10-K 1 flic-20171231x10k.htm 10-K flic 20171231 10K

 



UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

___________

 

FORM 10-K

 

(Mark One)

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

 



 

 

 

 

For the fiscal year ended

December 31, 2017

 

 

 

 

OR

 

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

 

For the transition period from           to          

 

Commission file number 001-32964

 

THE FIRST OF LONG ISLAND CORPORATION

(Exact Name Of Registrant As Specified In Its Charter)



 



 

 

 

 



New York

 

11-2672906

 



(State or Other Jurisdiction of Incorporation or Organization)

 

(I.R.S. Employer Identification No.)

 



 

 

 

 



10 Glen Head Road, Glen Head, NY

 

11545

 



(Address of Principal Executive Offices)

 

(Zip Code)

 



(516) 671-4900

Registrant's telephone number, including area code

 

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





 

 

Title of Each Class

 

Name of Each Exchange on Which Registered

 

 

 

Common Stock, $.10 par value per share

 

The NASDAQ Stock Market

 

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





None

(Title of class)

 

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

    Yes   No 

 

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 

 

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

 

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

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405) 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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 



 

 

Large accelerated filer   

 

Accelerated filer 

Non-accelerated filer 

 

Smaller reporting company 



 

Emerging growth company 



If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 



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

 

The aggregate market value of the Corporation’s voting common stock held by nonaffiliates as of June 30, 2017, the last business day of the Corporation’s most recently completed second fiscal quarter, was $663.5  million. This value was computed by reference to the price at which the stock was last sold on June 30, 2017 and excludes $26.6 million representing the market value of common stock beneficially owned by directors and executive officers of the registrant.

 

Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date.

 



 

 

Class

 

Outstanding, March 1, 2018

Common Stock, $.10 par value

 

25,018,449



 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Registrant’s Proxy Statement for the Annual Meeting of Stockholders to be held April 17, 2018 are incorporated by reference into Part III.

 


 

 

TABLE OF CONTENTS





 

 

PART I

ITEM 1.

Business

1

ITEM 1A.

Risk Factors

7

ITEM 1B.

Unresolved Staff Comments

12

ITEM 2.

Properties

12

ITEM 3.

Legal Proceedings

12

ITEM 4.

Mine Safety Disclosures

12

PART II

 

 

ITEM 5.

Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

13

ITEM 6.

Selected Financial Data

14

ITEM 7.

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

15

ITEM 7A.

Quantitative and Qualitative Disclosures About Market Risk

30

ITEM 8.

Financial Statements and Supplementary Data

34

ITEM 9. 

Changes In and Disagreements With Accountants on Accounting and Financial Disclosure

72

ITEM 9A.

Controls and Procedures

72

ITEM 9B.

Other Information

72

PART III

 

 

ITEM 10.

Directors, Executive Officers and Corporate Governance

72

ITEM 11.

Executive Compensation

72

ITEM 12.

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

73

ITEM 13.

Certain Relationships and Related Transactions and Director Independence

73

ITEM 14.

Principal Accountant Fees and Services

73

PART IV

 

 

ITEM 15.

Exhibits and Financial Statement Schedules

73

ITEM 16.

Form 10-K Summary

73

 

INDEX OF EXHIBITS

74

 

SIGNATURES

75

 

 

 


 

 

PART I



ITEM 1. BUSINESS



General



The First of Long Island Corporation (“Registrant”), a one-bank holding company, was incorporated on February 7, 1984 for the purpose of providing financial services through its wholly-owned subsidiary, The First National Bank of Long Island. The consolidated entity is referred to as the "Corporation," and the Bank and its subsidiaries are collectively referred to as the "Bank."



The Bank was organized in 1927 as a national banking association under the laws of the United States of America. The Bank has two wholly owned subsidiaries: FNY Service Corp., an investment company, and The First of Long Island Agency, Inc. The Bank and FNY Service Corp. jointly own another subsidiary, The First of Long Island REIT, Inc., a real estate investment trust (“REIT”).



All of the financial operations of the Corporation are aggregated in one reportable operating segment. All revenues are attributed to and all long-lived assets are located in the United States.



The Bank’s revenues are derived principally from interest on loans and investment securities, service charges and fees on deposit accounts, income from investment management and trust services and bank-owned life insurance (“BOLI”).



The Bank did not commence, abandon or significantly change any of its lines of business during 2017.



Markets Served and Products Offered



The Bank serves the financial needs of privately owned and publicly held businesses, professionals, consumers, public bodies and other organizations primarily in Nassau and Suffolk Counties, Long Island, and the boroughs of New York City. The Bank’s head office is located in Glen Head, New York, and the Bank has 37 other full service branches, ten commercial banking offices and two select service banking centers. Included in these totals are five full service branches in Queens, one in Brooklyn and two commercial banking offices in Manhattan. The Bank continues to evaluate potential new branch sites on Long Island and in the boroughs of New York City.



The Bank’s loan portfolio is primarily comprised of loans to borrowers on Long Island and in the boroughs of New York City, and its real estate loans are principally secured by properties located in those areas. The Bank’s investment securities portfolio is comprised of direct obligations of the U.S. government and its agencies and highly rated obligations of states and political subdivisions. The Bank has an Investment Management Division that provides investment management, pension trust, personal trust, estate and custody services.



In addition to its loan and deposit products, the Bank offers other services to its customers including the following:





 

 

 

Account Reconciliation Services

Mobile Banking

ACH Origination

Mobile Capture

ATM Banking and Deposit Automation

Mutual Funds, Annuities and Life Insurance

Bank by Mail

Night Depository Services

Bill Payment

Online Banking

Cash Management Services

Payroll Services

Collection Services

Personal Money Orders

Controlled Disbursement Accounts

Remote Deposit

Drive-Through Banking

Safe Deposit Boxes

Foreign Currency Sales and Purchases

Securities Transactions

Healthcare Remittance Automation

Signature Guarantee Services

Instant Issue Debit Cards

Telephone Banking

Investment Management and Trust Services

Travelers Checks

Lock Box Services

Wire Transfers - Domestic and International

Merchant Credit Card Services

Withholding Tax Depository Services



Competition



The Bank encounters substantial competition in its banking business from numerous other financial services organizations that have offices located in the communities served by the Bank. Principal competitors are money center, large regional and community banks located within the Bank’s market area, as well as mortgage brokers, brokerage firms and credit unions. The Bank competes for loans based on the quality of service it provides, loan structure, competitive pricing and branch locations, and competes for deposits by offering a high level of customer service, paying competitive rates and through the geographic distribution of its branch system.



 

1


 

 

Investment Activities



The investment policy of the Bank, as approved by the Board Asset Liability Committee (“BALCO”) and supervised by both the BALCO and the Management Investment Committee, is intended to promote investment practices which are both safe and sound and in full compliance with applicable regulations. Investment authority will be granted and amended as is necessary by the Board of Directors or BALCO.



The Bank's investment decisions seek to optimize income while keeping both credit and interest rate risk at acceptable levels, provide for the Bank's liquidity needs and provide securities that can be pledged, as needed, to secure deposits and borrowings.



The Bank’s investment policy generally limits individual maturities to twenty years and estimated average lives on collateralized mortgage obligations (“CMOs”) and other mortgage-backed securities to ten years. At the time of purchase, bonds of states and political subdivisions must generally be rated AA or better, notes of states and political subdivisions must generally be rated MIG-1 (or equivalent), commercial paper must be rated A-1 or P-1, and corporate bonds must be rated AA or better. In addition, management periodically reviews the creditworthiness of all securities in the Bank’s portfolio other than those issued by the U.S. government or its agencies. Any significant deterioration in the creditworthiness of an issuer is analyzed and action is taken if deemed appropriate.



At year-end 2017 and 2016, there were no holdings of securities of any one issuer, other than the U.S. government and its agencies, in an amount greater than 10% of stockholders’ equity.



At December 31, 2017, $464.2 million of the Corporation’s municipal securities were rated AA or better and $4.1 million were non-rated bonds issued by local municipalities. The Corporation’s pass-through mortgage securities portfolio at December 31, 2017 is comprised of $4.9 million and $66.8 million of securities issued by the Government National Mortgage Association (“GNMA”) and the Federal National Mortgage Association (“FNMA”), respectively. Each issuer’s pass-through mortgage securities are backed by residential mortgages conforming to the issuer’s underwriting guidelines and each issuer guarantees the timely payment of principal and interest on its securities. All of the Corporation’s CMOs were issued by GNMA and such securities are backed by GNMA residential pass-through mortgage securities. GNMA guarantees the timely payment of principal and interest on its CMOs and the underlying pass-through mortgage securities. Obligations of GNMA, a U.S. government agency, represent full faith and credit obligations of the U.S. government, while obligations of FNMA, which is a U.S. government-sponsored agency, do not.



The Bank has not engaged in the purchase and sale of securities for the primary purpose of producing trading profits and its current investment policy does not allow such activity.



Lending Activities



General. The Bank’s lending is subject to written underwriting standards and loan origination procedures, as approved by the Board Loan Committee and contained in the Bank’s loan policy. The loan policies allow for exceptions and set forth specific exception approval requirements. Decisions on loan applications are based on, among other things, the borrower’s credit history, the financial strength of the borrower, estimates of the borrower’s ability to repay the loan and the value of the collateral, if any. All real estate appraisals must meet the requirements of the Financial Institutions Reform, Recovery and Enforcement Act of 1989, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”), banking agency guidance and, for those loans in excess of $250,000, be reviewed by the Bank’s independent appraisal review function.



The Bank conducts its lending activities out of its main office in Glen Head, New York and its Suffolk County regional office in Hauppauge, New York. The Bank’s loan portfolio is primarily comprised of loans to small and medium-sized privately owned businesses, professionals and consumers on Long Island and in the boroughs of New York City. The Bank offers a full range of lending services including commercial and residential mortgage loans, home equity lines, commercial and industrial loans, small business credit scored loans, Small Business Administration (“SBA”) loans, construction and land development loans, consumer loans and commercial and standby letters of credit. The Bank makes both fixed and variable rate loans. Variable rate loans are primarily tied to and reprice with changes in the prime interest rate of the Bank, the prime interest rate as published in The Wall Street Journal, U.S. Treasury rates, Federal Home Loan Bank of New York advance rates and the London Interbank Offered Rate (LIBOR).



Residential mortgage loans in excess of $1.0 million and other loans in excess of $750,000 generally require the approval of the Management Loan Committee. Loans in excess of $12.5 million require the additional approval of two non-management members of the Board Loan Committee, while those in excess of $17.5 million require the approval of a majority of the Board of Directors.



