Note 4. Loans

The following table sets forth the composition of the loan portfolio at September 30, 2012 and December 31, 2011:


	September 30, 2012				December 31, 2011
(dollars in thousands)	Amount		Percent of Non-Covered Loans Held for Investment		Amount		Percent of Non-Covered Loans Held for Investment
Non-Covered Loans Held for Investment:
Mortgage Loans:
Multi-family		$18,468,229		68.88%		$17,430,628		68.28%
Commercial real estate		7,193,194		26.83		6,855,244		26.85
Acquisition, development, and construction		383,695		1.43		445,671		1.75
One-to-four family		131,115		0.49		127,361		0.50

Total mortgage loans held for investment		26,176,233		97.63		$24,858,904		97.38

Other Loans:
Commercial and industrial		582,572		2.17		599,986		2.35
Other		54,256		0.20		69,907		0.27

Total other loans held for investment		636,828		2.37		669,893		2.62

Total non-covered loans held for investment		26,813,061		100.00%		$25,528,797		100.00%

Net deferred loan origination costs		9,789				4,021
Allowance for losses on non-covered loans		(139,015)				(137,290)

Non-covered loans held for investment, net		26,683,835				$25,395,528
Covered loans		3,400,624				3,753,031
Allowance for losses on covered loans		(54,591)				(33,323)

Total covered loans, net		3,346,033				$ 3,719,708
Loans held for sale		1,211,767				1,036,918

Total loans, net		$31,241,635				$30,152,154

Non-Covered Loans

Non-Covered Loans Held for Investment

The vast majority of the loans the Company originates for investment are multi-family loans, most of which are collateralized by non-luxury apartment buildings in New York City that feature below-market rents. In addition, the Company originates commercial real estate (“CRE”) loans, most of which are collateralized by properties located in New York City and, to a lesser extent, on Long Island and in New Jersey.

To a lesser extent, the Company also originates acquisition, development, and construction (“ADC”) loans and commercial and industrial (“C&I”) loans. ADC loans are primarily originated for multi-family and residential tract projects in New York City and on Long Island, while C&I loans are made on both a secured and unsecured basis, to small and mid-size businesses in New York City, Long Island, New Jersey, and, to a lesser extent, Arizona, for working capital, business expansion, and the purchase of machinery and equipment.

Payments on multi-family and CRE loans generally depend on the income produced by the underlying properties which, in turn, depends on their successful operation and management. Accordingly, the ability of the Company’s borrowers to repay these loans may be impacted by adverse conditions in the local real estate market and the local economy. While the Company generally requires that such loans be qualified on the basis of the collateral property’s current cash flows, appraised value, and debt service coverage ratio, among other factors, there can be no assurance that its underwriting policies will protect the Company from credit-related losses or delinquencies.

ADC loans typically involve a higher degree of credit risk than loans secured by improved or owner-occupied real estate. The risk of loss on an ADC loan is largely dependent upon the accuracy of the initial appraisal of the property’s value upon completion of construction or development; the estimated cost of construction, including interest; and the estimated time to complete and/or sell or lease such property. The Company seeks to minimize these risks by maintaining consistent lending policies and rigorous underwriting standards. However, if the estimate of value proves to be inaccurate, the cost of completion is greater than expected, the length of time to complete and/or sell or lease the collateral property is greater than anticipated, or if there is a downturn in the local economy or real estate market, the property could have a value upon completion that is insufficient to assure full repayment of the loan. This could have a material adverse effect on the quality of the ADC loan portfolio, and could result in significant losses or delinquencies.

The Company seeks to minimize the risks involved in C&I lending by underwriting such loans on the basis of the cash flows produced by the business; by requiring that such loans be collateralized by various business assets, including inventory, equipment, and accounts receivable, among others; and by requiring personal guarantees. However, the capacity of a borrower to repay a C&I loan is substantially dependent on the degree to which his or her business is successful. In addition, the collateral underlying such loans may depreciate over time, may not be conducive to appraisal, or may fluctuate in value, based upon the results of operations of the business.

