10-K 1 hvb-10k_20141231.htm 10-K

 

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2014

Commission File number 001-34453

 

HUDSON VALLEY HOLDING CORP.

(Exact name of registrant as specified in its charter)

 

 

New York

 

13-3148745

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

21 Scarsdale Road, Yonkers, New York

 

10707

(Address of principal executive offices)

 

(Zip Code)

Registrant’s telephone number, including area code: (914) 961-6100

Securities Registered Pursuant to Section 12(b) of the Act:

 

Title of each Class

 

Name of each exchange on which registered

Common Stock, ($0.20 par value 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  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15 (d) of the Act.    Yes  ¨    No  x

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months 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 Website, 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 is 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 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. See definition of “large accelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):

 

Large accelerated filer

 

¨

  

Accelerated filer

 

x

 

 

 

 

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 Act)    Yes  ¨    No  x

 

Class

 

Outstanding at March 3, 2015

Common Stock ($0.20 par value)

 

20,072,296

The aggregate market value on June 30, 2014 of voting stock held by non-affiliates of the Registrant was approximately $267,656,000.

 

 

 

 

 

 


 

 

FORM 10-K

TABLE OF CONTENTS

 

 

  

 

  

 

  

Page No.

PART I

  

 

  

 

  

 

 

 

 

 

 

 

 

 

  

ITEM 1

 

BUSINESS

  

1

 

 

 

 

 

 

 

 

  

ITEM 1A

 

RISK FACTORS

  

12

 

 

 

 

 

 

 

 

  

ITEM 1B

 

UNRESOLVED STAFF COMMENTS

  

23

 

 

 

 

 

 

 

 

  

ITEM 2

 

PROPERTIES

  

23

 

 

 

 

 

 

 

 

  

ITEM 3

 

LEGAL PROCEEDINGS

  

24

 

 

 

 

 

 

 

 

  

ITEM 4

 

MINE SAFETY DISCLOSURE

  

24

 

 

 

 

 

 

 

PART II

  

 

 

 

  

 

 

 

 

 

 

 

 

 

  

ITEM 5

 

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

  

25

 

 

 

 

 

 

 

 

  

ITEM 6

 

SELECTED FINANCIAL DATA

  

27

 

 

 

 

 

 

 

 

  

ITEM 7

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

  

29

 

 

 

 

 

 

 

 

  

ITEM 7A

 

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

  

59

 

 

 

 

 

 

 

 

  

ITEM 8

 

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

  

62

 

 

 

 

 

 

 

 

  

ITEM 9

 

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

  

105

 

 

 

 

 

 

 

 

  

ITEM 9A

 

CONTROLS AND PROCEDURES

  

105

 

 

 

 

 

 

 

 

  

ITEM 9B

 

OTHER INFORMATION

  

105

 

 

 

 

 

 

 

PART III

  

 

 

 

  

 

 

 

 

 

 

 

 

 

  

ITEM 10

 

DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

  

106

 

 

 

 

 

 

 

 

  

ITEM 11

 

EXECUTIVE COMPENSATION

  

111

 

 

 

 

 

 

 

 

  

ITEM 12

 

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT, AND RELATED STOCKHOLDER MATTERS

  

130

 

 

 

 

 

 

 

 

  

ITEM 13

 

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

  

132

 

 

 

 

 

 

 

 

  

ITEM 14

 

PRINCIPAL ACCOUNTANT FEES AND SERVICES

  

133

 

 

 

 

 

 

 

PART IV

  

 

 

 

  

 

 

 

 

 

 

 

 

 

  

ITEM 15

 

EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

  

134

 

 

 

SIGNATURES

  

137

 

 

 


 

 

PART I

ITEM 1 —  BUSINESS

General

Hudson Valley Holding Corp. (“Hudson Valley” or the “Company”) is a New York corporation founded in 1982. The Company is registered as a bank holding company under the Bank Holding Company Act of 1956.

The Company provides financial services through its wholly-owned subsidiary, Hudson Valley Bank, N.A. (“HVB” or “the Bank”), a national banking association established in 1972, with operational headquarters in Westchester County, New York. HVB has seventeen branch offices in Westchester County, New York, four in Manhattan, New York, four in Bronx County, New York, two in Rockland County, New York, and one in Kings County, New York. During 2013, the Company announced and completed the consolidation and/or closure of its six Connecticut branches, one branch in Westchester, and one branch in Manhattan, New York.

The Company provides asset based lending products through a wholly-owned subsidiary of HVB, HVB Capital Credit LLC. HVB Capital Credit LLC, which was formed in 2013, has offices at 489 Fifth Avenue in Manhattan, New York.

The Company provides equipment loan and lease financing through a wholly-owned subsidiary of HVB, HVB Equipment Capital, LLC. HVB Equipment Capital, LLC, which was formed in 2014, also has offices at 489 Fifth Avenue in Manhattan, New York.

On January 22, 2015, the Company completed the sale of A.R. Schmeidler & Co., Inc. (“ARS”). ARS provided money management services and had offices at 500 Fifth Avenue in Manhattan, New York.

We derive substantially all of our revenue and income from providing banking and related services to businesses, professionals, municipalities, not-for-profit organizations and individuals within our market area. See “Our Market Area.”

Our principal executive offices are located at 21 Scarsdale Road, Yonkers, New York 10707.

Our principal customers are businesses, professionals, municipalities, not-for-profit organizations and individuals. Our strategy is to operate community-oriented banking institutions dedicated to providing personalized service to customers and focusing on products and services for selected segments of the market. We believe that our ability to attract and retain customers is due primarily to our focused approach to our markets, our personalized and professional services, our product offerings, our experienced staff, our knowledge of our markets and our ability to provide responsive solutions to customer needs. We provide these products and services to a diverse range of customers and do not rely on a single large depositor for a significant percentage of deposits.

On November 4, 2014, the Company signed a definitive Agreement and Plan of Merger (the “Merger Agreement”) with Sterling Bancorp (“Sterling”) whereby the Company will be merged with and into Sterling (the “Merger”). Immediately following the Merger, HVB will merge with and into Sterling’s wholly owned subsidiary, Sterling National Bank, with Sterling National Bank as the surviving entity. Subject to the terms and conditions of the Merger Agreement, upon completion of the Merger, the Company’s stockholders will have the right to receive 1.92 shares of Sterling common stock for each share of Company common stock. The Merger has been approved by the boards of directors of both the Company and Sterling and is subject to approval by the Company’s and Sterling’s shareholders as well as regulatory approval and other customary closing conditions. The Merger is subject to customary conditions and is anticipated to close in the second quarter of 2015.

Subsidiaries of the Bank and the Company

The Company’s direct subsidiaries at December 31, 2014 were the Bank and HVHC Risk Management Corp. The Company has no separate operations or revenues apart from HVHC Risk Management Corp. and the Bank and its subsidiaries.

The Bank’s direct subsidiaries include Grassy Sprain Real Estate Holdings, Inc. (“REIT”); HVB Capital Credit, LLC; HVB Equipment Capital, LLC; HVB Leasing Corp.; HVB Realty Corp.; Sprain Brook Realty Corp.; 369 East Realty Corp.; HVB Properties Corp.; HVB Fleet Services Corp.; and 21 Scarsdale Road Corp. HVB is the primary source of community banking activity within the consolidated group. HVB provides services through 28 branches, 23 automated teller machines, or ATMs, electronic banking, telephone banking, and its internet banking.

All significant intercompany balances and transactions have been eliminated in consolidation.

 

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Employees

At December 31, 2014, we employed 403 full-time employees and 18 part-time employees. None of our employees are represented by a collective bargaining organization. We provide a variety of benefit plans for our employees, including group life, health, dental, disability, retirement and stock option plans. We consider our employee relations to be satisfactory.

Our Market Area

The banking and financial services business in our market area is highly competitive. Due to their proximity to and location within New York City, our branches compete with regional and money center banks, as well as many other non-bank financial institutions. A number of these banks are larger than we are and are increasing their efforts to serve smaller commercial borrowers. Many of these competitors, by virtue of their size and resources, may enjoy efficiencies and competitive advantages over us in pricing, delivery and marketing of their products and services. We believe that, despite the continued growth of large institutions and the potential for large out-of-area banking and financial institutions to enter our market area, there will continue to be opportunities for efficiently-operated, service-oriented, well-capitalized, community-based banking organizations to grow by serving customers that are not well served by larger institutions or do not wish to bank with such large institutions.

Westchester County is a suburban county located in the northern sector of the New York metropolitan area. It has a large and varied economic base containing many corporate headquarters, research facilities, manufacturing firms as well as well-developed trade and service sectors. The median household income, based on 2010 census data, was $79,619. The County’s 2010 per capita income of $47,814 placed Westchester County among the highest of the nation’s counties. In June 2014, the County’s unemployment rate was 5.1 percent, as compared to New York State at 6.5 percent and the United States at 6.1 percent. The County has over 100,000 businesses, which form a large portion of our current and potential customer base.

New York City, which borders Westchester County, is the nation’s financial capital and the home of more than 8 million individuals representing virtually every race and nationality. According to the 2010 census data, the median household income in the city was $64,971, while the per capita income was $59,149. This places New York City in the top ranks of cities across the United States. In June 2014, New York City’s unemployment rate was 6.4 percent. New York City also has a vibrant and diverse business community with more than 100,000 businesses and professional service firms. New York City is comprised of five counties or boroughs: Bronx, Kings (Brooklyn), New York (Manhattan), Queens and Richmond (Staten Island).

New York City has many attractive attributes and we believe that there is an opportunity for community banks to service our niche markets of businesses and professionals very effectively. We initially expanded into New York City in 1999 in the Bronx borough.

We expanded into Rockland County, New York, by opening a full service branch in New City in 2007 with a second branch opening in Suffern, New York in January 2012. Rockland County’s 2010 per capita income was $34,304, while the median household income was $82,534. In June 2014, the County’s unemployment rate was 4.9 percent. We believe Rockland County offers attractive opportunities for us to develop new customers within our niche markets of businesses, professionals and not-for-profit organizations.

Competition

The banking and financial services business in our market area is highly competitive. There are approximately 113 banking institutions with 1,686 branch banking offices in our Westchester County, Rockland County, Bronx County, Kings County and New York County market areas. These banking institutions had deposits of approximately $992 billion as of June 30, 2014 according to FDIC data. Our branches compete with local offices of large New York City commercial banks due to their proximity to and location within New York City. Other financial institutions, such as mutual funds, finance companies, factoring companies, mortgage bankers and insurance companies, also compete with us for both loans and deposits, although they are not subject to the same extensive federal regulations that govern bank holding companies and federally insured banks. We are smaller in size than most of our competitors

Competition for depositors’ funds and for credit-worthy loan customers is intense. Competition among financial institutions is based upon interest rates and other credit and service charges, the quality of service provided, the convenience of banking facilities, the products offered and, in the case of larger commercial borrowers, relative lending limits.

Federal legislation permits banking organizations to expand across state lines to offer banking services. In view of this, it is possible for large organizations to enter many new markets, including our market area. Many of these competitors, by virtue of their size and resources, may enjoy efficiencies and competitive advantages over us in pricing, delivery and marketing of their products and services.

 

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In response to competition, we have focused our attention on customer service and on addressing the needs of businesses, professionals and not-for-profit organizations located in the communities in which we operate. We emphasize community relations and relationship banking.

During the past five years, we have focused on maintaining existing customer relationships and adding new relationships by providing products and services that meet these customers’ needs. The focus of our products and services continues to be businesses, professionals, not-for-profit organizations and municipalities. Our overall strategy included investigation of opportunities for expansion within our market area and beyond, as well as an ongoing review of our existing branch system to evaluate if our current locations have or have not met expectations for growth and profitability. We have invested in technology-based products and services to meet customer needs. In addition, we have expanded products and services in our deposit gathering and lending programs, and our offering of investment management and trust services.

Lending

We engage in a variety of lending activities which are primarily categorized as real estate, commercial and industrial, individual and lease financing. At December 31, 2014, gross loans totaled $1,927.4 million. Gross loans were comprised of the following loan types:

 

Real estate

 

 

74.7

%

Commercial & industrial

 

 

23.3

%

Individuals

 

 

0.7

%

Lease financing

 

 

1.3

%

Total

 

 

100.0

%

 

 

 

 

 

 

 

 

At December 31, 2014, HVB’s lending limit to one borrower under applicable regulations was approximately $46.9 million.

In managing our loan portfolios, we focus on:

(i)

the application of established underwriting criteria,

(ii)

the establishment of individual internal levels of lending authority below HVB’s legal lending authority,

(iii)

the involvement by senior management and the Board of Directors in the loan approval process for designated categories, types or amounts of loans,

(iv)

an awareness of concentration by industry or collateral, and

(v)

the monitoring of loans for timely payment and to seek to identify potential problem loans.

We utilize our Credit Department to assess acceptable and unacceptable credit risks based upon established underwriting criteria. We utilize our loan officers, branch managers and Credit Department to identify changes in a borrower’s financial condition that may affect the borrower’s ability to perform in accordance with loan terms. Lending policies and procedures place an emphasis on assessing a borrower’s income and cash flow as well as collateral values. Further, we utilize systems and analysis which assist in monitoring loan delinquencies. We utilize our loan officers, Asset Recovery Department and legal counsel in collection efforts on past due loans. Additional collateral or guarantees may be requested where delinquencies remain unresolved.

An independent qualified loan review firm reviews loans in our portfolios and confirms a risk grading to each reviewed loan. Loans are reviewed based upon the type of loan, the collateral for the loan, the amount of the loan and any other pertinent information. The loan review firm reports directly to the Audit Committee of the Board of Directors.

We have participated in loans originated by various other financial institutions within the normal course of business and within standard industry practices.

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Loan Portfolio” for further information related to our portfolio and lending activities.

Deposits

We offer deposit products ranging from demand-type accounts to certificates of deposit with maturities of up to five years. Deposits are generally derived from customers within our primary marketplace. We solicit only certain types of deposits from outside

 

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our market area, primarily from certain professionals and government agencies. To a lesser extent, we also utilize brokered certificates of deposit as a source of funding and to manage interest rate risk.

We set deposit rates to remain generally competitive with other financial institutions in our market, although we do not generally seek to match the highest rates paid by competing institutions. We have established a process to review interest rates on all deposit products and, based upon this process, update our deposit rates weekly. This process also established a procedure to set deposit interest rates on a relationship basis and to periodically review these deposit rates. Our Asset/Liability Management Policy and our Liquidity Policy set guidelines to manage overall interest rate risk and liquidity. These guidelines can affect the rates paid on deposits. Deposit rates are reviewed under these policies periodically since deposits are our primary source of liquidity.

For more information regarding our deposits, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Deposits.”

Other Services

We also offer a software application designed to meet the specific administrative needs of bankruptcy trustees through a marketing and licensing agreement with the application vendor. We have no current plans to expand this line of business.

Segments

We maintain only one business segment which is discussed in more detail in Notes 1 and 15 to the financial statements included elsewhere herein.

