10-Q 1 d417382d10q.htm FORM 10-Q Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

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

For the quarterly period ended September 30, 2012

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 0-16668

 

 

WSFS FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   22-2866913

(State or other jurisdiction of

Incorporation or organization)

 

(I.R.S. Employer

Identification Number)

 

WSFS Bank Center, 500 Delaware Avenue, Wilmington, Delaware   19801
(Address of principal executive offices)   (Zip Code)

(302) 792-6000

Registrant’s telephone number, including area code:

 

 

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨  (Do not check if smaller reporting company)    Smaller reporting company   ¨

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of November 2, 2012:

 

Common Stock, par value $.01 per share

 

8,735,520

(Title of Class)   (Shares Outstanding)

 

 

 


Table of Contents

WSFS FINANCIAL CORPORATION

FORM 10-Q

INDEX

PART I. Financial Information

 

         Page  

Item 1.

 

Financial Statements (Unaudited)

  
 

Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2012 and 2011

     1   
 

Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September  30, 2012 and 2011

     2   
 

Consolidated Statements of Condition as of September 30, 2012 and December 31, 2011

     3   
 

Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2012 and 2011

     4   
 

Notes to the Consolidated Financial Statements for the Three and Nine Months Ended September 30, 2012 and 2011

     5   

Item 2.

 

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

     32   

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

     47   

Item 4.

 

Controls and Procedures

     47   

PART II.

Other Information

    

Item 1.

 

Legal Proceedings

     47   

Item 1A.

 

Risk Factors

     47   

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

     47   

Item 3.

 

Defaults upon Senior Securities

     48   

Item 4.

 

Mine Safety Disclosures

     48   

Item 5.

 

Other Information

     48   

Item 6.

 

Exhibits

     48   

Signatures

       49   

Exhibit 31.1

 

Certification of CEO Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

  

Exhibit 31.2

 

Certification of CFO Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

  

Exhibit 32

 

Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

  

Exhibit 101.INS

 

Instance Document

  

Exhibit 101.SCH

 

Schema Document

  

Exhibit 101.CAL

 

Calculation Linkbase Document

  

Exhibit 101.LAB

 

Labels Linkbase Document

  

Exhibit 101.PRE

 

Presentation Linkbase Document

  

Exhibit 101.DEF

 

Definition Linkbase Document

  


Table of Contents

WSFS FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2012      2011      2012      2011  
     (Unaudited)  
     (In Thousands, Except Per Share Data)  

Interest income:

           

Interest and fees on loans

   $ 32,003      $ 32,940      $ 98,185      $ 97,699  

Interest on mortgage-backed securities

     4,344        7,052        14,953        20,962  

Interest and dividends on investment securities

     158        99        335        396  

Other interest income

     9        —           27        —     
  

 

 

    

 

 

    

 

 

    

 

 

 
     36,514        40,091        113,500        119,057  
  

 

 

    

 

 

    

 

 

    

 

 

 

Interest expense:

           

Interest on deposits

     3,237        4,619        10,652        14,876  

Interest on Federal Home Loan Bank advances

     1,403        2,484        4,985        7,866  

Interest on trust preferred borrowings

     369        340        1,114        1,015  

Interest on senior debt

     353        —           353        —     

Interest on other borrowings

     259        468        895        1,679  
  

 

 

    

 

 

    

 

 

    

 

 

 
     5,621        7,911        17,999        25,436  
  

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income

     30,893        32,180        95,501        93,621  

Provision for loan losses

     3,751        6,558        28,379        21,048  
  

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income after provision for loan losses

     27,142        25,622        67,122        72,573  
  

 

 

    

 

 

    

 

 

    

 

 

 

Noninterest income:

           

Credit/debit card and ATM income

     5,738        5,523        17,031        15,549  

Deposit service charges

     4,360        4,385        12,673        11,975  

Fiduciary & investment management income

     3,258        2,987        9,716        8,891  

Securities gains, net

     2,451        1,935        17,797        2,953  

Bank owned life insurance income

     1,126        197        1,447        1,795  

Mortgage banking activities, net

     914        257        1,882        1,035  

Loan fee income

     706        610        1,803        1,871  

Other income

     1,195        1,030        3,149        2,523  
  

 

 

    

 

 

    

 

 

    

 

 

 
     19,748        16,924        65,498        46,592  
  

 

 

    

 

 

    

 

 

    

 

 

 

Noninterest expenses:

           

Salaries, benefits and other compensation

     16,942        15,337        49,840        44,566  

Occupancy expense

     3,235        3,171        9,697        8,944  

Loan workout and OREO expenses

     2,115        1,864        4,902        5,989  

Equipment expense

     1,701        1,666        5,403        5,195  

Data processing and operations expenses

     1,402        1,325        4,190        4,026  

FDIC expenses

     1,384        1,436        4,262        4,478  

Professional Fees

     671        1,267        2,917        3,974  

Marketing Expense

     379        1,597        1,976        3,446  

Acquisition integration costs

     —           —           —           780  

Other operating expense

     4,324        4,749        12,972        13,053  
  

 

 

    

 

 

    

 

 

    

 

 

 
     32,153        32,412        96,159        94,451  
  

 

 

    

 

 

    

 

 

    

 

 

 

Income before taxes

     14,737        10,134        36,461        24,714  

Income tax provision

     4,758        3,348        12,708        8,199  
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income

     9,979        6,786        23,753        16,515  

Dividends on preferred stock and accretion of discount

     693        692        2,077        2,077  
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income allocable to common stockholders

   $ 9,286      $ 6,094      $ 21,676      $ 14,438  
  

 

 

    

 

 

    

 

 

    

 

 

 

Earnings per share:

           

Basic

   $ 1.07      $ 0.71      $ 2.49      $ 1.68  

Diluted

   $ 1.06      $ 0.70      $ 2.47      $ 1.66  

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

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Table of Contents

WSFS FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2012     2011     2012     2011  
     (Unaudited)     (Unaudited)  
     (In Thousands)     (In Thousands)  

Net Income

   $ 9,979     $ 6,786     $ 23,753     $ 16,515  

Other comprehensive income:

        

Unrealized gains on securities available for sale

     15,341       10,592       27,605       12,370  

Tax expense

     (5,783     (4,054     (10,440     (4,734
  

 

 

   

 

 

   

 

 

   

 

 

 

Net of tax amount

     9,558       6,538       17,165       7,636  

Reclassification adjustment for gains included in net income

     (2,451     (1,935     (17,797     (2,953

Tax expense

     931       735       6,763       1,122  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net of tax amount

     (1,520     (1,200     (11,034     (1,831

Total other comprehensive income

     8,038       5,338       6,131       5,805  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total comprehensive income

   $ 18,017     $ 12,124     $ 29,884     $ 22,320  
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

WSFS FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CONDITION

 

     Sept. 30,
2012
    Dec 31,
2011
 
     (Unaudited)  
     (In Thousands, Except Per Share Data)  

Assets

    

Cash and due from banks

   $ 73,236     $ 70,889  

Cash in non-owned ATMs

     373,577       397,119  

Interest-bearing deposits in other banks

     287       9  
  

 

 

   

 

 

 

Total cash and cash equivalents

     447,100       468,017  

Investment securities, available-for-sale

     910,055       859,362  

Investment securities, trading

     12,590       12,432  

Loans held-for-sale

     20,905       10,185  

Loans, net of allowance for loan losses of $45,598 at September 30, 2012 and $53,080 at December 31, 2011

     2,656,161       2,702,589  

Bank owned life insurance

     62,818       63,392  

Stock in Federal Home Loan Bank of Pittsburgh, at cost

     30,172        35,756  

Assets acquired through foreclosure

     6,996       11,695  

Premises and equipment

     37,107       35,964  

Goodwill

     28,146       28,146  

Intangible assets

     5,417       6,139  

Accrued Interest receivable

     10,292       11,743  

Other assets

     33,573        43,588  
  

 

 

   

 

 

 

Total assets

   $ 4,261,332     $ 4,289,008  
  

 

 

   

 

 

 

Liabilities and Stockholders’ Equity

    

Liabilities:

    

Deposits:

    

Noninterest-bearing demand

   $ 596,235     $ 525,444  

Interest-bearing demand

     413,042       389,495  

Money market

     799,786       805,570  

Savings

     388,878       368,390  

Time

     353,749       412,027  

Jumbo certificates of deposit – customer

     345,855       346,568  
  

 

 

   

 

 

 

Total customer deposits

     2,897,545       2,847,494  

Brokered deposits

     262,259       287,810  
  

 

 

   

 

 

 

Total deposits

     3,159,804       3,135,304  

Federal funds purchased and securities sold under agreements to repurchase

     100,000       50,000  

Federal Home Loan Bank advances

     392,870       538,682  

Trust preferred borrowings

     67,011       67,011  

Senior debt

     55,000       —     

Other borrowed funds

     29,942       67,927  

Accrued interest payable

     6,335       1,910  

Other liabilities

     32,575       36,041  
  

 

