10-K 1 a12-30324_110k.htm 10-K

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-K

 

(Mark One)

 

[X]     Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the fiscal year ended December 31, 2012

 

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

 

Commission File Number  001-11967

 

ASTORIA FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

 

Delaware          

 

11-3170868

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification Number)

 

One Astoria Federal Plaza, Lake Success, New York

 

11042

 

(516) 327-3000

(Address of principal executive offices)

 

(Zip code)

 

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Title of each class

 

Name of each exchange on which registered

 

Common Stock, par value $.01 per share

 

New York Stock Exchange

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

YES   X     NO       

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.

YES          NO   X  

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.        

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act).

Large accelerated filer   X    Accelerated filer          Non-accelerated filer          Smaller reporting company        

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES          NO   X  

 

The aggregate market value of Common Stock held by non-affiliates of the registrant as of June 30, 2012, based on the closing price for a share of the registrant’s Common Stock on that date as reported by the New York Stock Exchange, was $935.0 million.

 

The number of shares of the registrant’s Common Stock outstanding as of February 15, 2013 was 98,935,700 shares.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the definitive Proxy Statement to be utilized in connection with the Annual Meeting of Stockholders to be held on May 15, 2013 and any adjournment thereof, which will be filed with the Securities and Exchange Commission within 120 days from December 31, 2012, are incorporated by reference into Part  III.

 



Table of Contents

 

ASTORIA FINANCIAL CORPORATION

2012 ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS

 

 

 

 

 

 

Page

 

 

 

 

Part I

 

 

 

 

 

 

 

Item 1.

Business

 

3

Item 1A.

Risk Factors

 

39

Item 1B.

Unresolved Staff Comments

 

48

Item 2.

Properties

 

48

Item 3.

Legal Proceedings

 

49

Item 4.

Mine Safety Disclosures

 

51

 

 

 

 

Part II

 

 

 

 

 

 

 

Item 5.

Market for Astoria Financial Corporation’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

51

Item 6.

Selected Financial Data

 

53

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

55

Item 7A.

Quantitative and Qualitative Disclosures about Market Risk

 

98

Item 8.

Financial Statements and Supplementary Data

 

101

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

101

Item 9A.

Controls and Procedures

 

101

Item 9B.

Other Information

 

102

 

 

 

 

Part III

 

 

 

 

 

 

 

Item 10.

Directors, Executive Officers and Corporate Governance

 

102

Item 11.

Executive Compensation

 

103

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

103

Item 13.

Certain Relationships and Related Transactions, and Director Independence

 

104

Item 14.

Principal Accountant Fees and Services

 

104

 

 

 

 

Part IV

 

 

 

 

 

 

 

Item 15.

Exhibits and Financial Statement Schedules

 

105

 

 

 

 

SIGNATURES

 

 

106

 

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PRIVATE SECURITIES LITIGATION REFORM ACT SAFE HARBOR STATEMENT

 

This Annual Report on Form 10-K contains a number of forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act.  These statements may be identified by the use of the words “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “outlook,” “plan,” “potential,” “predict,” “project,” “should,” “will,” “would” and similar terms and phrases, including references to assumptions.

 

Forward-looking statements are based on various assumptions and analyses made by us in light of our management’s experience and perception of historical trends, current conditions and expected future developments, as well as other factors we believe are appropriate under the circumstances.  These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors (many of which are beyond our control) that could cause actual results to differ materially from future results expressed or implied by such forward-looking statements.  These factors include, without limitation, the following:

 

·

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

·

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

·

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

·

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

·

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

·

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

·

legislative or regulatory changes, including the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, or the Reform Act, and any actions regarding foreclosures, may adversely affect our business;

·

enhanced supervision and examination by the Office of the Comptroller of the Currency, or OCC, the Board of Governors of the Federal Reserve System, or the FRB, and the Consumer Financial Protection Bureau, or CFPB;

·

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

·

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

·

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

·

litigation or other matters before regulatory agencies, whether currently existing or commencing in the future, may be determined adverse to us or may delay the occurrence or non-occurrence of events longer than we anticipate.

 

We have no obligation to update any forward-looking statements to reflect events or circumstances after the date of this document.

 

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PART I

 

As used in this Form 10-K, “we,” “us” and “our” refer to Astoria Financial Corporation and its consolidated subsidiaries, principally Astoria Federal Savings and Loan Association.

 

ITEM 1.  BUSINESS

 

General

 

We are a Delaware corporation organized in 1993 as the unitary savings and loan holding company of Astoria Federal Savings and Loan Association and its consolidated subsidiaries, or Astoria Federal.  We are headquartered in Lake Success, New York and our principal business is the operation of our wholly-owned subsidiary, Astoria Federal.  Astoria Federal’s primary business is attracting retail deposits from the general public and businesses and investing those deposits, together with funds generated from operations, principal repayments on loans and securities and borrowings, primarily in one-to-four family, or residential, mortgage loans, multi-family mortgage loans, commercial real estate mortgage loans and mortgage-backed securities.  To a lesser degree, Astoria Federal also invests in consumer and other loans, U.S. government, government agency and government-sponsored enterprise, or GSE, securities and other investments permitted by federal banking laws and regulations.

 

Although we remain committed to offering traditional retail deposit products and residential mortgage loans, we have been developing strategies to grow other loan categories to diversify earning assets and to increase low cost savings, money market and NOW and demand deposits, or core deposits. These strategies include continued reliance on our multi-family and commercial real estate mortgage lending operations and, over time, significantly expanding our business banking operations. Our business banking initiative includes focusing on small and mid-sized businesses, with an emphasis on attracting clients from larger competitors.  We are also considering expanding our branch network into other locations on Long Island and opening branches in Manhattan.

 

Our results of operations are dependent primarily on our net interest income, which is the difference between the interest earned on our assets, primarily our loan and securities portfolios, and the interest paid on our deposits and borrowings.  Our net income is also affected by our provision for loan losses, non-interest income, general and administrative expense and income tax expense.  Non-interest income includes customer service fees; other loan fees; net gain on sales of securities; mortgage banking income, net; income from bank owned life insurance, or BOLI; and other non-interest income.  General and administrative expense consists of compensation and benefits expense; occupancy, equipment and systems expense; Federal Deposit Insurance Corporation, or FDIC, insurance premium expense; advertising expense; and other operating expenses.  Our earnings are also significantly affected by general economic and competitive conditions, particularly changes in market interest rates and U.S. Treasury yield curves, government policies and actions of regulatory authorities.

 

In addition to Astoria Federal, Astoria Financial Corporation has two other subsidiaries, AF Insurance Agency, Inc. and Astoria Capital Trust I.  AF Insurance Agency, Inc. is a licensed life insurance agency.  Through contractual agreements with various third parties, AF Insurance Agency, Inc. makes insurance products available primarily to the customers of Astoria Federal.  AF Insurance Agency, Inc. is a wholly-owned subsidiary which is consolidated with Astoria Financial Corporation for financial reporting purposes.  Our other subsidiary, Astoria Capital Trust I, is not consolidated with Astoria Financial Corporation for financial reporting purposes.  Astoria Capital Trust I was formed in 1999 for the purpose of issuing $125.0 million aggregate liquidation amount of 9.75% Capital Securities due November 1, 2029, or Capital Securities, and $3.9 million of common securities (which are the only voting securities of Astoria Capital Trust I), which are 100% owned by Astoria Financial Corporation, and using the proceeds to acquire Junior Subordinated Debentures issued by Astoria Financial Corporation.  Astoria Financial Corporation has fully and unconditionally guaranteed the Capital Securities along with all obligations of Astoria Capital Trust I under the trust agreement relating to the Capital Securities.

 

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Available Information

 

Our internet website address is www.astoriafederal.com.  Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports can be obtained free of charge from our investor relations website at http://ir.astoriafederal.com.  The above reports are available on our website immediately after they are electronically filed with or furnished to the Securities and Exchange Commission, or SEC.  Such reports are also available on the SEC’s website at www.sec.gov/edgar/searchedgar/webusers.htm.

 

Lending Activities

 

General

 

Our loan portfolio is comprised primarily of mortgage loans.  At December 31, 2012, 74% of our total loan portfolio was secured by residential properties and 24% was secured by multi-family properties and commercial real estate.  The remainder of the loan portfolio consists of a variety of consumer and other loans, including commercial and industrial loans originated in 2012 through our business banking initiatives.  At December 31, 2012, our net loan portfolio totaled $13.08 billion, or 79% of total assets.

 

We originate residential mortgage loans either directly through our banking and loan production offices in New York or indirectly through brokers and our third party loan origination program.  We originate multi-family and commercial real estate mortgage loans either through direct solicitation by our banking officers in New York or indirectly through commercial mortgage brokers.  Mortgage loan originations and purchases for portfolio totaled $4.12 billion for the year ended December 31, 2012 and $3.68 billion for the year ended December 31, 2011.  At December 31, 2012, $5.61 billion, or 43%, of our total mortgage loan portfolio was secured by properties located in New York and $7.28 billion, or 57%, of our total mortgage loan portfolio was secured by properties located in 34 other states and the District of Columbia.  Excluding New York, we have a concentration of greater than 5% of our total mortgage loan portfolio in four states:  9% in Connecticut, 8% in Illinois, 7% in New Jersey and 6% in Massachusetts.

 

We also originate mortgage loans for sale.  Generally, we originate fifteen and thirty year fixed rate residential mortgage loans that conform to GSE guidelines (conforming loans) for sale to various GSEs or other investors on a servicing released or retained basis.  The sale of such loans is generally arranged through a master commitment on a mandatory delivery or best efforts basis.  Originations of residential mortgage loans held-for-sale totaled $380.4 million in 2012 and $196.1 million in 2011, all of which were originated through our retail loan origination program.  Loans serviced for others totaled $1.44 billion at December 31, 2012.

 

We outsource the servicing of our residential mortgage loan portfolio, including our portfolio of mortgage loans serviced for other investors, to an unrelated third party under a sub-servicing agreement.

 

Residential Mortgage Lending

 

Our primary residential lending emphasis is on the origination and purchase of first mortgage loans secured by properties that serve as the primary residence of the owner.  To a much lesser degree, we have originated loans secured by non-owner occupied residential properties acquired as an investment by the borrower, although we discontinued originating such loans in January 2008.  We also originate a limited number of second home mortgage loans.  At December 31, 2012, residential mortgage loans totaled $9.71 billion, or 74% of our total loan portfolio, of which $7.91 billion, or 81%, were hybrid adjustable rate mortgage, or ARM, loans and $1.80 billion, or 19%, were fixed rate loans, of which 83% were fifteen year fixed rate mortgage loans.

 

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Residential mortgage loan originations and purchases for portfolio totaled $2.51 billion during 2012 and $3.47 billion during 2011.  Our residential retail loan origination program accounted for $1.04 billion of portfolio originations during 2012 and $1.33 billion during 2011.  We also have a residential broker network covering four states, primarily along the East Coast.  Our residential broker loan origination program consists of relationships with mortgage brokers and accounted for $540.0 million of portfolio originations during 2012 and $1.03 billion during 2011.  Our third party loan origination program includes relationships with other financial institutions and mortgage bankers covering nine states and the District of Columbia and accounted for residential portfolio purchases of $932.1 million during 2012 and $1.11 billion during 2011.  We purchase individual mortgage loans through our third party loan origination program which are subject to the same underwriting standards as our retail and broker originations.  Our various loan origination programs provide efficient and diverse delivery channels for deployment of our cash flows. Additionally, our broker and third party loan origination programs provide geographic diversification, reducing our exposure to concentrations of credit risk.

 

We offer amortizing hybrid ARM loans with terms up to forty years which initially have a fixed rate for three, five, seven or ten years and convert into one year ARM loans at the end of the initial fixed rate period.  Our amortizing hybrid ARM loans require the borrower to make principal and interest payments during the entire loan term.  Our portfolio of residential amortizing hybrid ARM loans totaled $4.91 billion, or 50% of our total residential mortgage loan portfolio, at December 31, 2012.  Prior to the 2010 fourth quarter, we offered interest-only hybrid ARM loans with terms of up to forty years, which have an initial fixed rate for five or seven years and convert into one year interest-only ARM loans at the end of the initial fixed rate period.  Our interest-only hybrid ARM loans require the borrower to pay interest only during the first ten years of the loan term.  After the tenth anniversary of the loan, principal and interest payments are required to amortize the loan over the remaining loan term.  Our portfolio of residential interest-only hybrid ARM loans totaled $3.00 billion, or 31% of our total residential mortgage loan portfolio, at December 31, 2012.  We do not originate one year ARM loans.  The ARM loans in our portfolio which currently reprice annually represent hybrid ARM loans (interest-only and amortizing) which have passed their initial fixed rate period.  We do not originate negative amortization loans, payment option loans or other loans with short-term interest-only periods.

 

Within our residential mortgage loan portfolio we have reduced documentation loan products, substantially all of which are hybrid ARM loans (interest-only and amortizing).  Reduced documentation loans are comprised primarily of SIFA (stated income, full asset) loans.  To a lesser extent, our portfolio of reduced documentation loans also includes SISA (stated income, stated asset) loans.  During the 2007 fourth quarter, we stopped offering reduced documentation loans.  Reduced documentation loans in our residential mortgage loan portfolio totaled $1.40 billion, or 14% of our total residential mortgage loan portfolio at December 31, 2012 and included $222.7 million of SISA loans.

 

Generally, ARM loans pose credit risks somewhat greater than the risks posed by fixed rate loans primarily because, as interest rates rise, the underlying payments of the borrower increase when the loan is beyond its initial fixed rate period, particularly if the interest rate during the initial fixed rate period was at a discounted rate, increasing the potential for default.  Interest-only hybrid ARM loans have an additional potential risk element when the loan payments adjust after the tenth anniversary of the loan to include principal payments, resulting in a further increase in the underlying payments.  Since our interest-only hybrid ARM loans have a relatively long period to the principal payment adjustment, we believe this alleviates some of the additional credit risk due to the longer period for the borrower’s income to adjust to anticipated higher future payments.  Additionally, we consider these risk factors in our underwriting of such loans and we do not offer loans with initial rates at deep discounts to the fully indexed rate.

 

Our reduced documentation loans have additional elements of risk since not all of the information provided by the borrower was verified.  SIFA and SISA loans required a prospective borrower to complete a standard mortgage loan application.  SIFA loans required the verification of a potential borrower’s asset information on the loan application, but not the income information provided.  Our reduced documentation loan products required the receipt of an appraisal of the real estate used as

 

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collateral for the mortgage loan and a credit report on the prospective borrower.  The loans were priced according to our internal risk assessment of the loan giving consideration to the loan-to-value ratio, the potential borrower’s credit scores and various other credit criteria.

 

We continue to manage the greater risk posed by our hybrid ARM loans through the application of sound underwriting policies and risk management procedures.  Our risk management procedures and underwriting policies include a variety of factors and analyses.  These include, but are not limited to, the determination of the markets in which we lend; the products we offer and the pricing of those products; the evaluation of potential borrowers and the characteristics of the property supporting the loan; the monitoring and analyses of the performance of our portfolio, in the aggregate and by segment, at various points in time and trends over time; and our collection efforts and marketing of delinquent and non-performing loans and foreclosed properties.  We monitor our market areas and the performance and pricing of our various loan product offerings to determine the prudence of continuing to offer such loans and to determine what changes, if any, should be made to our product offerings and related underwriting.

 

The objective of our residential mortgage loan underwriting is to determine whether timely repayment of the debt can be expected and whether the property that secures the loan provides sufficient value to recover our investment in the event of a loan default.  We review each loan individually utilizing such documents as the loan application, credit report, verification forms, tax returns and any other documents relevant and necessary to qualify the potential borrower for the loan.  We analyze the credit and income profiles of potential borrowers and evaluate various aspects of the potential borrower’s credit history including credit scores. We do not base our underwriting decisions solely on credit scores.  We consider the potential borrower’s income, liquidity, history of debt management and net worth.  We perform income and debt ratio analyses as part of the credit underwriting process.  Additionally, we obtain independent appraisals to establish collateral values to determine loan-to-value ratios.  We use the same underwriting standards for our retail, broker and third party mortgage loan originations.

 

Our current policy on owner-occupied, residential mortgage loans in New York, Connecticut and Massachusetts is to lend up to 80% of the appraised value of the property securing the loan for loan amounts up to $1.0 million and up to 75% for loan amounts over $1.0 million and not more than $1.5 million.  For select counties within New York, Connecticut and Massachusetts, our current policy is to lend up to 65% of the appraised value of the property securing the loan for loan amounts up to $2.0 million and up to 60% for loan amounts over $2.0 million and not more than $2.5 million.  In all other approved states, our current policy on owner-occupied, residential mortgage loans is to lend up to 80% of the appraised value of the property securing the loan for loan amounts up to $500,000, up to 75% for loan amounts over $500,000 and not more than $1.0 million and up to 70% for loan amounts over $1.0 million and not more than $1.5 million.  The exceptions to this policy are loans originated under our affordable housing program, which is consistent with our program for compliance with the Community Reinvestment Act, or CRA, and loans originated for sale.  See “Regulation and Supervision - Community Reinvestment” for further discussion of the CRA.  Prior to the 2007 fourth quarter, our policy generally was to lend up to 80% of the appraised value of the property securing the loan and, for mortgage loans which had a loan-to-value ratio of greater than 80%, we required the mortgagor to obtain private mortgage insurance.  In addition, we offered a variety of proprietary products which allowed the borrower to obtain financing of up to 90% loan-to-value without private mortgage insurance, through a combination of a first mortgage loan with an 80% loan-to-value and a home equity line of credit for the additional 10%.  During the 2007 fourth quarter, we revised our policy on originations of owner-occupied, residential mortgage loans to discontinue lending amounts in excess of 80% of the appraised value of the property securing the loan and during the 2008 third quarter we revised our policy to discontinue lending amounts in excess of 75% of the appraised value of the property.  During 2010, we revised our policy to the current limits, with certain exceptions, as noted above.  We periodically review our loan product offerings and related underwriting and make changes as necessary in response to market conditions.

 

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All of our hybrid ARM loans have annual and lifetime interest rate ceilings and floors.  Such loans have been offered with an initial interest rate which is less than the fully indexed rate for the loan at the time of origination, referred to as a discounted rate.  We determine the initial interest rate in accordance with market and competitive factors giving consideration to the spread over our funding sources in conjunction with our overall interest rate risk, or IRR, management strategies.  In 2006, to recognize the credit risks associated with interest-only hybrid ARM loans, we began underwriting such loans based on a fully amortizing loan (in effect underwriting interest-only hybrid ARM loans as if they were amortizing hybrid ARM loans).  Prior to 2007, we would underwrite our interest-only hybrid ARM loans using the initial note rate, which may have been a discounted rate.  In 2007, we began underwriting our interest-only hybrid ARM loans at the higher of the fully indexed rate or the initial note rate.  In 2009, we began underwriting our interest-only and amortizing hybrid ARM loans at the higher of the fully indexed rate, the initial note rate or 6.00%.  During the 2010 second quarter, we reduced the underwriting interest rate floor from 6.00% to 5.00% to reflect the current interest rate environment.  We monitor credit risk on interest-only hybrid ARM loans that were underwritten at the initial note rate, which may have been a discounted rate, in the same manner as we monitor credit risk on all interest-only hybrid ARM loans.  Our portfolio of residential interest-only hybrid ARM loans which were underwritten at the initial note rate, which may have been a discounted rate, totaled $2.18 billion, or 22% of our total residential mortgage loan portfolio, at December 31, 2012.