Supervision and Regulation

Banks and bank holding companies are extensively regulated under both federal and state law. The primary regulator of the Company is the Board of Governors of the Federal Reserve System (“FRB”). The primary regulators of the Bank is the Office of the Comptroller of the Currency (“OCC”) and the Federal Deposit Insurance Corporation (“FDIC” and together with the OCC and FRB, the “Banking Agencies”). Changes in statutes, regulations, or regulatory policies applicable to the Company and its subsidiaries could have a material effect on the results of the Company.

We have set forth below brief summaries of various aspects of the supervision and regulation of bank holding companies and banks. These summaries do not purport to be complete and are qualified in their entirety by reference to applicable laws, rules and regulations.

As a bank holding company, the Company is regulated by and subject to the supervision of the FRB and are required to file with the FRB an annual report and such other information as may be required. The FRB has the authority to conduct examinations of the Company as well.

The Bank Holding Company Act of 1956 (the “BHC Act”) limits the types of companies which we may acquire or organize and the activities in which they may engage. In general, a bank holding company and its subsidiaries are prohibited from engaging in or acquiring control of any company engaged in non-banking activities unless such activities are so closely related to banking or managing and controlling banks as to be a proper incident thereto. Activities determined by the FRB to be so closely related to banking within the meaning of the BHC Act include operating a mortgage company, finance company, credit card company, factoring company, trust company or savings association; performing certain data processing operations; providing limited securities brokerage services; acting as an investment or financial advisor; acting as an insurance agent for certain types of credit-related insurance; leasing personal property on a full-payout, non-operating basis; providing tax planning and preparation service; operating a collection agency; and providing certain courier services. The FRB also has determined that certain other activities, including real estate brokerage and syndication, land development, property management and underwriting of life insurance unrelated to credit transactions, are not closely related to banking and therefore are not proper activities for a bank holding company.

The BHC Act requires every bank holding company to obtain the prior approval of the FRB before acquiring substantially all the assets of, or direct or indirect ownership or control of more than five percent of the voting shares of, any bank. Subject to certain limitations and restrictions, a bank holding company, with the prior approval of the FRB, may acquire an out-of-state bank.

Certain provisions of the BHC Act were amended in 1999 through passage of the Gramm-Leach-Bliley Financial Modernization Act of 1999 (“GLBA”). Under this legislation, a bank holding company may elect to become a “financial holding company” and thereby engage in a broader range of activities than would be permissible for traditional bank holding companies. In order to qualify for the election, all of the depository institution subsidiaries of the bank holding company must be well capitalized and well managed,

 

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as defined under FRB regulations, and all such subsidiaries must have achieved a rating of “satisfactory” or better with respect to meeting community credit needs. Pursuant to the GLBA, financial holding companies are permitted to engage in activities that are “financial in nature” or incidental or complementary thereto, as determined by the FRB. The GLBA identifies several activities as “financial in nature”, including, among others, insurance underwriting and agency activities, investment advisory services, merchant banking and underwriting, and dealing in or making a market in securities.

We believe we meet the regulatory criteria that would enable us to elect to become a financial holding company. At this time, we have determined not to make such an election.

The GLBA also makes it possible for entities engaged in providing various other financial services to form financial holding companies and form or acquire banks. Accordingly, the GLBA makes it possible for a variety of financial services firms to offer products and services comparable to the products and services we offer.

There are various statutory and regulatory limitations regarding the extent to which present and future banking subsidiaries of the Company can finance or otherwise transfer funds to the Company or its non-banking subsidiaries, whether in the form of loans, extensions of credit, investments or asset purchases, including regulatory limitations on the payment of dividends directly or indirectly to the Company from the Bank. Federal bank regulatory agencies also have the authority to limit further the Bank’s payment of dividends based on such factors as the maintenance of adequate capital for such subsidiary bank, which could reduce the amount of dividends otherwise payable. Under applicable banking statutes, at December 31, 2014, the Bank could have declared additional dividends of approximately $22.0 million to the Company.

Under the policy of the FRB, the Company is expected to act as a source of financial strength to its banking subsidiaries and to commit resources to support its banking subsidiaries in circumstances where we might not do so absent such policy. In addition, any subordinated loans by the Company to its banking subsidiaries would also be subordinate in right of payment to depositors and obligations to general creditors of such subsidiary banks. The Company currently has no loans to the Bank.

The FRB has established capital adequacy guidelines for bank holding companies that are similar to the OCC capital requirements for the Bank described below. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Capital Resources” and Note 10 to the Consolidated Financial Statements. The Company and HVB are subject to various regulatory capital guidelines. To be considered “well capitalized,” an institution must generally have a Tier 1 leverage ratio of at least 5 percent, a Tier 1 capital ratio of 8 percent and a total capital ratio of 10 percent.

Basel III

In July 2013, the U.S. banking agencies published final rules establishing a new comprehensive capital framework for U.S. banking organizations. These rules implement the Basel Committee’s December 2010 framework, commonly referred to as Basel III, for strengthening international capital standards, as well as certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protections Act of 2010 (“Dodd-Frank Act”). Basel III regulations were published by the U.S. banking agencies in 2013, and when fully phased-in, will require bank holding companies and their bank subsidiaries to maintain substantially more capital, with a greater emphasis on common equity.

Basel III regulations, among other things, (i) introduce a new capital measure called “Common Equity Tier 1” (“CET1”), (ii) specify that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting specified requirements, (iii) define CET1 narrowly by requiring that most adjustments to regulatory capital measures be made to CET1 and not to the other components of capital, thus potentially requiring higher levels of CET1 in order to meet minimum ratios and (iv) expand the scope of the adjustments as compared to existing regulations.

When fully phased in on January 1, 2019, Basel III regulations will require banks and bank holding companies to maintain (i) as a newly adopted international standard, a minimum ratio of CET1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% CET1 ratio as that buffer is phased in, effectively resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7%), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio as that buffer is phased in, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation), (iii) a minimum ratio of Total (that is, Tier 1 plus Tier 2) capital to risk-weighted assets of at least 8.0%, plus the capital conservation buffer (which is added to the 8.0% total capital ratio as that buffer is phased in, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation) and (iv) as a newly adopted international standard, a minimum leverage ratio of 3%, calculated as the ratio of Tier 1 capital to balance sheet exposures plus certain off-balance sheet exposures (computed as the average for each quarter of the month-end ratios for the quarter).  

 

5


 

 

In connection with the Basel III regulations, the FDIC also changed its prompt corrective action regulations. Effective January 1, 2015, banks are required to have the following capital levels in order to be considered well capitalized:

6.5% CET1 to risk-weighted assets.

8.0% Tier 1 capital (i.e., CET1 plus Additional Tier 1) to risk-weighted assets.

10.0% Total capital (i.e., Tier 1 plus Tier 2) to risk-weighted assets.

5.0% Tier 1 leverage capital ratio

The Basel III regulations provide for a number of new deductions from and adjustments to CET1. These include, for example, the requirement that mortgage servicing rights, deferred tax assets dependent upon future taxable income and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such categories in the aggregate exceed 15% of CET1.

Implementation of the deductions and other adjustments to CET1 began on January 1, 2014 and will be phased-in over a five-year period (20% per year). The implementation of the capital conservation buffer will begin on January 1, 2016 at 0.625% and be phased in over a four-year period (increasing by that amount on each subsequent January 1, until it reaches 2.5% on January 1, 2019). On January 7, 2013, the Basel Committee released the revised Basel III Liquidity Coverage Ratio (“LCR”). The revised LCR standards allow banks to use a broader range of liquid assets to meet their liquidity buffer and reduce some of the run-off assumptions that banks must make in calculating their net cash outflows. The revised standards also clarify that banks may dip below the minimum LCR requirement during periods of stress. On October 17, 2014, the OCC, U.S. Treasury, FRB, and the FDIC issued the Final Rule regarding the implementation of a quantitative liquidity requirement consistent with the LCR standard established by the Basel Committee and are designed to promote the short term resilience of the liquidity risk profile of banks, to which it applies. The LCR will apply to all banking organizations with $250 billion or more in total consolidated assets or $10 billion or more in on-balance sheet foreign exposure and to these banking organizations’ subsidiary depository institutions that have assets of $10 billion or more. The rule also will apply a less stringent, modified LCR to bank holding companies and savings and loan holding companies that do not meet these thresholds, but have $50 billion or more in total assets. Bank holding companies and savings and loan holding companies with substantial insurance or commercial operations are not covered by the final rule.

The Basel Committee is considering further amendments to Basel III, including the imposition of additional capital surcharges on globally systemically important financial institutions. In addition to Basel III, the Dodd-Frank Act requires or permits the federal banking agencies to adopt regulations affecting banking institutions’ capital requirements in a number of respects, including potentially more stringent capital requirements for systemically important financial institutions.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 significantly changed the bank regulatory landscape and has impacted and will continue to impact the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. Generally, the Dodd-Frank Act was effective the day after it was signed into law, but different effective dates apply to specific sections of the law. The Dodd-Frank Act, among other things:

Directed the FRB to issue rules which limited debit-card interchange fees;

After a three-year phase-in period which began January 1, 2013, removes trust preferred securities as a permitted component of Tier 1 capital for bank holding companies with assets of $15 billion or more;

Provided for increases in the minimum reserve ratio for the deposit insurance fund from 1.15 percent to 1.35 percent and changes the basis for determining FDIC premiums from deposits to assets;

Created a new Consumer Financial Protection Bureau (“CFPB”) which has rulemaking authority for a wide range of consumer protection laws that applies to all banks and has broad powers to supervise and enforce consumer protection laws;

Required public companies to give stockholders a non-binding vote on executive compensation and on “golden parachute” payments in connection with approvals of pending mergers and acquisitions unless previously voted on by stockholders;

Directed federal banking regulators to promulgate rules prohibiting excessive compensation paid to executives of depository institutions and their holding companies with assets in excess of $1 billion;

 

6


 

 

Provided mortgage reform provisions regarding a customer’s ability to repay, requiring the ability to repay for variable-rate loans to be determined by using the maximum rate that will apply during the first five years of the loan term, and making more loans subject to provisions for higher cost loans, new disclosures, and certain other revisions;

Created a Financial Stability Oversight Council that will recommend to the FRB increasingly strict rules for capital, leverage, liquidity, risk management and other requirements as companies grow in size and complexity; and

Made permanent the $250 thousand limit for federal deposit insurance.

On June 20, 2012, the SEC adopted final rules regarding heightened independence requirements for Compensation Committee members. These rules require stock exchanges to adopt listing standards that address (i) independence of compensation committee members, (ii) the compensation committee’s authority to retain compensation advisers, (iii) the compensation committee’s consideration of the independence of any compensation advisers, and (iv) the compensation committee’s responsibility for the appointment, compensation and oversight of the work of any compensation adviser. On September 25, 2012, the New York Stock Exchange and NASDAQ released proposed compensation committee and compensation committee adviser independence listing standards, and on January 11, 2013, the SEC approved these standards.

Interchange fees on debit card transactions were limited to a maximum of 21 cents per transaction plus 5 basis points of the transaction amount under the rules promulgated under the Dodd-Frank Act. A debit card issuer may recover an additional one cent per transaction for fraud prevention purposes if the issuer complies with certain fraud-related requirements prescribed by the Federal Reserve. Issuers that, together with their affiliates, have less than $10 billion in assets, such as the Bank, are exempt from the debit card interchange fee standards.

The CFPB took over rulemaking responsibility over the principal federal consumer protection laws, such as the Truth in Lending Act, the Equal Credit Opportunity Act, the Real Estate Settlement Procedures Act and the Truth in Saving Act, among others, on July 21, 2011. Institutions that have assets of $10 billion or less, such as the Bank, will continue to be supervised in this area by their primary federal regulators (in the case of the Bank, the OCC). The Act also gave the CFPB expanded data collecting powers for fair lending purposes for both small business and mortgage loans, as well as expanded authority to prevent unfair, deceptive and abusive practices.

The CFPB continued to propose amendments to mortgage regulations to implement Dodd-Frank mortgage lending requirements in August and September of 2012, and in January 2013, the CFPB issued several final rules. On January 10, 2013, the CFPB issued a final rule amending Regulation Z to implement certain amendments to the Truth in Lending Act. The rule implements statutory changes that lengthen the time for which a mandatory escrow account established for a higher-priced mortgage loan must be maintained. The rule also exempts certain transactions from the statute’s escrow requirement. The rule became effective on June 1, 2013. Also on January 10, 2013, the CFPB issued a final rule implementing amendments to the Truth in Lending Act and the Real Estate Settlement Procedures Act. The rule amends Regulation Z by expanding the types of mortgage loans that are subject to the protections of the Home Ownership and Equity Protections Act of 1994 (“HOEPA”), revising and expanding the tests for coverage under HOEPA, and imposing additional restrictions on mortgages that are covered by HOEPA, including a pre-loan counseling requirement. The rule also amends Regulation Z and Regulation X by imposing other requirements related to homeownership counseling. The rule became effective on January 10, 2014.

On January 18, 2013, the CFPB amended Regulation B to implement changes to the Equal Credit Opportunity Act. The revisions to Regulation B require creditors to provide applicants with free copies of all appraisals and other written valuations developed in connection with an application for a loan to be secured by a first lien on a dwelling, and require creditors to notify applicants in writing that copies of appraisals will be provided to them promptly. The rule became effective on January 18, 2014. On January 20, 2013, the CFPB amended Regulation Z to implement requirements and restrictions to the Truth in Lending Act concerning loan originator compensation, qualifications of, and registration or licensing of loan originators, compliance procedures for depository institutions, mandatory arbitration, and the financing of single-premium credit insurance. These amendments revise or provide additional commentary on Regulation Z’s restrictions on loan originator compensation, including application of these restrictions to prohibitions on dual compensation and compensation based on a term of a transaction or a proxy for a term of a transaction, and to recordkeeping requirements. This rule also establishes tests for when loan originators can be compensated through certain profits-based compensation arrangements. The amendments to § 1026.36(h) and (i) are effective on June 1, 2013, while the other provisions of the rule became effective on January 10, 2014.

The final rules also implement the ability-to-repay and qualified mortgage (“QM”) provisions of the Truth in Lending Act, as amended by the Dodd-Frank Act (the “QM Rule”). The ability-to-repay provision requires creditors to make reasonable, good faith determinations that borrowers are able to repay their mortgages before extending the credit based on a number of factors and consideration of financial information about the borrower from reasonably reliable third-party documents. Under the Dodd-Frank Act and the QM Rule, loans meeting the definition of “qualified mortgage” are entitled to a presumption that the lender satisfied the

 

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ability-to-repay requirements. The presumption is a conclusive presumption/safe harbor for prime loans meeting the QM requirements, and a rebuttable presumption for higher-priced/subprime loans meeting the QM requirements. The definition of a “qualified mortgage” incorporates the statutory requirements, such as not allowing negative amortization or terms longer than 30 years. The QM Rule also adds an explicit maximum 43 percent debt-to-income ratio for borrowers if the loan is to meet the QM definition, though some mortgages that meet GSE, FHA and VA underwriting guidelines may, for a period not to exceed seven years, meet the QM definition without being subject to the 43 percent debt-to-income limits.