 

2


 

 

Commercial and Industrial Loans. Commercial and industrial loans include, among other things, short-term business loans and lines of credit; term and installment loans; loans secured by marketable securities, the cash surrender value of life insurance policies, deposit accounts or general business assets; small business credit scored loans as described hereinafter; and equipment finance loans. The Bank makes commercial and industrial loans on a demand basis, short-term basis, or installment basis. Short-term business loans are generally due and payable within one year and should be self-liquidating during the normal course of the borrower’s business cycle. Lines of credit are reaffirmed annually and generally require an annual cleanup period. Term and installment loans are usually due and payable within five years. Generally, it is the policy of the Bank to request personal guarantees of principal owners on loans made to privately-owned businesses.



Small Business Credit Scored Loans. The Bank makes small business credit scored loans and issues VISA® credit cards to businesses that generally have annual sales at the time of application of less than $2 million. Most of these loans are in the form of revolving credit lines and, depending on the type of business, the maximum amount generally ranges from $100,000 to $500,000. Others are installment loans made to finance business automobiles, trucks and equipment and can be secured by the asset financed and/or deposit accounts with the Bank. Both installment loans and revolving credit commitments generally have maturities up to sixty months. Business profile reports are used in conjunction with credit reports and FICO (Fair Isaac Corporation) small business score cards for loan underwriting and decision making purposes. Credit and FICO small business risk scores enable the Bank to quickly and efficiently identify and approve loans to low-risk business applicants and decline loans to high-risk business applicants. There were $1.0 million of small business credit scored term loans outstanding at December 31, 2017. In addition, the Bank had commitments on small business credit scored revolving lines of credit of $42.9 million, of which $17.7 million were drawn and funded.



Real Estate Mortgage Loans and Home Equity Lines. The Bank makes residential and commercial mortgage loans and establishes home equity lines of credit. Applicants for residential mortgage loans and home equity lines will be considered for approval provided they have satisfactory credit history and collateral and the Bank believes that there is sufficient monthly income to service both the loan or line applied for and existing debt. Applicants for commercial mortgage loans will be considered for approval provided they, as well as any guarantors, have satisfactory credit history and can demonstrate, through financial statements and otherwise, the ability to repay. Commercial and residential mortgage loans are made with terms not in excess of thirty years and are generally maintained in the Bank’s portfolio. The residential mortgage loans made by the Bank in recent years consist of both fixed rate loans with terms ranging from 10 to 30 years and variable rate loans that reprice in five, seven or ten years and then every year thereafter. Commercial mortgage loans generally reprice within five years and home equity lines generally mature within ten years. Depending on the type of property, the Bank will generally not lend more than 75% of appraised value on residential mortgage, home equity and commercial mortgage loans. The lending limitations with regard to appraised value are more stringent for loans on co-ops and condominiums.



In processing requests for commercial mortgage loans, the Bank generally requires an environmental assessment to identify the possibility of environmental contamination. The extent of the assessment procedures varies from property to property and is based on factors such as the use and location of the subject property and whether or not the property has a suspected environmental risk based on current or past use.



Construction Loans. From time to time, the Bank makes loans to finance the construction of both residential and commercial properties. The maturity of such loans is generally eighteen months or less and advances are made as the construction progresses. The advances can require the submission of bills by the contractor, verification by a Bank-approved inspector that the work has been performed, and title insurance updates to ensure that no intervening liens have been placed. Variable rate construction and land development loans are included in Commercial Mortgages on the Consolidated Balance Sheet and amounted to $8.5 million at December 31, 2017.



Consumer Loans and Lines.  The Bank makes auto loans, home improvement loans and other consumer loans, establishes revolving overdraft lines of credit and issues VISA® credit cards. Consumer loans are generally made on an installment basis over terms not in excess of five years. In reviewing loans and lines for approval, the Bank considers, among other things, the borrower’s ability to repay, stability of employment and residence, and past credit history.



Sources of Funds



The Corporation’s primary sources of cash are deposits, maturities and amortization of loans and investment securities, operations, borrowings and funds received under the Dividend Reinvestment and Stock Purchase Plan (“DRIP”). The Corporation uses cash from these and other sources to fund loan growth, purchase investment securities, repay borrowings, expand and improve its physical facilities, pay cash dividends and for general operating purposes. 



The Bank offers checking and interest-bearing deposit products. In addition to business and small business checking, the Bank has a variety of personal checking products that differ in minimum balance requirements, monthly maintenance fees, and per check charges, if any. The interest-bearing deposit products, which have a wide range of interest rates and terms, consist of checking accounts, which include negotiable order of withdrawal (“NOW”) accounts and IOLA, escrow service accounts, rent security accounts, a variety of personal and nonpersonal money market accounts, a variety of personal and nonpersonal savings products, time deposits, holiday club accounts, and a variety of individual retirement accounts. 

 

3


 

 



The Bank relies primarily on its branch network, customer service, calling programs, lending relationships, referral sources, competitive pricing and advertising to attract and retain local deposits. The flow of deposits is influenced by general economic conditions, changes in interest rates and competition.



Employees



As of December 31, 2017, the Bank had 333 full-time equivalent employees and considers employee relations to be good. Employees of the Bank are not represented by a collective bargaining unit.



Supervision and Regulation



General. The banking industry is highly regulated. Statutory and regulatory controls are designed primarily for the protection of depositors and the banking system, and not for the purpose of protecting shareholders. The following discussion is not intended to be a complete list of all the activities regulated by banking laws or of the impact of such laws and regulations on the Corporation and the Bank. Changes in applicable laws or regulations, and in their interpretation and application by regulatory agencies, cannot be predicted, but may have a material effect on our business and results of operations. 



As a registered bank holding company, the Corporation is regulated under the Bank Holding Company Act of 1956, as amended (“BHC Act”), and subject to inspection, examination and supervision by the Federal Reserve Board. In general, the BHC Act limits the business of bank holding companies to banking, managing or controlling banks, performing servicing activities for subsidiaries, and engaging in activities that the Federal Reserve has determined, by order or regulation, are so closely related to banking as to be a proper incident thereto under the BHC Act. The Corporation is also subject to the disclosure and regulatory requirements of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, as administered by the Securities and Exchange Commission (“SEC”). Our common stock is listed on the Capital Market tier of the NASDAQ Stock Market (“NASDAQ”) under the symbol “FLIC” and is subject to NASDAQ rules for listed companies. 



As a national bank, the Bank is subject to regulation and examination by the Office of the Comptroller of the Currency (“OCC”)  and the Federal Deposit Insurance Corporation (“FDIC”). Insured banks, such as the Bank, are subject to extensive regulation of many aspects of their businesses. These regulations relate to, among other things: (i) the nature and amount of loans that may be made by the Bank and the rates of interest that may be charged; (ii) types and amounts of other investments; (iii) branching; (iv) anti-money laundering; (v) permissible activities; (vi) reserve requirements; and (vii) dealings with officers, directors and affiliates. 



The Dodd-Frank Act made extensive changes in the regulation of depository institutions and their holding companies. For example, the Dodd-Frank Act created a new Consumer Financial Protection Bureau (“CFPB”) as an independent bureau of the Federal Reserve Board. The CFPB has assumed responsibility for the implementation of the federal financial consumer protection and fair lending laws and regulations, a function previously assigned to principal federal banking regulators, and has authority to impose new requirements. However, institutions of less than $10 billion in assets, such as the Bank, continue to be examined for compliance with consumer protection and fair lending laws and regulations by, and be subject to the enforcement authority of, their primary federal regulator, although the CFPB has limited back-up authority to examine such institutions.



Bank Holding Company Regulation. The BHC Act requires the prior approval of the Federal Reserve Board for the acquisition by a bank holding company of 5% or more of the voting stock or substantially all of the assets of any bank or bank holding company. Also, under the BHC Act, bank holding companies are prohibited, with certain exceptions, from engaging in, or from acquiring 5% or more of the voting stock of any company engaging in activities other than (i) banking or managing or controlling banks, (ii) furnishing services to or performing services for their subsidiaries or (iii) activities that the Federal Reserve Board has determined to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Bank holding companies that meet certain criteria specified by the Federal Reserve may elect to be regulated as a “financial holding company” and thereby engage in a broader array of financial activities including insurance and investment banking.



Payment of Dividends. A large source of the Corporation’s liquidity is dividends from the Bank. Prior approval of the OCC is required if the total of all dividends declared by a national bank in any calendar year would exceed the sum of the bank’s net profits for that year and its retained net profits for the preceding two calendar years, less any required transfers to surplus. Under the foregoing dividend restrictions, and while maintaining its “well-capitalized” status and absent affirmative governmental approvals, during 2018 the Bank could declare dividends to the Corporation of approximately $52.7 million plus any 2018 net profits retained to the date of the dividend declaration.



 

4


 

 

In addition, the Corporation and the Bank are subject to other regulatory policies and requirements relating to the payment of dividends, including requirements to maintain adequate capital above regulatory minimum capital levels. The Federal Reserve Board is authorized to determine under certain circumstances relating to the financial condition of a bank holding company or a bank that the payment of dividends would be an unsafe or unsound practice and to prohibit payment thereof. Federal Reserve guidance sets forth the supervisory expectation that bank holding companies will inform and consult with Federal Reserve staff in advance of declaring a dividend that exceeds earnings for the quarter and should inform the Federal Reserve and should eliminate, defer or significantly reduce dividends if (i) net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends, (ii) the prospective rate of earnings retention is not consistent with the bank holding company’s capital needs and overall current and prospective financial condition, or (iii) the bank holding company will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios.



Transactions with Affiliates. Federal laws strictly limit the ability of banks to engage in transactions with their affiliates, including their bank holding companies. Regulations promulgated by the Federal Reserve Board limit the types and amounts of these transactions (including loans due and extensions of credit from their U.S. bank subsidiaries) that may take place and generally require those transactions to be on an arm’s-length basis. In general, these regulations require that any “covered transactions” between a subsidiary bank and its parent company or the nonbank subsidiaries of the bank holding company be limited to 10% of the bank subsidiary’s capital and surplus and, with respect to such parent company and all such nonbank subsidiaries, to an aggregate of 20% of the bank subsidiary’s capital and surplus. Further, loans and extensions of credit to affiliates generally are required to be secured by eligible collateral in specified amounts. 



Source of Strength Doctrine. Federal Reserve policy has historically required bank holding companies to act as a source of financial and managerial strength to their subsidiary banks. The Dodd-Frank Act codified this policy as a statutory requirement. Under this requirement, the Corporation is expected to commit resources to support the Bank, including at times when the Corporation may not be in a financial position to provide such resources. Any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to depositors and to certain other indebtedness of such subsidiary banks. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to priority of payment.



Capital Requirements. As a bank holding company, the Corporation is subject to consolidated regulatory capital requirements administered by the Federal Reserve. The Bank is subject to similar capital requirements administered by the OCC. 