 

   

 

 

 

Total liabilities

     3,843,537       3,896,875  
  

 

 

   

 

 

 

Stockholders’ Equity:

    

Serial preferred stock $.01 par value, 7,500,000 shares authorized; issued 52,625 at September 30, 2012 and December 31, 2011

   $ 1     $ 1  

Common stock $.01 par value, 20,000,000 shares authorized; issued 18,314,319 at September 30, 2012 and 18,258,714 at December 31, 2011

     183       182  

Capital in excess of par value

     221,146       220,163  

Accumulated other comprehensive income

     17,333       11,202  

Retained earnings

     427,412       408,865  

Treasury stock at cost, 9,580,569 shares at September 30, 2012 and December 31, 2011

     (248,280     (248,280
  

 

 

   

 

 

 

Total stockholders’ equity

     417,795       392,133  
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 4,261,332     $ 4,289,008  
  

 

 

   

 

 

 

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

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Table of Contents

WSFS FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

     Nine Months Ended
September 30,
 
     2012     2011  
     (Unaudited)  
     (In Thousands)  

Operating activities:

    

Net Income

   $ 23,753     $ 16,515  

Adjustments to reconcile net income to net cash provided by operating activities:

    

Provision for loan losses

     28,379       21,048  

Depreciation, accretion and amortization

     11,926       7,991  

Decrease in accrued interest receivable

     1,451       439  

Decrease (increase) in other assets

     8,726       (5,047

Origination of loans held-for-sale

     (137,298     (69,659

Proceeds from sales of loans held-for-sale

     142,535       77,844  

Gain on mortgage banking activities, net

     (1,882     (1,035

Security gains, net

     (17,797     (2,953

Stock-based compensation expense

     1,600       1,216  

Excess tax benefits from share-based payment arrangements

     (99     (587

Increase in accrued interest payable

     4,425       5,216  

(Decrease) increase in other liabilities

     (3,432     11,884  

Loss on sale of assets acquired through foreclosure and valuation adjustments, net

     2,891       2,447  

Increase in value of bank-owned life insurance

     (1,447     (1,795

(Increase) decrease in capitalized interest, net

     (478     1  
  

 

 

   

 

 

 

Net cash provided by operating activities

   $ 63,253     $ 63,525  
  

 

 

   

 

 

 

Investing activities:

    

Maturities of investment securities

     5,039       11,727  

Sale of investment securities available for sale

     616,254       216,261  

Purchase of investment securities available-for-sale

     (751,363     (415,277

Repayments of investment securities available-for-sale

     101,729       130,184  

Disbursements for reverse mortgages

     (94     (396

Proceeds from loan disposition

     31,307       —     

Net increase in loans

     (38,190     (118,138

Payment of bank-owned life insurance

     2,021       2,885  

Net decrease (increase) in stock of Federal Home Loan Bank of Pittsburgh

     5,585       (102

Sales of assets acquired through foreclosure, net

     11,789       9,088  

Investment in premises and equipment, net

     (5,747     (8,090
  

 

 

   

 

 

 

Net cash (used for) investing activities

   $ (21,670   $ (171,858
  

 

 

   

 

 

 

Financing activities:

    

Net increase in demand and saving deposits

     101,059       162,096  

Net decrease in time deposits

     (58,991     (14,975

Net decrease in brokered deposits

     (25,717     (28,245

Receipts from FHLB advances

     27,299,083       9,846,709  

Repayments of FHLB advances

     (27,444,895     (9,766,892

Receipts from federal funds purchased and securities sold under agreement to repurchase

     14,135,000       3,103,525  

Repayments of federal funds purchased and securities sold under agreement to repurchase

     (14,085,000     (3,103,525

Repayment of unsecured debt

     (30,000     —     

Issuance of senior debt

     52,691       —     

Dividends paid

     (5,115     (5,067

Issuance of common stock and exercise of common stock options

     1,086        914  

Repurchase of common stock warrants

     (1,800     —     

Excess tax benefits from share-based payment arrangements

     99       587  
  

 

 

   

 

 

 

Net cash (used for) provided by financing activities

   $ (62,500   $ 195,127  
  

 

 

   

 

 

 

(Decrease) increase in cash and cash equivalents

     (20,917     86,794   

Cash and cash equivalents at beginning of period

     468,017       376,759  
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 447,100     $ 463,553  
  

 

 

   

 

 

 

Supplemental Disclosure of Cash Flow Information:

    

Cash paid for interest during the period

   $ 13,574     $ 20,220  

Cash paid for income taxes, net

     8,379       336  

Loans transferred to assets acquired through foreclosure

     9,290       14,391  

Other comprehensive income

     6,131       5,805  

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

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Table of Contents

WSFS FINANCIAL CORPORATION

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2012

(UNAUDITED)

1. BASIS OF PRESENTATION

Our Consolidated Financial Statements include the accounts of WSFS Financial Corporation (“the Company”, “our Company”, “we”, “our” or “us”), Wilmington Savings Fund Society, FSB (“WSFS Bank” or the “Bank”) and Montchanin Capital Management, Inc. (“Montchanin”). We also have one unconsolidated affiliate, WSFS Capital Trust III (“the Trust”). WSFS Bank has two fully-owned subsidiaries, WSFS Investment Group, Inc. (“WIG”) and Monarch Entity Services LLC (“Monarch”) and Montchanin has one wholly owned subsidiary, Cypress Capital Management, LLC (“Cypress”).

Founded in 1832, the Bank is one of the ten oldest banks continuously operating under the same name in the United States. We provide residential and commercial real estate, commercial and consumer lending services, as well as retail deposit and cash management services. In addition, we offer a variety of wealth management and trust services to personal and corporate customers through our Trust and Wealth Management division. Lending activities are funded primarily with customer deposits and borrowings. The Federal Deposit Insurance Corporation (“FDIC”) insures our customers’ deposits to their legal maximums. We serve our customers primarily from our 51 offices located in Delaware (42), Pennsylvania (7), Virginia (1) and Nevada (1) and through our website at www.wsfsbank.com.

Amounts subject to significant estimates are items such as the allowance for loan losses and reserves for lending related commitments, goodwill, intangible assets, post-retirement benefit obligations, the fair value of financial instruments and other-than-temporary impairments (“OTTI”). Among other effects, changes to such estimates could result in future reserves for impairments of investment securities, goodwill and intangible assets and increases of allowances for loan losses and lending related commitments as well as increased post-retirement benefits expense.

Our accounting and reporting policies conform with U.S. generally accepted accounting principles and prevailing practices within the banking industry for interim financial information and Rule 10-01 of the Securities and Exchange Commission (“SEC”) Regulation S-X. Rule 10-01 of Regulation S-X does not require us to include all information and notes for complete financial statements and prevailing practices within the banking industry. Operating results for the three and nine month periods ended September 30, 2012 are not necessarily indicative of the results that may be expected for any future quarters or for the year ending December 31, 2012. For further information, refer to the consolidated financial statements and the accompanying notes included in our Annual Report on Form 10-K for the year ended December 31, 2011, as filed with the SEC.

Whenever necessary, reclassifications have been made to prior period Consolidated Financial Statements to conform to the current period’s presentation. All significant intercompany transactions were eliminated in consolidation.

 

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Table of Contents

2. EARNINGS PER SHARE

The following table shows the computation of basic and diluted earnings per share:

 

     For the three months ended
September 30,
     For the nine months ended
September 30,
 
     2012      2011      2012      2011  
     (In Thousands, Except Per Share Data)  

Numerator:

           

Net income allocable to common stockholders

   $ 9,286      $ 6,094      $ 21,676      $ 14,438  
  

 

 

    

 

 

    

 

 

    

 

 

 

Denominator:

           

Denominator for basic earnings per share - weighted average shares

     8,712        8,605        8,702        8,594  

Effect of dilutive employee stock options and warrants

     83        96        77        124  
  

 

 

    

 

 

    

 

 

    

 

 

 

Denominator for diluted earnings per share – adjusted weighted average shares and assumed exercise

     8,795        8,701        8,779        8,718  
  

 

 

    

 

 

    

 

 

    

 

 

 

Earnings per share:

           

Basic:

           

Net income allocable to common shareholders

   $ 1.07      $ 0.71      $ 2.49      $ 1.68  
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted:

           

Net income allocable to common shareholders

   $ 1.06      $ 0.70      $ 2.47      $ 1.66  
  

 

 

    

 

 

    

 

 

    

 

 

 

Outstanding common stock equivalents having no dilutive effect

     338        537        361        538  

3. INVESTMENT SECURITIES

The following tables detail the amortized cost and the estimated fair value of the Company’s investment securities held-to-maturity and securities available-for-sale (which include reverse mortgages):

 

     Amortized
Cost
    Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair
Value
 
     (In Thousands)  

Available-for-sale securities:

         

September 30, 2012:

         

Reverse mortgages

   $ (552   $ —         $ —        $ (552

U.S. Government and government sponsored enterprises (“GSE”)