 

Multi-Family and Commercial Real Estate Lending

 

Our primary multi-family and commercial real estate lending emphasis is on the origination of mortgage loans on rent controlled and rent stabilized apartment buildings located in the greater New York metropolitan area, including the five boroughs of New York City, Nassau, Suffolk and Westchester counties in New York, and parts of New Jersey and Connecticut.  At December 31, 2012, multi-family mortgage loans totaled $2.41 billion, or 18% of our total loan portfolio, and commercial real estate loans totaled $773.9 million, or 6% of our total loan portfolio.  The multi-family and commercial real estate loans in our portfolio consist of both fixed rate and adjustable rate loans which were originated at prevailing market rates.  Multi-family and commercial real estate loans we currently offer are generally fixed rate, five to fifteen year term balloon loans amortized over fifteen to thirty years.  To a limited extent, we also offer interest-only mortgage loans secured by multi-family cooperative properties to qualified borrowers, underwritten on an amortizing basis.  Interest-only loans represented less than 2% of our total multi-family and commercial real estate loan portfolio at December 31, 2012 and generally require interest-only payments for the term of the loan, which generally ranges from five to ten years, and typically provide for a balloon payment at maturity.  Included in our multi-family and commercial real estate loan portfolios are loans secured by multi-family cooperative properties and mixed use loans secured by properties which are intended for both residential and commercial use. Mixed use loans are classified as multi-family or commercial real estate based on the respective percentage of income from residential and commercial uses.

 

Our policy generally has been to originate multi-family and commercial real estate mortgage loans in the New York metropolitan area, which includes New York, New Jersey and Connecticut, although prior to 2008 we originated loans in various other states including Florida and Pennsylvania.  During 2009, due primarily to conditions in the real estate market and economic environment at that time, we suspended originations of multi-family and commercial real estate loans.  During the 2011 third quarter, we resumed originations of multi-family and commercial real estate loans in select locations within the New York metropolitan area.  Originations of multi-family and commercial real estate loans totaled $1.61 billion during the year ended December 31, 2012 and $204.0 million during the year ended December 31, 2011.

 

In originating multi-family and commercial real estate loans, we primarily consider the ability of the net operating income generated by the real estate to support the debt service, the financial resources, income level and managerial expertise of the borrower, the marketability of the property and our lending experience with the borrower.  Our current policy for multi-family loans is to require a minimum debt service coverage ratio of 1.20 times and to finance up to 80% of the lesser of the purchase price or

 

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appraised value of the property securing the loan on purchases or 80% of the appraised value on refinances.  For commercial real estate loans, our current policy is to require a minimum debt service coverage ratio of 1.25 times and to finance up to 75% of the lesser of the purchase price or appraised value of the property securing the loan on purchases or 75% of the appraised value on refinances.  In addition, we perform analyses to determine the ability of the net operating income generated by the real estate to meet the debt service obligation under various stress scenarios.

 

The majority of the multi-family loans in our portfolio are secured by five to fifty-unit apartment buildings and mixed use properties (containing both residential and commercial uses).  Commercial real estate loans are typically secured by retail, office and mixed use properties (more commercial than residential uses).  The average balance of multi-family and commercial real estate loans originated during 2012 was $3.1 million.  At December 31, 2012, our single largest multi-family credit had an outstanding balance of $28.0 million, was current and was secured by a 123-unit apartment building with 2 retail units in Manhattan.  At December 31, 2012, the average balance of loans in our multi-family portfolio was approximately $1.3 million.  At December 31, 2012, our single largest commercial real estate credit had an outstanding principal balance of $14.4 million, was current and was secured by a building with 70% commercial and 30% residential tenancy in Manhattan.  At December 31, 2012, the average balance of loans in our commercial real estate portfolio was approximately $1.2 million.

 

Multi-family and commercial real estate loans generally involve a greater degree of credit risk than residential loans because they typically have larger balances and are more affected by adverse conditions in the economy.  As such, these loans require more ongoing evaluation and monitoring.  Because payments on loans secured by multi-family properties and commercial real estate often depend upon the successful operation and management of the properties and the businesses which operate from within them, repayment of such loans may be affected by factors outside the borrower’s control, such as adverse conditions in the real estate market or the economy or changes in government regulation.

 

Consumer and Other Loans

 

At December 31, 2012, $264.1 million, or 2.0%, of our total loan portfolio consisted of consumer and other loans which were primarily home equity lines of credit.  Included in consumer and other loans were $22.0 million of commercial and industrial loans at December 31, 2012, of which $14.4 million, or 65.7%, represent commercial and industrial loans originated in 2012.

 

Home equity lines of credit are adjustable rate loans which are indexed to the prime rate and generally reset monthly.  Such lines of credit were underwritten based on our evaluation of the borrower’s ability to repay the debt.  During the 2010 first quarter, we discontinued originating home equity lines of credit.  Prior to the 2007 fourth quarter, these lines of credit were generally limited to aggregate outstanding indebtedness secured by up to 90% of the appraised value of the property.  During the 2007 fourth quarter, we revised our policy on originations of home equity lines of credit to limit aggregate outstanding indebtedness to 75% of the appraised value of the property and only for loans where we hold the first lien mortgage on the property.  During the 2008 third quarter, we revised our policy to limit aggregate outstanding indebtedness to 60% of the appraised value of the property and only for properties located in New York.

 

We also offer overdraft protection, lines of credit, commercial loans and passbook loans.  Consumer and other loans, with the exception of home equity and commercial lines of credit, are offered primarily on a fixed rate, short-term basis.  The underwriting standards we employ for consumer and other loans include a determination of the borrower’s payment history on other debts and an assessment of the borrower’s ability to make payments on the proposed loan and other indebtedness.  In addition to the creditworthiness of the borrower, the underwriting process also includes a review of the value of the collateral, if any, in relation to the proposed loan amount.  Our consumer and other loans tend to have higher interest rates, shorter maturities and are considered to entail a greater risk of default than residential mortgage loans.

 

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As part of our strategy to diversify our earning assets, we are expanding our business banking operations. Business banking loans are comprised of commercial and industrial loans, which include working capital lines of credit, inventory and accounts receivable lines, equipment loans and other commercial loans. We focus on making commercial loans to small and medium-sized businesses in a wide variety of industries.  These loans are underwritten based upon the cash flow and earnings of the borrower and the value of the collateral securing such loans, if any.

 

Loan Approval Procedures and Authority

 

For individual loans with balances of $5.0 million or less or when the overall lending relationship is $40.0 million or less, loan approval authority has been delegated by the Board of Directors to various members of our underwriting and management staff.  For individual loan amounts or overall lending relationships in excess of these amounts, loan approval authority has been delegated by the Board of Directors to members of our Executive Loan Committee, which consists of senior executive management.

 

For mortgage loans secured by residential properties, upon receipt of a completed application from a prospective borrower, we generally order a credit report, verify income and other information and, if necessary, obtain additional financial or credit related information.  For mortgage loans secured by multi-family properties and commercial real estate, we obtain financial information concerning the operation of the property as well as credit information on the principal and borrower entity.  Personal guarantees are generally not obtained with respect to multi-family and commercial real estate loans.  An appraisal of the real estate used as collateral for mortgage loans is also obtained as part of the underwriting process.  All appraisals are performed by licensed or certified appraisers, the majority of which are licensed independent third party appraisers.  We have an internal appraisal review process to monitor third party appraisals.  The Board of Directors annually reviews and approves our appraisal policy.

 

Loan Portfolio Composition

 

The following table sets forth the composition of our loan portfolio in dollar amounts and percentages of the portfolio at the dates indicated.

 

 

 

At December 31,

 

 

 

2012

 

2011

 

2010

 

2009

 

2008

 

 

(Dollars in Thousands)

 

  Amount

 

Percent
of
Total

 

  Amount

 

Percent
of
Total

 

  Amount

 

Percent
of
Total

 

  Amount

 

Percent
of
Total

 

  Amount

 

Percent
of
Total

 

Mortgage loans (gross):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential

 

$

9,711,226

 

73.82

%

 

$

10,561,539

 

80.02

%

 

$

10,855,061

 

76.77

%

 

$

11,895,362

 

75.88

%

 

$

12,349,617

 

74.42

%

 

Multi-family

 

2,406,678

 

18.29

 

 

1,693,871

 

12.84

 

 

2,203,014

 

15.58

 

 

2,582,657

 

16.48

 

 

2,968,562

 

17.89

 

 

Commercial real estate

 

773,916

 

5.88

 

 

659,706

 

5.00

 

 

771,654

 

5.46

 

 

866,804

 

5.53

 

 

941,057

 

5.67

 

 

Total mortgage loans

 

12,891,820

 

97.99

 

 

12,915,116

 

97.86

 

 

13,829,729

 

97.81

 

 

15,344,823

 

97.89

 

 

16,259,236

 

97.98

 

 

Consumer and other loans (gross):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Home equity

 

231,920

 

1.77

 

 

259,036

 

1.96

 

 

282,453

 

2.00

 

 

302,410

 

1.93

 

 

307,831

 

1.85

 

 

Other

 

32,174

 

0.24

 

 

23,408

 

0.18

 

 

26,887

 

0.19

 

 

27,608

 

0.18

 

 

27,547

 

0.17

 

 

Total consumer and other loans

 

264,094

 

2.01

 

 

282,444

 

2.14

 

 

309,340

 

2.19

 

 

330,018

 

2.11

 

 

335,378

 

2.02

 

 

Total loans (gross)

 

13,155,914

 

100.00

%

 

13,197,560

 

100.00

%

 

14,139,069

 

100.00

%

 

15,674,841

 

100.00

%

 

16,594,614

 

100.00

%

 

Net unamortized premiums and deferred loan origination costs

 

68,058

 

 

 

 

77,044

 

 

 

 

83,978

 

 

 

 

105,881

 

 

 

 

117,830

 

 

 

 

Loans receivable

 

13,223,972

 

 

 

 

13,274,604

 

 

 

 

14,223,047

 

 

 

 

15,780,722

 

 

 

 

16,712,444

 

 

 

 

Allowance for loan losses

 

(145,501

)

 

 

 

(157,185

)

 

 

 

(201,499

)

 

 

 

(194,049

)

 

 

 

(119,029

)

 

 

 

Loans receivable, net

 

$

13,078,471

 

 

 

 

$

13,117,419

 

 

 

 

$

14,021,548

 

 

 

 

$

15,586,673

 

 

 

 

$

16,593,415

 

 

 

 

 

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Loan Maturity, Repricing and Activity

 

The following table shows the contractual maturities of our loans receivable at December 31, 2012 and does not reflect the effect of prepayments or scheduled principal amortization.

 

 

 

At December 31, 2012

 

(In Thousands)

 

  Residential

 

Multi-
Family

 

Commercial
Real Estate

 

Consumer
and
Other

 

Total

 

Amount due:

 

 

 

 

 

 

 

 

 

 

 

Within one year

 

$

4,880

 

$

24,492

 

$

42,295

 

$

22,032

 

$

93,699

 

After one year:

 

 

 

 

 

 

 

 

 

 

 

Over one to three years

 

22,490

 

189,635

 

139,992

 

3,740

 

355,857

 

Over three to five years

 

25,345

 

831,940

 

248,698

 

6,034

 

1,112,017

 

Over five to ten years

 

150,705

 

1,062,919

 

265,619

 

735

 

1,479,978

 

Over ten to twenty years

 

1,865,687

 

248,712

 

65,593

 

37,187

 

2,217,179

 

Over twenty years

 

7,642,119

 

48,980

 

11,719

 

194,366

 

7,897,184

 

Total due after one year

 

9,706,346

 

2,382,186

 

731,621

 

242,062

 

13,062,215

 

Total amount due

 

$

9,711,226

 

$

2,406,678

 

$

773,916

 

$

264,094

 

$

13,155,914

 

Net unamortized premiums and deferred loan costs

 

 

 

 

 

 

 

 

 

68,058

 

Allowance for loan losses

 

 

 

 

 

 

 

 

 

(145,501

)

Loans receivable, net

 

 

 

 

 

 

 

 

 

$

13,078,471

 

 

The following table sets forth at December 31, 2012, the dollar amount of our loans receivable contractually maturing after December 31, 2013, and whether such loans have fixed interest rates or adjustable interest rates.  Our interest-only and amortizing hybrid ARM loans are classified as adjustable rate loans.

 

 

 

Maturing After December 31, 2013

 

(In Thousands)  

 

Fixed

 

Adjustable

 

Total

 

Mortgage loans:

 

 

 

 

 

 

 

Residential

 

$

1,795,299

 

$

7,911,047

 

$

9,706,346

 

Multi-family

 

1,732,034

 

650,152

 

2,382,186

 

Commercial real estate

 

317,904

 

413,717

 

731,621

 

Consumer and other loans

 

10,261

 

231,801

 

242,062

 

Total

 

$

3,855,498

 

$

9,206,717

 

$

13,062,215

 

 

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The following table sets forth our loan originations, purchases, sales and principal repayments for the periods indicated, including loans held-for-sale.

 

 

 

For the Year Ended December 31,

 

(In Thousands)  

 

2012

 

2011

 

2010

 

Mortgage loans (gross) (1):

 

 

 

 

 

 

 

Balance at beginning of year

 

$

12,947,588

 

$

13,874,821

 

$

15,379,809

 

Originations:

 

 

 

 

 

 

 

Residential

 

1,958,318

 

2,563,247

 

2,738,933

 

Multi-family

 

1,329,880

 

198,875

 

-

 

Commercial real estate

 

280,879

 

5,100

 

-

 

Total originations

 

3,569,077

 

2,767,222

 

2,738,933

 

Purchases (2)

 

932,099

 

1,106,805

 

438,578

 

Principal repayments

 

(4,044,484

)

(4,404,011

)

(4,143,607

)

Sales

 

(342,783

)

(243,989

)

(335,932

)

Advances on construction loans in excess of originations

 

-

 

1,719

 

2,303

 

Transfer of loans to real estate owned

 

(43,249

)

(75,193

)

(100,147

)

Net loans charged off

 

(50,062

)

(79,786

)

(105,116

)

Balance at end of year

 

$

12,968,186

 

$

12,947,588

 

$

13,874,821

 

Consumer and other loans (gross):

 

 

 

 

 

 

 

Balance at beginning of year

 

$

282,444

 

$

309,340

 

$

330,431

 

Originations and advances

 

75,225

 

66,925

 

80,954

 

Principal repayments

 

(91,553

)

(92,293

)

(99,222

)

Sales

 

-

 

-

 

(389

)

Net loans charged off

 

(2,022

)

(1,528

)

(2,434

)

Balance at end of year

 

$

264,094

 

$

282,444

 

$

309,340

 

 

(1)

Includes loans classified as held-for-sale totaling $76.4 million at December 31, 2012, $32.5 million at December 31, 2011 and $45.1 million at December 31, 2010, exclusive of valuation allowances totaling $64,000 at December 31, 2012, $63,000 at December 31, 2011 and $169,000 at December 31, 2010.

(2)

Purchases of mortgage loans represent third party loan originations and are secured by residential properties.

 

Asset Quality

 

General

 

One of our key operating objectives has been and continues to be to maintain a high level of asset quality.  We continue to employ sound underwriting standards for new loan originations.  Through a variety of strategies, including, but not limited to, collection efforts and the marketing of delinquent and non-performing loans and foreclosed properties, we have been proactive in addressing problem and non-performing assets which, in turn, has helped to maintain the strength of our financial condition.

 

The underlying credit quality of our loan portfolio is dependent primarily on each borrower’s ability to continue to make required loan payments and, in the event a borrower is unable to continue to do so, the value of the collateral securing the loan, if any.  A borrower’s ability to pay typically is dependent, in the case of residential mortgage loans and consumer loans, primarily on employment and other sources of income, and in the case of multi-family and commercial real estate mortgage loans, on the cash flow generated by the property, which in turn is impacted by general economic conditions.  Other factors, such as unanticipated expenditures or changes in the financial markets, may also impact a borrower’s ability to pay.  Collateral values, particularly real estate values, are also impacted by a variety of factors including general economic conditions, demographics, natural disasters, maintenance and collection or foreclosure delays.

 

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Non-performing Assets

 

Non-performing assets include non-accrual loans, mortgage loans delinquent 90 days or more and still accruing interest and real estate owned, or REO.  Total non-performing assets decreased to $343.6 million at December 31, 2012, from $380.9 million at December 31, 2011, due to a decrease of $19.5 million in REO, net, coupled with a reduction in non-performing loans.  Non-performing loans, the most significant component of non-performing assets, decreased $17.8 million to $315.1 million at December 31, 2012, from $332.9 million at December 31, 2011.  The decrease in non-performing loans was primarily due to a decrease of $26.8 million in non-performing residential mortgage loans, partially offset by an increase of $8.6 million in non-performing multi-family and commercial real estate mortgage loans.  While the level of our non-performing loans has continued its downward trend throughout 2012, we expect the levels will remain somewhat elevated for some time, especially in certain states where judicial foreclosure proceedings are required.  We are impacted by both national and regional economic factors. With residential mortgage loans from various regions of the country held in our portfolio, the condition of the national economy impacts our earnings.  During 2011 and continuing through 2012, the U.S. economy has shown signs of a very slow and tenuous recovery from the recession which began in 2008.  The national unemployment rate, while still at a high level, declined to 7.8% for December 2012, compared to a peak of 10.0% for October 2009, although new job growth remains slow.  Softness persists in the housing and real estate markets, although the extent of such softness varies from region to region.  With respect to our multi-family mortgage loan origination activities, primarily focused in New York, we have observed favorable market conditions during 2012.  We continue to closely monitor the local and national real estate markets and other factors related to risks inherent in our loan portfolio.  The ratio of non-performing loans to total loans decreased to 2.38% at December 31, 2012, from 2.51% at December 31, 2011.  The ratio of non-performing assets to total assets decreased to 2.08% at December 31, 2012, from 2.24% at December 31, 2011.  The allowance for loan losses as a percentage of total non-performing loans decreased to 46.18% at December 31, 2012, from 47.22% at December 31, 2011.  For further discussion of our non-performing assets, non-performing loans and the allowance for loan losses, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” or “MD&A.”

 

We proactively manage our non-performing assets, in part, through the sale of certain delinquent and non-performing loans.  During the year ended December 31, 2012, we sold $22.0 million, net of charge-offs of $11.5 million, of delinquent and non-performing mortgage loans, primarily multi-family and commercial real estate loans.  Included in loans held-for-sale, net, are delinquent and non-performing mortgage loans totaling $3.9 million, net of charge-offs of $1.0 million and a $64,000 lower of cost or market valuation allowance, at December 31, 2012, substantially all of which were multi-family mortgage loans.  At December 31, 2011, such loans totaled $19.7 million, net of charge-offs of $11.4 million and a $63,000 lower of cost or market valuation allowance and consisted primarily of multi-family and commercial real estate mortgage loans.  Such loans are excluded from non-performing loans, non-performing assets and related ratios.

 

We discontinue accruing interest on loans when such loans become 90 days delinquent as to their payment due date (missed three payments) or at the time of a modification which is deemed to be a troubled debt restructuring.  In addition, we reverse all previously accrued and uncollected interest through a charge to interest income.  While loans are in non-accrual status, interest due is monitored and, generally, income is recognized only to the extent cash is received until a return to accrual status is warranted.  In some circumstances, we may continue to accrue interest on mortgage loans delinquent 90 days or more as to their maturity date but not their interest due.  In other cases, we may defer recognition of income until the principal balance has been recovered.

 

We obtain updated estimates of collateral values on residential mortgage loans at 180 days past due and annually thereafter and for loans to borrowers who have filed for bankruptcy initially when we are notified of the bankruptcy filing.  Updated estimates of collateral values on residential loans are obtained primarily through automated valuation models. Additionally, our loan servicer performs property

 

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Table of Contents

 

inspections to monitor and manage the collateral on our residential loans when they become 45 days past due and monthly thereafter until the foreclosure process is complete. We obtain updated estimates of collateral value using third party appraisals on non-performing multi-family and commercial real estate mortgage loans when the loans initially become non-performing and annually thereafter and multi-family and commercial real estate loans modified in a troubled debt restructuring at the time of the modification and annually thereafter.  Appraisals on multi-family and commercial real estate loans are reviewed by our internal certified appraisers.  We also obtain updated estimates of collateral value for certain other loans when the Asset Classification Committee believes repayment of such loans may be dependent on the value of the underlying collateral. Adjustments to final appraised values obtained from independent third party appraisers and automated valuation models are not made.

