10-K 1 stl-2013x930xmaster10k.htm 10-K STL-2013-9.30- Master 10K
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________ 
FORM 10-K
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended September 30, 2013 Commission File Number: 001-35385
________________________
STERLING BANCORP
(Exact name of Registrant as Specified in its Charter)
Delaware
 
80-0091851
(State or Other Jurisdiction of
Incorporation or Organization)
 
(IRS Employer
Identification Number)
 
 
 
400 Rella Blvd., Montebello, New York
 
10901
(Address of Principal Executive Office)
 
(Zip Code)
(845) 369-8040
(Registrant’s Telephone Number including Area Code)
Securities Registered Pursuant to Section 12(b) of the Act:
Title of Class
 
Name of Each Exchange On Which Registered
Common Stock, par value $0.01 per share
 
New York Stock Exchange
Cumulative Trust Preferred Securities 8.375% (Liquidation Amount $10 per Preferred Security) of Sterling Bancorp Trust I and Guarantee of Sterling Bancorp with respect thereto
 
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  ¨    NO  ý
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.    YES  ¨     NO  ý
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve 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  ý    NO  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for shorter period that the registrant was required to submit and post such files)   YES  ý     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 Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K.    ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer — See definition of “accelerated and large accelerated filer” in Rule 12b-2 of the Exchange Act (check one).
Large Accelerated Filer
o
 
 
Accelerated Filer
 
x
Non-Accelerated Filer
o
 
 
Smaller Reporting Company
 
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   YES  ¨     NO  ý
The aggregate market value of the voting stock held by non-affiliates of the Registrant, computed by reference to the closing price of the common stock as of March 31, 2013 was $294,182,103
As of December 5, 2013 there were 83,867,873 outstanding shares of the Registrant’s common stock.
___________________________________
DOCUMENT INCORPORATED BY REFERENCE
Proxy Statement for the Annual Meeting of Stockholders (Part III) to be filed within 120 days after the end of the Registrant’s fiscal year ended September 30, 2013.
 



STERLING BANCORP
FORM 10-K TABLE OF CONTENTS
September 30, 2013
 
PART I
 
 
ITEM 1.
ITEM 1A.
ITEM 1B.
ITEM 2.
ITEM 3.
ITEM 4.
PART II
 
 
ITEM 5.
ITEM 6.
ITEM 7.
ITEM 7A.
ITEM 8.
ITEM 9.
ITEM 9A.
ITEM 9B.
PART III
 
 
ITEM 10.
ITEM 11.
ITEM 12.
ITEM 13.
ITEM 14.
PART IV
 
 
ITEM 15.
SIGNATURES
 



PART I
ITEM 1.
Business

Sterling Bancorp
Sterling Bancorp (“Sterling” or the “Company”) is a Delaware corporation that owns all of the outstanding shares of common stock of Sterling National Bank (the “Bank”). At September 30, 2013, the Company had, on a consolidated basis, $4.0 billion in assets, $3.0 billion in deposits and stockholders’ equity of $482.9 million. As of September 30, 2013, the Company had 44,351,046 shares of common stock outstanding. Our financial condition and results of operations are discussed herein on a consolidated basis with the Bank.

Merger with Sterling Bancorp
On October 31, 2013, Provident New York Bancorp completed its acquisition of Sterling Bancorp (“Legacy Sterling”). In connection with the merger, Provident New York Bancorp completed the following corporate actions:

Legacy Sterling merged with and into Provident New York Bancorp. Provident New York Bancorp was the accounting acquirer and the surviving entity.
Provident New York Bancorp changed its legal entity name to Sterling Bancorp and became a bank holding company and a financial holding company as defined by the Bank Holding Company Act of 1956, as amended.
Provident Bank converted to a national bank charter.
Sterling National Bank merged into Provident Bank.
Provident Bank changed its legal entity name to Sterling National Bank.
Provident Municipal Bank merged into Sterling National Bank.

We refer to the transactions detailed above collectively as the “Merger”.

The Merger was a stock-for-stock transaction valued at $457.8 million based on the closing price of Provident New York Bancorp common stock on October 31, 2013. Under the terms of the Merger, each share of Legacy Sterling was converted into the right to receive 1.2625 shares of Provident New York Bancorp common stock. Consistent with our strategy of expanding in the greater New York metropolitan region, we believe the Merger creates a larger, more diversified company that will accelerate the build-out of our differentiated strategy targeting small-to-middle market commercial clients and consumers. See additional disclosure regarding the Merger with Sterling Bancorp in Note 22. Subsequent Events to the consolidated financial statements.

As of June 30, 2013, the date of Legacy Sterling’s last publicly available financial statements, Legacy Sterling had total assets of $2.7 billion, total loans including loans held for sale of $1.8 billion, and total deposits of $2.2 billion.

Sterling National Bank
The Bank is a growing full-service bank founded in 1888. Headquartered in Montebello, New York, the Bank is the principal subsidiary of the Company and accounts for substantially all of the Company’s consolidated assets and net income. As of September 30, 2013, the Bank had $4.0 billion in assets, $3.0 billion in deposits and 477 full-time equivalent employees. The Bank specializes in the delivery of services and solutions to business owners, their families and consumers in communities within the greater New York metropolitan region through 16 teams of dedicated relationship managers and 34 full-service financial centers.

Subsidiaries
The Company and the Bank maintain a number of wholly-owned subsidiaries, including two real estate investment trusts that hold real estate mortgage loans, several subsidiaries that hold foreclosed properties acquired by the Bank, a Vermont captive insurance company and other subsidiaries that have an immaterial impact on the financial condition or results of operations of the Company.

Senior Notes Capital Raise
In connection with the Merger, the Company completed the offering of $100 million of its senior notes due 2018 (the “Senior Notes”) on July 2, 2013. The Senior Notes, which bear interest at 5.50% annually, were issued under an indenture dated July 2, 2013 (the “Indenture”) between the Company and U.S. Bank National Association, as trustee. The Senior Notes were sold in a private placement and resold by the initial purchasers to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933 (the “Securities Act”).

The Senior Notes are unsecured obligations of the Company and rank equally with all other unsecured unsubordinated indebtedness, and will be effectively subordinated to any secured indebtedness to the extent of the value of the collateral securing such indebtedness, and structurally subordinated to the existing and future indebtedness of the Company’s subsidiaries. Interest on the Senior Notes will be payable on January 2 and July 2 beginning on January 2, 2014. Interest will be calculated on the basis of a 360-day year of twelve 30-day months. The Senior Notes will mature on July 2, 2018.

1



Additional Information
Sterling’s website (www.sterlingbancorp.com) contains a direct link to the Company’s filings with the Securities and Exchange Commission (“SEC”), including copies of annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to these filings, registration statements on Form S-4, as well as ownership reports on Forms 3, 4 and 5 filed by the Company’s directors and executive officers. Copies may also be obtained, without charge, by written request to Sterling Bancorp, 400 Rella Boulevard, Montebello, New York 10901, Attention: Investor Relations. Sterling’s website is not part of this Annual Report on Form 10-K.

Forward-Looking Statements
From time to time the Company has made and may continue to make written or oral forward-looking statements regarding our outlook or expectations for earnings, revenues, expenses, capital levels, asset quality or other future financial or business performance, strategies or expectations, or the impact of legal, regulatory or supervisory matters on our business operations or performance. This Annual Report on Form 10-K also includes forward-looking statements. With respect to all such forward-looking statements, you should review our risk Factors discussion in Item 1A. Risk Factors and our Cautionary Statement Regarding Forward-Looking Information included in Item 7.

Strategy
The Company operates as a regional bank providing a broad offering of deposit, lending and wealth management products to commercial, consumer and municipal clients in its market area. The Company seeks to differentiate itself by focusing on the following principles:
 
Prioritize client relationships over transactions.
Compete on service experience versus price superiority.
Deploy a single point of contact, holistic view of the client relationship.
Focus on defined customer segments and geographic markets.
Maximize efficiency through a technology enabled low-cost operating platform.
Maintain strong risk management systems.

Our strategic objectives include generating sustainable growth in revenues and earnings by expanding client acquisitions, improving asset quality and increasing operating efficiency. To achieve these goals we are: 1) focusing on high value client segments; 2) expanding our delivery and distribution channels; 3) creating a high productivity performance culture; 4) closely monitoring operating costs; and 5) proactively managing enterprise risk.
 
