Note 5. Loans

The following table sets forth the composition of the loan portfolio at September 30, 2013 and December 31, 2012:


	September 30, 2013					December 31, 2012
(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		$	20,183,746		69.22%		$	18,595,833		68.18%
Commercial real estate			7,244,862		24.85			7,436,598		27.27
One-to-four family			490,829		1.68			203,435		0.75
Acquisition, development, and construction			403,160		1.38			397,917		1.46

Total mortgage loans held for investment			28,322,597		97.13			26,633,783		97.66

Other Loans:
Commercial and industrial⁽¹⁾			792,029		2.72			590,044		2.16
Other			43,246		0.15			49,880		0.18

Total other loans held for investment			835,275		2.87			639,924		2.34

Total non-covered loans held for investment		$	29,157,872		100.00%		$	27,273,707		100.00%

Net deferred loan origination costs			15,524					10,757
Allowance for losses on non-covered loans			(141,314)					(140,948)

Non-covered loans held for investment, net		$	29,032,082				$	27,143,516
Covered loans			2,898,803					3,284,061
Allowance for losses on covered loans			(69,897)					(51,311)

Total covered loans, net		$	2,828,906				$	3,232,750
Loans held for sale			281,289					1,204,370

Total loans, net		$	32,142,277				$	31,580,636

(1)	The balance at September 30, 2013 includes $46.2 million of lease financing, net of unearned income.

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.

The Company also originates acquisition, development, and construction (“ADC”) loans, one-to-four family loans, and commercial and industrial (“C&I”) loans for investment. ADC loans are primarily originated for multi-family and residential tract projects in New York City and on Long Island, while secured and unsecured in-market C&I loans are made to small and mid-size businesses in New York City, on Long Island, in New Jersey, and, to a lesser extent, in Arizona. In-market C&I loans are typically made for working capital, business expansion, and the purchase of machinery and equipment. In June 2013, the Company began the funding of asset-based, equipment lease financing, and dealer floor plan loans to nationally recognized borrowers throughout the U.S. All of these C&I loans are senior debt-secured.

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. Accordingly, borrowers are required to provide a guarantee of repayment and completion, and loan proceeds are disbursed as construction progresses, as certified by in-house or third-party engineers. 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 conservative 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 in-market 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 an in-market 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.

To minimize the risk involved in specialty finance C&I lending, the Company participates in broadly syndicated asset-based loans, equipment loan and lease financing, and dealer floor plan loans that are presented by an approved list of select, nationally recognized sources with whom it has established long-term funding relationships. The loans, which are secured by a perfected first security interest in the underlying collateral and structured as senior debt, are made to large corporate obligors, the majority of which are publicly traded, carry investment grade or near-investment grade ratings, participate in stable industries, and are located nationwide. To further minimize the risk involved in specialty finance lending, the Company re-underwrites each transaction; in addition, it retains outside counsel to conduct a further review of the underlying documentation.

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 economic weakness in its local markets as a result of higher 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 losses on non-covered loans. These events, if they were to occur, would have an adverse impact on the Company’s results of operations and its capital.

While the vast majority of the one-to-four family loans the Company holds for investment are loans that were acquired in merger transactions prior to 2009, the portfolio also includes hybrid jumbo one-to-four family loans that the Company has been originating for investment since 2012. Such loans feature conservative loan-to-value ratios and are made to borrowers with a strong record of repaying their debt.

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 in the nation. Community banks, credit unions, mortgage companies, and mortgage brokers use its proprietary web-accessible mortgage banking platform to originate and close one-to-four family loans throughout the U.S. These loans are generally sold, servicing retained, to GSEs. To a much lesser extent, the Community Bank uses its mortgage banking platform to originate fixed-rate jumbo loans under contract for sale to other financial institutions. Although the volume of jumbo loan originations has been insignificant to date, and the Company does not expect the origination of such loans to represent a material portion of the held-for-sale loans it produces, it decided to originate jumbo loans to complement its position in the residential loan origination marketplace. The Company also services mortgage loans for various third parties, primarily including those it sells to GSEs. The unpaid principal balance of serviced loans was $21.4 billion at September 30, 2013 and $17.6 billion at December 31, 2012.