The Corporation and the Bank implemented the Basel III regulatory capital standards (“Basel III”) issued by the Federal Reserve Board and the OCC. Under the Basel III capital requirements, the Corporation and the Bank are required to maintain minimum ratios of capital to assets of 4.00% for Tier 1 capital to average assets, 4.50% for Common equity tier 1 capital to risk weighted assets, 6.00% for Tier 1 capital to risk weighted assets and 8.00% for Total capital to risk weighted assets. Common equity tier 1 capital, Tier 1 capital, Total capital, risk weighted assets and average assets are defined in the Basel III rules. Failure to meet the minimum capital requirements can result in certain mandatory and possibly additional discretionary actions by the regulators that, if undertaken, could have a direct material effect on the financial statements of the Corporation and Bank. The Corporation and the Bank exceeded the Basel III minimum capital adequacy requirements at December 31, 2017.



Basel III also phases-in a capital conservation buffer from 2016 through 2019. The capital conservation buffer must be maintained in order for a banking organization to avoid being subject to limitations on capital distributions, including dividend payments, and discretionary bonus payments to executive officers. The capital ratio phase-in schedule, including the capital conservation buffer, for banks with $250 billion or less in total assets is as follows:







 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 



 

2015

 

2016

 

2017

 

2018

 

2019

Minimum leverage measure (%)

 

4.0 

 

4.0 

 

4.0 

 

4.0 

 

4.0 

Minimum common equity tier 1 risk-based capital ("RBC") (%)

 

4.5 

 

4.5 

 

4.5 

 

4.5 

 

4.5 

Capital conservation buffer (%)

 

N/A

 

.625

 

1.25 

 

1.875 

 

2.5 

Minimum common equity tier 1 RBC with capital conservation buffer (%)

 

4.5 

 

5.125 

 

5.75 

 

6.375 

 

7.0 

Minimum tier 1 RBC (%)

 

6.0 

 

6.0 

 

6.0 

 

6.0 

 

6.0 

Minimum tier 1 RBC with capital conservation buffer (%)

 

6.0 

 

6.625 

 

7.25 

 

7.875 

 

8.5 

Minimum total RBC (%)

 

8.0 

 

8.0 

 

8.0 

 

8.0 

 

8.0 

Minimum total RBC with capital conservation buffer (%)

 

8.0 

 

8.625 

 

9.25 

 

9.875 

 

10.5 



 

5


 

 

Prompt Corrective Action Regulations. The Federal Deposit Insurance Act, as amended (“FDIA”), requires among other things, the federal banking agencies to take “prompt corrective action” with respect to banks that do not meet minimum capital requirements. The FDIA sets forth the following five capital tiers for purposes of implementing the prompt corrective action (“PCA”) regulations: “well-capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.” The PCA thresholds established by Basel III for each of the capital tiers is as follows:







 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 



 

Total RBC
Measure (%)

 

Tier 1 RBC
Measure (%)

 

Common Equity
Tier 1 RBC
Measure (%)

 

Leverage
Measure (%)

Well capitalized

 

> 10

 

>  8

 

> 6.5

 

>  5

Adequately capitalized

 

>  8

 

>  6

 

> 4.5

 

>  4

Undercapitalized

 

< 8

 

< 6

 

< 4.5

 

< 4

Significantly undercapitalized

 

< 6

 

< 4

 

< 3

 

< 3

Critically undercapitalized

 

Tangible equity to total assets <  2



The Bank was well capitalized under the Basel III PCA thresholds at December 31, 2017. 



Deposit Insurance. The FDIC imposes an assessment on financial institutions for deposit insurance. The assessment is based on the risk category of the institution as assigned by the FDIC, the institution’s average total assets and average tangible equity. The FDIC periodically adjusts the deposit insurance assessment rates, which may raise or lower the cost to an institution of maintaining FDIC insurance coverage. 



The FDIC may terminate the insurance of an institution’s deposits upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. Management is not aware of any practice, condition or violation that might lead to termination of the Bank’s deposit insurance.



Safety and Soundness Standards. The FDIA requires the federal bank regulatory agencies to prescribe standards, through regulations or guidelines, relating to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, asset quality, earnings, stock valuation and compensation, fees and benefits, and such other operational and managerial standards as the agencies deem appropriate. Guidelines adopted by the federal bank regulatory agencies establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risk and exposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director or principal stockholder. In addition, the agencies adopted regulations that authorize, but do not require, an agency to order an institution that has been given notice by an agency that it is not satisfying one or more of the safety and soundness standards to submit a compliance plan. If, after being so notified, an institution fails to submit an acceptable compliance plan or fails in any material respect to implement an acceptable compliance plan, the agency must issue an order directing action to correct the deficiency and may issue an order directing other actions of the types to which an undercapitalized institution is subject under the PCA provisions of the FDIA. If an institution fails to comply with such an order, the agency may seek to enforce such order in judicial proceedings and to impose civil money penalties. 



Community Reinvestment Act and Fair Lending Laws. The Community Reinvestment Act of 1977 (“CRA”) requires depository institutions to assist in meeting the credit needs of their market areas consistent with safe and sound banking practice. Under the CRA, each depository institution is required to help meet the credit needs of its market areas by, among other things, providing credit to low and moderate income individuals and communities. Depository institutions are periodically examined for compliance with the CRA and are assigned ratings. Banking regulators take into account CRA ratings when considering approval of proposed acquisition transactions. The Bank received a “Satisfactory” CRA rating on its most recent Federal examination. The Bank and the Corporation are firmly committed to the practice of fair lending and maintaining strict adherence to all federal and state fair lending laws which prohibit discriminatory lending practices. 



Federal Home Loan Bank System. The Bank is a member of the Federal Home Loan Bank System (“FHLB System”), which consists of 11 regional Federal Home Loan Banks (each a “FHLB”). The FHLB System provides a central credit facility primarily for member banks. As a member of the FHLB of New York, the Bank is required to acquire and hold shares of capital stock in the FHLB in an amount equal to 4.5% of its borrowings from the FHLB (transaction-based stock) plus .15% of the total principal amount at the beginning of the year of the Bank’s unpaid residential real estate loans, commercial real estate loans, home equity loans, CMOs, and other similar obligations (membership stock). At December 31, 2017, the Bank was in compliance with the FHLB’s capital stock ownership requirement. 



 

6


 

 

Financial Privacy. Federal regulations require the Bank to disclose its privacy policy, including identifying with whom it shares “nonpublic personal information,” to its customers at the time the customer establishes a relationship with the Bank and annually thereafter. In addition, we are required to provide our customers with the ability to “opt-out” of having the Bank share their nonpublic personal information with nonaffiliated third parties before we can disclose that information, subject to certain exceptions.



The federal banking agencies adopted guidelines establishing standards for safeguarding our customer information. The guidelines describe the agencies’ expectation that regulated entities create, implement and maintain an information security program, which would include administrative, technical and physical safeguards appropriate to the size and complexity and the nature and scope of our activities. The standards set forth in the guidelines are intended to ensure the security and confidentiality of customer records and information, protect against any anticipated threats or hazards to the security or integrity of customer records, and protect against unauthorized access to records or information that could result in substantial harm or inconvenience to customers. Additionally, the guidance states that banks, such as the Bank, should develop and implement a response program to address security breaches involving customer information, including customer notification procedures. The Bank has developed such a program. 



Anti-Money Laundering and the USA PATRIOT Act. A major focus of governmental policy on financial institutions in recent years has been aimed at combating money laundering and terrorist financing. The USA PATRIOT Act of 2001 (“Patriot Act”) substantially broadened the scope of United States anti-money laundering laws and regulations by imposing significant new compliance and due diligence obligations, creating new crimes and penalties and expanding the extra-territorial jurisdiction of the United States. The United States Treasury Department has issued and, in some cases, proposed a number of regulations that apply various requirements of the Patriot Act to financial institutions such as the Bank. These regulations impose obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing and to verify the identity of their customers. Certain of those regulations impose specific due diligence requirements on financial institutions that maintain correspondent or private banking relationships with non-U.S. financial institutions or persons. Failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing, or to comply with all of the relevant laws or regulations, could have serious legal, financial and reputational consequences for the institution. The Bank and the Corporation are firmly committed to maintaining strong policies, procedures and controls to ensure compliance with anti-money laundering laws and regulations and to combat money laundering and terrorist financing. 



Legislative Initiatives and Regulatory Reform. From time to time, various legislative and regulatory initiatives are introduced in Congress and state legislatures, as well as by regulatory agencies. Such initiatives may include proposals to expand or contract the powers of bank holding companies and depository institutions or proposals to change substantially the financial institution regulatory system. Such legislation could change banking statutes and the operating environment in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions and other financial institutions. The Corporation cannot predict whether any such legislation will be enacted, and, if enacted, the effect that it, or any implementing regulations, would have on our financial condition or results of operations. A change in statutes, regulations or regulatory policies applicable to the Corporation could have a material effect on our business. 



Availability of Reports



The Bank maintains a website at www.fnbli.com. The Corporation’s annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to these reports filed with or furnished to the SEC pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge through the Bank’s website as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. To access these reports go to the homepage of the Bank’s website and click on “Investor Relations,” then click on “SEC Filings,” and then click on “Corporate SEC Filings.” This will bring you to a listing of the Corporation’s reports maintained on the SEC’s EDGAR website. You can then click on any report to view its contents. Information on our website shall not be considered a part of this annual report on Form 10-K.



You may also read and copy any document we file with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, DC 20549. You should call 1-800-SEC-0330 for more information on the Public Reference Room. Our SEC filings are also available on the SEC’s website at www.sec.gov.

 

ITEM 1A. RISK FACTORS



The Corporation is exposed to a variety of risks, some of which are inherent in the banking business. The more significant of these are addressed by the Corporation’s written policies and procedures. While management is responsible for identifying, assessing and managing risk, the Board of Directors is responsible for risk oversight. The Board fulfills its risk oversight responsibilities largely through its committees. The following provides information regarding risk factors faced by the Corporation. Additional risks and uncertainties not currently known to the Corporation, or that the Corporation currently deems to be immaterial, could also have a material impact on the Corporation’s business, financial condition, or results of operations.



 

7


 

 

The inability to realize the full carrying value of the Bank’s investment securities, loans and bank-owned life insurance could negatively impact our financial condition and results of operations.



For investment securities, loans and bank-owned life insurance, there is always the risk that the Bank will be unable to realize their full carrying value. Credit risk in the Bank’s securities and bank-owned life insurance portfolios has been addressed by adopting board committee approved investment and bank-owned life insurance policies that, among other things, limit terms, types and amounts of holdings and specify minimum required credit ratings. Allowable investments include direct obligations of the U.S. government and its agencies, highly rated obligations of states and political subdivisions, highly rated corporate obligations and bank-owned life insurance policies issued by highly rated insurance carriers. At the time of purchase, bonds of states and political subdivisions must generally be rated AA or better, notes of states and political subdivisions must generally be rated MIG-1 (or equivalent), commercial paper must be rated A-1 or P-1, and corporate bonds must be rated AA or better. Bank-owned life insurance may only be purchased from insurance carriers rated A or better. For carriers rated AA or better, cash surrender value is limited to 15% of Tier 1 capital, and for those carriers rated below AA, the limitation is 10% of Tier 1 capital. The cash surrender value of policies with all carriers, plus corporate bond holdings of such carriers, cannot exceed 25% of Tier 1 capital. Management periodically reviews the creditworthiness of all securities in the Bank’s portfolio other than those issued by the U.S. government or its agencies and all bank-owned life insurance carriers. Any significant deterioration in the creditworthiness of an issuer or carrier will be analyzed and action taken if deemed appropriate.



