10-K 1 f10k_030817p.htm FORM 10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2016

 

Commission file number 001-33013

 

FLUSHING FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

 

Delaware

(State or other jurisdiction of incorporation or organization)

11-3209278

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

 

220 RXR Plaza, Uniondale, New York 11556

(Address of principal executive offices)

 

(718) 961-5400

(Registrant’s telephone number, including area code)

 

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

 

Common Stock $0.01 par value (and

associated Preferred Stock Purchase Rights)

(Title of each class)

NASDAQ Global Select Market

(Name of exchange on which registered)

 

Securities registered pursuant to Section 12(g) of the Act: None.

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in rule 405 of the Securities Act. __Yes  X No

 

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

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  X Yes  __No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  X Yes  __No

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [  ]

 

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

 

Large accelerated filer ___

Non-accelerated filer ___

Accelerated filer X

Smaller reporting company __

 

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

 

As of June 30, 2016, the last business day of the registrant’s most recently completed second fiscal quarter; the aggregate market value of the voting stock held by non-affiliates of the registrant was $542,576,000. This figure is based on the closing price on that date on the NASDAQ Global Select Market for a share of the registrant’s Common Stock, $0.01 par value, which was $19.88.

 

The number of shares of the registrant’s Common Stock outstanding as of February 28, 2017 was 28,810,855 shares.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Company’s definitive Proxy Statement for the Annual Meeting of Stockholders to be held on May 31, 2017 are incorporated herein by reference in Part III.

 

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TABLE OF CONTENTS

Page

PART I
Item 1.  Business. 1
GENERAL
Overview 1
Market Area and Competition 3
Lending Activities 4
Loan Portfolio Composition 4
Loan Maturity and Repricing 7
Multi-Family Residential Lending 8
Commercial Real Estate Lending 8
One-to-Four Family Mortgage Lending – Mixed-Use Properties 9
One-to-Four Family Mortgage Lending – Residential Properties 9
Construction Loans 10
Small Business Administration Lending 11
Taxi medallion 11
Commercial Business and Other Lending 11
Loan Extensions, Renewals, Modifications and Restructuring 12
Loan Approval Procedures and Authority 12
Loan Concentrations 13
Loan Servicing 13
Asset Quality 13
Loan Collection 13
Troubled Debt Restructured 14
Delinquent Loans and Non-performing Assets 15
Other Real Estate Owned 16
Environmental Concerns Relating to Loans 16
Classified Assets 16
Allowance for Loan Losses 19
Investment Activities 23
General 23
Mortgage-backed securities 24
Sources of Funds 27
General 27
Deposits 27
Borrowings 31
Subsidiary Activities 32
Personnel 33
Omnibus Incentive Plan 33
FEDERAL, STATE AND LOCAL TAXATION
Federal Taxation 33
General 33
Bad Debt Reserves 33
   

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Distributions 33
Corporate Alternative Minimum Tax 34
State and Local Taxation 34
New York State and New York City Taxation 34
New Jersey State Taxation 34
Delaware State Taxation 34
REGULATION
General 35
The Dodd - Frank Act 35
Basel III 36
Volcker Rule 36
New York State Law 37
FDIC Regulation 38
Transactions with Affiliates 41
Community Reinvestment Act 41
Federal Reserve System 42
Federal Home Loan Bank System 42
Holding Company Regulations 42
Acquisition of the Holding Company 43
Consumer Financial Protection Bureau 43
Mortgage Banking and Related Consumer Protection Regulations 43
Available Information 44
Item 1A.  Risk Factors 44
Changes in Interest, Including the Potential for Negative Interest Rates, May Significantly Impact Our Financial Condition and Results of Operations 45
Our Lending Activities Involve Risks that May Be Exacerbated Depending on the Mix of Loan Types 45
Failure to Effectively Manage Our Liquidity Could Significantly Impact Our Financial Condition and Results of Operations 46
Our Ability to Obtain Brokered Deposits as an Additional Funding Source Could be Limited 46
The Markets in Which We Operate Are Highly Competitive 47
Our Results of Operations May Be Adversely Affected by Changes in National and/or Local Economic Conditions 47
Changes in Laws and Regulations Could Adversely Affect Our Business 47
Current Conditions in, and Regulation of, the Banking Industry May Have a Material Adverse Effect on Our Results of Operations 48
The FDIC’s Adopted Restoration Plan and the Related Increased Assessment Rate Schedule May Have a Material Effect on Our Results of Operations 49
A Failure in or Breach of Our Operational or Security Systems or Infrastructure, or Those of Our Third Party Vendors and Other Service Providers, Including as a Result of Cyber Attacks, could Disrupt Our Business, Result in the Disclosure or Misuse of Confidential or Proprietary Information, Damage Our Reputation, Increase Our Costs and Cause Losses 50
We May Experience Increased Delays in Foreclosure Proceedings 51
We May Need to Recognize Other-Than-Temporary Impairment Charges in the Future 51
Our Inability to Hire or Retain Key Personnel Could Adversely Affect Our Business. 51
We Are Not Required to Pay Dividends on Our Common Stock. 51
   