 

We may agree to modify the contractual terms of a borrower’s loan.  In cases where such modifications represent a concession to a borrower experiencing financial difficulty, the modification is considered a troubled debt restructuring.  Modifications as a result of a troubled debt restructuring may include, but are not limited to, interest rate modifications, payment deferrals, restructuring of payments to interest-only from amortizing and/or extensions of maturity dates.  Modifications which result in insignificant payment delays and payment shortfalls are generally not classified as troubled debt restructurings.  Loans to borrowers in Chapter 7 bankruptcy, or Chapter 7 bankruptcy loans, are also reported as troubled debt restructurings, as relief granted by a court is also viewed as a concession to the borrower in the loan agreement.  These loans have been classified as troubled debt restructurings to comply with regulatory guidance issued in 2012 and totaled $12.5 million at December 31, 2012.  Loans modified in a troubled debt restructuring are initially placed on non-accrual status.  Loans modified in a troubled debt restructuring which are included in non-accrual loans totaled $32.8 million at December 31, 2012 and $18.8 million at December 31, 2011, of which $13.7 million at December 31, 2012 and $10.9 million at December 31, 2011 were less than 90 days past due.  Loans modified in a troubled debt restructuring, other than Chapter 7 bankruptcy loans, remain in non-accrual status until we determine that future collection of principal and interest is reasonably assured, which requires that the borrower demonstrate performance according to the restructured terms generally for a period of six months.  Loans modified in a troubled debt restructuring, other than Chapter 7 bankruptcy loans, which have complied with the terms of their restructure agreement for a satisfactory period of time are excluded from non-performing assets.  Restructured accruing loans totaled $98.7 million at December 31, 2012 and $73.7 million at December 31, 2011.  Loans modified in a troubled debt restructuring are individually classified as impaired and a charge-off is recorded for the portion of the recorded investment in the loan in excess of the present value of the discounted cash flows of the modified loan or the estimated fair value of the underlying collateral less estimated selling costs for collateral dependent loans.  For further detail on loans modified in a troubled debt restructuring, see Note 1 and Note 5 in Notes to Consolidated Financial Statements in Item 8, “Financial Statements and Supplementary Data.”

 

REO represents real estate acquired as a result of foreclosure or by deed in lieu of foreclosure and is initially recorded at the lower of cost or fair value, less estimated selling costs.  Write-downs required at the time of acquisition are charged to the allowance for loan losses.  Thereafter, we maintain a valuation allowance, representing decreases in the properties’ estimated fair value, through charges to earnings.  Such charges are included in other non-interest expense along with any additional property maintenance and protection expenses incurred in owning the property.  Fair value is estimated through current appraisals, in conjunction with a drive-by inspection and comparison of the REO property with similar properties in the area by either a licensed appraiser or real estate broker.  As these properties are actively marketed, estimated fair values are periodically adjusted by management to reflect current market conditions.  At December 31, 2012 we held 108 properties in REO totaling $28.5 million, net of a valuation allowance of $1.6 million, and at December 31, 2011 we held 174 properties in REO totaling $48.1 million, net of a valuation allowance of $2.5 million, all of which were residential properties.

 

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Table of Contents

 

Criticized and Classified Assets

 

Our Asset Review Department reviews and classifies our assets and independently reports the results of its reviews to the Loan Committee of our Board of Directors quarterly. Our Asset Classification Committee establishes policy relating to the internal classification of loans and also provides input to the Asset Review Department in its review of our assets.

 

Federal regulations and our policy require the classification of loans and other assets, such as debt and equity securities considered to be of lesser quality, as special mention, substandard, doubtful or loss. An asset criticized as special mention has potential weaknesses, which, if uncorrected, may result in the deterioration of the repayment prospects or in our credit position at some future date.  An asset classified as substandard is inadequately protected by the current net worth and paying capacity of the obligor or the collateral pledged, if any.  Substandard assets include those characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected.  Assets classified as doubtful have all of the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses present make collection or liquidation in full satisfaction of the loan amount, on the basis of currently existing facts, conditions and values, highly questionable and improbable.  Assets classified as loss are those considered uncollectible and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted.  Those assets classified as substandard, doubtful or loss are considered adversely classified.

 

Impaired Loans

 

We evaluate loans individually for impairment in connection with our individual loan review and asset classification process.  In addition, residential mortgage loans are individually evaluated for impairment at 180 days delinquent and annually thereafter and for loans to borrowers who have filed for bankruptcy initially when we are notified of the bankruptcy filing.

 

A loan is considered impaired when, based upon current information and events, it is probable we will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the loan agreement.  When an impairment analysis indicates the need for a specific allocation on an individual loan, the amount must be sufficient to cover probable incurred losses at the evaluation date based on the facts and circumstances of the loan.  When available information confirms that specific loans, or portions thereof, are uncollectible, these amounts are promptly charged-off against the allowance for loan losses.

 

Impaired loans totaled $341.9 million, net of their related allowance for loan losses of $5.0 million, at December 31, 2012 and $286.4 million, net of their related allowance for loan losses of $15.1 million, at December 31, 2011.  Interest income recognized on impaired loans amounted to $9.8 million for the year ended December 31, 2012.  For further detail on our impaired loans, see Note 1 and Note 5 of Notes to Consolidated Financial Statements in Item 8, “Financial Statements and Supplementary Data.”

 

Allowance for Loan Losses

 

For a discussion of our accounting policy related to the allowance for loan losses, see “Critical Accounting Policies - Allowance for Loan Losses” in Item 7, “MD&A.”

 

In addition to the requirements of U.S. generally accepted accounting principles, or GAAP, related to loss contingencies, a federally chartered savings association’s determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the OCC.  The OCC, in conjunction with the other federal banking agencies, provides guidance for financial institutions on both the responsibilities of management for the assessment and establishment of adequate valuation allowances and guidance for banking agency examiners to use in determining the adequacy of valuation allowances.  It is required that all institutions have effective systems and controls to identify, monitor and address asset

 

14



Table of Contents

 

quality problems, analyze all significant factors that affect the collectibility of the portfolio in a reasonable manner and establish acceptable allowance evaluation processes that meet the objectives of the federal regulatory agencies.  While we believe that the allowance for loan losses has been established and maintained at adequate levels, future adjustments may be necessary if economic or other conditions differ substantially from the conditions used in making our estimates at December 31, 2012.  In addition, there can be no assurance that the OCC or other regulators, as a result of reviewing our loan portfolio and/or allowance, will not request that we alter our allowance for loan losses, thereby affecting our financial condition and earnings.

 

Investment Activities

 

General

 

Our investment policy is designed to complement our lending activities, generate a favorable return within established risk guidelines which limit interest rate and credit risk, assist in the management of IRR and provide a source of liquidity.  In establishing our investment strategies, we consider our business plans, the economic environment, our interest rate sensitivity position, the types of securities held and other factors.  At December 31, 2012, our securities portfolio totaled $2.04 billion, or 12% of total assets.

 

Federally chartered savings associations have authority to invest in various types of assets, including U.S. Treasury obligations; securities of government agencies and GSEs; mortgage-backed securities, including collateralized mortgage obligations, or CMOs, and real estate mortgage investment conduits, or REMICs; certain certificates of deposit of insured banks and federally chartered savings associations; certain bankers acceptances; and, subject to certain limits, corporate securities, commercial paper and mutual funds.  Our investment policy also permits us to invest in certain derivative financial instruments.  We do not use derivatives for trading purposes.

 

Securities

 

Our securities portfolio is comprised primarily of residential mortgage-backed securities.  At December 31, 2012, our mortgage-backed securities totaled $1.94 billion, or 95% of total securities, of which $1.92 billion, or 94% of total securities, were REMIC and CMO securities, substantially all of which had fixed rates.  Of the REMIC and CMO securities portfolio, $1.90 billion, or 99%, are guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae as issuer.  The balance of this portfolio is comprised of privately issued securities, substantially all of which are investment grade securities.  In addition to our REMIC and CMO securities, at December 31, 2012, we had $21.6 million, or 1% of total securities, in mortgage-backed pass-through certificates guaranteed by either Fannie Mae, Freddie Mac or Ginnie Mae.  These securities provide liquidity, collateral for borrowings and minimal credit risk while providing appropriate returns and are an attractive alternative to other investments due to the wide variety of maturity and repayment options available.

 

Mortgage-backed securities generally yield less than the loans that underlie such securities because of the cost of payment guarantees that reduce credit risk and structured enhancements that reduce IRR.  However, mortgage-backed securities are more liquid than individual mortgage loans and more easily used to collateralize our borrowings.  In general, our mortgage-backed securities are weighted at no more than 20% for regulatory risk-based capital purposes, compared to the 50% risk weighting assigned to most non-securitized residential mortgage loans.  While our mortgage-backed securities carry a reduced credit risk compared to our whole loans, they, along with whole loans, remain subject to the risk of a fluctuating interest rate environment.  Changes in interest rates affect both the prepayment rate and estimated fair value of mortgage-backed securities and mortgage loans.

 

In addition to mortgage-backed securities, at December 31, 2012, we had $99.5 million of other securities, substantially all of which are obligations of GSEs which, by their terms, may be called by the issuer, typically after the passage of a fixed period of time.  At December 31, 2012, the amortized cost of

 

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Table of Contents

 

callable securities totaled $98.7 million.  During the year ended December 31, 2012, securities with an amortized cost of $107.9 million were called.

 

At December 31, 2012, our securities available-for-sale totaled $336.3 million and our securities held-to-maturity totaled $1.70 billion.  For further discussion of our securities portfolio, see Item 7, “MD&A,” Note 1 and Note 3 of Notes to Consolidated Financial Statements in Item 8, “Financial Statements and Supplementary Data,” and the tables that follow.

 

As a member of the Federal Home Loan Bank, or FHLB, of New York, or FHLB-NY, Astoria Federal is required to maintain a specified investment in the capital stock of the FHLB-NY. See “Regulation and Supervision - Federal Home Loan Bank System.”

 

Repurchase Agreements

 

We invest in various money market instruments, including repurchase agreements (securities purchased under agreements to resell) and overnight and term federal funds, although we had no investments in repurchase agreements or federal funds sold at December 31, 2012 and 2011.  Money market instruments are used to invest our available funds resulting from cash flow and to help satisfy liquidity needs.  For further discussion of our repurchase agreements, see Note 1 and Note 2 of Notes to Consolidated Financial Statements in Item 8, “Financial Statements and Supplementary Data.”

 

Securities Portfolio

 

The following table sets forth the composition of our available-for-sale and held-to-maturity securities portfolios at their respective carrying values in dollar amounts and percentages of the portfolios at the dates indicated.  Our available-for-sale securities portfolio is carried at estimated fair value and our held-to-maturity securities portfolio is carried at amortized cost.

 

 

 

At December 31,

 

 

 

2012

 

2011

 

2010

 

(Dollars in Thousands)

 

Amount

 

Percent
of Total

 

Amount

 

Percent
of Total

 

Amount

 

Percent
of Total

 

Securities available-for-sale:

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential mortgage-backed securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

GSE issuance REMICs and CMOs

 

$

204,827

 

60.91

%

 

$

298,620

 

86.76

%

 

$

509,233

 

90.62

%

 

Non-GSE issuance REMICs and CMOs

 

11,219

 

3.34

 

 

15,795

 

4.59

 

 

20,664

 

3.68

 

 

GSE pass-through certificates

 

21,375

 

6.35

 

 

25,192

 

7.32

 

 

29,896

 

5.32

 

 

Obligations of GSEs

 

98,879

 

29.40

 

 

-

 

-

 

 

-

 

-

 

 

Freddie Mac and Fannie Mae stock

 

-

 

-

 

 

4,580

 

1.33

 

 

2,160

 

0.38

 

 

Total securities available-for-sale

 

$

336,300

 

100.00

%

 

$

344,187

 

100.00

%

 

$

561,953

 

100.00

%

 

Securities held-to-maturity:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential mortgage-backed securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

GSE issuance REMICs and CMOs

 

$

1,693,437

 

99.60

%

 

$

2,054,380

 

96.41

%

 

$

1,933,650

 

96.50

%

 

Non-GSE issuance REMICs and CMOs

 

5,791

 

0.34

 

 

15,105

 

0.71

 

 

40,363

 

2.01

 

 

GSE pass-through certificates

 

257

 

0.02

 

 

475

 

0.02

 

 

772

 

0.04

 

 

Obligations of U.S. government and GSEs

 

-

 

-

 

 

57,868

 

2.72

 

 

25,000

 

1.25

 

 

Obligations of states and political subdivisions

 

-

 

-

 

 

2,976

 

0.14

 

 

3,999

 

0.20

 

 

Other

 

656

 

0.04

 

 

-

 

-

 

 

-

 

-

 

 

Total securities held-to-maturity

 

$

1,700,141

 

100.00

%

 

$

2,130,804

 

100.00

%

 

$

2,003,784

 

100.00

%

 

 

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Table of Contents

 

The following table sets forth certain information regarding the amortized costs, estimated fair values, weighted average yields and contractual maturities of our FHLB-NY stock, securities available-for-sale and securities held-to-maturity at December 31, 2012 and does not reflect the effect of prepayments or scheduled principal amortization on our REMICs, CMOs and pass-through certificates or the effect of callable features on our obligations of GSEs.

 

 

 

Within One Year

 

One to Five Years

 

Five to Ten Years

 

Over Ten Years

 

Total Securities

 

(Dollars in Thousands)

 

Amortized
Cost

 

Weighted
Average
Yield

 

Amortized
Cost

 

Weighted
Average
Yield

 

Amortized
Cost

 

Weighted
Average

Yield

 

Amortized
Cost

 

Weighted
Average

Yield

 

Amortized
Cost

 

Estimated
Fair
Value

 

Weighted
Average
Yield

 

FHLB-NY stock (1)(2)

 

$

-

 

 

-

%

 

$

-

 

 

-

%

 

$

-

 

 

-

%

 

$

171,194

 

 

4.50

%

 

$

171,194

 

 

$

171,194

 

 

4.50

%

 

Securities available-for-sale:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

REMICs and CMOs:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

GSE issuance

 

$

-

 

 

-

%

 

$

-

 

 

-

%

 

$

8,777

 

 

4.18

%

 

$

191,375

 

 

2.71

%

 

$

200,152

 

 

$

204,827

 

 

2.78

%

 

Non-GSE issuance

 

-

 

 

-

 

 

20

 

 

4.23

 

 

11,263

 

 

3.31

 

 

13

 

 

1.36

 

 

11,296

 

 

11,219

 

 

3.31

 

 

GSE pass-through certificates

 

6

 

 

6.79

 

 

2,742

 

 

6.85

 

 

2,055

 

 

3.16

 

 

15,545

 

 

2.32

 

 

20,348

 

 

21,375

 

 

3.01

 

 

Obligations of GSEs (3)

 

-

 

 

-

 

 

-

 

 

-

 

 

98,670

 

 

2.26

 

 

-

 

 

-

 

 

98,670

 

 

98,879

 

 

2.26

 

 

Fannie Mae stock (1)(4)

 

-

 

 

-

 

 

-

 

 

-

 

 

-

 

 

-

 

 

15

 

 

-

 

 

15

 

 

-

 

 

-

 

 

Total securities available-for-sale

 

$

6

 

 

6.79

%

 

$

2,762

 

 

6.83

%

 

$

120,765

 

 

2.51

%

 

$

206,948

 

 

2.69

%

 

$

330,481

 

 

$

336,300

 

 

2.66

%

 

Securities held-to-maturity:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

REMICs and CMOs:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

GSE issuance

 

$

-

 

 

-

%

 

$

7,025

 

 

4.50

%

 

$

61,211

 

 

3.73

%

 

$

1,625,201

 

 

2.29

%

 

$

1,693,437

 

 

$

1,718,269

 

 

2.35

%

 

Non-GSE issuance

 

-

 

 

-

 

 

11

 

 

2.72

 

 

4,973

 

 

4.94

 

 

807

 

 

4.75

 

 

5,791

 

 

5,903

 

 

4.91

 

 

GSE pass-through certificates

 

65

 

 

6.06

 

 

157

 

 

8.58

 

 

35

 

 

9.53

 

 

-

 

 

-

 

 

257

 

 

262

 

 

8.06

 

 

Other

 

-

 

 

-

 

 

-

 

 

-

 

 

656

 

 

7.25

 

 

-

 

 

-

 

 

656

 

 

656

 

 

7.25

 

 

Total securities held-to-maturity

 

$

65

 

 

6.06

%

 

$

7,193

 

 

4.59

%

 

$

66,875

 

 

3.86

%

 

$

1,626,008

 

 

2.29

%

 

$

1,700,141

 

 

$

1,725,090

 

 

2.36

%

 

 

(1)

Equity securities have no stated maturities and are therefore classified in the over ten years category.

(2)

The carrying amount of FHLB-NY stock equals cost. The weighted average yield represents the 2012 third quarter annualized dividend rate declared by the FHLB-NY in November 2012.

(3)

Callable in 2013 and various times thereafter.

(4)

The weighted average yield of Fannie Mae stock reflects the Federal Housing Finance Agency decision to suspend dividend payments indefinitely.

 

The following table sets forth the aggregate amortized cost and estimated fair value of our securities where the aggregate amortized cost of securities from a single issuer exceeds ten percent of our stockholders’ equity at December 31, 2012.

 

 

 

Amortized

 

Estimated

 

(In Thousands)

 

Cost

 

Fair Value

 

Freddie Mac

 

$

1,018,045

 

$

1,029,012

 

Fannie Mae

 

790,527

 

802,738

 

FHLB (1)

 

196,170

 

196,288

 

 

(1)

Includes FHLB-NY stock.

 

Sources of Funds

 

General

 

Our primary source of funds is the cash flow provided by our investing activities, including principal and interest payments on loans and securities.  Our other sources of funds are provided by operating activities (primarily net income) and financing activities, including deposits and borrowings.

 

Deposits

 

We offer a variety of deposit accounts with a range of interest rates and terms.  We presently offer passbook and statement savings accounts, money market accounts, NOW and demand deposit (checking) accounts and certificates of deposit.  At December 31, 2012, our deposits totaled $10.44 billion.  Of the total deposit balance, $1.28 billion, or 12%, represent Individual Retirement Accounts.  We held no brokered deposits at December 31, 2012.

 

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Table of Contents

 

The flow of deposits is influenced significantly by general economic conditions, changes in prevailing interest rates, pricing of deposits and competition.  Our deposits are primarily obtained from areas surrounding our banking offices.  We rely primarily on our sales and marketing efforts, including print advertising, competitive rates, quality service, our PEAK Process, new products, our business banking initiatives and long-standing customer relationships to attract and retain these deposits.  When we determine the levels of our deposit rates, consideration is given to local competition, yields of U.S. Treasury securities and the rates charged for other sources of funds.  Our strong level of core deposits has contributed to our low cost of funds.

 

Core deposits represented 62% of total deposits at December 31, 2012, of which $489.3 million were business deposits.  Our future deposit growth strategy includes expanding our business banking sales force and expanding our branch network into other locations on Long Island and opening branches in Manhattan.  We plan to focus on small and middle market businesses within our market area in order to further increase core deposits.

 

For further discussion of our deposits, see Item 7, “MD&A,” Note 7 of Notes to Consolidated Financial Statements in Item 8, “Financial Statements and Supplementary Data,” and the tables that follow.

 

The following table presents our deposit activity for the periods indicated.

 

 

 

For the Year Ended December 31,

 

(Dollars in Thousands)

 

2012

 

2011

 

2010

 

Opening balance

 

$

11,245,614

 

$

11,599,000

 

$

12,812,238

 

Net withdrawals

 

(899,677

)

(491,435

)

(1,404,253

)

Interest credited

 

98,021

 

138,049

 

191,015

 

Ending balance

 

$

10,443,958

 

$

11,245,614

 

$

11,599,000

 

Net decrease

 

$

(801,656

)

$

(353,386

)

$

(1,213,238

)

Percentage decrease

 

(7.13

)%

(3.05

)%

(9.47

)%

 

The following table sets forth the maturity periods of our certificates of deposit in amounts of $100,000 or more at December 31, 2012.

 

(In Thousands)

 

Amount

 

Within three months

 

$

157,439

 

Three to six months

 

86,143

 

Six to twelve months

 

119,497

 

Over twelve months

 

883,927

 

Total

 

$

1,247,006

 

 

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Table of Contents

 

The following table sets forth the distribution of our average deposit balances for the periods indicated and the weighted average nominal interest rates for each category of deposit presented.