The Dodd-Frank Act contains numerous other provisions affecting financial institutions of all types, many of which may have an impact on our operating environment in substantial and unpredictable ways. Consequently, the Dodd-Frank Act is likely to continue to increase our cost of doing business, it may limit or expand our permissible activities, and it may affect the competitive balance within our industry and market areas. The nature and extent of future legislative and regulatory changes affecting financial institutions, including as a result of the Dodd-Frank Act, remains very unpredictable at this time.

On July 6, 2012, President Obama signed into law the Biggert-Waters Flood Insurance Reform and Modernization Act of 2012, making substantial changes to the National Flood Insurance Program (“NFIP”). Effective immediately were the re-authorization of the NFIP through September 30, 2017, and an increase in per violation Civil Money Penalties (“CMP”) from $385 to $2,000 and the elimination of the $100,000 CMP cap. The effective dates on the remaining provisions are either delayed or are addressed in the Notice of Proposal Rulemaking dated October 11, 2013.

Volcker Rule

On December 10, 2013, the Banking Agencies along with the Commodity Futures Trading Commission (“CFTC”) and the Securities and Exchange Commission (“SEC”) issued final rules to implement the Volcker Rule contained in section 619 of the Dodd-Frank Act, generally to become effective on July 21, 2015. The Volcker Rule prohibits an insured depository institution and its affiliates (referred to as “banking entities”) from: (i) engaging in “proprietary trading” and (ii) investing in or sponsoring certain types of funds (“covered funds”) subject to certain limited exceptions. The rule also effectively prohibits short-term trading strategies by any U.S. banking entity if those strategies involve instruments other than those specifically permitted for trading and prohibits the use of some hedging strategies.

Regulation of the Bank

The Bank is subject to the supervision of, and to regular examination by, the OCC. Various laws and the regulations thereunder applicable to the Company and the Bank impose restrictions and requirements in many areas, including capital requirements, the maintenance of reserves, establishment of new offices, the making of loans and investments, consumer protection, employment practices, bank acquisitions and entry into new types of business. There are various legal limitations, including Sections 23A and 23B of the Federal Reserve Act, which govern the extent to which a bank subsidiary may finance or otherwise supply funds to its holding company or its holding company’s non-bank subsidiaries. Under federal law, no bank subsidiary may, subject to certain limited exceptions, make loans or extensions of credit to, or investments in the securities of, its parent or the non-bank subsidiaries of its parent (other than direct subsidiaries of such bank which are not financial subsidiaries) or take their securities as collateral for loans to any borrower. The Bank is also subject to collateral security requirements for any loans or extensions of credit permitted by such exceptions.

Dividend Limitations

The Company is a legal entity separate and distinct from its subsidiaries. The Company’s revenues (on a parent company only basis) result in substantial part from dividends paid by the Bank. The Bank’s dividend payments, without prior regulatory approval, are subject to regulatory limitations. Under the National Bank Act, dividends may be declared only if, after payment thereof, capital would be unimpaired and remaining surplus would equal 100 percent of capital. Moreover, a national bank may declare, in any one year, dividends only in an amount aggregating not more than the sum of its net profits for such year and its retained net profits for the preceding two years. In addition, the bank regulatory agencies have the authority to prohibit the Bank from paying dividends or otherwise supplying funds to the Company if the supervising agency determines that such payment would constitute an unsafe or unsound banking practice. Under applicable banking statutes, at December 31, 2014, the Bank could have declared additional dividends of approximately $22.0 million to the Company.

Capital Standards

The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), defines specific capital categories based upon an institution’s capital ratios. The capital categories, in declining order, are: (i) “well capitalized”; (ii) “adequately capitalized”; (iii) “undercapitalized”; (iv) “significantly undercapitalized”; and (v) “critically undercapitalized”. Under FDICIA and the FDIC’s

 

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prompt corrective action rules, the FDIC may take any one or more of the following actions against an undercapitalized bank: restrict dividends and management fees, restrict asset growth and prohibit new acquisitions, new branches or new lines of business without prior FDIC approval. If a bank is “significantly undercapitalized”, the FDIC may also require the bank to raise capital, restrict interest rates a bank may pay on deposits, require a reduction in assets, restrict any activities that might cause risk to the bank, require improved management, prohibit the acceptance of deposits from correspondent banks and restrict compensation to any senior executive officer. When a bank becomes “critically undercapitalized”, (i.e., the ratio of tangible equity to total assets is equal to or less than 2 percent), the FDIC must, within 90 days thereafter, appoint a receiver for the bank or take such action as the FDIC determines would better achieve the purposes of the law. Even where such other action is taken, the FDIC generally must appoint a receiver for a bank if the bank remains “critically undercapitalized” during the calendar quarter beginning 270 days after the date on which the bank became “critically undercapitalized”.

With respect to the Bank, the Basel Rules also revised the “prompt corrective action” regulations pursuant to Section 38 of the Federal Deposit Insurance Act, by (i) introducing a CET1 ratio requirement at each capital quality level (other than critically undercapitalized); (ii) increasing the minimum Tier 1 capital ratio requirement for each category; and (iii) requiring a leverage ratio of 5 percent to be well-capitalized.  Effective as of January 1, 2015, the OCC’s regulations implementing these provisions of FDICIA provide that an institution will be classified as “well capitalized” if it (i) has a total risk-based capital ratio of at least 10.0 percent, (ii) has a Tier 1 risk-based capital ratio of at least 8.0 percent, (iii) has a CET1 ratio of at least 6.5 percent, (iv) has a Tier 1 leverage ratio of at least 5.0 percent, and (v) meets certain other requirements. An institution will be classified as “adequately capitalized” if it (i) has a total risk-based capital ratio of at least 8.0 percent, (ii) has a Tier 1 risk-based capital ratio of at least 6.0 percent, (iii) has a CET1 ratio of at least 4.5 percent, (iv) has a Tier 1 leverage ratio of at least 4.0 percent, and (v) does not meet the definition of “well capitalized.” An institution will be classified as “undercapitalized” if it (i) has a total risk-based capital ratio of less than 8.0 percent, (ii) has a Tier 1 risk-based capital ratio of less than 6.0 percent, (iii) has a CET1 ratio of less than 4.5 percent or (iv) has a Tier 1 leverage ratio of less than 4.0 percent. An institution will be classified as “significantly undercapitalized” if it (i) has a total risk-based capital ratio of less than 6.0 percent, (ii) has a Tier 1 risk-based capital ratio of less than 4.0 percent, (iii) has a CET1 ratio of less than 3.0 percent or (iv) has a Tier 1 leverage ratio of less than 3.0 percent. An institution will be classified as “critically undercapitalized” if it has a tangible equity to total assets ratio that is equal to or less than 2.0 percent. An insured depository institution may be deemed to be in a lower capitalization category if it receives an unsatisfactory examination rating. Similar categories apply to bank holding companies. When the capital conservation buffer is fully phased in, the capital ratios applicable to depository institutions under the Basel Rules will exceed the ratios to be considered well-capitalized under the prompt corrective action regulations.

The Bank’s capital ratios were all above the minimum levels required for it to be considered a “well capitalized” financial institution at December 31, 2014 under the “prompt corrective action” regulations in effect as of such date. We believe that, as of December 31, 2014, the Company and the Bank would meet all capital adequacy requirements under the Basel Rules on a fully phased-in basis if such requirements were currently effective including after giving effect to the deductions described above.

In addition, significant provisions of FDICIA required federal banking regulators to impose standards in a number of other important areas to assure bank safety and soundness, including internal controls, information systems and internal audit systems, credit underwriting, asset growth, compensation, loan documentation and interest rate exposure.

See Note 10 to the Consolidated Financial Statements.

Insurance of Deposit Accounts

The Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund (“DIF”) of the FDIC. The DIF is the successor to the Bank Insurance Fund and the Savings Association Insurance Fund, which were merged in 2006. Under the FDIC’s risk-based system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and certain other factors with less risky institutions paying lower assessments on their deposits.

In 2011, as required by the Dodd-Frank Act, the FDIC approved a final rule revising the assessment base to consist of average consolidated total assets during the assessment period minus the average tangible equity during the assessment period. In addition, the final rule eliminated the adjustment for secured borrowings and made certain other changes to the impact of unsecured borrowings and brokered deposits on an institution’s deposit insurance assessment. The final rule also revised the assessment rate schedule to provide initial base assessment rates ranging from 5 to 35 basis points and total base assessment rates ranging from 2.5 to 45 basis points after adjustment. The final rule became effective on April 1, 2011.

As previously noted above, the Dodd-Frank Act makes permanent the $250 thousand limit for federal deposit insurance.

 

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The FDIC has authority to further increase insurance assessments. A significant increase in insurance premiums may have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what insurance assessment rates will be in the future.

Loans to Related Parties

The Bank’s authority to extend credit to its directors, executive officers and 10 percent stockholders, as well as to entities controlled by such persons, is currently governed by the requirements of the National Bank Act, Sarbanes-Oxley Act and Regulation O of the FRB thereunder. Among other things, these provisions require that extensions of credit to insiders (i) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with other persons not related to the lender and that do not involve more than the normal risk of repayment or present other unfavorable features and (ii) not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of the Bank’s capital. In addition, extensions of credit in excess of certain limits must be approved by the Bank’s Board of Directors. Under the Sarbanes-Oxley Act, the Company and its subsidiaries, other than the Bank, may not extend or arrange for any personal loans to its directors and executive officers.

Community Reinvestment Act and Fair Lending Developments

Under the Community Reinvestment Act (“CRA”), as implemented by the Federal Financial Institutions Examination Council (“FFIEC”), the Bank has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of our entire community, including low and moderate income neighborhoods. The CRA does not prescribe 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 particular community, consistent with the CRA. The CRA requires the regulatory agencies, in connection with its examination of a bank, 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. FIRREA amended the CRA to require public disclosure of an institution’s CRA rating and require the regulatory agencies to provide a written evaluation of an institution’s CRA performance utilizing a four-tiered descriptive rating system. Institutions are evaluated and rated by the regulatory agencies as “Outstanding”, “Satisfactory”, “Needs to Improve” or “Substantial Noncompliance.” Failure to receive at least a “Satisfactory” rating may inhibit an institution from undertaking certain activities, including acquisitions of other financial institutions, which require regulatory approval based, in part, on CRA Compliance considerations. As of its last CRA examination in May 2013, the Bank received a rating of “Satisfactory”.

USA Patriot Act

The USA Patriot Act of 2001 enhances the powers of domestic law enforcement organizations and makes numerous other changes aimed at countering the international terrorist threat to the security of the United States. Title III of the legislation most directly affects the financial services industry. It is intended to enhance the federal government’s ability to fight money laundering by monitoring currency transactions and suspicious financial activities. The USA Patriot Act has significant implications for depository institutions and other businesses involved in the transfer of money. Under the USA Patriot Act, a financial institution must establish due diligence policies, procedures and controls reasonably designed to detect and report money laundering and terrorist financing. Financial institutions must follow regulations adopted by the Treasury Department to encourage financial institutions, their regulatory authorities, and law enforcement authorities to share information about individuals, entities, and organizations engaged in or suspected of engaging in terrorist acts or money laundering activities. Financial institutions must follow regulations adopted by the Treasury Department setting forth minimum standards regarding customer identification. These regulations require financial institutions to implement reasonable procedures for verifying the identity of any person seeking to open an account, maintain records of the information used to verify the person’s identity, and consult lists of known or suspected terrorists and terrorist organizations provided to the financial institution by government agencies. Every financial institution must establish anti-money laundering programs, including the development of internal policies and procedures, designation of a compliance officer, employee training, and an independent audit function. The passage of the USA Patriot Act has increased our compliance activities, but has not otherwise affected our operations.

Office of Foreign Assets Control Regulation

The United States has imposed economic sanctions that affect transactions with designated foreign countries, nationals and others. These are typically known as the “OFAC” rules based on their administration by the U.S. Treasury Department Office of Foreign Assets Control (“OFAC”). The OFAC-administered sanctions targeting countries take many different forms. Generally, however, they contain one or more of the following elements: (i) restrictions on trade with or investment in a sanctioned country, including prohibitions against direct or indirect imports from and exports to a sanctioned country and prohibitions on “U.S. persons” engaging in financial transactions relating to making investments in, or providing investment-related advice or assistance to, a

 

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sanctioned country; and (ii) a blocking of assets in which the government or specially designated nationals of the sanctioned country have an interest, by prohibiting transfers of property subject to U.S. jurisdiction (including property in the possession or control of U.S. persons). Blocked assets (e.g. property and bank deposits) cannot be paid out, withdrawn, set off or transferred in any manner without a license from OFAC. Failure to comply with these sanctions could have serious legal and reputational consequences.

Sarbanes-Oxley Act of 2002

The Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley Act”) added new legal requirements for public companies affecting corporate governance, accounting and corporate reporting.

The Sarbanes-Oxley Act provides for, among other things:

a prohibition on personal loans made or arranged by the issuer to its directors and executive officers (except for loans made by a bank subject to Regulation O);

independence requirements for audit committee members;

independence requirements for company auditors;

certification of financial statements within the Annual Report on Form 10-K and Quarterly Reports on Form 10-Q by the chief executive officer and the chief financial officer;

the forfeiture by the chief executive officer and the chief financial officer of bonuses or other incentive-based compensation and profits from the sale of an issuer’s securities by such officers in the twelve month period following initial publication of any financial statements that later require restatement due to corporate misconduct;

disclosure of off-balance sheet transactions;

two-business day filing requirements for insiders filing on Form 4;

disclosure of a code of ethics for financial officers and filing a Current Report on Form 8-K for a change in or waiver of such code;

the reporting of securities violations “up the ladder” by both in-house and outside attorneys;

restrictions on the use of non-generally accepted accounting principles (“non-GAAP”) financial measures in press releases and SEC filings;

the formation of a public accounting oversight board;

various increased criminal penalties for violations of securities laws; and

an assertion by management with respect to the effectiveness of internal control over financial reporting.

Governmental Monetary Policy

Our business and earnings depend in large part on differences in interest rates. One of the most significant factors affecting our earnings is the difference between (1) the interest rates paid by us on our deposits and other borrowings (liabilities) and (2) the interest rates received by us on loans made to our customers and securities held in our investment portfolios (assets). The value of and yield on our assets and the rates paid on our liabilities are sensitive to changes in prevailing market rates of interest. Therefore, our earnings and growth will be influenced by general economic conditions, the monetary and fiscal policies of the Federal government, including the Federal Reserve System, whose function is to regulate the national supply of bank credit in order to influence inflation and overall economic growth. Its policies are used in varying combinations to influence overall growth of bank loans, investments and deposits and may also affect interest rates charged on loans, earned on investments or paid for deposits.

In view of changing conditions in the national and local economies, we cannot predict possible future changes in interest rates, deposit levels, loan demand, or availability of investment securities and the resulting effect on our business or earnings.

Available Information

We make available free of charge on our website (http://www.hudsonvalleybank.com) our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports, as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission. We provide electronic or paper copies of filings free of charge upon request.

 

 

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ITEM 1A —  RISK FACTORS

Risks Related to Our Business

Our concentration of commercial real estate loans has resulted in increased scrutiny by the OCC, and we may be subject to future regulatory action and loss of business opportunity as a result.

