings for the three and nine months ended September 30, 2016 and 2015 were as follows: 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
 
(in thousands)
Sales transactions:
 
 
 
 
 
 
 
Gross gains
$

 
$

 
$
271

 
$
3,274

Gross losses

 

 

 
(947
)
 

 

 
271

 
2,327

Maturities and other securities transactions:
 
 
 
 
 
 
 
Gross gains
2

 
158

 
2

 
287

Gross losses
(12
)
 
(1
)
 
(15
)
 
(133
)
 
(10
)
 
157

 
(13
)
 
154

Total (losses) gains on securities transactions, net
$
(10
)
 
$
157

 
$
258

 
$
2,481


Valley recognized gross gains from sales transactions of investment securities totaling $3.3 million for the nine months ended September 30, 2015 due to the sale of corporate debt securities and trust preferred securities with amortized cost totaling $25.9 million. These transactions included a corporate debt security classified as held to maturity and a previously impaired pooled trust preferred security with amortized costs of $9.8 million and $2.6 million, respectively. Additionally, Valley recognized $947 thousand of gross losses during the nine months ended September 30, 2015 primarily due to the sale of mostly trust preferred securities with a total amortized cost of $8.3 million. The vast majority of the sales of investment securities were due to an investment portfolio re-balancing during the third quarter of 2015 due to changes in our regulatory capital calculation under the new Basel III regulatory capital reform (effective for Valley on January 1, 2015). Under ASC Topic 320, “Investments - Debt and Equity Securities,” the sale of held to

27




maturity securities based upon the change in capital requirements is permitted without tainting the remaining held to maturity investment portfolio.
Note 8. Loans

The detail of the loan portfolio as of September 30, 2016 and December 31, 2015 was as follows: 
 
September 30, 2016
 
December 31, 2015
 
Non-PCI
Loans
 
PCI Loans*
 
Total
 
Non-PCI
Loans
 
PCI Loans*
 
Total
 
(in thousands)
Loans:
 
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
2,266,420

 
$
292,548

 
$
2,558,968

 
$
2,156,549

 
$
383,942

 
$
2,540,491

Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
7,178,836

 
1,135,019

 
8,313,855

 
6,069,532

 
1,355,104

 
7,424,636

Construction
670,801

 
131,767

 
802,568

 
607,694

 
147,253

 
754,947

  Total commercial real estate loans
7,849,637

 
1,266,786

 
9,116,423

 
6,677,226

 
1,502,357

 
8,179,583

Residential mortgage
2,637,311

 
188,819

 
2,826,130

 
2,912,079

 
218,462

 
3,130,541

Consumer:
 
 
 
 
 
 
 
 
 
 
 
Home equity
377,682

 
99,138

 
476,820

 
391,809

 
119,394

 
511,203

Automobile
1,121,430

 
176

 
1,121,606

 
1,238,826

 
487

 
1,239,313

Other consumer
524,540

 
9,648

 
534,188

 
426,147

 
15,829

 
441,976

Total consumer loans
2,023,652

 
108,962

 
2,132,614

 
2,056,782

 
135,710

 
2,192,492

Total loans
$
14,777,020

 
$
1,857,115

 
$
16,634,135

 
$
13,802,636

 
$
2,240,471

 
$
16,043,107

 
*
PCI loans include covered loans (mostly consisting of residential mortgage and commercial real estate loans) totaling $76.0 million and $122.3 million at September 30, 2016 and December 31, 2015, respectively.

Total non-covered loans include net unearned premiums and deferred loan costs of $10.5 million and $3.5 million at September 30, 2016 and December 31, 2015, respectively. The outstanding balances (representing contractual balances owed to Valley) for PCI loans totaled $2.0 billion and $2.4 billion at September 30, 2016 and December 31, 2015, respectively.

Valley transferred $174.5 million of residential mortgage loans from the loan portfolio to loans held for sale during the three months ended September 30, 2016. Exclusive of such transfers, there were no sales of loans from the held for investment portfolio during the three and nine months ended September 30, 2016 and 2015.

Purchased Credit-Impaired Loans (Including Covered Loans)

PCI loans are accounted for in accordance with ASC Subtopic 310-30 and are initially recorded at fair value (as determined by the present value of expected future cash flows) with no valuation allowance (i.e., the allowance for loan losses), and aggregated and accounted for as pools of loans based on common risk characteristics. The difference between the undiscounted cash flows expected at acquisition and the initial carrying amount (fair value) of the PCI loans, or the “accretable yield,” is recognized as interest income utilizing the level-yield method over the life of each pool. Contractually required payments for interest and principal that exceed the undiscounted cash flows expected at acquisition, or the “non-accretable difference,” are not recognized as a yield adjustment, as a loss accrual or a valuation allowance. Reclassifications of the non-accretable difference to the accretable yield may occur subsequent to the loan acquisition dates due to increases in expected cash flows of the loan pools. Valley's PCI loan portfolio included covered loans (i.e., loans in which the Bank will share losses with the FDIC under loss-sharing agreements) totaling $76.0 million and $122.3 million at September 30, 2016 and December 31, 2015, respectively.


28




The following table presents changes in the accretable yield for PCI loans during the three and nine months ended September 30, 2016 and 2015:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
 
(in thousands)
Balance, beginning of period
$
355,601

 
$
282,101

 
$
415,179

 
$
336,208

Accretion
(26,730
)
 
(24,814
)
 
(86,308
)
 
(78,921
)
Balance, end of period
$
328,871

 
$
257,287

 
$
328,871

 
$
257,287


FDIC Loss-Share Receivable

The receivable arising from the loss-sharing agreements with the FDIC is measured separately from the covered loan portfolio because the agreements are not contractually part of the covered loans and are not transferable should the Bank choose to dispose of the covered loans. The FDIC loss share receivable (which is included in other assets on Valley's consolidated statements of financial condition) totaled $7.7 million and $8.3 million at September 30, 2016 and December 31, 2015, respectively. The aggregate effect of changes in the FDIC loss-share receivable was a net reduction in non-interest income of $313 thousand and $55 thousand for the three months ended September 30, 2016 and 2015, respectively, and $872 thousand and $3.4 million for the nine months ended September 30, 2016 and 2015, respectively. The larger net reduction during the nine months ended September 30, 2015 was mainly caused by the prospective recognition of the effect of additional cash flows from certain loan pools which were covered by commercial loan loss-sharing agreements that expired in March 2015.

Credit Risk Management

For all of its loan types, Valley adheres to a credit policy designed to minimize credit risk while generating the maximum income given the level of risk. Management reviews and approves these policies and procedures on a regular basis with subsequent approval by the Board of Directors annually. Credit authority relating to a significant dollar percentage of the overall portfolio is centralized and controlled by the Credit Risk Management Division and by the Credit Committee. Valley closely monitors economic conditions and loan performance trends to manage and evaluate its exposure to credit risk. A reporting system supplements the management review process by providing management with frequent reports concerning loan production, loan quality, internal loan classification, concentrations of credit, loan delinquencies, non-performing, and potential problem loans. Loan portfolio diversification is an important factor utilized by Valley to manage its risk across business sectors and through cyclical economic circumstances.






29




Credit Quality
The following table presents past due, non-accrual and current loans (excluding PCI loans, which are accounted for on a pool basis, and non-performing loans held for sale) by loan portfolio class at September 30, 2016 and December 31, 2015: 
 
Past Due and Non-Accrual Loans
 
 
 
 
 
30-59
Days
Past Due
Loans
 
60-89
Days
Past Due
Loans
 
Accruing Loans
90 Days or More
Past Due
 
Non-Accrual
Loans
 
Total
Past Due
Loans
 
Current
Non-PCI
Loans
 
Total
Non-PCI
Loans
 
(in thousands)
September 30, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
4,306

 
$
788

 
$
145

 
$
7,875

 
$
13,114

 
$
2,253,306

 
$
2,266,420

Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
9,385

 
4,291

 
478

 
14,452

 
28,606

 
7,150,230

 
7,178,836

Construction

 

 
1,881

 
1,136

 
3,017

 
667,784

 
670,801

Total commercial real estate loans
9,385

 
4,291

 
2,359

 
15,588

 
31,623

 
7,818,014

 
7,849,637

Residential mortgage
9,982

 
2,733

 
590

 
14,013

 
27,318

 
2,609,993

 
2,637,311

Consumer loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity
693

 
527

 

 
820

 
2,040

 
375,642

 
377,682

Automobile
2,110

 
619

 
226

 
145

 
3,100

 
1,118,330

 
1,121,430

Other consumer
343

 
88

 

 

 
431

 
524,109

 
524,540

Total consumer loans
3,146

 
1,234

 
226

 
965

 
5,571

 
2,018,081

 
2,023,652

Total
$
26,819

 
$
9,046

 
$
3,320

 
$
38,441

 
$
77,626

 
$
14,699,394

 
$
14,777,020

December 31, 2015
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
3,920

 
$
524

 
$
213

 
$
10,913

 
$
15,570

 
$
2,140,979

 
$
2,156,549

Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
2,684

 

 
131

 
24,888

 
27,703

 
6,041,829

 
6,069,532

Construction
1,876

 
2,799

 

 
6,163

 
10,838

 
596,856

 
607,694

Total commercial real estate loans
4,560

 
2,799

 
131

 
31,051

 
38,541

 
6,638,685

 
6,677,226

Residential mortgage
6,681

 
1,626

 
1,504

 
17,930

 
27,741

 
2,884,338

 
2,912,079

Consumer loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
Home equity
1,308

 
111

 

 
2,088

 
3,507

 
388,302

 
391,809

Automobile
1,969

 
491

 
164

 
118

 
2,742

 
1,236,084

 
1,238,826

Other consumer
71

 
24

 
44

 

 
139

 
426,008

 
426,147

Total consumer loans
3,348

 
626

 
208

 
2,206

 
6,388

 
2,050,394

 
2,056,782

Total
$
18,509

 
$
5,575

 
$
2,056

 
$
62,100

 
$
88,240

 
$
13,714,396

 
$
13,802,636


Impaired loans. Impaired loans, consisting of non-accrual commercial and industrial loans and commercial real estate loans over $250 thousand and all loans which were modified in troubled debt restructuring, are individually evaluated for impairment. PCI loans are not classified as impaired loans because they are accounted for on a pool basis.



30




The following table presents the information about impaired loans by loan portfolio class at September 30, 2016 and December 31, 2015:
 
Recorded
Investment
With No Related
Allowance
 
Recorded
Investment
With Related
Allowance
 
Total
Recorded
Investment
 
Unpaid
Contractual
Principal
Balance
 
Related
Allowance
 
(in thousands)
September 30, 2016
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
4,312

 
$
22,816

 
$
27,128

 
$
34,156

 
$
3,506

Commercial real estate:
 
 
 
 
 
 
 
 
 
Commercial real estate
20,428

 
42,363

 
62,791

 
65,076

 
4,152

Construction
1,972

 
4,326

 
6,298

 
6,298

 
423

Total commercial real estate loans
22,400

 
46,689

 
69,089

 
71,374

 
4,575

Residential mortgage
8,706

 
9,802

 
18,508

 
19,983

 
708

Consumer loans:
 
 
 
 
 
 
 
 
 
Home equity
214

 
1,509

 
1,723

 
1,820

 
210

Total consumer loans
214

 
1,509

 
1,723

 
1,820

 
210

Total
$
35,632

 
$
80,816

 
$
116,448

 
$
127,333

 
$
8,999

December 31, 2015
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
7,863

 
$
17,851

 
$
25,714

 
$
33,071

 
$
3,439

Commercial real estate:
 
 
 
 
 
 
 
 
 
Commercial real estate
30,113

 
37,440

 
67,553

 
71,263

 
3,354

Construction
8,847

 
5,530

 
14,377

 
14,387

 
317

Total commercial real estate loans
38,960

 
42,970

 
81,930

 
85,650

 
3,671

Residential mortgage
7,842

 
14,770

 
22,612

 
24,528

 
1,377

Consumer loans:
 
 
 
 
 
 
 
 
 
Home equity
263

 
1,869

 
2,132

 
2,224

 
295

Total consumer loans
263

 
1,869

 
2,132

 
2,224

 
295

Total
$
54,928

 
$
77,460

 
$
132,388

 
$
145,473

 
$
8,782

The following tables present by loan portfolio class, the average recorded investment and interest income recognized on impaired loans for the three and nine months ended September 30, 2016 and 2015
 
Three Months Ended September 30,
 
2016
 
2015
 
Average
Recorded
Investment
 
Interest
Income
Recognized
 
Average
Recorded
Investment
 
Interest
Income
Recognized
 
(in thousands)
Commercial and industrial
$
31,499

 
$
293

 
$
28,892

 
$
232

Commercial real estate:
 
 
 
 
 
 
 
Commercial real estate
58,117

 
513

 
76,509

 
538

Construction
6,635

 
37

 
20,007

 
139

Total commercial real estate loans
64,752

 
550

 
96,516

 
677

Residential mortgage
20,193

 
225

 
25,336

 
208

Consumer loans:
 
 
 
 
 
 
 
Home equity
2,253

 
25

 
4,275

 
43

Total consumer loans
2,253

 
25

 
4,275

 
43

Total
$
118,697

 
$
1,093

 
$
155,019

 
$
1,160


31




 
Nine Months Ended September 30,
 
2016
 
2015
 
Average
Recorded
Investment
 
Interest
Income
Recognized
 
Average
Recorded
Investment
 
Interest
Income
Recognized
 
(in thousands)
Commercial and industrial
$
28,008

 
$
727

 
$
27,570

 
$
689

Commercial real estate:
 
 
 
 
 
 
 
Commercial real estate
66,871

 
1,627

 
76,900

 
1,918

Construction
8,814

 
138

 
16,066

 
415

Total commercial real estate loans
75,685

 
1,765

 
92,966

 
2,333

Residential mortgage
22,232

 
660

 
23,261

 
707

Consumer loans:
 
 
 
 
 
 
 
Home equity
2,560

 
68

 
4,125

 
111

Total consumer loans
2,560

 
68

 
4,125

 
111

Total
$
128,485

 
$
3,220

 
$
147,922

 
$
3,840

Interest income recognized on a cash basis (included in the table above) was immaterial for the three and nine months ended September 30, 2016 and 2015.
Troubled debt restructured loans. From time to time, Valley may extend, restructure, or otherwise modify the terms of existing loans, on a case-by-case basis, to remain competitive and retain certain customers, as well as assist other customers who may be experiencing financial difficulties. If the borrower is experiencing financial difficulties and a concession has been made at the time of such modification, the loan is classified as a troubled debt restructured loan (TDR). Valley’s PCI loans are excluded from the TDR disclosures below because they are evaluated for impairment on a pool by pool basis. When an individual PCI loan within a pool is modified as a TDR, it is not removed from its pool. All TDRs are classified as impaired loans and are included in the impaired loan disclosures above.
The majority of the concessions made for TDRs involve lowering the monthly payments on loans through either a reduction in interest rate below a market rate, an extension of the term of the loan without a corresponding adjustment to the risk premium reflected in the interest rate, or a combination of these two methods. The concessions rarely result in the forgiveness of principal or accrued interest. In addition, Valley frequently obtains additional collateral or guarantor support when modifying such loans. If the borrower has demonstrated performance under the previous terms of the loan and Valley’s underwriting process shows the borrower has the capacity to continue to perform under the restructured terms, the loan will continue to accrue interest. Non-accruing restructured loans may be returned to accrual status when there has been a sustained period of repayment performance (generally six consecutive months of payments) and both principal and interest are deemed collectible.
Performing TDRs (not reported as non-accrual loans) totaled $81.1 million and $77.6 million as of September 30, 2016 and December 31, 2015, respectively. Non-performing TDRs totaled $13.0 million and $21.0 million as of September 30, 2016 and December 31, 2015, respectively.


32




The following tables present loans by loan portfolio class modified as TDRs during the three and nine months ended September 30, 2016 and 2015. The pre-modification and post-modification outstanding recorded investments disclosed in the table below represent the loan carrying amounts immediately prior to the modification and the carrying amounts at September 30, 2016 and 2015, respectively. 
 
Three Months Ended
September 30, 2016
 
Three Months Ended
September 30, 2015
Troubled Debt Restructurings
Number
of
Contracts
 
Pre-Modification
Outstanding
Recorded
Investment
 
Post-Modification
Outstanding
Recorded
Investment
 
Number
of
Contracts
 
Pre-Modification
Outstanding
Recorded
Investment
 
Post-Modification
Outstanding
Recorded
Investment
 
($ in thousands)
Commercial and industrial
7

 
$
6,389

 
$
6,248

 
2

 
$
1,530

 
$
1,530

Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
1

 
1,667

 
1,870

 

 

 

Construction
2

 
2,078

 
2,078

 
2

 
4,974

 
3,451

Total commercial real estate
3

 
3,745

 
3,948

 
2

 
4,974

 
3,451

Residential mortgage
1

 
78

 
77

 
3

 
1,080

 
1,050

Consumer
1

 
23

 
18

 

 

 

Total
12

 
$
10,235

 
$
10,291

 
7

 
$
7,584

 
$
6,031


 
Nine Months Ended
September 30, 2016
 
Nine Months Ended
September 30, 2015
Troubled Debt Restructurings
Number
of
Contracts
 
Pre-Modification
Outstanding
Recorded
Investment
 
Post-Modification
Outstanding
Recorded
Investment
 
Number
of
Contracts
 
Pre-Modification
Outstanding
Recorded
Investment
 
Post-Modification
Outstanding
Recorded
Investment
 
($ in thousands)
Commercial and industrial
12

 
$
11,700

 
$
11,088

 
12

 
$
4,621

 
$
4,081

Commercial real estate:
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
4

 
8,325

 
8,174

 
4

 
6,562

 
6,444

Construction
2

 
2,079

 
2,078

 
3

 
5,474

 
4,635

Total commercial real estate
6

 
10,404

 
10,252

 
7

 
12,036

 
11,079

Residential mortgage
8

 
2,300

 
2,271

 
6

 
2,458

 
2,420

Consumer
2

 
77

 
69

 
1

 
1,081

 
1,072

Total
28

 
$
24,481

 
$
23,680

 
26

 
$
20,196

 
$
18,652


The TDR concessions made during the three and nine months ended September 30, 2016 and 2015 were mainly extensions of the loan terms. The total TDRs presented in the above table had allocated specific reserves for loan losses totaling $2.4 million and $602 thousand at September 30, 2016 and 2015, respectively. These specific reserves are included in the allowance for loan losses for loans individually evaluated for impairment disclosed in Note 9. One commercial and industrial TDR loan totaling $209 thousand was fully charged-off during the nine months ended September 30, 2016. There were no charge-offs related to TDR modifications during the third quarters of 2016 and 2015 and the nine months ended September 30, 2015.


33




We had four of residential non-PCI loans modified as TDRs within the previous 12 months for which there was a payment default (90 days or more past due) totaling $1.1 million during the three and nine months ended September 30, 2016 and none for the three and nine months ended September 30, 2015.
Credit quality indicators. Valley utilizes an internal loan classification system as a means of reporting problem loans within commercial and industrial, commercial real estate, and construction loan portfolio classes. Under Valley’s internal risk rating system, loan relationships could be classified as “Pass,” “Special Mention,” “Substandard,” “Doubtful,” and “Loss.” Substandard loans include loans that exhibit well-defined weakness and are characterized by the distinct possibility that Valley will sustain some loss if the deficiencies are not corrected. Loans classified as Doubtful have all the weaknesses inherent in those classified as Substandard with the added characteristic that the weaknesses present make collection or liquidation in full, based on currently existing facts, conditions and values, highly questionable and improbable. Loans classified as Loss are those considered uncollectible with insignificant value and are charged-off immediately to the allowance for loan losses, and, therefore, not presented in the table below. Loans that do not currently pose a sufficient risk to warrant classification in one of the aforementioned categories, but pose weaknesses that deserve management’s close attention are deemed Special Mention. Loans rated as Pass do not currently pose any identified risk and can range from the highest to average quality, depending on the degree of potential risk. Risk ratings are updated any time the situation warrants.
The following table presents the risk category of loans (excluding PCI loans) by class of loans at September 30, 2016 and December 31, 2015
Credit exposure - by internally assigned risk rating
Pass
 
Special
Mention
 
Substandard
 
Doubtful
 
Total Non-PCI Loans
 
(in thousands)
September 30, 2016
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
2,158,585

 
$
46,209

 
$
59,972

 
$
1,654

 
$
2,266,420

Commercial real estate
7,015,861

 
79,331

 
83,644

 

 
7,178,836

Construction
667,008

 
100

 
3,693

 

 
670,801

Total
$
9,841,454

 
$
125,640

 
$
147,309

 
$
1,654

 
$
10,116,057

December 31, 2015
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
2,049,752

 
$
68,243

 
$
36,254

 
$
2,300

 
$
2,156,549

Commercial real estate
5,893,354

 
79,279

 
96,899

 

 
6,069,532

Construction
596,530

 
1,102

 
10,062

 

 
607,694

Total
$
8,539,636

 
$
148,624

 
$
143,215

 
$
2,300

 
$
8,833,775


34




For residential mortgages, automobile, home equity and other consumer loan portfolio classes (excluding PCI loans), Valley also evaluates credit quality based on the aging status of the loan, which was previously presented, and by payment activity. The following table presents the recorded investment in those loan classes based on payment activity as of September 30, 2016 and December 31, 2015: 
Credit exposure - by payment activity
Performing
Loans
 
Non-Performing
Loans
 
Total Non-PCI
Loans
 
(in thousands)
September 30, 2016
 
 
 
 
 
Residential mortgage
$
2,623,298

 
$
14,013

 
$
2,637,311

Home equity
376,862

 
820

 
377,682

Automobile
1,121,285

 
145

 
1,121,430

Other consumer
524,540

 

 
524,540

Total
$
4,645,985

 
$
14,978

 
$
4,660,963

December 31, 2015
 
 
 
 
 
Residential mortgage
$
2,894,149

 
$
17,930

 
$
2,912,079

Home equity
389,721

 
2,088

 
391,809

Automobile
1,238,708

 
118

 
1,238,826

Other consumer
426,147

 

 
426,147

Total
$
4,948,725

 
$
20,136

 
$
4,968,861

Valley evaluates the credit quality of its PCI loan pools based on the expectation of the underlying cash flows of each pool, derived from the aging status and by payment activity of individual loans within the pool. The following table presents the recorded investment in PCI loans by class based on individual loan payment activity as of September 30, 2016 and December 31, 2015. 
Credit exposure - by payment activity
Performing
Loans
 
Non-Performing
Loans
 
Total
PCI Loans
 
(in thousands)
September 30, 2016
 
 
 
 
 
Commercial and industrial
$
283,759

 
$
8,789

 
$
292,548

Commercial real estate
1,123,123

 
11,896

 
1,135,019

Construction
130,442

 
1,325

 
131,767

Residential mortgage
185,790

 
3,029

 
188,819

Consumer
103,946

 
5,016

 
108,962

Total
$
1,827,060

 
$
30,055

 
$
1,857,115

December 31, 2015
 
 
 
 
 
Commercial and industrial
$
373,665

 
$
10,277

 
$
383,942

Commercial real estate
1,342,030

 
13,074

 
1,355,104

Construction
141,547

 
5,706

 
147,253

Residential mortgage
214,713

 
3,749

 
218,462

Consumer
129,891

 
5,819

 
135,710

Total
$
2,201,846

 
$
38,625

 
$
2,240,471

Other real estate owned (OREO) totaled $11.3 million and $19.0 million (including $1.0 million and $5.0 million of OREO properties which are subject to loss-sharing agreements with the FDIC) at September 30, 2016 and December 31, 2015, respectively. OREO included foreclosed residential real estate properties totaling $7.4 million and $7.0 million at September 30, 2016 and December 31, 2015, respectively. Residential mortgage and consumer loans secured by residential real estate properties for which formal foreclosure proceedings are in process totaled $7.7 million and $12.3 million at September 30, 2016 and December 31, 2015, respectively.