 

 

 

For the Year Ended December 31,

 

 

 

2012

 

2011

 

2010

 

(Dollars in Thousands)

 

Average
Balance

 

Percent
of Total

 

Weighted
Average

Nominal
Rate

 

Average
Balance

 

Percent
of Total

 

Weighted
Average

Nominal
Rate

 

Average
Balance

 

Percent
of Total

 

Weighted
Average
Nominal
Rate

 

Savings

 

$

2,818,440

 

26.17

%

 

0.16

%

 

$

2,762,155

 

24.36

%

 

0.35

%

 

$

2,384,477

 

19.39

%

 

0.40

%

 

Money market

 

1,318,943

 

12.24

 

 

0.68

 

 

616,048

 

5.44

 

 

0.74

 

 

343,996

 

2.80

 

 

0.44

 

 

NOW

 

1,150,805

 

10.68

 

 

0.08

 

 

1,095,396

 

9.67

 

 

0.11

 

 

1,036,836

 

8.43

 

 

0.11

 

 

Non-interest bearing NOW and demand deposit

 

782,351

 

7.26

 

 

-

 

 

703,323

 

6.21

 

 

-

 

 

638,844

 

5.19

 

 

-

 

 

Total

 

6,070,539

 

56.35

 

 

0.24

 

 

5,176,922

 

45.68

 

 

0.30

 

 

4,404,153

 

35.81

 

 

0.28

 

 

Certificates of deposit (1):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Within one year

 

1,007,105

 

9.35

 

 

0.19

 

 

1,624,587

 

14.33

 

 

0.49

 

 

2,894,471

 

23.53

 

 

1.10

 

 

One to three years

 

1,796,775

 

16.68

 

 

1.51

 

 

2,439,288

 

21.53

 

 

2.01

 

 

2,789,817

 

22.69

 

 

2.75

 

 

Three to five years

 

1,849,689

 

17.17

 

 

2.88

 

 

1,904,860

 

16.81

 

 

3.29

 

 

1,534,075

 

12.47

 

 

3.74

 

 

Over five years

 

265

 

-

 

 

2.24

 

 

119

 

-

 

 

2.49

 

 

85

 

-

 

 

3.47

 

 

Jumbo

 

48,859

 

0.45

 

 

0.75

 

 

187,294

 

1.65

 

 

0.86

 

 

676,244

 

5.50

 

 

1.53

 

 

Total

 

4,702,693

 

43.65

 

 

1.76

 

 

6,156,148

 

54.32

 

 

1.97

 

 

7,894,692

 

64.19

 

 

2.23

 

 

Total deposits

 

$

10,773,232

 

100.00

%

 

0.90

%

 

$

11,333,070

 

100.00

%

 

1.21

%

 

$

12,298,845

 

100.00

%

 

1.53

%

 

 

(1)  Terms indicated are original, not term remaining to maturity.

 

The following table presents, by rate categories, the remaining periods to maturity of our certificates of deposit outstanding at December 31, 2012 and the balances of our certificates of deposit outstanding at December 31, 2012, 2011 and 2010.

 

 

 

Period to maturity from December 31, 2012

 

At December 31,

 

(In Thousands)

 

Within
one year

 

One to
two years

 

Two to
three years

 

Over
three years

 

2012

 

2011

 

2010

 

Certificates of deposit:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

0.49% or less

 

$

1,005,892

 

$

108,494

 

$

20,913

 

$

19,070

 

$

1,154,369

 

$

890,956

 

$

817,629

 

0.50% to 0.99%

 

47,644

 

83,162

 

5,628

 

4,071

 

140,505

 

713,349

 

1,058,668

 

1.00% to 1.99%

 

204,971

 

416,476

 

332,817

 

236,200

 

1,190,464

 

963,326

 

1,435,656

 

2.00% to 2.99%

 

82,065

 

40,324

 

195,620

 

338,184

 

656,193

 

1,749,941

 

1,542,847

 

3.00% to 3.99%

 

38,358

 

223,263

 

433,418

 

51

 

695,090

 

863,415

 

1,211,024

 

4.00% and over

 

123,566

 

32

 

152

 

-

 

123,750

 

338,020

 

717,225

 

Total

 

$

1,502,496

 

$

871,751

 

$

988,548

 

$

597,576

 

$

3,960,371

 

$

5,519,007

 

$

6,783,049

 

 

Borrowings

 

Borrowings are used as a complement to deposit gathering as a funding source for asset growth and are an integral part of our IRR management strategy.  We enter into reverse repurchase agreements (securities sold under agreements to repurchase) with approved securities dealers and the FHLB-NY.  Reverse repurchase agreements are accounted for as borrowings and are secured by the securities sold under the agreements.  We also obtain advances from the FHLB-NY.  At December 31, 2012, FHLB-NY advances totaled $2.90 billion, or 66% of total borrowings.  Such advances are generally secured by a blanket lien against, among other things, our residential mortgage loan portfolio and our investment in FHLB-NY stock.  The maximum amount that the FHLB-NY will advance, for purposes other than for meeting withdrawals, fluctuates from time to time in accordance with the policies of the FHLB-NY.  See “Regulation and Supervision - Federal Home Loan Bank System.”  Occasionally, we will obtain funds through the issuance of unsecured debt obligations.  These obligations are classified as other borrowings in our consolidated statements of financial condition.  At December 31, 2012, borrowings totaled $4.37 billion.

 

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Table of Contents

 

Included in our borrowings are various obligations which, by their terms, may be called by the counterparty.  We believe the potential for these borrowings to be called does not present a liquidity concern as they have above current market coupons and, as such, are not likely to be called absent a significant increase in market interest rates.  In addition, we believe we can readily obtain replacement funding, although such funding may be at higher rates.  At December 31, 2012, we had $1.95 billion of borrowings which are callable within one year and at various times thereafter, of which $200.0 million are due in 2015, $200.0 million are due in 2016 and $1.55 billion are due in 2017.

 

For further information regarding our borrowings, including our borrowings outstanding, average borrowings, maximum borrowings and weighted average interest rates at and for each of the years ended December 31, 2012, 2011 and 2010, see Item 7, “MD&A” and Note 8 of Notes to Consolidated Financial Statements in Item 8, “Financial Statements and Supplementary Data.”

 

Market Area and Competition

 

Astoria Federal has been, and continues to be, a community-oriented federally chartered savings association offering a variety of financial services to meet the needs of the communities it serves.  Our retail banking network includes multiple delivery channels including full service banking offices, automated teller machines, or ATMs, and telephone, internet and mobile banking capabilities.  We consider our strong retail banking network, together with our reputation for financial strength and customer service, as well as our competitive pricing, as our major strengths in attracting and retaining customers in our market areas.  Our business banking expansion initiatives during 2012 are generating new core relationships within the communities we serve and deepening our existing relationships.

 

Astoria Federal’s deposit gathering sources are primarily concentrated in the communities surrounding Astoria Federal’s banking offices in Queens, Kings (Brooklyn), Nassau, Suffolk and Westchester counties of New York.  Astoria Federal ranked fourth in deposit market share, with a 5.8% market share, in the Long Island market, which includes the counties of Queens, Kings, Nassau and Suffolk, based on the annual FDIC “Summary of Deposits - Market Share Report” dated June 30, 2012.

 

Astoria Federal originates residential mortgage loans through its banking and loan production offices in New York, through a broker network covering four states, primarily along the East Coast, and through a third party loan origination program covering nine states and the District of Columbia.  Our various loan origination programs provide efficient and diverse delivery channels for deployment of our cash flows.  Additionally, our broker and third party loan origination programs provide geographic diversification, reducing our exposure to concentrations of credit risk.  Astoria Federal also originates multi-family and commercial real estate loans, primarily on rent controlled and rent stabilized apartment buildings located in the greater New York metropolitan area.

 

The New York metropolitan area has a high density of financial institutions, a number of which are significantly larger and have greater financial resources than we have.  Our competition for loans, both locally and nationally, comes principally from commercial banks, savings banks, savings and loan associations, mortgage banking companies and credit unions.  Additionally, over the past four years, we have faced increased competition as a result of the U.S. government’s intervention in the mortgage and credit markets, particularly from the government’s purchase of U.S. Treasury and mortgage-backed securities and the expansion of loan amount limits that conform to GSE guidelines, or the expanded conforming loan limits.  This has resulted in a narrowing of mortgage spreads, lower yields and accelerated mortgage prepayments.  We have expanded our multi-family and commercial real estate lending operations and will continue to expand our business banking operations.  These business lines are also being aggressively pursued by a number of competitors, both large and small.  Our most direct competition for deposits comes from commercial banks, savings banks, savings and loan associations and credit unions.  We also face competition for deposits from money market mutual funds and other corporate and government securities funds as well as from other financial intermediaries such as brokerage firms and insurance companies.

 

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Table of Contents

 

Subsidiary Activities

 

We have two direct wholly-owned subsidiaries, Astoria Federal and AF Insurance Agency, Inc., which are reported on a consolidated basis.  AF Insurance Agency, Inc. is a licensed life insurance agency.  Through contractual agreements with various third parties, AF Insurance Agency, Inc. makes insurance products available primarily to the customers of Astoria Federal.

 

We have one other direct subsidiary, Astoria Capital Trust I, which is not consolidated with Astoria Financial Corporation for financial reporting purposes.  Astoria Capital Trust I was formed in 1999 for the purpose of issuing $125.0 million of Capital Securities and $3.9 million of common securities and using the proceeds to acquire $128.9 million of Junior Subordinated Debentures issued by us.  The Junior Subordinated Debentures have an interest rate of 9.75%, mature on November 1, 2029 and are the sole assets of Astoria Capital Trust I.  The Junior Subordinated Debentures are prepayable, in whole or in part, at declining premiums to November 1, 2019, after which the Junior Subordinated Debentures are prepayable at par value.  The Capital Securities have the same prepayment provisions as the Junior Subordinated Debentures.  See Note 8 of Notes to Consolidated Financial Statements in Item 8, “Financial Statements and Supplementary Data” for further discussion of Astoria Capital Trust I, the Capital Securities and the Junior Subordinated Debentures.

 

At December 31, 2012, the following were wholly-owned subsidiaries of Astoria Federal and are reported on a consolidated basis.

 

AF Agency, Inc. was formed in 1990 and makes various annuity products available to the customers of Astoria Federal through an unaffiliated third party vendor.  Astoria Federal is reimbursed for expenses it incurs on behalf of AF Agency, Inc.  Fees generated by AF Agency, Inc. totaled $2.0 million for the year ended December 31, 2012.

 

Astoria Federal Mortgage Corp., or AF Mortgage, is an operating subsidiary through which Astoria Federal engages in lending activities primarily outside the State of New York through our third party loan origination program.

 

Astoria Federal Savings and Loan Association Revocable Grantor Trust was formed in November 2000 in connection with the establishment of a BOLI program by Astoria Federal.  Premiums paid to purchase BOLI in 2000 and 2002 totaled $350.0 million.  The carrying amount of our investment in BOLI was $418.2 million, or 3% of total assets, at December 31, 2012.  See Note 1 of Notes to Consolidated Financial Statements in Item 8, “Financial Statements and Supplementary Data” for further discussion of BOLI.

 

Fidata Service Corp., or Fidata, was incorporated in the State of New York in November 1982. Fidata qualifies as a Connecticut passive investment company and for alternative tax treatment under Article 9A of the New York State Tax Law.  Fidata maintains offices in Norwalk, Connecticut and invests in loans secured by real property which qualify as intangible investments permitted to be held by a Connecticut passive investment company.  Fidata mortgage loans totaled $5.09 billion at December 31, 2012.

 

Marcus I Inc. was incorporated in the State of New York in April 2006 and was formed to serve as assignee of certain loans in default and REO properties.  Marcus I Inc. assets were not material to our financial condition at December 31, 2012.

 

Suffco Service Corporation, or Suffco, serves as document custodian for the loans of Astoria Federal and Fidata and certain loans being serviced for Fannie Mae and other investors.

 

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Astoria Federal has four additional subsidiaries, one of which is a single purpose entity that has an interest in a real estate investment which is not material to our financial condition and the remaining three are inactive and have no assets.

 

Personnel

 

As of December 31, 2012, we had 1,446 full-time employees and 168 part-time employees, or 1,530 full time equivalents.  The employees are not represented by a collective bargaining unit and we consider our relationship with our employees to be good.

 

Regulation and Supervision

 

General

 

Astoria Federal is subject to extensive regulation, examination and supervision by the OCC, as its primary federal regulator, by the FDIC, as its deposit insurer, and by the CFPB.  We, as a unitary savings and loan holding company, are regulated, examined and supervised by the FRB.  Astoria Federal is a member of the FHLB-NY and its deposit accounts are insured up to applicable limits by the FDIC under the Deposit Insurance Fund, or DIF.  Astoria Federal must file reports with the OCC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions, such as mergers with, or acquisitions of, other financial institutions.  The OCC periodically performs safety and soundness examinations of Astoria Federal and tests its compliance with various regulatory requirements. The FDIC reserves the right to do so as well. The OCC has primary enforcement responsibility over federally chartered savings associations and has substantial discretion to impose enforcement action on an institution that fails to comply with applicable regulatory requirements, particularly with respect to its capital requirements.  In addition, the FDIC has the authority to recommend to the OCC that enforcement action be taken with respect to a particular federally chartered savings association and, if action is not taken by the OCC, the FDIC has authority to take such action under certain circumstances.  Similarly, we are subject to FRB regulation, supervision, examination and reporting requirements.

 

This regulation and supervision establishes a comprehensive framework to regulate and control the activities in which we can engage and is intended primarily for the protection of the DIF, the depositors and other consumers. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulation, whether by the OCC, the FDIC, the CFPB, the FRB or Congress, could have a material adverse impact on Astoria Federal and us and our respective operations.

 

The description of statutory provisions and regulations applicable to federally chartered savings associations and their holding companies and of tax matters set forth in this document does not purport to be a complete description of all such statutes and regulations and their effects on Astoria Federal and us.  Other than the disclosures noted in this section and in Item 1A, “Risk Factors,” there is no additional guidance from our banking regulators which is likely to have a material impact on our results of operations, liquidity, capital or financial position.

 

Regulatory Reform Legislation

 

In July 2010, President Obama signed into law the Reform Act, which is intended to address perceived weaknesses in the U.S. financial regulatory system and prevent future economic and financial crises.  As a result of the Reform Act, on July 21, 2011, the Office of Thrift Supervision, or OTS, our previous primary federal regulator, was merged into the OCC, which has taken over the regulation of all federal

 

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savings associations, such as Astoria Federal. The FRB acquired the OTS’ authority over all savings and loan holding companies, such as Astoria Financial Corporation.

 

The Reform Act also created the CFPB which is authorized to supervise certain consumer financial services companies and insured depository institutions with more than $10 billion in total assets, such as Astoria Federal, for consumer protection purposes.  The CFPB has exclusive examination and primary enforcement authority with respect to compliance with federal consumer financial protections laws and regulations by institutions under its supervision and is authorized to conduct investigations to determine whether any person is, or has, engaged in conduct that violates the federal consumer financial laws.  Investigations may be conducted jointly with the federal bank regulatory agencies, or the Agencies, and the CFPB may bring an administrative enforcement proceeding or civil action in Federal district court.  As an independent bureau within the FRB, the CFPB may impose requirements more severe than the previous bank regulatory agencies.

 

In addition, the Reform Act provides that the same standards for federal preemption of state consumer financial laws apply to both national banks and federal savings associations and eliminates the applicability of preemption to subsidiaries and affiliates of national banks and federal savings associations.  The Reform Act also includes provisions, some of which have resulted in final rulemaking and some of which may result in further rulemaking, that may affect our future operations.  We will not be able to determine the impact of these provisions until final rules are promulgated to implement these provisions and other regulatory guidance is provided interpreting these provisions.

 

Consumer Financial Protection Bureau Regulation of Mortgage Origination and Servicing

 

In July 2011, the CFPB took over rulemaking responsibility for the federal consumer financial protection laws, such as the Real Estate Settlement Procedures Act, or Regulation X, and the Truth in Lending Act, or Regulation Z, among others.  In January 2013, the CFPB issued a series of final rules related to mortgage loan origination and mortgage loan servicing.  Compliance with these rules will likely increase our overall regulatory compliance costs, which are included in non-interest expense.  We are still evaluating the recently issued rules to determine if they will have any long-term impact on our mortgage loan origination and servicing activities.

 

On January 10, 2013, the CFPB issued a final rule concerning lenders’ assessments of consumers’ ability to repay home loans. Currently, Regulation Z prohibits creditors from extending higher-priced mortgage loans without regard for the consumer’s ability to repay.  The rule extends application of this requirement to all loans secured by dwellings, not just higher-priced mortgages.  Creditors must, at a minimum, consider eight specified factors while making a reasonable and good faith determination that the consumer has a reasonable ability to repay the loan before entering any consumer credit transaction secured by virtually any dwelling.  The factors include information such as the consumer’s income, debt obligations, credit history and monthly payments on the loan.  The rule also establishes a safe harbor and presumption of compliance with the ability-to-repay requirement for so-called “qualified mortgages,” restricts the application of prepayment penalties and requires the retention of evidence of compliance with the ability-to-repay requirement for three years.  The rule becomes effective January 10, 2014.

 

Additionally, on January 10, 2013, the CFPB issued a final rule to expand the types of mortgage loans that are subject to the protections of the Home Ownership and Equity Protections Act of 1994, or HOEPA.  Loans that meet HOEPA’s high-cost coverage tests are subject to special disclosure requirements and restrictions on loan terms, and borrowers in high-cost mortgages have enhanced remedies for violations of the law.  The rule revises and expands the tests for coverage under HOEPA and imposes additional restrictions on mortgages that are covered by HOEPA, including a pre-loan counseling requirement.  The rule becomes effective January 10, 2014.

 

On January 17, 2013, the CFPB issued final rules concerning mortgage servicing standards, which amend both Regulation X and Regulation Z.  The Regulation X rule requires servicers to provide certain

 

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information to borrowers, to establish policies and procedures to achieve certain delineated objectives, to correct errors asserted by borrowers and to evaluate borrowers’ applications for available loss mitigation options.  The Regulation Z rule requires creditors, assignees and servicers to provide interest rate adjustment notices for adjustable-rate mortgages, periodic statements for residential mortgage loans, prompt crediting of mortgage payments and responses to requests for payoff amounts.  Both rules become effective January 10, 2014.

 

On January 20, 2013, the CFPB issued a final rule with multiple effective dates implementing requirements and restrictions imposed by the Reform Act concerning, among other things, qualifications of individual loan originators and the compensation practices with respect to such persons.  The rule prohibits loan origination organizations from basing compensation for themselves or individual loan originators on any of the origination transaction’s terms or conditions and prohibits such persons from receiving compensation from another person in connection with the same transaction.  The rule also imposes duties on loan originator organizations to ensure that their individual loan originators meet certain licensing or qualification standards and extends existing recordkeeping requirements.  In addition, effective June 1, 2013, the rule prohibits the inclusion of certain provisions in residential mortgage loan agreements that could restrict legal recourse by a consumer against the loan origination organization and prohibits the financing of single-premium credit insurance.  All other provisions of the rule become effective January 10, 2014.

 

Federally Chartered Savings Association Regulation

 

Business Activities

 

Astoria Federal derives its lending and investment powers from the Home Owners’ Loan Act, as amended, or HOLA, and the regulations of the OCC thereunder. Under these laws and regulations, Astoria Federal may invest in mortgage loans secured by residential and non-residential real estate, commercial and consumer loans, certain types of debt securities and certain other assets. Astoria Federal may also establish service corporations that may engage in activities not otherwise permissible for Astoria Federal, including certain real estate equity investments and securities and insurance brokerage activities. These investment powers are subject to various limitations, including (1) a prohibition against the acquisition of any corporate debt security that is not rated in one of the four highest rating categories, (2) a limit of 400% of an association’s capital on the aggregate amount of loans secured by non-residential real estate property, (3) a limit of 20% of an association’s assets on commercial loans, with the amount of commercial loans in excess of 10% of assets being limited to small business loans, (4) a limit of 35% of an association’s assets on the aggregate amount of consumer loans and acquisitions of certain debt securities, (5) a limit of 5% of assets on non-conforming loans (certain loans in excess of the specific limitations of HOLA), and (6) a limit of the greater of 5% of assets or an association’s capital on certain construction loans made for the purpose of financing what is or is expected to become residential property.