Credit risk in the Bank’s loan portfolio has been addressed by adopting a board committee approved loan policy and by maintaining independent loan and appraisal review functions and an independent credit department. The loan policy contains what the Corporation believes to be prudent underwriting guidelines, which include, among other things, specific loan approval requirements, maximum loan terms, loan to appraised value and debt service coverage limits for mortgage loans, credit score minimums, guarantor support and environmental study requirements.



The credit risk within the Bank’s loan portfolio primarily stems from factors such as changes in the borrowers financial condition, credit concentrations,  changes in collateral values, economic conditions and environmental contamination. The Bank’s commercial loans, including those secured by mortgages, are primarily made to small and medium-sized businesses. Such loans sometimes involve a higher degree of risk than those to larger companies because such businesses may have shorter operating histories, higher debt-to-equity ratios and may lack sophistication in internal record keeping and financial and operational controls. In addition, most of the Bank’s loans are made to businesses and consumers on Long Island and in the boroughs of New York City, and a large percentage of these loans are mortgage loans secured by properties located in those areas. At December 31, 2017, residential mortgage loans, including home equity lines of credit, amounted to approximately $1.6 billion and comprised approximately 58% of loans secured by real estate. The primary source of repayment for residential mortgage loans is cash flows from individual borrowers and co-borrowers. Also, at December 31, 2017, multifamily loans amounted to approximately $683 million and comprised approximately 57% of the Bank’s total commercial mortgage portfolio and approximately 24% of the Bank’s total loans secured by real estate. The primary source of repayment for multifamily loans is cash flows from the underlying properties, a substantial portion of which are rent stabilized or rent controlled. Such cash flows for both residential mortgage and multifamily loans are dependent on the strength of the local economy. 



Environmental impairment of properties securing mortgage loans is always a risk. However, at the present time, the Bank is not aware of any existing loans in the portfolio where there is environmental pollution originating on or near the mortgaged properties that would materially affect the value of the portfolio.



Uncertainty, changes in accounting rules and regulatory principals and other factors could result in a need to increase the Bank’s Allowance for Loan Losses and adversely impact our financial condition and results of operations.



The Bank maintains an allowance for loan losses in an amount believed to be adequate to absorb probable incurred losses in its loan portfolio. The maintenance of the allowance for loan losses is governed by a board committee approved allowance for loan and lease losses policy. In arriving at the allowance for loan losses, an impairment analysis is performed on each loan where it is probable that the borrower will not be able to make all required principal and interest payments according to contractual terms. In addition, incurred losses for all other loans in the Bank’s portfolio are determined on a pooled basis taking into account, among other things, historical loss experience, delinquencies, economic conditions, changes in value of underlying collateral, trends in nature and volume of loans, concentrations of credit, changes in lending policies and procedures, experience, ability and depth of lending staff, changes in quality of the loan review function, environmental risks and loan risk ratings. Because estimating the allowance for loan losses is highly subjective in nature and involves a variety of estimates and assumptions that are inherently uncertain, there is the risk that management’s estimate may not accurately capture probable incurred losses in the loan portfolio. The Bank’s allowance may need to be increased based on, among other things, additional information that comes to light after the estimate is made, changes in circumstances or a recommendation by bank regulators based on their review of the Bank’s loan portfolio. The impact of one or more of these factors on the Bank’s allowance could result in the need for a significant increase in the Bank’s provision for loan losses and have a material adverse impact on the Bank’s financial condition and results of operations.



 

8


 

 

In addition, the Financial Accounting Standards Board has adopted an Accounting Standards Update (“ASU”) 2016-13, that will be effective for reporting periods beginning after December 15, 2019. This standard changes the accounting methodology used to determine the allowance for loan losses from an incurred loss model to a current expected credit loss (“CECL”) model. The CECL model will require the Bank to maintain at each periodic reporting date an allowance for loan losses in an amount that is equal to its estimate of expected lifetime credit losses on the loans in its portfolio. Utilization of the CECL model may require the Bank to increase its allowance for loan losses and will increase the types and amount of data the Bank will need to collect and consider in determining an appropriate level for its allowance for loan losses.



Changes in interest rates, the shape of the yield curve and a sustained period of low interest rates could negatively impact our earnings.



The Bank’s results of operations are subject to risk resulting from interest rate fluctuations and having assets and liabilities that have different maturity, repricing and prepayment/withdrawal characteristics. The Bank defines interest rate risk as the risk that the Bank's net interest income and/or economic value of equity (“EVE”) will change when interest rates change. The Bank has addressed interest rate risk by adopting a board committee approved interest rate risk policy which sets forth quantitative risk limits and calls for monitoring and controlling interest rate risk through a variety of techniques including the use of interest rate sensitivity models and traditional repricing gap analysis. Management utilizes a consultant with expertise in bank asset liability management to aid them in these efforts.



A sustained period of low interest rates and a flattening of the yield curve over the past several years have resulted in continued pressure on our net interest margin. The historic low interest rate environment appears to be ending as the Federal Reserve Bank (“FRB”) has slowly changed from an accommodative monetary policy to a tightening of monetary policy. The FRB has increased the federal funds target rate 100 basis points since December 2016 and has stated that it plans to increase rates an additional three times in 2018 if economic growth continues to expand and the unemployment rate remains at historic lows.



Increases in the federal funds target rate have already begun to exert upward pressure on non-maturity deposit liability rates and the cost of overnight borrowings.  Should short-term rates continue to increase and a further flattening of the yield curve were to occur, the Bank’s loans and investment securities could reprice slower than its interest-bearing liabilities, which would have a negative effect on net interest income. However, over a longer period of time, the effect on the Bank’s earnings should be positive primarily because with the passage of time the yield curve should steepen and more loans and investment securities would reprice at the higher rates and there would be no offsetting increase in interest expense for those interest-earning assets funded by noninterest-bearing checking deposits and capital.



When interest rates decline, borrowers tend to refinance higher rate loans at lower rates and prepayments on mortgage loans and mortgage-backed securities are elevated. Under those circumstances, the Bank may not be able to reinvest the resulting cash flows in new interest-earning assets with rates as favorable as those on the prepaid loans or investment securities. In addition, subject to the floors contained in many of the Bank’s loan agreements, the Bank’s loans at variable interest rates may adjust to lower rates at their reset dates. While lower rates could reduce the Bank’s cost of funds on non-maturity deposits, certificates of deposits and FHLB advances, the cost savings would be somewhat constrained as overall funding rates have not increased significantly from the decade-long historic low interest rate environment and a significant portion of the Bank’s funding comes from noninterest-bearing checking deposits and capital.



The Bank may not have sufficient funds or funding sources to meet liquidity demands.



Liquidity risk is the risk that the Bank will not have sufficient funds to accommodate loan growth, meet deposit outflows or make contractual payments on borrowing arrangements. The Bank has addressed liquidity risk by adopting a board committee approved liquidity policy and liquidity contingency plan that set forth quantitative risk limits and a protocol for responding to liquidity stress conditions should they arise. The Bank encounters significant competition in its market area from branches of larger banks, various community banks, credit unions and other financial services organizations. This, in addition to consumer confidence in the equity markets, could cause deposit outflows, and such outflows could be significant.



The Bank has both internal and external sources of liquidity that can be used to fund loan growth and accommodate deposit outflows. The Bank’s primary internal sources of liquidity are overnight investments, maturities and monthly payments on its investment securities and loan portfolios, operations and investment securities designated as available-for-sale.  



The Bank is a member of the FRB of New York and the FHLB of New York, and has a federal funds line with a commercial bank. In addition to customer deposits, the Bank’s primary external sources of liquidity are secured borrowings from the FHLB of New York and FRB of New York. In addition, the Bank can purchase overnight federal funds under its existing line. However, the Bank’s FRB of New York membership, FHLB of New York membership and federal funds line do not represent legal commitments to extend credit to the Bank. The amount that the Bank can potentially borrow is currently dependent on, among other things, the amount of unencumbered eligible securities and loans that the Bank can use as collateral and the collateral margins required by the lenders.



 

9


 

 

A decline in the Corporation’s market capitalization could negatively impact the price, trading volume and liquidity of our common stock. 



The Corporation’s market capitalization on December 31, 2017 was approximately $703 million, exceeding the $500 million market capitalization which may make the Corporation’s common stock more attractive to certain investors. In addition, the Corporation’s common stock is included in the Russell 3000 and Russell 2000 Indexes, which are reconstituted annually. Upon reconstitution in May 2017, the average market capitalization of companies in the Russell 2000 Index was $2.0 billion, the median market capitalization was $784 million, the capitalization of the largest company in the index was $3.4 billion and the capitalization of the smallest company in the index was $144 million. The Corporation believes that a market capitalization in excess of $500 million and inclusion in the Russell indexes have positively impacted the price, trading volume and liquidity of its common stock. Conversely, if the Corporation’s market capitalization falls below the minimum necessary to be included in the indexes at any future reconstitution date, the opposite could occur.



Changes in national and local economic conditions could negatively impact our financial condition and results of operations.



Although the economy has improved, national and local economic conditions could deteriorate. This poses risks to both the Corporation’s business and the banking industry as a whole. Specific risks include reduced loan demand from quality borrowers; increased competition for loans; increased loan loss provisions resulting from deterioration in loan quality; reduced net interest income and net interest margin caused by a sustained period of low interest rates; interest rate volatility; price competition for deposits due to liquidity concerns or otherwise; volatile equity markets; and higher cost to attract capital to support growth.



In addition to the significant risks posed by economic conditions, the Corporation could experience deposit outflows as national and local economic conditions improve and investors pursue alternative investment opportunities.



The Bank’s internal controls and those of its third-party service providers may be ineffective or circumvented, resulting in significant financial loss, adverse action by governmental bodies and damaged reputation. 



The Corporation relies on its system of internal controls and the internal controls of its third-party service providers (“TPSPs”) to ensure that transactions are captured, recorded, processed and reported properly; confidential customer information is safeguarded; and fraud by employees and persons outside the Corporation is detected and prevented. The Corporation’s internal controls and/or those of its TPSPs may prove to be ineffective or employees of the Corporation and/or its TPSPs may fail to comply with or override the controls, either of which could result in significant financial loss to the Corporation, adverse action by bank regulatory authorities or the SEC and damage to the Corporation’s reputation.



The Bank’s inability to keep pace with technological advances could negatively impact our business, financial condition and results of operations.