     50,747       308        (3     51,052  

State and political subdivisions

     3,120       29        (1     3,148  

Collateralized Mortgage Obligation (“CMO”) (1)

     247,991       7,462        (131     255,322  

Federal National Mortgage Association (“FNMA”) Mortgage-Backed Securities (“MBS”)

     446,296       15,193        (54     461,435  

Federal Home Loan Mortgage Corporation (“FHLMC”) MBS

     70,110       2,246        —          72,356  

Government National Mortgage Association (“GNMA”) MBS

     63,757       3,537        —          67,294  
  

 

 

   

 

 

    

 

 

   

 

 

 
   $ 881,469     $ 28,775      $ (189   $ 910,055  
  

 

 

   

 

 

    

 

 

   

 

 

 

December 31, 2011:

         

Reverse mortgages

   $ (646   $ —         $ —        $ (646

GSE

     38,776       262        (13     39,025  

State and political subdivisions

     4,159       39        (8     4,190  

CMO (1)

     323,980       6,933        (2,527     328,386  

FNMA

     320,019       9,379        (44     329,354  

FHLMC

     93,305       1,781        —          95,086  

GNMA

     60,991       3,033        (57     63,967  
  

 

 

   

 

 

    

 

 

   

 

 

 
   $ 840,584     $ 21,427      $ (2,649   $ 859,362  
  

 

 

   

 

 

    

 

 

   

 

 

 

Trading securities

         

September 30, 2012:

         

CMO

   $ 12,590     $ —         $ —        $ 12,590  
  

 

 

   

 

 

    

 

 

   

 

 

 

December 31, 2011:

         

CMO

   $ 12,432     $ —         $ —        $ 12,432  
  

 

 

   

 

 

    

 

 

   

 

 

 

 

(1) Includes agency CMO and SASCO 2002 RM-1 Class O securities classified as available-for-sale

 

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Table of Contents

The scheduled maturities of investment securities available-for-sale at September 30, 2012 and December 31, 2011 were as follows:

 

     Available-for-Sale  
     Amortized
Cost
     Fair
Value
 
     (In Thousands)  

September 30, 2012

     

Within one year (1)

   $ 8,889      $ 8,941  

After one year but within five years

     42,447        42,729  

After five years but within ten years

     273,536        282,968  

After ten years

     556,597        575,417  
  

 

 

    

 

 

 
   $ 881,469      $ 910,055  
  

 

 

    

 

 

 

December 31, 2011

     

Within one year (1)

   $ 7,916      $ 7,966  

After one year but within five years

     32,225        32,465  

After five years but within ten years

     129,597        135,649  

After ten years

     670,846        683,282  
  

 

 

    

 

 

 
   $ 840,584      $ 859,362  
  

 

 

    

 

 

 

 

(1) Reverse mortgages do not have contractual maturities. We have included reverse mortgages in maturities within one year.

The portfolio of available-for-sale mortgage-backed securities (“MBS”) includes 164 securities with an amortized cost of $828.2 million comprised of all GSE securities. All securities were AAA-rated at the time of purchase. All securities were re-evaluated for OTTI at September 30, 2012. The result of this evaluation showed no OTTI for the third quarter of 2012.

At September 30, 2012, investment securities with market values aggregating $431.2 million were pledged as collateral for retail customer repurchase agreements, municipal deposits, and other obligations. From time to time, investment securities are also pledged as collateral for FHLB borrowings. There were no FHLB pledged investment securities at September 30, 2012.

 

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Table of Contents

During the first nine months of 2012, we sold $616.3 million of investment securities categorized as available-for-sale for net gains of $17.7 million. In the first nine months of 2011, proceeds from the sale of investment securities available-for-sale were $216.1 million and resulted in net gains of $3.0 million. A portion of these sales during 2012 were the result of the completion of the Asset Strategies undertaken during the second quarter and were mainly due to maintaining the capital and earnings neutrality of these efforts. These and additional sales were completed as part of our ongoing portfolio management aimed at minimizing credit risk and decreasing prepayment/premium risk due to faster prepayments caused by declining mortgage interest rates in this historically-low rate environment. Lastly, the sales during the third quarter of 2012 were also aimed at limiting extension risk, which decreased the weighted average duration of the MBS portfolio to 4.2 years at September 30, 2012, from 4.5 years at June 30, 2012. The cost basis of all investment securities sales are based on the specific identification method.

As of September 30, 2012, our investment securities portfolio had remaining unamortized premiums of $22.6 million. In addition, at September 30, 2012 we had $216,000 of unaccreted discounts related to our investment securities portfolio.

MBS have expected maturities that differ from their contractual maturities. These differences arise because borrowers may have the right to call or prepay obligations with or without a prepayment penalty.

At September 30, 2012, we owned investment securities totaling $17.1 million in which the amortized cost basis exceeded fair value. Total unrealized losses on those securities were $189,000 at September 30, 2012. The temporary impairment is the result of changes in market interest rates subsequent to the purchase of the securities. Our investment portfolio is reviewed each quarter for indications of impairment. This review includes analyzing the length of time and the extent to which the fair value has been lower than the cost, the financial condition and near-term prospects of the issuer, including any specific events which may influence the operations of the issuer and our intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in the market. We evaluate our intent and ability to hold securities based upon our investment strategy for the particular type of security and our cash flow needs, liquidity position, capital adequacy and interest rate risk position. In addition, we do not have the intent to sell, nor is it more likely-than-not we will be required to sell these securities before we are able to recover the amortized cost basis.

For these investment securities with unrealized losses, the table below shows our gross unrealized losses and fair value by investment category and length of time that individual securities have been in a continuous unrealized loss position at September 30, 2012.

 

     Less than 12 months      12 months or longer      Total  
     Fair
Value
     Unrealized
Loss
     Fair
Value
     Unrealized
Loss
     Fair
Value
     Unrealized
Loss
 
     (In Thousands)  

Available-for-sale securities:

                 

U.S Government and agencies

   $ 2,008      $ 3      $ —         $ —         $ 2,008      $ 3  

State and political subdivisions

     —           —           125        1        125        1  

CMO

     10,694        131        —           —           10,694        131  

FNMA

     4,288        54        —           —           4,288        54  

FHLMC

     —           —           —           —           —           —     

GNMA

     —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total temporarily impaired investments

   $ 16,990      $ 188      $ 125      $ 1      $ 17,115      $ 189  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

For these investment securities with unrealized losses, the table below shows our gross unrealized losses and fair value by investment category and length of time that individual securities were in a continuous unrealized loss position at December 31, 2011.

 

     Less than 12 months      12 months or longer      Total  
     Fair
Value
     Unrealized
Loss
     Fair
Value
     Unrealized
Loss
     Fair
Value
     Unrealized
Loss
 
     (In Thousands)  

Available-for-sale securities:

                 

U.S Government and agencies

   $ 5,047      $ 13      $ —         $ —         $ 5,047      $ 13  

State and political subdivisions

     —           —           440        8        440        8  

CMO

     78,955        2,194        9,933        333        88,888        2,527  

FNMA

     6,959        44        —           —           6,959        44  

FHLMC

     —           —           —           —           —           —     

GNMA

     5,420        57        —           —           5,420        57  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total temporarily impaired investments

   $ 96,381      $ 2,308      $ 10,373      $ 341      $ 106,754      $ 2,649  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

We own $12.5 million par value of SASCO RM-1 2002 class B securities which are classified as trading, of which, $1.5 million is interest paid in kind. We expect to recover all principal and interest due to seasoning and excess collateral. Based on FASB ASC 320, Investments – Debt and Equity Securities (“ASC 320”) when these securities were acquired they were classified as trading because it was our intent to sell them in the near term. We use the guidance under ASC 320 to provide a reasonable estimate of fair value. We estimated the value of these securities based on the pricing of BBB+ securities that have an active market through a technique which estimates the fair value of this asset using the income approach as of September 30, 2012.

During 2011, we purchased 100% of SASCO 2002-RM1 Class O certificates for $2.5 million. As of September 30, 2012, the market value of the SASCO 2002-RM1 O securities was determined in accordance with FASB ASC 820-10, Fair Value Measurement (“ASC 820”), to be $6.1 million. These securities have been included in our CMO portfolio since their purchase.

4. ALLOWANCE FOR LOAN LOSSES AND CREDIT QUALITY INFORMATION

Allowance for Loan Losses

We maintain an allowance for loan losses and charge losses to this allowance when such losses are realized. The determination of the allowance for loan losses requires significant judgment reflecting our best estimate of impairment related to specifically identified impaired loans as well as probable loan losses in the remaining loan portfolio. Our evaluation is based upon a continuing review of these portfolios.

We established our loan loss allowance in accordance with guidance provided in the Securities and Exchange Commission’s Staff Accounting Bulletin 102 (“SAB 102”). Its methodology for assessing the appropriateness of the allowance consists of several key elements which include: specific allowances for identified problem loans; formula allowances for commercial and commercial real estate loans; and allowances for pooled homogenous loans.