35



Note 9. Allowance for Credit Losses

The allowance for credit losses consists of the allowance for loan losses and the allowance for unfunded letters of credit. Management maintains the allowance for credit losses at a level estimated to absorb probable loan losses of the loan portfolio and unfunded letter of credit commitments at the balance sheet date. The allowance for loan losses is based on ongoing evaluations of the probable estimated losses inherent in the loan portfolio, including unexpected additional credit impairment of PCI loan pools subsequent to acquisition.

The following table summarizes the allowance for credit losses at September 30, 2016 and December 31, 2015
 
September 30,
2016
 
December 31,
2015
 
(in thousands)
Components of allowance for credit losses:
 
 
 
Allowance for loan losses
$
110,697

 
$
106,178

Allowance for unfunded letters of credit
2,217

 
2,189

Total allowance for credit losses
$
112,914

 
$
108,367


The following table summarizes the provision for credit losses for the periods indicated:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
 
(in thousands)
Components of provision for credit losses:
 
 
 
 
 
 
 
Provision for loan losses
$
5,949

 
$

 
$
8,041

 
$
4,382

Provision for unfunded letters of credit
(109
)
 
94

 
28

 
212

Total provision for credit losses
$
5,840

 
$
94

 
$
8,069

 
$
4,594


The following tables detail activity in the allowance for loan losses by portfolio segment for the three and nine months ended September 30, 2016 and 2015:
 
Commercial
and Industrial
 
Commercial
Real Estate
 
Residential
Mortgage
 
Consumer
 
Unallocated
 
Total
 
(in thousands)
Three Months Ended
September 30, 2016
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
48,025

 
$
51,877

 
$
3,495

 
$
4,691

 
$

 
$
108,088

Loans charged-off
(3,763
)
 

 
(518
)
 
(782
)
 

 
(5,063
)
Charged-off loans recovered
902

 
44

 
495

 
282

 

 
1,723

Net (charge-offs) recoveries
(2,861
)
 
44

 
(23
)
 
(500
)
 

 
(3,340
)
Provision for loan losses
5,588

 
539

 
(94
)
 
(84
)
 


 
5,949

Ending balance
$
50,752

 
$
52,460

 
$
3,378

 
$
4,107

 
$

 
$
110,697

Three Months Ended
September 30, 2015
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
41,714

 
$
44,185

 
$
5,055

 
$
5,542

 
$
6,339

 
$
102,835

Loans charged-off
(1,124
)
 
(40
)
 
(111
)
 
(734
)
 

 
(2,009
)
Charged-off loans recovered
2,550

 
536

 
151

 
488

 

 
3,725

Net recoveries (charge-offs)
1,426

 
496

 
40

 
(246
)
 

 
1,716

Provision for loan losses
4,397

 
(2,403
)
 
(546
)
 
(829
)
 
(619
)
 

Ending balance
$
47,537

 
$
42,278

 
$
4,549

 
$
4,467

 
$
5,720

 
$
104,551



36



 
Commercial
and Industrial
 
Commercial
Real Estate
 
Residential
Mortgage
 
Consumer
 
Unallocated
 
Total
 
(in thousands)
Nine Months Ended
September 30, 2016
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
48,767

 
$
48,006

 
$
4,625

 
$
4,780

 
$

 
$
106,178

Loans charged-off
(5,507
)
 
(519
)
 
(750
)
 
(2,553
)
 

 
(9,329
)
Charged-off loans recovered
2,418

 
1,591

 
604

 
1,194

 

 
5,807

Net (charge-offs) recoveries
(3,089
)
 
1,072

 
(146
)
 
(1,359
)
 

 
(3,522
)
Provision for loan losses
5,074

 
3,382

 
(1,101
)
 
686

 

 
8,041

Ending balance
$
50,752

 
$
52,460

 
$
3,378

 
$
4,107

 
$

 
$
110,697

Nine Months Ended
September 30, 2015
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
43,676

 
$
42,840

 
$
5,093

 
$
5,179

 
$
5,565

 
$
102,353

Loans charged-off
(5,103
)
 
(2,780
)
 
(499
)
 
(2,642
)
 

 
(11,024
)
Charged-off loans recovered
5,587

 
1,686

 
395

 
1,172

 

 
8,840

Net (charge-offs) recoveries
484

 
(1,094
)
 
(104
)
 
(1,470
)
 

 
(2,184
)
Provision for loan losses
3,377

 
532

 
(440
)
 
758

 
155

 
4,382

Ending balance
$
47,537

 
$
42,278

 
$
4,549

 
$
4,467

 
$
5,720

 
$
104,551

At December 31, 2015, Valley refined and enhanced its assessment of the adequacy of the allowance for loan losses, including both changes to look-back periods for certain portfolios, as well as enhancements to its qualitative factor framework. The enhancements were meant to increase the level of precision in the allowance for credit losses. As a result, Valley no longer has an “unallocated” segment in its allowance for credit losses, as the risks and uncertainties meant to be captured by the unallocated allowance have been included in the qualitative framework for the respective loan portfolio segment (reported in the tables above) at September 30, 2016. As such, the unallocated allowance has in essence been reallocated to the applicable portfolios based on the risks and uncertainties it was meant to capture.

37



The following table represents the allocation of the allowance for loan losses and the related loans by loan portfolio segment disaggregated based on the impairment methodology at September 30, 2016 and December 31, 2015. 
 
Commercial
and Industrial
 
Commercial
Real Estate
 
Residential
Mortgage
 
Consumer
 
Total
 
(in thousands)
September 30, 2016
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
3,506

 
$
4,575

 
$
708

 
$
210

 
$
8,999

Collectively evaluated for impairment
47,246

 
47,885

 
2,670

 
3,897

 
101,698

Total
$
50,752

 
$
52,460

 
$
3,378

 
$
4,107

 
$
110,697

Loans:
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
27,128

 
$
69,089

 
$
18,508

 
$
1,723

 
$
116,448

Collectively evaluated for impairment
2,239,292

 
7,780,548

 
2,618,803

 
2,021,929

 
14,660,572

Loans acquired with discounts related to credit quality
292,548

 
1,266,786

 
188,819

 
108,962

 
1,857,115

Total
$
2,558,968

 
$
9,116,423

 
$
2,826,130

 
$
2,132,614

 
$
16,634,135

December 31, 2015
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
3,439

 
$
3,671

 
$
1,377

 
$
295

 
$
8,782

Collectively evaluated for impairment
45,328

 
44,335

 
3,248

 
4,485

 
97,396

Total
$
48,767

 
$
48,006

 
$
4,625

 
$
4,780

 
$
106,178

Loans:
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
25,714

 
$
81,930

 
$
22,612

 
$
2,132

 
$
132,388

Collectively evaluated for impairment
2,130,835

 
6,595,296

 
2,889,467

 
2,054,650

 
13,670,248

Loans acquired with discounts related to credit quality
383,942

 
1,502,357

 
218,462

 
135,710

 
2,240,471

Total
$
2,540,491

 
$
8,179,583

 
$
3,130,541

 
$
2,192,492

 
$
16,043,107


Note 10. Goodwill and Other Intangible Assets
The changes in the carrying amount of goodwill as allocated to Valley's business segments, or reporting units thereof, for goodwill impairment analysis were: 
 
Business Segment / Reporting Unit
 
Wealth
Management*
 
Consumer
Lending
 
Commercial
Lending
 
Investment
Management
 
Total
 
(in thousands)
Balance at December 31, 2015
$
20,517

 
$
199,119

 
$
314,260

 
$
152,443

 
$
686,339

Goodwill from business combinations
701

 
697

 
1,416

 
436

 
3,250

Balance at September 30, 2016
$
21,218

 
$
199,816

 
$
315,676

 
$
152,879

 
$
689,589

 
*
Valley’s Wealth Management Division is comprised of trust, asset management, and insurance services. This reporting unit is included in the Consumer Lending segment for financial reporting purposes.
Goodwill from business combinations, in the table above, includes the effect of the combined adjustments to the estimated fair values of the acquired assets (including core deposits presented in the table below) and liabilities as of the acquisition date of CNL, and goodwill related to the acquisition of certain assets from an independent insurance agency during the first quarter of 2016 (see Note 2 for further details). There was no impairment of goodwill during the three and nine months ended September 30, 2016 and 2015.

38




The following table summarizes other intangible assets as of September 30, 2016 and December 31, 2015: 
 
Gross
Intangible
Assets
 
Accumulated
Amortization
 
Valuation
Allowance
 
Net
Intangible
Assets
 
(in thousands)
September 30, 2016
 
 
 
 
 
 
 
Loan servicing rights
$
68,662

 
$
(51,301
)
 
$
(746
)
 
$
16,615

Core deposits
61,504

 
(36,230
)
 

 
25,274

Other
4,087

 
(1,938
)
 

 
2,149

Total other intangible assets
$
134,253

 
$
(89,469
)
 
$
(746
)
 
$
44,038

December 31, 2015
 
 
 
 
 
 
 
Loan servicing rights
$
75,932

 
$
(59,251
)
 
$
(289
)
 
$
16,392

Core deposits
62,714

 
(31,934
)
 

 
30,780

Other
4,374

 
(2,664
)
 

 
1,710

Total other intangible assets
$
143,020

 
$
(93,849
)
 
$
(289
)
 
$
48,882


Loan servicing rights are accounted for using the amortization method. Under this method, Valley amortizes the loan servicing assets in proportion to, and over the period of, estimated net servicing revenues. On a quarterly basis, Valley stratifies its loan servicing assets into groupings based on risk characteristics and assesses each group for impairment based on fair value. Impairment charges on loan servicing rights are recognized in earnings when the book value of a stratified group of loan servicing rights exceeds its estimated fair value. See the "Assets and Liabilities Measured at Fair Value on a Non-recurring Basis" section of Note 6 for additional information regarding the fair valuation and impairment of loan servicing rights.

Core deposits are amortized using an accelerated method and have a weighted average amortization period of 11 years. The line item labeled “Other” included in the table above primarily consists of customer lists and covenants not to compete, which are amortized over their expected lives generally using a straight-line method and have a weighted average amortization period of approximately 20 years. Valley evaluates core deposits and other intangibles for impairment when an indication of impairment exists. No impairment was recognized during the three and nine months ended September 30, 2016 and 2015.

The following table presents the estimated future amortization expense of other intangible assets for the remainder of 2016 through 2020: 
 
Loan
Servicing
Rights
 
Core
Deposits
 
Other
 
(in thousands)
2016
$
1,308

 
$
1,332

 
$
74

2017
4,262

 
4,842

 
280

2018
3,361

 
4,215

 
249

2019
2,554

 
3,671

 
235

2020
1,952

 
3,127

 
220


Valley recognized amortization expense on other intangible assets, including net impairment charges on loan servicing rights, totaling approximately $2.7 million and $2.2 million for the three months ended September 30, 2016 and 2015, respectively, and $8.5 million and $6.7 million for the nine months ended September 30, 2016 and 2015, respectively.
Note 11. Stock–Based Compensation
On April 28, 2016, Valley’s shareholders approved the new 2016 Long-Term Stock Incentive Plan (the "2016 Stock Plan") administered by the Compensation and Human Resources Committee (the “Committee”) appointed by Valley’s Board of Directors. The purpose of the 2016 Stock Plan is to provide incentives to attract, retain and

39




motivate officers and other key employees by providing a direct financial interest in Valley's continued success, and provide the flexibility to grant equity awards to non-employee directors as part of their compensation. The 2016 Stock Plan will also ensure that Valley has sufficient shares to meet its anticipated long-term equity compensation needs. Effective January 1, 2016, the 2.2 million of common shares remaining under Valley's 2009 Long-Term Stock Incentive Plan (the "2009 Stock Plan") became available for future grants under the 2016 Stock Plan. Accordingly, Valley will no longer grant new awards under the 2009 Stock Plan.
Under the 2016 Stock Plan, Valley may award shares to its employees and non-employee directors shares of common stock in the form of stock appreciation rights, both incentive and non-qualified stock options, restricted stock and restricted stock units (RSUs). As of September 30, 2016, up to 8.3 million shares of common stock were available for issuance under the 2016 Stock Plan. The essential features of each award are described in the award agreement relating to that award. The grant, exercise, vesting, settlement or payment of an award may be based upon the fair value of Valley’s common stock on the last sale price reported for Valley’s common stock on such date or the last sale price reported preceding such date, except for performance-based awards with a market condition. The grant date fair values of performance-based awards that vest based on a market condition are determined by a third party specialist using a Monte Carlo valuation model.

Valley awarded time-based restricted stock totaling 534 thousand shares and 492 thousand shares during the nine months ended September 30, 2016 and 2015, respectively, to both executive officers and key employees of Valley. Time-based restricted stock issued during the three months ended September 30, 2016 and 2015 were immaterial. Valley also awarded 431 thousand and 313 thousand shares of performance-based RSUs under the 2016 Stock Plan during the nine months ended September 30, 2016, respectively, to certain executive officers. There were no awards of the performance-based RSUs during the three months ended September 30, 2016 and 2015. The RSUs earn dividend equivalents (equal to cash dividends paid on Valley's common stock) over the applicable performance period. Dividend equivalents and accrued interest, per the terms of the agreements, are accumulated and paid to the grantee at the vesting date, or forfeited if the performance conditions are not met.

The performance-based awards vest based on (i) growth in tangible book value per share plus dividends (75 percent of performance shares) and (ii) total shareholder return as compared to our peer group (25 percent of performance shares). The majority of the performance-based awards "cliff" vest after three years based on the cumulative performance of Valley during that time period. The non-performance based awards have vesting periods ranging from three to six years. Generally, the restrictions on such awards lapse at an annual or bi-annual rate of one-third of the total award commencing with the first or second anniversary of the date of grant, respectively. The average grant date fair value of non-performance and performance-based restricted stock awarded during the nine months ended September 30, 2016 was $8.58.

Valley recorded stock-based compensation expense of $2.2 million and $2.0 million for the three months ended September 30, 2016 and 2015, respectively, and $7.4 million and $6.5 million for the nine months ended September 30, 2016 and 2015, respectively. The fair values of stock awards are expensed over the shorter of the vesting or required service period. As of September 30, 2016, the unrecognized amortization expense for all stock-based employee compensation totaled approximately $16.9 million and will be recognized over an average remaining vesting period of approximately 3 years.
Note 12. Derivative Instruments and Hedging Activities

Valley enters into derivative financial instruments to manage exposures that arise from business activities that result in the payment of future known and uncertain cash amounts, the value of which are determined by interest rates.

Cash Flow Hedges of Interest Rate Risk. Valley’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, Valley uses interest rate swaps and caps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the payment of either fixed or variable-rate amounts in exchange for the receipt of variable or fixed-rate amounts from a counterparty. Interest rate caps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty if interest rates rise above the strike rate on the contract in exchange for an up-front premium.

Fair Value Hedges of Fixed Rate Assets and Liabilities. Valley is exposed to changes in the fair value of certain of its fixed rate assets or liabilities due to changes in benchmark interest rates based on one-month LIBOR. From time to time, Valley uses interest rate swaps to manage its exposure to changes in fair value. Interest rate swaps designated as fair value hedges involve the receipt of variable rate payments from a counterparty in exchange for Valley making fixed rate payments over the life of the agreements without the exchange of the underlying notional amount. For derivatives that are designated and qualify as fair value hedges, the gain or loss on the derivative as well as the loss or gain on the hedged item attributable to the hedged risk are recognized in earnings. Valley includes the gain or loss on the hedged items in the same income statement line item as the loss or gain on the related derivatives.

Valley terminated an interest rate swap with a notional amount of $125 million in August 2016.  The terminated swap, originally maturing in September 2023, was used to hedge the change in the fair value of Valley’s $125 million of 5.125 percent subordinated notes issued in September 2013. The transaction resulted in an adjusted annual interest rate of 3.32 percent on the subordinated notes, after amortization of the derivative valuation adjustment recorded at the termination date. The subordinated notes had a net carrying value of $137.1 million at September 30, 2016.

Non-designated Hedges. Derivatives not designated as hedges may be used to manage Valley’s exposure to interest rate movements or to provide service to customers but do not meet the requirements for hedge accounting under U.S. GAAP. Derivatives not designated as hedges are not entered into for speculative purposes.

Under a program, Valley executes interest rate swaps with commercial lending customers to facilitate their respective risk management strategies. These interest rate swaps with customers are simultaneously offset by interest rate swaps that Valley executes with a third party, such that Valley minimizes its net risk exposure resulting from such transactions. As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer swaps and the offsetting swaps are recognized directly in earnings.

During 2014, Valley issued $25 million of market linked certificates of deposit through a broker dealer. The rate paid on these hybrid instruments is based on a formula derived from the spread between the long and short ends of the constant maturity swap (CMS) rate curve. This type of instrument is referred to as a "steepener" since it derives its value from the slope of the CMS curve. Valley has determined that these hybrid instruments contain an embedded swap contract which has been bifurcated from the host contract. Valley entered into a swap (with a total notional amount of $25 million) almost simultaneously with the deposit issuance where the receive rate on the swap mirrors the pay rate on the brokered deposits. The bifurcated derivative and the stand alone swap are both marked to market through other non-interest expense. Although these instruments do not meet the hedge accounting requirements, the change in fair value of both the bifurcated derivative and the stand alone swap tend to move in opposite directions with changes in three-month LIBOR rate and therefore provide an effective economic hedge.


40




Valley regularly enters into mortgage banking derivatives which are non-designated hedges. These derivatives include interest rate lock commitments provided to customers to fund certain residential mortgage loans to be sold into the secondary market and forward commitments for the future delivery of such loans. Valley enters into forward commitments for the future delivery of residential mortgage loans when interest rate lock commitments are entered into in order to economically hedge the effect of future changes in interest rates on Valley’s commitments to fund the loans as well as on its portfolio of mortgage loans held for sale.

Amounts included in the consolidated statements of financial condition related to the fair value of Valley’s derivative financial instruments were as follows: 
 
September 30, 2016
 
December 31, 2015
 
Fair Value
 
 
 
Fair Value
 
 
 
Other Assets
 
Other Liabilities
 
Notional Amount
 
Other Assets
 
Other Liabilities
 
Notional Amount
 
(in thousands)
Derivatives designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
Cash flow hedge interest rate caps and swaps
$
286

 
$
25,636

 
$
907,000

 
$
1,284

 
$
24,823

 
$
907,000

Fair value hedge interest rate swaps

 
1,273

 
8,053

 
7,658

 
1,306

 
133,209

Total derivatives designated as hedging instruments
$
286

 
$
26,909

 
$
915,053

 
$
8,942

 
$
26,129

 
$
1,040,209

Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps and embedded derivatives
$
45,013

 
$
44,980

 
$
824,736

 
$
24,628

 
$
24,623

 
$
654,134

Mortgage banking derivatives
720

 
783

 
451,901

 
204

 
92

 
73,438

Total derivatives not designated as hedging instruments
$
45,733

 
$
45,763

 
$
1,276,637

 
$
24,832

 
$
24,715

 
$
727,572


Gains (losses) included in the consolidated statements of income and in other comprehensive income, on a pre-tax basis, related to interest rate derivatives designated as hedges of cash flows were as follows: 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
 
(in thousands)
Amount of loss reclassified from accumulated other comprehensive loss to interest expense
$
(3,578
)
 
$
(1,323
)
 
$
(10,146
)
 
$
(4,651
)
Amount of gain (loss) recognized in other comprehensive income
2,962

 
(10,588
)
 
(11,695
)
 
(17,604
)
The net gains or losses related to cash flow hedge ineffectiveness were immaterial during the three and nine months ended September 30, 2016 and 2015. The accumulated net after-tax losses related to effective cash flow hedges included in accumulated other comprehensive loss were $18.6 million and $17.6 million at September 30, 2016 and December 31, 2015, respectively.
Amounts reported in accumulated other comprehensive loss related to cash flow interest rate derivatives are reclassified to interest expense as interest payments are made on the hedged variable interest rate liabilities. Valley estimates that $10.4 million will be reclassified as an increase to interest expense over the next 12 months.


41




Gains (losses) included in the consolidated statements of income related to interest rate derivatives designated as hedges of fair value were as follows:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
 
(in thousands)
Derivative - interest rate swaps:
 
 
 
 
 
 
 
Interest income
$
129

 
$
(93
)
 
$
32

 
$
10

Interest expense
(127
)
 
4,302

 
6,670

 
3,211

Hedged item - loans and borrowings:
 
 
 
 
 
 
 
Interest income
$
(129
)
 
$
93

 
$
(32
)
 
$
(10
)
Interest expense
133

 
(4,329
)
 
(6,646
)
 
(3,270
)

The amounts recognized in non-interest expense related to ineffectiveness of fair value hedges were immaterial for the three and nine months ended September 30, 2016 and 2015.

The net gains (losses) included in the consolidated statements of income related to derivative instruments not designated as hedging instruments were as follows: 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
 
(in thousands)
Non-designated hedge interest rate derivatives
 
 
 
 
 
 
 
Other non-interest expense
$
171

 
$
(263
)
 
$
(218
)
 
$
(155
)

Credit Risk Related Contingent Features. By using derivatives, Valley is exposed to credit risk if counterparties to the derivative contracts do not perform as expected. Management attempts to minimize counterparty credit risk through credit approvals, limits, monitoring procedures and obtaining collateral where appropriate. Credit risk exposure associated with derivative contracts is managed at Valley in conjunction with Valley’s consolidated counterparty risk management process. Valley’s counterparties and the risk limits monitored by management are periodically reviewed and approved by the Board of Directors.

Valley has agreements with its derivative counterparties providing that if Valley defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then Valley could also be declared in default on its derivative counterparty agreements. Additionally, Valley has an agreement with several of its derivative counterparties that contains provisions that require Valley’s debt to maintain an investment grade credit rating from each of the major credit rating agencies, from which it receives a credit rating. If Valley’s credit rating is reduced below investment grade or such rating is withdrawn or suspended, then the counterparty could terminate the derivative positions, and Valley would be required to settle its obligations under the agreements. As of September 30, 2016, Valley was in compliance with all of the provisions of its derivative counterparty agreements. As of September 30, 2016, the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk related to these agreements was $69.3 million. Valley has derivative counterparty agreements that require minimum collateral posting thresholds for certain counterparties. At September 30, 2016, Valley had $92.1 million in collateral posted with its counterparties.