The delivery of financial products and services has increasingly become technology-driven. The Bank’s ability to competitively meet the needs of its customers in a cost-efficient manner is dependent on its ability to keep pace with technological advances and to invest in new technology as it becomes available. The ability to keep pace with technological change is important, and failure to do so could have a material adverse impact on the Corporation’s business, financial condition and results of operations. 



System failures, interruptions and security breaches could negatively impact our customers, reputation, and results of operations.



The Bank outsources most of its data processing to TPSPs. If TPSPs encounter difficulties, or if the Bank has difficulty communicating with them, the Bank’s ability to adequately process and account for customer transactions could be affected, and the Bank’s business operations could be adversely impacted. Threats to information security also exist in the processing of customer information through TPSPs. The Bank’s website and online banking products have been the target of cyber attacks in the past. While the Bank and its TPSPs believe they have successfully blocked attempts to infiltrate the Bank’s systems, there is always the possibility that successful attacks have not yet been identified and that future attacks may not be blocked.  A significant cybersecurity incident may be determined to be material insider information and would prohibit corporate insiders from trading in Company stock until appropriate public disclosures are made.



 

10


 

 

The Board Audit Committee has oversight responsibility for cybersecurity risk, which it administers through periodic meetings with management and the approval of information technology and cybersecurity policies.  In this regard, board committee approved policies address information security, IT vulnerability assessment, cybersecurity incident response and electronic communications.  These policies are intended to prevent, detect and respond to cybersecurity incidents. In addition, these policies prevent or limit the impact of systems failures, interruptions and security breaches and rely on commonly used security and processing systems to provide the security and authentication necessary for the processing of data. The Bank makes use of logon and user access controls, multifactor and out of band authentication, transaction limits, firewalls, antivirus software, intrusion protection monitoring, vulnerability scans and independent penetration testing. The Bank also ensures employee awareness of cybersecurity trends. System failures or interruptions are addressed in the board committee approved emergency and disaster recovery policy and business continuity policy. In addition, for TPSPs of data processing and other significant services, the board committee approved vendor management policy and procedures require reviews of audit reports prepared by independent registered public accounting firms regarding their financial condition and the effectiveness of their internal controls.



These precautions may not protect our systems from all compromises or breaches of security and there can be no assurance that such events will not occur or that they will be adequately addressed if they do. The Bank carries a cyber liability insurance policy to mitigate the amount of any financial loss. However, the occurrence of any systems failure, interruption or breach of security could damage the Bank’s reputation and result in a loss of customers and business, could subject the Bank to additional regulatory scrutiny, or could expose the Bank to civil litigation and possible financial liability beyond any insurance coverage. Any of these occurrences could have a material adverse effect on the Corporation’s financial condition and results of operations.



The inability to attract, motivate or retain qualified key personnel could negatively impact our performance.



The Corporation’s future success depends in part on the continued service of its executive officers and other key members of management and its staff, as well as its ability to continue to attract, motivate and retain additional highly qualified employees. The loss of services of key personnel and our inability to timely recruit or promote qualified replacements could have an adverse effect on the Bank’s business, operating results and financial condition. Their skills, knowledge of the Bank’s market and years of industry experience may be difficult to replace.



Changes in laws, government regulation and supervisory guidance could have a significant negative impact on our financial condition and results of operations.



The Corporation and the Bank are subject to regulation, supervision and examination by, among others, the Federal Reserve Board, OCC and FDIC. The FDIC also insures the Bank’s deposits. Regulation and supervision govern the activities in which a bank and its holding company may engage and are intended primarily for the protection of depositors. Regulatory requirements affect virtually all aspects of the Corporation’s and the Bank’s business, including, among other things, investment practices, lending practices, deposit offerings and capital levels. The regulators have extensive discretion in connection with their supervisory and enforcement activities, including imposing restrictions on bank operations and expansion plans, imposing deposit insurance premiums and other assessments, setting required levels for the allowance for loan losses, capital and liquidity, and imposing restrictions on the ability to pay cash dividends and other capital distributions to stockholders. Changes in laws, regulations and supervisory guidance, or the Corporation’s and the Bank’s compliance with these laws and regulations as judged by the regulators, could have a significant negative impact on the Corporation’s financial condition and results of operations. The Corporation manages the risk of noncompliance with laws and regulations by having board committee approved compliance policies, hiring and retaining employees with the experience and skills necessary to address compliance on an ongoing basis, and consulting, when necessary with legal counsel and other outside experts on compliance matters.



We may be adversely affected by recent changes in U.S. tax laws.



The Tax Cuts and Jobs Act (“Tax Act”), which was enacted in December 2017, is likely to have both positive and negative effects on our financial performance. For example, the new legislation will result in a reduction in the federal corporate tax rate from 35% to 21% beginning in 2018, which will have a favorable impact on our earnings and capital generation abilities. However, the new legislation also enacted limitations on certain deductions that will have an impact on the banking industry, borrowers and the market for single-family residential real estate. These limitations include (1) a lower limit on the deductibility of mortgage interest on single-family residential mortgage loans, (2) the elimination of interest deductions for home equity loans, (3) a limitation on the deductibility of business interest expense and (4) a limitation on the deductibility of property taxes and state and local income taxes.



The recent changes in the tax laws may have an adverse effect on the market for, and the valuation of, residential properties, and on the demand for such loans in the future, and could make it harder for borrowers to make their loan payments. In addition, these recent changes may also have a disproportionate effect on taxpayers in states with high residential home prices and high state and local taxes, like New York. If home ownership becomes less attractive, demand for mortgage loans could decrease. The value of properties securing loans in our portfolio may be adversely impacted as a result of the changing economics of home ownership, which could require an increase in our provision for loan losses, which would reduce our profitability and could materially adversely affect our business, financial condition and results of operations.

 

11


 

 

Weather-related and terrorist events could cause significant harm to our business. 



Weather-related events have adversely impacted our market area, especially flood prone areas located near coastal waters and otherwise. Significant flooding and other storm-related damage may become more common in the future. Financial institutions have been, and continue to be, targets of terrorist threats aimed at compromising operating and communication systems, and the metropolitan New York area remains a central target for potential acts of terrorism. Weather-related and terrorist events could cause significant damage, impact the stability of our facilities and result in additional operating expenses, impair the ability of our borrowers to repay their loans, reduce the value of collateral securing repayment of our loans and result in the loss of revenue. While we have established and regularly test disaster recovery procedures, the occurrence of any such event could have a material adverse effect on our business, results of operations and financial condition. 



Competition within our market area could limit our ability to increase interest-earning assets.



Competition in the banking and financial services industry is intense. In our market area, we compete with numerous commercial banks, savings institutions, mortgage brokers, credit unions, finance companies, mutual funds, insurance companies and brokerage and investment banking firms operating locally and elsewhere. Some of our competitors have substantially greater resources and lending limits than we have and have greater name recognition and market presence that benefit them in attracting business. In addition, large competitors may be able to price loans and deposits more aggressively than we do. Competitive forces may limit our ability to increase our interest-earning assets. Our profitability depends upon our continued ability to successfully compete in our market area. For additional information see “Item 1 – Business – Competition.”

 

ITEM 1B. UNRESOLVED STAFF COMMENTS 



None. 

 

ITEM 2. PROPERTIES



The Corporation neither owns nor leases any real estate. Office facilities of the Corporation and the Bank’s main office are located at 10 Glen Head Road, Glen Head, New York in a building owned by the Bank. 



As of December 31, 2017, the Bank owns 23 buildings and leases 38 other facilities, all of which are in Nassau and Suffolk Counties, Long Island and the New York City boroughs of Queens, Brooklyn and Manhattan. The Corporation believes that the physical facilities of the Bank are suitable and adequate at present and are being fully utilized.

 

ITEM 3. LEGAL PROCEEDINGS



In the ordinary course of business, the Corporation is party to various legal actions which are incidental to the operation of its business. Although the ultimate outcome and amount of liability, if any, with respect to these legal actions cannot presently be ascertained with certainty, in the opinion of management, based upon information currently available to us, any resulting liability is believed to be immaterial to the Corporation's consolidated financial position, results of operations and cash flows.



ITEM 4. MINE SAFETY DISCLOSURES



Not applicable.

 

 

12


 

 

PART II



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



The Corporation’s common stock trades on the NASDAQ Capital Market tier of the NASDAQ Stock Market under the symbol “FLIC.” At December 31, 2017, there were 585 stockholders of record of the Corporation’s Common Stock. The number of stockholders of record includes banks and brokers who act as nominees, each of whom may represent more than one stockholder. The following table sets forth high and low sales prices and dividends declared, by quarter, for the years ended December 31, 2017 and 2016. 







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

2017

 

2016

Quarter

 

High

 

Low

 

Dividends
Declared

 

High

 

Low

 

Dividends
Declared

First

 

$

29.30 

 

$

26.00 

 

$

.14

 

$

20.33 

 

$

17.43 

 

$

.13

Second

 

 

30.15 

 

 

25.60 

 

 

.14

 

 

21.29 

 

 

18.06 

 

 

.13

Third

 

 

31.10 

 

 

26.05 

 

 

.15

 

 

22.35 

 

 

18.68 

 

 

.14

Fourth

 

 

33.50 

 

 

27.50 

 

 

.15

 

 

29.67 

 

 

20.99 

 

 

.14



Performance Graph



The following performance graph compares the Corporation's total stockholder return with the NASDAQ U.S. Benchmark and NASDAQ U.S. Benchmark Banks Indexes over a 5-year measurement period assuming $100 invested on January 1, 2013, and dividends reinvested in the Corporation’s stock.





Picture 6





Issuer Purchase of Equity Securities 



The Corporation did not repurchase any shares of its own common stock in the fourth quarter of 2017. 

 

 

13


 

 

ITEM 6. SELECTED FINANCIAL DATA



The following is selected consolidated financial data for the past five years, adjusted as appropriate to reflect the Corporation’s stock splits. This data should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the accompanying consolidated financial statements and related notes.