Specific reserves are established for certain impaired loans in cases where we have identified significant conditions or circumstances related to a specific credit that indicates a loss is probable to occur.

The formula allowances for commercial, commercial real estate and construction loans are calculated by applying estimates of default and loss severity to outstanding loans based on the risk grade of loans. Default rates are determined through a past twelve quarter migration analysis. Loss severity is based on a three year historical analysis. As a result, changes in risk grades affect the amount of the formula allowance.

 

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Table of Contents

Pooled loans are usually smaller, not-individually-graded and homogenous in nature, such as consumer installment loans and residential mortgages. Loan loss allowances for pooled loans are first based on a five-year net charge-off history. The average loss allowance per homogenous pool is based on the product of average annual historical loss rate and the homogeneous pool balances. These separate risk pools are then assigned a reserve for losses based upon this historical loss information.

Qualitative and environmental adjustment factors are taken into consideration when determining the above reserve estimates. These adjustment factors are based upon our evaluation of various current conditions, including those listed below.

 

 

General economic and business conditions affecting the Bank’s key lending areas,

 

 

Credit quality trends,

 

 

Recent loss experience in particular segments of the portfolio,

 

 

Collateral values and loan-to-value ratios,

 

 

Loan volumes and concentrations, including changes in mix,

 

 

Seasoning of the loan portfolio,

 

 

Specific industry conditions within portfolio segments,

 

 

Bank regulatory examination results, and

 

 

Other factors, including changes in quality of the loan origination, servicing and risk management processes.

Our loan officers and risk managers meet at least quarterly to discuss and review these conditions and risks associated with individual problem loans. In addition, various regulatory agencies and loan review consultants periodically review our loan ratings and allowance for loan losses.

During the first quarter of 2012, we made certain improvements to the method in which we determine the allowance for loan loss. These improvements include:

 

 

Used a three year loss migration analysis to determine the probability of default

 

 

Segregated the commercial loan segment to more specifically analyze the risks associated with business, owner-occupied CRE, investor CRE and Construction loan portfolios

 

 

Improved the data used to determine qualitative adjustment factors

 

 

Established a portion of the allowance for loan losses related to model and complexity risk

 

 

Revised our loan risk rating system based on recommendations from industry experts

 

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Table of Contents

The following table provides the activity of the allowance for loan losses and loan balances for the three and nine months ended September 30, 2012:

 

    Commercial     Owner
Occupied
Commercial
    Commercial
Mortgages
    Construction     Residential     Consumer     Complexity
Risk (1)
    Total  
    (In Thousands)  

Three months ended September 30, 2012

               

Allowance for loan losses

               

Beginning balance

  $ 9,891      $ 4,091      $ 9,618      $ 5,307      $ 6,265      $ 10,341      $ 916      $ 46,429   

Charge-offs

    (1,281     (926     (709     (676     (705     (2,573     —          (6,870

Recoveries

    455        184        18       1,314       113       204       —          2,288  

Provision

    (127     (4     (2,281     (810     2,690       4,300       (17     3,751  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

  $ 8,938      $ 3,345      $ 6,646      $ 5,135      $ 8,363      $ 12,272      $ 899      $ 45,598   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Nine months ended September 30, 2012

               

Allowance for loan losses

               

Beginning balance

  $ 15,067      $ 9,235      $ 7,556      $ 4,074      $ 6,544      $ 10,604      $ —        $ 53,080   

Charge-offs

    (11,316     (3,614     (5,600     (10,680     (3,344     (5,494     —          (40,048

Recoveries

    1,305       190       382       1,642       171       497       —          4,187  

Provision

    3,882        (2,466     4,308       10,099       4,992       6,665       899       28,379  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

  $ 8,938      $ 3,345      $ 6,646      $ 5,135      $ 8,363      $ 12,272      $ 899      $ 45,598   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Period-end allowance allocated to:

               

Loans individually evaluated for impairment

  $ 1,244      $ 222      $ 90      $ 94      $ 1,199      $ 24      $ —        $ 2,873   

Loans collectively evaluated for impairment

    7,694       3,123       6,556       5,041       7,164       12,248       899       42,725  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

  $ 8,938      $ 3,345      $ 6,646      $ 5,135      $ 8,363      $ 12,272      $ 899      $ 45,598   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Period-end loan balances evaluated for:

               

Loans individually evaluated for impairment

  $ 3,579      $ 13,324      $ 5,875      $ 2,620      $ 18,072      $ 6,694      $ —        $ 50,164 (2) 

Loans collectively evaluated for impairment

    694,626       737,670       598,681       111,557       232,270       276,791       —          2,651,595  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

  $ 698,205      $ 750,994      $ 604,556      $ 114,177      $ 250,342      $ 283,485      $ —        $ 2,701,759   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Represents the portion of the allowance for loan losses established to account for the inherent complexity and uncertainty of estimates.
(2) The difference between this amount and nonaccruing loans at September 30, 2012, represents accruing troubled debt restructured loans.

 

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Table of Contents

The following table provides the activity of the allowance for loan losses and loan balances for the three and nine months ended September 30, 2011:

 

     Commercial     Commercial
Mortgages
    Construction     Residential     Consumer     Total  
     (In Thousands)  

Three months ended September 30, 2011

            

Allowance for loan losses

            

Beginning balance

   $ 25,236      $ 12,330      $ 5,831      $ 3,707      $ 9,144      $ 56,248   

Charge-offs

     (1,431     (5,302     (1,107     (877     (1,248     (9,965

Recoveries

     71       94       51       25       106       347  

Provision

     1,645       302       926       427       3,258       6,558  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 25,521      $ 7,424      $ 5,701      $ 3,282      $ 11,260      $ 53,188   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Nine months ended September 30, 2011

            

Allowance for loan losses

            

Beginning balance

   $ 26,480      $ 10,564      $ 10,019      $ 4,028      $ 9,248      $ 60,339   

Charge-offs

     (7,641     (6,609     (8,179     (2,183     (5,472     (30,084

Recoveries

     409       381       557       116       422       1,885  

Provision

     6,273       3,088       3,304       1,321       7,062       21,048  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 25,521      $ 7,424      $ 5,701      $ 3,282      $ 11,260      $ 53,188   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Period-end allowance allocated to:

            

Specific reserves(1)

   $ 1,810      $ 1,604      $ 3,005      $ 808      $ 120      $ 7,347   

General reserves(2)

     23,711       5,820       2,696       2,474       11,140       45,841  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 25,521      $ 7,424      $ 5,701      $ 3,282      $ 11,260      $ 53,188   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Period-end loan balances evaluated for:

            

Specific reserves(1)

   $ 21,270      $ 20,306      $ 21,701      $ 17,666      $ 3,176      $ 84,119 (3) 

General reserves(2)

     1,376,272       583,564       89,803       267,668       293,991       2,611,298  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 1,397,542      $ 603,870      $ 111,504      $ 285,334      $ 297,167      $ 2,695,417   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Specific reserves represent loans individually evaluated for impairment.
(2) General reserves represent loans collectively evaluated for impairment.
(3) The difference between this amount and nonaccruing loans at September 30, 2011, represents accruing troubled debt restructured loans.

 

12


Table of Contents

Non-Accrual and Past Due Loans

The following tables show our nonaccrual and past due loans at the dates indicated:

 

September 30, 2012

(In Thousands)

   30–59 Days
Past Due and
Still Accruing
    60–89 Days
Past Due and
Still Accruing
    Greater Than
90 Days

Past Due and
Still Accruing
    Total
Past Due

And Still
Accruing
    Accruing
Current
Balances
    Nonaccrual
Loans
    Total
Loans
 

Commercial

   $ 332      $ —        $ 1,869      $ 2,201      $ 692,425      $ 3,579      $ 698,205   

Owner occupied commercial (1)

     —          —          —          —          737,670       13,324       750,994  

Commercial mortgages

     —          80       —          80       598,601        5,875        604,556  

Construction

     —          —          —          —          111,557       2,620        114,177  

Residential

     5,272       1,218       —          6,490       234,498       9,354        250,342  

Consumer

     1,788       147       —          1,935       276,362       5,188        283,485  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 7,392      $ 1,445      $ 1,869      $ 10,706      $ 2,651,113      $ 39,940      $ 2,701,759   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

% of Total Loans

     0.28     0.05     0.07     0.40     98.12     1.48     100
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

                                                                                                                                                                

December 31, 2011

(In Thousands)

   30–59 Days
Past Due and
Still Accruing
    60–89 Days
Past Due and
Still Accruing
    Greater Than
90 Days

Past Due and
Still Accruing
    Total
Past Due
And Still
Accruing
    Accruing
Current
Balances
    Nonaccrual
Loans
    Total
Loans
 

Commercial

   $ 1,087      $ 63      $ 78      $ 1,228      $ 1,435,876      $ 23,080      $ 1,460,184   

Commercial mortgages

     479       243       —          722       605,764       15,814       622,300  

Construction

     3,727       —          —          3,727       80,074       22,124       105,925  

Residential

     5,501       1,238       887       7,626       258,820       9,057       275,503  

Consumer

     2,783       709       —          3,492       287,247       1,018       291,757  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 13,577      $ 2,253      $ 965      $ 16,795      $ 2,667,781      $ 71,093      $ 2,755,669   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

% of Total Loans

     0.49     0.08     0.04     0.61     96.81     2.58     100
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Prior to 2012, owner-occupied commercial loans were included in commercial loan balances.