42




Note 13. Balance Sheet Offsetting
Certain financial instruments, including derivatives (consisting of interest rate caps and swaps) and repurchase agreements (accounted for as secured long-term borrowings), may be eligible for offset in the consolidated balance sheet and/or subject to master netting arrangements or similar agreements. Valley is party to master netting arrangements with its financial institution counterparties; however, Valley does not offset assets and liabilities under these arrangements for financial statement presentation purposes. The master netting arrangements provide for a single net settlement of all swap agreements, as well as collateral, in the event of default on, or termination of, any one contract. Collateral, usually in the form of cash or marketable investment securities, is posted by the counterparty with net liability positions in accordance with contract thresholds. Master repurchase agreements which include “right of set-off” provisions generally have a legally enforceable right to offset recognized amounts. In such cases, the collateral would be used to settle the fair value of the repurchase agreement should Valley be in default. The table below presents information about Valley’s financial instruments that are eligible for offset in the consolidated statements of financial condition as of September 30, 2016 and December 31, 2015.
 
 
 
 
 
 
 
 
Gross Amounts Not Offset
 
 
 
Gross Amounts
Recognized
 
Gross Amounts
Offset
 
Net Amounts
Presented
 
Financial
Instruments
 
Cash
Collateral
 
Net
Amount
 
(in thousands)
September 30, 2016
 
 
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
Interest rate caps and swaps
$
45,299

 
$

 
$
45,299

 
$

 
$

 
$
45,299

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
Interest rate caps and swaps
$
71,889

 
$

 
$
71,889

 
$

 
$
(71,889
)
 
$

Repurchase agreements
265,000

 

 
265,000

 

 
(265,000
)
*

Total
$
336,889

 
$

 
$
336,889

 
$

 
$
(336,889
)
 
$

December 31, 2015
 
 
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
Interest rate caps and swaps
$
33,570

 
$

 
$
33,570

 
$
(8,942
)
 
$

 
$
24,628

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
Interest rate caps and swaps
$
50,752

 
$

 
$
50,752

 
$
(8,942
)
 
$
(41,810
)
 
$

Repurchase agreements
475,000

 

 
475,000

 

 
(475,000
)
*

Total
$
525,752

 
$

 
$
525,752

 
$
(8,942
)
 
$
(516,810
)
 
$

 
*
Represents fair value of non-cash pledged investment securities.
Note 14. Tax Credit Investments

Valley’s tax credit investments are primarily related to investments promoting qualified affordable housing projects, and other investments related to community development and renewable energy sources. Some of these tax-advantaged investments support Valley’s regulatory compliance with the Community Reinvestment Act (CRA). Valley’s investments in these entities generate a return primarily through the realization of federal income tax credits, and other tax benefits, such as tax deductions from operating losses of the investments, over specified time periods. These tax credits and deductions are recognized as a reduction of income tax expense.

Valley’s tax credit investments are carried in other assets on the consolidated statements of financial condition. Valley’s unfunded capital and other commitments related to the tax credit investments are carried in accrued expenses and other liabilities on the consolidated statements of financial condition. Valley recognizes amortization of tax credit investments, including impairment losses, within non-interest expense of the consolidated statements

43




of income using the equity method of accounting. An impairment loss is recognized when the fair value of the tax credit investment is less than its carrying value.

The following table presents the balances of Valley’s affordable housing tax credit investments, other tax credit investments, and related unfunded commitments at September 30, 2016 and December 31, 2015.
 
September 30,
2016
 
December 31,
2015
 
(in thousands)
Other Assets:
 
 
 
Affordable housing tax credit investments, net
$
30,375

 
$
32,094

Other tax credit investments, net
60,062

 
70,681

Total tax credit investments, net
$
90,437

 
$
102,775

Other Liabilities:
 
 
 
Unfunded affordable housing tax credit commitments
$
5,330

 
$
7,330

Unfunded other tax credit commitments
7,428

 
12,545

    Total unfunded tax credit commitments
$
12,758

 
$
19,875


The following table presents other information relating to Valley’s affordable housing tax credit investments and other tax credit investments for the three and nine months ended September 30, 2016 and 2015
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
 
(in thousands)
Components of Income Tax Expense:
 
 
 
 
 
 
 
Affordable housing tax credits and other tax benefits
$
1,065

 
$
1,660

 
$
3,195

 
$
4,774

Other tax credit investment credits and tax benefits
6,118

 
7,510

 
12,654

 
16,031

Total reduction in income tax expense
$
7,183

 
$
9,170

 
$
15,849

 
$
20,805

Amortization of Tax Credit Investments:
 
 
 
 
 
 
 
Affordable housing tax credit investment losses
$
33

 
$
543

 
$
1,392

 
$
1,516

Affordable housing tax credit investment impairment losses
128

 
451

 
328

 
979

Other tax credit investment losses
107

 
144

 
775

 
934

Other tax credit investment impairment losses
6,182

 
4,086

 
18,865

 
10,802

Total amortization of tax credit investments recorded in non-interest expense
$
6,450

 
$
5,224

 
$
21,360

 
$
14,231

Note 15. Business Segments
The information under the caption “Business Segments” in Management’s Discussion and Analysis of Financial Condition and Results of Operations is incorporated herein by reference.

44





Item 2. Management’s Discussion and Analysis (MD&A) of Financial Condition and Results of Operations

The following MD&A should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this report. The words "Valley," the "Company," "we," "our" and "us" refer to Valley National Bancorp and its wholly owned subsidiaries, unless we indicate otherwise. Additionally, Valley’s principal subsidiary, Valley National Bank, is commonly referred to as the “Bank” in this MD&A.

The MD&A contains supplemental financial information, described in the sections that follow, which has been determined by methods other than U.S. generally accepted accounting principles (U.S. GAAP) that management uses in its analysis of our performance. Management believes these non-GAAP financial measures provide information useful to investors in understanding our underlying operational performance, our business and performance trends and facilitates comparisons with the performance of others in the financial services industry. These non-GAAP financial measures should not be considered in isolation or as a substitute for or superior to financial measures calculated in accordance with U.S. GAAP. These non-GAAP financial measures may also be calculated differently from similar measures disclosed by other companies.
Cautionary Statement Concerning Forward-Looking Statements

This Quarterly Report on Form 10-Q, both in the MD&A and elsewhere, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are not historical facts and include expressions about management’s confidence and strategies and management’s expectations about new and existing programs and products, acquisitions, relationships, opportunities, taxation, technology, market conditions and economic expectations. These statements may be identified by such forward-looking terminology as “should,” “expect,” “believe,” “view,” “opportunity,” “allow,” “continues,” “reflects,” “typically,” “usually,” “anticipate,” or similar statements or variations of such terms. Such forward-looking statements involve certain risks and uncertainties and our actual results may differ materially from such forward-looking statements. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements in addition to those risk factors disclosed in Valley’s Annual Report on Form 10-K for the year ended December 31, 2015, include, but are not limited to:

weakness or a decline in the U.S. economy, in particular in New Jersey, New York Metropolitan area (including Long Island) and Florida;
unexpected changes in market interest rates for interest earning assets and/or interest bearing liabilities;
less than expected cost savings from the maturity, modification or prepayment of long-term borrowings that mature through 2022;
further prepayment penalties related to the early extinguishment of high cost borrowings;
less than expected cost savings in 2016 and 2017 from Valley's branch efficiency and cost reduction plans;
lower than expected cash flows from purchased credit-impaired loans;
claims and litigation pertaining to fiduciary responsibility, contractual issues, environmental laws and other matters;
cyber attacks, computer viruses or other malware that may breach the security of our websites or other systems to obtain unauthorized access to confidential information, destroy data, disable or degrade service, or sabotage our systems;
results of examinations by the OCC, the FRB, the CFPB and other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our allowance for credit losses, write-down assets, require us to reimburse customers, change the way we do business, or limit or eliminate certain other banking activities;

45




government intervention in the U.S. financial system and the effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve;
our inability to pay dividends at current levels, or at all, because of inadequate future earnings, regulatory restrictions or limitations, and changes in the composition of qualifying regulatory capital and minimum capital requirements (including those resulting from the U.S. implementation of Basel III requirements);
higher than expected loan losses within one or more segments of our loan portfolio;
unexpected significant declines in the loan portfolio due to the lack of economic expansion, increased competition, large prepayments, changes in regulatory lending guidance or other factors;
unanticipated credit deterioration in our loan portfolio;
unanticipated loan delinquencies, loss of collateral, decreased service revenues, and other potential negative effects on our business caused by severe weather or other external events;
an unexpected decline in real estate values within our market areas;
changes in accounting policies or accounting standards, including the potential issuance of new authoritative accounting guidance which may increase the required level of our allowance for credit losses;
higher than expected income tax expense or tax rates, including increases resulting from changes in tax laws, regulations and case law;
higher than expected FDIC insurance assessments;
the failure of other financial institutions with whom we have trading, clearing, counterparty and other financial relationships;
lack of liquidity to fund our various cash obligations;
unanticipated reduction in our deposit base;
potential acquisitions that may disrupt our business;
declines in value in our investment portfolio, including additional other-than-temporary impairment charges on our investment securities;
future goodwill impairment due to changes in our business, changes in market conditions, or other factors;
legislative and regulatory actions (including the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act and related regulations) subject us to additional regulatory oversight which may result in higher compliance costs and/or require us to change our business model;
our inability to promptly adapt to technological changes;
our internal controls and procedures may not be adequate to prevent losses;
the inability to realize expected revenue synergies from the CNL merger in the amounts or in the timeframe anticipated;
inability to retain customers and employees, including those of CNL; and
other unexpected material adverse changes in our operations or earnings.
Critical Accounting Policies and Estimates

Valley’s accounting policies are fundamental to understanding management’s discussion and analysis of its financial condition and results of operations. Our significant accounting policies are presented in Note 1 to the consolidated financial statements included in Valley’s Annual Report on Form 10-K for the year ended December 31, 2015. We identified our policies on the allowance for loan losses, security valuations and impairments, goodwill and other intangible assets, and income taxes to be critical because management has to make subjective and/or complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions. Management has reviewed the

46




application of these policies with the Audit Committee of Valley’s Board of Directors. Our critical accounting policies are described in detail in Part II, Item 7 in Valley’s Annual Report on Form 10-K for the year ended December 31, 2015.
New Authoritative Accounting Guidance

See Note 5 to the consolidated financial statements for a description of new authoritative accounting guidance including the respective dates of adoption and effects on results of operations and financial condition.

Executive Summary

Company Overview. At September 30, 2016, Valley had consolidated total assets of approximately $22.4 billion, total net loans of $16.5 billion, total deposits of $17.0 billion and total shareholders’ equity of $2.3 billion. Our commercial bank operations include branch office locations in northern and central New Jersey, the New York City Boroughs of Manhattan, Brooklyn, Queens, and Long Island; and Florida. Of our current 209 branch network, 67 percent, 18 percent and 15 percent of the branches are located in New Jersey, New York and Florida, respectively. We have grown both in asset size and locations significantly over the past several years primarily through bank acquisitions.

Valley’s most recent bank acquisition was completed on December 1, 2015 when Valley acquired CNLBancshares, Inc. (CNL) and its wholly-owned subsidiary, CNLBank, a commercial bank with approximately $1.6 billion in assets, $825 million in loans, and $1.2 billion in deposits, after purchase accounting adjustments, and a branch network of 16 offices on the date of its acquisition by Valley. The CNL acquisition helped strengthen Valley's Florida branch network (originally established in 2014) covering several major markets in Florida. In late February 2016, we completed the full systems integration of CNLBank's operations into Valley and realized the related staffing efficiencies effective April 1, 2016. See Item 1 of Valley’s Annual Report on Form 10-K for the year ended December 31, 2015 for more details regarding our acquisition of CNL and other past merger activity.
Quarterly Results. Net income for the third quarter of 2016 was $42.8 million or 0.16 per diluted common share, compared to $36.0 million, or 0.15 per diluted common share, for the third quarter of 2015. The $6.8 million increase in quarterly net income as compared to the same quarter one year ago was largely due to: (i) a $20.2 million increase in our net interest income mostly due to higher average loan balances (due to both acquired loans and organic growth) and the prepayment, modification, and maturity of $845 million, $405 million and $257 million of high cost long-term borrowings in the fourth quarter of 2015, third quarter of 2016 and the nine months ended September 30, 2016, respectively, (ii) a $3.9 million increase in non-interest income mostly caused by increases in net gains on sales of residential mortgage loans and, to a much lesser extent, net gains on sales of assets, partially offset by (iii) a $5.7 million increase in the provision for credit losses and (iv) a $4.6 million increase in non-interest expense mostly due to increases in salary and employee benefit expense and amortization of tax credit investments, and (v) an increase in income tax expense mainly due to higher pre-tax income. See the "Net Interest Income," "Non-Interest Income," and "Non-Interest Expense" sections below for more details on the items above impacting our third quarter 2016 results, as well as other items discussed elsewhere in this MD&A.
Economic Overview and Indicators. During the third quarter of 2016, real gross domestic product (GDP) grew at a 2.9 percent annual rate after advancing 1.4 percent in the second quarter of 2016. The pace of hiring picked up somewhat compared to the prior quarter and business fixed investment remained weak. While growth in residential fixed investment has recently slowed, it has been solid over recent quarters reflecting higher levels of disposable income from earlier declines in commodity prices and rising confidence in the health of the labor market.

The labor market continued to improve as the pace of hiring accelerated somewhat from a monthly average of 146 thousand last quarter to 192 thousand in the most recent quarter. The civilian unemployment rate increased from 4.9 percent as of June 30, 2016 to 5.0 percent as of September 30, 2016, but was mostly reflective of an increase in the labor force. Measures of wages have increased, albeit modestly over recent months, which may have contributed to the growth in the labor force.
In the third quarter of 2016, the pace of U.S. existing home sales decreased compared to the linked second quarter and the same period a year ago. However, home sales are expected to rise from current levels as market conditions remain generally favorable. Higher readings of consumer confidence that has been boosted by a strengthening labor market and higher levels of household disposable income should continue to support the housing market. However, low levels of home inventory may weigh on sales volume.

47





Personal consumption of goods and services decreased modestly in the third quarter of 2016 after growing at a faster pace in the first six months of 2016. Slowing sales may continue to weigh on business inventories that remain at elevated levels which may result in slower overall business investment. Equity and home prices continued to rise in the third quarter of 2016 which may support consumer spending through the final months of the year.

The Federal Reserve’s Open Market Committee (FOMC) maintained the target range for the federal funds rate at 0.25 to 0.50 percent in their November 2016 meeting, citing concerns about continued low levels of inflation and inflation expectations. In determining future policy actions, the FOMC will assess progress - both realized and expected - toward its objectives of maximum employment and 2-percent inflation. The FOMC has maintained its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and will continue rolling over maturing Treasury securities at auction. This policy should help maintain accommodative financial conditions through at least 2017. The FOMC has continued to emphasize that changes in monetary policy will be data dependent.

The 10-year U.S. Treasury note yield ended the third quarter at 1.60 percent, representing a 67 basis point decline from December 31, 2015. The spread between the 2- and 10-year U.S. Treasury note yields ended the third quarter of 2016 at 0.83 percentage points, which was 8 basis points and 38 basis points lower than June 30, 2016 and December 31, 2015, respectively.

Residential mortgage loan originations were relatively strong during the third quarter of 2016. We expect the residential mortgage application volume to continue to produce similar levels of originations, as long as the interest rate environment remains accommodative to borrowers. We also continued to see increased demand for commercial real estate and construction loans in the third quarter of 2016, especially within our New York City and New Jersey markets. However, spreads between shorter and longer dated interest rates remain lower compared to the prior year average, and may weigh on our net interest income and margin in future periods. Additionally, the relatively weak pace of personal consumption and overall business investment reported in the third quarter may challenge our business operations and results, as highlighted throughout the remaining MD&A discussion below.




48




The following economic indicators are just a few of the many factors that may be used to assess the market conditions in our primary markets of northern and central New Jersey, the New York City metropolitan area, and Florida.
 
For the Month Ended
 
September 30,
2016
 
June 30,
2016
 
March 31,
2016
 
December 31,
2015
 
September 30,
2015
Selected Economic Indicators:
 
 
 
 
 
 
 
 
 
Unemployment rate:
 
 
 
 
 
 
 
 
 
U.S.
4.90
%
 
4.90
%
 
5.00
%
 
5.00
%
 
5.10
%
New York Metro Region (1)
5.20

 
4.40

 
4.70

 
4.40

 
5.00

New Jersey
5.30

 
4.90

 
4.40

 
4.90

 
5.60

New York
4.80

 
4.80

 
4.80

 
5.30

 
5.30

Miami-Fort Lauderdale Metro Region
5.10

 
4.60

 
4.90

 
5.00

 
5.70

Florida
4.70

 
4.70

 
5.00

 
5.10

 
5.20

 
Three Months Ended
 
September 30,
2016
 
June 30,
2016
 
March 31,
2016
 
December 31,
2015
 
September 30,
2015
2-year U.S. Treasury rate (2)
0.73
%
 
0.77
%
 
0.84
%
 
0.84
%
 
0.69
%
10-year U.S. Treasury rate (2)
1.56

 
1.75

 
1.91

 
2.19

 
2.22

Real Gross Domestic Product (3)
2.9

 
1.20

 
1.10

 
1.40

 
2.00

Change in personal income (4) :
 
 
 
 
 
 
 
 
 
New Jersey
NA

 
2.86

 
3.28

 
3.65

 
4.09

New York
NA

 
2.69

 
4.08

 
2.89

 
4.24

Florida
NA

 
4.42

 
4.34

 
5.00

 
5.11

Homeowner vacancy rates:
 
 
 
 
 
 
 
 
 
New Jersey
1.8

 
1.90

 
1.80

 
1.40

 
1.40

New York
2.20

 
2.10

 
2.20

 
2.40

 
1.60

Florida
2.30

 
2.30

 
2.30

 
2.70

 
2.60

Number of U.S. regional existing home sales (5) :
 
 
 
 
 
 
 
 
 
Northeast census region
700,000

 
756,667

 
703,333

 
726,667

 
713,333

South census region
2,173,333

 
2,233,333

 
2,226,667

 
2,116,667

 
2,193,333

Number of building permits authorized for new homes (2) :
 
 
 
 
 
 
 
 
 
New Jersey
1,909

 
1,749

 
2,581

 
2,809

 
2,172

New York
2,982

 
2,322

 
2,380

 
5,632

 
2,638

Florida
10,372

 
8,664

 
8,536

 
9,907

 
9,141

 
NA—not available
(1)
As reported by the Bureau of Labor Statistics for the NY-NJ-PA Metropolitan Statistical Area.
(2)
Quarterly average for the period presented.
(3)
Quarterly, compounded annual rate of change.
(4)
Quarterly average, year over year percent change.
(5)
Quarterly average, seasonally adjusted annual rate.
Sources: Bureau of Labor Statistics, U.S. Census Bureau, Federal Reserve Economic Data (FRED)
Loans. Loans increased by $135.0 million, or 3.3 percent on an annualized basis, to $16.6 billion at September 30, 2016 from June 30, 2016 largely due to a $328.8 million net increase in total commercial real estate loans. The overall loan growth was partially offset by a decrease of $229.2 million in residential mortgage loans caused, in part, by the transfer of $174.5 million of performing 30-year fixed rate mortgages to loans held for sale during the third quarter of 2016. The transfer was the result of our continuous efforts to effectively manage the level of interest rate risk on our balance sheet. The sale of these loans is expected to be completed during the fourth quarter of 2016 and result in a pre-tax gain of approximately $7 million. We also originated for sale $171.9 million of

49




residential mortgage loans during the third quarter. Total new organic loan originations, excluding new lines of credit and purchased loans, totaled over $900 million mostly in the commercial loan categories during the third quarter of 2016. See further details on our loan activities, including the covered loan portfolio, under the “Loan Portfolio” section below.
Asset Quality. Our past due loans and non-accrual loans, discussed further below, exclude PCI loans. Under U.S. GAAP, the PCI loans (acquired at a discount that is due, in part, to credit quality) are accounted for on a pool basis and are not subject to delinquency classification in the same manner as loans originated by Valley. All of the loans acquired from CNL in the fourth quarter of 2015 are accounted for as PCI loans. As of September 30, 2016, PCI loans totaled $1.9 billion and represented approximately 11.2 percent of our total loan portfolio.
Total non-PCI loan portfolio delinquencies (including loans past due 30 days or more and non-accrual loans) as a percentage of total loans decreased to 0.47 percent at September 30, 2016 as compared to 0.49 percent at June 30, 2016 due to strong collections within non-accrual loans, partially offset by higher levels of accruing past due loans mostly within the commercial real estate loan portfolio. At September 30, 2016, accruing past due loans totaled $39.2 million and included $4.7 million of matured performing loans in the normal process of renewal. Overall, our non-performing assets (including non-accrual loans) decreased by 16.7 percent to $51.0 million at September 30, 2016 as compared to $61.3 million at June 30, 2016 mostly due to a 19.7 percent decrease in non-accrual loans to $38.4 million.
Our lending strategy is based on underwriting standards designed to maintain high credit quality and we remain optimistic regarding the overall future performance of our loan portfolio. However, due to the potential for future credit deterioration caused by the unpredictable direction of U.S. economic and political environments, as well as the housing and labor markets, management cannot provide assurance that our non-performing assets will not increase from the levels reported as of September 30, 2016. See the "Non-Performing Assets" section below for further analysis of our asset quality.
Deposits and Other Borrowings. The mix of the deposit categories of total average deposits for the third quarter of 2016 remained relatively unchanged as compared to the second quarter of 2016. Non-interest bearing deposits represented approximately 30 percent of total average deposits for the three months ended September 30, 2016, while savings, NOW and money market accounts were 51 percent and time deposits were 19 percent of the total average deposits. Overall, average deposits totaling $16.7 billion for the third quarter of 2016 increased by $215.4 million as compared to the second quarter of 2016 due, in large part, to increased volumes of low cost brokered money market deposit balances used for loan funding and liquidity purposes, and to a lesser extent, increases in non-interest deposits and retail time deposits during the third quarter of 2016.
In August 2016, we elected to prepay $405 million of FHLB borrowings with various maturity dates in 2018. The prepaid borrowings with a total average cost of 3.69 percent were funded with a new fixed-rate five-year FHLB advance totaling $405 million. The transaction was accounted for as a debt modification under U.S. GAAP. As a result, the new advance has an adjusted annual interest rate of 2.51 percent, after amortization of prepayment penalties totaling $20.0 million paid to the FHLB.
Additionally, Valley terminated an interest rate swap with a notional amount of $125 million in August 2016. The terminated swap, originally maturing in September 2023, was used to hedge the change in the fair value of Valley’s 5.125 percent subordinated notes issued in September 2013. The transaction will result in an adjusted fixed annual interest rate of 3.32 percent on the subordinated notes, after amortization of the derivative valuation adjustment recorded at the termination date. See Note 12 to the consolidated financial statements for additional information regarding our derivative transactions.
Average short-term borrowings increased $221.2 million, or 18.2 percent, to $1.4 billion for the three months ended September 30, 2016 as compared to the second quarter of 2016 mostly due to increased use of short-term FHLB advances starting in late June 2016 for additional liquidity to fund new loan volumes. Actual ending balances for short-term borrowings increased $21.5 million to $1.4 billion at September 30, 2016 as compared to June 30, 2016 mostly due to the higher level of FHLB advances which totaled approximately $1.1 billion at September 30, 2016.