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(dollars in thousands, except per share data)

2017

 

2016

 

2015

 

2014

 

2013

INCOME STATEMENT DATA:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest Income

$

118,265 

 

 

$

104,123 

 

 

$

92,135 

 

 

$

81,976 

 

 

$

74,851 

 

Interest Expense

 

21,709 

 

 

 

18,002 

 

 

 

16,529 

 

 

 

15,048 

 

 

 

12,364 

 

Net Interest Income

 

96,556 

 

 

 

86,121 

 

 

 

75,606 

 

 

 

66,928 

 

 

 

62,487 

 

Provision for Loan Losses

 

4,854 

 

 

 

3,480 

 

 

 

4,317 

 

 

 

3,189 

 

 

 

2,997 

 

Net Income

 

35,122 

 

 

 

30,880 

 

 

 

25,890 

 

 

 

23,014 

 

 

 

21,300 

 

PER SHARE DATA:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic Earnings

$

1.44 

 

 

$

1.35 

 

 

$

1.23 

 

 

$

1.11 

 

 

$

1.04 

 

Diluted Earnings

 

1.43 

 

 

 

1.34 

 

 

 

1.22 

 

 

 

1.10 

 

 

 

1.03 

 

Cash Dividends Declared

 

.58 

 

 

 

.55 

 

 

 

.52 

 

 

 

.48 

 

 

 

.45 

 

Dividend Payout Ratio

 

40.56 

%

 

 

41.04 

%

 

 

42.62 

%

 

 

43.64 

%

 

 

43.69 

%

Book Value

$

14.37 

 

 

$

12.90 

 

 

$

11.85 

 

 

$

11.20 

 

 

$

10.04 

 

Tangible Book Value

 

14.36 

 

 

 

12.90 

 

 

 

11.84 

 

 

 

11.19 

 

 

 

10.03 

 

BALANCE SHEET DATA AT YEAR END:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Assets

$

3,894,708 

 

 

$

3,510,320 

 

 

$

3,130,343 

 

 

$

2,721,494 

 

 

$

2,399,892 

 

Loans

 

2,950,352 

 

 

 

2,545,421 

 

 

 

2,248,183 

 

 

 

1,804,819 

 

 

 

1,477,937 

 

Allowance for Loan Losses

 

33,784 

 

 

 

30,057 

 

 

 

27,256 

 

 

 

23,221 

 

 

 

20,848 

 

Deposits

 

2,821,997 

 

 

 

2,608,717 

 

 

 

2,284,675 

 

 

 

1,985,025 

 

 

 

1,782,128 

 

Borrowed Funds

 

704,938 

 

 

 

586,224 

 

 

 

577,214 

 

 

 

481,486 

 

 

 

395,463 

 

Stockholders' Equity

 

354,450 

 

 

 

305,830 

 

 

 

250,936 

 

 

 

233,303 

 

 

 

206,556 

 

AVERAGE BALANCE SHEET DATA:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Assets

$

3,695,850 

 

 

$

3,329,308 

 

 

$

2,897,548 

 

 

$

2,515,103 

 

 

$

2,240,139 

 

Loans

 

2,758,116 

 

 

 

2,364,187 

 

 

 

1,990,823 

 

 

 

1,584,198 

 

 

 

1,286,227 

 

Allowance for Loan Losses

 

32,022 

 

 

 

28,238 

 

 

 

24,531 

 

 

 

21,554 

 

 

 

19,847 

 

Deposits

 

2,812,733 

 

 

 

2,590,988 

 

 

 

2,215,883 

 

 

 

1,922,172 

 

 

 

1,747,888 

 

Borrowed Funds

 

540,307 

 

 

 

432,554 

 

 

 

419,372 

 

 

 

347,946 

 

 

 

272,737 

 

Stockholders' Equity

 

334,088 

 

 

 

290,806 

 

 

 

243,330 

 

 

 

224,585 

 

 

 

203,125 

 

FINANCIAL RATIOS: 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Return on Average Assets (ROA)

 

.95 

%

 

 

.93 

%

 

 

.89 

%

 

 

.92 

%

 

 

.95 

%

Return on Average
  Stockholders' Equity (ROE)

 

10.51 

%

 

 

10.62 

%

 

 

10.64 

%

 

 

10.25 

%

 

 

10.49 

%

Average Equity to Average Assets

 

9.04 

%

 

 

8.73 

%

 

 

8.40 

%

 

 

8.93 

%

 

 

9.07 

%



 

 

14


 

 

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



Overview – 2017 Versus 2016



Analysis of 2017 Earnings. Net income and diluted earnings per share (“EPS”) for 2017 were $35.1 million and $1.43, respectively, representing increases of 13.7% and 6.7%, respectively, over the comparable 2016 amounts. Dividends per share increased 5.5% from $.55 for 2016 to $.58 for 2017. Returns on average assets and average equity for 2017 were .95% and 10.51%, respectively, as compared to .93% and 10.62%, respectively, for 2016. 



Net income for 2017 increased $4.2 million over 2016. The increase is primarily attributable to increases in net interest income of $10.4 million, or 12.1%, and noninterest income, before securities gains and losses, of $1.2 million, or 15.8%. The impact of these items was partially offset by securities losses of $1.9 million and increases in the provision for loan losses of $1.4 million, noninterest expense, before debt extinguishment costs of $3.2 million, or 6.3%, and income tax expense of $840,000.



The increase in net interest income is mainly attributable to growth in average interest-earning assets of $335.6 million, or 10.4%, which was driven by an increase in the average balance of loans of $393.9 million, or 16.7%. Although most of the loan growth occurred in residential and commercial mortgage loans, commercial and industrial loans also grew with an increase in average outstandings of $19.6 million, or 18.9%. The growth in loans was funded mainly by growth in the average balances of noninterest-bearing checking deposits of $81.0 million, or 10.2%, interest-bearing deposits of $140.8 million, or 7.8%, short-term borrowings of $74.7 million and stockholders’ equity of $43.3 million, or 14.9%. Also funding the growth in loans was a decrease in the average balance of taxable investment securities of $46.7 million, or 12.5%.



The increase in noninterest income, before securities gains and losses, of $1.2 million, or 15.8%, is primarily attributable to increases in income from BOLI of $530,000, service charges on deposit accounts of $126,000, checkbook income of $116,000 and Investment Management Division income of $90,000. Also contributing to the increase in noninterest income were refunds of sales taxes, real estate taxes and telecommunications charges of $167,000.



The increase in noninterest expense, before debt extinguishment costs, of $3.2 million, or 6.3%, is primarily attributable to increases in salaries of $2.0 million, or 9.2%, employee benefits expense of $261,000, or 3.8%, occupancy and equipment expense of $981,000, or 10.6%, and marketing expense of $389,000. Also contributing to the increase was a valuation allowance of $725,000 recorded in the fourth quarter of 2017 on other real estate owned. The impact of these items was partially offset by decreases in consulting fees of $635,000, computer and telecommunications expense of $743,000 and FDIC insurance expense of $201,000.



During the fourth quarter of 2017, the Bank sold approximately $88.6 million of mortgage-backed securities with a yield of 1.55% and an expected average life of 3.4 years and reinvested substantially all of the proceeds in mortgage-backed securities with a yield of 2.61% and an expected average life of 4.9 years. The sale resulted in a pretax loss of $1.9 million and an after-tax loss of $1.3 million, or $.05 per share. Due to changes in federal tax law enacted in December 2017, most of the future incremental income will be taxed at a federal tax rate of 21% while the $1.9 million pre-tax loss in 2017 will receive a federal tax benefit at a rate of 35%. Considering both the future incremental income on the replacement securities and the change in the federal tax rate effective in 2018, the payback period for the 2017 loss is approximately 1.7 years. The securities loss negatively impacted 2017 ROA and ROE by 3 and 38 basis points, respectively.



The $1.4 million increase in the provision for loan losses in 2017 is mainly due to more loan growth, an increase in net chargeoffs of $448,000 from $679,000 in 2016 to $1,127,000 in 2017 and a decline in historical loss rates in 2016. The impact of these items was partially offset by improved economic conditions in 2017 and a $510,000 decline in specific reserves on loans individually deemed to be impaired.



The $840,000 increase in income tax expense is due to higher pre-tax earnings in 2017 and a decline in income from tax-exempt securities. Another important contributor to the increase in income tax expense is the fact that in 2017 the Corporation was subject to New York State (“NYS”) and New York City (“NYC”) taxes based on capital rather than business income and did not record the potential NYS and NYC tax benefits of deductible temporary differences that arose in 2017. The impact of these items was partially offset by a $909,000 credit to income tax expense in 2017 resulting from a reduction in the Corporation’s net deferred tax liability to reflect the decrease in the federal income tax rate effective January 1, 2018. In addition, the Corporation realized higher tax benefits in 2017 from stock awards and BOLI. The vesting and exercise of stock awards resulted in tax benefits over and above those accrued during the vesting period of $762,000 and $385,000 in 2017 and 2016, respectively.

 

Analysis of Fourth Quarter 2017 Earnings.  Net income for the fourth quarter of 2017 was $7.6 million, up slightly from $7.5 million in the same quarter last year. The increase is primarily attributable to increases in net interest income and income from BOLI of $1.9 million and $188,000, respectively, and decreases in the provision for loan losses and income tax expense of $319,000 and $968,000, respectively. These items were substantially offset by increases in salaries and occupancy and equipment expense of $536,000 and $380,000, respectively, and the aforementioned securities loss and valuation allowance of $1.9 million and $725,000, respectively. The securities loss negatively impacted fourth quarter 2017 ROA and ROE by 13 and 141 basis points, respectively. The decrease in

 

15


 

 

the provision for loan losses was primarily driven by a decrease in specific reserves in the fourth quarter of 2017 of $821,000 versus an increase of $482,000 in the same quarter last year, as partially offset by higher net chargeoffs in the 2017 quarter and adjustments to qualitative factors used in determining the allowance for loan losses. The decrease in income tax expense occurred because of lower pretax earnings in the fourth quarter of 2017 and for the same reasons for a decrease discussed above with respect to the full year periods. Other fourth quarter variances occurred for substantially the same reasons discussed above with respect to the full year periods.



Asset Quality. The Bank’s allowance for loan losses to total loans decreased three basis points from 1.18% at year-end 2016 to 1.15% at year-end 2017. The decrease is primarily due to an improvement in the local housing market and overall economic conditions and a decline in specific reserves.



The overall credit quality of the Bank’s loan portfolio remains excellent. Nonaccrual loans amounted to $1.0 million, or .03% of total loans outstanding, at December 31, 2017, compared to $2.6 million, or .10%, at December 31, 2016. The decrease is attributable to paydowns and loans returned to an accrual status based on the demonstrated ability of the borrowers to service their debt, as partially offset by new nonaccrual loans. Troubled debt restructurings amounted to $1.0 million, or .04% of total loans outstanding, at December 31, 2017, representing a decrease of $498,000 from year-end 2016. The decrease was primarily attributable to payoffs of some loans and paydowns on other loans. Troubled debt restructurings at year-end include $785,000 that are performing in accordance with their modified terms and $100,000 that are nonaccrual and included in the aforementioned amount of nonaccrual loans. Loans past due 30 through 89 days amounted to $2.8 million, or .09% of total loans outstanding, at December 31, 2017, compared to $1.1 million, or .04%, at December 31, 2016. Management does not believe that the increase in loans past due 30 through 89 days is indicative of a deterioration in the overall credit quality of the Bank’s loan portfolio.