Asset Quality

The following table presents information regarding the quality of the Company’s non-covered loans held for investment at September 30, 2013:


(in thousands)	Loans 30-89 Days Past Due			Non- Accrual Loans			Loans 90 Days or More Delinquent and Still Accruing Interest			Total Past Due Loans			Current Loans			Total Loans Receivable
Multi-family		$	3,141		$	69,016		$	--		$	72,157		$	20,111,589		$	20,183,746
Commercial real estate			4,409			34,475			--			38,884			7,205,978			7,244,862
One-to-four family			1,730			10,663			--			12,393			478,436			490,829
Acquisition, development, and construction			--			3,629			--			3,629			399,531			403,160
Commercial and industrial			--			5,197			--			5,197			786,832			792,029
Other			605			1,384			--			1,989			41,257			43,246

Total		$	9,885		$	124,364		$	--		$	134,249		$	29,023,623		$	29,157,872

The following table presents information regarding the quality of the Company’s non-covered loans held for investment at December 31, 2012:


(in thousands)	Loans 30-89 Days Past Due			Non- Accrual Loans			Loans 90 Days or More Delinquent and Still Accruing Interest			Total Past Due Loans			Current Loans			Total Loans Receivable
Multi-family		$	19,945		$	163,460		$	--		$	183,405		$	18,412,428		$	18,595,833
Commercial real estate			1,679			56,863			--			58,542			7,378,056			7,436,598
One-to-four family			2,645			10,945			--			13,590			189,845			203,435
Acquisition, development, and construction			1,178			12,091			--			13,269			384,648			397,917
Commercial and industrial			262			17,372			--			17,634			572,410			590,044
Other			1,876			599			--			2,475			47,405			49,880

Total		$	27,585		$	261,330		$	--		$	288,915		$	26,984,792		$	27,273,707

The following table summarizes the Company’s portfolio of non-covered held-for-investment loans by credit quality indicator at September 30, 2013:


(in thousands)	Multi-Family		Commercial Real Estate			One-to-Four Family			Acquisition, Development, and Construction			Total Mortgage Loans			Commercial and Industrial			Other			Total Other Loans
Credit Quality Indicator:
Pass		$20,001,264		$	7,168,850		$	484,618		$	396,764		$	28,051,496		$	773,544		$	41,863		$	815,407
Special mention		83,086			31,384			268			2,448			117,186			11,888			--			11,888
Substandard		94,964			44,128			5,943			3,948			148,983			6,428			1,383			7,811
Doubtful		4,432			500			--			--			4,932			169			--			169

Total		$20,183,746		$	7,244,862		$	490,829		$	403,160		$	28,322,597		$	792,029		$	43,246		$	835,275

The following table summarizes the Company’s portfolio of non-covered held-for-investment loans by credit quality indicator at December 31, 2012:


(in thousands)	Multi-Family		Commercial Real Estate			One-to-Four Family			Acquisition, Development, and Construction			Total Mortgage Loans			Commercial and Industrial			Other			Total Other Loans
Credit Quality Indicator:
Pass		$18,285,333		$	7,337,315		$	195,232		$	383,557		$	26,201,437		$	561,541		$	49,281		$	610,822
Special mention		55,280			26,523			294			--			82,097			10,211			--			10,211
Substandard		253,794			72,260			7,909			11,277			345,240			18,292			599			18,891
Doubtful		1,426			500			--			3,083			5,009			--			--			--

Total		$18,595,833		$	7,436,598		$	203,435		$	397,917		$	26,633,783		$	590,044		$	49,880		$	639,924

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 generally have been updated within the last twelve months.

Troubled Debt Restructurings

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.

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, 2013, loans on which concessions were made with respect to rate reductions and/or extension of maturity dates amounted to $74.7 million; loans on which forbearance agreements were reached amounted to $7.5 million.

The following table presents information regarding the Company’s TDRs as of September 30, 2013 and December 31, 2012:


	September 30, 2013						December 31, 2012
(in thousands)	Accruing		Non-Accrual		Total		Accruing		Non-Accrual		Total
Loan Category:
Multi-family		$10,558		$50,778		$61,336		$ 66,092		$114,556		$180,648
Commercial real estate		2,216		16,349		18,565		37,457		39,127		76,584
Acquisition, development, and construction		--		1,058		1,058		--		510		510
Commercial and industrial		1,248		--		1,248		1,463		--		1,463
One-to-four family		--		--		--		--		1,101		1,101

Total		$14,022		$68,185		$82,207		$105,012		$155,294		$260,306

The $55.5 million decline in accruing multi-family loans noted in the preceding table was due to a $49.6 million loan that was transferred to non-accrual in the second quarter of 2013. The $35.2 million decline in accruing CRE loans noted in the preceding table was due to the pay-off of a single CRE loan in the first quarter of 2013.