We focus on delivering products and services to small-to-middle market commercial businesses and affluent consumers.  We believe that this is a client segment that is undeserved by larger bank competitors in our market area.

The Bank targets the following geographic markets: the New York Metro Market, which includes Manhattan and Long Island; and the New York Suburban Market, which consists of Rockland, Orange, Sullivan, Ulster, Putnam and Westchester counties in New York and Bergen County in New Jersey. We believe the Bank operates in an attractive footprint that presents us with significant opportunities to execute our strategy. Based on data from Oxxford Information Technology, we estimate the total number of small-to-middle market businesses in our footprint exceeds 550 thousand.

We deploy a team-based distribution strategy in which clients are served by a focused and experienced group of relationship managers that are responsible for all aspects of the client relationship and delivery of our products and services. A significant portion of the Bank’s growth in 2013 was driven by the recruitment of new teams. As of September 30, 2013, the Bank had 16 commercial banking teams. We expect to continue to grow deposits and loan balances through the addition of new teams.

The Bank focuses on building broad client relationships by providing superior customer service allowing us to gather low cost, core deposits and originate high quality loans. The Bank maintains a disciplined pricing strategy on deposits that allows us to compete for loans while maintaining an appropriate spread over funding costs. We offer diverse loan products to commercial businesses, real estate owners, developers and consumers. In 2013, we continued to emphasize growth in our commercial loan balances;  as a result, we believe that we have developed a high quality, diversified loan portfolio with a favorable mix of loan types, maturities and yields. 
 
The Company augments organic growth with opportunistic acquisitions. Between fiscal 2002 and August 2012, the Company completed six acquisitions, including: National Bank of Florida in 2002; Ellenville National Bank in 2004; Warwick Community Bancorp in 2005; a branch office of HSBC Bank USA in 2005; Hudson Valley Investment Advisors in 2007; and Gotham Bank of New York in August 2012. On October 31, 2013, the Company completed the acquisition of Legacy Sterling. These acquisitions have supported the expansion of the Company into attractive markets and diversified businesses. See additional disclosure of our acquisitions in Note 2. Acquisitions and Note 22. Subsequent Events to the consolidated financial statements.

2



Lending Activities
General. Our commercial banking teams focus on the origination of commercial real estate loans and commercial & industrial loans. We also originate residential mortgage loans and consumer loans such as home equity lines of credit, homeowner loans and personal loans in our market area. We sell many of the residential mortgage loans we originate and we enter into loan participations in some commercial loans for portfolio management purposes.

Commercial Real Estate Lending. We originate real estate loans secured predominantly by first liens on commercial real estate. The underlying collateral of our commercial real estate loans consists of multi-family properties, retail properties including shopping centers and strip centers, office buildings, nursing homes, industrial and warehouse properties, hotels, motels, restaurants, and schools. To a lesser extent we originate commercial real estate loans for medical use, non-profits, gas stations and other categories. We may, from time to time, purchase commercial real estate loan participations. At September 30, 2013, loans secured by commercial real estate totaled $1.3 billion, or 52.9% of our total loan portfolio. Substantially all of our commercial real estate loans are secured by properties located in our primary market area.

The majority of our commercial real estate loans have a term of ten years and are structured as five-year fixed rate loans with a rate adjustment for the second five-year period or as ten-year fixed-rate loans. Amortization on these loans is typically based on 20 to 25 year terms with balloon maturities generally in five or ten years. Interest rates on commercial real estate loans generally range from 200 basis points to 300 basis points above a reference index.

In the underwriting of commercial real estate loans, we generally lend up to 75% of the appraised value. Decisions to lend are based on the economic viability of the property and the creditworthiness of the borrower. In evaluating a proposed commercial real estate loan, we primarily emphasize the ratio of the projected net cash flow to the debt service requirement (generally targeting a minimum ratio of 120%), computed after deductions for a vacancy factor and property expenses we deem appropriate. In addition, a personal guarantee of the loan or a portion thereof is generally required from the principal(s) of the borrower, except for loans secured by multi-family properties. We require title insurance insuring the priority of our lien, fire and extended coverage casualty insurance, and flood insurance, if appropriate, in order to protect our security interest in the underlying property.

Commercial real estate loans typically involve significant loan balances concentrated with single borrowers or groups of related borrowers. In addition, the payment experience on loans secured by income-producing properties typically depends on the successful operation of the related real estate project and may be subject to adverse conditions in the real estate market and in the general economy. For commercial real estate loans in which the borrower is a significant tenant, repayment experience also depends on the successful operation of the borrower’s underlying business.

Commercial & Industrial Lending. We make various types of secured and unsecured commercial & industrial loans to businesses in our market area for the purpose of financing working capital, the acquisition of equipment, business expansion, and other business purposes. The terms of these loans generally range from less than one year to seven years. The loans are either structured on a fixed-rate basis or carry adjustable interest rates indexed to a lending rate that is determined internally, or a short-term market rate index. At September 30, 2013, we had commercial & industrial loans outstanding with an aggregate balance of $439.8 million, or 18.2% of our total loan portfolio.

Underwriting of a commercial & industrial loan is based on an assessment of the applicant’s willingness and ability to repay in accordance with the proposed terms as well as an overall assessment of the risks involved. This includes an evaluation of the applicant to determine character and capacity to manage. Personal guarantees of the principals are generally required, except in the case of not-for-profit corporations. In addition to an evaluation of the loan applicant’s financial statements, we analyze the adequacy of the primary and secondary sources of repayment to be relied upon in the transaction. Credit agency reports of the applicant’s credit history supplement the analysis of the applicant’s creditworthiness. Checking with other banks and trade investigations may also be conducted. Collateral supporting a secured transaction also is analyzed to determine its marketability.

Residential Mortgage Lending. We offer conforming and non-conforming, fixed-rate and adjustable-rate ( “ARM”) residential mortgage loans with maturities up to 30 years and maximum loan amounts generally up to $4.0 million that are fully amortizing with monthly or bi-weekly loan payments. Our residential mortgage loan portfolio totaled $400.0 million, or 16.6% of our total loan portfolio at September 30, 2013.

Residential mortgage loans are generally underwritten according to Fannie Mae and Freddie Mac guidelines for loans they designate as acceptable for purchase. Loans that conform to such guidelines are referred to as “conforming loans.” We generally originate fixed-rate loans in amounts up to the maximum conforming loan limits as established by Fannie Mae and Freddie Mac, which are currently $417 thousand in many locations in the continental U.S. and are $625.5 thousand in high-cost areas such as New York City and surrounding counties in which we originate the majority of our residential mortgage loans. Private mortgage insurance is generally required for loans

3


with loan-to-value ratios in excess of 80%. In order to manage our exposure to rising interest rates, we sell the majority of our conforming fixed rate residential mortgage loans to government sponsored entities such as Fannie Mae and Freddie Mac. We realized proceeds from the sale of residential mortgage loans totaling $94.1 million and $79.1 million for the fiscal years ended September 30, 2013 and 2012, respectively.

We also originate loans above conforming limits, referred to as “jumbo loans,” which have been underwritten to substantially the same credit standards as conforming loans. These loans are generally intended to be held in our residential mortgage loan portfolio. Our bi-weekly residential mortgage loans result in shorter repayment schedules than conventional monthly mortgage loans, and are repaid through an automatic deduction from the borrower’s savings or checking account. We retain the servicing rights on a majority of loans sold. As of September 30, 2013, loans serviced for others, excluding loan participations, totaled $249.0 million. Effective October 1, 2013, we transferred the servicing function for residential mortgage loans we own and service for others to a nationally recognized mortgage loan servicer. We anticipate the transfer will have a neutral to modestly positive impact on operating expenses and will better position the Company to grow its residential mortgage lending business.

We currently offer several ARM loan products secured by residential properties with rates that are fixed for a period ranging from six months to ten years. After the initial term, if the loan is not already refinanced, the interest rate on these loans generally resets every year based upon a contractual spread or margin above the average yield on U.S. Treasury securities, adjusted to a constant maturity of one year, as published weekly by the Federal Reserve Board and subject to certain periodic and lifetime limitations on interest rate changes. Many of the borrowers who select these loans have shorter-term credit needs than those who select long-term, fixed-rate loans. ARM loans generally pose different credit risks than fixed-rate loans primarily because the underlying debt service payments of the borrowers rise as interest rates rise, thereby increasing the potential for default.