The credit quality of the Bank’s securities portfolio also remains excellent. The Bank’s mortgage securities are backed by mortgages underwritten on conventional terms, with 74% of these securities being full faith and credit obligations of the U.S. government and the balance being obligations of U.S. government sponsored entities. The remainder of the Bank’s securities portfolio principally consists of high quality, general obligation municipal securities rated AA or better by major rating agencies. In selecting municipal securities for purchase, the Bank uses credit agency ratings for screening purposes only and then performs its own credit analysis. On an ongoing basis, the Bank periodically assesses the credit strength of the municipal securities in its portfolio and makes decisions to hold or sell based on such assessments.



Key Strategic Initiatives. Key strategic initiatives will continue to include loan and deposit growth through effective relationship management, targeted solicitation efforts, new product offerings and continued expansion of the Bank’s branch distribution system on Long Island and in the New York City boroughs of Queens and Brooklyn. With respect to loan growth, the Bank will continue to prudently manage concentration risk and further develop its broker and correspondent relationships. Small business credit scored loans, equipment finance loans and SBA loans, along with the Bank’s traditional commercial and industrial loan products, will be originated to diversify the Bank’s loan portfolio and help mitigate the impact of the low rate environment on the Bank’s earnings.



The Bank achieved a significant milestone in December 2017 by opening its 50th branch which is located in Astoria, Queens. The Bank’s growing branch distribution system consists of branches in Nassau and Suffolk Counties, Long Island and the New York City boroughs of Queens, Brooklyn and Manhattan. The Bank expects to open three or four more branches in Queens and Brooklyn over the next twelve months and continues to evaluate sites for further branch expansion. In addition to loan and deposit growth, management is also focused on growing noninterest income from existing and potential new sources, which may include the development or acquisition of fee-based businesses.



Tax Reform. On December 22, 2017, the Tax Act was signed into law. The most significant impact of the Tax Act on the Corporation is a reduction in the federal corporate tax rate from 35% to 21% commencing in 2018. Some of the other provisions affecting the Corporation are:

·

Advance refunding municipal bonds issued after December 31, 2017 will no longer be tax-exempt.

·

The Corporation will no longer be able to deduct any compensation in excess of $1 million paid to a named executive officer.

·

Bonus depreciation is increased to 100% for qualified property placed in service after September 27, 2017 and before January 1, 2023, with phase downs over the next four years.

·

The immediate expensing of tangible property that qualifies as Internal Revenue Code Section 179 property is increased to $1 million with an increase of the phase-out threshold to $2.5 million.



The Corporation’s effective tax rate for 2017 is 22.0%. Considering, among other things, the changes included in the Tax Act, the Corporation currently expects that its effective tax rate for 2018 will be in the range of 14% to 16%.



Challenges We Face. Beginning in December 2015, there have been five 25 basis point increases in the federal funds target rate to its current level of 1.25% to 1.50%. These increases have exerted upward pressure on non-maturity deposit rates and have caused these rates and overnight borrowing rates to move upward. Further increases in the federal funds target rate are expected in the foreseeable future. At the same time, the Bank generally lends and invests at a spread to intermediate and long-term interest rates which remain relatively low and without what management believes to be near term prospects for sustained improvement. This together with

 

16


 

 

significant price competition for loans in the Bank’s marketplace have resulted in suboptimal investing and lending rates. These factors are expected to continue to exert downward pressure on net interest margin.



The banking industry continues to be faced with new and complex regulatory requirements and enhanced supervisory oversight. The financial markets expect that regulatory relief will be forthcoming, but the timing, magnitude and positive impact of any such relief are yet to be determined. In the current environment, banking regulators are increasingly concerned about, among other things, growth, commercial real estate concentrations, underwriting of commercial real estate and commercial and industrial loans, capital levels, cyber security and predatory sales practices. Regulatory requirements and enhanced supervisory oversight are exerting downward pressure on revenues and upward pressure on required capital levels and the cost of doing business.



Overview – 2016 Versus 2015



Analysis of 2016 Earnings. Net income and EPS for 2016 were $30.9 million and $1.34, respectively, representing increases of 19.3% and 9.8%, respectively, over the comparable 2015 amounts. Dividends per share increased 5.8% from $.52 for 2015 to $.55 for 2016. Returns on average assets and average equity for 2016 were .93% and 10.62%, respectively, as compared to .89% and 10.64%, respectively, for 2015. 



Net income for 2016 increased $5.0 million over 2015. The increase was primarily attributable to an increase in net interest income of $10.5 million, or 13.9%, and a decrease in the provision for loan losses of $837,000. The impact of these items was partially offset by increases in noninterest expense, before debt extinguishment costs, of $4.7 million and income tax expense of $1.6 million.



The increase in net interest income was primarily driven by growth in average interest-earning assets of $431.2 million, or 15.4%, partially offset by a seven basis point decline in net interest margin. Average interest-earning assets grew mostly because of increases in the average balances of loans of $373.4 million, or 18.8%, and securities of $45.6 million, or 5.7%. Although most of the loan growth occurred in mortgage loans, commercial and industrial loans also grew with an increase in average outstandings of $23.5 million, or 27.5%. The growth in loans and securities was primarily funded by growth in the average balances of noninterest-bearing checking deposits of $56.0 million, or 7.6%, interest-bearing deposits of $319.1 million, or 21.6%, and stockholders’ equity of $47.5 million, or 19.5%.



The decrease in the provision for loan losses for 2016 versus the prior year was largely due to lesser loan growth, a decline in historical loss rates and a lower increase in specific reserves. These items were partially offset by higher net chargeoffs in 2016.



The increase in noninterest expense, before debt extinguishment costs, of $4.7 million, or 10.4%, was largely attributable to increases in salaries, employee benefits expense, consulting expense, occupancy and equipment expense and computer and telecommunications expense. The increase in consulting expense included a one-time charge of $800,000 in 2016 for advisory services rendered in renegotiating the Bank’s data processing contract. The Corporation expects that the cost savings negotiated by the consultant over the life of the contract will far exceed the one-time consulting charge.



In the fourth quarter of 2016, the Corporation adopted ASU 2016-09 “Improvements to Employee Share-Based Payment Accounting” effective as of January 1, 2016. Adoption of the ASU increased 2016 net income through a credit to income tax expense in the amount of $385,000, or $.02 per share.



The increase in income tax expense was attributable to higher pre-tax earnings in 2016 as compared to the prior year, partially offset by the credit to income tax expense from the adoption of ASU 2016-09, additional New York State income tax benefits derived from the Corporation’s captive REIT and the inclusion of a one-time charge of $402,000 in 2015 caused by changes in New York City tax law.



Analysis of Fourth Quarter 2016 Earnings.  Net income for the fourth quarter of 2016 was $7.5 million, an increase of $900,000, or 13.6%, over $6.6 million earned in the same quarter of 2015. EPS was $.31 for the fourth quarter of 2016, unchanged from the fourth quarter of 2015. The increase in net income was primarily attributable to an increase in net interest income of $2.1 million, partially offset by increases in salaries of $133,000, occupancy and equipment expense of $182,000 and income tax expense of $414,000, and a partial writedown of $168,000 on the Bank’s investment in a trade association. The increases in net interest income, salaries and occupancy and equipment expense occurred for substantially the same reasons discussed with respect to the full year periods. Excluding the aforementioned one-time charge of $402,000, income tax expense also increased for the same reasons discussed with respect to the full year periods.



Asset Quality. The Bank’s allowance for loan losses to total loans decreased three basis points from 1.21% at year-end 2015 to 1.18% at year-end 2016. The decrease was primarily due to improved economic conditions and a reduction in the historical loss component of the allowance for loan losses.



 

17


 

 

The credit quality of the Bank’s loan portfolio at year-end 2016 was excellent. Nonaccrual loans amounted to $2.6 million, or .10% of total loans outstanding, compared to $1.4 million, or .06%, at December 31, 2015, and troubled debt restructurings amounted to $1.5 million, or .06% of total loans outstanding at December 31, 2016. Of the troubled debt restructurings, $757,000 were performing in accordance with their modified terms and $788,000 were nonaccrual and included in the aforementioned amount of nonaccrual loans. Troubled debt restructurings declined $2.9 million during 2016 from $4.5 million at year-end 2015. The decrease was primarily attributable to the payoff of two loans to one borrower, partially offset by two loans that were restructured in troubled debt restructurings during the year. Loans past due 30 through 89 days amounted to $1.1 million, or .04% of total loans outstanding, at December 31, 2016, compared to $1.0 million, or .04%, at December 31, 2015.



The credit quality of the Bank’s securities portfolio at year-end 2016 was also excellent. The Bank’s mortgage securities were backed by mortgages underwritten on conventional terms, with 60% of these securities being full faith and credit obligations of the U.S. government and the balance being obligations of U.S. government sponsored entities. The remainder of the Bank’s securities portfolio principally consisted of high quality, general obligation municipal securities rated AA or better by major rating agencies.

 

Application of Critical Accounting Policies



In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported asset and liability balances and revenue and expense amounts. Our determination of the allowance for loan losses is a critical accounting estimate because it is based on our subjective evaluation of a variety of factors at a specific point in time and involves difficult and complex judgments about matters that are inherently uncertain. In the event that management’s estimate needs to be adjusted based on, among other things, additional information that comes to light after the estimate is made or changes in circumstances, such adjustment could result in the need for a significantly different allowance for loan losses and thereby materially impact, either positively or negatively, the Bank’s results of operations.



The Bank’s Allowance for Loan and Lease Losses Committee (“ALLL Committee”), which is a management committee chaired by the Chief Credit Officer, meets on a quarterly basis and is responsible for determining the allowance for loan losses after considering, among other things, the results of credit reviews performed by the Bank’s independent loan review consultants and the Bank’s credit department. In addition, and in consultation with the Bank’s Chief Financial Officer and Chief Risk Officer, the ALLL Committee is responsible for implementing and maintaining accounting policies and procedures surrounding the calculation of the required allowance. The Board Loan Committee reviews and approves the Bank’s Loan Policy at least once each calendar year. The Bank’s allowance for loan losses is reviewed and ratified by the Board Loan Committee on a quarterly basis and is subject to periodic examination by the OCC whose safety and soundness examination includes a determination as to the adequacy of the allowance for loan losses to absorb probable incurred losses.



The first step in determining the allowance for loan losses is to identify loans in the Bank’s portfolio that are individually deemed to be impaired and then measure impairment losses based on either the fair value of collateral or the discounted value of expected future cash flows. In estimating the fair value of real estate collateral, management utilizes appraisals or evaluations adjusted for costs to dispose and a distressed sale adjustment, if needed. Estimating the fair value of collateral other than real estate is also subjective in nature and sometimes requires difficult and complex judgments. Determining expected future cash flows can be more subjective than determining fair values. Expected future cash flows could differ significantly, both in timing and amount, from the cash flows actually received over the loan’s remaining life.