As part of a routine safety and soundness exam conducted by the OCC during the fourth quarter of 2011, we were made aware that we would be required to reduce our concentrations in commercial real estate (“CRE”) and classified loans relative to tier 1 capital plus the allowance for loan and lease losses. In response, we sold approximately $474 million in loans at the end of the first quarter of 2012, of which $27.8 million were nonperforming, and another $25.5 million were performing classified loans, a significant step toward reducing the Bank’s concentrations of CRE loans and classified assets to less than 400 percent and 25 percent of tier 1 capital plus the allowance for loan and lease losses, respectively. At December 31, 2014, the Bank’s concentration of CRE loans and classified loans was 333.3 percent and 16.5 percent, respectively, of tier 1 capital plus the allowance for loan and lease losses.

We can provide no assurances that we will not become subject to some form of administrative action in the future. These limitations and any future administrative actions may restrict our business opportunities and adversely affect our operating results. In addition, further deterioration in our loan portfolio, including further declines in the market values of real estate supporting certain CRE loans, would result in further provisions for loan losses in future periods, which would have a material adverse affect on our business and results of operations.

Further additions to our nonperforming loans may occur and adversely affect our results of operations and financial condition.

At December 31, 2014 and 2013, our non-accrual loans totaled $22.4 million and $23.5 million, or 1.2% and 1.4% of the loan portfolio, respectively. At December 31, 2014 and 2013, our nonperforming assets (which include non-accrual loans, accruing loans 90 days or more past due, nonperforming loans held for sale and foreclosed real estate, also called other real estate owned) totaled $22.4 million and $23.5 million, or 0.7% and 0.8% of total assets, respectively. In addition, we had $7.9 million and $4.6 million of accruing loans that were 31-89 days delinquent at December 31, 2014 and 2013, respectively.

Despite improvements in overall economic and market conditions, we expect to continue to incur additional losses relating to nonperforming loans. Our nonperforming assets adversely affect our net income in various ways. First, we do not record interest income on non-accrual loans or other real estate owned, thereby adversely affecting our income and increasing our loan administration costs. Second, when we take collateral in foreclosures and similar proceedings, we are required to mark the related loan to the then fair market value of the collateral, which may result in a loss. Third, these loans and other real estate owned also increase our risk profile and the capital our regulators believe is appropriate in light of such risks. Adverse changes in the value of our problem assets, or the underlying collateral, or in these borrowers’ performance or financial conditions, whether or not due to economic and market conditions beyond our control, could adversely affect our business, results of operations and financial condition. In addition, the resolution of nonperforming assets requires significant commitments of time from management and our directors, which can be detrimental to the performance of their other responsibilities. There can be no assurance that we will not experience further additions to nonperforming loans in the future, or that our nonperforming assets will not result in further losses in the future.

As regulated entities, the Company and the Bank are subject to extensive supervision and regulation, including maintaining certain capital requirements, which may limit their operations and potential growth. Failure to meet any such requirements would subject us to regulatory action.

The Company is supervised by the FRB and the Bank is supervised by the OCC. As such, each is subject to extensive supervision and prudential regulation, including risk-based and leverage capital requirements. The Company and the Bank must maintain certain risk-based and leverage capital ratios as required by the FRB or the OCC, respectively that may change depending upon general economic conditions and the particular condition, risk profile and growth plans of the Company and the Bank.

In today’s economic and regulatory environment, banking regulators, including the OCC, continue to direct greater scrutiny to banks with higher levels of commercial real estate loans like us. As a general matter, such banks, including the Bank, are expected to maintain higher capital levels as well as other measures due to commercial real estate lending growth and exposures. If we do not maintain these higher capital levels, we may be subject to enforcement actions. More generally, compliance with capital requirements may limit loan growth or other operations that require the use of capital and could adversely affect our ability to expand or maintain present business levels.

If we fail to meet any regulatory capital requirement or are otherwise deemed to be operating in an unsafe and unsound manner or in violation of law, we may be subject to a variety of informal or formal remedial measures and enforcement actions. Such informal remedial measures and enforcement actions may include a memorandum of understanding which is initiated by the regulator and

 

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outlines an institution’s agreement to take specified actions within specified time periods to correct violations of law or unsafe and unsound practices. In addition, as part of our regular examination process, regulators may advise us to operate under various restrictions as a prudential matter. Any of these restrictions, in whatever manner imposed, could have a material adverse effect on our business and results of operations.

In addition to informal remedial actions, we may also be subject to formal enforcement actions. Failure to comply with an informal enforcement action could cause us to be subject to formal enforcement actions. Formal enforcement actions include written agreements, cease and desist orders, the imposition of substantial fines and other civil penalties and, in the most severe cases, the termination of deposit insurance or the appointment of a conservator or receiver for our bank subsidiary. Furthermore, if the Bank fails to meet any regulatory capital requirement, it will be subject to the prompt corrective action framework of the FDICIA, which imposes progressively more restrictive constraints on operations, management and capital distributions as the capital category of an institution declines, up to and including, ultimately, the appointment of a conservator or receiver. A failure to meet regulatory capital requirements could also subject us to capital raising requirements. Additional capital raisings would be dilutive to holders of our common stock. See “Risk Factors — Risks Relating to Our Common Stock” for more information.

Any remedial measure or enforcement action, whether formal or informal, could impose restrictions on our ability to operate our business and adversely affect our prospects, financial condition or results of operations. In addition, any formal enforcement action could harm our reputation and our ability to retain and attract customers and impact the trading price of our common stock.

Increases to the allowance for loan losses may cause our earnings to decrease.

In determining our loan loss reserves for each quarter, we make various assumptions and judgments about the future performance of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of loans. In determining the amount of the allowance for loan losses, we rely on loan quality reviews, past experience, and an evaluation of economic conditions, among other factors. If our assumptions prove to be incorrect, our allowance for credit losses may not be sufficient to cover probable incurred losses in our loan portfolio, resulting in additions to the allowance and a corresponding decrease in income. In addition, bank regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or loan charge-offs. Any increase in our allowance for loan losses or loan charge-offs as required by these regulatory authorities or otherwise could have a material adverse effect on our results of operations or financial condition.

Declines in value may adversely impact the carrying amount of our investment portfolio and result in other-than-temporary impairment charges.

Numerous factors, including lack of liquidity for sales of certain investment securities, absence of reliable pricing information for investment securities, adverse changes in business climate or adverse actions by regulators could have a negative impact on the valuation of our investment portfolio in future periods. If an impairment charge is significant enough, it could affect the ability of the Bank to upstream dividends to us, which could have a material adverse effect on our liquidity and our ability to pay dividends to stockholders, and could also negatively impact our regulatory capital ratios and result in us not being classified as “well capitalized” for regulatory purposes.

A prolonged or worsened downturn in the economy in general and the real estate market in our key market areas in particular would adversely affect our loan portfolio and our growth potential.

Our primary lending market area is Westchester County, New York and New York City and to an increasing extent, Rockland County, New York, with a primary focus on businesses, professionals and not-for-profit organizations located in this area. Accordingly, the asset quality of our loan portfolio largely depends upon the area’s economy and real estate markets. The Bank’s primary lending market area and asset quality have been adversely affected by continued weakness in the economy. A prolonged or worsened downturn in the economy in our primary lending area would adversely affect our asset quality, operations and limit our future growth potential.

In particular, a downturn in our local real estate market could negatively affect our business because a significant portion (approximately 75% as of December 31, 2014) of our loans are secured, either on a primary or secondary basis, by real estate. Our ability to recover on defaulted loans by selling the real estate collateral would then be diminished and we would be more likely to suffer losses on defaulted loans. The Bank’s loans have already been adversely affected by the current decline in the real estate market. Continuation or worsening of such conditions could have additional negative effects on our business in the future.

 

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Difficult market conditions have adversely affected our industry.

Prior to 2014, declines in the real estate markets negatively impacted the credit performance of real estate related loans and resulted in significant write-downs of asset values by financial institutions. These write-downs caused many financial institutions to seek additional capital, to reduce or eliminate dividends, to merge with larger and stronger institutions and, in some cases, to fail. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced or ceased providing funding to borrowers, including to other financial institutions. This market turmoil and tightening of credit have led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and widespread reduction of business activity generally.

As a result of the foregoing, there is a potential for new laws and regulations regarding lending and funding practices and liquidity and capital standards, and financial institution regulatory agencies are now expected to be very aggressive in responding to concerns and trends identified in examinations, including the more frequent issuance of informal remedial measures and formal enforcement orders. These negative developments in the financial services industry and the impact of new legislation in response to those developments could negatively impact our operations by restricting our business operations, including our ability to originate loans and work with borrowers to collect loans, and adversely impact our financial performance.

Higher FDIC deposit insurance premiums and assessments could adversely affect our financial condition.

As a result of the financial crisis which began in 2008, the Deposit Insurance Fund (“DIF”) was significantly depleted. As a result, the FDIC increased the required deposit insurance premiums and instituted special assessments. The insurance premiums have remained at the elevated levels although no special assessments have been levied since 2009. Continuation of the elevated insurance levels may adversely affect our financial condition.

Certain of our goodwill and intangible assets may become impaired in the future.

We test our goodwill and intangible assets for impairment on a periodic basis. It is possible that future impairment testing could result in a value of our goodwill and intangibles which may be less than the carrying value and, as a result, may adversely affect our financial condition and results of operations. If we determine that impairment exists at a given time, our earnings and the book value of the related goodwill and intangibles will be reduced by the amount of the impairment. During 2014, the Company recorded an impairment charge totaling $1.2 million on the remaining goodwill in connection with the sale of ARS. At December 31, 2014, the Company’s goodwill totaled $4.0 million which is subject to annual review. A goodwill impairment analysis performed in the fourth quarter of 2013 indicated pretax impairment of $18.7 million primarily driven by the loss of clients and a reduction in the projected earnings capacity of the Company’s asset management subsidiary. The impairment charge was recorded in net income in the fourth quarter of 2013.

Our income is sensitive to changes in interest rates.

Our profitability, like that of most banking institutions, depends to a large extent upon our net interest income. Net interest income is the difference between interest income received on interest-earning assets, including loans and securities, and the interest paid on interest-bearing liabilities, including deposits and borrowings. Accordingly, our results of operations and financial condition depend largely on movements in market interest rates and our ability to manage our assets and liabilities in response to such movements. Management estimates that, as of December 31, 2014, a 200 basis point increase in interest rates would result in a 1.1% increase in net interest income and a 100 basis point decrease would result in a 2.4% decrease in net interest income. See also “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part 7 of this document.

In addition, changes in interest rates may result in an increase in higher cost deposit products within our existing portfolios, as well as a flow of funds away from bank accounts into direct investments (such as U.S. government and corporate securities and other investment instruments such as mutual funds) to the extent that we may not pay rates of interest competitive with these alternative investments. Our inability to re-deploy excess liquidity into higher yielding assets will continue to compress margins and earnings.

We may need to raise additional capital in the future and such capital may not be available when needed or at all.

If the Merger is not completed, we may need to raise additional capital in the future to provide us with sufficient capital resources and liquidity to meet our commitments and business needs. Our ability to raise additional capital, if needed, will depend on, among other things, conditions in the capital markets at that time, which are outside of our control, and our financial performance. We cannot assure you that such capital will be available to us on acceptable terms or at all. Our inability to raise sufficient additional capital on acceptable terms when needed could adversely affect our businesses, financial condition and results of operations.

 

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Our markets are intensely competitive, and our principal competitors are larger than us.

We face significant competition both in making loans and in attracting deposits. This competition is based on, among other things, interest rates and other credit and service charges, the quality of services rendered, the convenience of the banking facilities, the range and type of products offered and the relative lending limits in the case of loans to larger commercial borrowers. Our market area has a very high density of financial institutions, many of which are branches of institutions that are significantly larger than we are and have greater financial resources and higher lending limits than we do. Many of these institutions offer services that we do not or cannot provide. Nearly all such institutions compete with us to varying degrees.

Our competition for loans comes principally from commercial banks, savings banks, savings and loan associations, credit unions, mortgage banking companies, insurance companies and other financial service companies. Our most direct competition for deposits has historically come from commercial banks, savings banks, savings and loan associations, and money market funds and other securities funds offered by brokerage firms and other similar financial institutions. We face additional competition for deposits from non-depository competitors such as the mutual fund industry, securities and brokerage firms, and insurance companies. Competition may increase in the future as a result of recently proposed regulatory changes in the financial services industry.

If we cannot fully integrate new business lines and technologies, our operating expenses could increase without corresponding revenue being recognized.

We have introduced two new lending products, asset based and equipment financing, during 2014 and 2013. Personnel have been hired and systems purchased to start these business lines. If we are unable to achieve the required loan origination levels to offset these costs, our non-interest expenses could increase without revenue to offset these costs.

In addition, we have purchased new mobile banking platforms. If we are unable to integrate the platforms and generate the anticipated fees, our non-interest expense could increase without a corresponding increase to fee income.

Inflation can have an impact on the cost of our operations.

The consolidated financial statements and notes thereto incorporated by reference herein have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”), which requires the measurement of financial position and operating results in terms of historical dollar amounts or estimated fair value without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, nearly all of our assets and liabilities are monetary in nature. As a result, interest rates have a greater impact on our performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods and services.

Extensive regulation and supervision may have a negative impact on our ability to compete in a cost-effective manner and subject us to material compliance costs and penalties.

The Company, primarily through its principal subsidiary and certain non-bank subsidiaries, is subject to extensive federal and state regulation and supervision. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds and the banking system as a whole. Such laws are not designed to protect the Company’s stockholders. These regulations affect the Company’s lending practices, capital structure, investment practices, dividend policy and growth, among other things. The Company is also subject to a number of federal laws, which, among other things, require it to lend to various sectors of the economy and population, and establish and maintain comprehensive programs relating to anti-money laundering and customer identification. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on the Company’s business, financial condition and results of operations. The Company’s compliance with certain of these laws will be considered by banking regulators when reviewing bank merger and bank holding company acquisitions.

The Dodd-Frank Wall Street Reform and Consumer Protection Act may affect our business activities, financial position and profitability by increasing our regulatory compliance burden and associated costs, placing restrictions on certain products and services, and limiting our future capital raising strategies.

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law by the President of the United States. The Dodd-Frank Act implements significant changes in financial regulation and will impact all financial institutions, including the Company and the Bank. Among the Dodd-Frank Act’s significant regulatory changes, was the creation of a new financial consumer protection agency, known as the CFPB, that is empowered to promulgate new consumer protection regulations and revise existing regulations in many areas of consumer protection. CFPB has exclusive authority to issue regulations, orders and

 

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guidance to administer and implement the objectives of federal consumer protection laws. CFPB will also have the ability to participate, with the OCC, in our consumer compliance examinations. Moreover, the Dodd-Frank Act permits states to adopt stricter consumer protection laws and authorizes state attorney generals’ to enforce consumer protection rules issued by the CFPB. The Dodd-Frank Act also restricts the authority of the Comptroller of the Currency to preempt state consumer protection laws applicable to national banks, such as the Bank, and may affect the preemption of state laws as they affect subsidiaries and agents of national banks, changes the scope of federal deposit insurance coverage, and potentially increases the FDIC assessment payable by the Bank. We expect that the CFPB and certain other provisions in the Dodd-Frank Act will significantly increase our regulatory compliance burden and costs and may restrict the financial products and services we offer to our customers.