We require title insurance on all of our residential mortgage loans, and we also require that borrowers maintain fire and extended coverage or all risk casualty insurance (and, if appropriate, flood insurance) in an amount at least equal to the lesser of the loan balance or the replacement cost of the improvements, but in any event in an amount calculated to avoid the effect of any coinsurance clause. Residential mortgage loans generally are required to have a mortgage escrow account from which disbursements are made for real estate taxes and for hazard and flood insurance.

Acquisition, Development and Construction Lending. We originate acquisition, development and construction (“ADC”) loans to builders in our market area. Since 2011, the Company has deemphasized this lending activity and we currently originate ADC loans on an exception basis. ADC loans totaled $102.5 million, or 4.2% of our total loan portfolio at September 30, 2013.

ADC loans help finance the purchase of land intended for further development, including single-family homes, multi-family housing, and commercial income properties. In some cases, we have made an acquisition loan before the borrower received approval to develop the land as planned; however, we did not originate any such loans in fiscal 2013. In general, the maximum loan-to-value ratio for a land acquisition loan is 50% of the appraised value of the property, although higher loan-to-value ratios may be allowed for certain borrowers we deem to be lower risk. We also fund development loans to builders in our market area to finance improvements to real estate, consisting mainly of single-family subdivisions, typically to finance the cost of utilities, roads, sewers and other development costs. Builders generally rely on the sale of single-family homes to repay development loans, although in some cases the improved building lots may be sold to another builder. The maximum loan amount is generally limited to the cost of the improvements plus limited approval of soft costs subject to an overall loan-to-value limitation. In general, we do not originate loans with interest reserves. Advances are made in accordance with a schedule reflecting the cost of the improvements.

We also make construction loans to finance the cost of completing homes on the improved property. Advances on construction loans are made in accordance with a schedule reflecting the cost of construction. Repayment of construction loans on residential subdivisions is normally expected from the sale of units to individual purchasers except in cases of owner occupied construction loans. In the case of income-producing property, repayment is usually expected from permanent financing upon completion of construction. We provide permanent mortgage financing on most of our construction loans on income-producing property. Collateral coverage and risk profile are maintained by restricting the number of model or speculative units in each project.

ADC lending exposes us to greater credit risk than permanent mortgage financing. The repayment of ADC loans generally depends on the sale of the property to third parties or the availability of permanent financing upon completion of all improvements. In the event we make an acquisition loan on property that is not yet approved for the planned development, there is the risk that approvals will not be granted or will be delayed. These events may adversely affect the borrower and the collateral value of the property. Development and construction loans also expose us to the risk that improvements will not be completed on time in accordance with specifications and projected costs. In addition, the ultimate sale or rental of the property may not occur as anticipated.


4


Consumer Lending. We originate a variety of consumer loans, including homeowner loans, home equity lines of credit, new and used automobile loans, and personal unsecured loans, including fixed-rate installment loans and variable lines of credit. As of September 30, 2013, consumer loans totaled $193.6 million or 8.1% of the total loan portfolio.

We offer fixed-rate, fixed-term second mortgage loans, referred to as homeowner loans, and we also offer adjustable-rate home equity lines of credit secured by junior liens on residential properties. As of September 30, 2013, homeowner loans totaled $29.1 million or 1.2% of our total loan portfolio. The disbursed portion of home equity lines of credit totaled $157.3 million, or 6.5% of our total loan portfolio at September 30, 2013, with $99.6 million remaining undisbursed.

Loan Portfolio Composition. The following table sets forth the composition of our loan portfolio, excluding loans held for sale, by type of loan at the periods indicated.
 
 
September 30,
 
2013
 
2012
 
2011
 
2010
 
2009
 
Amount
 
%
 
Amount
 
%
 
Amount
 
%
 
Amount
 
%
 
Amount
 
%
 
(Dollars in thousands)
Residential mortgage
$
400,009

 
16.6
%
 
$
350,022

 
16.5
%
 
$
389,765

 
22.9
%
 
$
434,900

 
25.5
%
 
$
460,728

 
27.0
%
Commercial real estate
1,277,037

 
52.9

 
1,072,504

 
50.6

 
703,356

 
41.4

 
579,232

 
34.0

 
546,767

 
32.1

Commercial & industrial
439,787

 
18.2

 
343,307

 
16.2

 
209,923

 
12.3

 
217,927

 
12.8

 
242,629

 
14.2

Acquisition, development & construction
102,494

 
4.2

 
144,061

 
6.8

 
175,931

 
10.3

 
231,258

 
13.6

 
201,611

 
11.9

Total commercial loans
1,819,318

 
75.3

 
1,559,872

 
73.6

 
1,089,210

 
64.0

 
1,028,417

 
60.4

 
991,007

 
58.2

Consumer
193,571

 
8.1

 
209,578

 
9.9

 
224,824

 
13.1

 
238,224

 
14.1

 
251,522

 
14.8

Total loans
2,412,898

 
100.0
%
 
2,119,472

 
100.0
%
 
1,703,799

 
100.0
%
 
1,701,541

 
100.0
%
 
1,703,257

 
100.0
%
Allowance for loan losses
(28,877
)
 
 
 
(28,282
)
 
 
 
(27,917
)
 
 
 
(30,843
)
 
 
 
(30,050
)
 
 
Total loans, net
$
2,384,021

 
 
 
$
2,091,190

 
 
 
$
1,675,882

 
 
 
$
1,670,698

 
 
 
$
1,673,207

 
 

Loan Portfolio Maturities and Yields. The following table summarizes the scheduled repayments of our loan portfolio at September 30, 2013. Demand loans, loans having no stated repayment schedule or maturity, and overdraft loans are reported as being due in one year or less. Weighted average rates are computed based on the rate of the loan at September 30, 2013.
 
 
Residential mortgage
 
Commercial  real estate
 
Commercial & industrial
 
Acquisition, development & construction
 
Consumer
 
Total
 
Amount
 
Rate
 
Amount
 
Rate
 
Amount
 
Rate
 
Amount
 
Rate
 
Amount
 
Rate
 
Amount
 
Rate
 
(Dollars in thousands)
Maturing within:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 
 
< 1 year
$
5,923

 
4.63
%
 
$
69,858

 
4.96
%
 
$
147,755

 
4.96
%
 
$
40,336

 
4.48
%
 
$
4,105

 
13.48
%
 
$
267,977

 
4.43
%
2-5 years
21,802

 
4.53

 
329,997

 
4.66

 
110,768

 
4.66

 
44,158

 
4.52

 
6,760

 
6.96

 
513,485

 
4.52

> 5 years
372,284

 
4.57

 
877,182

 
4.48

 
181,264

 
4.48

 
18,000

 
3.09

 
182,706

 
4.29

 
1,631,436

 
4.42

Total loans
$
400,009

 
4.57
%
 
$
1,277,037

 
4.55
%
 
$
439,787

 
4.55
%
 
$
102,494

 
4.25
%
 
$
193,571

 
4.58
%
 
$
2,412,898

 
4.44
%


5


The following table sets forth the composition of fixed-rate and adjustable-rate loans at September 30, 2013 that are contractually due after September 30, 2014:
 
 
Fixed
 
Adjustable
 
Total
 
(Dollars in thousands)
Residential mortgage
$
229,263

 
$
164,823

 
$
394,086

Commercial real estate
615,491

 
591,688

 
1,207,179

Commercial & industrial
140,129

 
151,903

 
292,032

Acquisition, development & construction
8,644

 
53,514

 
62,158

Total commercial loans
764,264

 
797,105

 
1,561,369

Consumer
34,757

 
154,709

 
189,466

Total loans
$
1,028,284

 
$
1,116,637

 
$
2,144,921



Loan Approval/Authority and Underwriting. The Board of Directors has established the Credit Risk Committee (the “CRC”) to oversee the lending functions of the Bank. The CRC oversees the performance of the Bank’s loan portfolio and its various components, assists in the development of strategic initiatives to enhance portfolio performance, and considers matters for approval and recommendation to the Board of Directors.

The Management Credit Committee (the “MCC”) consists of the Chief Executive Officer, Chief Risk Officer, Chief Credit Officer, and other senior lending personnel. The MCC is authorized to approve loans within the existing policy limits established by the Board of Directors. For loans that are not within policy guidelines but are nonetheless deemed desirable, the MCC may recommend approval to the CRC, which in turn may recommend approval to the Board.