Impaired Loans

The following tables provide an analysis of our impaired loans at September 30, 2012 and December 31, 2011:

 

September 30, 2012

(In Thousands)

   Ending
Loan
Balances
     Loans with
No Specific
Reserve (1)
     Loans with
Specific
Reserve
     Related
Specific
Reserve
     Contractual
Principal
Balances
     Average
Loan
Balances
 

Commercial

   $ 3,579      $ 1,735       $ 1,844       $ 1,244       $ 10,714       $ 8,530   

Owner-Occupied Commercial (2)

     13,324        12,088        1,236        222        16,293        13,918   

Commercial mortgages

     5,875        5,243        632        90        9,316        15,394   

Construction

     2,620        2,121        499        94        19,245        25,446   

Residential

     18,072         15,126         2,946         1,199        19,919         18,502   

Consumer

     6,694         5,988         706        24        8,242         4,113   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 50,164       $ 42,301       $ 7,863       $ 2,873       $ 83,729       $ 85,903   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents
                                                                             

December 31, 2011

(In Thousands)

   Ending
Loan
Balances
     Loans with
No Specific
Reserve (1)
     Loans with
Specific
Reserve
     Related
Specific
Reserve
     Contractual
Principal
Balances
     Average
Loan
Balances
 

Commercial

   $ 23,193       $ 19,353       $ 3,840       $ 2,630       $ 26,815       $ 22,396   

Commercial mortgages

     15,814        13,602        2,212        295        21,278        16,237  

Construction

     22,124        14,166        7,958        723        34,862        27,323  

Residential

     16,227        9,649        6,578        964        19,312        17,480  

Consumer

     2,621        1,336        1,285        101        2,788        3,916  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 79,979       $ 58,106       $ 21,873       $ 4,713       $ 105,055       $ 87,352   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Reflects loan balances at their remaining book balance.
(2) Prior to 2012, owner-occupied commercial loans were included in commercial loan balances.

Interest income of $150,000 and $478,000 was recognized on impaired loans during the three and nine months ended September 30, 2012, respectively.

Credit Quality Indicators

Below is a description of each of our risk ratings for all commercial loans:

Pass. These borrowers presently show no current or potential problems and their loans are considered fully collectible.

Special Mention. Borrowers have potential weaknesses that deserve management’s close attention. Borrowers in this category may be experiencing adverse operating trends, e.g.: declining revenues or margins, high leverage, tight liquidity, or increasing inventory without increasing sales. These adverse trends can have a potential negative effect on the borrower’s repayment capacity. These assets are not adversely classified and do not expose the Bank to significant risk that would warrant a more severe rating. Borrowers in this category may also be experiencing significant management problems, pending litigation, or other structural credit weaknesses.

Substandard. Borrowers have well-defined weaknesses that require extensive oversight by management. Borrowers in this category may exhibit one or more of the following: inadequate debt service coverage, unprofitable operations, insufficient liquidity, high leverage, and weak or inadequate capitalization. Relationships in this category are not adequately protected by the sound financial worth and paying capacity of the obligor or the collateral pledged on the loan, if any. The distinct possibility exists that the Bank will sustain some loss if the deficiencies are not corrected.

Doubtful. Borrowers have well-defined weaknesses inherent in the Substandard category with the added characteristic that the possibility of loss is extremely high. Current circumstances in the credit relationship make collection or liquidation in full highly questionable. A doubtful asset has some pending event that may strengthen the asset that defers the loss classification. Such impending events include: perfecting liens on additional collateral, obtaining collateral valuations, an acquisition or liquidation preceding, proposed merger, or refinancing plan.

Loss. Borrowers are uncollectible or of such negligible value that continuance as a bankable asset is not supportable. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical to defer writing off this asset even though partial recovery may be recognized sometime in the future.

Residential and Consumer Loans

The residential and consumer loan portfolios are monitored on an ongoing basis using delinquency information and loan type as credit quality indicators. These credit quality indicators are assessed in the aggregate in these relatively homogeneous portfolios. Loans that are greater than 90 days past due are generally considered nonperforming and placed in nonaccrual status.

 

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The following tables provide an analysis of problem loans as of September 30, 2012 and December 31, 2011:

Commercial credit exposure credit risk profile by internally assigned risk rating (in thousands):

 

    Commercial     Owner-Occupied
Commercial (1)
    Commercial Mortgages     Construction     Total Commercial  
    Sept. 30,
2012
    Dec. 31,
2011
    Sept. 30,
2012
    Dec. 31,
2011
    Sept. 30,
2012
    Dec. 31,
2011
    Sept. 30,
2012
    Dec. 31,
2011
    September 30, 2012     December 31, 2011  
                    Amount     Percent     Amount     Percent  

Risk Rating:

                       

Special mention

  $ 14,758      $ 85,848      $ 29,413        —        $ 30,722      $ 50,044      $ 429      $ 9,747      $ 75,322        $ 145,639     

Substandard:

                       

Accrual

    73,204       107,896       54,344       —          13,812       13,664       13,053       19,039       154,413         140,599    

Nonaccrual

    1,334       23,193       12,088       —          5,243       15,814       2,121       22,124       20,786         61,131    

Doubtful/Nonaccrual

    2,245       —          1,236       —          632       —          499       —          4,612         —       
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

Total Special Mention, Substandard and Doubtful

    91,541       216,937       97,081       —          50,409       79,522       16,102       50,910       255,133       12     347,369       16

Pass

    606,664       1,242,519       653,913       —          554,147       543,277       98,075       55,244       1,912,799       88       1,841,040       84  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Commercial Loans

  $ 698,205      $ 1,459,456      $ 750,994        —        $ 604,556      $ 622,799      $ 114,177      $ 106,154      $ 2,167,932        100   $ 2,188,409        100
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

Consumer credit exposure credit risk profile based on payment activity (in thousands):

 

     Residential      Consumer      Total Residential and Consumer  
     Sept. 30,
2012
     Dec. 31,
2011
     Sept. 30,
2012
     Dec. 31,
2011
     September 30, 2012     December 31, 2011  
                 Amount      Percent     Amount      Percent  

Nonperforming (2)

   $ 18,072       $ 16,227       $ 6,694       $ 2,621       $ 24,766         5   $ 18,848         3

Performing

     232,270        259,276        276,791        289,136        509,061        95       548,412        97  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 250,342       $ 275,503       $ 283,485       $ 291,757       $ 533,827         100   $ 567,260         100
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

      

 

 

    

 

(1) Prior to 2012, owner-occupied commercial loans were included in commercial loan balances.
(2) Includes $10.2 million at September 30, 2012 and $8.9 million at December 31, 2011 of troubled debt restructured mortgages and home equity installment loans performing in accordance with modified terms and are accruing interest

 

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Table of Contents

Troubled Debt Restructurings (TDR)

The book balance of TDRs at September 30, 2012 and December 31, 2011 was $22.3 million and $27.7 million, respectively. The balances at September 30, 2012 include approximately $12.1 million in nonaccrual status and $10.2 million in accrual status compared to $18.8 million in nonaccrual status and $8.9 million of in accrual status at December 31, 2011. Approximately $1.2 million and $1.3 million in specific reserves have been established for these loans as of September 30, 2012 and December 31, 2011, respectively.

During the nine months ending September 30, 2012, the terms of 104 loans were either modified or identified as troubled debt restructurings, of which 15 were related to commercial loans that were already placed on nonaccrual. Nonaccruing restructured loans remain in nonaccrual status until there has been a period of sustained repayment performance for a reasonable period, usually six months. The remaining 89 loans represented residential and consumer loans. Our concessions on restructured loans consisted mainly of forbearance agreements, reduction in interest rates or extensions of maturities. Principal balances are generally not forgiven by us when a loan is modified as a TDR.

The following table presents loans identified as TDRs during the three and nine months ended September 30, 2012:

 

(In Thousands)

   Three Months Ended
Sept. 30, 2012
     Nine Months Ended
Sept. 30, 2012
 

Commercial

   $ 710       $ 9,986   

Construction

     —          378  

Residential

     2,779        4,170  

Consumer

     2,165         2,312   
  

 

 

    

 

 

 

Total

   $ 5,654       $ 16,846   
  

 

 

    

 

 

 

The TDRs described above increased the allowance for loan losses by $357,000 through allocation of a specific reserve, and resulted in charge offs of $8.1 million during the nine months ending September 30, 2012.