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Average long-term borrowings (which include junior subordinated debentures issued to capital trusts which are presented separately on the consolidated statements of condition) decreased $104.4 million, or 6.4 percent, to $1.5 billion for the third quarter of 2016 from $1.6 billion for the second quarter of 2016 primarily due to the May 2016 prepayment of $87 million of FHLB advances assumed in the acquisition of CNL, as well as the maturity and repayment of $75 million and $27 million in high cost FHLB advances during late July and April 2016, respectively. The $87 million prepayment of FHLB borrowings was entirely funded by cash balances that were held as collateral at the FHLB of Atlanta. Actual ending balances for long-term borrowings decreased $94.7 million to $1.5 billion at September 30, 2016 as compared to June 30, 2016 primarily due to the maturity and repayment of FHLB advances during July 2016, as well the unamortized portion of the $20 million prepayment penalty related to the debt modification during the third quarter of 2016.

Selected Performance Indicators. The following table presents our annualized performance ratios for the periods indicated:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
Return on average assets
0.78
%
 
0.74
%
 
0.72
%
 
0.68
%
Return on average shareholders’ equity
7.61

 
7.20

 
7.04

 
6.82

Return on average tangible shareholders’ equity (ROATE)
11.29

 
10.36

 
10.48

 
10.00


ROATE, which is a non-GAAP measure, is computed by dividing net income by average shareholders’ equity less average goodwill and average other intangible assets, as follows:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
 
($ in thousands)
Net income
$
42,842

 
$
35,954

 
$
118,056

 
$
98,286

Average shareholders’ equity
2,251,461

 
1,997,369

 
2,236,578

 
1,921,578

Less: Average goodwill and other intangible assets
(733,830
)
 
(609,632
)
 
(734,788
)
 
(611,540
)
Average tangible shareholders’ equity
$
1,517,631

 
$
1,387,737

 
$
1,501,790

 
$
1,310,038

Annualized ROATE
11.29
%
 
10.36
%
 
10.48
%
 
10.00
%

Management believes the ROATE measure provides information useful to management and investors in understanding our underlying operational performance, our business and performance trends and the measure facilitates comparisons with the performance of others in the financial services industry. This non-GAAP financial measure should not be considered in isolation or as a substitute for or superior to financial measures calculated in accordance with U.S. GAAP. These non-GAAP financial measures may also be calculated differently from similar measures disclosed by other companies.

All of the above ratios are, from time to time, impacted by net gains and losses on securities transactions, net gains on sales of loans and net impairment losses on securities recognized in non-interest income. These amounts can vary widely from period to period due to, among other factors, the level of sales of our investment securities classified as available for sale, the amount of residential mortgage loans originated for sale, and the results of our quarterly impairment analysis of the held to maturity and available for sale investment portfolios. See the “Non-Interest Income” section below for more details.


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Net Interest Income
Net interest income on a tax equivalent basis totaling $156.3 million for the third quarter of 2016 increased $2.8 million and $20.4 million from the second quarter of 2016 and third quarter of 2015, respectively. Interest income on a tax equivalent basis increased $2.3 million to $193.4 million for the third quarter of 2016 as compared to the second quarter of 2016 mainly due to increases of $317.8 million and $140.3 million in average loans and investments, respectively, partially offset by a 4 basis point decline in the yield on average loans. The decrease in yield on average loans for the third quarter of 2016 as compared to the linked second quarter was due, in part, to a decline in periodic interest income recoveries from non-performing loans (including closed purchased credit-impaired loan pools), as well as a moderate decrease in loan prepayment penalty fees. Interest expense of $37.1 million for the three months ended September 30, 2016 decreased $516 thousand from the second quarter of 2016, and decreased $3.7 million as compared to the third quarter of 2015. During third quarter of 2016, our interest expense on long-term borrowings declined by approximately $1.3 million largely due to the $405 million in FHLB borrowings modified at lower interest rates during August 2016, as well as the maturity of $27 million and $75 million of high cost FHLB borrowings in late April and July 2016, respectively. The reduction in interest expense from the FHLB modifications and repayments was partially offset by higher interest expense on short-term borrowings and interest bearing deposits, which was mostly caused by increases of $221.2 million and $152.2 million in their respective average balances during the third quarter of 2016. The average short-term borrowings increased due to new short-term FHLB borrowings used to fund certain maturities of long-term borrowings over the last two quarters, while average interest bearing deposits increased, in part, due to higher brokered money market deposit account balances.
Average interest earning assets increased to $19.9 billion for the third quarter of 2016 as compared to approximately $17.6 billion for the third quarter of 2015 largely due to the acquired loans and investments totaling $825.5 million and $327.3 million, respectively, in the acquisition of CNL on December 1, 2015, as well as strong organic and purchased loan growth over the last twelve month period. The broad-based loan growth within several loan categories since September 30, 2015 was largely supplemented by purchases of loan participations in multi-family loans and 1-4 family loans totaling a combined $713 million primarily from local third party originators during the last twelve months ended September 30, 2016. Compared to the second quarter of 2016, average interest earning assets increased by $359.3 million from $19.5 billion largely due to organic and purchased loan growth mainly within commercial real estate and other consumer loans during the second and third quarters of 2016, partially offset by a decline in overnight cash balances. Average overnight cash balances declined due to the $87 million prepayment of FHLB advances in May 2016, as well as normal fluctuations in the timing of loan originations and other investment activities. As a result of the loan growth over the last six months, average loans increased $317.8 million from the second quarter of 2016. Our average investments also increased $140.3 million as compared to the linked second quarter of 2016 largely due to the purchase of residential mortgage-backed securities during the third quarter of 2016.
Average interest bearing liabilities increased $1.6 billion to $14.6 billion for the third quarter of 2016 as compared to the third quarter of 2015 mainly due to deposits and other borrowings totaling $1.2 billion and $147.8 million, respectively, assumed in the acquisition of CNL during the fourth quarter of 2015, and a much greater use of short-term FHLB advances since late December 2015 as part of our overall funding and liquidity strategy, as well low cost brokered money market deposits. Compared to the second quarter of 2016, average interest bearing liabilities increased $269.0 million in the third quarter of 2016 mostly due to higher levels of both short-term FHLB advances and brokered money market deposit account balances. See additional information under "Deposits and Other Borrowings" in the Executive Summary section above.
The net interest margin on a tax equivalent basis of 3.14 percent for the third quarter of 2016 was unchanged from the second quarter of 2016, and increased 5 basis points as compared to the third quarter of 2015. The yield on average interest earning assets decreased by 2 basis points on a linked quarter basis mostly due to the lower yield on average loans. The yield on average loans decreased 4 basis points to 4.13 percent for the third quarter of 2016 and was negatively impacted by the aforementioned decreases in periodic interest income and fees as compared to the second quarter of 2016. Our yield on average taxable investment securities decreased by 6 basis points during the third quarter of 2016 as compared to the second quarter of 2016 largely due to increased premium amortization expense caused by higher principal repayments on residential mortgage-backed securities, as well as the purchases of lower yielding residential mortgage-backed securities issued by Ginnie Mae. The overall cost of average interest bearing liabilities

52




decreased by 3 basis points from 1.05 percent in the linked second quarter of 2016. The decrease was primarily due to a 9 basis point decrease in the cost of long-term borrowings mostly caused by the aforementioned debt modification. Our cost of total deposits was 0.47 percent for the third quarter of 2016 and remained unchanged as compared to the second quarter of 2016.
The expected future level of our net interest margin is subject to a multitude of conditional, and sometimes unpredictable, factors that can impact the actual margin results. For example, our margin may continue to face the risk of compression in the future due to, among other factors, the relatively low level of market interest rates on most interest earning asset alternatives, further repayment of higher yielding interest earning assets, and the re-pricing risk related to our interest earning assets with short durations if long-term market rates were to decline below current levels. However, we continuously manage our balance sheet and explore ways to reduce our cost of funds to optimize our net interest margin and overall returns. The aforementioned borrowings repaid in late July and the debt modification of $405 million in high cost FHLB borrowings during August 2016 are all expected to benefit our future net interest income and margin. Additionally, potential future loan growth from solid loan demand in our primary markets (that has continued into the early stages of the fourth quarter of 2016) is anticipated to positively impact our future net interest income.



53




The following table reflects the components of net interest income for the three months ended September 30, 2016, June 30, 2016 and September 30, 2015:

Quarterly Analysis of Average Assets, Liabilities and Shareholders’ Equity and
Net Interest Income on a Tax Equivalent Basis
 
Three Months Ended
 
September 30, 2016
 
June 30, 2016
 
September 30, 2015
 
Average
Balance
 
Interest
 
Average
Rate
 
Average
Balance
 
Interest
 
Average
Rate
 
Average
Balance
 
Interest
 
Average
Rate
 
($ in thousands)
Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest earning assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans (1)(2)
$
16,570,723

 
$
171,146

 
4.13
%
 
$
16,252,915

 
$
169,430

 
4.17
%
 
$
14,709,618

 
$
157,146

 
4.27
%
Taxable investments (3)
2,531,202

 
15,844

 
2.50

 
2,433,896

 
15,572

 
2.56

 
2,070,806

 
13,806

 
2.67

Tax-exempt investments (1)(3)
628,951

 
6,189

 
3.94

 
585,948

 
5,745

 
3.92

 
553,225

 
5,528

 
4.00

Federal funds sold and other interest bearing deposits
165,956

 
193

 
0.47

 
264,813

 
296

 
0.45

 
263,642

 
150

 
0.23

Total interest earning assets
19,896,832

 
193,372

 
3.89

 
19,537,572

 
191,043

 
3.91

 
17,597,291

 
176,630

 
4.01

Allowance for loan losses
(109,504
)
 
 
 
 
 
(107,892
)
 
 
 
 
 
(105,114
)
 
 
 
 
Cash and due from banks
279,720

 

 
 
 
294,046

 
 
 
 
 
244,748

 
 
 
 
Other assets
2,012,532

 
 
 
 
 
2,003,679

 
 
 
 
 
1,792,769

 
 
 
 
Unrealized gains (losses) on securities available for sale, net
1,890

 
 
 
 
 
2,972

 
 
 
 
 
(9,529
)
 
 
 
 
Total assets
$
22,081,470

 
 
 
 
 
$
21,730,377

 
 
 
 
 
$
19,520,165

 
 
 
 
Liabilities and shareholders’ equity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Savings, NOW and money market deposits
$
8,509,793

 
$
10,165

 
0.48
%
 
$
8,369,553

 
$
9,961

 
0.48
%
 
$
7,090,155

 
$
5,587

 
0.32
%
Time deposits
3,082,100

 
9,412

 
1.22

 
3,070,113

 
9,223

 
1.20

 
3,104,238

 
9,535

 
1.23

Total interest bearing deposits
11,591,893

 
19,577

 
0.68

 
11,439,666

 
19,184

 
0.67

 
10,194,393

 
15,122

 
0.59

Short-term borrowings
1,439,352

 
3,545

 
0.99

 
1,218,154

 
3,120

 
1.02

 
170,115

 
126

 
0.30

Long-term borrowings (4)
1,518,757

 
13,935

 
3.67

 
1,623,136

 
15,269

 
3.76

 
2,582,734

 
25,482

 
3.95

Total interest bearing liabilities
14,550,002

 
37,057

 
1.02

 
14,280,956

 
37,573

 
1.05

 
12,947,242

 
40,730

 
1.26

Non-interest bearing deposits
5,077,032

 
 
 
 
 
5,013,821

 
 
 
 
 
4,397,325

 
 
 
 
Other liabilities
202,975

 
 
 
 
 
197,090

 
 
 
 
 
178,229

 
 
 
 
Shareholders’ equity
2,251,461

 
 
 
 
 
2,238,510

 
 
 
 
 
1,997,369

 
 
 
 
Total liabilities and shareholders’ equity
$
22,081,470

 
 
 
 
 
$
21,730,377

 
 
 
 
 
$
19,520,165

 
 
 
 
Net interest income/interest rate spread (5)

 
$
156,315

 
2.87
%
 
 
 
$
153,470

 
2.86
%
 
 
 
$
135,900

 
2.75
%
Tax equivalent adjustment
 
 
(2,169
)
 
 
 
 
 
(2,015
)
 
 
 
 
 
(1,940
)
 
 
Net interest income, as reported
 
 
$
154,146

 
 
 
 
 
$
151,455

 
 
 
 
 
$
133,960

 
 
Net interest margin (6)
 
 
 
 
3.10
%
 
 
 
 
 
3.10
%
 
 
 
 
 
3.05
%
Tax equivalent effect
 
 
 
 
0.04
%
 
 
 
 
 
0.04
%
 
 
 
 
 
0.04
%
Net interest margin on a fully tax equivalent basis (6)
 
 
 
 
3.14
%
 
 
 
 
 
3.14
%
 
 
 
 
 
3.09
%



54




The following table reflects the components of net interest income for the nine months ended September 30, 2016 and 2015:

Analysis of Average Assets, Liabilities and Shareholders’ Equity and
Net Interest Income on a Tax Equivalent Basis
 
Nine Months Ended
 
September 30, 2016
 
September 30, 2015
 
Average
Balance
 
Interest
 
Average
Rate
 
Average
Balance
 
Interest
 
Average
Rate
 
($ in thousands)
Assets
 
 
 
 
 
 
 
 
 
 
 
Interest earning assets:
 
 
 
 
 
 
 
 
 
 
 
Loans (1)(2)
$
16,273,482

 
$
506,652

 
4.15
%
 
$
14,144,921

 
$
465,803

 
4.39
%
Taxable investments (3)
2,487,853

 
46,895

 
2.51

 
2,189,527

 
44,326

 
2.70

Tax-exempt investments (1)(3)
594,846

 
17,611

 
3.95

 
543,992

 
16,616

 
4.07

Federal funds sold and other interest bearing deposits
285,378

 
846

 
0.40

 
280,663

 
516

 
0.25

Total interest earning assets
19,641,559

 
572,004

 
3.88

 
17,159,103

 
527,261

 
4.10

Allowance for loan losses
(108,150
)
 
 
 
 
 
(104,650
)
 
 
 
 
Cash and due from banks
290,124

 
 
 
 
 
319,936

 
 
 
 
Other assets
2,009,780

 
 
 
 
 
1,791,633

 
 
 
 
Unrealized losses on securities available for sale, net
(1,691
)
 
 
 
 
 
(4,091
)
 
 
 
 
Total assets
$
21,831,622

 
 
 
 
 
$
19,161,931

 
 
 
 
Liabilities and shareholders’ equity
 
 
 
 
 
 
 
 
 
 
 
Interest bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Savings, NOW and money market deposits
$
8,404,929

 
$
29,369

 
0.47
%
 
$
7,103,105

 
$
17,493

 
0.33
%
Time deposits
3,093,311

 
28,220

 
1.22

 
2,885,922

 
25,637

 
1.18

Total interest bearing deposits
11,498,240

 
57,589

 
0.67

 
9,989,027

 
43,130

 
0.58

Short-term borrowings
1,240,235

 
8,537

 
0.92

 
184,586

 
427

 
0.31

Long-term borrowings (4)
1,650,999

 
45,948

 
3.71

 
2,578,452

 
75,649

 
3.91

Total interest bearing liabilities
14,389,474

 
112,074

 
1.04
%
 
12,752,065

 
119,206

 
1.25
%
Non-interest bearing deposits
5,003,375

 
 
 
 
 
4,313,620

 
 
 
 
Other liabilities
202,204

 
 
 
 
 
174,668

 
 
 
 
Shareholders’ equity
2,236,569

 
 
 
 
 
1,921,578

 
 
 
 
Total liabilities and shareholders’ equity
$
21,831,622

 
 
 
 
 
$
19,161,931

 
 
 
 
Net interest income/interest rate spread (5)
 
 
$
459,930

 
2.84
%
 
 
 
$
408,055

 
2.85
%
Tax equivalent adjustment
 
 
(6,176
)
 
 
 
 
 
(5,832
)
 
 
Net interest income, as reported
 
 
$
453,754

 
 
 
 
 
$
402,223

 
 
Net interest margin (6)
 
 
 
 
3.08
%
 
 
 
 
 
3.13
%
Tax equivalent effect
 
 
 
 
0.04
%
 
 
 
 
 
0.04
%
Net interest margin on a fully tax equivalent basis (6)
 
 
 
 
3.12
%
 
 
 
 
 
3.17
%
 
 
(1)
Interest income is presented on a tax equivalent basis using a 35 percent federal tax rate.
(2)
Loans are stated net of unearned income and include non-accrual loans.
(3)
The yield for securities that are classified as available for sale is based on the average historical amortized cost.
(4)
Includes junior subordinated debentures issued to capital trusts which are presented separately on the consolidated
statements of financial condition.
(5)
Interest rate spread represents the difference between the average yield on interest earning assets and the average cost of interest bearing liabilities and is presented on a fully tax equivalent basis.
(6)
Net interest income as a percentage of total average interest earning assets.


55




The following table demonstrates the relative impact on net interest income of changes in the volume of interest earning assets and interest bearing liabilities and changes in rates earned and paid by us on such assets and liabilities. Variances resulting from a combination of changes in volume and rates are allocated to the categories in proportion to the absolute dollar amounts of the change in each category.

Change in Net Interest Income on a Tax Equivalent Basis
 
Three Months Ended
September 30, 2016
Compared to September 30, 2015
 
Nine Months Ended
September 30, 2016
Compared to September 30, 2015
 
Change
Due to
Volume
 
Change
Due to
Rate
 
Total
Change
 
Change
Due to
Volume
 
Change
Due to
Rate
 
Total
Change
 
(in thousands)
Interest Income:
 
 
 
 
 
 
 
 
 
 
 
Loans*
$
19,359

 
$
(5,359
)
 
$
14,000

 
$
67,288

 
$
(26,439
)
 
$
40,849

Taxable investments
2,922

 
(884
)
 
2,038

 
5,763

 
(3,194
)
 
2,569

Tax-exempt investments*
746

 
(85
)
 
661

 
1,517

 
(522
)
 
995

Federal funds sold and other interest bearing deposits
(71
)
 
114

 
43

 
9

 
321

 
330

Total increase (decrease) in interest income
22,956

 
(6,214
)
 
16,742

 
74,577

 
(29,834
)
 
44,743

Interest Expense:
 
 
 
 
 
 
 
 
 
 
 
Savings, NOW and money market deposits
1,280

 
3,298

 
4,578

 
3,615

 
8,261

 
11,876

Time deposits
(68
)
 
(55
)
 
(123
)
 
1,878

 
705

 
2,583

Short-term borrowings
2,607

 
812

 
3,419

 
6,028

 
2,082

 
8,110

Long-term borrowings and junior subordinated debentures
(9,869
)
 
(1,678
)
 
(11,547
)
 
(25,986
)
 
(3,715
)
 
(29,701
)
Total (decrease) increase in interest expense
(6,050
)
 
2,377

 
(3,673
)
 
(14,465
)
 
7,333

 
(7,132
)
Total increase (decrease) in net interest income
$
29,006

 
$
(8,591
)
 
$
20,415

 
$
89,042

 
$
(37,167
)
 
$
51,875

 
*
Interest income is presented on a tax equivalent basis using a 35 percent tax rate.
Non-Interest Income

The following table presents the components of non-interest income for the three and nine months ended September 30, 2016 and 2015:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
 
(in thousands)
Trust and investment services
$
2,628

 
$
2,450

 
$
7,612

 
$
7,520

Insurance commissions
4,580

 
4,119

 
14,133

 
12,454

Service charges on deposit accounts
5,263

 
5,241

 
15,460

 
15,794

(Losses) gains on securities transactions, net
(10
)
 
157

 
258

 
2,481

Fees from loan servicing
1,598

 
1,703

 
4,753

 
4,948

Gains on sales of loans, net
4,823

 
2,014

 
9,723

 
3,034

Gains (losses) on sales of assets, net
310

 
(558
)
 
1,009

 
(77
)
Bank owned life insurance
1,683

 
1,806

 
5,464

 
5,188

Change in FDIC loss-share receivable
(313
)
 
(55
)
 
(872
)
 
(3,380
)
Other
4,291

 
4,042

 
13,025

 
11,802

Total non-interest income
$
24,853

 
$
20,919

 
$
70,565

 
$
59,764


56





Insurance commissions increased $461 thousand and $1.7 million for the three and nine months ended September 30, 2016, respectively, as compared with the same periods in 2015 mainly due to higher commissions generated from the Bank's insurance agency subsidiary, including additional fees related to certain intangible assets acquired from an independent insurance agency during the first quarter of 2016. See Note 2 to the consolidated financial statements for more details on this acquisition.

Net gains on securities transactions decreased $2.2 million for the nine months ended September 30, 2016 as compared with the same period in 2015 due to an immaterial amount of investment securities sold during the nine months ended September 30, 2016. Net gains during the first nine months of 2015 related to the sale of corporate debt securities and trust preferred securities with a total unamortized cost of approximately $34.2 million, including one corporate debt security classified as held to maturity with amortized cost of $9.8 million during the first quarter of 2015. The sales of these securities were primarily due to an investment portfolio re-balancing during the first quarter of 2015 due to changes in our regulatory capital calculation under the new Basel III regulatory capital reform (effective for Valley on January 1, 2015). Under ASC Topic 320, “Investments - Debt and Equity Securities,” the sale of held to maturity securities based upon the change in capital requirements is permitted without tainting the remaining held to maturity investment portfolio.

Net gains on sales of loans increased $2.8 million and $6.7 million for the three and nine months ended September 30, 2016 and 2015, respectively, as compared to the same periods in 2015 largely due to a higher volume of residential mortgage loans originated for sale during three and nine months ended September 30, 2016 and the continued success of our low fixed cost mortgage refinance programs. Loans originated for sale (including both new and refinanced loans) increased $118.0 million to $171.9 million for the third quarter of 2016 as compared to the same quarter in 2015. During the third quarter of 2016, we sold $149.2 million of fixed-rate residential mortgage loans as compared to $40.4 million in the third quarter of 2015. Our net gains on sales of loans for each period are comprised of both gains on sales of residential mortgages and the net change in the mark to market gains and losses on our loans held for sale carried at fair value at each period end. The net change in the fair value of loans held for sale resulted in net gains of $696 thousand and $660 thousand for the three months ended September 30, 2016 and 2015, respectively, and $346 thousand and $813 thousand for the nine months ended September 30, 2016 and 2015, respectively. Our decision to either sell or retain our mortgage loan production is dependent upon, among other factors, the levels of interest rates, consumer demand, the economy and our ability to maintain the appropriate level of interest rate risk on our balance sheet. See further discussions of our residential mortgage loan origination activity under the “Loan Portfolio” section of this MD&A below.

Net gains on sales of assets increased $868 thousand and $1.1 million for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. The quarter over quarter increase was mainly as result of losses on seven branches during the third quarter of 2015 that were closed as part of our on-going branch "right-sizing" effort initiated in the second half of 2015. The increase during the nine months ended September 30, 2016 as compared to the same period in 2015 was mainly due to net gains from the sale of two former branch locations that were closed in the second quarter of 2016. See the "Branch Efficiency and Cost Reduction Plans" section below for additional information.