The MCC may also authorize lending authority to individual Bank officers for both single and dual initial approval authority. Other than overdrafts, the only single initial lending authorities are for credit secured small business loans up to $250,000 and up to $500,000 if secured by residential property. Two loan officers with sufficient authority acting together may approve loans up to $3 million.

We have established a risk rating system for our commercial & industrial loans, commercial real estate loans and ADC loans. The risk rating system assesses a variety of factors to rank the risk of default and risk of loss associated with the loan. These ratings are assessed by commercial credit personnel who do not have responsibility for loan originations. We determine our maximum loan-to-one-borrower limits based on the rating of the loan. The majority of our loans fall into four categories. The maximum for the best-rated borrowers is $20 million, $15 million for the next group of borrowers, $12 million for the third group and $6 million for the last group. Sub-limits apply based on reliance on any single property, and for commercial business loans. On occasion, the Board of Directors may approve higher exposure limits for loans to one borrower in an amount not to exceed the legal lending limit of the Bank. The Board may also authorize the Chief Risk Officer, or Management Credit Committee to approve loans for specific borrowers up to a designated Board approved limit in excess of the policy limit, for that borrower.

In connection with our residential mortgage and commercial real estate loans, we generally require property appraisals to be performed by independent appraisers who are approved by the Board. Appraisals are then reviewed by the appropriate loan underwriting areas. Under certain conditions, appraisals may not be required for loans under $250,000 or in other limited circumstances. We also require title insurance, hazard insurance and, if indicated, flood insurance on property securing mortgage loans. Title insurance is not required for consumer loans under $100,000, such as home equity lines of credit and homeowner loans and in connection with certain residential mortgage refinances.

Loan Origination Fees and Costs. In addition to interest earned on loans, we may collect loan origination fees. Such fees vary with the volume and type of loans and commitments made, and competitive conditions in the marketplace, which in turn respond to the demand and availability of funding. We defer loan origination fees and costs, and amortize such amounts as an adjustment to yield over the term of the loan using the level yield method. Deferred loan origination costs (net of deferred fees) were $1.2 million at September 30, 2013.

To the extent that originated residential mortgage loans are sold with servicing retained, we capitalize a mortgage servicing asset at the time of the sale. The capitalized amount is amortized thereafter (over the period of estimated net servicing income) as a reduction of servicing fee income. The unamortized amount is fully charged to income when loans are prepaid. Originated mortgage servicing rights with an amortized cost of $2.0 million are included in other assets at September 30, 2013.


6


Loans to One Borrower. At September 30, 2013, our five largest aggregate amounts loaned to any one borrower and certain related interests (including any unused lines of credit) consisted of secured and unsecured financing of $24.8 million, $24.0 million, $22.6 million, $21.2 million and $18.0 million. In addition, we have 52 relationships with an amount loaned of $10 million or more, with an aggregate exposure of $706.5 million. See “Regulation — Loans to One Borrower” for a discussion of applicable regulatory limitations.

Delinquent Loans, Troubled Debt Restructuring, Impaired Loans, Other Real Estate Owned and Classified Assets
Collection Procedures for Residential and Commercial Mortgage Loans and Consumer Loans. A late payment notice is generated after the 16th day of the loan payment due date requesting the payment due plus any late charge assessed. Legal action, notwithstanding ongoing collection efforts, is generally initiated after 90 days of the original due date for failure to make payment. Unsecured consumer loans are generally charged-off after 120 days. For commercial loans, procedures vary depending on individual circumstances.

Loans Past Due and Non-Performing Assets. Loans are reviewed on a regular basis and are placed on non-accrual status when full payment of principal or interest is in doubt, or when either principal or interest is 90 days or more past due, unless the loan is well secured and in the process of collection. Interest accrued and unpaid at the time a loan is placed on non-accrual status is reversed against interest income. Interest payments received on non-accrual loans are generally applied to the principal balance of the outstanding loan. However, based on an assessment of the borrower’s financial condition and payment history, an interest payment may be applied to interest income on a cash basis. Appraisals are performed at least annually on classifieds loans. At September 30, 2013, we had non-accrual loans of $22.8 million, and we had $4.1 million of loans 90 days past due and still accruing interest which were well secured and in the process of collection. At September 30, 2012, we had non-accrual loans of $35.4 million and $4.4 million of loans 90 days past due and still accruing interest.

Impaired Loans. A loan is impaired when it is probable the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans are based on one of three measures — the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent. If the measure of an impaired loan is less than its recorded investment, the Company may write-down a portion of the loan against the allowance for loan losses or a portion of the allowance for loan losses may be allocated so that the loan is reported net of its specific allowance. Impaired loans generally include a portion of classified loans, non-performing loans and accruing and performing troubled debt restructured loans. At September 30, 2013, we had $36.8 million in impaired loans with $1.6 million in specific allowances.

Troubled Debt Restructuring. The Company has formally modified loans to certain borrowers who experienced financial difficulty. If the terms of the modification include a concession, as defined by accounting principles generally accepted in the U.S., the loan is considered a troubled debt restructuring (“TDR”), which are also considered impaired loans. Nearly all of these loans are secured by real estate. Total TDRs were $26.1 million at September 30, 2013, of which $2.2 million were non-accrual and $23.9 million were performing according to terms and still accruing interest income. TDRs still accruing interest income are loans modified for borrowers that are experiencing one or more financial difficulties and are still performing in accordance with the terms of their loan prior to the modification. Loan modifications include actions such as extension of maturity date or the lowering of interest rates and monthly payments. Commitments to lend additional funds to borrowers with loans that have been modified were $4.1 million at September 30, 2013.

Other Real Estate Owned. Real estate acquired as a result of foreclosure or by deed in lieu of foreclosure is classified as other real estate owned (“OREO”) until such time as it is sold. When real estate is acquired through foreclosure or by deed in lieu of foreclosure, it is recorded at the lower of our investment in the loan or fair value less cost to sell. If the fair value less cost to sell is less than the loan balance, the difference is charged against the allowance for loan losses. At September 30, 2013, we had 23 OREO properties with a recorded balance of $6.0 million. After transfer to OREO we regularly update the fair value of the property. Subsequent declines in fair value are charged to current earnings and included in other non-interest expense as part of other real estate owned expense.

Classification of Assets. Our policies, consistent with regulatory guidelines, provide for the classification of loans and other assets that are considered to be of lesser quality such as substandard, doubtful, or loss assets. An asset is considered substandard if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Substandard assets include those characterized by the distinct possibility that the Bank 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, 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 is not warranted and are charged-off. Assets that do not expose us to risk sufficient to warrant classification in one of the aforementioned categories, but which possess potential weaknesses that deserve our close attention, are designated as “special mention”. As of September 30, 2013, we had $13.5 million of assets designated as “special mention”.

Our determination as to the classification of our assets and the amount of our loss allowance are subject to review by our regulators, which can order the establishment of an additional loan loss allowance. Management regularly reviews our asset portfolio to determine

7


whether any assets require classification in accordance with applicable regulations. On the basis of management’s review of our assets at September 30, 2013, classified assets consisted of loans of $61.1 million, OREO of $6.0 million, and $3.6 million of private label mortgage-backed securities.

Loan Portfolio Delinquencies. The following table sets forth certain information on our loan portfolio delinquencies at the dates indicated.
 