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Goodwill Recorded as a Result of Acquisitions Could Become Impaired, Negatively Impacting Our Earnings and Capital 52
We May Not Fully Realize the Expected Benefit of Our Deferred Tax Assets 52
Item 1B.  Unresolved Staff Comments 52
Item 2.  Properties 52
Item 3.  Legal Proceedings 52
Item 4.  Mine Safety Disclosures 52
PART II
Item 5.  Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 53
Stock Performance Graph 55
Item 6.  Selected Financial Data 56
Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations 58
General 58
Overview 58
Management Strategy 59
Trends and Contingencies 61
Interest Rate Sensitivity Analysis 63
Interest Rate Risk 64
Analysis of Net Interest Income 65
Rate/Volume Analysis 67
Comparison of Operating Results for the Years Ended December 31, 2016 and 2015 67
Comparison of Operating Results for the Years Ended December 31, 2015 and 2014 69
Liquidity, Regulatory Capital and Capital Resources 71
Critical Accounting Policies 73
Contractual Obligations 74
Item 7A.  Quantitative and Qualitative Disclosures About Market Risk 75
Item 8.  Financial Statements and Supplementary Data 76
Item 9.  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 144
Item 9A.  Controls and Procedures 144
Item 9B.  Other Information 144
PART III
Item 10.  Directors, Executive Officers and Corporate Governance 145
Item 11.  Executive Compensation 145
Item 12.  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 145
Item 13.  Certain Relationships and Related Transactions, and Director Independence 145
Item 14.  Principal Accounting Fees and Services 145
PART IV
Item 15.  Exhibits, Financial Statement Schedules 146
(a)  1.  Financial Statements 146
(a)  2.  Financial Statement Schedules 146
(a)  3.  Exhibits Required by Securities and Exchange Commission Regulation S-K 147
SIGNATURES
POWER OF ATTORNEY

 

 iv

 

CAUTIONARY NOTE REGARDING FORWARD LOOKING STATEMENTS

 

Statements contained in this Annual Report on Form 10-K (this “Annual Report”) relating to plans, strategies, economic performance and trends, projections of results of specific activities or investments and other statements that are not descriptions of historical facts may be forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking information is inherently subject to risks and uncertainties, and actual results could differ materially from those currently anticipated due to a number of factors, which include, but are not limited to, factors discussed under the captions “Business — General — Allowance for Loan Losses” and “Business — General — Market Area and Competition” in Item 1 below, “Risk Factors” in Item 1A below, in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Overview” in Item 7 below, and elsewhere in this Annual Report and in other documents filed by the Company with the Securities and Exchange Commission from time to time. Forward-looking statements may be identified by terms such as “may,” “will,” “should,” “could,” “expects,” “plans,” “intends,” “anticipates,” “believes,” “estimates,” “predicts,” “forecasts,” “potential” or “continue” or similar terms or the negative of these terms. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We have no obligation to update these forward-looking statements.

 

PART I

 

As used in this Annual Report on Form 10-K, the words “we,” “us,” “our” and the “Company” are used to refer to Flushing Financial Corporation and our consolidated subsidiaries, including the surviving entity of the merger (the “Merger”) on February 28, 2013 of our wholly owned subsidiary, Flushing Savings Bank, FSB (the “Savings Bank”) with and into Flushing Commercial Bank (the “Commercial Bank”). The surviving entity of the Merger was the Commercial Bank, whose name has been changed to “Flushing Bank.” References herein to the “Bank” mean the Savings Bank (including its wholly owned subsidiary, the Commercial Bank) prior to the Merger and the surviving entity after the Merger.