Because many of the Dodd-Frank Act’s provisions require regulatory rulemaking, we are uncertain as to the impact that some of the provisions of the Dodd-Frank Act will have on the Company and the Bank and cannot provide assurance that the Dodd-Frank Act will not adversely affect our financial condition and results of operations for other reasons.

Technological change may affect our ability to compete.

The banking industry continues to undergo rapid technological changes, with frequent introductions of new technology-driven products and services. In addition to improving customer services, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend, in part, on our ability to address the needs of customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. There can be no assurance that we will be able to effectively implement new technology-driven products and services or be successful in marketing such products and services to the public.

In addition, because of the demand for technology-driven products, banks are increasingly contracting with outside vendors to provide data processing and core banking functions. The use of technology-related products, services, delivery channels and processes exposes a bank to various risks, particularly transaction, strategic, reputation and compliance risks. There can be no assurance that we will be able to successfully manage the risks associated with our increased dependency on technology.

The failure of our operating facilities or our computer systems or network, or the intentional disruption of our systems by malicious third parties, could disrupt our businesses and cause financial losses.

Our business is dependent on the technology services we provide to clients and our ability to process and monitor, on a daily basis, a large number of financial transactions. Our financial, accounting, data processing or other operating systems which facilitate these services may fail to operate properly or become disabled as a result of events that are wholly or partially beyond our control, such as a spike in transaction volume, cyber attack or other unforeseen catastrophic events, which may adversely affect our ability to process these transactions or provide services.

In addition, our operations rely on the secure processing, storage and transmission of confidential and other information on our computer systems and networks. Although we take protective measures to maintain the confidentiality, integrity and availability of our clients’ information, the nature of the threats continues to evolve. As a result, our computer systems, software and networks may be vulnerable to unauthorized access, loss or destruction of data (including confidential client information), account takeovers, unavailability of service, computer viruses or other malicious code, cyber attacks and other events that could have an adverse security impact. Despite the defensive measures we take to manage our internal technological and operational infrastructure, these threats may originate externally from third parties such as foreign governments, organized crime and other hackers, and outsourced or infrastructure-support providers and application developers, or may originate internally from within our organization. Given the increasingly high volume of our transactions, certain errors may be repeated or compounded before they can be discovered and rectified.

We also face the risk of operational disruption, failure, termination or capacity constraints of any of the third parties that facilitate our business activities, including exchanges, clearing agents, clearing houses or other financial intermediaries. Such parties could also be the source of an attack on, or breach of, our operational systems, data or infrastructure. In addition, as interconnectivity with our clients grows, we increasingly face the risk of operational failure with respect to our clients’ systems.

If one or more of these events occurs, it could potentially jeopardize the confidential, proprietary and other information processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our, as well as our clients’ or other third parties’, operations, which could result in damage to our reputation, substantial costs, regulatory penalties and/or client dissatisfaction or loss. Potential costs of a cyber incident may include, but would not be limited to, remediation costs, increased protection costs, lost revenue from the unauthorized use of proprietary information or the loss of current and/or future customers, and litigation.

 

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Our framework for managing risks and risk management procedures and practices may not be effective in identifying and mitigating every risk to the Company, thereby resulting in losses.

Our risk management framework seeks to mitigate risk and loss to the Company. The Company has established processes and procedures intended to identify, measure, monitor, report and analyze the types of risk to which the Company is subject. However, as with any risk management framework, there are inherent limitations to the Company’s risk management strategies because there may exist, or develop in the future, risks that the Company has not appropriately anticipated or identified. Any lapse in the Company’s risk management framework and governance structure or other inadequacies in the design or implementation of the Company’s risk management framework, governance, procedures or practices could, individually or in the aggregate, cause unexpected losses for the Company, materially and adversely affect the Company’s financial condition and results of operations, require significant resources to remediate any risk management deficiency, attract heightened regulatory scrutiny, expose the Company to regulatory investigations or legal proceedings, subject the Company to fines, penalties or judgments, harm the Company’s reputation, or otherwise cause a decline in investor confidence.

The inability to attract and retain key personnel could adversely impact our financial condition and results of operations.

To a large degree, our success depends on our ability to attract and retain key personnel whose expertise, knowledge of our markets, and years of industry experience would make them difficult to replace. Competition for skilled leaders in our industry can be intense, and we may not be able to hire or retain the people we would like to have working for us. In addition, as a result of the Merger, we may be subject to a greater risk of losing certain of our key personnel. The unexpected loss of services of one or more of our key personnel could have a material adverse impact on our business, given the specialized knowledge of such personnel and the difficulty of finding qualified replacements on a timely basis. To attract and retain personnel with the skills and knowledge to support our business, we offer a variety of benefits that may reduce our earnings.

If federal, state, or local tax authorities were to determine that we did not adequately provide for our taxes, our income tax expense could be increased, adversely affecting our earnings.

The amount of income taxes we are required to pay on our earnings is based on federal and state legislation and regulations. We provide for current and deferred taxes in our financial statements, based on our results of operations, business activity, legal structure, interpretation of tax statutes, assessment of risk of adjustment upon audit, and application of financial accounting standards. We may take tax return filing positions for which the final determination of tax is uncertain. Our net income and earnings per share may be reduced if a federal, state, or local authority assesses additional taxes that have not been provided for in our consolidated financial statements. There can be no assurance that we will achieve our anticipated effective tax rate either due to a change in tax law, a change in regulatory or judicial guidance, or an audit assessment that denies previously recognized tax benefits. One of our subsidiaries, Grassy Sprain Real Estate Holdings, Inc., qualifies as a real estate investment trust (“REIT”) under the laws of the State of New York. A qualified REIT is entitled to special tax treatment by the State of New York, which lowers the Company’s tax rate. If the State of New York changes the provisions of the tax code related to REITs, our tax rate could increase.  

Changes in Accounting Policies or Accounting Standards can cause us to change the manner in which we report our financial results and condition in adverse ways and could subject us to additional costs and expenses.

The Company’s accounting policies are fundamental to understanding its financial results and condition. Some of these policies require use of estimates and assumptions that may affect the value of the Company’s assets or liabilities and financial results. The Company identified its accounting policies regarding the allowance for loan losses, security valuations, goodwill and other intangible assets, and income taxes to be critical because they require management to make difficult, subjective and complex judgments about matters that are inherently uncertain. Under each of these policies, it is possible that materially different amounts would be reported under different conditions, using different assumptions, or as new information becomes available.

From time to time the Financial Accounting Standards Board (“FASB”) and the SEC change their guidance governing the form and content of the Company’s external financial statements. In addition, accounting standard setters and those who interpret GAAP, such as the FASB, SEC, banking regulators and the Company’s outside independent registered accounting firm, may change or even reverse their previous interpretations or positions on how these standards should be applied. Changes in GAAP and changes in current interpretations are beyond the Company’s control, can be hard to predict and could materially impact how the Company reports its financial results and condition. In certain cases, the Company could be required to apply a new or revised guidance retroactively or apply existing guidance differently (also retroactively) which may result in the Company restating prior period financial statements for material amounts. Additionally, significant changes to GAAP may require costly technology changes, additional training and personnel, and other expenses that will negatively impact our results of operations.

 

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We are subject to environmental liability risk associated with lending activities.

A significant portion of our loan portfolio is secured by real property. During the ordinary course of business, we may foreclose on and take title to properties securing certain loans. In doing so, there is a risk that hazardous or toxic substances could be found on these properties. If hazardous or toxic substances are found, we may be liable for remediation costs, as well as for personal injury and property damage. Environmental laws may require us to incur substantial expenses and may materially reduce the affected property’s value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability. Although we have policies and procedures to perform an environmental review prior to originating certain commercial real estate loans, as well as before initiating any foreclosure action on real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on our financial condition and results of operations.

Risk Related to the Merger

Because the market price of Sterling common stock will fluctuate, Company shareholders cannot be certain of the market value of the Merger consideration they will receive.

Upon completion of the Merger, each share of Company common stock (except for specified shares of Company common stock owned by the Company or Sterling) will be converted into the right to receive 1.92 shares of Sterling common stock. The market value of the Merger consideration will vary from the closing price of Sterling common stock on the date Sterling and the Company announced the Merger, on the date that the joint proxy statement/prospectus was mailed to Company shareholders, on the date of the special meeting of Company shareholders and on the date the Merger is completed and thereafter. Any change in the market price of Sterling common stock prior to the completion of the Merger will affect the market value of the Merger consideration that Company shareholders will receive upon completion of the Merger, and there will be no adjustment to the Merger consideration for changes in the market price of either shares of Sterling common stock or shares of Company common stock. Stock price changes may result from a variety of factors that are beyond the control of Sterling and the Company, including, but not limited to, general market and economic conditions, changes in our respective businesses, operations and prospects and regulatory considerations. Therefore, at the time of the Company special meeting you will not know the precise market value of the consideration you will receive at the effective time of the Merger. You should obtain current market quotations for shares of Sterling common stock and for shares of Company common stock.

The market price of Sterling common stock after the Merger may be affected by factors different from those affecting the shares of the Company or Sterling currently.

Upon completion of the Merger, holders of Company common stock will become holders of Sterling common stock. Sterling’s business differs in important respects from that of the Company, and, accordingly, the results of operations of the combined company and the market price of Sterling common stock after the completion of the Merger may be affected by factors different from those currently affecting the independent results of operations of each of Sterling and the Company.

Regulatory approvals may not be received, may take longer than expected or may impose conditions that are not presently anticipated or that could have an adverse effect on the combined company following the Merger.

Before the Merger and the Bank merger may be completed, Sterling and the Company must obtain approvals from the FRB and the OCC. Other approvals, waivers or consents from regulators may also be required. In determining whether to grant these approvals the regulators consider a variety of factors, including the regulatory standing of each party.  An adverse development in either party’s regulatory standing or such factors could result in an inability to obtain approval or delay their receipt. These regulators may impose conditions on the completion of the Merger or the Bank merger or require changes to the terms of the Merger or the Bank merger. Such conditions or changes could have the effect of delaying or preventing completion of the Merger or the Bank merger or imposing additional costs on or limiting the revenues of the combined company following the Merger and the Bank merger, any of which might have an adverse effect on the combined company following the Merger.

Combining the two companies may be more difficult, costly or time consuming than expected and the anticipated benefits and cost savings of the Merger may not be realized.

Sterling and the Company have operated and, until the completion of the Merger, will continue to operate, independently. The success of the Merger, including anticipated benefits and cost savings, will depend, in part, on Sterling’s ability to successfully combine and integrate the businesses of Sterling and the Company in a manner that permits growth opportunities and does not materially disrupt the existing customer relations nor result in decreased revenues due to loss of customers. It is possible that the integration process could result in the loss of key employees, the disruption of either company's ongoing businesses or inconsistencies in standards, controls, procedures and policies that adversely affect the combined company's ability to maintain relationships with clients, customers, depositors and employees or to achieve the anticipated benefits and cost savings of the Merger. The loss of key employees could adversely affect Sterling’s ability to successfully conduct its business, which could have an adverse effect on

 

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Sterling’s financial results and the value of its common stock. If Sterling experiences difficulties with the integration process and attendant systems conversion, the anticipated benefits of the Merger may not be realized fully or at all, or may take longer to realize than expected. As with any merger of financial institutions, there also may be business disruptions that cause Sterling and/or the Company to lose customers or cause customers to remove their accounts from Sterling and/or the Company and move their business to competing financial institutions. Integration efforts between the two companies will also divert management attention and resources. In addition, though the integration and systems conversion of Sterling and legacy Sterling Bancorp following the completion of the Provident New York Bancorp merger on October 31, 2013 is nearly complete, it remains a top priority and continues to utilize human and capital resources. The risk of a diversion of Sterling’s management’s attention away from ongoing business concerns may be increased by two merger integration processes which are relatively close in time. These integration matters could have an adverse effect on each of the Company and Sterling during this transition period and for an undetermined period after completion of the Merger on the combined company. In addition, the actual cost savings of the Merger could be less than anticipated.  

The unaudited pro forma condensed combined financial statements included in the registration statement filed with the SEC in connection with the Merger are preliminary and the actual financial condition and results of operations after the Merger may differ materially.

The unaudited pro forma condensed combined financial statements in the registration statement filed with the SEC in connection with the Merger are presented for illustrative purposes only and are not necessarily indicative of what the combined company’s actual financial condition or results of operations would have been had the Merger been completed on the dates indicated. The unaudited pro forma condensed combined financial statements reflect adjustments to illustrate the effect of the Merger had it been completed on the dates indicated, which are based upon preliminary estimates, to record the Company’s identifiable assets acquired and liabilities assumed at fair value and the resulting goodwill recognized. The purchase price allocation for the Merger reflected in such registration statement is preliminary, and final allocation of the purchase price will be based upon the actual purchase price and the fair value of the assets and liabilities of the Company as of the date of the completion of the Merger. Accordingly, the final acquisition accounting adjustments may differ materially from the pro forma adjustments reflected in the registration statement.

Certain of our directors and executive officers have interests in the Merger that may differ from the interests of our shareholders.

Our shareholders should be aware that some of our directors and executive officers have interests in the Merger and have arrangements that are different from, or in addition to, those of our shareholders generally. Our board of directors was aware of these interests and considered these interests, among other matters, when making its decision to approve the Merger Agreement, and in recommending that our shareholders vote in favor of adopting the merger agreement.  

The material interests considered by our board of directors were as follows:

The terms of the restricted stock, restricted stock unit and stock option awards held by Company directors and executive officers provide for accelerated vesting of the awards upon a change in control such as the Merger.  

Subject to the terms of the Merger Agreement, we have, in consultation with Sterling, accelerated the payment of certain compensatory amounts so that they were paid in 2014 for tax planning purposes with respect to Sections 280G and 4999 of the Code. Such amounts included the acceleration of the vesting date of the Company restricted stock, restricted stock units and 2014 bonuses under our Annual Incentive Plan and the Long Term Incentive Plan.  

We previously entered into change of control agreements on April 10, 2014 and July 7, 2014 with a number of our executive officers, which entitle each of them to certain payments and benefits upon a qualifying termination in connection with a change in control such as the Merger.  

We previously entered into a consulting agreement, dated October 6, 2014, with our retiring executive chairman, which entitles him to terminate the consulting agreement and receive certain payments and benefits in connection with a change in control such as the Merger.

In connection with the execution of the Merger Agreement, our president and chief executive officer entered into a one-year consulting agreement, dated as of November 4, 2014, with Sterling National Bank, which entitles him to the receipt of consulting fees for providing services in connection with the integration of Sterling and the Company.  

Our supplemental deferred compensation agreement dated as of October 1, 2010, and our supplemental retirement plans each provide for accelerated vesting of retirement benefits in connection with a change in control such as the Merger.  