 
Loans delinquent for
 
 
 
 
 
30-89 Days
 
90 days or more still
accruing & non-accrual
 
Total
 
Number
 
Amount
 
Number
 
Amount
 
Number
 
Amount
 
(Dollars in thousands)
At September 30, 2013:
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage
6
 
$
621

 
52
 
$
9,316

 
58
 
$
9,937

Commercial real estate
8
 
4,335

 
26
 
8,769

 
34
 
13,104

Commercial & industrial
5
 
180

 
8
 
789

 
13
 
969

Acquisition, development & construction
2
 
768

 
11
 
5,420

 
13
 
6,188

Consumer
14
 
566

 
28
 
2,612

 
42
 
3,178

Total
35
 
$
6,470

 
125
 
$
26,906

 
160
 
$
33,376

At September 30, 2012:
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage
10
 
$
1,352

 
56
 
$
11,314

 
66
 
$
12,666

Commercial real estate
7
 
1,875

 
30
 
10,453

 
37
 
12,328

Commercial & industrial
7
 
237

 
2
 
344

 
9
 
581

Acquisition, development & construction
9
 
7,067

 
29
 
15,404

 
38
 
22,471

Consumer
22
 
1,816

 
21
 
2,299

 
43
 
4,115

Total
55
 
$
12,347

 
138
 
$
39,814

 
193
 
$
52,161

At September 30, 2011:
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage
8
 
$
1,212

 
40
 
$
7,976

 
48
 
$
9,188

Commercial real estate
4
 
1,105

 
34
 
13,214

 
38
 
14,319

Commercial & industrial
2
 
490

 
3
 
243

 
5
 
733

Acquisition, development & construction
4
 
4,265

 
24
 
16,984

 
28
 
21,249

Consumer
20
 
794

 
26
 
2,150

 
46
 
2,944

Total
38
 
$
7,866

 
127
 
$
40,567

 
165
 
$
48,433

At September 30, 2010:
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage
1
 
$
113

 
36
 
$
8,033

 
37
 
$
8,146

Commercial real estate
4
 
1,469

 
26
 
9,857

 
30
 
11,326

Commercial & industrial
2
 
3,403

 
6
 
1,376

 
8
 
4,779

Acquisition, development & construction
2
 
6,681

 
11
 
5,730

 
13
 
12,411

Consumer
27
 
681

 
22
 
1,844

 
49
 
2,525

Total
36
 
$
12,347

 
101
 
$
26,840

 
137
 
$
39,187

At September 30, 2009:
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage
2
 
$
390

 
32
 
$
7,357

 
34
 
$
7,747

Commercial real estate
2
 
398

 
24
 
6,803

 
26
 
7,201

Commercial & industrial
18
 
999

 
8
 
457

 
26
 
1,456

Acquisition, development & construction
1
 
366

 
20
 
11,270

 
21
 
11,636

Consumer
22
 
494

 
13
 
582

 
35
 
1,076

Total
45
 
$
2,647

 
97
 
$
26,469

 
142
 
$
29,116



8


Risk Elements. The table below sets forth the amounts and categories of our non-performing assets at the dates indicated.
 
 
September 30,
 
2013
 
2012
 
2011
 
2010
 
2009
 
(Dollars in thousands)
Non-performing loans:
 
 
 
 
 
 
 
 
 
Residential mortgage
$
7,484

 
$
9,051

 
$
7,485

 
$
6,080

 
$
4,425

Commercial real estate
7,195

 
8,815

 
11,225

 
6,886

 
5,826

Commercial & industrial
500

 
344

 
243

 
1,376

 
457

Acquisition, development & construction
5,420

 
15,404

 
16,538

 
5,730

 
10,830

Consumer
2,208

 
1,830

 
986

 
1,341

 
371

Accruing loans past due 90 days or more
4,099

 
4,370

 
4,090

 
5,427

 
4,560

Total non-performing loans
26,906

 
39,814

 
40,567

 
26,840

 
26,469

OREO
6,022

 
6,403

 
5,391

 
3,891

 
1,712

Total non-performing assets
$
32,928

 
$
46,217

 
$
45,958

 
$
30,731

 
$
28,181

TDRs accruing and not included above
$
23,895

 
$
14,077

 
$
8,470

 
$
16,047

 
$
674

Ratios:
 
 
 
 
 
 
 
 
 
Non-performing loans to total loans
1.12
%
 
1.87
%
 
2.38
%
 
1.58
%
 
1.55
%
Non-performing assets to total assets
0.81

 
1.15

 
1.46

 
1.02

 
0.93


For the year ended September 30, 2013, gross interest income that would have been recorded had the non-accrual loans at the end of the year remained on accrual status throughout the year amounted to $635 thousand. Interest income actually recognized on such loans totaled $374 thousand.

Allowance for Loan Losses. We believe the allowance for loan losses is critical to the understanding of our financial condition and results of operations. Selection and application of this “critical accounting policy” involves judgments, estimates, and uncertainties that are susceptible to change. In the event that different assumptions or conditions were to occur, and depending upon the severity of such changes, materially different financial condition or results of operations is a reasonable possibility. In addition, as an integral part of their examination process, our regulatory agencies periodically review the allowance for loan losses. Such agencies may require us to recognize additions to the allowance based on their judgments of information available to them at the time of their examination.

We maintain our allowance for loan losses at a level that the Company believes is adequate to absorb probable losses inherent in the existing loan portfolio based on an evaluation of the collectibility of loans, underlying collateral, geographic and other concentrations, and prior loss experience. We use a risk rating system to evaluate the adequacy of the allowance for loan losses. With this system, each loan, with the exception of those included in large groups of smaller-balance homogeneous loans, is risk rated between one and ten, by credit administration, loan review or loan committee, with one being the best case and ten being a loss or the worst case. Loans with risk ratings between six and nine are monitored more closely by the credit administration team and may result in specific valuation allowances. We calculate an average loss estimate by loan type that is a twelve quarter average for commercial loans and eight quarter average for consumer loans. To the loss estimate we apply individual qualitative loss factors that result in an overall loss factor at an appropriate level for the allowance for loan losses for a particular loan type. These qualitative loss factors are determined by management, based on historical loss experience for the applicable loan category, and are adjusted to reflect our evaluation of:

levels of, and trends in, delinquencies and non-accruals;
trends in volume and terms of loans;
effects of any changes in lending policies and procedures;
experience, ability, and depth of lending management and staff;
national and local economic trends and conditions;
concentrations of credit by such factors as location, industry, inter-relationships, and borrower; and
for commercial loans, trends in risk ratings.

The allowance for loan losses also includes an element for estimated probable but undetected losses. All loan losses are charged to the related allowance and all recoveries are credited to it. The Company analyzes loans by two broad segments or classes: real estate secured loans and loans that are either unsecured or secured by other collateral. The segments or classes considered real estate secured are:

9


residential mortgage loans; commercial real estate loans; ADC loans; homeowner loans, and home equity lines of credit. The segments or classes considered unsecured or secured by other than real estate collateral are: commercial & industrial loans, and consumer loans. Commercial loan segments and residential mortgage loans over $500,000 are reviewed for impairment once they are past due 90 days or more, or are classified substandard or doubtful. If a loan is deemed to be impaired in one of the real estate secured segments, it is generally considered collateral dependent. If the value of the collateral securing a collateral dependent impaired loan is less than the carrying value of the loan, a charge-off is recognized equal to the difference between the appraised value and the book value of the loan. In addition, impairment reserves are recognized for estimated costs to hold and to liquidate the collateral. The ranges for the costs to hold and liquidate are 12-22% for the following segments: commercial real estate, residential and ADC loans and 7-13% for homeowner loans and home equity lines of credit. Impaired loans in the real estate secured segments are re-appraised using a summary or drive-by appraisal report every six to nine months.

For loans in the consumer segment we charge-off the full amount of the loan when it becomes 90 to 120 days or more past due, or earlier in the case of bankruptcy, after giving effect to any cash or marketable securities pledged as collateral for the loan. For loans in the commercial & industrial loan segment, we conduct a cash flow projection, and charge-off the difference between the net present value of the cash flows discounted at the effective note rate and the carrying value of the loan, and generally recognize a 10% impairment reserve to account for the imprecision of our estimates. 

ADC lending exposes us to greater credit risk than permanent mortgage financing. The repayment of ADC loans depends on the sale of the property to third parties or the availability of permanent financing upon completion of all improvements. In the event we make an acquisition loan on property that is not yet approved for the planned development, there is the risk that approvals will not be granted or will be delayed. These events may adversely affect the borrower and the collateral value of the property. ADC loans also expose us to the risk that improvements will not be completed on time in accordance with specifications and projected costs. In addition, the ultimate sale or rental of the property may not occur as anticipated. All of these factors are considered as part of the underwriting, structuring and pricing of the loan. We have deemphasized this type of loan.

Commercial real estate loans subject us to the risks that the property securing the loan may not generate sufficient cash flow to service the debt or the borrower may use the cash flow for other purposes. In addition, the foreclosure process, if necessary, may be slow and properties may deteriorate in the process. The market values are also subject to a wide variety of factors, including general economic conditions, industry specific factors, environmental factors, interest rates and the availability and terms of credit.