The ability of the Company’s borrowers to repay their loans, and the value of the collateral securing such loans, could be adversely impacted by continued or more significant economic weakness in its local markets as a result of increased unemployment, declining real estate values, or increased residential and office vacancies. This not only could result in the Company experiencing an increase in charge-offs and/or non-performing assets, but also could necessitate an increase in the provision for loan losses. These events, if they were to occur, would have an adverse impact on the Company’s results of operations and its capital.

Loans Held for Sale

The Community Bank’s mortgage banking operation is one of the largest aggregators of one-to-four family loans for sale to GSEs in the nation. Community banks, credit unions, mortgage companies, and mortgage brokers use the subsidiary’s proprietary web-accessible mortgage banking platform to originate and close one-to-four family loans in all 50 states. The Company sells these loans, primarily servicing retained.

Prior to December 2010, the Company would originate one-to-four family loans for its customers in its branches and on its website on a pass-through, or conduit, basis, and would sell the loans to the third-party conduit shortly after they closed. Since then, the Company had been originating one-to-four family loans through its mortgage banking operation, directly and indirectly, rather than through the single third-party conduit with which it previously worked. The vast majority of the one-to-four family loans produced for the Company’s customers are aggregated with loans produced by its mortgage banking clients throughout the nation, and then sold.

The Company also services mortgage loans for various third parties. At September 30, 2012, the unpaid principal balance of serviced loans amounted to $16.6 billion. At December 31, 2011, the unpaid principal balance of loans serviced for others amounted to $13.1 billion.

Asset Quality

The following table presents information regarding the quality of the Company’s non-covered loans held for investment at September 30, 2012:


(in thousands)	30-89 Days Past Due			Non- Accrual			90 Days or More Delinquent and Still Accruing Interest			Total Past Due			Current			Total Loans Receivable
Multi-family		$	33,644		$	139,293		$	--		$	172,937		$	18,295,292		$	18,468,229
Commercial real estate			4,631			54,641			--			59,272			7,133,922			7,193,194
Acquisition, development, and construction			--			24,813			--			24,813			358,882			383,695
One-to-four family			3,563			9,487			--			13,050			118,065			131,115
Commercial and industrial			5,831			17,342			--			23,173			559,399			582,572
Other			1,233			992			--			2,225			52,031			54,256

Total		$	48,902		$	246,568		$	--		$	295,470		$	26,517,591		$	26,813,061

The following table presents information regarding the quality of the Company’s non-covered loans held for investment at December 31, 2011:


(in thousands)	30-89 Days Past Due			Non- Accrual			90 Days or More Delinquent and Still Accruing Interest			Total Past Due			Current			Total Loans Receivable
Multi-family		$	46,702		$	205,064		$	--		$	251,766		$	17,178,862		$	17,430,628
Commercial real estate			53,798			68,032			--			121,830			6,733,414			6,855,244
Acquisition, development, and construction			6,520			29,886			--			36,406			409,265			445,671
One-to-four family			2,712			11,907			--			14,619			112,742			127,361
Commercial and industrial			1,223			8,827			--			10,050			589,936			599,986
Other			702			2,099			--			2,801			67,106			69,907

Total		$	111,657		$	325,815		$	--		$	437,472		$	25,091,325		$	25,528,797

The following table summarizes the Company’s non-covered loan portfolio by credit quality indicator at September 30, 2012:


(in thousands)	Multi-Family		Commercial Real Estate			Acquisition, Development, and Construction			One-to-Four Family			Total Mortgage Segment			Commercial and Industrial			Other			Total Other Loan Segment
Credit Quality Indicator:
Pass		$18,170,382		$	7,089,632		$	350,651		$	124,100		$	25,734,765		$	540,616		$	53,263		$	593,879
Special mention		54,093			31,223			5,900			301			91,517			19,772			--			19,772
Substandard		242,263			72,339			24,061			6,714			345,377			22,184			993			23,177
Doubtful		1,491			--			3,083			--			4,574			--			--			--