The $63.8 million decline in non-accrual multi-family loans primarily reflects two loan relationships totaling $50.6 million that were repaid during the second and third quarters of 2013, and a $41.6 million transfer to other real estate owned during the first quarter of 2013. These decreases were partially offset by the aforementioned $49.6 million loan that was transferred from accruing TDR to non-accrual TDR. The $22.8 million decline in non-accrual CRE loans was primarily due to the pay-off of a $22.0 million loan relationship during the second quarter of 2013.

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.

In the nine months ended September 30, 2013, the Company classified two CRE loans and one ADC loan totaling $2.8 million as non-accrual TDRs. While other concessions were granted to the borrowers, the interest rates on the loans were maintained. As a result, these TDRs did not have a financial impact on the Company’s results of operations.

During the nine months ended September 30, 2013, 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. However, the Company does consider a loan with multiple modifications or forbearance periods to be in default, and would also consider a loan to be in default if it were in bankruptcy or was partially charged off subsequent to modification.

Covered Loans

The following table presents the carrying value of covered loans acquired in the AmTrust and Desert Hills acquisitions as of September 30, 2013:


(dollars in thousands)	Amount			Percent of Covered Loans
Loan Category:
One-to-four family		$	2,631,042		90.8%
All other loans			267,761		9.2

Total covered loans		$	2,898,803		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, 2013 and December 31, 2012, the unpaid principal balances of covered loans were $3.5 billion and $3.9 billion, respectively. The carrying values of such loans were $2.9 billion and $3.3 billion, respectively, at the corresponding dates.

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 amount by which the undiscounted contractual cash flows exceed 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 respective acquisition dates.

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 for the nine months ended September 30, 2013 were as follows:


(in thousands)	Accretable Yield
Balance at beginning of period		$1,201,172
Reclassification to non-accretable difference		(166,560)
Accretion		(118,522)

Balance at end of period		$ 916,090

In the preceding table, the line item “reclassification to non-accretable difference” includes changes in cash flows that the Company expects to collect due to changes in prepayment assumptions, changes in interest rates on variable loans, and changes in loss assumptions. As of the Company’s most recent periodic evaluation, prepayment assumptions increased and, accordingly, future expected interest cash flows decreased. In addition, coupon rates on variable rate loans reset lower which also resulted in a decrease in future expected interest cash flows. These two decreases caused a reduction in the accretable yield. Partially offsetting the effect of these decreases was an improvement in underlying credit assumptions. As the underlying credit assumptions improved, the projected loss assumptions on defaulting loans decreased, which, in turn, resulted in an increase in accretable yield.

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 and OREO 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 lower than the acquisition-date estimates, the FDIC loss share receivable will be reduced.

The following table presents information regarding the Company’s covered loans that were 90 days or more past due at September 30, 2013 and December 31, 2012:


(in thousands)	September 30, 2013		December 31, 2012
Covered Loans 90 Days or More Past Due:
One-to-four family		$227,758		$297,265
Other loans		10,817		15,308

Total covered loans 90 days or more past due		$238,575		$312,573

The following table presents information regarding the Company’s covered loans that were 30 to 89 days past due at September 30, 2013 and December 31, 2012:


(in thousands)	September 30, 2013		December 31, 2012
Covered Loans 30-89 Days Past Due:
One-to-four family		$48,039		$75,129
Other loans		4,432		6,057

Total covered loans 30-89 days past due		$52,471		$81,186

At September 30, 2013, the Company had $52.5 million of covered loans that were 30 to 89 days past due, and covered loans of $238.6 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 $2.6 billion at September 30, 2013 and was considered current at 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.

Loans that may have been classified as non-performing loans by AmTrust or Desert Hills were 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 (i.e., 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 such 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 $9.5 million and $18.6 million, respectively, in the three and nine months ended September 30, 2013. These provisions were largely due to credit deterioration in the acquired portfolios of one-to-four family and home equity loans, and were largely offset by FDIC indemnification income of $7.6 million and $14.9 million, respectively, recorded in non-interest income for the three and nine months ended September 30, 2013.