The Bank and the FDIC share in the losses on loans and real estate owned as part of the loss-sharing agreements from FDIC-assisted transactions, including loss-sharing agreements acquired from 1st United on November 1, 2014. The asset arising from the loss-sharing agreements is referred to as the “FDIC loss-share receivable” and it is included in "Other assets" on Valley's consolidated statements of financial condition. Within the non-interest income category, we may recognize income or expense related to the change in the FDIC loss-share receivable resulting from (i) a change in the estimated credit losses on the pools of covered loans, (ii) income from reimbursable expenses incurred during the period, (iii) accretion of the discount resulting from the present value of the receivable recorded at the acquisition dates, and (iv) prospective recognition of decreases in the receivable attributable to better than originally estimated cash flows on certain covered loan pools. The aggregate effect of changes in the FDIC loss-share receivable was a net reduction in non-interest income of $313 thousand and $55 thousand for the three months ended September 30, 2016 and 2015, respectively, and $872 thousand and $3.4

57




million for the nine months ended September 30, 2016 and 2015, respectively. The majority of the larger reduction in both the receivable and non-interest income during the the nine months ended September 30, 2015 related to the prospective adjustment to the receivable for better than originally estimated cash flows on certain pools of covered loans since the acquisition. These prospective adjustments were recognized only through the March 2015 expiration date of the related commercial loan loss-sharing agreements from Valley's 2010 FDIC-assisted transactions.

See the “FDIC Loss-Share Receivable Related to Covered Loans and Foreclosed Assets” section below in this MD&A and Note 8 to the consolidated financial statements for further details.

Non-Interest Expense

The following table presents the components of non-interest expense for the three and nine months ended September 30, 2016 and 2015:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
 
(in thousands)
Salary and employee benefits expense
$
58,107

 
$
54,315

 
$
174,438

 
$
165,601

Net occupancy and equipment expense
20,658

 
21,526

 
65,615

 
65,858

FDIC insurance assessment
4,804

 
4,168

 
14,998

 
11,972

Amortization of other intangible assets
2,675

 
2,232

 
8,452

 
6,721

Professional and legal fees
4,031

 
4,643

 
13,398

 
12,043

Amortization of tax credit investments
6,450

 
5,224

 
21,360

 
14,231

Telecommunications expense
2,459

 
2,050

 
7,139

 
6,101

Other
14,084

 
14,494

 
45,896

 
41,655

Total non-interest expense
$
113,268

 
$
108,652

 
$
351,296

 
$
324,182


Salary and employee benefits expense increased $3.8 million and $8.8 million for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015 largely due to additional staffing expenses related to our acquisition of CNL on December 1, 2015. However, the increase during the nine months ended September 30, 2016 was partially offset by lower cash incentive compensation accruals, as well as an increase in net periodic pension income from our frozen qualified pension plan as compared to 2015 period. Our health care expenses increased by $547 thousand and $719 thousand during the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015. While this increase can be mostly attributed to the CNL acquisition, our health care expenses are at times volatile due to self-funding of a large portion of our insurance plan and these medical expenses can fluctuate based on our plan experience into the foreseeable future.

Net occupancy and equipment expenses decreased $868 thousand for the three months ended September 30, 2016 as compared to the same period of 2015 mainly due to a reduction in branch rental expense caused by the reversal of an accrued lease obligation of a terminated lease for a previously closed branch location during the third quarter of 2016 and lower periodic repairs and maintenance expenses. The decreases were partially offset by an increase in depreciation expense mostly caused by the acquired CNL branches. See the "Branch Efficiency and Cost Reduction Plans" section below for additional information.

FDIC insurance assessments increased $636 thousand and $3.0 million for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015 largely due to our growth resulting from the CNL acquisition and expansion of our commercial lending segment during the nine months ended September 30, 2016.


58




Amortization of intangible assets increased $443 thousand and $1.7 million for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015 mainly due to increases of $577 thousand and $1.8 million in amortization expense of core deposit intangibles during the respective periods of 2016 due to the CNL acquisition.

Amortization of tax credit investments increased $1.2 million and $7.1 million for the three and nine months ended September 30, 2016, respectively, as compared to the same periods in 2015 mainly due to additional purchases of tax-advantaged investments over the last twelve months. These investments, while negatively impacting the level of our operating expenses and efficiency ratio, directly reduce our income tax expense and effective tax rate. See Note 14 for more details regarding our tax credit investments.
 
Other non-interest expense increased $4.2 million for nine months ended September 30, 2016 as compared to the same period in 2015 due, in part, to operating losses and debt prepayment penalties totaling $1.3 million and $315 thousand, respectively, during the second quarter of 2016. Within other non-interest expense, we also experienced moderate increases in several items, including debit card and ATM expenses, travel and entertainment, and insurance expense as compared to the nine months ended September 30, 2015 partly caused by our growth, both organically and through acquisition.

The efficiency ratio measures total non-interest expense as a percentage of net interest income plus total non-interest income. We believe this non-GAAP measure, provides a meaningful comparison of our operational performance and facilitates investors’ assessments of business performance and trends in comparison to our peers in the banking industry. Our overall efficiency ratio, and its comparability to some of our peers, is negatively impacted by the amortization of tax credit investments within non-interest expense and, from time to time, reductions in our non-interest income related to changes in the FDIC loss-share receivable.

The following table presents our efficiency ratio and a reconciliation of the efficiency ratio adjusted for such items during the three and nine months ended September 30, 2016 and 2015:

 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2016
 
2015
 
2016
 
2015
 
($ in thousands)
Total non-interest expense
$
113,268

 
$
108,652

 
$
351,296

 
$
324,182

Less: Amortization of tax credit investments
6,450

 
5,224

 
21,360

 
14,231

Total non-interest expense, adjusted
$
106,818

 
$
103,428

 
$
329,936

 
$
309,951

 
 
 
 
 
 
 
 
Net interest income
$
154,146

 
$
133,960

 
$
453,754

 
$
402,223

Total non-interest income
24,853

 
20,919


70,565

 
59,764

Total net interest income and non-interest income
$
178,999

 
$
154,879

 
$
524,319

 
$
461,987

Less: Change in FDIC loss-share receivable
(313
)
 
(55
)
 
(872
)
 
(3,380
)
Total net interest income and non-interest income, adjusted
$
179,312

 
$
154,934

 
$
525,191

 
$
465,367

Efficiency ratio
63.28
%
 
70.15
%
 
67.00
%
 
70.17
%
Efficiency ratio, adjusted
59.57
%
 
66.76
%
 
62.82
%
 
66.60
%

Branch Efficiency and Cost Reduction Plans

In the second quarter of 2015, we disclosed a branch efficiency plan to "right-size" our branch network. We, like many in the banking industry, have experienced a significant decline in branch foot traffic as the emergence of self-service technology continues to reshape the banking industry. In response to these shifts in customer preference we have invested in new delivery channels and systems that will modernize the branch banking experience. Mobile

59




banking, remote deposit, enhanced ATMs, online account opening, cash recyclers and complementary online services are part of our modernization plan and will redefine the traditional banking experience at Valley.

As a result of our reviews and the evolution of banking in general, our current plan included the closure and consolidation of 31 branch locations based upon our continuous evaluation of customer delivery channel preferences, branch usage patterns, and other factors. Of the 31 branches, 30 branches were closed as of September 30, 2016 (including 3 Florida branches closed during the third quarter of 2016 and 13 mostly New Jersey branches closed in the second quarter of 2016). The remaining branch, located in Sebastian, Florida, was sold with its deposits totaling approximately $13 million to another financial institution during October 2016. The transaction is expected to result in an immaterial gain for the fourth quarter of 2016.

We have continued to evaluate the operational efficiency of our entire branch network (consisting of 110 leased and 99 owned office locations) to ensure the optimal performance of our retail operations, in conjunction with several other factors, including our customers’ delivery channel preferences, branch usage patterns, and the potential opportunity to move existing customer relationships to another branch location without imposing a negative impact on their banking experience.

In addition to the branch closures, Valley commenced a cost reduction plan in the fourth quarter of 2015 aimed at achieving operational efficiencies through streamlining various aspects of Valley's business model, staff reductions and further utilization of technological enhancements. When both of these plans were consummated, we expected the fully implemented reduction in annual operating expenses to be approximately $18 million. Due to enhancements to the original plans, including the three additional branch closures during the third quarter of 2016, we now believe these savings will ultimately increase to nearly $20 million. These measures are currently on track to save $15 million in pre-tax operating expenses for the full year of 2016, exclusive of the CNL staffing reductions effective April 1, 2016.
Income Taxes

Income tax expense was $17.0 million and $10.2 million for the three months ended September 30, 2016 and 2015, respectively, and $46.9 million and $34.9 million for the nine months ended September 30, 2016 and 2015, respectively. Our effective tax rate was 28.5 percent and 22.1 percent for the third quarters of 2016 and 2015, respectively, and 28.4 percent and 26.2 percent for the nine months ended September 30, 2016 and 2015, respectively. The increase in effective tax rate during both the three and nine months of 2016 was mostly due to an increase in the marginal tax expense as a result of an increase in income before taxes as compared to the same periods of 2015.

U.S. GAAP requires that any change in judgment or change in measurement of a tax position taken in a prior annual period be recognized as a discrete event in the quarter in which it occurs, rather than being recognized as a change in effective tax rate for the current year. Our adherence to these tax guidelines may result in volatile effective income tax rates in future quarterly and annual periods. Factors that could impact management’s judgment include changes in income, tax laws and regulations, and tax planning strategies. For the remainder of 2016, we anticipate that our effective tax rate will range from 27 percent to 30 percent. The effective tax rate is generally lower than the statutory rate primarily due to tax credits derived from our investments in qualified affordable housing projects and other investments related to community development and renewable energy sources, as well as earnings from other tax-exempt investments. See Note 14 to the consolidated financial statements for additional information regarding our tax credit investments.
Business Segments

We have four business segments that we monitor and report on to manage our business operations. These segments are consumer lending, commercial lending, investment management, and corporate and other adjustments. Our reportable segments have been determined based upon Valley’s internal structure of operations and lines of business. Each business segment is reviewed routinely for its asset growth, contribution to income before income taxes and return on average interest earning assets and impairment (if events or circumstances indicate a possible

60




inability to realize the carrying amount). Expenses related to the branch network, all other components of retail banking, along with the back office departments of our subsidiary bank are allocated from the corporate and other adjustments segment to each of the other three business segments. Interest expense and internal transfer expense (for general corporate expenses) are allocated to each business segment utilizing a “pool funding” methodology, which involves the allocation of uniform funding cost based on each segments’ average earning assets outstanding for the period. The financial reporting for each segment contains allocations and reporting in line with our operations, which may not necessarily be comparable to any other financial institution. The accounting for each segment includes internal accounting policies designed to measure consistent and reasonable financial reporting, and may result in income and expense measurements that differ from amounts under U.S. GAAP. Furthermore, changes in management structure or allocation methodologies and procedures may result in changes in reported segment financial data.

The following tables present the financial data for each business segment for the three months ended September 30, 2016 and 2015:
 
Three Months Ended September 30, 2016
 
Consumer
Lending
 
Commercial
Lending
 
Investment
Management
 
Corporate
and Other
Adjustments
 
Total
 
($ in thousands)
Average interest earning assets
$
5,038,230

 
$
11,532,493

 
$
3,326,109

 
$

 
$
19,896,832

Income (loss) before income taxes
17,071

 
46,456

 
6,657

 
(10,293
)
 
59,891

Annualized return on average interest earning assets (before tax)
1.36
%
 
1.61
%
 
0.80
%
 
N/A

 
1.20
%
 
 
Three Months Ended September 30, 2015
 
Consumer
Lending
 
Commercial
Lending
 
Investment
Management
 
Corporate
and Other
Adjustments
 
Total
 
($ in thousands)
Average interest earning assets
$
4,904,768

 
$
9,804,850

 
$
2,887,673

 
$

 
$
17,597,291

Income (loss) before income taxes
12,018

 
38,192

 
4,291

 
(8,368
)
 
46,133

Annualized return on average interest earning assets (before tax)
0.98
%
 
1.56
%
 
0.59
%
 
N/A

 
1.05
%
Consumer Lending

This segment, representing approximately 29.8 percent of our loan portfolio at September 30, 2016, is mainly comprised of residential mortgage loans, home equity loans and automobile loans. The duration of the residential mortgage loan portfolio (which represented 17.0 percent of our loan portfolio at September 30, 2016, including covered loans) is subject to movements in the market level of interest rates and forecasted prepayment speeds. The weighted average life of the automobile loans (representing 6.7 percent of total loans at September 30, 2016) is relatively unaffected by movements in the market level of interest rates. However, the average life may be impacted by new loans as a result of the availability of credit within the automobile marketplace and consumer demand for purchasing new or used automobiles. The consumer lending segment also includes the Wealth Management Division, comprised of trust, asset management, insurance services, and asset-based lending support services.

Average interest earning assets in this segment increased $133.5 million to $5.0 billion for the three months ended September 30, 2016 as compared to the third quarter of 2015. The increase was largely due to continued solid organic growth in secured personal lines of credit over the last 12-month period, partially offset by declines in auto loan volume and our election to originate a higher volume of residential mortgage loans for sale, rather than investment during 2016. At September 30, 2016, our consumer lending portfolio also included $111.3 million of PCI loans (mostly consisting of residential mortgage loans and home equity loans) acquired in connection with the

61




CNL merger during the fourth quarter of 2015. These increases were partially offset by the transfer of $174.5 million of performing 30-year fixed rate mortgages to loans held for sale during the third quarter of 2016.

Income before income taxes generated by the consumer lending segment increased $5.1 million to $17.1 million for the third quarter of 2016 as compared to $12.0 million for the third quarter of 2015 largely due to increases in net interest income and non-interest income totaling $1.9 million and $3.2 million for the third quarter of 2016, respectively, and a decrease of $2.2 million in internal transfer expense as compared to the same periods in 2015. The increase in net interest income was mainly due to the higher average loan balances since September 30, 2015, partially offset by a 8 basis point decline in the yield on average loans as the new loan volume was generated at current market interest rates below the yield on the average portfolio. The increase in non-interest income was mostly driven by a $2.8 million increase in the net gains on sales of loans caused by a higher level of sales volumes during third quarter of 2016. The positive impact of the aforementioned items was partially offset by increases in the provision for credit losses and non-interest expense totaling $1.5 million and $698 thousand, respectively, as compared to the third quarter of 2015.

The net interest margin on the consumer lending portfolio increased 7 basis points to 2.78 percent for the third quarter of 2016 as compared to the same quarter one year ago. The net interest margin was positively impacted by a 15 basis point decrease in the costs associated with our funding sources, partially offset by a 8 basis point decline in yield on average loans. The decrease in our cost of funds was primarily due to the lower cost of our average long-term borrowings driven by the prepayment, modification and maturity of high cost borrowings over the last twelve months. See the "Executive Summary" and the "Net Interest Income" sections above for more details on our deposits and other borrowings.
Commercial Lending

The commercial lending segment is comprised of floating rate and adjustable rate commercial and industrial loans and construction loans, as well as fixed rate owner occupied and commercial real estate loans. Due to the portfolio’s mix of interest rate characteristics, commercial lending is Valley’s business segment that is most sensitive to movements in market interest rates. Commercial and industrial loans totaled approximately $2.6 billion and represented 15.4 percent of the total loan portfolio at September 30, 2016. Commercial real estate loans and construction loans totaled $9.1 billion and represented 54.8 percent of the total loan portfolio at September 30, 2016.

Average interest earning assets in this segment increased $1.7 billion to $11.5 billion for the three months ended September 30, 2016 as compared to the third quarter of 2015. This increase was due, in part, to solid organic commercial real estate loan growth across many segments of borrowers, purchases of participations in multi-family loans (mostly in New York City) totaling over $505 million over the last 12 months, as well as PCI loans totaling $581 million at September 30, 2016 that were acquired in connection with the CNL merger.

For the three months ended September 30, 2016, income before income taxes for the commercial lending segment increased $8.3 million to $46.5 million as compared to the same quarter of 2015 mostly due to an increase in net interest income, partially offset by an increases in the provision for credit losses and internal transfer expense. Net interest income increased $14.4 million to $106.8 million for the third quarter of 2016 as compared to the same period in 2015 largely due to the aforementioned organic, purchased and acquired loan growth over the last 12 months. Provision for credit losses increased $4.2 million during the three months ended September 30, 2016 as compared to $1.3 million for the third quarter of 2015. See further details in the "Allowance for Credit Losses" section. Internal transfer expense increased $2.5 million during the third quarter of 2016 as compared to the same period in 2015 due, in part, to the acquisition of CNL.

The net interest margin for this segment decreased 7 basis points to 3.70 percent for the third quarter of 2016 as compared to the same quarter one year ago as a result of a 22 basis point decline in yield on average loans, partially offset by a 15 basis point decrease in the cost of our funding sources. The decrease in the yield on loans was primarily due to the new and refinanced loan volumes at current interest rates that are relatively low compared to

62




the overall yield of our loan portfolio, as well as lower reforecasted yields on certain PCI loan pools recognized during the nine months ended September 30, 2016.
Investment Management

The investment management segment generates a large portion of our income through investments in various types of securities and interest-bearing deposits with other banks. These investments are mainly comprised of fixed rate securities and, depending on our liquid cash position, federal funds sold and interest-bearing deposits with banks (primarily the Federal Reserve Bank of New York) as part of our asset/liability management strategies. The fixed rate investments are one of Valley’s least sensitive assets to changes in market interest rates. However, a portion of the investment portfolio is invested in shorter-duration securities to maintain the overall asset sensitivity of our balance sheet. See the “Asset/Liability Management” section below for further analysis.

Average interest earning assets in this segment increased $438.4 million during the third quarter of 2016 as compared to the third quarter of 2015. The increase was partly due to $327.3 million of investment securities classified as available for sale that were acquired in connection with the CNL merger and additional investment purchases during the third quarter of 2016 primarily consisting of residential mortgage-backed securities issued by Ginnie Mae.

For the quarter ended September 30, 2016, income before income taxes for the investment management segment increased approximately $2.4 million to $6.7 million compared to the third quarter in 2015 mainly due to a $3.1 million increase in net interest income. The increase in net interest income was mainly driven by the higher average investment balances in the third quarter of 2016.

The net interest margin for this segment increased 12 basis points to 1.96 percent for the third quarter of 2016 as compared to the same quarter one year ago largely due to a 15 basis point decrease in costs associated with our funding sources, as well as a 3 basis point decrease in the yield on average investments.
Corporate and other adjustments

The amounts disclosed as “corporate and other adjustments” represent income and expense items not directly attributable to a specific segment, including net securities gains and losses not reported in the investment management segment above, interest expense related to subordinated notes, and income and expense from derivative financial instruments.

The pre-tax net loss for the corporate segment increased $3.1 million to $11.4 million for the three months ended September 30, 2016 as compared to the three months ended September 30, 2015. The higher pre-tax loss was mainly caused by a $3.6 million increase in non-interest expense, partially offset by an increase of $740 thousand in internal transfer income as compared to the third quarter of 2015. The increase in non-interest expense during the third quarter of 2016 related to increases in several general expense categories including, but not limited to, salary and employee benefits expense and the amortization of tax credit investments. See further details in the "Non-Interest Expense" section above.


63




The following tables present the financial data for each business segment for the nine months ended September 30, 2016 and 2015:
 
Nine Months Ended September 30, 2016
 
Consumer
Lending
 
Commercial
Lending
 
Investment
Management
 
Corporate
and Other
Adjustments
 
Total
 
($ in thousands)
Average interest earning assets
$
5,110,845

 
$
11,162,637

 
$
3,368,077

 
$

 
$
19,641,559

Income (loss) before income taxes
45,332

 
137,748

 
16,019

 
(34,145
)
 
164,954

Annualized return on average interest earning assets (before tax)
1.18
%
 
1.65
%
 
0.63
%
 
N/A

 
1.12
%
 
 
Nine Months Ended September 30, 2015
 
Consumer
Lending
 
Commercial
Lending
 
Investment
Management
 
Corporate
and Other
Adjustments
 
Total
 
($ in thousands)
Average interest earning assets
$
4,670,699

 
$
9,474,222

 
$
3,014,182

 
$

 
$
17,159,103

Income (loss) before income taxes
30,158

 
116,283

 
11,963

 
(25,193
)
 
133,211

Annualized return on average interest earning assets (before tax)
0.86
%
 
1.64
%
 
0.53
%
 
N/A

 
1.04
%

Consumer Lending
Average interest earning assets in this segment increased $440.1 million to $5.1 billion for the nine months ended September 30, 2016 as compared to the same period in 2015. The increase was largely due to the aforementioned solid organic growth in secured personal lines of credit over the last 12-month period, partially offset by declines in auto loan volume and our election to originate a higher volume of residential mortgage loans for sale, rather than investment during 2016.
Income before income taxes generated by the consumer lending segment increased $15.2 million to $45.3 million for the nine months ended September 30, 2016 as compared to the same period of 2015 largely due to a $11.4 million increase in net interest income. The increase in net interest income as compared to the same period one year ago was mainly due to additional interest income generated from higher average loan balances. Non-interest income also increased $8.1 million for the nine months ended September 30, 2016 as compared to the same period of 2015 mainly due to a $6.7 million increase in net gains on sales of loans caused by a higher level of sales volumes during the nine months ended September 30, 2016 as compared to the same period of 2015. The positive impact of these items was partially offset by increases in both non-interest expense and internal transfer expense totaling $3.4 million and $1.1 million, respectively, as compared to the nine months ended September 30, 2015.

The net interest margin on the consumer lending portfolio increased 6 basis points to 2.78 percent for the nine months ended September 30, 2016 as compared to the same period in 2015 mainly due to a 15 basis point decrease in the costs associated with our funding sources, partially offset by a 9 basis point decline in yield on average loans. The decrease in yield on average loans was largely caused by purchased, new and refinanced loan volumes that remain at relatively low interest rates as compared to the overall yield of our loan portfolio, as well as repayment of higher yielding loans, including PCI loans.
Commercial Lending
Average interest earning assets in this segment increased $1.7 billion to $11.2 billion for the nine months ended September 30, 2016 as compared to the same period in 2015. This increase was due, in part, to solid organic commercial real estate loan growth across many segments of borrowers, including new loan production from our

64




Florida markets, and the PCI loans acquired from CNL in December 2015. We also supplemented our organic originations with purchases of participations in multi-family loans totaling over $505 million over the last 12 months, as well as $505.4 million of PCI loans acquired from CNL.
 
For the nine months ended September 30, 2016, income before income taxes for the commercial lending segment increased $21.5 million to $137.7 million as compared to the same period in 2015 mostly due to an increase in both net interest income and non-interest income, partially offset by an increase in internal transfer expense and the provision for credit losses. Net interest income increased $33.9 million to $313.7 million for the nine months ended September 30, 2016 as compared to the same period in 2015 largely due to the aforementioned organic, purchased and acquired loan growth over the last 12 months. Non-interest income increased $3.0 million as compared to the nine months ended September 30, 2015 largely due to the positive aggregate effect of changes in the FDIC loss-share receivable. See the "Non-interest income" section above for further details. Internal transfer expense increased $10.7 million during the nine months ended September 30, 2016 as compared to the same period in 2015 due, in part, to additional operating expenses related to our growth, including the acquisition of CNL. The provision for credit losses increased $3.8 million during nine months ended September 30, 2016 as compared to the same period in 2015. See further details in the "Allowance for Credit Losses" section below and Note 9 to the consolidated financial statements.