 

In October 2006, the Agencies published the “Interagency Guidance on Nontraditional Mortgage Product Risks,” or the Guidance. The Guidance describes sound practices for managing risk, as well as marketing, originating and servicing nontraditional mortgage products, which include, among other things, interest-only loans. The Guidance sets forth supervisory expectations with respect to loan terms and underwriting standards, portfolio and risk management practices and consumer protection.

 

In December 2006, the Agencies published guidance entitled “Interagency Guidance on Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices,” or the CRE Guidance, to address concentrations of commercial real estate loans in savings associations. The CRE Guidance reinforces and enhances the OCC’s existing regulations and guidelines for real estate lending and loan portfolio management, but does not establish specific commercial real estate lending limits.

 

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In June 2007, the Agencies issued the “Statement on Subprime Mortgage Lending,” or the Statement, to address the growing concerns facing the subprime mortgage market, particularly with respect to rapidly rising subprime default rates that may indicate borrowers do not have the ability to repay adjustable rate subprime loans originated by financial institutions. In particular, the Agencies expressed concern in the Statement that current underwriting practices do not take into account that many subprime borrowers are not prepared for “payment shock” and that the current subprime lending practices compound risk for financial institutions. The Statement describes the prudent safety and soundness and consumer protection standards that financial institutions should follow to ensure borrowers obtain loans that they can afford to repay. The Statement also reinforces the April 2007 Interagency Statement on Working with Mortgage Borrowers, in which the Agencies encouraged institutions to work constructively with residential borrowers who are financially unable or reasonably expected to be unable to meet their contractual payment obligations on their home loans.

 

In October 2009, the Agencies adopted a policy statement supporting prudent commercial real estate mortgage loan workouts, or the Policy Statement. The Policy Statement provides guidance for examiners, and for financial institutions that are working with commercial real estate mortgage loan borrowers who are experiencing diminished operating cash flows, depreciated collateral values, or prolonged delays in selling or renting commercial properties. The Policy Statement details risk-management practices for loan workouts that support prudent and pragmatic credit and business decision-making within the framework of financial accuracy, transparency, and timely loss recognition. Financial institutions that implement prudent loan workout arrangements after performing comprehensive reviews of borrowers’ financial conditions will not be subject to criticism for engaging in these efforts, even if the restructured loans have weaknesses that result in adverse credit classifications. In addition, performing loans, including those renewed or restructured on reasonable modified terms, made to creditworthy borrowers, will not be subject to adverse classification solely because the value of the underlying collateral declined. The Policy Statement reiterates existing guidance that examiners are expected to take a balanced approach in assessing institutions’ risk-management practices for loan workout activities.

 

We have evaluated the Guidance, the CRE Guidance, the Statement and the Policy Statement to determine our compliance and, as necessary, modified our risk management practices, underwriting guidelines and consumer protection standards. See “Lending Activities — Residential Mortgage Lending and Multi-Family and Commercial Real Estate Lending” for a discussion of our loan product offerings and related underwriting standards and “Asset Quality” in Item 7, “MD&A” for information regarding our loan portfolio composition.

 

In January 2013, pursuant to the Reform Act, the Agencies issued final rules on appraisal requirements for higher-priced mortgage loans which become effective in January 2014.  For mortgage loans with an annual percentage rate that exceeds a certain threshold, Astoria Federal must obtain an appraisal using a licensed or certified appraiser.  The appraiser must prepare a written appraisal report based on a physical inspection of the interior of the property.  Astoria Federal must also then disclose to applicants information about the purpose of the appraisal and provide them with a free copy of the appraisal report.

 

“Qualified Mortgages” are exempt from the new appraisal requirement rules stated above. As defined by the CFPB, Qualified Mortgages are mortgages that meet the following standards prohibiting or limiting certain high risk products and features: (1) no excessive upfront points and fees - generally points and fees paid by the borrower must not exceed 3% of the total amount borrowed; (2) no toxic loan features - prohibited features include interest-only loans, negative-amortization loans, terms beyond 30 years and balloon loans; and (3) limit on debt-to-income ratios - borrowers’ debt-to-income ratios must be no higher than 43%.

 

Lenders that generate Qualified Mortgage loans will receive specific protections against borrower lawsuits that could result from failing to satisfy the ability-to-repay rule.  There are two levels of liability protections for Qualified Mortgages, the Safe Harbor protection and the Rebuttable Presumption protection. Safe Harbor Qualified Mortgages are lower priced loans with interest rates closer to the prime

 

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rate, issued to borrowers with high credit scores.  Borrowers suing lenders under Safe Harbor Qualified Mortgages are faced with overcoming the pre-determined legal conclusion that the lender has satisfied the ability-to-repay rule. Rebuttable Presumption Qualified Mortgages are loans at higher prices that are granted to borrowers with lower credit scores.  Lenders generating Rebuttable Presumption Qualified Mortgages receive the protection of a presumption that they have legally satisfied the ability-to-repay rule while the borrower can rebut that presumption by proving that the lender did not consider the borrower’s living expenses after their mortgage and other debts.

 

Capital Requirements

 

The OCC capital regulations currently require federally chartered savings associations to meet four minimum capital ratios: a 1.5% Tangible capital ratio, a 4% Tier 1 leverage capital ratio, a 4% Tier 1 risk-based capital ratio and an 8% Total risk-based capital ratio. In assessing an institution’s capital adequacy, the OCC takes into consideration not only these numeric factors but also qualitative factors as well, and has the authority to establish higher capital requirements for individual institutions where necessary. Astoria Federal, as a matter of prudent management, targets as its goal the maintenance of capital ratios that exceed these minimum requirements and that are consistent with Astoria Federal’s risk profile.  At December 31, 2012, Astoria Federal exceeded each of its capital requirements with a Tangible capital ratio of 9.24%, Tier 1 leverage capital ratio of 9.24%, Tier 1 risk-based capital ratio of 15.23% and Total risk-based capital ratio of 16.49%.

 

The Reform Act requires the Agencies to establish consolidated risk-based and leverage capital requirements for insured depository institutions, depository institution holding companies and systemically important nonbank financial companies. These requirements must be no less than those to which insured depository institutions are currently subject to. As a result, by no later than July 2015, we will become subject to consolidated capital requirements which we have not been subject to previously.

 

In addition, in September 2010, the Basel Committee adopted the Basel III capital rules. These rules, which will be phased in over a period of years, set new standards for common equity, tier 1 and total capital, determined on a risk-weighted basis.  The Basel III capital rules will be implemented through regulations issued by the Agencies. In June 2012, the Agencies issued a notice of proposed rulemaking for three separate sets of proposed rules, or the Proposed Rules, which will subject all savings and loan holding companies, including Astoria Financial Corporation, to consolidated capital requirements.  The Proposed Rules would revise the quantity and quality of required minimum risk-based and leverage capital requirements, consistent with the Reform Act and the Basel III capital standards, and revise the FRB’s rules for calculating risk-weighted assets to enhance their risk sensitivity.  The new minimum regulatory capital ratios and changes to the calculation of risk-weighted assets were expected to be phased-in beginning in January 2013; however, the Agencies announced on November 9, 2012 that the Proposed Rules would not become effective in January 2013.  At this time, no final rules have been announced or published and no further guidance has been issued by any of the Agencies.  If the Proposed Rules are adopted as proposed, we believe that we would have been in compliance with the new minimum capital requirements as of December 31, 2012.

 

The Proposed Rules revise the quantity and quality of capital required by: (1) establishing a new minimum common equity tier 1 ratio of 4.5% of risk-weighted assets; (2) raising the minimum tier 1 capital ratio from 4.0% to 6.0% of risk-weighted assets; (3) maintaining the minimum total capital ratio of 8.0% of risk-weighted assets; and (4) maintaining a minimum tier 1 capital to adjusted average consolidated assets, known as the leverage ratio, of 4.0%.  These changes, as proposed, would have been phased in incrementally beginning January 1, 2013 to provide time for banking organizations to meet the new capital standards, with full implementation to occur by January 1, 2015.  If the effectiveness of the rules had not been delayed, the required minimum common equity tier 1 capital would have been 3.5% on January 1, 2013, 4.0% on January 1, 2014 and 4.5% on January 1, 2015, and the required minimum tier 1 capital ratio would have been 4.5% on January 1, 2013, 5.5% on January 1, 2014 and 6.0% on January 1, 2015.

 

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In addition, the Proposed Rules revise the definition of capital to improve the ability of regulatory capital instruments to absorb losses and revise the FRB rules for calculating risk-weighted assets to enhance risk sensitivity, which will exclude certain non-qualifying capital instruments, including cumulative preferred stock and trust preferred securities, such as our Capital Securities, as a component of tier 1 capital.  Under the Proposed Rules, had effectiveness not been delayed, a depository institution holding company with assets of $15 billion or more would be allowed to include only 75% of non-qualifying capital instruments in regulatory capital as of January 1, 2013, 50% as of January 1, 2014 and 25% as of January 1, 2015.  As of January 1, 2016 and thereafter, no amount of non-qualifying capital instruments would be included in regulatory capital.

 

Furthermore, the Proposed Rules add a requirement for a minimum common equity tier 1 capital conservation buffer, or Conservation Buffer, of 2.5% of risk-weighted assets to be applied to the common equity tier 1 capital ratio, the tier 1 capital ratio and the total capital ratio.  Failure to maintain the Conservation Buffer would result in restrictions on capital distributions and certain discretionary cash bonus payments to executive officers.  The required minimum Conservation Buffer would be phased in incrementally, starting at 0.625% on January 1, 2016 and increasing to 1.25% on January 1, 2017, 1.875% on January 1, 2018 and 2.5% on January 1, 2019.  If a banking organization’s Conservation Buffer is less than the required minimum and its net income for the four calendar quarters preceding the applicable calendar quarter, net of any capital distributions, certain discretionary bonus payments and associated tax effects not already reflected in net income, or Eligible Retained Income, is negative, it would be prohibited from making capital distributions or certain discretionary cash bonus payments to executive officers.  As a result, under the Proposed Rules, if adopted, should Astoria Federal fail to maintain the Conservation Buffer we would be subject to limits on, and in the event Astoria Federal has negative Eligible Retained Income for any four consecutive calendar quarters, we would be prohibited in, our ability to obtain capital distributions from Astoria Federal.  If we do not receive sufficient cash dividends from Astoria Federal, then we may not have sufficient funds to pay dividends, repurchase our common stock or service our debt obligations.

 

Moreover, the Proposed Rules revise existing and establish new risk weights for certain exposures, including, among other exposures, residential mortgage loans, commercial loans, which generally include commercial real estate loans, multi-family loans, past due loans and GSE exposures.  Under the Proposed Rules, residential mortgage loans guaranteed by the U.S. government or its agencies would maintain their current risk-based capital treatment (a risk weight of 0% for those unconditionally guaranteed and a risk weight of 20% for those that are conditionally guaranteed).  All other residential mortgage loans would be separated into “category 1 residential mortgage exposures,” which generally include traditional, first-lien, prudently underwritten mortgage loans, and “category 2 residential mortgage exposures,” which generally include junior-liens, mortgage loans 90 days or more past due or on non-accrual status and non-traditional mortgage products, including interest-only mortgage loans and reduced documentation mortgage loans. The risk weights for category 1 residential mortgage exposures would range from 35% to 100% and risk weights for category 2 residential mortgage exposures would range from 100% to 200%, in each case depending on the loan-to-value ratio of the applicable exposure.  Under the Proposed Rules, multi-family and commercial loans would have a risk weight of 100%, except multi-family loans that satisfy certain criteria would have a risk weight of 50%.  Loans and other exposures, except for residential mortgage loans, that are 90 days or more past due would have a risk weight of 150%, and preferred stock issued by a GSE would have a risk weight of 100% and exposures to GSEs that are not equity exposures would have a risk weight of 20%.  Under the Proposed Rules, this risk weight framework would take effect on January 1, 2015, with an option for early adoption.

 

In October 2012, the OCC published its final rules requiring annual capital-adequacy stress tests for national banks and federal savings associations with consolidated assets of more than $10 billion, which were proposed in January 2012.  Although the final rules became effective on October 9, 2012, the Agencies revised the timeline for implementing the final rules for national banks and federal savings associations with consolidated assets between $10 billion and $50 billion, such as Astoria Federal,

 

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delaying the requirement to perform annual capital-adequacy stress tests until October 2013.  Under the rules, the OCC will provide institutions with economic scenarios, reflecting baseline, adverse and severely adverse conditions.  Astoria Federal will be required to use the scenarios to calculate, for each quarter-end within a nine-quarter planning horizon, the impact of such scenarios on revenues, losses, loan loss reserves and regulatory capital levels and ratios, taking into account all relevant exposures and activities. On or before March 31 of each year beginning in 2014, Astoria Federal will be required to submit a report of the results of its stress test to the OCC and publish a summary of the results between June 15 and June 30 of each year following the submission to the OCC.  The rule also requires each institution to establish and maintain a system of controls, oversight and documentation, including policies and procedures, designed to ensure that the stress testing processes used by the institution are effective in meeting the requirements of the rule.

 

In June 2011, the Agencies also proposed guidance on stress testing for banking organizations with more than $10 billion in total consolidated assets, such as Astoria Federal.  The proposed guidance provides an overview of how a banking organization should structure its stress testing activities and ensure they fit into overall risk management.  The guidance outlines broad principles for a satisfactory stress testing framework and describes the manner in which stress testing should be employed as an integral component of risk management that is applicable at various levels of aggregation within a banking organization, as well as for contributing to capital and liquidity planning.

 

The Federal Deposit Insurance Corporation Improvement Act, or FDICIA, required that the Agencies revise their risk-based capital standards to take into account IRR concentration of risk and the risks of non-traditional activities.  The OCC regulations do not include a specific IRR component of the risk based capital requirement.  However, the OCC expects all federal savings associations to have an independent IRR measurement process in place that measures both earnings and capital at risk, as described in the Advisory on Interest Rate Risk Management, or the IRR Advisory, and a Joint Agency Policy Statement on IRR, or the 1996 IRR policy statement (each described below).

 

In June 1996, the Agencies adopted the 1996 IRR policy statement.  The 1996 IRR policy statement provides guidance to examiners and bankers on sound practices for managing IRR.  The 1996 IRR policy statement also outlines fundamental elements of sound management that have been identified in prior regulatory guidance and discusses the importance of these elements in the context of managing IRR.  Specifically, the guidance emphasizes the need for active board of director and senior management oversight and a comprehensive risk management process that effectively identifies, measures and controls IRR.

 

In January 2010, the Agencies released the IRR Advisory to remind institutions of the supervisory expectations regarding sound practices for managing IRR. While some degree of IRR is inherent in the business of banking, the Agencies expect institutions to have sound risk management practices in place to measure, monitor and control IRR exposures, and IRR management should be an integral component of an institution’s risk management infrastructure. The Agencies expect all institutions to manage their IRR exposures using processes and systems commensurate with their earnings and capital levels, complexity, business model, risk profile and scope of operations, and the IRR Advisory reiterates the importance of effective corporate governance, policies and procedures, risk measuring and monitoring systems, stress testing, and internal controls related to the IRR exposures of institutions.

 

The IRR Advisory encourages institutions to use a variety of techniques to measure IRR exposure which includes simple maturity gap analysis, income measurement and valuation measurement for assessing the impact of changes in market rates as well as simulation modeling to measure IRR exposure. Institutions are encouraged to use the full complement of analytical capabilities of their IRR simulation models. The IRR Advisory also reminds institutions that stress testing, which includes both scenario and sensitivity analysis, is an integral component of IRR management. The IRR Advisory indicates that institutions should regularly assess IRR exposures beyond typical industry conventions, including changes in rates of greater magnitude (for example, up and down 300 and 400 basis points as compared to up and down 200

 

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basis points which is the general practice) across different tenors to reflect changing slopes and twists of the yield curve.

 

The IRR Advisory emphasizes that effective IRR management not only involves the identification and measurement of IRR, but also provides for appropriate actions to control this risk. The adequacy and effectiveness of an institution’s IRR management process and the level of its IRR exposure are critical factors in the Agencies’ evaluation of an institution’s sensitivity to changes in interest rates and capital adequacy.

 

Prompt Corrective Regulatory Action

 

FDICIA established a system of prompt corrective action to resolve the problems of undercapitalized institutions. Under this system, the banking regulators are required to take certain, and authorized to take other, supervisory actions against undercapitalized institutions, based upon five categories of capitalization which FDICIA created: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized,” the severity of which depends upon the institution’s degree of capitalization. Generally, a capital restoration plan must be filed with the OCC within 45 days of the date an association receives notice that it is “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized,” and the plan must be guaranteed by any parent holding company. In addition, various mandatory supervisory actions become immediately applicable to the institution, including restrictions on growth of assets and other forms of expansion.  Under current OCC regulations, generally, a federally chartered savings association is treated as well capitalized if its Total risk-based capital ratio is 10% or greater, its Tier 1 risk-based capital ratio is 6% or greater and its Tier 1 leverage capital ratio is 5% or greater, and it is not subject to any order or directive by the OCC to meet a specific capital level.  As of December 31, 2012, Astoria Federal was considered “well capitalized” by the OCC, with a Total risk-based capital ratio of 16.49%, Tier 1 risk-based capital ratio of 15.23% and Tier 1 leverage capital ratio of 9.24%.

 

Insurance of Deposit Accounts

 

Astoria Federal is a member of the DIF and pays its deposit insurance assessments to the DIF.

 

Effective January 1, 2007, the FDIC established a new risk-based assessment system for determining the deposit insurance assessments to be paid by insured depository institutions.  Under this new assessment system, the FDIC assigns an institution to one of four risk categories, with the first category having two sub-categories, based on the institution’s most recent supervisory ratings and capital ratios. For institutions within Risk Category I, assessment rates generally depend upon a combination of CAMELS (capital adequacy, asset quality, management, earnings, liquidity, sensitivity to market risk) component ratings and financial ratios, or for large institutions with long-term debt issuer ratings, such as Astoria Federal, assessment rates depend on a combination of long-term debt issuer ratings, CAMELS component ratings and financial ratios.  The FDIC has the flexibility to adjust rates, without further notice-and-comment rulemaking, provided that no such adjustment can be greater than three basis points from one quarter to the next, that adjustments cannot result in rates more than three basis points above or below the base rates and that rates cannot be negative.  The FDIC also established 1.25% of estimated insured deposits as the designated reserve ratio of the DIF. In December 2010, the FDIC amended its regulations to increase the designated reserve ratio of the DIF from 1.25% to 2.00% of estimated insured deposits of the DIF effective January 1, 2011.  In December 2012, the FDIC held the designated reserve ratio at 2.00% for 2013.  The FDIC is authorized to change the assessment rates as necessary, subject to the previously discussed limitations, to maintain the designated reserve ratio.

 

As a result of the failures of a number of banks and thrifts, there has been a significant increase in the loss provisions of the DIF.  This resulted in a decline in the DIF reserve ratio during 2008 below the then minimum designated reserve ratio of 1.15%. As a result, the FDIC was required to establish a restoration plan to restore the reserve ratio to 1.15% within a period of five years, which was subsequently extended

 

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to eight years. In order to restore the reserve ratio to 1.15%, the FDIC adopted a final rule in February 2009 which set the initial base assessment rates beginning April 1, 2009 and provided for the following adjustments to an institution’s assessment rate: (1) a decrease for long-term unsecured debt, including most senior and subordinated debt; (2) an increase for secured liabilities above a threshold amount; and (3) for non-Risk Category I institutions, an increase for brokered deposits above a threshold amount.

 

The Reform Act increased the minimum designated reserve ratio for the DIF from 1.15% to 1.35% of insured deposits, which must be reached by September 30, 2020, and provides that in setting the assessments necessary to meet the new requirement, the FDIC shall offset the effect of this provision on insured depository institutions with total consolidated assets of less than $10 billion, so that more of the cost of raising the reserve ratio will be borne by the institutions with more than $10 billion in assets, such as Astoria Federal.  In October 2010, the FDIC adopted a restoration plan to ensure that the DIF reserve ratio reaches 1.35% by September 30, 2020, as required by the Reform Act.  The FDIC is expected to pursue further rulemaking regarding the method that will be used to reach the reserve ratio of 1.35% so that more of the cost of raising the reserve ratio to 1.35% will be borne by institutions with more than $10 billion in assets.