 

 

Item 1. Business.

 

GENERAL

 

Overview

 

We are a Delaware corporation organized in May 1994. The Bank was organized in 1929 as a New York State-chartered mutual savings bank. In 1994, the Bank converted to a federally chartered mutual savings bank and changed its name from Flushing Savings Bank to Flushing Savings Bank, FSB. The Bank converted from a federally chartered mutual savings bank to a federally chartered stock savings bank on November 21, 1995, at which time Flushing Financial Corporation acquired all of the stock of the Savings Bank. On February 28, 2013, the Savings Bank merged with and into the Commercial Bank, with the Commercial Bank as the surviving entity. Pursuant to the Merger, the Commercial Bank’s charter was changed to a full-service New York State commercial bank charter, and its name was changed to Flushing Bank. Also in connection with the Merger, Flushing Financial Corporation became a bank holding company. We have not made any significant changes to our operations or services as a result of the Merger. The primary business of Flushing Financial Corporation has been the operation of the Bank. The Bank owns three subsidiaries: Flushing Preferred Funding Corporation, Flushing Service Corporation, and FSB Properties Inc. The Bank has an internet branch, iGObanking.com®. The activities of Flushing Financial Corporation are primarily funded by dividends, if any, received from the Bank, issuances of junior subordinated debt, and issuances of equity securities. Flushing Financial Corporation’s common stock is traded on the NASDAQ Global Select Market under the symbol “FFIC.”

 

Flushing Financial Corporation also owns Flushing Financial Capital Trust II, Flushing Financial Capital Trust III, and Flushing Financial Capital Trust IV (the “Trusts”), which are special purpose business trusts formed to issue a total of $60.0 million of capital securities and $1.9 million of common securities (which are the only voting securities). Flushing Financial Corporation owns 100% of the common securities of the Trusts. The Trusts used the proceeds from the issuance of these securities to purchase junior subordinated debentures from Flushing Financial Corporation. The Trusts are not included in our consolidated financial statements as we would not absorb the losses of the Trusts if losses were to occur.

 

Unless otherwise disclosed, the information presented in this Annual Report reflects the financial condition and results of operations of Flushing Financial Corporation, the Bank and the Bank’s subsidiaries on a consolidated basis (collectively, the “Company”). Management views the Company as operating a single unit – a community bank. Therefore, segment information is not provided. At December 31, 2016, the Company had total assets of $6.1 billion, deposits of $4.2 billion and stockholders’ equity of $513.9 million.

 

1
 

Our principal business is attracting retail deposits from the general public and investing those deposits together with funds generated from ongoing operations and borrowings, primarily in (1) originations and purchases of multi-family residential properties, commercial business loans, commercial real estate mortgage loans and, to a lesser extent, one-to-four family (focusing on mixed-use properties, which are properties that contain both residential dwelling units and commercial units); (2) construction loans, primarily for residential properties; (3) Small Business Administration (“SBA”) loans and other small business loans; (4) mortgage loan surrogates such as mortgage-backed securities; and (5) U.S. government securities, corporate fixed-income securities and other marketable securities. We also originate certain other consumer loans including overdraft lines of credit. At December 31, 2016, we had gross loans outstanding of $4,819.1 million (before the allowance for loan losses and net deferred costs), with gross mortgage loans totaling $4,187.8 million, or 86.9% of gross loans, and non-mortgage loans totaling $631.3 million, or 13.1% of gross loans. Mortgage loans are primarily multi-family, commercial and one-to-four family mixed-use properties, which totaled 82.6% of gross loans. Our revenues are derived principally from interest on our mortgage and other loans and mortgage-backed securities portfolio, and interest and dividends on other investments in our securities portfolio. Our primary sources of funds are deposits, Federal Home Loan Bank of New York (“FHLB-NY”) borrowings, repurchase agreements, principal and interest payments on loans, mortgage-backed, other securities and to a lesser extent proceeds from sales of securities and loans. The Bank’s primary regulator is the New York State Department of Financial Services (“NYDFS”) (formerly, the New York State Banking Department), and its primary federal regulator is the Federal Deposit Insurance Corporation (“FDIC”). Deposits are insured to the maximum allowable amount by the FDIC. Additionally, the Bank is a member of the Federal Home Loan Bank (“FHLB”) system.