The net interest margin for this segment decreased 19 basis points to 3.75 percent for the nine months ended September 30, 2016 as compared to the same period in 2015 as a result of a 34 basis point decline in yield on average loans, partially offset by a 15 basis point decrease in the cost of our funding sources. The decrease in the yield on loans was primarily due to the new and refinanced loan volumes at current interest rates that are relatively low compared to the overall yield of our loan portfolio, as well as lower reforecasted yields on certain PCI loan pools recognized during the nine months ended September 30, 2016.
Investment Management

Average interest earning assets in this segment increased $353.9 million during the nine months ended September 30, 2016 as compared to the same period in 2015. The increase was due, in part, to the aforementioned investment securities acquired in connection with the CNL merger and additional purchases of investment securities mostly in the third quarter of 2016.

For the nine months ended September 30, 2016, income before income taxes for the investment management segment increased approximately $4.1 million to $16.0 million compared to the same period of 2015 largely due to a $5.4 million increase in net interest income. The increase in net interest income was mainly driven by higher average balances for the nine months ended September 30, 2016 as compared to the same period in 2015. This increase was partially offset by higher internal transfer expense totaling $35.8 million during the nine months ended September 30, 2016 as compared to $34.4 million for the same period in 2015.

The net interest margin for this segment increased 2 basis points to 1.88 percent for the for nine months ended September 30, 2016 as compared to the same period one year ago largely due to the 15 basis point decrease in costs associated with our funding sources, partially offset by a 13 basis point decrease in the yield on average investments driven by principal repayments of higher yielding investments and additional investments at current low interest rates.
Corporate and other adjustments

The pre-tax net loss for the corporate segment increased $10.1 million to $35.3 million for the nine months ended September 30, 2016 as compared to the same period of 2015 mainly due to a $22.6 million increase in non-interest expense, partially offset by a $13.2 million increase in internal transfer income. The increase in non-interest expense related to increases in several general expense categories, including, but not limited to, salary and employee benefits expense related to the acquisition of the CNL, amortization of tax credit investments, and the FDIC insurance assessment expense. See further details in the "Non-Interest Expense" section above.

65




ASSET/LIABILITY MANAGEMENT

Interest Rate Sensitivity

Our success is largely dependent upon our ability to manage interest rate risk. Interest rate risk can be defined as the exposure of our interest rate sensitive assets and liabilities to the movement in interest rates. Our Asset/Liability Management Committee is responsible for managing such risks and establishing policies that monitor and coordinate our sources and uses of funds. Asset/Liability management is a continuous process due to the constant change in interest rate risk factors. In assessing the appropriate interest rate risk levels for us, management weighs the potential benefit of each risk management activity within the desired parameters of liquidity, capital levels and management’s tolerance for exposure to income fluctuations. Many of the actions undertaken by management utilize fair value analysis and attempts to achieve consistent accounting and economic benefits for financial assets and their related funding sources. We have predominately focused on managing our interest rate risk by attempting to match the inherent risk and cash flows of financial assets and liabilities. Specifically, management employs multiple risk management activities such as optimizing the level of new residential mortgage originations retained in our mortgage portfolio through increasing or decreasing loan sales in the secondary market, product pricing levels, the desired maturity levels for new originations, the composition levels of both our interest earning assets and interest bearing liabilities, as well as several other risk management activities.

We use a simulation model to analyze net interest income sensitivity to movements in interest rates. The simulation model projects net interest income based on various interest rate scenarios over a 12-month and 24-month period. The model is based on the actual maturity and re-pricing characteristics of rate sensitive assets and liabilities. The model incorporates certain assumptions which management believes to be reasonable regarding the impact of changing interest rates and the prepayment assumptions of certain assets and liabilities as of September 30, 2016. The model assumes immediate changes in interest rates without any proactive change in the composition or size of the balance sheet, or other future actions that management might undertake to mitigate this risk. In the model, the forecasted shape of the yield curve remains static as of September 30, 2016. The impact of interest rate derivatives, such as interest rate swaps and caps, is also included in the model.

Our simulation model is based on market interest rates and prepayment speeds prevalent in the market as of September 30, 2016. Although the size of Valley’s balance sheet is forecasted to remain static as of September 30, 2016 in our model, the composition is adjusted to reflect new interest earning assets and funding originations coupled with rate spreads utilizing our actual originations during the third quarter of 2016. The model also utilizes an immediate parallel shift in the market interest rates at September 30, 2016.

The assumptions used in the net interest income simulation are inherently uncertain. Actual results may differ significantly from those presented in the table below due to the frequency and timing of changes in interest rates and changes in spreads between maturity and re-pricing categories. Overall, our net interest income is affected by changes in interest rates and cash flows from our loan and investment portfolios. We actively manage these cash flows in conjunction with our liability mix, duration and interest rates to optimize the net interest income, while structuring the balance sheet in response to actual or potential changes in interest rates. Additionally, our net interest income is impacted by the level of competition within our marketplace. Competition can negatively impact the level of interest rates attainable on loans and increase the cost of deposits, which may result in downward pressure on our net interest margin in future periods. Other factors, including, but not limited to, the slope of the yield curve and projected cash flows will impact our net interest income results and may increase or decrease the level of asset sensitivity of our balance sheet.

Convexity is a measure of how the duration of a financial instrument changes as market interest rates change. Potential movements in the convexity of bonds held in our investment portfolio, as well as the duration of the loan portfolio may have a positive or negative impact on our net interest income in varying interest rate environments. As a result, the increase or decrease in forecasted net interest income may not have a linear relationship to the results reflected in the table above. Management cannot provide any assurance about the actual effect of changes in interest rates on our net interest income.

66





The following table reflects management’s expectations of the change in our net interest income over the next 12- month period in light of the aforementioned assumptions. While an instantaneous and severe shift in interest rates was used in this simulation model, we believe that any actual shift in interest rates would likely be more gradual and would therefore have a more modest impact than shown in the table below.
 
Estimated Change in
Future Net Interest Income
Changes in Interest Rates
Dollar
Change
 
Percentage
Change
(in basis points)
($ in thousands)
+200
$
(747
)
 
(0.12
)%
+100
867

 
0.14

–100
(382
)
 
(0.06
)

As noted in the table above, a 100 basis point immediate increase in interest rates is projected to increase net interest income over the next 12 months by 0.14 percent. The sensitivity of our balance sheet to such a move in interest rates at September 30, 2016 decreased as compared to June 30, 2016 (which was a decrease of 2.07 percent in net interest income over a 12 month period). The improved projected net interest income as compared to June 30, 2016 was due, in part, to several items, including new re-pricing assumptions related to our deposits without stated maturities (based upon a comprehensive study of our deposit sensitivity completed by a third party advisor during the third quarter of 2016) which decreased the overall expected sensitivity of such deposits to changes in interest rates at September 30, 2016.  Additionally, the reduced effective interest rate on the $405 million of debt modified in August 2016 and the termination of a $125 million interest rate swap, which effectively converted the formerly hedged 5.125 percent subordinated notes back to fixed rate instruments with an adjusted yield of 3.32 percent, contributed to the increase in projected net interest income as compared to the June 30, 2016 projection.  See the "Executive Summary" section above for more details on the debt and swap transactions.  The slight decrease in the projected net interest income under a 200 basis point immediate increase in interest rates scenario (shown in the table above) was partially due to interest rate caps on some of our variable rate loan products.

Our interest rate swaps and caps designated as cash flow hedging relationships are designed to protect us from upward movements in interest rates on certain deposits and other borrowings based on the prime rate (as reported by The Wall Street Journal) or the three-month LIBOR rate. We have 11 cash flow hedge interest rate swaps with a total notional value of $782 million at September 30, 2016 that currently pay fixed and receive floating rates. We also utilize fair value and non-designated hedge interest rate swaps to effectively convert fixed rate loans and brokered certificates of deposit to floating rate instruments. The cash flow hedges are expected to benefit our net interest income in a rising interest rate environment. However, due to the prolonged low level of market interest rates and the strike rate of these instruments, the cash flow hedge interest rate swaps and cap negatively impacted our net interest income during the three and nine months ended September 30, 2016. We expect this negative trend to continue into the foreseeable future due to the moderate pace of the Federal Reserve’s current monetary policies designed to impact the level of market interest rates. See Note 12 to the consolidated financial statements for further details on our derivative transactions.

Despite the negative impact of such derivative transactions, the possibility of an improving U.S. economy, the debt modification of $405 million in high cost FHLB borrowings during August 2016, an additional $75 million in high cost borrowings that matured in July 2016, and solid commercial lending demand and approved new loan pipelines during the fourth quarter of 2016 could all benefit our future net interest income.
Liquidity

Bank Liquidity

Liquidity measures the ability to satisfy current and future cash flow needs as they become due. A bank’s liquidity reflects its ability to meet loan demand, to accommodate possible outflows in deposits and to take advantage of

67




interest rate opportunities in the marketplace. Liquidity management is monitored by our Asset/Liability Management Committee and the Investment Committee of the Board of Directors of Valley National Bank, which review historical funding requirements, current liquidity position, sources and stability of funding, marketability of assets, options for attracting additional funds, and anticipated future funding needs, including the level of unfunded commitments. Our goal is to maintain sufficient liquidity to cover current and potential funding requirements.

The Bank has no required regulatory liquidity ratios to maintain; however, it adheres to an internal liquidity policy. The current policy maintains that we may not have a ratio of loans to deposits in excess of 125 percent or reliance on wholesale funding greater than 25 percent of total funding. The Bank was in compliance with the foregoing policies at September 30, 2016.

On the asset side of the balance sheet, the Bank has numerous sources of liquid funds in the form of cash and due from banks, interest bearing deposits with banks (including the Federal Reserve Bank of New York), investment securities held to maturity that are maturing within 90 days or would otherwise qualify as maturities if sold (i.e., 85 percent of original cost basis has been repaid), investment securities available for sale, loans held for sale, and, from time to time, federal funds sold and receivables related to unsettled securities transactions. These liquid assets totaled approximately $2.0 billion, representing 9.9 percent of earning assets, at September 30, 2016 and $2.1 billion, representing 10.7 percent of earning assets, at December 31, 2015. Of the $2.0 billion of liquid assets at September 30, 2016, approximately $462 million of various investment securities were pledged to counterparties to support our earning asset funding strategies. We anticipate the receipt of approximately $436 million in principal from securities in the total investment portfolio over the next 12 months due to normally scheduled principal repayments and expected prepayments of certain securities, primarily residential mortgage-backed securities.

Additional liquidity is derived from scheduled loan payments of principal and interest, as well as prepayments received. Loan principal payments (including loans held for sale at September 30, 2016) are projected to be approximately $4.6 billion over the next 12 months. As a contingency plan for significant funding needs, liquidity could also be derived from the sale of conforming residential mortgages from our loan portfolio, or from the temporary curtailment of lending activities.

On the liability side of the balance sheet, we utilize multiple sources of funds to meet liquidity needs, including retail and commercial deposits, brokered and municipal deposits, and short-term and long-term borrowings. Our core deposit base, which generally excludes fully insured brokered deposits and both retail and brokered certificates of deposit over $250 thousand, represents the largest of these sources. Core deposits totaled approximately $15.0 billion and $14.5 billion at September 30, 2016 and December 31, 2015, respectively. The level of interest bearing deposits is affected by interest rates offered, which is often influenced by our need for funds and the need to match the maturities of assets and liabilities.

Additional funding may be provided through deposit gathering networks and in the form of federal funds purchased through our well established relationships with numerous correspondent banks. While there are no firm lending commitments currently in place, management believes that we could borrow approximately $777 million for a short time from these banks on a collective basis. The Bank is also a member of the Federal Home Loan Bank of New York (FHLB) and has the ability to borrow from them in the form of FHLB Advances secured by pledges of certain eligible collateral, including but not limited to U.S. government and agency mortgage-backed securities and a blanket assignment of qualifying first lien mortgage loans, consisting of both residential mortgage and commercial real estate loans. In addition to the FHLB Advances, the Bank has pledged such assets to collateralize $250 million in municipal deposit letters of credit issued by the FHLB on Valley’s behalf to secure certain public deposits at September 30, 2016. Furthermore, we are able to obtain overnight borrowings from the Federal Reserve Bank via the discount window as a contingency for additional liquidity. At September 30, 2016, our borrowing capacity under the Federal Reserve's discount window was $1.0 billion.

We also have access to other short-term and long-term borrowing sources to support our asset base, such as repos (i.e., securities sold under agreements to repurchase). Our short-term borrowings increased $356.4 million to $1.4 billion at September 30, 2016 as compared to December 31, 2015 due to a $582 million increase in FHLB

68




advances, partially offset by decreases of $175.6 million and $50 million in repo balances and overnight federal funds purchased, respectively. The overall increase in short-term borrowings was largely driven by higher levels of loan originations (including residential mortgages originated for sale), repayments of long-term borrowings, and a moderate decline in our use of time deposits in our current liquidity/funding strategies.
Corporation Liquidity

Valley’s recurring cash requirements primarily consist of dividends to preferred and common shareholders and interest expense on subordinated notes and junior subordinated debentures issued to capital trusts. As part of our on-going asset/liability management strategies, Valley could also use cash to repurchase shares of its outstanding common stock under its share repurchase program or redeem its callable junior subordinated debentures. These cash needs are routinely satisfied by dividends collected from the Bank. Projected cash flows from the Bank are expected to be adequate to pay preferred and common dividends, if declared, and interest expense payable to subordinated note holders and capital trusts, given the current capital levels and current profitable operations of the bank subsidiary. In addition to dividends received from the Bank, Valley can satisfy its cash requirements by utilizing its own cash and potential new funds borrowed from outside sources or capital issuances. Valley also has the right to defer interest payments on its $41.5 million of junior subordinated debentures, and therefore distributions on its trust preferred securities for consecutive quarterly periods up to five years, but not beyond the stated maturity dates, and subject to other conditions.
Investment Securities Portfolio

As of September 30, 2016, we had approximately $1.8 billion and $1.3 billion in held to maturity and available for sale investment securities, respectively. Our total investment portfolio was comprised of U.S. Treasury securities, U.S. government agencies, tax-exempt issuances of states and political subdivisions, residential mortgage-backed securities (including 12 private label mortgage-backed securities), single-issuer trust preferred securities principally issued by bank holding companies (including 2 pooled securities), high quality corporate bonds and perpetual preferred and common equity securities issued by banks at September 30, 2016. There were no securities in the name of any one issuer exceeding 10 percent of shareholders’ equity, except for residential mortgage-backed securities issued by Ginnie Mae, Fannie Mae and Freddie Mac.

Among other securities, our investments in the private label mortgage-backed securities, trust preferred securities, perpetual preferred securities, equity securities, and bank issued corporate bonds may pose a higher risk of future impairment charges to us as a result of the uncertain direction of the U.S. economy and its potential negative effect on the future performance of the security issuers and, if applicable, the underlying mortgage loan collateral of the security.
Other-Than-Temporary Impairment Analysis

We may be required to record impairment charges on our investment securities if they suffer a decline in value that is considered other-than-temporary. Numerous factors, including lack of liquidity for re-sales of certain investment securities, absence of reliable pricing information for investment securities, adverse changes in business climate, adverse actions by regulators, or unanticipated changes in the competitive environment could have a negative effect on our investment portfolio and may result in other-than temporary impairment on our investment securities in future periods. See our Annual Report on Form 10-K for the year ended December 31, 2015, for additional information regarding our impairment analysis by security type.

The investment grades in the table below reflect the most current independent analysis performed by third parties of each security as of the date presented and not necessarily the investment grades at the date of our purchase of the securities. For many securities, the rating agencies may not have performed an independent analysis of the tranches owned by us, but rather an analysis of the entire investment pool. For this and other reasons, we believe the assigned investment grades may not accurately reflect the actual credit quality of each security and should not be viewed in isolation as a measure of the quality of our investment portfolio.


69




The following table presents the held to maturity and available for sale investment securities portfolios by investment grades at September 30, 2016.
 
September 30, 2016
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
 
(in thousands)
Held to maturity investment grades:*
 
 
 
 
 
 
 
AAA Rated
$
1,335,441

 
$
44,757

 
$
(1,420
)
 
$
1,378,778

AA Rated
237,097

 
13,736

 

 
250,833

A Rated
45,675

 
3,185

 

 
48,860

Non-investment grade
3,705

 
104

 
(44
)
 
3,765

Not rated
223,233

 
571

 
(14,058
)
 
209,746

Total investment securities held to maturity
$
1,845,151

 
$
62,353

 
$
(15,522
)
 
$
1,891,982

Available for sale investment grades:*
 
 
 
 
 
 
 
AAA Rated
$
1,062,159

 
$
13,191

 
$
(2,092
)
 
$
1,073,258

AA Rated
77,181

 
2,253

 
(1,387
)
 
78,047

A Rated
28,000

 
79

 
(8
)
 
28,071

BBB Rated
49,242

 
842

 
(622
)
 
49,462

Non-investment grade
16,553

 
321

 
(1,606
)
 
15,268

Not rated
32,707

 
538

 
(642
)
 
32,603

Total investment securities available for sale
$
1,265,842

 
$
17,224

 
$
(6,357
)
 
$
1,276,709

 
*
Rated using external rating agencies (primarily S&P and Moody’s). Ratings categories include the entire range. For example, “A rated” includes A+, A, and A-. Split rated securities with two ratings are categorized at the higher of the rating levels.

The held to maturity portfolio includes $223.2 million in investments not rated by the rating agencies with aggregate unrealized losses of $14.1 million at September 30, 2016. The unrealized losses for this category primarily relate to 4 single-issuer bank trust preferred issuances with a combined amortized cost of $35.9 million. All single-issuer trust preferred securities classified as held to maturity, including the aforementioned four securities, are paying in accordance with their terms and have no deferrals of interest or defaults. Additionally, we analyze the performance of each issuer on a quarterly basis, including a review of performance data from the issuer’s most recent bank regulatory report to assess the company’s credit risk and the probability of impairment of the contractual cash flows of the applicable security. Based upon our quarterly review at September 30, 2016, all of the issuers appear to meet the regulatory capital minimum requirements to be considered a “well-capitalized” financial institution and/or have maintained performance levels adequate to support the contractual cash flows of the security.

There was no other-than-temporary impairment recognized in earnings as a result of Valley's impairment analysis of its securities during the nine months ended September 30, 2016 and 2015 as the collateral supporting much of the investment securities has improved or performed as expected.

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Loan Portfolio

The following table reflects the composition of the loan portfolio as of the dates presented:
 
September 30,
2016
 
June 30,
2016
 
March 31,
2016
 
December 31,
2015
 
September 30,
2015
 
($ in thousands)
Loans
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
2,558,968

 
$
2,528,749

 
$
2,537,545

 
$
2,540,491

 
$
2,400,618

Commercial real estate:
 
 
 
 
 
 
 
 
 
Commercial real estate
8,313,855

 
8,018,794

 
7,585,139

 
7,424,636

 
6,960,677

Construction
802,568

 
768,847

 
776,057

 
754,947

 
569,653

Total commercial real estate
9,116,423

 
8,787,641

 
8,361,196

 
8,179,583

 
7,530,330

Residential mortgage
2,826,130

 
3,055,353

 
3,101,814

 
3,130,541

 
2,999,262

Consumer:
 
 
 
 
 
 
 
 
 
Home equity
476,820

 
485,730

 
491,555

 
511,203

 
478,129

Automobile
1,121,606

 
1,141,793

 
1,188,063

 
1,239,313

 
1,219,758

Other consumer
534,188

 
499,914

 
455,814

 
441,976

 
388,717

Total consumer loans
2,132,614

 
2,127,437

 
2,135,432

 
2,192,492

 
2,086,604

Total loans (1)(2)
$
16,634,135

 
$
16,499,180

 
$
16,135,987

 
$
16,043,107

 
$
15,016,814

As a percent of total loans:
 
 
 
 
 
 
 
 
 
Commercial and industrial
15.4
%
 
15.3
%
 
15.8
%
 
15.8
%
 
16.0
%
Commercial real estate
54.8
%
 
53.3
%
 
51.8
%
 
51.0
%
 
50.1
%
Residential mortgage
17.0
%
 
18.5
%
 
19.2
%
 
19.5
%
 
20.0
%
Consumer loans
12.8
%
 
12.9
%
 
13.2
%
 
13.7
%
 
13.9
%
Total
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%
 
(1)
Includes covered loans subject to loss-sharing agreements with the FDIC (primarily consisting of residential mortgage loans and commercial real estate loans) totaling $76.0 million, $81.1 million, $86.8 million, $122.3 million and $129.5 million at September 30, 2016, June 30, 2016, March 31, 2016, December 31, 2015 and September 30, 2015, respectively.
(2)
Includes net unearned premiums and deferred loan costs of $10.5 million, $8.3 million, $5.6 million, $3.5 million and $106 thousand at September 30, 2016, June 30, 2016, March 31, 2016, December 31, 2015 and September 30, 2015, respectively.

Total loans increased $135.0 million to approximately $16.6 billion at September 30, 2016 from June 30, 2016. Our loan portfolio includes purchased credit-impaired (PCI) loans, which are loans acquired at a discount that is due, in part, to credit quality. At September 30, 2016, our PCI loan portfolio decreased $118.3 million to $1.9 billion as compared to June 30, 2016 primarily due to larger loan repayments, of which some resulted from continued efforts by management to encourage borrower prepayment. The non-PCI loan portion of the loan portfolio increased $253.3 million (net of $174.5 million in performing residential mortgage loans transferred to loans held for sale during the third quarter) to approximately $14.8 billion at September 30, 2016 as compared to June 30, 2016 largely due to increases in total commercial real estate loans and collateralized personal lines of credit within the other consumer loan category discussed further below. During the third quarter of 2016, Valley also originated $171.9 million of residential mortgage loans for sale rather than investment. Loans held for sale totaled $202.4 million and $4.5 million at September 30, 2016 and June 30, 2016, respectively. See additional information regarding our residential mortgage loan activities below.