Total		$18,468,229		$	7,193,194		$	383,695		$	131,115		$	26,176,233		$	582,572		$	54,256		$	636,828

The following table summarizes the Company’s non-covered loan portfolio by credit quality indicator at December 31, 2011:


(in thousands)	Multi-Family		Commercial Real Estate			Acquisition, Development, and Construction			One-to-Four Family			Total Mortgage Segment			Commercial and Industrial			Other			Total Other Loan Segment
Credit Quality Indicator:
Pass		$17,135,461		$	6,704,824		$	399,811		$	118,293		$	24,358,389		$	570,442		$	67,808		$	638,250
Special mention		58,134			64,802			6,489			--			129,425			13,234			--			13,234
Substandard		237,033			85,618			39,371			9,068			371,090			15,928			2,099			18,027
Doubtful		--			--			--			--			--			382			--			382

Total		$17,430,628		$	6,855,244		$	445,671		$	127,361		$	24,858,904		$	599,986		$	69,907		$	669,893

The preceding classifications follow regulatory guidelines and can be generally described as follows: pass loans are of satisfactory quality; special mention loans have a potential weakness or risk that may result in the deterioration of future repayment; substandard loans are inadequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged (these loans have a well-defined weakness and there is a distinct possibility that the Company will sustain some loss); and doubtful loans, based on existing circumstances, have weaknesses that make collection or liquidation in full highly questionable and improbable. In addition, one-to-four family residential loans are classified utilizing an inter-regulatory agency methodology that incorporates the extent of delinquency and the loan-to-value ratios. These classifications are the most current available and have been generally updated within the last twelve months.

Troubled Debt Restructurings

In accordance with GAAP, the Company is required to account for certain held-for-investment loan modifications or restructurings as Troubled Debt Restructurings (“TDRs”). In general, a modification or restructuring of a loan constitutes a TDR if the Company grants a concession to a borrower experiencing financial difficulty. Loans modified as TDRs are placed on non-accrual status until the Company determines that future collection of principal and interest is reasonably assured, which generally requires that the borrower demonstrate performance according to the restructured terms for a period of at least six consecutive months.

The following table presents information regarding the Company’s TDRs as of September 30, 2012 and December 31, 2011:


	September 30, 2012						December 31, 2011
(in thousands)	Accruing		Non-Accrual		Total		Accruing		Non-Accrual		Total
Loan Category:
Multi-family		$74,825		$117,683		$192,508		$60,454		$166,248		$226,702
Commercial real estate		37,473		39,881		77,354		3,389		39,054		42,443
Acquisition, development, and construction		--		11,734		11,734		--		15,886		15,886
Commercial and industrial		1,523		--		1,523		--		667		667
One-to-four family		--		1,101		1,101		--		1,411		1,411

Total		$113,821		$170,399		$284,220		$63,843		$223,266		$287,109

In an effort to proactively manage delinquent loans, the Company has selectively extended to certain borrowers concessions such as rate reductions, extension of maturity dates, and forbearance agreements. As of September 30, 2012, loans on which concessions were made with respect to rate reductions and/or extension of maturity dates amounted to $252.9 million and loans on which forbearance agreements were reached amounted to $31.3 million.

The eligibility of a borrower for work-out concessions of any nature depends upon the facts and circumstances of each transaction, which may change from period to period, and involve judgment by Company personnel regarding the likelihood that the concession will result in the maximum recovery for the Company.

The financial effects of TDRs granted in the three and nine months ended September 30, 2012 were as follows:


	Financial Effect of Modifications
	For the Three Months Ended September 30, 2012											For the Nine Months Ended September 30, 2012
	Weighted Average Interest Rate											Weighted Average Interest Rate
(dollars in thousands)	Number of Loans		Pre- Modification			Post- Modification			Charge-off Amount			Number of Loans		Pre- Modification			Post- Modification			Charge-off Amount
Loan Category:
Multi-family		--		--	%		--	%		$	--		4		6.19	%		5.34	%		$	188
Commercial real estate		--		--			--				--		3		6.30			4.50				--
Acquisition, development, and construction		--		--			--				--		--		--			--				--
Other		--		--			--				--		--		--			--				--

Total/average		--		--	%		--	%		$	--		7		6.28	%		4.71	%		$	188

As of September 30, 2012, there were no payment defaults on any loans that had been modified as TDRs during the preceding twelve months. A loan is considered to be in payment default once it is 30 days contractually past due under the modified terms.