Commercial & industrial lending also exposes us to risk because repayment depends on the successful operation of the business which is subject to a wide range of risks and uncertainties. In addition, the ability to successfully liquidate collateral, if any, is subject to a variety of risks because we must gain control of assets used in the borrower’s business before foreclosing which we cannot be assured of doing, and the value in a foreclosure sale or other means of liquidation may be uncertain.


10


Allowance for Loan Losses. The following table sets forth activity in our allowance for loan losses for the years indicated.
 
 
September 30,
 
2013
 
2012
 
2011
 
2010
 
2009
 
(Dollars in thousands)
Balance at beginning of period
$
28,282

 
$
27,917

 
$
30,843

 
$
30,050

 
$
23,101

Charge-offs:
 
 
 
 
 
 
 
 
 
Residential mortgage
(2,547
)
 
(2,551
)
 
(2,140
)
 
(749
)
 
(461
)
Commercial real estate
(3,725
)
 
(2,707
)
 
(1,802
)
 
(987
)
 
(902
)
Commercial & industrial
(1,354
)
 
(1,526
)
 
(5,400
)
 
(6,578
)
 
(7,271
)
Acquisition, development & construction
(3,422
)
 
(4,124
)
 
(8,939
)
 
(848
)
 
(1,515
)
Consumer
(2,009
)
 
(1,901
)
 
(1,989
)
 
(1,168
)
 
(1,140
)
Total charge-offs
(13,057
)
 
(12,809
)
 
(20,270
)
 
(10,330
)
 
(11,289
)
Recoveries:
 
 
 
 
 
 
 
 
 
Residential mortgage
101

 
356

 
15

 
3

 
2

Commercial real estate
577

 
528

 
2

 
23

 

Commercial & industrial
410

 
1,116

 
605

 
670

 
249

Acquisition, development & construction
182

 
299

 
10

 
261

 
200

Consumer
232

 
263

 
128

 
166

 
187

Total recoveries
1,502

 
2,562

 
760

 
1,123

 
638

Net charge-offs
(11,555
)
 
(10,247
)
 
(19,510
)
 
(9,207
)
 
(10,651
)
Provision for loan losses
12,150

 
10,612

 
16,584

 
10,000

 
17,600

Balance at end of period
$
28,877

 
$
28,282

 
$
27,917

 
$
30,843

 
$
30,050

Ratios:
 
 
 
 
 
 
 
 
 
Net charge-offs to average loans outstanding
0.52
%
 
0.56
%
 
1.17
%
 
0.56
%
 
0.62
%
Allowance for loan losses to non-performing loans
107

 
71

 
69

 
115

 
114

Allowance for loan losses to total loans
1.20

 
1.48

 
1.64

 
1.81

 
1.76


Allocation of Allowance for Loan Losses. The following tables set forth the allowance for loan losses allocated by loan category, the total loan balances by category (excluding loans held for sale), and the percent of loans in each category to total loans at the dates indicated. The allowance for loan losses allocated to each category is not necessarily indicative of future losses in any particular category and does not restrict the use of the allowance to absorb losses in other categories.
 
September 30,
 
2013
 
2012
 
2011
 
Allowance
for loan
losses
 
Loan
balance
 
% of total loans
 
Allowance
for loan
losses
 
Loan
balance
 
% of total loans
 
Allowance
for loan
losses
 
Loan
balance
 
% of total loans
 
(Dollars in thousands)
Residential mortgage
$
4,474

 
$
400,009

 
16.6
%
 
$
4,359

 
$
350,022

 
16.5
%
 
$
3,498

 
$
389,765

 
22.9
%
Commercial real estate
9,967

 
1,277,037

 
52.9

 
7,230

 
1,072,504

 
50.6

 
5,568

 
703,356

 
41.4

Commercial & industrial
5,302

 
439,787

 
18.2

 
4,603

 
343,307

 
16.2

 
5,945

 
209,923

 
12.3

Acquisition, development & construction
5,806

 
102,494

 
4.2

 
8,526

 
144,061

 
6.8

 
9,895

 
175,931

 
10.3

Consumer
3,328

 
193,571

 
8.1

 
3,564

 
209,578

 
9.9

 
3,011

 
224,824

 
13.1

Total
$
28,877

 
$
2,412,898

 
100.0
%
 
$
28,282

 
$
2,119,472

 
100.0
%
 
$
27,917

 
$
1,703,799

 
100.0
%
 

11


 
September 30,
 
2010
 
2009
 
Allowance
for loan
losses
 
Loan
balance
 
% of total loans
 
Allowance
for loan
losses
 
Loan
balance
 
% of total loans
 
(Dollars in thousands)
Residential mortgage
$
2,641

 
$
434,900

 
25.6
%
 
$
3,106

 
$
460,728

 
27.1
%
Commercial real estate
5,915

 
579,231

 
34.0

 
7,695

 
546,767

 
32.1

Commercial & industrial
8,970

 
217,928

 
12.8

 
8,928

 
242,629

 
14.2

Acquisition, development & construction
9,752

 
231,258

 
13.6

 
7,680

 
201,611

 
11.8

Consumer
3,565

 
238,224

 
14.0

 
2,641

 
251,522

 
14.8

Total
$
30,843

 
$
1,701,541

 
100.0
%
 
$
30,050

 
$
1,703,257

 
100.0
%

Investment Securities
Our investment securities policy is reviewed and approved by our Board of Directors. This policy dictates that investment decisions be made based on the safety of the investment, liquidity requirements, potential returns, cash flow targets, and consistency with our interest rate risk management strategy. The Board’s Enterprise Risk Committee oversees our investment program and evaluates our investment policy and objectives. Our Chief Financial Officer, Chief Executive Officer, Treasurer and certain other senior officers have the authority to purchase and sell securities within specific guidelines established in the investment policy. In addition, a summary of all transactions is reviewed by the Enterprise Risk Committee at least quarterly.

Our current investment policy generally permits investments in debt securities issued by the U.S. government and U.S. agencies, municipal bonds and notes, and corporate debt obligations, as well as investments in preferred and common stock of government agencies and government sponsored enterprises such as Fannie Mae, Freddie Mac and the Federal Home Loan Bank (federal agency securities) and, to a lesser extent, other equity securities. Securities in these categories are classified as “investment securities” for financial reporting purposes. The policy also permits investments in mortgage-backed securities, including pass-through securities issued and guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae as well as collateralized mortgage obligations (“CMOs”) issued or backed by securities issued by these government agencies. Also permitted are investments in securities issued or backed by the Small Business Administration, privately issued mortgage-backed securities and CMOs, and asset-backed securities collateralized by auto loans, credit card receivables, and home equity and home improvement loans. Our current investment strategy uses a risk management approach of diversified investing in fixed-rate securities with short- to intermediate-term maturities, as well as adjustable-rate securities, which may have a longer term to maturity. Our objective is to increase the overall yield on investment securities while managing interest rate and credit risk.

FASB ASC Topic 320, Investments - Debt and Equity Securities, requires that, at the time of purchase, we designate a security as held to maturity, available for sale, or trading, depending on our intent and ability to hold the security. Securities designated available for sale are reported at fair value, while securities designated held to maturity are reported at amortized cost. We do not have a trading portfolio.

Government and Agency Securities. At September 30, 2013, we held government and agency securities as available for sale with a fair value of $261.5 million, consisting primarily of agency obligations with maturities of more than one year through ten years. In addition, we held $77.3 million in government and agency securities as held to maturity at amortized cost. While these securities generally provide lower yields than other investments such as mortgage-backed securities, our current investment strategy is to maintain investments in such instruments to the extent appropriate for liquidity purposes and as collateral for borrowings and municipal deposits.

Corporate Bonds. At September 30, 2013, we held corporate debt securities as available for sale with a fair value of $118.6 million. Corporate bonds have a higher risk of default due to potential for adverse changes in the creditworthiness of the issuer. In recognition of this risk, our policy limits investments in corporate bonds to securities with maturities of ten years or less and rated “A” or better by at least one nationally recognized rating agency at time of purchase, and to a total investment size of no more than $10.0 million per issuer. Our total corporate bond portfolio limit is the lesser of 5% of total assets or 75% of tangible capital.