Total commercial and industrial loans increased $30.2 million from June 30, 2016 to approximately $2.6 billion at September 30, 2016, despite a $35.4 million decline in the PCI loan portion of the portfolio during the third quarter of 2016. Exclusive of the decline in PCI loans, the non-PCI commercial and industrial loan portfolio increased by $65.6 million, or approximately 11.9 percent on an annualized basis, to $2.3 billion at September 30, 2016 from June 30, 2016. This growth was partially driven by new organic customer relationships originated during the third

71




quarter of 2016. In addition to the PCI loan repayments, the level of loan growth within this portfolio continues to be challenged by strong market competition for both new and existing commercial loan borrowers within our primary markets, and relatively stable levels of line of credit usage by our customer base during 2016.
Commercial real estate loans (excluding construction loans) increased $295.1 million from June 30, 2016 to $8.3 billion at September 30, 2016 mainly due to a $356.2 million, or 20.9 percent on an annualized basis, increase in the non-PCI loan portfolio. The increase in non-PCI loans was primarily due to solid organic loan volumes in New York and New Jersey, as well as approximately $99 million of participations in multi-family loans (mostly in New York City) purchased in September 2016. The purchased participation loans are seasoned loans with expected shorter durations. Each purchased participation loan was stress-tested by Valley under its normal underwriting criteria to further satisfy ourselves as to their credit quality. The organic loan volumes generated across a broad based segment of borrowers within the commercial real estate portfolio were partially offset by a $61.1 million decline in the acquired PCI loan portion of the portfolio. Construction loans increased $33.7 million to $802.6 million at September 30, 2016 from June 30, 2016. The increase was mostly due to advances on existing construction projects.
Total residential mortgage loans decreased $229.2 million, or approximately 30.0 percent on an annualized basis, to approximately $2.8 billion at September 30, 2016 from June 30, 2016 mostly due to the aforementioned transfer of $174.5 million in mortgage loans to loans held for sale, as well as a large percentage of new loans originated for sale rather than investment during the third quarter of 2016. Valley sold approximately $149.2 million of residential mortgage loans originated for sale (including $4.5 million of loans held for sale at June 30, 2016) during the third quarter of 2016. New and refinanced residential mortgage loan originations totaled approximately $258.3 million for the third quarter of 2016 as compared to $177.7 million and $115.1 million for the second quarter of 2016 and third quarter of 2015, respectively. Of the $258.3 million in total originations, $18.1 million, or 7.0 percent, represented new Florida residential mortgage loans. We expect to continue to sell a large portion of our new fixed rate residential mortgage loan originations as part of our overall interest rate risk management strategies.
Home equity loans decreased $8.9 million to $476.8 million at September 30, 2016 as compared to June 30, 2016 mostly due to normal repayment activity largely within the PCI loan portion of the portfolio. New home equity loan volumes and customer usage of existing home equity lines of credit continue to be weak, despite the relatively favorable low interest rate environment.
Automobile loans decreased by $20.2 million to $1.1 billion at September 30, 2016 as compared to June 30, 2016 as our new indirect auto loan volumes continued to not keep pace with the normal portfolio repayment activity in the third quarter of 2016. The decline in indirect auto originations during the first nine months of 2016 was largely caused by current market loan pricing and fee constraints resulting from new regulatory lending guidance. During the third quarter of 2016, management implemented various strategies to enhance new auto volumes, including new technology to improve the decision-making process for our auto dealer network. These enhancements and continued growth in our relatively new Florida markets led to much improved new loan volumes as compared to the linked second quarter of 2016. While we're optimistic that this positive trend in new loan production will continue into the fourth quarter of 2016, we can provide no assurance that our auto loans will not continue to decline in future periods.
Other consumer loans increased $34.3 million, or 27.4 percent on an annualized basis, to $534.2 million at September 30, 2016 as compared to $499.9 million at June 30, 2016 mainly due to continued growth and customer usage of collateralized personal lines of credit.
We are cautiously optimistic that we will continue to experience overall loan growth primarily within the commercial lending segment during the fourth quarter of 2016 and the foreseeable future. Our approved organic commercial loan pipeline continued to be strong at the end of the third quarter, despite the market competition for high quality commercial credits. However, we can make no assurances that our total loans will increase, or remain at current levels in the future.

72




Most of our lending is in northern and central New Jersey, New York City, Long Island and Florida, with the exception of smaller auto and residential mortgage loan portfolios derived from the other neighboring states of New Jersey, which could present a geographic and credit risk if there was another significant broad based economic downturn or a prolonged economic recovery within these regions. We are witnessing new loan activity across Valley's entire geographic footprint, including new loans and solid loan pipelines from our Florida lending operations. Valley’s Florida Division accounted for approximately $90 million of over $1 billion in new and purchased commercial loan volume, excluding lines of credit, during the third quarter of 2016. However, the New Jersey and New York Metropolitan markets continue to account for a disproportionately larger percentage of our lending activity. To mitigate these risks, we are making efforts to maintain a diversified portfolio as to type of borrower and loan to guard against a potential downward turn in any one economic sector. Geographically, we intend to make further inroads into the Florida lending market, through acquisition or select de novo branch efforts.
Purchased Credit-Impaired Loans (Including Covered Loans)

PCI loans totaled $1.9 billion and $2.2 billion at September 30, 2016 and December 31, 2015, respectively, mostly consisting of loans acquired in business combinations subsequent to 2011, and covered loans in which the Bank will share losses with the FDIC under loss-sharing agreements. Our covered loans, consisting primarily of residential mortgage loans and commercial real estate loans, totaled $76.0 million and $122.3 million at September 30, 2016 and December 31, 2015, respectively. The decrease in covered loans was largely due to the expiration of a commercial loss-sharing agreement acquired from 1st United Bancorp, Inc. effective January 1, 2016 and the reclassification of such loans to non-covered PCI loans during the first quarter of 2016. Additional information regarding all of our loss-sharing agreements with the FDIC can be found in our Annual Report on Form 10-K for the year ended December 31, 2015.

As required by U.S. GAAP, all of our PCI loans are accounted for under ASC Subtopic 310-30. This accounting guidance requires the PCI loans to be aggregated and accounted for as pools of loans based on common risk characteristics. A pool is accounted for as one asset with a single composite interest rate, aggregate fair value and expected cash flows. For PCI loan pools accounted for under ASC Subtopic 310-30, the difference between the contractually required payments due and the cash flows expected to be collected, considering the impact of prepayments, is referred to as the non-accretable difference. The contractually required payments due represent the total undiscounted amount of all uncollected principal and interest payments. Contractually required payments due may increase or decrease for a variety of reasons, e.g. when the contractual terms of the loan agreement are modified, when interest rates on variable rate loans change, or when principal and/or interest payments are received. The Bank estimates the undiscounted cash flows expected to be collected by incorporating several key assumptions including probability of default, loss given default, and the amount of actual prepayments after the acquisition dates. The non-accretable difference, which is neither accreted into income nor recorded on our consolidated balance sheet, reflects estimated future credit losses and uncollectable contractual interest expected to be incurred over the life of the loans. The excess of the undiscounted cash flows expected at the acquisition date over the carrying amount (fair value) of the PCI loans is referred to as the accretable yield. This amount is accreted into interest income over the remaining life of the loans, or pool of loans, using the level yield method. The accretable yield is affected by changes in interest rate indices for variable rate loans, changes in prepayment assumptions, and changes in expected principal and interest payments over the estimated lives of the loans. Prepayments affect the estimated life of PCI loans and could change the amount of interest income, and possibly principal, expected to be collected. Reclassifications of the non-accretable difference to the accretable yield may occur subsequent to the loan acquisition dates due to increases in expected cash flows of the loan pools.

At both acquisition and subsequent quarterly reporting dates, we use a third party service provider to assist with validation of our assessment of the contractual and estimated cash flows. Valley provides the third party with updated loan-level information derived from Valley’s main operating system, contractually required loan payments and expected cash flows for each loan pool individually reviewed by us. Using this information, the third party provider determines both the contractual cash flows and cash flows expected to be collected. The loan-level information used to reforecast the cash flows was subsequently aggregated on a pool basis. The expected payment data, discount rates, impairment data and changes to the accretable yield received back from the third party were

73




reviewed by Valley to determine whether this information is accurate and the resulting financial statement effects are reasonable.

Similar to contractual cash flows, we reevaluate expected cash flows on a quarterly basis. Unlike contractual cash flows which are determined based on known factors, significant management assumptions are necessary in forecasting the estimated cash flows. We attempt to ensure the forecasted expectations are reasonable based on the information currently available; however, due to the uncertainties inherent in the use of estimates, actual cash flow results may differ from our forecast and the differences may be significant. To mitigate such differences, we carefully prepare and review the assumptions utilized in forecasting estimated cash flows.

On a quarterly basis, Valley analyzes the actual cash flow versus the forecasts at the loan pool level and variances are reviewed to determine their cause. In re-forecasting future estimated cash flow, Valley will adjust the credit loss expectations for loan pools, as necessary. These adjustments are based, in part, on actual loss severities recognized for each loan type, as well as changes in the probability of default. For periods in which Valley does not reforecast estimated cash flows, the prior reporting period’s estimated cash flows are adjusted to reflect the actual cash received and credit events which transpired during the current reporting period.

The following tables summarize the changes in the carrying amounts of PCI loans (net of the allowance for loan losses, if applicable), and the accretable yield on these loans for the three and nine months ended September 30, 2016 and 2015. 
 
Three Months Ended September 30,
 
2016
 
2015
 
Carrying
Amount, Net
 
Accretable
Yield
 
Carrying
Amount, Net
 
Accretable
Yield
 
(in thousands)
PCI loans:
 
 
 
 
 
 
 
Balance, beginning of the period
$
1,975,401

 
$
355,601

 
$
1,571,271

 
$
282,101

Accretion
26,730

 
(26,730
)
 
24,814

 
(24,814
)
Payments received
(145,016
)
 

 
(116,493
)
 

Transfers to other real estate owned

 

 
(2,004
)
 

Balance, end of the period
$
1,857,115

 
$
328,871

 
$
1,477,588

 
$
257,287

 
Nine Months Ended September 30,
 
2016
 
2015
 
Carrying
Amount, Net
 
Accretable
Yield
 
Carrying
Amount, Net
 
Accretable
Yield
 
(in thousands)
PCI loans:
 
 
 
 
 
 
 
Balance, beginning of the period
$
2,240,471

 
$
415,179

 
$
1,721,601

 
$
336,208

Accretion
83,114

 
(83,114
)
 
78,921

 
(78,921
)
Payments received
(462,100
)
 

 
(319,267
)
 
 
Transfers to other real estate owned
(1,176
)
 

 
(3,084
)
 

 Other, net
(3,194
)
 
(3,194
)
 
(583
)
 

Balance, end of the period
$
1,857,115

 
$
328,871

 
$
1,477,588

 
$
257,287

PCI loans in the table above at September 30, 2015 are presented net of the allocation of the allowance for loan losses totaling $200 thousand. This allowance allocation was established due to a decrease in the expected cash flows for certain pools of covered loans based on higher levels of credit impairment than originally forecasted by us at the acquisition dates. There was no allowance allocation for PCI loan losses at September 30, 2016.
Although we recognized additional credit impairment for certain covered pools prior to 2012, and excluding PCI loans recently acquired from CNL in December of 2015, on an aggregate basis the acquired pools of loans are performing better than originally expected at the acquisition dates. Based on our current estimates, we expect to receive more future cash flows than originally modeled at the acquisition dates. For the pools with better than

74




expected cash flows, the forecasted increase is recorded as a prospective adjustment to our interest income on these loan pools over future periods. The decrease in the FDIC loss-share receivable due to the increase in expected cash flows for covered loan pools is recognized on a prospective basis over the shorter period of the lives of the loan pools and the loss-share agreements accordingly with a corresponding reduction in non-interest income for the period. See section below for further details regarding the FDIC loss-share receivable. Conversely, an increase or decrease in expected future cash flows of covered loans since the acquisition dates will increase or decrease (if applicable) the clawback liability (the amount the FDIC requires us to pay back if certain thresholds are met) accordingly. 
FDIC Loss-Share Receivable Related to Covered Loans and Foreclosed Assets

The receivable arising from the loss-sharing agreements with the FDIC is measured separately from the covered loan portfolio because the agreements are not contractually part of the covered loans and are not transferable should the Bank choose to dispose of the covered loans. The FDIC loss share receivable (which is included in other assets on Valley's consolidated statements of financial condition) totaled $7.7 million and $8.3 million at September 30, 2016 and December 31, 2015, respectively. The aggregate effect of changes in the FDIC loss-share receivable was a net reduction in non-interest income of $313 thousand and $55 thousand for the three months ended September 30, 2016 and 2015, respectively, and $872 thousand and $3.4 million for the nine months ended September 30, 2016 and 2015, respectively. The larger net reduction during the nine months ended September 30, 2015 was mainly caused by the prospective recognition of the effect of additional cash flows from certain loan pools which were covered by commercial loan loss-sharing agreements that expired in March 2015.
Non-performing Assets
Non-performing assets (excluding PCI loans) include non-accrual loans, other real estate owned (OREO), other repossessed assets (consisting of automobiles) and non-accrual debt securities at September 30, 2016. Loans are generally placed on non-accrual status when they become past due in excess of 90 days as to payment of principal or interest. Exceptions to the non-accrual policy may be permitted if the loan is sufficiently collateralized and in the process of collection. OREO is acquired through foreclosure on loans secured by land or real estate. OREO and other repossessed assets are reported at the lower of cost or fair value, less cost to sell at the time of acquisition and at the lower of fair value, less estimated costs to sell, or cost thereafter. The level of non-performing assets has decreased 33.3 percent over the last 12 month period to $51.0 million at September 30, 2016 mostly due to strong collections within non-accrual loan category over the last six months and a steady decline in OREO balances since September 30, 2015. As a result, non-performing assets as a percentage of total loans and non-performing assets declined to 0.31 percent at September 30, 2016 as compared to 0.37 percent at June 30, 2016 (as shown in the table below). Past due loans and non-accrual loans in the table below exclude PCI loans. Under U.S. GAAP, the PCI loans (acquired at a discount that is due, in part, to credit quality) are accounted for on a pool basis and are not subject to delinquency classification in the same manner as loans originated by Valley. For details regarding performing and non-performing PCI loans, see the "Credit quality indicators" section in Note 8 to the consolidated financial statements.



75




The following table sets forth by loan category accruing past due and non-performing assets on the dates indicated in conjunction with our asset quality ratios: 
 
September 30, 2016
 
June 30,
2016
 
March 31,
2016
 
December 31,
2015
 
September 30, 2015
 
($ in thousands)
Accruing past due loans: (1)
 
30 to 59 days past due:
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
4,306

 
$
5,187

 
$
8,395

 
$
3,920

 
$
2,081

Commercial real estate
9,385

 
5,076

 
1,389

 
2,684

 
2,950

Construction

 

 
1,326

 
1,876

 
4,707

Residential mortgage
9,982

 
10,177

 
14,628

 
6,681

 
5,617

Consumer
3,146

 
2,535

 
3,200

 
3,348

 
3,491

Total 30 to 59 days past due
26,819

 
22,975

 
28,938

 
18,509

 
18,846

60 to 89 days past due:
 
 
 
 
 
 
 
 
 
Commercial and industrial
788

 
5,714

 
613

 
524

 
1,996

Commercial real estate
4,291

 
834

 
120

 


 
1,415

Construction

 

 

 
2,799

 

Residential mortgage
2,733

 
2,326

 
3,056

 
1,626

 
1,977

Consumer
1,234

 
644

 
731

 
626

 
722

Total 60 to 89 days past due
9,046

 
9,518

 
4,520

 
5,575

 
6,110

90 or more days past due:
 
 
 
 
 
 
 
 
 
Commercial and industrial
145

 
218

 
221

 
213

 
224

Commercial real estate
478

 
131

 
131

 
131

 
245

Construction
1,881

 

 

 

 

Residential mortgage
590

 
314

 
2,613

 
1,504

 
3,468

Consumer
226

 
139

 
66

 
208

 
166

Total 90 or more days past due
3,320

 
802

 
3,031

 
2,056

 
4,103

Total accruing past due loans
$
39,185

 
$
33,295

 
$
36,489

 
$
26,140

 
$
29,059

Non-accrual loans: (1)
 
 
 
 
 
 
 
 
 
Commercial and industrial
$
7,875

 
$
6,573

 
$
11,484

 
$
10,913

 
$
12,845

Commercial real estate
14,452

 
19,432

 
26,604

 
24,888

 
22,129

Construction
1,136

 
5,878

 
5,978

 
6,163

 
5,959

Residential mortgage
14,013

 
14,866

 
16,747

 
17,930

 
16,657

Consumer
965

 
1,130

 
1,807

 
2,206

 
1,634

Total non-accrual loans
38,441

 
47,879

 
62,620

 
62,100

 
59,224

Other real estate owned (OREO) (2)
10,257

 
10,903

 
12,368

 
13,563

 
14,691

Other repossessed assets
307

 
369

 
495

 
437

 
369

Non-accrual debt securities (3)
2,025

 
2,118

 
2,102

 
2,142

 
2,182

Total non-performing assets (NPAs)
$
51,030

 
$
61,269

 
$
77,585

 
$
78,242

 
$
76,466

Performing troubled debt restructured loans
$
81,093

 
$
82,140

 
$
80,506

 
$
77,627

 
$
91,210

Total non-accrual loans as a % of loans
0.23
%
 
0.29
%
 
0.39
%
 
0.39
%
 
0.39
%
Total NPAs as a % of loans and NPAs
0.31

 
0.37

 
0.48

 
0.49

 
0.51

Total accruing past due and non-accrual loans as a % of loans
0.47

 
0.49

 
0.61

 
0.55

 
0.59

Allowance for loan losses as a % of non-accrual loans
287.97

 
225.75

 
168.34

 
170.98

 
176.53



76




 

(1)
Past due loans and non-accrual loans exclude PCI loans that are accounted for on a pool basis.
(2)
This table excludes covered OREO properties related to FDIC-assisted transactions totaling $1.0 million, $1.2 million, $2.4 million, $5.0 million, and $5.4 million at September 30, 2016, June 30, 2016, March 31, 2016, December 31, 2015, and September 30, 2015, respectively.
(3)
Includes other-than-temporarily impaired trust preferred securities classified as available for sale, which are presented at carrying value, net of net unrealized losses totaling $728 thousand, $634 thousand, $651 thousand, $610 thousand, $570 thousand, $630 thousand at September 30, 2016, June 30, 2016, March 31, 2016, and December 31, 2015, September 30, 2015, respectively.

Loans past due 30 to 59 days increased $3.8 million to $26.8 million at September 30, 2016 as compared to June 30, 2016 largely due to a $4.3 million increase in commercial real estate loans. Commercial real estate loans increased mainly due to two new loan relationships totaling $7.4 million (including a $2.3 million potential problem loan), partially offset by the migration of a $3.8 million potential problem loan into the loans past due 60 to 89 days category at September 30, 2016.

Loans past due 60 to 89 days decreased $472 thousand to $9.0 million at September 30, 2016 as compared to June 30, 2016. Within the category, commercial and industrial loans decreased $4.9 million to $788 thousand at September 30, 2016 from $5.7 million at June 30, 2016. The decrease was mostly due to one loan relationship collateralized by Chicago taxi cab medallions totaling $5.2 million that was partially charged off by $3.7 million during the third quarter, and the adjusted aggregate carrying value of $1.5 million reclassified to non-accrual loans at September 30, 2016 (See further discussion below). The commercial real estate loan category increased $3.5 million at September 30, 2016 as compared to June 30, 2016 mostly due to the aforementioned potential problem loan totaling $3.8 million that mitigated from loans past due 30 to 59 days reported at June 30, 2016.

Loans past due 90 days or more and still accruing increased $2.5 million to $3.3 million at September 30, 2016 compared to $802 thousand at June 30, 2016. The increase in this delinquency category was mostly due to $1.9 million and $347 thousand of matured performing construction and commercial real estate loans, respectively. These loans were in the normal process of renewal at September 30, 2016. All of the loans past due 90 days or more and still accruing are considered to be well secured and in the process of collection.

Non-accrual loans decreased $9.4 million to $38.4 million at September 30, 2016 as compared to $47.9 million at June 30, 2016 largely due to several full repayments of impaired commercial real estate and construction loans and one commercial real estate loan totaling $3.4 million transferred to OREO during the third quarter of 2016. As previously noted above, our non-accrual commercial and industrial loans included $1.5 million of loans collateralized by Chicago taxi medallions at September 30, 2016. This impaired loan relationship is the only past due relationship in our entire taxi medallion loan portfolio totaling $152.0 million (including $19.2 million of contractual outstanding balances within our PCI loan portfolio). Of the $152.0 million taxi medallion loan portfolio, $141.0 million and $11.0 million represent New York City and Chicago taxi medallion loans, respectively. Valley's historical taxi medallion lending criteria has been conservative in regards to capping the loan amounts in relation to market valuations, as well as obtaining personal guarantees and other collateral whenever possible. We will continue to closely monitor this portfolio's performance and the potential impact of the changes in market valuations for taxi medallions due to relatively new competing services.

OREO properties decreased $646 thousand to $10.3 million at September 30, 2016 from $10.9 million at June 30, 2016. During the quarter ended September 30, 2016, we sold the aforementioned $3.4 million commercial real estate loan transferred to OREO from non-accrual loans for an immaterial gain. Our residential mortgage loan foreclosure activity remains low due to the nominal amount of individual loan delinquencies within the residential mortgage and home equity portfolios and the average time to complete a foreclosure in the State of New Jersey, which currently exceeds two and a half years. The residential mortgage and consumer loans secured by residential real estate properties for which formal foreclosure proceedings are in-process totaled $7.7 million at September 30, 2016. We believe this lengthy legal process negatively impacts the level of our non-accrual loans and NPAs, and the ability to compare our NPA levels to similar banks located outside of our primary markets as of September 30, 2016.

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Troubled debt restructured loans (TDRs) represent loan modifications for customers experiencing financial difficulties where a concession has been granted. Performing TDRs (i.e., TDRs not reported as loans 90 days or more past due and still accruing or as non-accrual loans) totaled $81.1 million at September 30, 2016 and consisted of 95 loans (primarily in the commercial and industrial loan and commercial real estate portfolios). On an aggregate basis, the $81.1 million in performing TDRs at September 30, 2016 had a modified weighted average interest rate of approximately 4.74 percent as compared to a pre-modification weighted average interest rate of 4.99 percent.
Allowance for Credit Losses
The allowance for credit losses includes the allowance for loan losses and the reserve for unfunded commercial letters of credit. Management maintains the allowance for credit losses at a level estimated to absorb probable losses inherent in the loan portfolio and unfunded letter of credit commitments at the balance sheet dates, based on ongoing evaluations of the loan portfolio. Our methodology for evaluating the appropriateness of the allowance for loan losses includes:
segmentation of the loan portfolio based on the major loan categories, which consist of commercial, commercial real estate (including construction), residential mortgage, and other consumer loans (including automobile and home equity loans);
tracking the historical levels of classified loans and delinquencies;
assessing the nature and trend of loan charge-offs;
providing specific reserves on impaired loans; and
evaluating the PCI loan pools for additional credit impairment subsequent to the acquisition dates.
Additionally, the qualitative factors, such as the volume of non-performing loans, concentration risks by size, type, and geography, new markets, collateral adequacy, credit policies and procedures, staffing, underwriting consistency, loan review and economic conditions are taken into consideration when evaluating the adequacy of the allowance for credit losses. The allowance for credit loss methodology and accounting policy are fully described in Part II, Item 7 and Note 1 to the consolidated financial statements in Valley’s Annual Report on Form 10-K for the year ended December 31, 2015.

While management utilizes its best judgment and information available, the ultimate adequacy of the allowance for credit losses is dependent upon a variety of factors largely beyond our control, including the view of the OCC toward loan classifications, performance of the loan portfolio, and the economy. The OCC may require, based on their judgments about information available to them at the time of their examination, that certain loan balances be charged off or require that adjustments be made to the allowance for loan losses when their credit evaluations differ from those of management

78




The table below summarizes the relationship among loans, loans charged-off, loan recoveries, the provision for credit losses and the allowance for credit losses for the periods indicated.
 