In addition to estimating losses for loans individually deemed to be impaired, management also estimates collective impairment losses for pools of loans that are not specifically reviewed. The Bank’s highest average annualized loss experience over periods of 24, 36, 48 or 60 months is generally the starting point in determining its allowance for loan losses for each pool of loans. Management believes that this approach appropriately reflects losses from the current economic cycle and those incurred losses in the Bank’s loan portfolio. However, since future losses could vary significantly from those experienced in the past, on a quarterly basis management adjusts its historical loss experience to reflect current conditions. In doing so, management considers a variety of general qualitative factors and then subjectively determines the weight to assign to each in estimating losses. The factors include, among others: (1) delinquencies, (2) economic conditions as judged by things such as national and local unemployment levels, (3) changes in value of underlying collateral as judged by things such as median home prices, commercial vacancy rates and forecasted vacancy and rental rates in the Bank’s service area, (4) trends in the nature and volume of loans, (5) concentrations of credit, (6) changes in lending policies and procedures, (7) experience, ability and depth of lending staff, (8) changes in the quality of the loan review function, (9) environmental risks, and (10) loan risk ratings. Substantially all of the Bank’s allowance for loan losses allocable to pools of loans that are collectively evaluated for impairment results from these qualitative adjustments to historical loss experience. Because of the nature of the qualitative factors and the difficulty in assessing their impact, management’s resulting estimate of losses may not accurately reflect actual losses in the portfolio.



Although the allowance for loan losses has two separate components, one for impairment losses on individual loans and one for collective impairment losses on pools of loans, the entire allowance for loan losses is available to absorb realized losses as they occur whether they relate to individual loans or pools of loans.

 

 

18


 

 

Net Interest Income



Average Balance Sheet; Interest Rates and Interest Differential. The following table sets forth the average daily balances for each major category of assets, liabilities and stockholders’ equity as well as the amounts and average rates earned or paid on each major category of interest-earning assets and interest-bearing liabilities. The average balances of investment securities include unrealized gains and losses on available-for-sale securities, and the average balances of loans include nonaccrual loans. 







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

2017

 

2016

 

2015

(dollars in thousands)

 

Average
Balance

 

Interest/
Dividends

 

Average
Rate

 

Average
Balance

 

Interest/
Dividends

 

Average
Rate

 

Average
Balance

 

Interest/
Dividends

 

Average
Rate

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-earning bank balances

 

$

25,356 

 

$

281 

 

1.11 

%

 

$

32,711 

 

$

168 

 

.51 

%

 

$

20,568 

 

$

52 

 

.25 

%

Investment securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

 

327,491 

 

 

7,473 

 

2.28 

 

 

 

374,199 

 

 

7,813 

 

2.09 

 

 

 

355,177 

 

 

7,939 

 

2.24 

 

Nontaxable (1)

 

 

461,149 

 

 

20,744 

 

4.50 

 

 

 

465,457 

 

 

21,056 

 

4.52 

 

 

 

438,835 

 

 

20,902 

 

4.76 

 

Loans (1)

 

 

2,758,116 

 

 

97,040 

 

3.52 

 

 

 

2,364,187 

 

 

82,469 

 

3.49 

 

 

 

1,990,823 

 

 

70,573 

 

3.54 

 

Total interest-earning assets

 

 

3,572,112 

 

 

125,538 

 

3.51 

 

 

 

3,236,554 

 

 

111,506 

 

3.45 

 

 

 

2,805,403 

 

 

99,466 

 

3.55 

 

Allowance for loan losses

 

 

(32,022)

 

 

 

 

 

 

 

 

(28,238)

 

 

 

 

 

 

 

 

(24,531)

 

 

 

 

 

 

Net interest-earning assets

 

 

3,540,090 

 

 

 

 

 

 

 

 

3,208,316 

 

 

 

 

 

 

 

 

2,780,872 

 

 

 

 

 

 

Cash and due from banks

 

 

31,555 

 

 

 

 

 

 

 

 

30,450 

 

 

 

 

 

 

 

 

28,665 

 

 

 

 

 

 

Premises and equipment, net

 

 

36,279 

 

 

 

 

 

 

 

 

31,597 

 

 

 

 

 

 

 

 

29,011 

 

 

 

 

 

 

Other assets

 

 

87,926 

 

 

 

 

 

 

 

 

58,945 

 

 

 

 

 

 

 

 

59,000 

 

 

 

 

 

 



 

$

3,695,850 

 

 

 

 

 

 

 

$

3,329,308 

 

 

 

 

 

 

 

$

2,897,548 

 

 

 

 

 

 

Liabilities and Stockholders' Equity:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Savings, NOW & money market deposits

 

$

1,635,044 

 

 

7,113 

 

.44 

 

 

$

1,501,096 

 

 

5,344 

 

.36 

 

 

$

1,159,573 

 

 

2,564 

 

.22 

 

Time deposits

 

 

305,029 

 

 

5,479 

 

1.80 

 

 

 

298,194 

 

 

5,107 

 

1.71 

 

 

 

320,626 

 

 

5,987 

 

1.87 

 

Total interest-bearing deposits

 

 

1,940,073 

 

 

12,592 

 

.65 

 

 

 

1,799,290 

 

 

10,451 

 

.58 

 

 

 

1,480,199 

 

 

8,551 

 

.58 

 

Short-term borrowings

 

 

132,137 

 

 

1,345 

 

1.02 

 

 

 

57,395 

 

 

296 

 

.52 

 

 

 

55,134 

 

 

183 

 

.33 

 

Long-term debt

 

 

408,170 

 

 

7,772 

 

1.90 

 

 

 

375,159 

 

 

7,255 

 

1.93 

 

 

 

364,238 

 

 

7,795 

 

2.14 

 

Total interest-bearing liabilities

 

 

2,480,380 

 

 

21,709 

 

.88 

 

 

 

2,231,844 

 

 

18,002 

 

.81 

 

 

 

1,899,571 

 

 

16,529 

 

.87 

 

Checking deposits

 

 

872,660 

 

 

 

 

 

 

 

 

791,698 

 

 

 

 

 

 

 

 

735,684 

 

 

 

 

 

 

Other liabilities

 

 

8,722 

 

 

 

 

 

 

 

 

14,960 

 

 

 

 

 

 

 

 

18,963 

 

 

 

 

 

 



 

 

3,361,762 

 

 

 

 

 

 

 

 

3,038,502 

 

 

 

 

 

 

 

 

2,654,218 

 

 

 

 

 

 

Stockholders' equity

 

 

334,088 

 

 

 

 

 

 

 

 

290,806 

 

 

 

 

 

 

 

 

243,330 

 

 

 

 

 

 



 

$

3,695,850 

 

 

 

 

 

 

 

$

3,329,308 

 

 

 

 

 

 

 

$

2,897,548 

 

 

 

 

 

 

Net interest income (1)

 

 

 

 

$

103,829 

 

 

 

 

 

 

 

$

93,504 

 

 

 

 

 

 

 

$

82,937 

 

 

 

Net interest spread (1)

 

 

 

 

 

 

 

2.63 

%

 

 

 

 

 

 

 

2.64 

%

 

 

 

 

 

 

 

2.68 

%

Net interest margin (1)

 

 

 

 

 

 

 

2.91 

%

 

 

 

 

 

 

 

2.89 

%

 

 

 

 

 

 

 

2.96 

%



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 







(1) Tax-equivalent basis. Interest income on a tax-equivalent basis includes the additional amount of interest income that would have been earned if the Corporation's investment in tax-exempt loans and investment securities had been made in loans and investment securities subject to federal income taxes yielding the same after-tax income. The tax-equivalent amount of $1.00 of nontaxable income was $1.54 for each period presented, using the statutory federal income tax rate of 35%.



 

19


 

 

Rate/Volume Analysis. The following table sets forth the effect of changes in volumes, rates and rate/volume on tax-equivalent interest income, interest expense and net interest income. 







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

2017 versus 2016

 

2016 versus 2015



 

Increase (decrease) due to changes in:

 

Increase (decrease) due to changes in:

(in thousands)

 

Volume

 

Rate

 

Rate/
Volume(1)

 

Net
Change

 

Volume

 

Rate

 

Rate/
Volume(1)

 

Net
Change

Interest Income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-earning bank balances

 

$

(38)

 

$

195 

 

$

(44)

 

$

113 

 

$

31 

 

$

54 

 

$

31 

 

$

116 

Investment securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

 

(975)

 

 

726 

 

 

(91)

 

 

(340)

 

 

425 

 

 

(523)

 

 

(28)

 

 

(126)

Nontaxable

 

 

(195)

 

 

(118)

 

 

 

 

(312)

 

 

1,268 

 

 

(1,050)

 

 

(64)

 

 

154 

Loans

 

 

13,741 

 

 

711 

 

 

119 

 

 

14,571 

 

 

13,235 

 

 

(1,128)

 

 

(211)

 

 

11,896 

Total interest income

 

 

12,533 

 

 

1,514 

 

 

(15)

 

 

14,032 

 

 

14,959 

 

 

(2,647)

 

 

(272)

 

 

12,040 

Interest Expense:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Savings, NOW &
  money market deposits

 

 

477 

 

 

1,186 

 

 

106 

 

 

1,769 

 

 

755 

 

 

1,564 

 

 

461 

 

 

2,780 

Time deposits

 

 

117 

 

 

249 

 

 

 

 

372 

 

 

(419)

 

 

(495)

 

 

34 

 

 

(880)

Short-term borrowings

 

 

385 

 

 

288 

 

 

376 

 

 

1,049 

 

 

 

 

102 

 

 

 

 

113 

Long-term debt

 

 

638 

 

 

(112)

 

 

(9)

 

 

517 

 

 

234 

 

 

(751)

 

 

(23)

 

 

(540)

Total interest expense

 

 

1,617 

 

 

1,611 

 

 

479 

 

 

3,707 

 

 

577 

 

 

420 

 

 

476 

 

 

1,473 

Increase (decrease) in
  net interest income

 

$

10,916 

 

$

(97)

 

$

(494)

 

$

10,325 

 

$

14,382 

 

$

(3,067)

 

$

(748)

 

$

10,567 



(1) Represents the change not solely attributable to change in rate or change in volume but a combination of these two factors. The rate/volume variance could be allocated between the volume and rate variances shown in the table based on the absolute value of each to the total for both.



Net Interest Income – 2017 Versus 2016



Net interest income on a tax-equivalent basis was $103.8 million in 2017, an increase of $10.3 million, or 11.0%, over  $93.5 million in 2016.  The increase is mainly attributable to growth in average interest-earning assets of $335.6 million, or 10.4%, which was driven by an increase in the average balance of loans of $393.9 million, or 16.7%. The growth in loans was funded mainly by growth in the average balances of noninterest bearing checking deposits of $81.0 million, or 10.2%, interest-bearing deposits of $140.8 million, or 7.8%, short-term borrowings of $74.7 million and stockholders’ equity of $43.3 million, or 14.9%. Also funding the growth in loans was a decrease in the average balance of taxable investment securities of $46.7 million, or 12.5%. Substantial contributors to the growth in deposit