Four current Company directors will join the board of Sterling and Sterling National Bank upon completion of the Merger, and Sterling will also establish an advisory board consisting of Company directors who are not joining the boards of Sterling and Sterling National Bank and who wish to serve on the advisory board. Members of the Sterling board are expected to receive compensation consistent with the compensation paid to current non-employee directors of Sterling. During 2014, such compensation included an annual retainer fee of $24,000 and per-meeting fees. Directors are also eligible to receive stock awards and stock option grants and are eligible to participate in Sterling’s Deferred Director Fee

 

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Plan.  Members of the Sterling advisory board will be eligible to receive fees for their service on the advisory board that are substantially similar to the fees received by members of our Business Development Board as of the date of the Merger Agreement, which in 2014 totaled approximately $1,250 in value per person. As of the date of this Annual Report on Form 10-K, Sterling had not yet identified which of our current directors will join the boards of Sterling and Sterling National Bank upon completion of the Merger.

Termination of the Merger Agreement could negatively impact the Company or Sterling.

If the Merger Agreement is terminated, there may be various consequences. For example, our or Sterling’s businesses may have been impacted adversely by the failure to pursue other beneficial opportunities due to the focus of management on the Merger, without realizing any of the anticipated benefits of completing the Merger. Additionally, if the Merger Agreement is terminated, the market price of our or Sterling’s common stock could decline to the extent that the current market prices reflect a market assumption that the Merger will be completed. If the Merger Agreement is terminated under certain circumstances, the Company or Sterling may be required to pay to the other party a termination fee of $20 million.

The Company and Sterling will be subject to business uncertainties and contractual restrictions while the Merger is pending.

Uncertainty about the effect of the Merger on employees and customers may have an adverse effect on the Company or Sterling. These uncertainties may impair our or Sterling’s ability to attract, retain and motivate key personnel until the Merger is completed, and could cause customers and others that deal with the Company or Sterling to seek to change existing business relationships with the Company or Sterling. Retention of certain employees by the Company or Sterling may be challenging while the Merger is pending, as certain employees may experience uncertainty about their future roles with the Company or Sterling. If key employees depart because of issues relating to the uncertainty and difficulty of integration or a desire not to remain with the Company or Sterling, our business or Sterling’s business could be harmed. In addition, subject to certain exceptions, the Company has agreed to operate its business in the ordinary course prior to closing, and each of the Company and Sterling has agreed to certain restrictive covenants.

If the Merger is not completed, Sterling and the Company will have incurred substantial expenses without realizing the expected benefits of the Merger.

Each of Sterling and the Company has incurred and will incur substantial expenses in connection with the negotiation and completion of the transactions contemplated by the Merger Agreement. If the Merger is not completed, Sterling and the Company would have to recognize these expenses without realizing the expected benefits of the Merger.

The Merger Agreement limits the Company’s ability to pursue acquisition proposals and requires either company to pay a termination fee of $20 million under limited circumstances, including circumstances relating to acquisition proposals for the Company. Additionally, certain provisions of our articles of incorporation and bylaws may deter potential acquirers.

The Merger Agreement prohibits the Company from initiating, soliciting, knowingly encouraging or knowingly facilitating certain third-party acquisition proposals.  In addition, unless the Merger Agreement has been terminated in accordance with its terms, we have an unqualified obligation to submit the Merger proposal to a vote by the shareholders of the Company, even if the Company receives a proposal that the our board believes is superior to the Merger. The Merger Agreement also provides that Sterling or the Company must pay a termination fee in the amount of $20 million in the event that the Merger Agreement is terminated under certain circumstances, including involving our failure to abide by certain obligations not to solicit acquisition proposals.  These provisions might discourage a potential competing acquirer that might have an interest in acquiring all or a significant part of the Company from considering or proposing such an acquisition. Each of the members of the Company’s board, solely in his or her capacity as a shareholder of the Company, and certain of their affiliates, has entered into voting agreements and have agreed to vote his or her shares of the Company’s common stock in favor of the Merger Agreement and certain related matters and against alternative transactions. The Company’s shareholders that are party to these voting agreements beneficially own and are entitled to vote in the aggregate approximately 24.9% of the outstanding shares of the Company’s common stock as of the record date. Additionally, certain provisions of our certificate of incorporation or bylaws or of the New York Business Corporation Law (“NYBCL”) could make it more difficult for a third-party to acquire control of the Company or may discourage a potential competing acquirer.  

The shares of Sterling common stock to be received by Company shareholders as a result of the Merger will have different rights from the shares of Company common stock.

Upon completion of the Merger, Company shareholders will become Sterling stockholders and their rights as stockholders will be governed by the Delaware General Corporation Law and the Sterling certificate of incorporation and bylaws. The rights associated with Company common stock are different from the rights associated with Sterling common stock.

Holders of Company and Sterling common stock will have a reduced ownership and voting interest after the Merger and will exercise less influence over management.

Holders of Company and Sterling common stock currently have the right to vote in the election of the board of directors and on other matters affecting the Company and Sterling, respectively. Upon the completion of the Merger, each Company shareholder who receives shares of Sterling common stock will become a stockholder of Sterling with a percentage ownership of Sterling that is smaller

 

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than the stockholder’s percentage ownership of the Company. It is currently expected that the former shareholders of the Company as a group will receive shares in the Merger constituting approximately 30% of the outstanding shares of Sterling common stock immediately after the Merger. As a result, current stockholders of Sterling as a group will own approximately 70% of the outstanding shares of Sterling common stock immediately after the Merger. Because of this, Company shareholders may have less influence on the management and policies of Sterling than they now have on the management and policies of the Company and current Sterling stockholders may have less influence than they now have on the management and policies of Sterling.

Company shareholders will not have dissenters' or appraisal rights in the Merger.  

Dissenters’ rights are statutory rights that, if applicable under law, enable shareholders to dissent from an extraordinary transaction, such as a merger, and to demand that the corporation pay the fair value for their shares as determined by a court in a judicial proceeding instead of receiving the consideration offered to shareholders in connection with the extraordinary transaction. Under the NYBCL, a shareholder may not dissent from a merger as to shares that are listed on a national securities exchange at the record date fixed to determine the shareholders entitled to receive notice of the meeting of shareholders to vote upon the agreement of merger or consolidation.

Because the Company’s common stock is listed on the New York Stock Exchange, a national securities exchange, and is expected to continue to be so listed on the record date, and because the Merger otherwise satisfies the foregoing requirements of the NYBCL, holders of Company common stock will not be entitled to dissenters’ or appraisal rights in the Merger with respect to their shares of Company common stock.

Pending litigation against the Company and Sterling could result in an injunction preventing the completion of the Merger or a judgment resulting in the payment of damages.

The outcome of any such litigation is uncertain. If the cases are not resolved, these lawsuits could prevent or delay completion of the Merger and result in substantial costs to Sterling and the Company, including any costs associated with the indemnification of directors and officers. Plaintiffs may file additional lawsuits against Sterling, the Company and/or the directors and officers of either company in connection with the Merger. The defense or settlement of any lawsuit or claim that remains unresolved at the time the Merger is completed may adversely affect Sterling’s business, financial condition, results of operations and cash flows.

Risks Relating to Our Common Stock

Market conditions and other factors may affect the value of our common stock.

The trading price of the shares of our common stock will depend on many factors, which may change from time to time, including:

conditions in the credit, mortgage and housing markets, the markets for securities relating to mortgages or housing, and developments with respect to financial institutions generally;

interest rates;

the market for similar securities;

government action or regulation;

general economic conditions or conditions in the financial markets;

our past and future dividend practice;

our financial condition, performance, creditworthiness and prospects; and

the stock price of Sterling Bancorp, our partner in the Merger.

Accordingly, the shares of common stock that an investor purchases may trade at a price lower than that at which they were purchased.

 

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There may be future dilution of our common stock.

The Company is currently authorized to issue up to 25 million shares of common stock, of which 20,082,568 shares were outstanding as of December 31, 2014, and up to 15 million shares of preferred stock, of which no shares are outstanding. The Company’s certificate of incorporation authorizes the Board of Directors to, among other things, issue additional shares of common or preferred stock, or securities convertible or exchangeable into common or preferred stock, without stockholder approval. We may issue such additional equity or convertible securities to raise additional capital in connection with acquisitions, as part of our employee and director compensation or otherwise. The issuance of any additional shares of common or preferred stock or convertible securities could substantially dilute holders of our common stock. Moreover, to the extent that we issue restricted stock, stock options, or warrants to purchase our common stock in the future and those stock options or warrants are exercised or the restricted stock vests, our stockholders may experience further dilution. Holders of our shares of common stock have no preemptive rights that entitle them to purchase their pro rata share of any offering of shares of any class or series and, therefore, such sales or offerings could result in increased dilution to our stockholders.

We may reduce or eliminate the cash dividend on our common stock.

We increased our total per share dividend in 2014 to $0.28 per share from a total per share dividend of $0.24 in 2013, compared to a total per share dividend of $0.72 in 2012. Holders of our common stock are only entitled to receive such cash dividends as our Board of Directors may declare out of funds legally available for such payments. Although we have historically declared cash dividends on our common stock, we are not required to do so and we may reduce or eliminate our common stock cash dividend in the future. This could adversely affect the market price of our common stock. Also, as a bank holding company, the Company’s ability to declare and pay dividends depends on certain federal regulatory considerations, including the guidelines of the FRB regarding capital adequacy and dividends.

Dividends from the Bank are the only current significant source of cash for the Company. There are various statutory and regulatory limitations regarding the extent to which the Bank can pay dividends or otherwise transfer funds to the Company. Federal bank regulatory agencies also have the authority to limit further the Bank’s payment of dividends based on such factors as the maintenance of adequate capital for the Bank, which could reduce the amount of dividends otherwise payable. Under applicable banking statutes, at December 31, 2014, the Bank could have declared additional dividends of approximately $22.0 million to the Company. No assurance can be given that the Bank will have the profitability necessary to permit the payment of dividends in the future; therefore, no assurance can be given that the Company would have any funds available to pay dividends to stockholders.

Federal bank regulators require us to maintain certain levels of regulatory capital. The failure to maintain these capital levels or to comply with applicable laws, regulations and supervisory agreements could subject us to a variety of informal and formal enforcement actions. Moreover, dividends can be restricted by any of our regulatory authorities if the agency believes that our financial condition warrants such a restriction.

The Company’s ability to declare and pay dividends is restricted under the New York Business Corporation Law, which provides that dividends may only be paid by a corporation out of its surplus.

The FRB issued a supervisory letter dated February 24, 2009 to bank holding companies that contains guidance on when the board of directors of a bank holding company should eliminate, defer or severely limit dividends including, for example, when net income available for stockholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends. The letter also contains guidance on the redemption of stock by bank holding companies which urges bank holding companies to advise the FRB of any such redemption or repurchase of common stock for cash or other value which results in the net reduction of a bank holding company’s capital during the quarter. The Company did not redeem or repurchase any common stock in the years ended December 31, 2014, 2013 or 2012.

Our common stock price may fluctuate due to the potential sale of stock by our existing stockholders.

We are aware that several of our large stockholders may in the future liquidate some or all of their shares of Company common stock for estate planning and other reasons. In addition, other stockholders may sell their shares of common stock from time to time on the New York Stock Exchange or otherwise. As a result, substantial amounts of our common stock are eligible for future sale. While we cannot predict either the magnitude or the timing of such sales, if a large number of common shares are sold during a short time frame, it may have the effect of reducing the market price of our common stock.

 

22


 

 

Our earnings may be subject to increased volatility.

Our earnings may experience volatility as a result of several factors. These factors include, among others:

interest rate risk and margin compression;

regulatory action against the Bank;

a continuation of the poor economic conditions, or further adverse economic developments;

instability in the financial markets;

our inability to generate or maintain creditworthy customer relationships in our primary markets;

unexpected increases in operating costs, including special assessments for FDIC insurance;

further credit deterioration in our loan portfolio or unanticipated credit deterioration, or defaults by our loan customers;

credit deterioration or defaults by issuers of securities within our investment portfolio; or

increased costs relating to the Merger, including payment of the termination fee.

If any one or more of these events occur, we may experience significant declines in our net interest margin and non-interest income, or we may be required to record substantial charges to our earnings, including increases in the provision for loan losses, credit-related impairment on securities (both permanent and other-than-temporary), and impairment on goodwill and other intangible assets, in future periods.

Our certificate of incorporation, the New York Business Corporation Law and federal banking laws and regulations may prevent a takeover of our company.

If the Merger is not completed, provisions of the Company’s certificate of incorporation, the New York Business Corporation Law and federal banking laws and regulations, including regulatory approval requirements, could make it more difficult for another third party to acquire us, even if doing so would be perceived to be beneficial to our stockholders. The combination of these provisions may inhibit a non-negotiated merger or other business combination, which, in turn, could adversely affect the market price of our common stock.

 

ITEM 1B —  UNRESOLVED STAFF COMMENTS

None

 

 

ITEM 2 —  PROPERTIES

Our principal executive offices, including administrative and operating departments, and HVB’s main branch, are located at 21 Scarsdale Road, Yonkers, New York, in premises we own.

HVB operates 28 branches. HVB owns the following branch locations:

 

Address

 

City

 

County

 

State

37 East Main Street

 

Elmsford

 

Westchester

 

New York

61 South Broadway

 

Yonkers

 

Westchester

 

New York

150 Lake Avenue

 

Yonkers

 

Westchester

 

New York

865 McLean Avenue

 

Yonkers

 

Westchester

 

New York

21 Scarsdale Road

 

Yonkers

 

Westchester

 

New York

664 Main Street

 

Mount Kisco

 

Westchester

 

New York

  

HVB leases the following branch locations:

 

Address

 

City

 

County

 

State

35 East Grassy Sprain Road

 

Yonkers

 

Westchester

 

New York

403 East Sandford Boulevard

 

Mount Vernon

 

Westchester

 

New York

1835 East Main Street

 

Peekskill

 

Westchester

 

New York

500 Westchester Avenue

 

Port Chester

 

Westchester

 

New York

501 Marble Avenue

 

Pleasantville

 

Westchester

 

New York

 

23


 

 

328 Central Avenue

 

White Plains

 

Westchester

 

New York

5 Huguenot Street

 

New Rochelle

 

Westchester

 

New York

40 Church Street

 

White Plains

 

Westchester

 

New York

875 Mamaroneck Avenue

 

Mamaroneck

 

Westchester

 

New York

399 Knollwood Road

 

White Plains

 

Westchester

 

New York

111 Brook Street

 

Eastchester

 

Westchester

 

New York

3130 East Tremont Avenue

 

Bronx

 

Bronx

 

New York

975 Allerton Avenue

 

Bronx

 

Bronx

 

New York

369 East 149th Street

 

Bronx

 

Bronx

 

New York

1250 Waters Place

 

Bronx

 

Bronx

 

New York

16 Court Street

 

Brooklyn

 

Kings

 

New York

60 East 42nd Street

 

Manhattan

 

New York

 

New York

233 Broadway

 

Manhattan

 

New York

 

New York

350 Park Avenue

 

Manhattan

 

New York

 

New York

112 West 34th Street

 

Manhattan

 

New York

 

New York

254 South Main Street

 

New City

 

Rockland

 

New York

4 Executive Boulevard

 

Suffern

 

Rockland

 

New York

  

Of the above leased properties, 4 properties have lease terms that expire within the next 2 years. We currently expect to renew the leases of each of these properties.