 

Our operating results are significantly affected by national and local economic conditions, including the strength of the local economy. The unemployment rate was 5.2% at December 2016 and 2015, for the New York City region, according to the New York Department of Labor. In this economic environment, we saw improvements in our non-performing loans. Non-performing loans totaled $21.4 million, $26.1 million and $34.2 million at December 31, 2016, 2015 and 2014, respectively. Foreclosed properties decreased by 89.2% to $0.5 million at December 31, 2016 from $4.9 million at December 31, 2015. Additionally, net charge-offs of impaired loans decreased in 2016 to a recovery of $0.7 million from net charge-offs of $2.6 million for the year ended December 31, 2015, as we continue to maintain conservative underwriting standards to reduce risk.

 

Our operating results are also affected by extensions, renewals, modifications and restructuring of loans in our loan portfolio. Loans which are renewed, modified or restructured are required to be fully underwritten in accordance with our policy for new loans, except when the borrower is seeking a reduction in the interest rate due to a decline in interest rates in the market, or for a loan classified as a troubled debt restructured (“TDR”). Our policy for modifying a loan due to the borrower’s request for changes in the terms will depend on the change requested. The borrower must be current and have a good payment history to have a loan modified. If the borrower is seeking additional funds, the loan is fully underwritten in accordance with our policy for new loans. If the borrower is seeking a reduction in the interest rate due to a decline in interest rates in the market, we generally limit our review as follows: (1) for income producing properties and business loans, to a review of the operating results of the property/business and a satisfactory inspection of the property, and (2) for one-to-four residential properties, to a satisfactory inspection of the property. Our policy on restructuring a loan when the loan will be classified as a TDR requires the loan to be fully underwritten in accordance with Company policy. The borrower must demonstrate the ability to repay the loan under the new terms. When the restructuring results in a TDR, we may waive some requirements of Company policy provided the borrower has demonstrated the ability to meet the requirements of the restructured loan and repay the restructured loan. While our formal lending policies do not prohibit making additional loans to a borrower or any related interest of the borrower who is past due in principal or interest more than 90 days, it has been our practice not to make additional loans to a borrower or a related interest of the borrower if the borrower is past due more than 90 days as to principal or interest. During the last three fiscal years, we did not make any additional loans to a borrower or any related interest of the borrower who was past due in principal or interest more than 90 days. All extensions, renewals, restructurings and modifications must be approved by either the Board of Directors of the Bank (the “Bank Board of Directors”) or its Loan Committee (the “Loan Committee”).

 

2
 

Our operating results are also affected by losses on non-performing loans. Our policy requires a reappraisal by an independent third party when a loan becomes twelve months delinquent. We generally obtain a reappraisal by an independent third party for loans over 90 days delinquent when the outstanding loan balance is at least $1.0 million. We also obtain reappraisals when our internally prepared valuation of a property indicates there has been a decline in value below the outstanding balance of the loan, or when a property inspection has indicated significant deterioration in the condition of the property. These internal valuations are prepared when a loan becomes 90 days delinquent.

 

The Bank has a business banking unit which focuses on the development of a full complement of commercial business deposit, loan and cash management products. As of December 31, 2016 and 2015, the business banking unit had $613.0 million and $525.3 million, respectively, in gross loans outstanding and $144.4 million and $146.3 million, respectively, of customer deposits.

 

The Bank has an internet branch, iGObanking.com®, which provides access to consumers in markets outside our geographic locations. Accounts can be opened online at www.iGObanking.com or by mail. Currently iGObanking.com® does not accept loan applications. As of December 31, 2016 and 2015, iGObanking.com® had $417.3 million and $323.7 million, respectively, of customer deposits.

 

The Bank has a governmental banking unit, which provides banking services to public entities including counties, cities, towns, villages, school districts, libraries, fire districts and the various courts throughout the New York City metropolitan area. At December 31, 2016 and 2015, the government banking unit had $1,062.1 million and $975.9 million, respectively, in customer deposits.

 

Market Area and Competition

 

We are a community oriented financial institution offering a wide variety of financial services to meet the needs of the communities we serve. The Bank’s main office is in Uniondale, New York, located in Nassau County. At December 31, 2016, the Bank operated out of 19 full-service offices, located in the New York City Boroughs of Queens, Brooklyn, and Manhattan, and in Nassau County, New York. We also operate an internet branch, iGObanking.com®. We maintain our executive offices in Uniondale in Nassau County, New York. Substantially all of our mortgage loans are secured by properties located in the New York City metropolitan area.