 

In accordance with the Reform Act, on February 7, 2011, the FDIC adopted a final rule that redefines the assessment base for deposit insurance assessments as average consolidated total assets minus average tangible equity, rather than on deposit bases, and adopts a new assessment rate schedule, as well as alternative rate schedules that become effective when the reserve ratio reaches certain levels.  The final rule also makes conforming changes to the unsecured debt and brokered deposit adjustments to assessment rates, eliminates the secured liability adjustment and creates a new assessment rate adjustment for unsecured debt held that is issued by another insured depository institution.

 

The new rate schedule and other revisions to the assessment rules became effective on April 1, 2011.  As revised by the final rule, the initial base assessment rates for depository institutions with total assets of less than $10 billion range from five to nine basis points for Risk Category I institutions and are fourteen basis points for Risk Category II institutions, twenty-three basis points for Risk Category III institutions and thirty-five basis points for Risk Category IV institutions.  However, for large insured depository institutions, generally defined as those with at least $10 billion in total assets, such as Astoria Federal, the final rule eliminated risk categories and the use of long-term debt issuer ratings when calculating the initial base assessment rates and combined CAMELS ratings and financial measures into two scorecards, one for most large insured depository institutions and another for highly complex insured depository institutions, to calculate assessment rates.  A highly complex institution is generally defined as an insured depository institution with more than $50 billion in total assets that is controlled by a parent company with more than $500 billion in total assets. Each scorecard has two components - a performance score and loss severity score, which are combined and converted to an initial assessment rate.  The FDIC has the ability to adjust a large or highly complex insured depository institution’s total score by a maximum of 15 points, up or down based upon significant risk factors that are not captured by the scorecard.  Under the new assessment rate schedule, the initial base assessment rate for large and highly complex insured depository institutions ranges from five to thirty-five basis points, and the total base assessment rate, after applying the unsecured debt and brokered deposit adjustments, ranges from two and one-half to forty-five basis points.

 

Under the Federal Deposit Insurance Reform Act of 2005, institutions that were in existence on December 31, 1996 and paid deposit insurance assessments prior to that date, or were a successor to such an institution, were granted a One-Time Assessment Credit in 2006.  Astoria Federal received a $14.0 million One-Time Assessment Credit which was used to offset 100% of the 2007 deposit insurance assessment and 90% of the 2008 deposit insurance assessment. During the 2009 first quarter, we utilized the remaining balance of this credit.  Our expense for FDIC deposit insurance assessments totaled $46.3 million in 2012 and $36.9 million in 2011.

 

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In November 2009, the FDIC adopted a final rule which required insured depository institutions to prepay their projected quarterly deposit insurance assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012 on December 30, 2009, together with their regular deposit insurance assessment for the third quarter of 2009, which for Astoria Federal totaled $105.7 million.  We utilized the remaining prepaid assessments balance during 2012.

 

The deposit insurance assessment rates are in addition to the assessments for payments on the bonds issued in the late 1980s by the Financing Corporation to recapitalize the now defunct Federal Savings and Loan Insurance Corporation.  The Financing Corporation payments will continue until the bonds mature in 2017 through 2019. Our expense for these payments totaled $1.0 million in 2012 and $1.2 million in 2011.

 

In accordance with certain provisions of the Reform Act, the FDIC adopted rules in November and December 2010 which provided for temporary unlimited insurance coverage of certain non-interest bearing transaction accounts.  Such coverage began on December 31, 2010 and terminated on December 31, 2012.  Beginning January 1, 2013, such accounts are insured under the general deposit insurance coverage rules of the FDIC.

 

Loans to One Borrower

 

Under the HOLA, savings associations are generally subject to the national bank limits on loans to one borrower. Generally, savings associations may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of the institution’s unimpaired capital and surplus. Additional amounts may be loaned, not in excess of 10% of unimpaired capital and surplus, if such loans or extensions of credit are secured by readily-marketable collateral.  Astoria Federal is in compliance with applicable loans to one borrower limitations.  At December 31, 2012, Astoria Federal’s largest aggregate amount of loans to one borrower totaled $54.0 million. All of the loans for the largest borrower were performing in accordance with their terms and the borrower had no affiliation with Astoria Federal.

 

Qualified Thrift Lender Test

 

The HOLA requires savings associations to meet a Qualified Thrift Lender, or QTL, test. Under the QTL test, a savings association is required to maintain at least 65% of its “portfolio assets” (total assets less (1) specified liquid assets up to 20% of total assets, (2) intangibles, including goodwill, and (3) the value of property used to conduct business) in certain “qualified thrift investments” (primarily residential mortgages and related investments, including certain mortgage-backed securities, credit card loans, student loans, and small business loans) on a monthly basis during at least 9 out of every 12 months.  As of December 31, 2012, Astoria Federal maintained in excess of 91% of its portfolio assets in qualified thrift investments and had more than 65% of its portfolio assets in qualified thrift investments for each of the 12 months in the year ended December 31, 2012.  Therefore, Astoria Federal qualified under the QTL test.

 

A savings association that fails the QTL test will immediately be prohibited from: (1) making any new investment or engaging in any new activity not permissible for a national bank, (2) paying dividends, unless such payment would be permissible for a national bank, is necessary to meet the obligations of a company that controls the savings association, and is specifically approved by the OCC and the FRB, and (3) establishing any new branch office in a location not permissible for a national bank in the association’s home state.  A savings association that fails to meet the QTL test is deemed to have violated the HOLA and may be subject to OCC enforcement action.  In addition, if the association does not requalify under the QTL test within three years after failing the test, the association would be prohibited from retaining any investment or engaging in any activity not permissible for a national bank.

 

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Limitation on Capital Distributions

 

The OCC regulations impose limitations upon certain capital distributions by savings associations, such as certain cash dividends, payments to repurchase or otherwise acquire its shares, payments to shareholders of another institution in a cash-out merger and other distributions charged against capital.

 

The OCC regulates all capital distributions by Astoria Federal directly or indirectly to us, including dividend payments.  A subsidiary of a savings and loan holding company, such as Astoria Federal, must file a notice or seek affirmative approval from the OCC at least 30 days prior to each proposed capital distribution. Whether an application is required is based on a number of factors including whether the institution qualifies for expedited treatment under the OCC rules and regulations or if the total amount of all capital distributions (including each proposed capital distribution) for the applicable calendar year exceeds net income for that year to date plus the retained net income for the preceding two years. Currently, Astoria Federal must seek approval from the OCC for future capital distributions.  In addition, as a subsidiary of a savings and loan holding company, Astoria Federal must receive approval from the FRB before declaring a dividend.

 

During 2012, we were required to file applications with the OCC and the FRB for proposed capital distributions, all of which were approved. Astoria Federal paid dividends to Astoria Financial Corporation totaling $40.8 million in 2012.

 

Astoria Federal may not pay dividends to us if, after paying those dividends, it would fail to meet the required minimum levels under risk-based capital guidelines and the minimum leverage and tangible capital ratio requirements or if the dividend would violate a prohibition contained in any statute, regulation or agreement.  Under the Federal Deposit Insurance Act, or FDIA, an insured depository institution such as Astoria Federal is prohibited from making capital distributions, including the payment of dividends, if, after making such distribution, the institution would become “undercapitalized” (as such term is used in the FDIA).  Payment of dividends by Astoria Federal also may be restricted at any time at the discretion of the OCC if it deems the payment to constitute an unsafe and unsound banking practice.

 

Liquidity

 

Astoria Federal maintains sufficient liquidity to ensure its safe and sound operation, in accordance with OCC regulations.

 

Assessments

 

The OCC charges assessments to recover the costs of examining savings associations and their affiliates. These assessments are generally based on an institution’s total assets, with a surcharge for an institution with a composite rating of 3, 4 or 5 in its most recent safety and soundness examination.  Our expense for these assessments totaled $3.6 million in 2012 and $3.2 million in 2011.

 

Branching

 

Federally chartered savings associations may branch nationwide to the extent allowed by federal statute. All of Astoria Federal’s branches are located in New York.

 

Community Reinvestment

 

Under the CRA, as implemented by OCC regulations, a federally chartered savings association has a continuing and affirmative obligation, consistent with its safe and sound operation, to ascertain and meet the credit needs of its entire community, including low and moderate income areas.  The CRA does not establish specific lending requirements or programs for financial institutions, nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its

 

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particular community.  The CRA requires the OCC, in connection with its examination of a federally chartered savings association, to assess the institution’s record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such institution. The assessment focuses on three tests: (1) a lending test, to evaluate the institution’s record of making loans, including community development loans, in its designated assessment areas; (2) an investment test, to evaluate the institution’s record of investing in community development projects, affordable housing, and programs benefiting low or moderate income individuals and areas and small businesses; and (3) a service test, to evaluate the institution’s delivery of banking services throughout its CRA assessment area, including low and moderate income areas.  The CRA also requires all institutions to make public disclosure of their CRA ratings.  Astoria Federal has been rated as “outstanding” over its last seven CRA examinations.  Regulations require that we publicly disclose certain agreements that are in fulfillment of CRA. We have no such agreements in place at this time.

 

Transactions with Related Parties

 

Astoria Federal is subject to the affiliate and insider transaction rules set forth in Sections 23A, 23B, 22(g) and 22(h) of the Federal Reserve Act, or FRA, and Regulation W and Regulation O issued by the FRB.  These provisions, among other things, prohibit, limit or place restrictions upon a savings institution extending credit to, or entering into certain transactions with, its affiliates (which for Astoria Federal would include us and our non-federally chartered savings association subsidiaries, if any), principal stockholders, directors and executive officers.  The Reform act expands the affiliate transaction rules in Sections 23A and 23B of the FRA to broaden the definition of affiliate and to apply this definition to securities lending, repurchase agreement and derivatives activities that Astoria Federal may have with an affiliate. This expansion became effective in July 2012.  In addition, the FRB regulations include additional restrictions on savings associations under Section 11 of HOLA, including provisions prohibiting a savings association from making a loan to an affiliate that is engaged in non-bank holding company activities and provisions prohibiting a savings association from purchasing or investing in securities issued by an affiliate that is not a subsidiary.  The FRB regulations also include certain specific exemptions from these prohibitions. The FRB and the OCC require each depository institution that is subject to Sections 23A and 23B to implement policies and procedures to ensure compliance with Regulation W.

 

Section 402 of the Sarbanes-Oxley Act of 2002, or Sarbanes-Oxley, prohibits the extension of personal loans to directors and executive officers of issuers (as defined in Sarbanes-Oxley).  The prohibition, however, does not apply to loans advanced by an insured depository institution, such as Astoria Federal, that is subject to the insider lending restrictions of Section 22(h) of the FRA.

 

Standards for Safety and Soundness

 

Pursuant to the requirements of FDICIA, as amended by the Riegle Community Development and Regulatory Improvement Act of 1994, the Agencies adopted guidelines establishing general standards relating to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, IRR exposure, asset growth, asset quality, earnings, compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director or principal shareholder. In addition, the OCC adopted regulations pursuant to FDICIA to require a savings association that is given notice by the OCC that it is not satisfying any of such safety and soundness standards to submit a compliance plan to the OCC. If, after being so notified, a savings association fails to submit an acceptable compliance plan or fails in any material respect to implement an accepted compliance plan, the OCC must issue an order directing corrective actions and may issue an order directing other actions of the types to which a significantly undercapitalized institution is subject under the “prompt corrective action” provisions of FDICIA. If a savings association fails to

 

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comply with such an order, the OCC may seek to enforce such order in judicial proceedings and to impose civil money penalties. For further discussion, see “Regulation and Supervision - Federally Chartered Savings Association Regulation - Prompt Corrective Regulatory Action.”

 

Insurance Activities

 

Astoria Federal is generally permitted to engage in certain insurance activities through its subsidiaries. However, Astoria Federal is subject to regulations prohibiting depository institutions from conditioning the extension of credit to individuals upon either the purchase of an insurance product or annuity or an agreement by the consumer not to purchase an insurance product or annuity from an entity that is not affiliated with the depository institution.  The regulations also require prior disclosure of this prohibition to potential insurance product or annuity customers.

 

Privacy Protection

 

Astoria Federal is subject to OCC regulations implementing the privacy protection provisions of the Gramm-Leach Bliley Act, or Gramm-Leach.  These regulations require Astoria Federal to disclose its privacy policy, including identifying with whom it shares “nonpublic personal information,” to customers at the time of establishing the customer relationship and annually thereafter.  The regulations also require Astoria Federal to provide its customers with initial and annual notices that accurately reflect its privacy policies and practices.  In addition, to the extent its sharing of such information is not covered by an exception, Astoria Federal is required to provide its customers with the ability to “opt-out” of having Astoria Federal share their nonpublic personal information with unaffiliated third parties.

 

Astoria Federal is subject to regulatory guidelines establishing standards for safeguarding customer information.  These regulations implement certain provisions of Gramm-Leach.  The guidelines describe the Agencies’ expectations for the creation, implementation and maintenance of an information security program, which would include administrative, technical and physical safeguards appropriate to the size and complexity of the institution and the nature and scope of its activities.  The standards set forth in the guidelines are intended to ensure the security and confidentiality of customer records and information, protect against any anticipated threats or hazards to the security or integrity of such records and protect against unauthorized access to or use of such records or information that could result in substantial harm or inconvenience to any customer.

 

Anti-Money Laundering and Customer Identification

 

Astoria Federal is subject to regulations implementing the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001, or the USA PATRIOT Act. The USA PATRIOT Act gives the federal government powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing and broadened anti-money laundering requirements.  By way of amendments to the Bank Secrecy Act, Title III of the USA PATRIOT Act takes measures intended to encourage information sharing among bank regulatory agencies and law enforcement bodies.  Further, certain provisions of Title III impose affirmative obligations on a broad range of financial institutions, including banks, thrifts, brokers, dealers, credit unions, money transfer agents and parties registered under the Commodity Exchange Act.

 

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Among other requirements, Title III of the USA PATRIOT Act and the related regulations impose the following requirements with respect to financial institutions:

 

·

Establishment of anti-money laundering programs.

·

Establishment of a program specifying procedures for obtaining identifying information from customers seeking to open new accounts, including verifying the identity of customers within a reasonable period of time.

·

Establishment of enhanced due diligence policies, procedures and controls designed to detect and report money laundering.

·

Prohibition on correspondent accounts for foreign shell banks and compliance with recordkeeping obligations with respect to correspondent accounts of foreign banks.

 

In addition, bank regulators are directed to consider a holding company’s effectiveness in combating money laundering when ruling on Bank Holding Company Act and Bank Merger Act applications.

 

Federal Home Loan Bank System

 

Astoria Federal is a member of the FHLB System which consists of twelve regional FHLBs. The FHLB provides a central credit facility primarily for member institutions.  Astoria Federal, as a member of the FHLB-NY, is currently required to acquire and hold shares of the FHLB-NY Class B stock.  The Class B stock has a par value of $100 per share and is redeemable upon five years notice, subject to certain conditions. The Class B stock has two subclasses, one for membership stock purchase requirements and the other for activity-based stock purchase requirements.  The minimum stock investment requirement in the FHLB-NY Class B stock is the sum of the membership stock purchase requirement, determined on an annual basis at the end of each calendar year, and the activity-based stock purchase requirement, determined on a daily basis.  For Astoria Federal, the membership stock purchase requirement is 0.2% of the Mortgage-Related Assets, as defined by the FHLB-NY, which consists principally of residential mortgage loans and mortgage-backed securities including CMOs and REMICs, held by Astoria Federal. The activity-based stock purchase requirement for Astoria Federal is equal to the sum of: (1) 4.5% of outstanding borrowings from the FHLB-NY; (2) 4.5% of the outstanding principal balance of Acquired Member Assets, as defined by the FHLB-NY, and delivery commitments for Acquired Member Assets; (3) a specified dollar amount related to certain off-balance sheet items, which for Astoria Federal is zero; and (4) a specified percentage ranging from 0% to 5% of the carrying value on the FHLB-NY’s balance sheet of derivative contracts between the FHLB-NY and its members, which for Astoria Federal is also zero.  The FHLB-NY can adjust the specified percentages and dollar amount from time to time within the ranges established by the FHLB-NY capital plan.

 

Astoria Federal was in compliance with the FHLB-NY minimum stock investment requirements with an investment in FHLB-NY stock at December 31, 2012 of $171.2 million.  Dividends from the FHLB-NY to Astoria Federal amounted to $7.0 million for the year ended December 31, 2012.

 

Federal Reserve System

 

FRB regulations require federally chartered savings associations to maintain cash reserves against their transaction accounts (primarily NOW and demand deposit accounts).  A reserve of 3% is to be maintained against aggregate transaction accounts between $12.4 million and $79.5 million (subject to adjustment by the FRB) plus a reserve of 10% (subject to adjustment by the FRB between 8% and 14%) against that portion of total transaction accounts in excess of $79.5 million.  The first $12.4 million of otherwise reservable balances (subject to adjustment by the FRB) is exempt from the reserve requirements.  Astoria Federal is in compliance with the foregoing requirements.

 

Required reserves must be maintained in the form of either vault cash, an account at a Federal Reserve Bank or a pass-through account as defined by the FRB.  Pursuant to the Emergency Economic Stabilization Act of 2008, the Federal Reserve Banks pay interest on depository institutions’ required and

 

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excess reserve balances.  The interest rate paid on required reserve balances is currently the average target federal funds rate over the reserve maintenance period.  The rate on excess balances will be set equal to the lowest target federal funds rate in effect during the reserve maintenance period.

 

FHLB System members are also authorized to borrow from the Federal Reserve “discount window,” but FRB regulations require institutions to exhaust all FHLB sources before borrowing from a Federal Reserve Bank.

 

Holding Company Regulation

 

We are a unitary savings and loan holding company within the meaning of the HOLA.  As such, we are registered with the FRB and are subject to the FRB regulations, examinations, supervision and reporting requirements.  In addition, the FRB has enforcement authority over us and our subsidiaries other than Astoria Federal.  Among other things, this authority permits the FRB to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings association.

 

Gramm-Leach also restricts the powers of new unitary savings and loan holding companies. Unitary savings and loan holding companies that are “grandfathered,” i.e., unitary savings and loan holding companies in existence or with applications filed with the OTS on or before May 4, 1999, such as us, retain their authority under the prior law.  All other unitary savings and loan holding companies are limited to financially related activities permissible for financial holding companies, as defined under Gramm-Leach. Gramm-Leach also prohibits non-financial companies from acquiring grandfathered unitary savings and loan holding companies.

 

Except under limited circumstances, a savings and loan holding company is prohibited (directly or indirectly, or through one or more subsidiaries) from (i) acquiring control of another savings association or holding company thereof, or acquiring all or substantially all of the assets thereof, without prior written approval of the FRB; (ii) acquiring or retaining, with certain exceptions, more than 5% of the voting shares a non-subsidiary savings association, a non-subsidiary holding company, or a non-subsidiary company engaged in activities other than those permitted by the HOLA; or (iii) acquiring or retaining control of a depository institution that is not federally insured.  In evaluating applications by holding companies to acquire savings associations, the FRB must consider the financial and managerial resources and future prospects of the company and institution involved, the effect of the acquisition on the risk to the DIF, the convenience and needs of the community and competitive factors.

 

We are currently required to file a notice with the FRB at least 30 days prior to declaring any future cash dividend.  The notice must evidence our compliance with applicable FRB guidance regarding payment of dividends.  This process enables the FRB to comment on, object to or otherwise prohibit us from paying the proposed dividend.  The supervisory guidance issued by the FRB states that we should either eliminate, defer or significantly reduce dividends if (1) our net income available to common shareholders over the past year is insufficient to fully fund a dividend, (2) our prospective rate of earnings retention is not consistent with our capital needs and our overall current or prospective financial condition or (3) we will not meet, or are in danger of not meeting, our minimum regulatory capital adequacy ratios.