The Company does not consider a payment to be in default when the loan is in forbearance, or otherwise granted a delay of payment, when the agreement to forebear or allow a delay of payment is part of a modification. Subsequent to the modification, the loan is not considered to be in default until payment is contractually past due in accordance with the modified terms. In addition, the Company does consider a loan with multiple modifications of forbearance periods to be in default.

Covered Loans

The following table presents the balance of covered loans acquired in the AmTrust and Desert Hills acquisitions as of September 30, 2012:


(dollars in thousands)	Amount			Percent of Covered Loans
Loan Category:
One-to-four family		$	3,069,827		90.3%
All other loans			330,797		9.7

Total covered loans		$	3,400,624		100.0%

The Company refers to the loans acquired in the AmTrust and Desert Hills acquisitions as “covered loans” because the Company is being reimbursed for a substantial portion of losses on these loans under the terms of the FDIC loss sharing agreements. Covered loans are accounted for under Accounting Standards Codification (“ASC”) Topic 310-30, “Loans and Debt Securities Acquired with Deteriorated Credit Quality” (“ASC 310-30”), and initially measured at fair value, which includes estimated future credit losses expected to be incurred over the lives of the loans. Under ASC 310-30, purchasers are permitted to aggregate acquired loans into one or more pools, provided that the loans have common risk characteristics. A pool is then accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows.

At September 30, 2012 and December 31, 2011, the outstanding balances of covered loans (representing amounts owed to the Company) were $4.1 billion and $4.5 billion, respectively. The carrying values of such loans were $3.4 billion and $3.8 billion, respectively, at September 30, 2012 and December 31, 2011.

At the respective acquisition dates, the Company estimated the fair values of the AmTrust and Desert Hills loan portfolios, which represented the expected cash flows from the portfolios discounted at market-based rates. In estimating such fair value, the Company (a) calculated the contractual amount and timing of undiscounted principal and interest payments (the “undiscounted contractual cash flows”); and (b) estimated the expected amount and timing of undiscounted principal and interest payments (the “undiscounted expected cash flows”). The amount by which the undiscounted expected cash flows exceed the estimated fair value (the “accretable yield”) is accreted into interest income over the lives of the loans. The difference between the undiscounted contractual cash flows and the undiscounted expected cash flows is referred to as the “non-accretable difference.” The non-accretable difference represents an estimate of the credit risk in the loan portfolios at the acquisition date.

The accretable yield is affected by changes in interest rate indices for variable rate loans, changes in prepayment assumptions, and changes in expected principal and interest payments over the estimated lives of the loans. Changes in interest rate indices for variable rate loans increase or decrease the amount of interest income expected to be collected, depending on the direction of interest rates. Prepayments affect the estimated lives of covered loans and could change the amount of interest income and principal expected to be collected. Changes in expected principal and interest payments over the estimated lives of covered loans are driven by the credit outlook and actions that may be taken with borrowers.

The Company periodically evaluates the estimates of the cash flows it expects to collect. Expected future cash flows from interest payments are based on variable rates at the time of the periodic evaluation. Estimates of expected cash flows that are impacted by changes in interest rate indices for variable rate loans and prepayment assumptions are treated as prospective yield adjustments and included in interest income.