 

We face intense competition both in making loans and in attracting deposits. Competition for loans in our market is primarily based on the types of loans offered and the related terms for these loans, including fixed-rate versus adjustable-rate loans and the interest rate on the loan. For adjustable rate loans, competition is also based on the repricing period, the index to which the rate is referenced, and the spread over the index rate. Also, competition is influenced by the ability of a financial institution to respond to customer requests and to provide the borrower with a timely decision to approve or deny the loan application.

 

Our market area has a high density of financial institutions, many of which have greater financial resources, name recognition and market presence, and all of which are competitors to varying degrees. Particularly intense competition exists for deposits, as we compete with 115 banks and thrifts in the counties in which we have branch locations. Our market share of deposits, as of June 30, 2016, in these counties was approximately 0.33% of the total deposits of these FDIC insured competing financial institutions, and we are the 25th largest financial institution. In addition, we compete with credit unions, the stock market and mutual funds for customers’ funds. Competition for deposits in our market and for national brokered deposits is primarily based on the types of deposits offered and rate paid on the deposits. Particularly intense competition also exists in all of the lending activities we emphasize. In addition to the financial institutions mentioned above, we compete against mortgage banks and insurance companies located both within our market and available on the internet. Competition for loans in our market is primarily based on the types of loans offered and the related terms for these loans, including fixed-rate versus adjustable-rate loans and the interest rate on the loan. For adjustable rate loans, competition is also based on the repricing period, the index to which the rate is referenced, and the spread over the index rate. Also, competition is influenced by the ability of a financial institution to respond to customer requests and to provide the borrower with a timely decision to approve or deny the loan application. The internet banking arena also has many larger financial institutions which have greater financial resources, name recognition and market presence. Our future earnings prospects will be affected by our ability to compete effectively with other financial institutions and to implement our business strategies. Our strategy for attracting deposits includes using various marketing techniques, delivering enhanced technology and customer friendly banking services, and focusing on the unique personal and small business banking needs of the multi-ethnic communities we serve. Our strategy for attracting new loans is primarily dependent on providing timely response to applicants and maintaining a network of quality brokers. See “Risk Factors – The Markets in Which We Operate Are Highly Competitive” included in Item 1A of this Annual Report.

 

3
 

For a discussion of our business strategies, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Overview — Management Strategy” included in Item 7 of this Annual Report.

 

Lending Activities

 

Loan Portfolio Composition. Our loan portfolio consists primarily of mortgage loans secured by multi-family residential, commercial real estate, one-to-four family mixed-use property, one-to-four family residential property, and commercial business loans. In addition, we also offer construction loans, SBA loans and other consumer loans. Substantially all of our mortgage loans are secured by properties located within our market area. At December 31, 2016, we had gross loans outstanding of $4,819.1 million (before the allowance for loan losses and net deferred costs).

 

In recent years we have focused our mortgage loan origination efforts on multi-family residential mortgage loans, although starting in 2014 we increased our focus on commercial real estate and business loans with full banking relationships. In prior years we had focused our mortgage loan originations on multi-family residential, commercial real estate and one-to-four family mixed-use property mortgage loans. These loans generally have higher yields than one-to-four family residential properties, and include prepayment penalties that we collect if the loans pay in full prior to the contractual maturity. We expect to continue this emphasis on multi-family residential mortgage loans, commercial real estate and business loans with full banking relationships through marketing and by maintaining competitive interest rates and origination fees. Our marketing efforts include frequent contact with mortgage brokers and other professionals who serve as referral sources.

 

Fully underwritten one-to-four family residential mortgage loans generally are considered by the banking industry to have less risk than other types of loans. Multi-family residential, commercial real estate and one-to-four family mixed-use property mortgage loans generally have higher yields than one-to-four family residential property mortgage loans and shorter terms to maturity, but typically involve higher principal amounts and may expose the lender to a greater risk of credit loss than one-to-four family residential property mortgage loans. The greater risk associated with multi-family residential, commercial real estate and one-to-four family mixed-use property mortgage loans could require us to increase our provisions for loan losses and to maintain an allowance for loan losses as a percentage of total loans in excess of the allowance we currently maintain. We continually review the composition of our mortgage loan portfolio to manage the risk in the portfolio. See “General – Overview” in this Item 1 of this Annual Report. To date, we have not experienced significant losses in our multi-family residential, commercial real estate and one-to-four family mixed-use property mortgage loan portfolios.