There was one residential TDR in the amount of $84,000 which defaulted (defined as past due 90 days) during the three and nine months ended September 30, 2012 that was restructured within the last twelve months prior to September 30, 2012.

5. TAXES ON INCOME

We account for income taxes in accordance with FASB ASC 740, Income Taxes (“ASC 740”) (Formerly SFAS No. 109, Accounting for Income Taxes and FASB Interpretation No. 48, Accounting for Uncertainty In Income Taxes, an Interpretation of FASB Statement 109). ASC 740 requires the recording of deferred income taxes that reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. We exercise significant judgment in the evaluation of the amount and timing of the recognition of the resulting tax assets and liabilities. The judgments and estimates required for the evaluation are updated based upon changes in business factors and the tax laws. If actual results differ from the assumptions and other considerations used in estimating the amount and timing of tax recognized, there can be no assurance that additional expenses will not be required in future periods. No valuation allowance has been recorded on our deferred tax assets due to our history of prior earnings along with our expectations of future income. ASC 740 prescribes a minimum probability threshold that a tax position must meet before a financial statement benefit is recognized. We recognize, when applicable, interest and penalties related to unrecognized tax benefits in the provision for income taxes in the financial statements. Assessment of uncertain tax positions under ASC 740 requires careful consideration of the technical merits of a position based on our analysis of tax regulations and interpretations.

 

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Table of Contents

The total amount of unrecognized tax benefits as of September 30, 2012 and December 31, 2011 were $3,000 and $88,000, respectively, all of which would affect our September 30, 2012 effective tax rate if recognized. As of September 30, 2012 and December 31, 2011, the total amount of accrued interest included in such unrecognized tax benefits were $3,000 and $15,000, respectively. Penalties of $6,000 were included in such unrecognized tax benefits at December 31, 2011, but none are included at September 30, 2012. We record interest and penalties on potential income tax deficiencies as income tax expense. Our Federal and state tax returns for the 2009 through 2011 tax years are subject to examination as of September 30, 2012. We were recently notified of the IRS intention to audit our 2010 tax return. There are currently no other income tax audits in process.

6. SEGMENT INFORMATION

Under the definition of FASB ASC 280, Segment Reporting (“ASC 280”) (Formerly SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information) we discuss our business in three segments. There is one segment for each of WSFS Bank, Cash Connect, (the ATM division of WSFS Bank), and Trust and Wealth Management. Trust and Wealth Management was reorganized during 2011 and is comprised of Montchanin, Christiana Trust, Monarch Entity Services LLC, Private Banking and WSFS Investment Group, Inc. in a single reportable segment because each has similar economic characteristics, products, customers and distribution methods. As required by ASC 280, all prior years’ information has been updated to reflect this presentation.

The WSFS Bank segment provides financial products to commercial and retail customers through its 51 offices located in Delaware (42), Pennsylvania (7) and Virginia (1) and Nevada (1). Retail and Commercial Banking, Commercial Real Estate Lending and other banking business units are operating departments of WSFS. These departments share the same regulator, the same market, many of the same customers and provide similar products and services through the general infrastructure of the Bank. Because of these and other reasons, these departments are not considered discrete segments and are appropriately aggregated within the WSFS Bank segment in accordance with ASC 280.

Cash Connect provides turnkey ATM services through strategic partnerships with several of the largest networks, manufacturers and service providers in the ATM industry. The balance sheet category “Cash in non-owned ATMs” includes cash from which fee income is earned through bailment arrangements with customers of Cash Connect.

The Trust and Wealth Management segment is comprised of Christiana Trust, Monarch Entity Services LLC, Montchanin, Private Banking and WSFS Investment Group, Inc. Christiana Trust was acquired in December 2010 and WSFS’ Trust and Wealth Management business was consolidated into Christiana Trust. Christiana Trust provides investment, fiduciary, and agency services from locations in Delaware and Nevada. These services are provided to individuals and families as well as corporations and institutions. Monarch Entity Services LLC provides commercial domicile services from locations in Delaware and Nevada. Montchanin has one consolidated wholly owned subsidiary, Cypress Capital Management, LLC (Cypress). Cypress is a Wilmington-based investment advisory firm serving high net-worth individuals and institutions. WSFS Investment Group, Inc. markets various third-party insurance products and securities and Private Banking specializes in meeting the needs of professionals and their practices, including deposit services and credit needs of existing and start-up practices.

 

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Table of Contents

An operating segment is a component of an enterprise that engages in business activities from which it may earn revenues and incur expenses, whose operating results are regularly reviewed by the enterprise’s chief operating decision makers to make decisions about resources to be allocated to the segment and assess its performance, and for which discrete financial information is available. We evaluate performance based on pretax ordinary income relative to resources used, and allocate resources based on these results. The accounting policies applicable to our segments are those that apply to our preparation of the accompanying Consolidated Financial Statements. Segment information for the three and nine months ended September 30, 2012 and 2011 follows:

For the three months ended September 30, 2012

 

     WSFS Bank      Cash Connect      Trust &
Wealth
Management
     Total  
     (In Thousands)  

External customer revenues:

           

Interest income

   $ 34,475      $ —         $ 2,039      $ 36,514  

Noninterest income

     11,686        4,707        3,355        19,748  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total external customer revenues

     46,161        4,707        5,394        56,262  
  

 

 

    

 

 

    

 

 

    

 

 

 

Inter-segment revenues:

           

Interest income

     944        —           1,358        2,302  

Noninterest income

     2,122        148        24        2,294  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total inter-segment revenues

     3,066        148        1,382        4,596  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenue

     49,227        4,855        6,776        60,858  
  

 

 

    

 

 

    

 

 

    

 

 

 

External customer expenses:

           

Interest expense

     5,377        —           244        5,621  

Noninterest expenses

     27,300         2,113        2,740        32,153   

Provision for loan loss

     2,997        —           754        3,751  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total external customer expenses

     35,674         2,113        3,738        41,525   
  

 

 

    

 

 

    

 

 

    

 

 

 

Inter-segment expenses

           

Interest expense

     1,358        338        606        2,302  

Noninterest expenses

     172        586        1,536        2,294  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total inter-segment expenses

     1,530        924        2,142        4,596  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total expenses

     37,204         3,037        5,880        46,121   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income before taxes and extraordinary items

   $ 12,023       $ 1,818      $ 896      $ 14,737   

Provision for income taxes

              4,758  
           

 

 

 

Consolidated net income

            $ 9,979   
           

 

 

 

Capital expenditures

   $ 1,289      $ 311      $ 3      $ 1,603  
  

 

 

    

 

 

    

 

 

    

 

 

 

As of September 30, 2012

           

Cash and cash equivalents

   $ 52,821      $ 390,356      $ 3,923      $ 447,100  

Other segment assets

     3,622,291        1,976        189,965        3,814,232  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total segment assets

   $ 3,675,112      $ 392,332      $ 193,888      $ 4,261,332  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

For the three months ended September 30, 2011

 

     WSFS Bank      Cash Connect      Trust &
Wealth
Management
     Total  
     (In Thousands)  

External customer revenues:

           

Interest income

   $ 37,729      $ —         $ 2,362      $ 40,091  

Noninterest income

     9,389        4,235        3,300        16,924  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total external customer revenues

     47,118        4,235        5,662        57,015  
  

 

 

    

 

 

    

 

 

    

 

 

 

Inter-segment revenues:

           

Interest income

     1,136        —           1,406        2,542  

Noninterest income

     1,793        202        21        2,016  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total inter-segment revenues

     2,929        202        1,427        4,558  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenue

     50,047        4,437        7,089        61,573  
  

 

 

    

 

 

    

 

 

    

 

 

 

External customer expenses:

           

Interest expense

     7,600        —           311        7,911  

Noninterest expenses

     27,524        2,187        2,701        32,412  

Provision for loan loss

     6,068        —           490        6,558  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total external customer expenses

     41,192        2,187        3,502        46,881  
  

 

 

    

 

 

    

 

 

    

 

 

 

Inter-segment expenses

           

Interest expense

     1,406        349        787        2,542  

Noninterest expenses

     223        358        1,435        2,016  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total inter-segment expenses

     1,629        707        2,222        4,558  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total expenses

     42,821        2,894        5,724        51,439  
  

 

 

    

 

 

    

 

 

    

 

 

 

Income before taxes and extraordinary items

   $ 7,226      $ 1,543      $ 1,365      $ 10,134  

Provision for income taxes

              3,348  
           

 

 

 

Consolidated net income

            $ 6,786  
           

 

 

 

Capital expenditures

   $ 2,374      $ 837      $ 2      $ 3,213  
  

 

 

    

 

 

    

 

 

    

 

 

 

As of December 31, 2011

           

Cash and cash equivalents

   $ 48,107      $ 416,949      $ 2,961      $ 468,017  

Other segment assets

     3,618,744        2,155        200,092        3,820,991  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total segment assets

   $ 3,666,851      $ 419,104      $ 203,053      $ 4,289,008  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