State and Municipal Bonds. At September 30, 2013, we held $147.7 million at carrying value in bonds issued by states and political subdivisions, $19.0 million of which were classified as held to maturity at amortized cost and are mainly unrated and $128.7 million of which were classified as available for sale at fair value. The policy limits investments in municipal bonds to securities with maturities of 20 years or less and rated as investment grade by at least one nationally recognized rating agency at the time of purchase, and favors issues that are insured. However, we also purchase securities that are issued by local government entities within our service area. Such local entity obligations generally are not rated, and are subject to internal credit reviews. In addition, the policy generally imposes an investment size limit of $5.0 million per municipal issuer and a total municipal bond portfolio limit of 10% of assets. At September 30, 2013, we did not hold any obligations that were rated less than “A-” as available for sale.

12



Equity Securities. At September 30, 2013, we held $24.3 million (at cost) of Federal Home Loan Bank of New York (“FHLB”) common stock, a portion of which must be held as a condition of membership in the Federal Home Loan Bank System, with the remainder held as a condition to our borrowing under the FHLB advance program. Dividends on FHLB stock recorded during the year ended September 30, 2013 amounted to $864 thousand.

Mortgage-Backed Securities. Mortgage-backed securities are created by pooling mortgages and issuing a security collateralized by the pool of mortgages with an interest rate that is less than the interest rate on the underlying mortgages. Mortgage-backed securities typically represent a participation interest in a pool of single-family or multi-family mortgages, although most of our mortgage-backed securities are collateralized by single-family mortgages. The issuers of such securities (generally U.S. Government agencies and government sponsored enterprises, including Fannie Mae, Freddie Mac and Ginnie Mae) pool and resell the participation interests in the form of securities to investors, such as us, and guarantee the payment of principal and interest to these investors. Investments in mortgage-backed securities involve a risk in addition to the guarantee of repayment of principal outstanding that actual prepayments will be greater or less than the prepayment rate estimated at the time of purchase, which may require adjustments to the amortization of any premium or accretion of any discount relating to such instruments, thereby affecting the net yield and duration of such securities. We review prepayment estimates for our mortgage-backed securities at purchase to ensure that prepayment assumptions are reasonable considering the underlying collateral for the securities at issue and current interest rates, and to determine the yield and estimated maturity of the mortgage-backed securities portfolio. Periodic reviews of current prepayment speeds are performed in order to ascertain whether prepayment estimates require modification that would cause amortization or accretion adjustments. As a result of our reviews, we anticipated an acceleration of prepayments.

A portion of our mortgage-backed securities portfolio is invested in CMOs, including Real Estate Mortgage Investment Conduits (“REMICs”), backed by Fannie Mae and Freddie Mac and certain private issuers. CMOs and REMICs are types of debt securities issued by special-purpose entities that aggregate pools of mortgages and mortgage-backed securities and create different classes of securities with varying maturities and amortization schedules, as well as a residual interest, with each class possessing different risk characteristics. The cash flows from the underlying collateral are generally divided into “tranches” or classes that have descending priorities with respect to the distribution of principal and interest cash flows, while cash flows on pass-through mortgage-backed securities are distributed pro rata to all security holders. Our practice is to limit fixed-rate CMO investments primarily to the early-to-intermediate tranches, which have the greatest cash flow stability. Floating rate CMOs are purchased with emphasis on the relative trade-offs between lifetime rate caps, prepayment risk, and interest rates.

At September 30, 2013, our mortgage-backed securities portfolio totaled $605.3 million, consisting of $449.2 million in available for sale securities at fair value and $156.1 million in held to maturity securities at amortized cost.

Available for Sale Portfolio. The following table sets forth the composition of our available for sale portfolio at the dates indicated.
 
 
September 30,
 
2013
 
2012
 
2011
 
Amortized
cost
 
Fair value
 
Amortized
cost
 
Fair value
 
Amortized
cost
 
Fair value
 
(Dollars in thousands)
Residential mortgage-backed securities:
 
 
 
 
 
 
 
 
 
 
 
Fannie Mae
$
214,191

 
$
211,438

 
$
155,601

 
$
161,407

 
$
136,699

 
$
139,991

Freddie Mac
67,272

 
67,629

 
81,509

 
85,260

 
98,511

 
100,675

Ginnie Mae
3,374

 
3,462

 
4,488

 
4,778

 
4,973

 
5,180

CMO/other
169,336

 
166,654

 
191,867

 
193,064

 
81,170

 
82,412

Total residential mortgage-backed securities
454,173

 
449,183

 
433,465

 
444,509

 
321,353

 
328,258

Other securities:
 
 
 
 
 
 
 
 
 
 
 
Federal agencies
273,637

 
261,547

 
404,820

 
408,823

 
199,741

 
204,648

Corporate bonds
118,575

 
114,933

 

 

 
16,984

 
17,062

State and municipal
127,324

 
128,730

 
146,136

 
156,481

 
177,666

 
188,684

Equities

 

 
1,087

 
1,059

 
1,192

 
1,192

Total other securities
519,536

 
505,210

 
552,043

 
566,363

 
395,583

 
411,586

Total available for sale securities
$
973,709

 
$
954,393

 
$
985,508

 
$
1,010,872

 
$
716,936

 
$
739,844


13




Held to Maturity Portfolio. The following table sets forth the composition of our held to maturity portfolio at the dates indicated.
 
 
September 30,
 
2013
 
2012
 
2011
 
Amortized
cost
 
Fair value
 
Amortized
cost
 
Fair value
 
Amortized
cost
 
Fair value
 
(Dollars in thousands)
Residential mortgage-backed securities:
 
 
 
 
 
 
 
 
 
 
 
Fannie Mae
$
70,502

 
$
70,815

 
$
28,637

 
$
29,849

 
$
1,298

 
$
1,361

Freddie Mac
59,869

 
60,164

 
42,706

 
44,053

 
32,858

 
32,841

CMO/other
25,776

 
25,494

 
27,921

 
28,119

 
25,828

 
25,983

Total residential mortgage-backed securities
156,147

 
156,473

 
99,264

 
102,021

 
59,984

 
60,185

Other securities:
 
 
 
 
 
 
 
 
 
 
 
Federal agencies
77,341

 
73,883

 
22,236

 
22,342

 
29,973

 
29,857

State and municipal
19,011

 
19,021

 
19,376

 
20,435

 
18,583

 
19,691

Other
1,500

 
1,519

 
1,500

 
1,526

 
1,500

 
1,539

Total other securities
97,852

 
94,423

 
43,112

 
44,303

 
50,056

 
51,087

Total held to maturity securities
$
253,999

 
$
250,896

 
$
142,376

 
$
146,324

 
$
110,040

 
$
111,272




Portfolio Maturities and Yields. The following table summarizes the composition, maturities and weighted average yield of the investment securities portfolio at September 30, 2013. Maturities are based on the final contractual payment dates and do not reflect the impact of prepayments or early redemptions that may occur. State and municipal securities yields have not been adjusted to a tax-equivalent basis.
 
1 Year or Less
 
1-5 years
 
5-10 years
 
10 years or more
 
Total
 
Amortized
cost
 
Yield
 
Amortized
cost
 
Yield
 
Amortized
cost
 
Yield
 
Amortized
cost
 
Yield
 
Amortized
cost
 
Fair
Value
 
Yield
 
(Dollars in thousands)
Available for sale:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage-backed securities
$

 
%
 
$
7,849

 
1.69
%
 
$
107,980

 
2.19
%
 
$
338,344

 
2.17
%
 
$
454,173

 
$
449,183

 
2.16
%
Federal agencies

 

 
22,442

 
1.10

 
251,195

 
1.64

 

 

 
273,637

 
261,547

 
1.59

Corporate bonds

 

 
28,043

 
1.58

 
90,532

 
2.36

 

 

 
118,575

 
114,933

 
2.17

State and municipal
2,242

 
2.21

 
30,572

 
3.20

 
75,928

 
3.15

 
18,582

 
2.98

 
127,324

 
128,730

 
3.12

Total
$
2,242

 
2.21
%
 
$
88,906

 
2.03
%
 
$
525,635

 
2.09
%
 
$
356,926

 
2.21
%
 
$
973,709

 
$
954,393

 
2.13
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Held to maturity:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage-backed securities:
$

 
%
 
$

 
%
 
$
31,723

 
2.29
%
 
$
124,424

 
2.49
%
 
$
156,147

 
$
156,473

 
2.45
%
Federal agencies

 

 
12,373

 
1.10

 
64,968

 
1.70

 

 

 
77,341

 
73,883

 
1.60

State and municipal
2,800

 
2.49

 
2,133

 
3.38

 
7,934

 
2.45

 
6,144

 
3.56

 
19,011

 
19,021

 
2.88

Other
1,000

 
2.84

 
250

 
1.29

 
250

 
3.75

 

 

 
1,500

 
1,519

 
2.73

Total
$
3,800

 
2.58
%
3,800,000

$
14,756

 
1.39
%
 
$
104,875

 
1.92
%
 
$
130,568

 
2.54
%
 
$
253,999

 
$
250,896

 
2.22
%


14


Sources of Funds
General. Deposits, borrowings, repayments and prepayments of loans and securities, proceeds from sales of loans and securities, proceeds from maturing securities and cash flows from operations are our primary sources of funds for use in lending, investing and for other general corporate purposes.