 

Our mortgage loan portfolio consists of adjustable rate mortgage (“ARM”) loans and fixed-rate mortgage loans. Interest rates we charge on loans are affected primarily by the demand for such loans, the supply of money available for lending purposes, the rate offered by our competitors and the creditworthiness of the borrower. Many of those factors are, in turn, affected by local and national economic conditions, and the fiscal, monetary and tax policies of the federal, state and local governments.

 

In general, consumers show a preference for ARM loans in periods of high interest rates and for fixed-rate loans when interest rates are low. In periods of declining interest rates, we may experience refinancing activity in ARM loans, as borrowers show a preference to lock-in the lower rates available on fixed-rate loans. In the case of ARM loans we originated, volume and adjustment periods are affected by the interest rates and other market factors as discussed above as well as consumer preferences. We have not in the past, nor do we currently, originate ARM loans that provide for negative amortization.

 

At December 31, 2016, we had $11.5 million in construction loans outstanding. We obtain a first lien position on the underlying collateral, and generally obtain guarantees on construction loans. These loans generally have a term of two years or less. Construction loans involve a greater degree of risk than other loans because, among other things, the underwriting of such loans is based on an estimated value of the developed property, which can be difficult to ascertain in light of uncertainties inherent in such estimations. In addition, construction lending entails the risk that the project may not be completed due to cost overruns or changes in market conditions. The greater risk associated with construction loans could require us to increase our provision for loan losses, and to maintain an allowance for loan losses as a percentage of total loans in excess of the allowance we currently maintain.

 

The business banking unit focuses on loan and deposit relationships to businesses located within our market area. These loans are generally personally guaranteed by the owners, and may be secured by the assets of the business, including real estate. The interest rate on these loans is generally an adjustable rate based on a published index. These loans, while providing us a higher rate of return, also present a higher level of risk. The greater risk associated with business loans could require us to increase our provision for loan losses, and to maintain an allowance for loan losses as a percentage of total loans in excess of the allowance we currently maintain. To date, we have not incurred significant losses in our business loan portfolio.

 

At times, we may purchase loans from banks, mortgage bankers and other financial institutions when the loans complement our loan portfolio strategy. Loans purchased must meet our underwriting standards when they were originated. Our lending activities are subject to federal and state laws and regulations. See “— Regulation.”

 

4
 

The following table sets forth the composition of our loan portfolio at the dates indicated.

 

   At December 31,
   2016  2015  2014  2013  2012
      Percent     Percent     Percent     Percent     Percent
   Amount  of Total  Amount  of Total  Amount  of Total  Amount  of Total  Amount  of Total
   (Dollars in thousands)
Mortgage Loans:                                                  
Multi-family residential  $2,178,504    45.21%  $2,055,228    46.98%  $1,923,460    50.64%  $1,712,039    50.02%  $1,534,438    47.62%
Commercial real estate   1,246,132    25.86    1,001,236    22.90    621,569    16.36    512,552    14.97    515,438    16.00 
One-to-four family -                                                  
mixed-use property   558,502    11.59    573,043    13.11    573,779    15.10    595,751    17.40    637,353    19.79 
One-to-four family -                                                  
residential (1)   185,767    3.85    187,838    4.30    187,572    4.94    193,726    5.66    198,968    6.18 
Co-operative apartment (2)   7,418    0.15    8,285    0.19    9,835    0.26    10,137    0.30    6,303    0.20 
Construction   11,495    0.24    7,284    0.17    5,286    0.14    4,247    0.12    14,381    0.45 
                                                   
Gross mortgage loans   4,187,818    86.90    3,832,914    87.65    3,321,501    87.44    3,028,452    88.47    2,906,881    90.24 
                                                   
Non-mortgage loans:                                                  
Small Business Administration   15,198    0.32    12,194    0.28    7,134    0.19    7,792    0.23    9,496    0.29 
Taxi medallion   18,996    0.39    20,881    0.48    22,519    0.59    13,123    0.38    9,922    0.31 
Commercial business and other   597,122    12.39    506,622    11.59    447,500    11.78    373,641    10.92    295,076    9.16 
                                                   