Changes in the accretable yield for covered loans were as follows for the nine months ended September 30, 2012:


(in thousands)	Accretable Yield
Balance at beginning of period		$1,365,978
Reclassification to non-accretable difference		(172,775)
Accretion		(135,531)

Balance at end of period		$1,057,672

The line item in the preceding table titled “reclassification to non-accretable difference” includes changes in cash flows the Company expects to collect due to changes in prepayment assumptions and changes in interest rates on variable rate loans. As of the Company’s last periodic evaluation, prepayment assumptions increased and, accordingly, future expected interest cash flows decreased. This resulted in a decrease in the accretable yield. In addition, these decreases were coupled with additional reductions in the expected cash flows from interest payments, as interest rates continued to be very low. As a result, a large percentage of the Company’s covered variable rate loans continue to reset at lower interest rates. Partially offsetting these decreases were increases in the expected principal and interest payments driven by better expectations relating to credit.

In connection with the AmTrust and Desert Hills transactions, the Company has acquired other real estate owned (“OREO”), all of which is covered under FDIC loss sharing agreements. Covered OREO is initially recorded at its estimated fair value on the acquisition date, based on independent appraisals less the estimated selling costs. Any subsequent write-downs due to declines in fair value are charged to non-interest expense, and partially offset by loss reimbursements under the FDIC loss sharing agreements. Any recoveries of previous write-downs are credited to non-interest expense and partially offset by the portion of the recovery that is due to the FDIC.

The FDIC loss share receivable represents the present value of the estimated losses on covered loans to be reimbursed by the FDIC. The estimated losses were based on the same cash flow estimates used in determining the fair value of the covered loans. The FDIC loss share receivable is reduced as losses on covered loans are recognized and as loss sharing payments are received from the FDIC. Realized losses in excess of acquisition-date estimates will result in an increase in the FDIC loss share receivable. Conversely, if realized losses are less than the acquisition-date estimates, the FDIC loss share receivable will be reduced.

The following table presents information regarding the Company’s covered loans 90 days or more past due at September 30, 2012 and December 31, 2011:


(in thousands)	September 30, 2012		December 31, 2011
Covered Loans 90 Days or More Past Due:
One-to-four family		$297,293		$314,821
Other loans		19,844		32,621

Total covered loans 90 days or more past due		$317,137		$347,442

The following table presents information regarding the Company’s covered loans that were 30 to 89 days past due at September 30, 2012 and December 31, 2011:


(in thousands)	September 30, 2012		December 31, 2011
Covered Loans 30-89 Days Past Due:
One-to-four family		$84,471		$103,495
Other loans		7,449		8,494

Total covered loans 30-89 days past due		$91,920		$111,989

At September 30, 2012, the Company had $91.9 million of covered loans that were 30 to 89 days past due, and covered loans of $317.1 million that were 90 days or more past due but considered to be performing due to the application of the yield accretion method under ASC 310-30. The remaining portion of the Company’s covered loan portfolio totaled $3.0 billion at September 30, 2012 and was considered current as of that date. ASC 310-30 allows the Company to aggregate credit-impaired loans acquired in the same fiscal quarter into one or more pools, provided that the loans have common risk characteristics. A pool is then accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows. Accordingly, loans that may have been classified as non-performing loans by AmTrust or Desert Hills are no longer classified as non-performing because, at the respective dates of acquisition, the Company believed that it would fully collect the new carrying value of these loans. The new carrying value represents the contractual balance, reduced by the portion that is expected to be uncollectible (referred to as the “non-accretable difference”) and by an accretable yield (discount) that is recognized as interest income. It is important to note that management’s judgment is required in reclassifying loans subject to ASC 310-30 as performing loans, and its judgment is dependent on having a reasonable expectation about the timing and amount of the cash flows to be collected, even if the loan is contractually past due.

The primary credit quality indicator for covered loans is the expectation of underlying cash flows. The Company recorded provisions for losses on covered loans of $2.8 million and $21.3 million, respectively, during the three and nine months ended September 30, 2012. These provisions were largely due to credit deterioration in the acquired portfolios of one-to-four family and home equity loans. The provisions for losses on covered loans were largely offset by FDIC indemnification income of $2.3 million and $17.0 million, respectively, recorded in non-interest income for the three and nine months ended September 30, 2012.