 

As discussed above, the Reform Act requires the Agencies to establish consolidated risk-based and leverage capital requirements for insured depository institutions, depository institution holding companies and systemically important nonbank financial companies.  These requirements must be no less than those to which insured depository institutions are currently subject.  In addition, the Reform Act specifically authorizes the FRB to issue regulations relating to capital requirements for savings and loan holding companies.  As a result, by no later than July 2015, we will become subject to consolidated capital requirements which we have not been subject to previously.  In addition, pursuant to the Reform Act, we are required to serve as a source of strength for Astoria Federal.

 

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In October 2012, the FRB published two final rules with stress testing requirements for certain bank holding companies, state member banks, and savings and loan holding companies.  In accordance with these rules, the FRB began conducting supervisory stress tests in the fall of 2012 for the 19 bank holding companies that participated in the 2009 Supervisory Capital Assessment Program and subsequent Comprehensive Capital Analysis and Reviews.  The final rules also required these companies to conduct their own stress tests, with the results to be publicly disclosed in March 2013.

 

In addition to the stress test requirements applicable to these 19 bank holding companies, under the final rules, institutions, such as Astoria Financial Corporation, will be required to conduct annual stress tests as of September 30 of each year.  Institutions with less than $50 billion in assets, such as Astoria Financial Corporation, will be required to submit regulatory reports to the FRB on their stress tests by March 31 of each year.  A summary of the company-run stress tests is required to be published.  The stress test requirement is predicated on a company being subject to consolidated capital requirements and, therefore, the FRB has delayed effectiveness of this requirement for savings and loan holding companies, such as Astoria Financial Corporation, until the FRB has established risk-based capital requirements for such institutions.

 

Federal Securities Laws

 

We are subject to the periodic reporting, proxy solicitation, tender offer, insider trading restrictions and other requirements under the Exchange Act.

 

Delaware Corporation Law

 

We are incorporated under the laws of the State of Delaware.  Thus, we are subject to regulation by the State of Delaware and the rights of our shareholders are governed by the Delaware General Corporation Law.

 

Federal Taxation

 

General

 

We report our income on a calendar year basis using the accrual method of accounting and are subject to federal income taxation in the same manner as other corporations.

 

Corporate Alternative Minimum Tax

 

In addition to the regular income tax, corporations (including savings and loan associations) generally are subject to an alternative minimum tax, or AMT, in an amount equal to 20% of alternative minimum taxable income to the extent the AMT exceeds the corporation’s regular tax.  The AMT is available as a credit against future regular income tax.  We do not expect to be subject to the AMT for federal tax purposes.

 

Tax Bad Debt Reserves

 

Effective for tax years commencing January 1, 1996, federal tax legislation modified the methods by which a thrift computes its bad debt deduction.  As a result, Astoria Federal is required to claim a deduction equal to its actual loan loss experience, and the “reserve method” is no longer available.  Any cumulative reserve additions (i.e., bad debt deductions) in excess of actual loss experience for tax years 1988 through 1995 have been fully recaptured over a six year period.  Generally, reserve balances as of December 31, 1987 will only be subject to recapture upon distribution of such reserves to shareholders.  For further discussion of bad debt reserves, see “Distributions.”

 

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Distributions

 

To the extent that Astoria Federal makes “nondividend distributions” to shareholders, such distributions will be considered to result in distributions from Astoria Federal’s “base year reserve,” (i.e., its tax bad debt reserve as of December 31, 1987), to the extent thereof, and then from its supplemental tax-basis reserve for losses on loans, and an amount based on the amount distributed will be included in Astoria Federal’s taxable income.  Nondividend distributions include distributions in excess of Astoria Federal’s current and accumulated earnings and profits, as calculated for federal income tax purposes, distributions in redemption of stock and distributions in partial or complete liquidation.  However, dividends paid out of Astoria Federal’s current or accumulated earnings and profits will not constitute nondividend distributions and, therefore, will not be included in Astoria Federal’s taxable income.

 

The amount of additional taxable income created from a nondividend distribution is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Thus, approximately one and one-half times the nondividend distribution would be includable in gross income for federal income tax purposes, assuming a 35% federal corporate income tax rate.

 

Dividends Received Deduction and Other Matters

 

We may exclude from our income 100% of dividends received from Astoria Federal as a member of the same affiliated group of corporations.  The corporate dividends received deduction is generally 70% in the case of dividends received from unaffiliated corporations with which we will not file a consolidated tax return, except that if we own more than 20% of the stock of a corporation distributing a dividend, 80% of any dividends received may be deducted.

 

State and Local Taxation

 

The following is a general discussion of taxation in New York State and New York City, which are the two principal tax jurisdictions affecting our operations.

 

New York State Taxation

 

New York State imposes an annual franchise tax on banking corporations, based on net income allocable to New York State, at a rate of 7.1%.  If, however, the application of an alternative minimum tax (based on taxable assets allocated to New York, “alternative” net income, or a flat minimum fee) results in a greater tax, an alternative minimum tax will be imposed.  We were subject to the alternative minimum tax for New York State for the year ended December 31, 2012.  In addition, New York State imposes a tax surcharge of 17.0% of the New York State Franchise Tax, calculated using an annual franchise tax rate of 9.0% (which represents the 2000 annual franchise tax rate), allocable to business activities carried on in the Metropolitan Commuter Transportation District.  These taxes apply to us, Astoria Federal and certain of Astoria Federal’s subsidiaries.  Certain other subsidiaries are subject to a general business corporation tax in lieu of the tax on banking corporations or are subject to taxes of other jurisdictions.  The rules regarding the determination of net income allocated to New York State and alternative minimum taxes differ for these subsidiaries.

 

New York State passed legislation during 2010 to conform the bad debt deduction allowed under Article 32 of the New York State tax law to the bad debt deduction allowed for federal income tax purposes.  As a result, Astoria Federal no longer establishes or maintains a New York reserve for losses on loans and is required to claim a deduction for bad debts in an amount equal to its actual loan loss experience.  In addition, this legislation eliminated the potential recapture of the New York tax bad debt reserve that could have otherwise occurred in certain circumstances under New York State tax law prior to 2010.

 

Fidata qualifies for alternative tax treatment under Article 9A of the New York State tax law as a Connecticut passive investment company.  Fidata maintains an office in Norwalk, Connecticut and

 

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invests in loans secured by real property.  Such loans constitute intangible investments permitted to be held by a Connecticut passive investment company.

 

New York City Taxation

 

Astoria Federal is also subject to the New York City Financial Corporation Tax calculated, subject to a New York City income and expense allocation, on a similar basis as the New York State Franchise Tax.  New York City also enacted legislation during 2010 that is substantially similar to the New York State legislation described above.  A significant portion of Astoria Federal’s entire net income is derived from outside of the New York City jurisdiction which has the effect of significantly reducing the New York City taxable income of Astoria Federal.  We were subject to the alternative minimum tax for New York City (which is similar to the New York State alternative minimum tax) for the year ended December 31, 2012.

 

ITEM 1A.    RISK FACTORS

 

The following is a summary of risk factors relevant to our operations which should be carefully reviewed.  These risk factors do not necessarily appear in the order of importance.

 

Changes in interest rates may reduce our net income.

 

Our earnings depend largely on the relationship between the yield on our interest-earning assets, primarily our mortgage loans and mortgage-backed securities, and the cost of our deposits and borrowings.  This relationship, known as the interest rate spread, is subject to fluctuation and is affected by economic and competitive factors which influence market interest rates, the volume and mix of interest-earning assets and interest-bearing liabilities and the level of non-performing assets.  Fluctuations in market interest rates affect customer demand for our products and services.  We are subject to IRR to the degree that our interest-bearing liabilities reprice or mature more slowly or more rapidly or on a different basis than our interest-earning assets.

 

In addition, the actual amount of time before mortgage loans and mortgage-backed securities are repaid can be significantly impacted by changes in mortgage prepayment rates and market interest rates.  Mortgage prepayment rates will vary due to a number of factors, including the regional economy in the area where the underlying mortgages were originated, seasonal factors, demographic variables and the assumability of the underlying mortgages.  However, the major factors affecting prepayment rates are prevailing interest rates, related mortgage refinancing opportunities and competition.

 

At December 31, 2012, $1.95 billion of our borrowings contain features that would allow them to be called prior to their contractual maturity.  This would generally occur during periods of rising interest rates.  If this were to occur, we would need to either renew the borrowings at a potentially higher rate of interest, which would negatively impact our net interest income, or repay such borrowings.  If we sell securities or other assets to fund the repayment of such borrowings, any decline in estimated market value with respect to the securities or assets sold would be realized and could result in a loss upon such sale.

 

Interest rates do and will continue to fluctuate.  Although we cannot predict future Federal Open Market Committee, or FOMC, or FRB actions or other factors that will cause rates to change, the FOMC has indicated their desire to maintain their accommodative monetary stance at least through mid-2015.  This is a continuation of their efforts of the past few years during which we have seen historic lows on mortgage interest rates and elevated mortgage loan prepayments.  While this may continue, a flat U.S. Treasury yield curve adversely impacts our net interest rate spread and net interest margin.  No assurance can be given that changes in interest rates or mortgage loan prepayments will not have a negative impact on our net interest income, net interest rate spread or net interest margin.

 

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Our results of operations are affected by economic conditions in the New York metropolitan area and nationally.

 

Our retail banking and a significant portion of our lending business (approximately 47% of our residential and 97% of our multi-family and commercial real estate mortgage loan portfolios at December 31, 2012) are concentrated in the New York metropolitan area.  As a result of this geographic concentration, our results of operations largely depend upon economic conditions in this area, although they also depend on economic conditions in other areas.

 

We are operating in a challenging economic environment, both nationally and locally.  Financial institutions continue to be affected by continued softness in the housing and real estate markets.  Depressed real estate values and home sales volumes and financial stress on borrowers as a result of the current economic environment, including elevated unemployment levels, have had an adverse effect on our borrowers, which has adversely affected our results of operations and may continue to do so in the future, as well as adversely affect our financial condition.  In addition, depressed real estate values have adversely affected the value of property used as collateral for our loans.  At December 31, 2012, the average loan-to-value ratio of our mortgage loan portfolio was less than 59% based on current principal balances and original appraised values.  However, no assurance can be given that the original appraised values are reflective of current market conditions as we have experienced significant declines in real estate values in all markets in which we lend.

 

As a residential lender, we are particularly vulnerable to the impact of a severe job loss recession.  Significant increases in job losses and unemployment have a negative impact on the financial condition of residential borrowers and their ability to remain current on their mortgage loans.  Continued weakness or deterioration in national and local economic conditions, including an accelerating pace of job losses, particularly in the New York metropolitan area, could have a material adverse impact on the quality of our loan portfolio, which could result in increases in loan delinquencies, causing a decrease in our interest income as well as an adverse impact on our loan loss experience, causing an increase in our allowance for loan losses and related provision and a decrease in net income.  Such deterioration could also adversely impact the demand for our products and services, and, accordingly, our results of operations.

 

Strong competition within our market areas could hurt our profits and slow growth.

 

Our profitability depends upon our continued ability to compete successfully in our market areas.  The New York metropolitan area has a high density of financial institutions, a number of which are significantly larger and have greater financial resources than we have.  We face intense competition both in making loans and attracting deposits.  Our competition for loans, both locally and nationally, comes principally from commercial banks, savings banks, savings and loan associations, mortgage banking companies and credit unions.  Our most direct competition for deposits comes from commercial banks, savings banks, savings and loan associations and credit unions.  We also face competition for deposits from money market mutual funds and other corporate and government securities funds as well as from other financial intermediaries such as brokerage firms and insurance companies.  Price competition for loans and deposits could result in earning less on our loans and paying more on our deposits, which would reduce our net interest income.  Competition also makes it more difficult to grow our loan and deposit balances.

 

We may not be able to fully execute on our new business initiatives which could have a material adverse effect on our financial condition or results of operations.

 

We have historically been a community-oriented retail bank offering traditional deposit products and focusing on residential mortgage lending. However, the current economic environment has made it difficult for us to profitably grow our business in the same manner as it has in the past. Accordingly, we have been developing strategies to grow other loan categories to diversify earning assets and to increase low cost core deposits. These strategies include continued reliance on our multi-family and commercial

 

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real estate mortgage lending operations and, over time, significantly expanding our business banking operations. Our business banking initiative includes focusing on small and mid-sized businesses, with an emphasis on attracting clients from larger competitors. We are also considering expanding our branch network into other locations on Long Island and opening branches in Manhattan. There are costs, risks and uncertainties associated with the development, implementation and execution of these new initiatives, including the investment of time and resources, the possibility that these initiatives will be unprofitable and the risk of additional liabilities associated with these initiatives. In addition, our ability to successfully execute on these new initiatives will depend in part on our ability to attract and retain talented individuals to help manage these initiatives and the existence of satisfactory market conditions that will allow us to profitably grow these businesses. Our potential inability to successfully execute these initiatives could have a material adverse effect on our business, financial condition or results of operations.  We expect our non-interest expense to increase in connection with the increased staff related to these initiatives and the potential addition of new branches.  We anticipate realizing these costs in advance of realizing increased revenues and deposit growth from these initiatives.

 

Multi-family and commercial real estate lending may expose us to increased lending risks.

 

Our policy generally has been to originate multi-family and commercial real estate mortgage loans in the New York metropolitan area.  At December 31, 2012, multi-family loans totaled $2.41 billion, or 18% of our total loan portfolio, and commercial real estate loans totaled $773.9 million, or 6% of our total loan portfolio.  Multi-family and commercial real estate loans generally involve a greater degree of credit risk than residential loans because they typically have larger balances and are more affected by adverse conditions in the economy.  Because payments on loans secured by multi-family properties and commercial real estate often depend upon the successful operation and management of the properties and the businesses which operate from within them, repayment of such loans may be affected by factors outside the borrower’s control, such as adverse conditions in the real estate market or the economy or changes in government regulation.  At December 31, 2012, non-performing multi-family and commercial real estate loans totaled $17.5 million, or 0.55% of our total portfolio of multi-family and commercial real estate mortgage loans.

 

We have originated multi-family and commercial real estate loans in areas other than the New York metropolitan area.  At December 31, 2012, loans in states other than New York, New Jersey and Connecticut comprised 3% of the total multi-family and commercial real estate loan portfolio.  We could be subject to additional risks with respect to multi-family and commercial real estate lending in areas other than the New York metropolitan area since we have less experience in these areas with this type of lending and less direct oversight of the local market and the borrowers’ operations.

 

Astoria Federal’s ability to pay dividends or lend funds to us is subject to regulatory limitations which, to the extent we need but are not able to access such funds, may prevent us from making future dividend payments or principal and interest payments due on our debt obligations.

 

We are a unitary savings and loan holding company currently regulated by the FRB and almost all of our operating assets are owned by Astoria Federal.  We rely primarily on dividends from Astoria Federal to pay cash dividends to our stockholders, to engage in share repurchase programs and to pay principal and interest on our debt obligations.  The OCC regulates all capital distributions by Astoria Federal directly or indirectly to us, including dividend payments.  As the subsidiary of a savings and loan holding company, Astoria Federal must file a notice with the OCC at least 30 days prior to each capital distribution.  However, if the total amount of all capital distributions (including each proposed capital distribution) for the applicable calendar year exceeds net income for that year to date plus the retained net income for the preceding two years, then Astoria Federal must file an application to receive the approval of the OCC for a proposed capital distribution.  During 2012, we were required to file applications with the OCC for proposed capital distributions and we anticipate that in 2013 we will continue to be required to file such

 

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applications for proposed capital distributions.  In addition, as the subsidiary of a savings and loan holding company, Astoria Federal must also receive approval from the FRB before declaring a dividend.

 

In addition, Astoria Federal may not pay dividends to us if, after paying those dividends, it would fail to meet the required minimum levels under risk-based capital guidelines and the minimum leverage and tangible capital ratio requirements or the OCC notified Astoria Federal that it was in need of more than normal supervision.  Under the prompt corrective action provisions of the FDIA, an insured depository institution such as Astoria Federal is prohibited from making a capital distribution, including the payment of dividends, if, after making such distribution, the institution would become “undercapitalized” (as such term is used in the FDIA).  Payment of dividends by Astoria Federal also may be restricted at any time at the discretion of the OCC if it deems the payment to constitute an unsafe or unsound banking practice.  Furthermore, capital standards imposed on us and similarly situated institutions have been and continue to be refined by bank regulatory agencies under the Reform Act.  Deterioration of economic conditions and further changes to regulatory guidance could result in revised capital standards that may indicate the need for us or Astoria Federal to maintain greater capital positions, which could lead to limitations in dividend payments to us by Astoria Federal.

 

There can be no assurance that Astoria Federal will be able to pay dividends at past levels, or at all, in the future.  If we do not receive sufficient cash dividends or are unable to borrow from Astoria Federal, then we may not have sufficient funds to pay dividends to our shareholders, repurchase our common stock or service our debt obligations.

 

In addition to regulatory restrictions on the payment of dividends, Astoria Federal is subject to certain restrictions imposed by federal law on any extensions of credit it makes to its affiliates and on investments in stock or other securities of its affiliates.  We are considered an affiliate of Astoria Federal.  These restrictions prevent affiliates of Astoria Federal, including us, from borrowing from Astoria Federal, unless various types of collateral secure the loans.  Federal law limits the aggregate amount of loans to and investments in any single affiliate to 10% of Astoria Federal’s capital stock and surplus and also limits the aggregate amount of loans to and investments in all affiliates to 20% of Astoria Federal’s capital stock and surplus.

 

The Reform Act imposes further restrictions on transactions with affiliates and extensions of credit to executive officers, directors and principal shareholders, by, among other things, expanding covered transactions to include securities lending, repurchase agreement and derivatives activities with affiliates.

 

We are subject to regulatory requirements and limitations that may impact our ability to pay future dividends.

 

We are currently required to file a notice with the FRB at least 30 days prior to declaring a cash dividend.  The notice must evidence our compliance with applicable FRB guidance regarding payment of dividends.  This process enables the FRB to comment on, object to or otherwise prohibit us from paying the proposed dividend.   The supervisory guidance issued by the FRB states that we should either eliminate, defer or significantly reduce dividends if (1) our net income available to common shareholders over the past year is insufficient to fully fund a dividend, (2) our prospective rate of earnings retention is not consistent with our capital needs and our overall current or prospective financial condition or (3) we will not meet, or are in danger of not meeting, our minimum regulatory capital adequacy ratios.

 

We operate in a highly regulated industry, which limits the manner and scope of our business activities.

 

We are subject to extensive supervision, regulation and examination by the FRB, OCC, CFPB and FDIC.  As a result, we are limited in the manner in which we conduct our business, undertake new investments and activities and obtain financing.  This regulatory structure is designed primarily for the protection of the DIF and our depositors, as well as other consumers and not to benefit our stockholders.  This

 

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regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to capital levels, the timing and amount of dividend payments, the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes.  In addition, we must comply with significant anti-money laundering and anti-terrorism laws.  Government agencies have substantial discretion to impose significant monetary penalties on institutions which fail to comply with these laws.

 

Changes in laws, government regulation and monetary policy may have a material effect on our results of operations.

 

Financial institutions have been the subject of significant legislative and regulatory changes and may be the subject of further significant legislation or regulation in the future, none of which is within our control.  Significant new laws or regulations or changes in, or repeals of, existing laws or regulations, including those with respect to federal and state taxation, may cause our results of operations to differ materially.  In addition, the costs and burden of compliance have significantly increased and could adversely affect our ability to operate profitably.  Further, federal monetary policy significantly affects credit conditions for Astoria Federal, as well as for our borrowers, particularly as implemented through the Federal Reserve System, primarily through open market operations in U.S. government securities, the discount rate for bank borrowings and reserve requirements.  A material change in any of these conditions could have a material impact on Astoria Federal or our borrowers, and therefore on our results of operations.

 

The regulatory reform legislation that became effective in 2011 has created uncertainty and may have a material effect on our operations and capital requirements.