HVB Capital Credit LLC is located at 489 Fifth Avenue, New York, New York in leased premises.

HVB Equipment Capital LLC is located at 489 Fifth Avenue, New York, New York in leased premises.

We currently operate 23 ATM machines, 20 of which are located in the Banks’ facilities. Three ATMs are located at off-site locations in New York: St. Joseph’s Hospital, Yonkers, College of Mount Saint Vincent, Riverdale, and Concordia College, Bronxville.

In our opinion, the premises, fixtures and equipment are adequate and suitable for the conduct of our business. All facilities are well maintained and provide adequate parking.

 

 

ITEM 3 —  LEGAL PROCEEDINGS

On November 25, 2014, an action captioned Graner v. Hudson Valley Holding Corp., et al., Index No. 70348/2014 (Sup. Ct., Westchester Cnty.), was filed on behalf of a putative class of Hudson Valley shareholders against Hudson Valley, its current directors, and Sterling. On January 7, 2015, plaintiff filed an amended complaint. As amended, the complaint alleges that the Hudson Valley board breached its fiduciary duties by agreeing to the Merger and certain terms of the Merger Agreement and by failing to disclose all material information concerning the Merger to shareholders. The complaint further alleges that Sterling aided and abetted those alleged fiduciary breaches. The action seeks, among other things, an order enjoining the operation of certain provisions of the Merger Agreement, enjoining any shareholder vote on the Merger, as well as other equitable relief and/or money damages in the event that the Merger is consummated. The defendants believe that the claims are without merit.

Various claims and lawsuits are pending against the Company and its subsidiaries in the ordinary course of business. In the opinion of management, resolution of each of these other matters is not expected to have a material effect on the financial condition or results of operations of the Company and its subsidiaries.

 

 

ITEM  4 —  MINE SAFETY DISCLOSURE

Not applicable

 

 

 

 

24


 

 

PART II

ITEM 5 —  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock was held of record as of March 3, 2015 by approximately 602 registered stockholders. Our common stock trades on the New York Stock Exchange under the symbol “HVB”.

The table below sets forth the closing price range of our common stock for each quarter indicated and the cash dividends per common share for each quarter. The amounts shown in the table below have been adjusted to reflect all dividends and stock splits.

 

 

 

2014

 

 

 

High

 

 

Low

 

 

Dividend

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First Quarter

 

$

19.44

 

 

$

16.52

 

 

$

0.06

 

Second Quarter

 

 

19.09

 

 

 

16.82

 

 

 

0.06

 

Third Quarter

 

 

18.23

 

 

 

16.71

 

 

 

0.08

 

Fourth Quarter

 

 

27.31

 

 

 

18.04

 

 

 

0.08

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2013

 

 

 

High

 

 

Low

 

 

Dividend

 

 

 

 

 

 

 

 

 

 

 

 

 

 

First Quarter

 

$

16.06

 

 

$

14.31

 

 

$

0.06

 

Second Quarter

 

 

18.69

 

 

 

14.01

 

 

 

0.06

 

Third Quarter

 

 

21.03

 

 

 

17.42

 

 

 

0.06

 

Fourth Quarter

 

 

21.09

 

 

 

17.99

 

 

 

0.06

 

 

In 1998, the Board of Directors of the Company adopted a policy of paying quarterly cash dividends to holders of its common stock. For information regarding the amount of past dividends, see “We may reduce or eliminate the cash dividend on our common stock” under Item 1A.

Any funds which the Company may require in the future to pay cash dividends, as well as various Company expenses, are expected to be obtained by the Company chiefly in the form of cash dividends from HVB and secondarily from sales of common stock pursuant to the Company’s stock option plan. The ability of the Company to declare and pay dividends in the future will depend not only upon its future earnings and financial condition, but also upon the future earnings and financial condition of the Bank and its ability to transfer funds to the Company in the form of cash dividends and otherwise. See further discussion in “Supervision and Regulation” under Item 1 of this Annual Report on Form 10-K. The Company is a separate and distinct legal entity from HVB. The Company’s right to participate in any distribution of the assets or earnings of HVB is subordinate to prior claims of creditors of HVB.

There were no purchases made by the Company of its common stock during the year ended December 31, 2014.

The following table sets forth information regarding the Company’s Stock Option Plans as of December 31, 2014:

 

 

 

 

 

 

 

 

 

 

 

Number of Shares

 

 

 

Number of Shares

 

 

 

 

 

 

Remaining Available

 

 

 

to be Issued

 

 

Weighted-Average

 

 

for Future Issuance

 

 

 

Upon Exercise of

 

 

Exercise Price of

 

 

Under Equity

 

Plan Category

 

Outstanding Options

 

 

Outstanding Options

 

 

Compensation Plans

 

Equity compensation plans approved by stockholders

 

 

88,466

 

 

$

25.14

 

 

 

952,061

 

Equity compensation plans not approved by stockholders

 

 

 

 

 

 

 

 

 

  

All equity compensation plans have been approved by the Company’s stockholders. Additional details related to the Company’s equity compensation plans are provided in Note 11 to the Company’s consolidated financial statements presented in this Form 10-K.

 

25


 

 

Stockholder Return

The following compares the Company’s total stockholder return on a hypothetical $100 investment on December 31, 2009 and for the years 2010 through 2014, with the Russell 2000 and the SNL $1 billion to $5 billion Bank indexes.

 

 

Period Ending

 

Index

12/31/09

 

12/31/10

 

12/31/11

 

12/31/12

 

12/31/13

 

12/31/14

 

Hudson Valley Holding Corp.

$

100.00

 

$

113.99

 

$

111.14

 

$

85.08

 

$

112.77

 

$

152.74

 

Russell 2000

 

100.00

 

 

126.86

 

 

121.56

 

 

141.43

 

 

196.34

 

 

205.95

 

SNL Bank $1B-$5B

 

100.00

 

 

113.35

 

 

103.38

 

 

127.47

 

 

185.36

 

 

193.81

 

The graph assumes all dividends were reinvested. Returns are market capitalization weighted.

 

 

 

 

26


 

 

ITEM 6 —  SELECTED FINANCIAL DATA

The following table sets forth selected historical consolidated financial data for the years ended and at the dates indicated. The selected historical consolidated financial data as of December 31, 2014 and 2013, and for the years ended December 31, 2014, 2013 and 2012, are derived from our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The selected historical consolidated financial data as of December 31, 2012, 2011 and 2010 and for the years ended December 31, 2011 and 2010 are derived from our consolidated financial statements that are not included in this Annual Report on Form 10-K. Share and per share data have been restated to reflect the effects of 10 percent stock dividends issued in 2011 and 2010. The information set forth below should be read in conjunction with the consolidated financial statements and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this Annual Report on Form 10-K.

 

 

 

Years Ended December 31,

 

 

 

2014

 

 

2013

 

 

2012

 

 

2011

 

 

2010

 

 

 

(Dollars in thousands, except per share data)

 

Operating Results:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total interest income

 

$

97,091

 

 

$

89,583

 

 

$

110,052

 

 

$

128,617

 

 

$

128,339

 

Total interest expense

 

 

4,763

 

 

 

5,646

 

 

 

6,723

 

 

 

10,758

 

 

 

17,683

 

Net interest income

 

 

92,328

 

 

 

83,937

 

 

 

103,329

 

 

 

117,859

 

 

 

110,656

 

Provision for loan losses

 

 

1,792

 

 

 

2,476

 

 

 

8,507

 

 

 

64,154

 

 

 

46,527

 

Income (loss) before income taxes

 

 

11,924

 

 

 

(3,496

)

 

 

46,126

 

 

 

(7,550

)

 

 

3,708

 

Net income (loss)

 

 

7,942

 

 

 

1,130

 

 

 

29,181

 

 

 

(2,137

)

 

 

5,113

 

Basic earnings (loss) per common share

 

 

0.40

 

 

 

0.06

 

 

 

1.49

 

 

 

(0.11

)

 

 

0.26

 

Diluted earnings (loss) per common share

 

 

0.40

 

 

 

0.06

 

 

 

1.49

 

 

 

(0.11

)

 

 

0.26

 

Weighted average shares outstanding

 

 

19,721,575

 

 

 

19,597,431

 

 

 

19,538,294

 

 

 

19,462,055

 

 

 

19,393,895

 

Diluted weighted average shares outstanding

 

 

19,770,051

 

 

 

19,597,713

 

 

 

19,545,037

 

 

 

19,462,055

 

 

 

19,455,971

 

Cash dividend per common share

 

$

0.28

 

 

$

0.24

 

 

$

0.72

 

 

$

0.64

 

 

$

0.59

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial Position:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities

 

$

819,874

 

 

$

548,436

 

 

$

455,295

 

 

$

520,802

 

 

$

459,934

 

Loans, net

 

 

1,900,814

 

 

 

1,606,179

 

 

 

1,440,760

 

 

 

1,541,405

 

 

 

1,689,187

 

Total assets

 

 

3,138,570

 

 

 

2,999,199

 

 

 

2,891,246

 

 

 

2,797,670

 

 

 

2,669,033

 

Deposits

 

 

2,781,072

 

 

 

2,633,744

 

 

 

2,519,961

 

 

 

2,425,282

 

 

 

2,234,412

 

Borrowings

 

 

28,161

 

 

 

50,767

 

 

 

51,052

 

 

 

69,522

 

 

 

124,345

 

Stockholders' equity

 

 

297,566

 

 

 

284,309

 

 

 

290,971

 

 

 

277,562

 

 

 

289,917

 

 

 

27


 

 

Financial Ratios

Significant ratios of the Company for the periods indicated were as follows:

 

 

 

Year Ended December 31,

 

 

 

2014

 

 

2013

 

 

2012

 

 

2011

 

 

2010

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings Ratios:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income as a percentage of:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Average earning assets

 

 

0.27

%

 

 

0.04

%

 

 

1.10

%

 

 

(0.08

)%

 

 

0.20

%

Average total assets

 

 

0.26

 

 

 

0.04

 

 

 

1.02

 

 

 

(0.08

)

 

 

0.18

 

Average total stockholders' equity

 

 

2.73

 

 

 

0.39

 

 

 

10.05

 

 

 

(0.72

)

 

 

1.75

 

Adjusted average total stockholders' equity (1)

 

 

2.72

 

 

 

0.38

 

 

 

10.10

 

 

 

(0.72

)

 

 

1.77

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Capital Ratios:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Average total stockholders' equity to average total assets

 

 

9.43

%

 

 

9.84

%

 

 

10.19

%

 

 

10.59

%

 

 

10.43

%

Average net loans as a multiple of average total stockholders' equity

 

 

5.92

 

 

 

5.05

 

 

 

5.63

 

 

 

6.33

 

 

 

5.86

 

Leverage capital

 

 

9.32

%

 

 

9.52

%

 

 

9.32

%

 

 

8.80

%

 

 

9.60

%

Tier 1 capital (to risk weighted assets)

 

 

13.89

 

 

 

16.21

 

 

 

16.46

 

 

 

11.33

 

 

 

13.92

 

Total risk-based capital (to risk weighted assets)

 

 

15.14

 

 

 

17.46

 

 

 

17.72

 

 

 

12.58

 

 

 

15.18

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses as a percentage of year-end loans

 

 

1.42

%

 

 

1.59

%

 

 

1.81

%

 

 

1.95

%

 

 

2.25

%

Loans (net) as a percentage of year-end total assets  (2)

 

 

60.56

 

 

 

53.55

 

 

 

49.83

 

 

 

55.10

 

 

 

63.29

 

Loans (net) as a percentage of year-end total deposits  (2)

 

 

68.35

 

 

 

60.98

 

 

 

57.17

 

 

 

63.56

 

 

 

75.60

 

Securities as a percentage of year-end total assets

 

 

26.12

 

 

 

18.29

 

 

 

15.75

 

 

 

18.62

 

 

 

17.23

 

Average interest earning assets as a percentage of average interest

   bearing liabilities

 

 

168.94

 

 

 

170.73

 

 

 

169.33

 

 

 

161.63

 

 

 

150.04

 

Dividends per share as a percentage of diluted earnings per share

 

 

70.00

 

 

 

400.00

 

 

 

48.32

 

 

 

 

 

 

226.92

 

  

 

(1)

Adjusted average stockholders’ equity excludes unrealized losses, net of tax, of $1,490 and $3,985 in 2014 and 2013, respectively, and unrealized gains, net of tax, of $1,536, $1,229, and $3,078 in 2012, 2011 and 2010, respectively. Adjusted average stockholders’ equity is a non-GAAP financial measure. Please refer to pages below for a reconciliation to GAAP. Management believes this alternate presentation more closely reflects actual performance, as it is more consistent with the Company’s stated asset/liability management strategies, which have not resulted in significant realization of temporary market gains or losses on securities available for sale which were primarily related to changes in interest rates. Net income as a percentage of adjusted average stockholders’ equity is one of several factors utilized by management to determine total compensation.

(2)

Loans, net, exclude $474 million in loans held for sale at year-end 2011. These were sold at the end of the first quarter of 2012.

 

 

 

 

28


 

 

ITEM 7 —  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This section presents discussion and analysis of the Company’s consolidated financial condition at December 31, 2014 and 2013, and consolidated results of operations for each of the three years in the period ended December 31, 2014. The Company is consolidated with its wholly-owned subsidiaries Hudson Valley Bank, N.A. and its subsidiaries (collectively “HVB” or “the Bank”) and HVHC Risk Management Corp. This discussion and analysis should be read in conjunction with the financial statements and supplementary financial information contained elsewhere in this Annual Report on Form 10-K.

Forward-Looking Statements

The Company has made in this Annual Report on Form 10-K various forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 with respect to earnings, credit quality and other financial and business matters for periods subsequent to December 31, 2014. Such statements are not historical facts and include expressions about management’s confidence and strategies and management’s expectations about items such as new and existing programs and products, relationships, opportunities, taxation, technology, market conditions and economic expectations.  These statements may be identified by such forward-looking terminology as “should,” “expect,” “believe,” “view,” “intends,” “estimates,” “predicts,” “opportunity,” “allow,” “continues,” “reflects,” “typically,” “usually,” “anticipate,” and words of similar import. The Company cautions that these forward-looking statements are subject to numerous assumptions, risks and uncertainties, and that statements relating to subsequent periods increasingly are subject to greater uncertainty because of the increased likelihood of changes in underlying factors and assumptions. Actual results could differ materially from forward-looking statements.

Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements, in addition to those risk factors disclosed in this Annual Report on Form 10-K include, but are not limited to, statements regarding:

the OCC and other bank regulators may require us to modify or change our mix of assets, including our concentration in certain types of loans, or require us to take further remedial actions;

our inability to deploy our excess cash, reduce our expenses and improve our operating leverage and efficiency;

our ability to pay quarterly cash dividends to shareholders in light of our earnings, the current and future economic environment, FRB guidance, our Bank’s capital plan and other regulatory requirements applicable to Hudson Valley or Hudson Valley Bank;

the possibility that we may need to raise additional capital in the future and our ability to raise such capital on terms that are favorable to us;

further increases in our nonperforming loans and allowance for loan losses;

ineffectiveness in managing our loan portfolios;

lower than expected future performance of our investment portfolio;

inability to effectively integrate and manage new businesses and lending teams;

a lack of opportunities for growth and increased or unexpected competition in attracting and retaining customers;

continued poor economic conditions generally and in our market area in particular, which may adversely affect the ability of borrowers to repay their loans and the value of real property or other property held as collateral for such loans;

lower than expected demand for our products and services;

possible additional impairment of our goodwill and other intangible assets;

our inability to manage interest rate risk;

increased expense and burdens resulting from the regulatory environment in which we operate and our ability to comply with existing and future regulatory requirements;

our inability to maintain regulatory capital above the minimum levels the Bank has set as its minimum capital levels or such higher capital levels as may be required;

proposed legislative and regulatory action may adversely affect us and the financial services industry;

legislative and regulatory actions (including the impact of the Dodd-Frank Act and Consumer Protection Act and related regulations) may subject us to additional regulatory oversight which may result in increased compliance costs and/or require us to change our business model;

 

29


 

 

future increased FDIC special assessments or changes to regular assessments;

potential liabilities under federal and state environmental laws;

legislative and regulatory changes to laws governing New York State’s taxation of HVB’s REIT subsidiary;

our ability to obtain regulatory approvals and meet other closing conditions to the Merger, including approval by Sterling Bancorp and Hudson Valley Holding Corp. stockholders, on the expected terms and schedule;

delay in closing the Merger;

difficulties and delays in integrating the Sterling and Hudson Valley businesses or fully realizing cost savings and other benefits;

business disruption following the proposed Merger transaction; changes in asset quality and credit risk;

the inability to sustain revenue and earnings growth; changes in interest rates and capital markets; and

the inability to realize cost savings or revenues or to implement integration plans and other consequences associated with mergers, acquisitions and divestitures.

We assume no obligation for updating any such forward-looking statements at any time.

 Overview of Management’s Discussion and Analysis

This overview is intended to highlight selected information included in this Annual Report on Form 10-K. It does not contain sufficient information for a complete understanding of the Company’s financial condition and operating results and, therefore, should be read in conjunction with this entire Annual Report on Form 10-K.

The Company derives substantially all of its revenue from providing banking and related services to businesses, professionals, municipalities, not-for profit organizations and individuals within its market area, primarily Westchester County and Rockland County, New York, and portions of New York City. The Company’s assets consist primarily of cash and cash equivalents, loans and investment securities, which are funded by deposits, borrowings and capital. The primary source of revenue is net interest income, the difference between interest income on cash and cash equivalents, loans and investments, and interest expense on deposits and borrowed funds. The Company’s strategy includes consummation of the Merger, and to a lesser extent, investigation of opportunities for expansion within our market area, select lending opportunities outside our market area, as well as an ongoing review of our existing branch system to evaluate if our current locations have or have not met expectations for growth and profitability. Considering current economic conditions, the Company’s primary market risk exposures are interest rate risk, the risk of deterioration of market values of collateral supporting the Company’s loan portfolio, particularly commercial and residential real estate, and potential risks associated with the impact of regulatory changes that have occurred and may continue to take place in reaction to current conditions in the financial system. Interest rate risk is the exposure of net interest income to changes in interest rates. Commercial and residential real estate are the primary collateral for the majority of the Company’s loans.

The Company recorded net income of $7.9 million or $0.40 per diluted share in 2014 compared to net income of $1.1 million or $0.06 per diluted share in 2013. The overall increase in 2014, compared to 2013, reflected higher net interest income, lower non-interest expense, and a lower provision for loan losses, partially offset by lower non-interest income and higher income taxes.

Net interest income was $92.3 million for the year ended December 31, 2014, compared to $83.9 million for the year ended December 31, 2013. The $8.4 million or 10.0% increase in net interest income was attributable to the combination of higher levels of interest-earnings assets and the lower cost of interest-bearing liabilities, partially offset by lower yields on interest-earning assets.

 

The provision for loan losses totaled $1.8 million for the year ended December 31, 2014 compared to $2.5 million for the year ended December 31, 2013. The decline in the provision reflects continued improvement in overall asset quality and the continued improvements in the resolution of classified and nonperforming loans.

Non-interest income was $13.7 million for the year ended 2014 compared to $15.1 million for the year ended December 31, 2013. The decline in non-interest income was due to the recognition of the $1.9 million pre-tax prepayment penalty for the redemption of all of the outstanding Federal Home Loan Bank of New York (“FHLB”) advances and the $0.9 million pre-tax loss the Company recognized on the sale of A.R. Schmeidler partially offset by the pretax other-than-temporary impairment charge of $1.2 million the Company recorded in 2013.

Non-interest expense was $92.3 million for the year ended December 31, 2014 compared to $100.1 million for the year ended December 31, 2013. The decline in non-interest expense was attributable to the $18.7 million pretax goodwill impairment charge the Company recorded in 2013, partially offset by a $1.2 million pre-tax goodwill impairment charge and higher compensation and professional fees recorded in 2014.

 

30


 

 

Total investment securities increased $271.5 million to $819.9 million at December 31, 2014 compared to $548.4 million at the prior year end. Total loans increased $296.6 million to $1,927.4 million at December 31, 2014, compared to $1,630.8 million at the prior year end. The overall increase in investment securities was the result of the previously reported $300 million securities purchase. The overall increase in loans was primarily the result of increased organic loan growth in excess of payoffs and pay downs during the year.

The increase in investment securities and loans was primarily funded by the $406.5 million reduction in cash and cash equivalents and the $147.4 million increase in deposits. Cash and cash equivalents totaled $292.9 million at December 31, 2014, compared to $699.4 million at December 31, 2013. Total deposits were $2,781.1 million at December 31, 2014, compared to $2,633.7 million at December 31, 2013. The Company continued to emphasize its core deposit growth, while placing less emphasis on non-core deposits including deposits which are obtained on a bid basis.

Hudson Valley’s capital ratios remain significantly in excess of “well capitalized” levels generally applicable to banks under current regulations. At December 31, 2014, Hudson Valley Holding Corp. posted a total risk-based capital ratio of 15.1 percent, a Tier 1 risk-based capital ratio of 13.9 percent, and a Tier 1 leverage ratio of 9.3 percent. At December 31, 2014, Hudson Valley Bank, N.A. posted a total risk-based capital ratio of 14.8 percent, a Tier 1 risk-based capital ratio of 13.6 percent, and a Tier 1 leverage ratio of 9.1 percent.

Critical Accounting Policies

Application of Critical Accounting Policies — The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). The Company’s significant accounting policies are more fully described in Note 1 to the Consolidated Financial Statements. Certain accounting policies require management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reporting period. On an on-going basis, management evaluates its estimates and assumptions, and the effects of revisions are reflected in the financial statements in the period in which they are determined to be necessary. The accounting policies described below are those that most frequently require management to make estimates and judgments, and therefore, are critical to understanding the Company’s results of operations. Senior management has discussed the development and selection of these accounting estimates and the related disclosures with the Audit Committee of the Company’s Board of Directors.

Securities — Securities are classified as either available for sale, representing securities the Company may sell in the ordinary course of business, or as held to maturity, representing securities that the Company has determined that it is more likely than not it would not be required to sell prior to maturity or recovery of cost. Securities available for sale are reported at fair value with unrealized gains and losses (net of tax) excluded from operations and reported in other comprehensive income. Securities held to maturity are stated at amortized cost. Interest income includes amortization of purchase premium and accretion of purchase discount. The amortization of premiums and accretion of discounts is determined by using the level yield method. Securities are not acquired for purposes of engaging in trading activities. Realized gains and losses from sales of securities are determined using the specific identification method. The Company regularly reviews declines in the fair value of securities below their costs for purposes of determining whether such declines are other-than-temporary in nature. In estimating other-than-temporary impairment (“OTTI”), management considers adverse changes in expected cash flows, the length of time and extent that fair value has been less than cost and the financial condition and near term prospects of the issuer. The Company also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of these criteria is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) OTTI related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis.

Allowance for Loan Losses — The Company maintains an allowance for loan losses to absorb inherent probable losses in the loan portfolio. The Company calculates the allowance for loan losses on a quarterly basis applying and documenting a systematic methodology. The Company’s methodology for assessing the appropriateness of the allowance consists of a specific component for identified problem loans, and a formula component which addresses historical loan loss experience together with other relevant risk factors affecting the portfolio. This methodology applies to all portfolio segments.

The specific component incorporates the Company’s analysis of impaired loans. The accounting standards prescribe the measurement methods, income recognition and disclosures related to impaired loans. A loan is recognized as impaired when it is probable that principal and/or interest are not collectible in accordance with the loan’s contractual terms. In addition, a loan which has been renegotiated with a borrower experiencing financial difficulties for which the terms of the loan have been modified with a

 

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concession that the Company would not otherwise have granted are considered troubled debt restructurings (“TDR”) and are also recognized as impaired. Measurement of impairment can be based on 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, taking into account estimated selling costs, if the loan is collateral dependent. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant change. If the fair value of an impaired loan is less than the related recorded amount, a specific valuation component is established within the allowance for loan losses or, if the impairment is considered to be permanent, a full or partial charge-off is recorded against the allowance for loan losses. Triggering events that may impact the Company’s decision to record a specific reserve instead of a partial charge-off on impaired loans typically involve some uncertainty as to the amount of loss to be recorded. Examples include ongoing negotiations with a borrower, new appraisals or other collateral evaluations not yet received or completed and other factors where the decision to record a charge-off is considered premature. Subsequent changes in impairment are recorded as an adjustment to the provision for loan losses. The Company has groups of smaller balance homogenous loans which are collectively reviewed for impairment. These groups include residential 1-4 family loans, home equity lines of credit and consumer loans. These loans are not individually risk rated while performing. They are either charged off or evaluated for impairment after 90 days delinquency.

The formula component is calculated by first applying historical loss experience factors to outstanding loans by type. The Company’s primary loan types are commercial real estate (“CRE”), construction, residential real estate, commercial & industrial, lease financing and other loans. The Company uses a three year average loss experience as the starting point for the formula component. The three year average loss experience is calculated over the loss emergence period (“LEP”). The LEP is an estimate of the average amount of time from the point at which a loss is incurred on a loan to the point at which the loss is confirmed. This component is then adjusted to reflect qualitative risk factors not addressed by historical loss experience. These factors include the evaluation of then-existing economic and business conditions affecting the key lending areas of the Company and other conditions, such as new loan products, credit quality trends (including trends in nonperforming loans expected to result from existing conditions), collateral values, loan volumes and concentrations, recent charge-off and delinquency experience, specific industry conditions within portfolio segments that existed as of the balance sheet date and the impact that such conditions were believed to have had on the collectability of the loan portfolio, changes in the Company’s lending policy, changes in the experience and ability of our lending management staff, changes in the Company’s loan review system, and other external considerations, including regulatory requirements. Senior management reviews these conditions quarterly. Management’s evaluation of the loss related to each of these conditions is quantified by portfolio segment and reflected in the formula component. The evaluations of the inherent loss with respect to these conditions is subject to a higher degree of uncertainty due to the subjective nature of such evaluations and because they are not identified with specific problem credits.

Actual losses can vary significantly from the estimated amounts. The Company’s methodology permits adjustments to the allowance in the event that, in management’s judgment, significant factors which affect the collectability of the loan portfolio as of the evaluation date have changed.

Management believes the allowance for loan losses is the best estimate of probable losses which have been incurred as of December 31, 2014 and 2013. While the Company attributes portions of the allowance for loan losses to the Company’s portfolio segments, the entire allowance is available to absorb credit losses inherent in the total loan portfolio. There is no assurance that the Company will not be required to make future adjustments to the allowance in response to changing economic conditions, particularly in the Company’s service area, since the majority of the Company’s loans are collateralized by real estate. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on their judgments at the time of their examinations.

Goodwill and Other Intangible Assets — Goodwill and identified intangible assets with indefinite useful lives are not subject to amortization. Identified intangible assets that have finite useful lives are amortized over those lives by a method which reflects the pattern in which the economic benefits of the intangible asset are used up. Goodwill is subject to impairment testing on an annual basis, or more often if events or circumstances indicate that impairment may exist. Identifiable intangible assets are subject to impairment if events or circumstances indicate that impairment may exist. If such testing indicates impairment in the values and/or remaining amortization periods of the intangible assets, adjustments are made to reflect such impairment.

Income Taxes — Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The deferred tax asset is evaluated for realizability at each balance sheet date. At December 31, 2014 and 2013, the Company determined the deferred tax asset was fully realizable. The effect on deferred tax assets and liabilities from a change in tax rates is recognized in income in the period the change is enacted. At December 31, 2014 and 2013, the Company

 

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had no unrecognized tax benefits. The Company does not expect the total amount of unrecognized tax benefits to significantly increase within the next twelve months. The Company policy is to recognize interest and penalties related to unrecognized tax benefits as a component of income tax expense. There were no expenses accrued for interest and penalties on unrecognized tax benefits for the years ended December 31, 2014 and 2013.

Comparison of Results of Operations and Financial Condition for the Years Ended December 31, 2014 and 2013

Results of Operations

Summary

Net income for the year ended December 31, 2014 increased $6.8 million to $7.9 million, compared to $1.1 million for the year ended December 31, 2013. Diluted earnings per common share increased to $0.40 per common share for the year ended December 31, 2014, compared to $0.06 per common share for the year ended December 31, 2013. The overall increase in 2014, compared to 2013, reflected higher net interest income, increased margin, lower non-interest expense, and a lower provision for loan losses, partially offset by lower non-interest income and higher income taxes.

In addition to earnings per share, key performance measurements for the Company are return on average shareholder’s equity (“ROAE”) and return on average assets (“ROAA”). ROAE totaled 2.7 percent for 2014 as compared to 0.4 percent for 2013, while ROAE was 0.26 percent for 2014 as compared to 0.04 percent for 2013.

 

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Average Balances and Interest Rates

The following table sets forth the daily average balances of interest earning assets and interest bearing liabilities as well as total interest and corresponding yields and rates for each of the periods indicated:

 

 

 

Year Ended December 31,

 

 

 

2014

 

 

2013

 

 

2012

 

 

 

Average Balance

 

 

Interest (3)

 

 

Yield/ Rate

 

 

Average Balance

 

 

Interest (3)

 

 

Yield/ Rate

 

 

Average Balance

 

 

Interest (3)

 

 

Yield/ Rate

 

 

 

(Dollars in thousands)

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits in banks

 

$

461,196

 

 

$

1,164

 

 

 

0.25

%

 

$

759,011

 

 

$

1,985

 

 

 

0.26

%

 

$

535,868

 

 

$

1,254

 

 

 

0.23

%

Federal funds sold

 

 

18,179

 

 

 

31

 

 

 

0.17

%

 

 

22,256

 

 

 

38

 

 

 

0.17

%

 

 

19,695

 

 

 

39

 

 

 

0.20

%

Securities: (1)