For the nine months ended September 30, 2012

 

     WSFS Bank      Cash Connect      Trust &
Wealth
Management
     Total  
     (In Thousands)  

External customer revenues:

           

Interest income

   $ 107,199      $ —         $ 6,301      $ 113,500  

Noninterest income

     42,238        13,254        10,006        65,498  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total external customer revenues

     149,437        13,254        16,307        178,998  
  

 

 

    

 

 

    

 

 

    

 

 

 

Inter-segment revenues:

           

Interest income

     3,099        —           4,344        7,443  

Noninterest income

     6,368        568        79        7,015  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total inter-segment revenues

     9,467        568        4,423        14,458  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenue

     158,904        13,822        20,730        193,456  
  

 

 

    

 

 

    

 

 

    

 

 

 

External customer expenses:

           

Interest expense

     17,330        —           669        17,999  

Noninterest expenses

     81,267        6,628        8,264        96,159  

Provision for loan loss

     26,786        —           1,593        28,379  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total external customer expenses

     125,383        6,628        10,526        142,537  
  

 

 

    

 

 

    

 

 

    

 

 

 

Inter-segment expenses

           

Interest expense

     4,344        1,008        2,091        7,443  

Noninterest expenses

     647        1,711        4,657        7,015  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total inter-segment expenses

     4,991        2,719        6,748        14,458  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total expenses

     130,374        9,347        17,274        156,995  
  

 

 

    

 

 

    

 

 

    

 

 

 

Income before taxes and extraordinary items

   $ 28,530      $ 4,475      $ 3,456      $ 36,461  

Provision for income taxes

              12,708  
           

 

 

 

Consolidated net income

            $ 23,753  
           

 

 

 

Capital expenditures

   $ 5,406      $ 321      $ 20      $ 5,747  
  

 

 

    

 

 

    

 

 

    

 

 

 

As of September 30, 2012

           

Cash and cash equivalents

   $ 52,821      $ 390,356      $ 3,923      $ 447,100  

Other segment assets

     3,622,291        1,976        189,965        3,814,232  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total segment assets

   $ 3,675,112      $ 392,332      $ 193,888      $ 4,261,332  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

For the nine months ended September 30, 2011

 

     WSFS Bank      Cash Connect      Trust &
Wealth
Management
     Total  
     (In Thousands)  

External customer revenues:

           

Interest income

   $ 111,984      $ —         $ 7,073      $ 119,057  

Noninterest income

     25,275        11,484        9,833        46,592  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total external customer revenues

     137,259        11,484        16,906        165,649  
  

 

 

    

 

 

    

 

 

    

 

 

 

Inter-segment revenues:

           

Interest income

     3,344        —           4,505        7,849  

Noninterest income

     5,610        524        93        6,227  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total inter-segment revenues

     8,954        524        4,598        14,076  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenue

     146,213        12,008        21,504        179,725  
  

 

 

    

 

 

    

 

 

    

 

 

 

External customer expenses:

           

Interest expense

     24,434        —           1,002        25,436  

Noninterest expenses

     79,866        5,824        8,761        94,451  

Provision for loan loss

     19,802        —           1,246        21,048  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total external customer expenses

     124,102        5,824        11,009        140,935  
  

 

 

    

 

 

    

 

 

    

 

 

 

Inter-segment expenses

           

Interest expense

     4,505        913        2,431        7,849  

Noninterest expenses

     617        1,162        4,448        6,227  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total inter-segment expenses

     5,122        2,075        6,879        14,076  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total expenses

     129,224        7,899        17,888        155,011  
  

 

 

    

 

 

    

 

 

    

 

 

 

Income before taxes and extraordinary items

   $ 16,989      $ 4,109      $ 3,616      $ 24,714  

Provision for income taxes

              8,199  
           

 

 

 

Consolidated net income

            $ 16,515  
           

 

 

 

Capital expenditures

   $ 6,768      $ 1,014      $ 308      $ 8,090  
  

 

 

    

 

 

    

 

 

    

 

 

 

As of December 31, 2011

           

Cash and cash equivalents

   $ 48,107      $ 416,949      $ 2,961      $ 468,017  

Other segment assets

     3,618,744        2,155        200,092        3,820,991  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total segment assets

   $ 3,666,851      $ 419,104      $ 203,053      $ 4,289,008  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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7. FAIR VALUE DISCLOSURES OF FINANCIAL ASSETS

FAIR VALUE OF FINANCIAL ASSETS

ASC 820-10 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820-10 establishes a fair value hierarchy that prioritizes the use of inputs used in valuation methodologies into the following three levels:

Level 1: Inputs to the valuation methodology are quoted prices, unadjusted, for identical assets or liabilities in active markets. A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available.

Level 2: Inputs to the valuation methodology include quoted prices for similar assets or liabilities in active markets; inputs to the valuation methodology include quoted prices for identical or similar assets or liabilities in markets that are not active; or inputs to the valuation methodology that are derived principally from or can be corroborated by observable market data by correlation or other means.

Level 3: Inputs to the valuation methodology are unobservable and significant to the fair value measurement. Level 3 assets and liabilities include financial instruments whose value is determined using discounted cash flow methodologies, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

The table below presents the balances of assets measured at fair value as of September 30, 2012 (there are no material liabilities measured at fair value):

 

Description

   Quoted
Prices  in
Active
Markets for
Identical
Asset

(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
    Total
Fair Value
 
     (in Thousands)  

Assets Measured at Fair Value on a Recurring Basis

          

Available-for-sale securities:

          

Collateralized mortgage obligations

   $ —         $ 249,272      $ 6,050     $ 255,322  

FNMA

     —           461,435        —          461,435  

FHLMC

     —           72,356        —          72,356  

GNMA

     —           67,294        —          67,294  

U.S. Government and agencies

     —           51,052        —          51,052  

State and political subdivisions

     —           3,148        —          3,148  

Reverse mortgages

     —           —           (552     (552

Trading Securities

     —           —           12,590       12,590  
  

 

 

    

 

 

    

 

 

   

 

 

 

Total assets measured at fair value on a recurring basis

   $ —         $ 904,557      $ 18,088     $ 922,645  

Assets Measured at Fair Value on a Nonrecurring Basis

          

Other real estate owned

   $ —         $ —         $ 6,996     $ 6,996  

Impaired Loans

     —           —           47,291        47,291   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total assets measured at fair value on a nonrecurring basis

   $ —         $ —         $ 54,287      $ 54,287   

 

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The table below presents the balances of assets measured at fair value as of December 31, 2011 (there are no material liabilities measured at fair value):

 

Description

   Quoted
Prices in
Active
Markets for
Identical
Asset
(Level  1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
    Total
Fair Value
 
     (in Thousands)  

Assets Measured at Fair Value on a Recurring Basis

          

Available-for-sale securities:

          

Collateralized mortgage obligations

   $ —         $ 324,450      $ 3,936     $ 328,386  

FNMA

     —           329,354        —          329,354  

FHLMC

     —           95,086        —          95,086  

GNMA

     —           63,967        —          63,967  

U.S. Government and agencies

     —           39,025        —          39,025  

State and political subdivisions

     —           4,190        —          4,190  

Reverse mortgages

     —           —           (646     (646

Trading Securities

     —           —           12,432       12,432  
  

 

 

    

 

 

    

 

 

   

 

 

 

Total assets measured at fair value on a recurring basis

   $ —         $ 856,072      $ 15,722     $ 871,794  

Assets Measured at Fair Value on a Nonrecurring Basis

          

Other real estate owned

   $ —         $ 11,695      $ —        $ 11,695  

Impaired Loans

     —           74,562        —          74,562  
  

 

 

    

 

 

    

 

 

   

 

 

 

Total assets measured at fair value on a nonrecurring basis

   $ —         $ 86,257      $ —        $ 86,257  

Fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models or obtained from third parties that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include unobservable parameters. Our valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While we believe our valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

Available- for-sale securities. As of September 30, 2012, securities classified as available for sale are reported at fair value using both Level 2 and Level 3 inputs. Included in the Level 2 total are approximately $51.0 million in Federal Agency debentures, $850.4 million in Federal Agency MBS, and $3.1 million in municipal bonds. Agency and MBS securities are predominately AAA-rated. We believe this Level 2 designation is appropriate for these securities under ASC 820-10 as, with almost all fixed income securities, none are exchange traded, and all are priced by correlation to observed market data. For these securities we obtain fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, U.S. government and agency yield curves, live trading levels, trade execution data, market consensus prepayment speeds, credit information, and the security’s terms and conditions, among other factors.

 

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Included in the Level 3 total is a small equity traunche of a reverse mortgage security purchased on July 15, 2011. This security is Level 3 because there is no active market for this security and no observable inputs that reflect quoted prices for identical assets in active markets (Level 1) or inputs other than quoted prices that are observable for the asset through corroboration with observable market data (Level 2). In order to establish the fair value for a Level 3 asset a “mark-to-model” has been developed using the income approach described in ASC 820-10-35-32 and is similar to the methodology used to value our trading securities described below.