Three Months Ended
 
Nine Months Ended
 
September 30,
2016
 
June 30,
2016
 
September 30,
2015
 
September 30,
2016
 
September 30,
2015
 
($ in thousands)
Average loans outstanding
$
16,570,723

 
$
16,252,915

 
$
14,709,618

 
$
16,273,482

 
$
14,144,921

Beginning balance - Allowance for credit losses
$
110,414

 
$
107,675

 
$
104,887

 
$
108,367

 
$
104,287

Loans charged-off:
 
 
 
 
 
 
 
 
 
Commercial and industrial
(3,763
)
 
(493
)
 
(1,124
)
 
(5,507
)
 
(5,103
)
Commercial real estate

 
(414
)
 

 
(519
)
 
(1,864
)
Construction

 

 
(40
)
 

 
(916
)
Residential mortgage
(518
)
 
(151
)
 
(111
)
 
(750
)
 
(499
)
Consumer
(782
)
 
(697
)
 
(734
)
 
(2,553
)
 
(2,642
)
Total charge-offs
(5,063
)
 
(1,755
)
 
(2,009
)
 
(9,329
)
 
(11,024
)
Charged-off loans recovered:
 
 
 
 
 
 
 
 
 
Commercial and industrial
902

 
990

 
2,550

 
2,418

 
5,587

Commercial real estate
34

 
1,458

 
535

 
1,581

 
773

Construction
10

 

 
1

 
10

 
913

Residential mortgage
495

 
94

 
151

 
604

 
395

Consumer
282

 
523

 
488

 
1,194

 
1,172

Total recoveries
1,723

 
3,065

 
3,725

 
5,807

 
8,840

Net (charge-offs) recoveries
(3,340
)
 
1,310

 
1,716

 
(3,522
)
 
(2,184
)
Provision charged for credit losses
5,840

 
1,429

 
94

 
8,069

 
4,594

Ending balance - Allowance for credit losses
$
112,914

 
$
110,414

 
$
106,697

 
$
112,914

 
$
106,697

Components of allowance for credit losses:
 
 
 
 
 
 
 
 
 
Allowance for loan losses
$
110,697

 
$
108,088

 
$
104,551

 
$
110,697

 
$
104,551

Allowance for unfunded letters of credit
2,217

 
2,326

 
2,146

 
2,217

 
2,146

Allowance for credit losses
$
112,914

 
$
110,414

 
$
106,697

 
$
112,914

 
$
106,697

Components of provision for credit losses:
 
 
 
 
 
 
 
 
 
Provision for loan losses
$
5,949

 
$
1,363

 
$

 
$
8,041

 
$
4,382

Provision for unfunded letters of credit
(109
)
 
66

 
94

 
28

 
212

Provision for credit losses
$
5,840

 
$
1,429

 
$
94

 
$
8,069

 
$
4,594

 
 
 
 
 
 
 
 
 
 
Annualized ratio of net charge-offs (recoveries) to average loans outstanding
0.08
%
 
(0.03
)%
 
(0.05
)%
 
0.03
%
 
0.02
%
Allowance for credit losses as a % of non-PCI loans
0.76

 
0.76

 
0.79

 
0.76

 
0.79

Allowance for credit losses as a % of total loans
0.68

 
0.67

 
0.71

 
0.68

 
0.71


During the third quarter of 2016, we recognized net loan charge-offs of $3.3 million as compared to net recoveries of charge-offs totaling $1.3 million and $1.7 million for the second quarter of 2016 and the third quarter of 2015, respectively. The quarter over quarter increase in net loan charge-offs was largely due to the $3.7 million partial charge-off related to a Chicago taxi medallion relationship within the commercial and industrial loan portfolio.


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During the third quarter of 2016, we recorded a $5.8 million provision for credit losses as compared to a provision of $1.4 million and $94 thousand for the second quarter of 2016 and third quarter of 2015, respectively. The increase in the provision from the linked second quarter of 2016 was mostly due to longer estimated loss emergence periods for most of our commercial loan portfolios based upon our updated annual loss emergence study performed at September 30, 2016, as well as a moderate increase in allocated reserves for internally classified loans. The loss emergence period (LEP) assumption represents the estimated average amount of time from the point at which a loss is incurred to the point at which a loss is confirmed, typically by a charge-off. A longer LEP assumption will increase the level of the allowance for loan losses, and conversely, a shorter LEP will reduce the level of such reserves.
The following table summarizes the allocation of the allowance for credit losses to specific loan portfolio categories and the allocations as a percentage of each loan category:
 
September 30, 2016
 
June 30, 2016
 
September 30, 2015
 
Allowance
Allocation
 
Allocation
as a % of
Loan
Category
 
Allowance
Allocation
 
Allocation
as a % of
Loan
Category
 
Allowance
Allocation
 
Allocation
as a % of
Loan
Category
 
($ in thousands)
Loan Category:
 
 
 
 
 
 
 
 
 
 
 
Commercial and Industrial loans*
$
52,969

 
2.07
%
 
$
50,351

 
1.99
%
 
$
49,682

 
2.07
%
Commercial real estate loans:
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
35,513

 
0.43
%
 
35,869

 
0.45
%
 
29,950

 
0.43
%
Construction
16,947

 
2.11
%
 
16,008

 
2.08
%
 
12,328

 
2.16
%
Total commercial real estate loans
52,460

 
0.58
%
 
51,877

 
0.59
%
 
42,278

 
0.56
%
Residential mortgage loans
3,378

 
0.12
%
 
3,495

 
0.11
%
 
4,549

 
0.15
%
Consumer loans:
 
 
 
 
 
 
 
 
 
 
 
Home equity
796

 
0.17
%
 
968

 
0.20
%
 
1,127

 
0.24
%
Auto and other consumer
3,311

 
0.20
%
 
3,723

 
0.23
%
 
3,341

 
0.21
%
Total consumer loans
4,107

 
0.19
%
 
4,691

 
0.22
%
 
4,468

 
0.21
%
Unallocated

 


 

 

 
5,720

 

Total allowance for credit losses
$
112,914

 
0.68
%
 
$
110,414

 
0.67
%
 
$
106,697

 
0.71
%
 
*
Includes the reserve for unfunded letters of credit.

The allowance for credit losses comprised of our allowance for loan losses and reserve for unfunded letters of credit, as a percentage of total loans was 0.68 percent at September 30, 2016 and 0.67 percent at June 30, 2016, as compared to 0.71 percent of total loans at September 30, 2015. At September 30, 2016, our allowance allocations for losses as a percentage of total loans remained relatively stable in several loan categories as compared to June 30, 2016, but increased for commercial and industrial loans due, in part, to the aforementioned increase in the loss emergence period and a higher level of net loan charge-offs and internally classified loans (including taxi medallion loans) at September 30, 2016. The overall mix of these items, significant loan growth in the commercial real estate and other consumer loan categories of the portfolio, assumptions based on the current economic environment, as well as other qualitative factors impacted our estimate of the allowance for credit losses at September 30, 2016.

During the fourth quarter of 2015, Valley refined and enhanced its assessment of the adequacy of the allowance for loan losses by extending the loss look-back period on the majority of its loan portfolios from three years to four years in order to capture more of the current economic cycle as it continued throughout 2015. Valley also enhanced its qualitative factor framework to capture the risks of several factors, including, but not limited to, the impact of changes in capitalization rates on collateral values, concentrations of certain loan types, including multi-family and exculpated loans, the volume of loans purchased from and serviced by third parties, as well as the rate of growth in Valley's real estate portfolios. These enhancements are meant to increase the level of precision in the allowance for credit losses. As a result, Valley no longer has an “unallocated” segment in its allowance for credit losses, as the risks and

80




uncertainties meant to be captured by the unallocated allowance have been included in the qualitative framework for the respective portfolios at September 30, 2016 and June 30, 2016. As such, the unallocated allowance has in essence been reallocated to the certain portfolios based on the risks and uncertainties it was meant to capture.
Our allowance for credit losses as a percentage of total non-PCI loans (excluding PCI loans with carrying values totaling approximately $1.9 billion) was 0.76 percent at both September 30, 2016 and June 30, 2016, as compared to 0.79 percent at September 30, 2015. PCI loans, including all of the loans acquired from CNL during the fourth quarter of 2015, are accounted for on a pool basis and initially recorded net of fair valuation discounts related to credit which may be used to absorb future losses on such loans before any allowance for loan losses is recognized subsequent to acquisition. Due to the adequacy of such discounts, there were no allowance reserves related to PCI loans at September 30, 2016.
Capital Adequacy

A significant measure of the strength of a financial institution is its shareholders’ equity. Our shareholders’ equity totaled approximately $2.3 billion and represented approximately 10 percent of total assets at both September 30, 2016 and December 31, 2015. During the nine months ended September 30, 2016, total shareholders’ equity increased $50.0 million, which was comprised of (i) net income of $118.1 million, (ii) a decrease in our accumulated other comprehensive loss of $11.4 million, (iii) net proceeds of $4.2 million from the re-issuance of treasury and authorized common shares issued under our dividend reinvestment plan totaling a combined 445 thousand shares, and (iv) an increase of $5.8 million attributable to the effect of our stock incentive plan, partially offset by (v) cash dividends declared on common and preferred stock totaling $84.1 million and $5.4 million, respectively. See Note 4 to the consolidated financial statements for additional information regarding changes in our accumulated other comprehensive loss during the three and nine months ended September 30, 2016.
Valley and Valley National Bank are subject to the regulatory capital requirements administered by the Federal Reserve Bank and the OCC. Quantitative measures established by regulation to ensure capital adequacy require Valley and Valley National Bank to maintain minimum amounts and ratios of common equity Tier 1 capital, total and Tier 1 capital to risk-weighted assets, and Tier 1 capital to average assets, as defined in the regulations.

Effective January 1, 2015, Valley implemented the Basel III regulatory capital framework and related Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”). Basel III final rules require a new common equity Tier 1 capital to risk-weighted assets ratio of 4.5 percent, Tier 1 capital to risk-weighted assets of 6.0 percent, ratio of total capital to risk-weighted assets of 8.0 percent, and minimum leverage ratio of 4.0 percent. The new rule changes included the implementation of a new capital conservation buffer that is added to the minimum requirements for capital adequacy purposes. The capital conservation buffer is subject to a three year phase-in period that started on January 1, 2016, at 0.625 percent of risk-weighted assets and increases each subsequent year by 0.625 percent until reaching its final level of 2.5 percent when fully phased-in on January 1, 2019. As of September 30, 2016, and December 31, 2015, Valley and Valley National Bank exceeded all capital adequacy requirements with the capital conservation buffer under the Basel III Capital Rules (see tables below).





81




The following tables present Valley’s and Valley National Bank’s actual capital positions and ratios under Basel III risk-based capital guidelines at September 30, 2016 and December 31, 2015:
 
Actual
 
Minimum Capital
Requirements with Capital Conservation Buffer
 
To Be Well Capitalized
Under Prompt Corrective
Action Provision
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
 
 ($ in thousands)
As of September 30, 2016
 
 
 
 
 
 
 
 
 
 
 
Total Risk-based Capital
 
 
 
 
 
 
 
 
 
 
 
Valley
$
1,950,848

 
11.64
%
 
$
1,445,052

 
8.625
%
 
N/A

 
N/A

Valley National Bank
1,890,118

 
11.32

 
1,440,144

 
8.625

 
$
1,669,732

 
10.00
%
Common Equity Tier 1 Capital
 
 
 
 
 
 
 
 
 
 
 
Valley
1,461,806

 
8.73

 
858,654

 
5.125

 
N/A

 
N/A

Valley National Bank
1,677,204

 
10.04

 
855,738

 
5.125

 
1,085.326

 
6.50

Tier 1 Risk-based Capital
 
 
 
 
 
 
 
 
 
 
 
Valley
1,568,934

 
9.36

 
1,109,967

 
6.625

 
N/A

 
N/A

Valley National Bank
1,677,204

 
10.04

 
1,106,197

 
6.625

 
1,335,785

 
8.00

Tier 1 Leverage Capital
 
 
 
 
 
 
 
 
 
 
 
Valley
1,568,934

 
7.35

 
854,230

 
4.00

 
N/A

 
N/A

Valley National Bank
1,677,204

 
7.87

 
852,343

 
4.00

 
1,065,429

 
5.00


 
Actual
 
Minimum Capital
Requirements
 
To Be Well Capitalized
Under Prompt Corrective
Action Provision
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
 
 ($ in thousands)
As of December 31, 2015
 
 
 
 
 
 
 
 
 
 
 
Total Risk-based Capital
 
 
 
 
 
 
 
 
 
 
 
Valley
$
1,910,304

 
12.02
%
 
$
1,271,171

 
8.00
%
 
N/A

 
N/A

Valley National Bank
1,826,420

 
11.53

 
1,266,942

 
8.00

 
$
1,583,677

 
10.00
%
Common Equity Tier 1 Capital
 
 
 
 
 
 
 
 
 
 
 
Valley
1,431,973

 
9.01

 
715,034

 
4.50

 
N/A

 
N/A

Valley National Bank
1,618,053

 
10.22

 
712,655

 
4.50

 
1,029,390

 
6.50

Tier 1 Risk-based Capital
 
 
 
 
 
 
 
 
 
 
 
Valley
1,543,937

 
9.72

 
953,378

 
6.00

 
N/A

 
N/A

Valley National Bank
1,618,053

 
10.22

 
950,206

 
6.00

 
1,266,942

 
8.00

Tier 1 Leverage Capital
 
 
 
 
 
 
 
 
 
 
 
Valley
1,543,937

 
7.90

 
781,388

 
4.00

 
N/A

 
N/A

Valley National Bank
1,618,053

 
8.29

 
780,831

 
4.00

 
976,039

 
5.00


The Dodd-Frank Act requires federal banking agencies to issue regulations that require banks with total consolidated assets of more than $10.0 billion to conduct and publish company-run annual stress tests to assess the potential impact of different scenarios on the consolidated earnings and capital of each bank and certain related items over a nine-quarter forward-looking planning horizon, taking into account all relevant exposures and activities. On October 9, 2012, the FRB published final rules implementing the stress testing requirements for banks with total consolidated assets of more than $10.0 billion but less than $50.0 billion. These rules set forth the timing and type of stress test activities, as well as rules governing controls, oversight and disclosure.


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In March 2014, the FRB, OCC, and FDIC issued final supervisory guidance for these stress tests. This joint final supervisory guidance discusses supervisory expectations for stress test practices, provides examples of practices that would be consistent with those expectations, and offers additional details about stress test methodologies. It also emphasizes the importance of stress testing as an ongoing risk management practice.

On July 28, 2016, we submitted our latest stress testing results, utilizing data as of December 31, 2015, to the FRB. The full disclosure of the stress testing results, including the results for Valley National Bank, a summary of the supervisory severely adverse scenario and additional information regarding the methodologies used to conduct the stress test may be found on the Shareholder Relations section of our website (www.valleynationalbank.com) under the Dodd-Frank Act Stress Test Reports section.

Tangible book value per common share is computed by dividing shareholders’ equity less preferred stock, goodwill and other intangible assets by common shares outstanding as follows: 
 
September 30,
2016
 
December 31,
2015
 
($ in thousands, except for share data)
Common shares outstanding
254,461,906

 
253,787,561

Shareholders’ equity
$
2,257,073

 
$
2,207,091

Less: Preferred stock
111,590

 
111,590

Less: Goodwill and other intangible assets
733,627

 
735,221

Tangible shareholders’ equity
$
1,411,856

 
$
1,360,280

Tangible book value per common share
$
5.55

 
$
5.36

Book value per common share
$
8.43

 
$
8.26

Management believes the tangible book value per common share ratio provides information useful to management and investors in understanding our underlying operational performance, our business and performance trends and facilitates comparisons with the performance of others in the financial services industry. This non-GAAP financial measure should not be considered in isolation or as a substitute for or superior to financial measures calculated in accordance with U.S. GAAP. This non-GAAP financial measure may also be calculated differently from similar measures disclosed by other companies.
Typically, our primary source of capital growth is through retention of earnings. Our rate of earnings retention is derived by dividing undistributed earnings per common share by earnings (or net income available to common stockholders) per common share. Our retention ratio was 25.0 percent for the nine months ended September 30, 2016 as compared to zero for the year ended December 31, 2015. Our rate of earnings retention increased during the nine months of 2016 as compared to the full year of 2015, which was negatively impacted by $51.1 million in pre-tax debt prepayment penalties recognized during the fourth quarter of 2015, and, to a much lesser extent, merger costs from the acquisition of CNL in December 2015. We expect our future retention rate to improve due to, among other factors, synergies realized from the integration of CNL's back office operations completed in February 2016 and the related CNL staffing reductions effective April 1, 2016, as well as our current branch efficiency and cost reduction plans discussed elsewhere in this MD&A.
Cash dividends declared amounted to $0.33 per common share for both the nine months ended September 30, 2016 and 2015. The Board is committed to examining and weighing relevant facts and considerations, including its commitment to shareholder value, each time it makes a cash dividend decision in this economic environment. The Federal Reserve has cautioned all bank holding companies about distributing dividends which may reduce the level of capital or not allow capital to grow in light of the increased capital levels as required under the Basel III rules. Prior to the date of this filing, Valley has received no objection or adverse guidance from the FRB or the OCC regarding the current level of its quarterly common stock dividend.

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Off-Balance Sheet Arrangements, Contractual Obligations and Other Matters

For a discussion of Valley’s off-balance sheet arrangements and contractual obligations see information included in Valley’s Annual Report on Form 10-K for the year ended December 31, 2015 in the MD&A section -“Off-Balance Sheet Arrangements” and Notes 12 and 13 to the consolidated financial statements included in this report.
Item 3.
Quantitative and Qualitative Disclosures About Market Risk

Market risk refers to potential losses arising from changes in interest rates, foreign exchange rates, equity prices, and commodity prices. Valley’s market risk is composed primarily of interest rate risk. See page 67 for a discussion of interest rate sensitivity.

Item 4.
Controls and Procedures
Valley’s Chief Executive Officer (CEO) and Chief Financial Officer (CFO), with the assistance of other members of Valley’s management, have evaluated the effectiveness of Valley’s disclosure controls and procedures (as defined in Rule 13a-15(e) or Rule 15d-15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on such evaluation, Valley’s CEO and CFO have concluded that Valley’s disclosure controls and procedures are effective as of the end of the period covered by this report.
Valley’s CEO and CFO have also concluded that there have not been any changes in Valley’s internal control over financial reporting during the quarter ended September 30, 2016 that have materially affected, or are reasonably likely to materially affect, Valley’s internal control over financial reporting.
Valley’s management, including the CEO and CFO, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, provides reasonable, not absolute, assurance that the objectives of the control system are met. The design of a control system reflects resource constraints and the benefits of controls must be considered relative to their costs. Because there are inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Valley have been or will be detected.
These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns occur because of simple error or mistake. Controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events. There can be no assurance that any design will succeed in achieving its stated goals under all future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with the policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

84





PART II - OTHER INFORMATION 
Item 1.
Legal Proceedings

In the normal course of business, we may be a party to various outstanding legal proceedings and claims. There have been no material changes in the legal proceedings previously disclosed under Part I, Item 3 of Valley’s Annual Report on Form 10-K for the year ended December 31, 2015.

Item 1A.
Risk Factors

There has been no material change in the risk factors previously disclosed under Part I, Item 1A of Valley’s Annual Report on Form 10-K for the year ended December 31, 2015.

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

During the quarter, we did not sell any equity securities not registered under the Securities Act of 1933, as amended. Purchases of equity securities by the issuer and affiliated purchasers during the three months ended September 30, 2016 were as follows:

ISSUER PURCHASES OF EQUITY SECURITIES 
Period
 
Total  Number of
Shares  Purchased (1)
 
Average
Price Paid
Per Share
 
Total Number of Shares
Purchased as Part of
Publicly Announced
Plans (2)
 
Maximum Number of
Shares that May Yet Be
Purchased Under the Plans (2)
July 1, 2016 to July 30, 2016
 

 
$

 

 
4,112,465

August 1, 2016 to August 31, 2016
 
8,358

 
9.38

 

 
4,112,465

September 1, 2016 to September 30, 2016
 
666

 
9.61

 

 
4,112,465

Total
 
9,024

 
$
9.40

 

 
 
 
(1)
Represents repurchases made in connection with the vesting of employee restricted stock awards.
(2)
On January 17, 2007, Valley publicly announced its intention to repurchase up to 4.7 million outstanding common shares in the open market or in privately negotiated transactions. The repurchase plan has no stated expiration date. No repurchase plans or programs expired or terminated during the three months ended September 30, 2016.


85




Item 6.
Exhibits
 
 
 
 
(3)
Articles of Incorporation and By-laws:
 
(3.1)
Restated Certificate of Incorporation of the Registrant, incorporated herein by reference to Exhibit 3.A of the Registrant's Annual Report on Form 10-K filed on February 29, 2016.
 
(3.2)
Certificate of Designations relating to the 6.25% Fixed-to-Floating Rate Non-Cumulative Perpetual Preferred Stock, Series A, incorporated herein by reference to Exhibit 3.1 of the Registrant’s Form 8-K filed on June 19, 2015.
 
(3.3)
By-laws of the Registrant, as amended, incorporated herein by reference to Exhibit 3.1 to the Registrant's Form 8-K filed on October 28, 2016.
(10)
Material Contracts
 
 
 
 
(10.1)
Amendment to the Employment Agreement between Valley, Valley National Bank and for Rudy Schupp, dated September 23, 2016.+*
 
(10.2)
Severance Letter Agreement, dated as of September 21, 2016, between Valley National Bank, Valley National Bancorp and Ira Robbins, incorporated herein by reference to Exhibit 10.1 of the Registrant's Form 8-K filed on September 27, 2016.+
 
(10.3)
Amended and Restated Change in Control Agreement among Valley National Bank, Valley National Bancorp and Ira Robbins, dated as of September 21, 2016, incorporated herein by reference to Exhibit 10.2 of the Registrant's Form 8-K filed on September 27, 2016.+
 
(10.4)
Severance Letter Agreement, dated as of September 21, 2016, between Valley National Bank, Valley National Bancorp and Thomas A. Iadanza, incorporated herein by reference to Exhibit 10.3 of the Registrant's Form 8-K filed on September 27, 2016.+
 
(10.5)
Amended and Restated Change in Control Agreement among Valley National Bank, Valley National Bancorp and Thomas A. Iadanza, dated as of September 21, 2016, incorporated herein by reference to Exhibit 10.4 of the Registrant's Form 8-K filed on September 27, 2016.+
(31.1)
 
Certification pursuant to Securities Exchange Rule 13a-14(a)/15d-14(a) signed by Gerald H. Lipkin, Chairman of the Board, President and Chief Executive Officer of the Company.*
 
 
 
(31.2)
 
Certification pursuant to Securities Exchange Rule 13a-14(a)/15d-14(a) signed by Alan D. Eskow, Senior Executive Vice President and Chief Financial Officer of the Company.*
 
 
 
(32)
 
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, signed by Gerald H. Lipkin, Chairman of the Board, President and Chief Executive Officer of the Company, and Alan D. Eskow, Senior Executive Vice President and Chief Financial Officer of the Company.*
 
 
 
(101)
 
Interactive Data File *
 
*
Filed herewith.
+
Management contract and compensatory plan or agreement.


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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
 
 
 
 
 
 
 
 
VALLEY NATIONAL BANCORP
 
 
 
 
(Registrant)
 
 
 
Date:
 
 
 
/s/ Gerald H. Lipkin
November 8, 2016
 
 
 
Gerald H. Lipkin
 
 
 
 
Chairman of the Board, President
 
 
 
 
and Chief Executive Officer
 
 
 
Date:
 
 
 
/s/ Alan D. Eskow
November 8, 2016
 
 
 
Alan D. Eskow
 
 
 
 
Senior Executive Vice President and
 
 
 
 
Chief Financial Officer

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