 

As a result of the financial crisis which occurred in the banking and financial markets commencing in the second half of 2007, the overall bank regulatory climate is now marked by caution, conservatism and a focus on compliance and risk management.  We expect to continue to face increased regulation and supervision of our industry as a result of the financial crisis and there will be additional requirements and conditions imposed on us to the extent that we participate in any of the programs established or to be established by the Treasury or by the Agencies. Such additional regulation and supervision may increase our costs and limit our ability to pursue business opportunities.  In addition, there are many provisions of the Reform Act which are to be implemented through regulations that have not yet been adopted by the Agencies, which creates a risk of uncertainty as to the effect that such provisions will ultimately have.  In addition to the creation of the CFPB, we believe the following provisions of the Reform Act have had or will have the most impact on us:

 

·

The assumption by the OCC of regulatory authority over all federal savings associations, such as Astoria Federal, and the acquisition by the FRB of regulatory authority over all savings and loan holding companies, such as Astoria Financial Corporation, as well as all subsidiaries of savings and loan holding companies other than depository institutions. Although the laws and regulations currently applicable to us generally have not changed by virtue of the elimination of the OTS (except to the extent such laws have been modified by the Reform Act), the application of these laws and regulations may vary as administered by the OCC and the FRB.

·

The significant roll back of the federal preemption of state consumer protection laws that is currently enjoyed by federal savings associations and national banks. As a result, we are subject to state consumer protection laws in each state where we do business, and those laws can be interpreted and enforced differently in different states.

·

The establishment of consolidated risk-based and leverage capital requirements for insured depository institutions, depository institution holding companies and systemically important nonbank financial companies, as discussed below.

·

The increase in the minimum designated reserve ratio for the DIF from 1.15% to 1.35% of insured deposits, which must be reached by September 30, 2020, and the requirement that deposit

 

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insurance assessments be based on average consolidated total assets minus average tangible equity, rather than on deposit bases. As a result of these provisions, our deposit insurance premiums have substantially increased.

 

New and future rulemaking from the Consumer Financial Protection Bureau may have a material effect on our operations and operating costs.

 

The CFPB has the authority to implement and enforce a variety of existing consumer protection statutes and to issue new regulations and, with respect to institutions of our size, has exclusive examination and primary enforcement authority with respect to such laws and regulations.  As an independent bureau within the FRB, the CFPB may impose requirements more severe than the previous bank regulatory agencies.

 

Pursuant to the Reform Act, the CFPB issued a series of final rules in January 2013 related to mortgage loan origination and mortgage loan servicing.  These final rules, most provisions of which become effective January 10, 2014, prohibit creditors, such as Astoria Federal, from extending mortgage loans without regard for the consumer’s ability to repay and add restrictions and requirements to mortgage origination and servicing practices.  In addition, these rules restrict the application of prepayment penalties and compensation practices relating to mortgage loan underwriting.  Compliance with these rules will likely increase our overall regulatory compliance costs and may require us to change our underwriting practices.  Moreover, it is possible that these rules may adversely affect the volume of mortgage loans that we underwrite and may subject Astoria Federal to increased potential liability related to its residential loan origination activities.

 

As a result of the Reform Act and other proposed changes, we may become subject to more stringent capital requirements.

 

The Reform Act requires the federal banking agencies to establish consolidated risk-based and leverage capital requirements for insured depository institutions, depository institution holding companies and systemically important nonbank financial companies. These requirements must be no less than those to which insured depository institutions are currently subject, and the new requirements will effectively eliminate the use of trust preferred securities as a component of tier 1 capital for depository institution holding companies of our size. In addition, the Reform Act specifically authorizes the FRB to issue regulations relating to capital requirements for savings and loan holding companies.  As a result, by no later than July 2015, we will become subject to consolidated capital requirements which we have not been subject to previously.

 

The Agencies issued a notice of proposed rulemaking for three sets of proposed rules during 2012, or the Proposed Rules, which will subject all savings and loan holding companies, including Astoria Financial Corporation, to consolidated capital requirements.  The Proposed Rules would revise the quantity and quality of required minimum risk-based and leverage capital requirements, consistent with the Reform Act and the Basel III capital standards, and revise the FRB’s rules for calculating risk-weighted assets to enhance their risk sensitivity.  The new minimum regulatory capital ratios and changes to the calculation of risk-weighted assets were expected to be phased-in beginning in January 2013; however, the Agencies announced on November 9, 2012, that the Proposed Rules would not become effective in January 2013. At this time, no final rules have been announced or published and no further guidance has been issued by any of the Agencies.  If the Proposed Rules are adopted as proposed, we believe we would have been in compliance with the new minimum capital requirements as of December 31, 2012.

 

The Proposed Rules revise the quantity and quality of capital required by: (1) establishing a new minimum common equity tier 1 ratio of 4.5% of risk-weighted assets; (2) raising the minimum tier 1 capital ratio from 4.0% to 6.0% of risk-weighted assets; (3) maintaining the minimum total capital ratio of 8.0% of risk-weighted assets; and (4) maintaining a minimum tier 1 capital to adjusted average consolidated assets, known as the leverage ratio, of 4.0%.  These changes, as proposed, would have been

 

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phased in incrementally beginning January 1, 2013 to provide time for banking organizations to meet the new capital standards, with full implementation to occur by January 1, 2015.  If the effectiveness of the rules had not been delayed, the required minimum common equity tier 1 capital would have been 3.5% on January 1, 2013, 4.0% on January 1, 2014 and 4.5% on January 1, 2015, and the required minimum tier 1 capital ratio would have been 4.5% on January 1, 2013, 5.5% on January 1, 2014 and 6.0% on January 1, 2015.

 

In addition, the Proposed Rules revise the definition of capital to improve the ability of regulatory capital instruments to absorb losses and revise the FRB rules for calculating risk-weighted assets to enhance risk sensitivity, which will exclude certain non-qualifying capital instruments, including cumulative preferred stock and trust preferred securities, such as our Capital Securities, as a component of tier 1 capital.  Under the Proposed Rules, had effectiveness not been delayed, a depository institution holding company with assets of $15 billion or more would be allowed to include only 75% of non-qualifying capital instruments in regulatory capital as of January 1, 2013, 50% as of January 1, 2014 and 25% as of January 1, 2015.  As of January 1, 2016 and thereafter, no amount of non-qualifying capital instruments would be included in regulatory capital.

 

Furthermore, the Proposed Rules add a requirement for a minimum Conservation Buffer of 2.5% of risk-weighted assets to be applied to the common equity tier 1 capital ratio, the tier 1 capital ratio and the total capital ratio.  Failure to maintain the Conservation Buffer would result in restrictions on capital distributions and certain discretionary cash bonus payments to executive officers.  The required minimum Conservation Buffer would be phased in incrementally, starting at 0.625% on January 1, 2016 and increasing to 1.25% on January 1, 2017, 1.875% on January 1, 2018 and 2.5% on January 1, 2019.  If a banking organization’s Conservation Buffer is less than the required minimum and its net income for the four calendar quarters preceding the applicable calendar quarter, net of any capital distributions, certain discretionary bonus payments and associated tax effects not already reflected in net income, or Eligible Retained Income, is negative, it would be prohibited from making capital distributions or certain discretionary cash bonus payments to executive officers.  As a result, under the Proposed Rules, if adopted, should Astoria Federal fail to maintain the Conservation Buffer we would be subject to limits on, and in the event Astoria Federal has negative Eligible Retained Income for any four consecutive calendar quarters, we would be prohibited in, our ability to obtain capital distributions from Astoria Federal.  If we do not receive sufficient cash dividends from Astoria Federal, then we may not have sufficient funds to pay dividends, repurchase our common stock or service our debt obligations.

 

Moreover, the Proposed Rules revise existing and establish new risk weights for certain exposures, including, among other exposures, residential mortgage loans, commercial loans, which generally include commercial real estate loans, multi-family loans, past due loans and GSE exposures.  Under the Proposed Rules, residential mortgage loans guaranteed by the U.S. government or its agencies would maintain their current risk-based capital treatment (a risk weight of 0% for those unconditionally guaranteed and a risk weight of 20% for those that are conditionally guaranteed).  All other residential mortgage loans would be separated into “category 1 residential mortgage exposures,” which generally include traditional, first-lien, prudently underwritten mortgage loans, and “category 2 residential mortgage exposures,” which generally include junior-liens, mortgage loans 90 days or more past due or on non-accrual status and non-traditional mortgage products, including interest-only mortgage loans and reduced documentation mortgage loans. The risk weights for category 1 residential mortgage exposures would range from 35% to 100% and risk weights for category 2 residential mortgage exposures would range from 100% to 200%, in each case depending on the loan-to-value ratio of the applicable exposure.  Under the Proposed Rules, multi-family and commercial loans would have a risk weight of 100%, except multi-family loans that satisfy certain criteria would have a risk weight of 50%.  Loans and other exposures, except for residential mortgage loans, that are 90 days or more past due would have a risk weight of 150%, and preferred stock issued by a GSE would have a risk weight of 100% and exposures to GSEs that are not equity exposures would have a risk weight of 20%.  Under the Proposed Rules, this risk weight framework would take effect on January 1, 2015, with an option for early adoption.

 

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In October 2012, the OCC published its final rules requiring annual capital-adequacy stress tests for national banks and federal savings associations with consolidated assets of more than $10 billion, which were proposed in January 2012.  Although the final rules became effective on October 9, 2012, the Agencies revised the timeline for implementing the final rules for national banks and federal savings associations with consolidated assets between $10 billion and $50 billion, such as Astoria Federal, delaying the requirement to perform annual capital-adequacy stress tests until October 2013.  Under the rules, the OCC will provide institutions with economic scenarios, reflecting baseline, adverse and severely adverse conditions. Astoria Federal will be required to use the scenarios to calculate, for each quarter-end within a nine-quarter planning horizon, the impact of such scenarios on revenues, losses, loan loss reserves and regulatory capital levels and ratios, taking into account all relevant exposures and activities. On or before March 31 of each year beginning in 2014, Astoria Federal will be required to submit a report of the results of its stress test to the OCC and publish a summary of the results between June 15 and June 30 of each year following the submission to the OCC.  The rule also requires each institution to establish and maintain a system of controls, oversight and documentation, including policies and procedures, designed to ensure that the stress testing processes used by the institution are effective in meeting the requirements of the rule.

 

In October 2012, the FRB published two final rules with stress testing requirements for certain bank holding companies, state member banks, and savings and loan holding companies.  In accordance with these rules, the FRB began conducting supervisory stress tests in the fall of 2012 for the 19 bank holding companies that participated in the 2009 Supervisory Capital Assessment Program and subsequent Comprehensive Capital Analysis and Reviews.  The final rules also required these companies to conduct their own stress tests, with the results to be publicly disclosed in March 2013.  In addition to the stress test requirements applicable to these 19 bank holding companies, under the final rules, institutions, such as Astoria Financial Corporation, will be required to conduct annual stress tests as of September 30 of each year.  Institutions with less than $50 billion in assets, such as Astoria Financial Corporation, are required to submit regulatory reports to the FRB on their stress tests by March 31 of each year.  A summary of the company-run stress tests is required to be published. The stress test requirement is predicated on a company being subject to consolidated capital requirements and, therefore, the FRB will delay effectiveness of this requirement for savings and loan holding companies, such as Astoria Financial Corporation, until the FRB has established risk-based capital requirements for such institutions.

 

While we are continuing to review the impact of the Reform Act, Basel III and the related proposed rulemaking, there can be no assurance that the Reform Act and the Proposed Rules, if adopted, will not have a material impact on our business, financial condition and results of operations.

 

Our transition to the OCC as Astoria Federal’s primary banking regulator and the FRB as our holding company regulator may increase our compliance costs.

 

On July 21, 2011, the OTS was eliminated and the OCC took over the regulation of all federal savings associations, including Astoria Federal.  The FRB also acquired the OTS’s authority over all savings and loan holding companies, including Astoria Financial Corporation.  Consequently, we are now subject to regulation, supervision and examination by the OCC and the FRB, rather than the OTS.  Additionally, the CFPB supervises our compliance with consumer protection laws.  As a result of becoming subject to regulation by these three entities and in light of the overall enhanced regulatory scrutiny in our industry, we have enhanced various systems and added staff to keep up with the operational and regulatory burden associated with an institution of our size.  For example, we have, among other things, established and commenced implementing (a) a comprehensive enterprise risk management program, including the creation of an Enterprise Risk Management Department and an Enterprise Risk Management Committee of the Board of Directors of each of Astoria Federal and Astoria Financial Corporation, and (b) a comprehensive compliance management program, including the creation of a centralized Corporate Compliance Department.  These enhancements have resulted in and will continue to result in additional investments in both technology and staffing that are likely to increase our non-interest expense.  Moreover, as our regulators adopt implementing regulations and guidance with respect to their

 

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supervision of federal savings banks, we must evaluate and may need to further modify various policies and procedures, further enhance our technology and staffing to ensure continued compliance with this regulatory burden.

 

Our ability to originate residential mortgage loans for portfolio has been adversely affected by the increased competition resulting from the unprecedented involvement of the U.S. government and GSEs in the residential mortgage market.

 

Over the past few years, we have faced increased competition for residential mortgage loans due to the unprecedented involvement of the GSEs in the mortgage market as a result of the economic crisis, which has caused the interest rate for thirty year fixed rate mortgage loans that conform to GSE guidelines to remain artificially low.  In addition, the U.S. Congress has expanded the conforming loan limits in many of our operating markets, allowing larger balance loans to continue to be acquired by the GSEs.  As a result, more loans in our portfolio qualified under the expanded conforming loan limits and were refinanced into conforming fixed rate mortgages which we originate but do not retain for portfolio.  Our residential mortgage loan repayments have remained at elevated levels and outpaced our loan production as a result of these factors, making it difficult for us to grow our residential mortgage loan portfolio and balance sheet.

 

The ultimate resolution of Fannie Mae and Freddie Mac may materially impact our results of operations.

 

Both Fannie Mae and Freddie Mac are under conservatorship with the Federal Housing Finance Agency.  On February 11, 2011, the Obama administration presented the U.S. Congress with a report of its proposals for reforming America’s housing finance market with the goal of scaling back the role of the U.S. government in, and promoting the return of private capital to, the mortgage markets and ultimately winding down Fannie Mae and Freddie Mac.  Without mentioning a specific time frame, the report calls for  the reduction of the role of Fannie Mae and Freddie Mac in the mortgage markets by, among other things, reducing conforming loan limits, increasing guarantee fees and requiring larger down payments by borrowers.  The report presents three options for the long-term structure of housing finance, all of which call for the unwinding of Fannie Mae and Freddie Mac and a reduced role of the government in the mortgage market: (1) a system with U.S. government insurance limited to a narrowly targeted group of borrowers; (2) a system similar to (1) above except with an expanded guarantee during times of crisis; and (3) a system where the U.S. government offers catastrophic reinsurance for the securities of a targeted range of mortgages behind significant private capital.  We cannot be certain if or when Fannie Mae and Freddie Mac will be wound down, if or when reform of the housing finance market will be implemented or what the future role of the U.S. government will be in the mortgage market, and, accordingly, we will not be able to determine the impact that any such reform may have on us until a definitive reform plan is adopted.

 

Changes in the fair value of our securities may reduce our stockholders’ equity and net income.

 

At December 31, 2012, $336.3 million of our securities were classified as available-for-sale.  The estimated fair value of our available-for-sale securities portfolio may increase or decrease depending on changes in interest rates.  In general, as interest rates rise, the estimated fair value of our fixed rate securities portfolio will decrease.  Our securities portfolio is comprised primarily of fixed rate securities.  We increase or decrease stockholders’ equity by the amount of the change in the unrealized gain or loss (difference between the estimated fair value and the amortized cost) of our available-for-sale securities portfolio, net of the related tax effect, under the category of accumulated other comprehensive income/loss.  Therefore, a decline in the estimated fair value of this portfolio will result in a decline in reported stockholders’ equity, as well as book value per common share and tangible book value per common share.  This decrease will occur even though the securities are not sold.  In the case of debt securities, if these securities are never sold, the decrease will be recovered over the life of the securities.

 

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We conduct a periodic review and evaluation of the securities portfolio to determine if the decline in the fair value of any security below its cost basis is other-than-temporary. Factors which we consider in our analysis include, but are not limited to, the severity and duration of the decline in fair value of the security, the financial condition and near-term prospects of the issuer, whether the decline appears to be related to issuer conditions or general market or industry conditions, our intent and ability to not sell the security for a period of time sufficient to allow for any anticipated recovery in fair value and the likelihood of any near-term fair value recovery.  We generally view changes in fair value caused by changes in interest rates as temporary, which is consistent with our experience.  If we deem such decline to be other-than-temporary, the security is written down to a new cost basis and the resulting loss is charged to earnings as a component of non-interest income, except for the amount of the total other-than-temporary impairment, or OTTI, for a debt security that does not represent credit losses which is recognized in other comprehensive income/loss, net of applicable taxes.

 

We have, in the past, recorded OTTI charges.  We continue to monitor the fair value of our securities portfolio as part of our ongoing OTTI evaluation process.  No assurance can be given that we will not need to recognize OTTI charges related to securities in the future.

 

Declines in the market value of our common stock may have a material effect on the value of our reporting unit which could result in a goodwill impairment charge and adversely affect our results of operations.

 

At December 31, 2012, the carrying amount of our goodwill totaled $185.2 million.  We performed our annual goodwill impairment test as of September 30, 2012 and determined there was no goodwill impairment as of our annual impairment test date.  We would test our goodwill for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of our reporting unit below its carrying amount.  No events have occurred and no circumstances have changed since our annual impairment test date that would more likely than not reduce the fair value of our reporting unit below its carrying amount.  Our market capitalization is less than our total stockholders’ equity at December 31, 2012.  We considered this and other factors in our goodwill impairment analyses.  No assurance can be given that we will not record an impairment loss on goodwill in a subsequent period.  However, our tangible capital ratio and Astoria Federal’s regulatory capital ratios would not be affected by this potential non-cash expense.

 

A natural disaster could harm our business.

 

Astoria Federal’s primary market area was affected by Hurricane Sandy in October 2012.  Although Hurricane Sandy did not have a material adverse effect on our operations, financial condition or results of operations, a similar or worse natural disaster could have a material adverse effect.  Natural disasters can disrupt our operations, result in damage to our properties, reduce or destroy the value of the collateral for our loans and negatively affect the local economies in which we operate, which could have a material adverse effect on our results of operations and financial condition.  The occurrence of a natural disaster could result in one or more of the following: (i) an increase in loan delinquencies; (ii) an increase in problem assets and foreclosures; (iii) a decrease in the demand for our products and services; or (iv) a decrease in the value of the collateral for loans, especially real estate, in turn reducing customers’ borrowing power, the value of assets associated with problem loans and collateral coverage.

 

ITEM 1B.     UNRESOLVED STAFF COMMENTS

 

None.

 

ITEM 2.       PROPERTIES

 

We operate 85 full-service banking offices, of which 50 are owned and 35 are leased.  We own our principal executive office located in Lake Success, New York.  We are obligated under a lease

 

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commitment through 2017 for our residential mortgage operating facility in Mineola, New York.  At December 31, 2012, approximately two-thirds of this facility was sublet.  We are obligated under an operating lease commitment through 2021 for office space in Jericho, New York to house our multi-family and commercial real estate lending and business banking departments and other operations.  We lease office facilities for our wholly-owned subsidiaries Fidata in Norwalk, Connecticut, and Suffco in Farmingdale, New York.  We believe such facilities are suitable and adequate for our operational needs.  For further information regarding our lease obligations, see Item 7, “MD&A” and Note 10 of Notes to Consolidated Financial Statements in Item 8, “Financial Statements and Supplementary Data.”

 

ITEM 3.       LEGAL PROCEEDINGS

 

In the ordinary course of our business, we are routinely made a defendant in or a party to pending or threatened legal actions or proceedings which, in some cases, seek substantial monetary damages from or other forms of relief against us.  In our opinion, after consultation with legal counsel, we believe it unlikely that such actions or proceedings will have a material adverse effect on our financial condition, results of operations or liquidity.

 

City of New York Notice of Determination

By “Notice of Determination” dated September 14, 2010 and August 26, 2011, the City of New York has notified us of alleged tax deficiencies in the amount of $13.3 million, including interest and penalties, related to our 2006 through 2008 tax years.  The deficiencies relate to our operation of two subsidiaries of Astoria Federal, Fidata and AF Mortgage.  Fidata is a passive investment company which maintains offices in Connecticut.  AF Mortgage is an operating subsi