The amount of our investment in reverse mortgages represents the estimated value of future cash flows of the reverse mortgages at a rate deemed appropriate for these mortgages, based on the market rate for similar collateral. The projected cash flows depend on assumptions about life expectancy of the mortgagor and the future changes in collateral values. Due to the significant amount of management judgment and the unobservable input calculations, these reverse mortgages have been classified as Level 3.

Trading securities. The amount included in the trading securities category represents the fair value of a BBB-rated traunche of a reverse mortgage security. There has never been an active market for these securities. As such, we classify these trading securities as Level 3 under ASC 820-10. As prescribed by ASC 820-10 management used various observable and unobservable inputs to develop a range of likely fair value prices where this security would be exchanged in an orderly transaction between market participants at the measurement date. The unobservable inputs reflect assumptions about the assumptions market participants would use in pricing this asset. Included in these inputs were the median of a selection of other BBB-rated securities as well as quoted market prices from higher rated traunches of this asset class. The unobservable inputs consist of prepayments, house price appreciation and interest rates. We have completed a sensitivity analysis at September 30, 2012, which showed any increase or decrease in these inputs would not have a significant impact on the fair value of these assets. As a result, the value assigned to this security is determined primarily through a discounted cash flow analysis. All of these assumptions require a significant degree of management judgment.

The changes in Level 3 assets measured at fair value on a recurring basis are summarized as follows:

 

     Trading
Securities
     Reverse
Mortgages
    Available-
for-sale
Securities
    Total  
(In Thousands)                          

Balance at December 31, 2010

   $ 12,432      $ (686   $ —        $ 11,746  

Total net (losses) income for the period included in net income

     —           (137     265       128  

Purchases, sales, issuances, and settlements, net

     —           177       2,755       2,932  

Mark-to-market adjustment

     —           —          916       916  
  

 

 

    

 

 

   

 

 

   

 

 

 

Balance at December 31, 2011

   $ 12,432      $ (646     3,936     $ 15,722  

Total net income (losses) for the period included in net income

     33        (29     —          4  

Purchases, sales, issuances, and settlements, net

     —           45       —          45  

Mark-to-market adjustment

     —           —          (436     (436
  

 

 

    

 

 

   

 

 

   

 

 

 

Balance at March 31, 2012

   $ 12,465      $ (630   $ 3,500     $ 15,335  

Total net losses for the period included in net income

     —           (47     —          (47

Purchases, sales, issuances, and settlements, net

     —           45       —          45  

Mark-to-market adjustment

     —           —          845       845  
  

 

 

    

 

 

   

 

 

   

 

 

 

Balance at June 30, 2012

   $ 12,465      $ (632   $ 4,345     $ 16,178  

Total net income for the period included in net income

     —           35       —          35  

Purchases, sales, issuances, and settlements, net

     —           45       —          45  

Mark-to-market adjustment

     125        —          1,705       1,830  
  

 

 

    

 

 

   

 

 

   

 

 

 

Balance at September 30, 2012

   $ 12,590      $ (552   $ 6,050     $ 18,088  
  

 

 

    

 

 

   

 

 

   

 

 

 

 

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Other real estate owned. Other real estate owned consists of loan collateral which has been repossessed through foreclosure or other measures. Initially, foreclosed assets are recorded as held for sale at the lower of the loan balance or fair value of the collateral less estimated selling costs. Subsequent to foreclosure, valuations are updated periodically and the assets may be marked down further, reflecting a new cost basis. The fair value of our real estate owned was estimated using Level 3 inputs based on appraisals obtained from third parties.

Impaired loans. We evaluate and value impaired loans at the time the loan is identified as impaired, and the fair values of such loans are estimated using Level 3 inputs in the fair value hierarchy. The collateral for each loan has a unique appraisal and our discount of the value is based on the factors unique to each impaired loan. The significant unobservable input in determining the fair value is our subjective discount on appraisals of the collateral securing the loan, which range from 10% - 50%. Collateral may consist of real estate and/or business assets including equipment, inventory and accounts receivable. The value of these assets is determined based on appraisals by qualified licensed appraisers hired by us. Appraised and reported values may be discounted based on our historical knowledge, changes in market conditions from the time of valuation, estimated costs to sell, and/or our expertise and knowledge of the client and the client’s business.

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a net amount of $47.3 million and $75.3 million at September 30, 2012 and December 31, 2011, respectively. The valuation allowance on impaired loans was $2.9 million as of September 30, 2012 and $4.7 million as of December 31, 2011.

Due to the continuing weakness in the real estate market, we now utilize a more significant level of unobservable inputs and, as such, have reclassified the hierarchical levels of both Other Real Estate Owned and Impaired Loans to Level 3 as of March 31, 2012.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The reported fair values of financial instruments are based on a variety of factors. In certain cases, fair values represent quoted market prices for identical or comparable instruments. In other cases, fair values have been estimated based on assumptions regarding the amount and timing of estimated future cash flows that are discounted to reflect current market rates and varying degrees of risk. Accordingly, fair values may not represent actual values of the financial instruments that could have been realized as of period-end or that will be realized in the future.

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

Cash and Short-Term Investments: For cash and short-term investments, including due from banks, federal funds sold, securities purchased under agreements to resell and interest-bearing deposits with other banks, the carrying amount is a reasonable estimate of fair value.

Investments and Mortgage-Backed Securities: Since quoted market prices are not available, fair value is estimated using quoted prices for similar securities, which we obtain from a third party vendor. We utilize one of the largest providers of securities pricing to the industry and we periodically assesses the inputs used by this vendor to price the various types of securities owned by us to validate the vendor’s methodology. The fair value of our investment in reverse mortgages is based on the net present value of estimated cash flows, which have been updated to reflect recent external appraisals of the underlying collateral. For additional discussion of our mortgage-backed securities-trading or our internally developed models, see Fair Value of Financial Assets, to the Consolidated Financial Statements.

Loans: Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type: commercial, commercial mortgages, construction, residential mortgages and consumer. For loans that reprice frequently, book value approximates fair value. The fair values of other types of loans are estimated by discounting expected cash flows using the current rates at which similar loans would be made to borrowers with comparable credit ratings and for similar remaining maturities. The fair value of nonperforming loans is based on recent external appraisals of the underlying collateral. Estimated cash flows, discounted using a rate commensurate with current rates and the risk associated with the estimated cash flows, are utilized if appraisals are not available. This technique does not contemplate an exit price.

Bank-Owned Life Insurance: The estimated fair value approximates the book value for this investment.

 

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Table of Contents

Stock in the Federal Home Loan Bank of Pittsburgh: The fair value of FHLB stock is assumed to be equal to its cost. We carry FHLB stock at cost, or par value, and evaluate FHLB stock for impairment based on the ultimate recoverability of par value rather than by recognizing temporary declines in value. As part of the impairment assessment of FHLB stock, management considers, among other things, (i) the significance and length of time of any declines in net assets of the FHLB compared to its capital stock, (ii) commitments by the FHLB to make payments required by law or regulations and the level of such payments in relation to its operating performance and (iii) the impact of legislative and regulatory changes on FHLB. The FHLB has access to the U.S. Government-Sponsored Enterprise Credit Facility, a secured lending facility that serves as a liquidity backstop, substantially reducing the likelihood that the FHLB would need to sell securities to raise liquidity and, thereby, cause the realization of large economic losses. On August 8, 2011, Standard & Poors (“S&P”) downgraded the FHLB from AAA to AA+, similar to their downgrade of the U.S. sovereign rating. The reduction in the FHLB credit rating was due to the belief, by S&P, that the FHLB system is certain to receive U.S. government support, if necessary, resulting from the important role the FHLB system plays as primary liquidity providers to U.S. mortgage and housing-market participants. Despite the downgrade, the FHLB continues to have a very high degree of government support and was in compliance with all regulatory capital requirements as of September 30, 2012. As a result, we have determined there was no OTTI related to our FHLB stock investment as of September 30, 2012.

Demand Deposits, Savings Deposits and Time Deposits: The fair value of demand deposits and savings deposits is determined by projecting future cash flows using an estimated economic life based on account characteristics. The resulting cash flow is discounted using rates available on alternative funding sources. The fair value of time deposits is estimated using the rate and maturity characteristics of the deposits to estimate their cash flow. The cash flow is discounted at rates for similar term wholesale funding.

Borrowed Funds: Rates currently available to us for debt with similar terms and remaining maturities are used to estimate fair value of existing debt.

Off-Balance Sheet Instruments: The fair value of off-balance sheet instruments, including commitments to extend credit and standby letters of credit, is estimated using the fees currently charged to enter into similar agreements with comparable remaining terms and reflects the present creditworthiness of the counterparties.

The book value and estimated fair value of our financial instruments are as follows:

 

     Fair Value    September 30, 2012      December 31, 2011  
     Measurement    Book Value      Fair Value      Book Value      Fair Value  
(In Thousands)