Deposits. We offer a variety of deposit accounts with a range of interest rates and terms. Our deposit accounts consist of savings accounts, NOW accounts, checking accounts, money market accounts, club accounts, certificates of deposit and IRAs and other qualified plan accounts. We also provide a variety of commercial checking accounts and other products for businesses.

At September 30, 2013, our deposits totaled $3.0 billion. Interest-bearing demand deposits totaled $434.4 million and non-interest-bearing demand deposits totaled $943.9 million. NOW, savings and money market deposits totaled $1.8 billion. We also had a total of $268.1 million in certificates of deposit, of which $239.1 million had maturities of one year or less.

We focus on gathering low cost, core deposits through our commercial relationship teams and our financial centers. We also gather deposits from municipalities in our market area.

Distribution of Deposit Accounts by Type. The following table sets forth the distribution of total deposit accounts, by account type, at the dates indicated.
 
September 30,
 
2013
 
2012
 
2011
 
Amount
 
%
 
Amount
 
%
 
Amount
 
%
 
(Dollars in thousands)
Non-interest bearing demand:
 
 
 
 
 
 
 
 
 
 
 
Retail
$
163,986

 
5.5
%
 
$
167,050

 
5.4
%
 
$
194,299

 
8.5
%
Commercial
457,147

 
15.4

 
412,630

 
13.3

 
296,505

 
12.9

Municipal
322,801

 
10.9

 
367,624

 
11.8

 
160,422

 
7.0

Total non-interest bearing demand
943,934

 
31.9

 
947,304

 
30.4

 
651,226

 
28.4

Interest bearing demand:
 
 
 
 
 
 
 
 
 
 
 
Retail
237,854

 
8.0

 
213,755

 
6.9

 
164,637

 
7.2

Commercial
53,083

 
1.8

 
38,486

 
1.2

 
37,092

 
1.6

Municipal
143,461

 
4.8

 
195,882

 
6.3

 
200,773

 
8.7

Total interest bearing demand
434,398

 
14.7

 
448,123

 
14.4

 
402,502

 
17.5

Savings
580,125

 
19.6

 
506,538

 
16.3

 
429,825

 
18.7

Money market
735,709

 
24.8

 
821,704

 
26.4

 
509,483

 
22.2

Subtotal
2,694,166

 
90.9

 
2,723,669

 
87.5

 
1,993,036

 
86.8

Certificates of deposit
268,128

 
9.1

 
387,482

 
12.5

 
303,659

 
13.2

Total deposits
$
2,962,294

 
100.0
%
 
$
3,111,151

 
100.0
%
 
$
2,296,695

 
100.0
%

15



As of September 30, 2013 and September 30, 2012 the Company had $757.1 million and $901.7 million, respectively, in municipal deposits. Of these amounts, approximately $374.3 million and $424.6 million were deposits related to school district tax deposits due on September 30, 2013 and September 30, 2012, respectively, which we generally retain only for a short period of time.

The following table sets forth the distribution of average deposit accounts by account category and the average rates paid at the dates indicated.
 
September 30,
 
2013
 
2012
 
2011
 
Average
balance
 
Rate
 
Average
balance
 
Rate
 
Average
balance
 
Rate
 
(Dollars in thousands)
Non-interest bearing demand
$
646,373

 
%
 
$
520,265

 
%
 
$
472,388

 
%
Interest bearing demand
466,110

 
0.08

 
399,819

 
0.12

 
315,623

 
0.19

Savings
572,246

 
0.17

 
485,624

 
0.08

 
432,227

 
0.10

Money market
819,442

 
0.30

 
671,325

 
0.33

 
489,347

 
0.33

Certificates of deposit
352,469

 
0.60

 
289,230

 
0.87

 
373,142

 
0.93

Total interest bearing deposits
2,210,267

 
0.27

 
1,845,998

 
0.30

 
1,610,339

 
0.38

Total deposits
$
2,856,640

 
0.21

 
$
2,366,263

 
0.24

 
$
2,082,727

 
0.29


Certificates of Deposit by Interest Rate Range. The following table sets forth information concerning certificates of deposit by interest rate range at the dates indicated.
 
As of September 30, 2013
 
 
 
 
 
Period to maturity
 
Total at September 30,
 
1 year or less
 
1-2 years
 
2-3 years
 
3 years or more
 
Total
 
% of
total
 
2012
 
2011
 
(Dollars in thousands)
Interest rate range:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
   1.00% and below
$
218,204

 
$
11,072

 
$
2,046

 
$
5,464

 
$
236,786

 
88.3
%
 
$
239,149

 
$
245,777

   1.01% to 2.00%
4,922

 
225

 
2,606

 
1,127

 
8,880

 
3.3

 
114,836

 
15,024

   2.01% to 3.00%
3,773

 
5,951

 
533

 

 
10,257

 
3.8

 
11,569

 
16,842

   3.01% to 4.00%
5,838

 

 

 

 
5,838

 
2.3

 
9,101

 
10,526

   4.01% to 5.00%
6,367

 

 

 

 
6,367

 
2.4

 
12,524

 
15,002

   5.01% to 6.00%

 

 

 

 

 

 
303

 
488

Total
$
239,104

 
$
17,248

 
$
5,185

 
$
6,591

 
$
268,128

 
100.0
%
 
$
387,482

 
$
303,659


Certificates of Deposit by Time to Maturity. The following table sets forth certificates of deposit by time remaining until maturity as of September 30, 2013.
 
Period to maturity
 
 
 
 
 
3 months or
less
 
3-6 months
 
6-12 months
 
Over 12
months
 
Total
 
Rate
 
(Dollars in thousands)
 
 
Certificates of deposit less than $100,000
$
69,973

 
$
34,083

 
$
39,179

 
$
20,668

 
$
163,903

 
0.30
%
Certificates of deposit $100,000 or more
39,224

 
24,993

 
31,652

 
8,356

 
104,225

 
0.50

 
$
109,197

 
$
59,076

 
$
70,831

 
$
29,024

 
$
268,128

 
0.38
%

16



Brokered Deposits. We utilize brokered deposits on a limited basis and maintain limits for the use of wholesale deposits and other short-term funding in general to be less than 10% of total assets. Most of the brokered deposit funding maintained by the Bank has a maturity to coincide with the anticipated inflows of deposits through municipal tax collections.

Listed below are the Company’s brokered deposits:
 
 
September 30,
 
2013
 
2012
 
(Dollars in thousands)
Savings
$

 
$
13,344

Money market
34,571

 
46,566

Reciprocal CDAR’s 1
1,343

 
1,354

CDAR’s one way
768

 
764

Total brokered deposits
$
36,682

 
$
62,028

1 
Certificate of deposit account registry service
Short-term Borrowings. Our short-term borrowings (which include borrowings with a maturity in less than one year) consisted of advances and overnight borrowings principally from the Federal Home Loan Bank. At September 30, 2011, short-term borrowings also included $51.5 million of debt guaranteed by the FDIC which matured in February 2012. At September 30, 2013, we had access to additional Federal Home Loan Bank advances up to an additional $588 million.

The following table sets forth information concerning balances and interest rates on our short-term borrowings at the dates indicated.
 
At or for the year ended September 30,
 
2013
 
2012
 
2011
 
(Dollars in thousands)
Balance at end of year
$
158,897

 
$
10,136

 
$
61,500

Average balance during year
88,779

 
27,286

 
55,098

Maximum amount outstanding