Gross non-mortgage loans   631,316    13.10    539,697    12.35    477,153    12.56    394,556    11.53    314,494    9.76 
                                                   
Gross loans   4,819,134    100.00%   4,372,611    100.00%   3,798,654    100.00%   3,423,008    100.00%   3,221,375    100.00%
                                                   
Unearned loan fees and deferred                                                  
costs, net   16,559         15,368         11,719         11,170         12,746      
                                                   
Less: Allowance for loan losses   (22,229)        (21,535)        (25,096)        (31,776)        (31,104)     
Loans, net  $4,813,464        $4,366,444        $3,785,277        $3,402,402        $3,203,017      

 

(1)One-to-four family residential mortgage loans also include home equity and condominium loans. At December 31, 2016, gross home equity loans totaled $52.4 million and condominium loans totaled $22.7 million.
(2)Consists of loans secured by shares representing interests in individual co-operative units that are generally owner occupied.

 

5
 

The following table sets forth our loan originations (including the net effect of refinancing) and the changes in our portfolio of loans, including purchases, sales and principal reductions for the years indicated:

 

   For the years ended December 31,
(In thousands)  2016  2015  2014
       
Mortgage Loans               
                
At beginning of year  $3,832,914   $3,321,501   $3,028,452 
                
Mortgage loans originated:               
Multi-family residential   245,175    205,393    314,148 
Commercial real estate   296,620    376,036    165,054 
One-to-four family mixed-use property   62,735    68,295    50,070 
One-to-four family residential   24,820    40,831    24,727 
Co-operative apartment   470    1,625    170 
Construction   15,772    4,999    1,566 
Total mortgage loans originated   645,592    697,179    555,735 
                
Mortgage loans purchased:               
Multi-family residential   126,022    168,450    106,830 
Commercial real estate   26,101    76,053    14,794 
                
Total mortgage loans purchased   152,123    244,503    121,624 
                
Less:               
Principal reductions   434,587    416,101    363,206 
Loans transferred to loans held for sale   -    300    - 
Mortgage loan sales   7,259    11,057    12,871 
Charge-offs   419    1,440    1,780 
Mortgage loan foreclosures   546    1,371    6,453 
                
At end of year  $4,187,818   $3,832,914   $3,321,501 
                
Non-mortgage loans               
                
At beginning of year  $539,697   $477,153   $394,556 
                
Loans originated:               
Small Business Administration   8,447    11,261    1,611 
Commercial business   290,444    243,316    227,904 
Other   1,738    2,777    3,056 
Total other loans originated   300,629    257,354    232,571 
                
Non-mortgage loans purchased:               
Taxi Medallion   -    -    14,431 
Commercial business   34,594    34,425    33,805 
Total non-mortgage loans purchased   34,594    34,425    48,236 
                
Less:               
Non-mortgage loan sales   3,211    3,935    4 
Loans transferred to loans held for sale   -    -    1,150 
Principal reductions   239,653    222,895    196,394 
Charge-offs   740    2,405    662 
                
At end of year  $631,316   $539,697   $477,153 

 

6
 

Loan Maturity and Repricing. The following table shows the maturity of our total loan portfolio at December 31, 2016. Scheduled repayments are shown in the maturity category in which the payments become due.

 

   Mortgage loans  Non-mortgage loans   
         One-to-four                     
         family  One-to-four              Commercial   
   Multi-family  Commercial  mixed-use  family  Co-operative     Small Business  Taxi  business   
(In thousands)  residential  real estate  property  residential  apartment  Construction  Administration  Medallion  and other  Total loans
                               
Amounts due within one year  $206,074   $176,764   $38,803   $7,756   $251   $7,799   $2,176   $12,055   $180,982   $632,660 
Amounts due after one year:                                                  
One to two years   184,443    132,153    28,609    7,170    260    3,696    1,463    4,235    79,689    441,718 
Two to three years   181,955    113,596    27,404    7,048    260    -    1,309    2,706    65,210    399,488 
Three to five years   179,895    106,904    27,268    7,128    260    -    1,151    -    55,841    378,447 
Over five years   1,426,137    716,715    436,418    156,665    6,387    -    9,099    -    215,400    2,966,821 
Total due after one year   1,972,430    1,069,368    519,699    178,011    7,167    3,696    13,022    6,941    416,140    4,186,474 
Total amounts due  $2,178,504   $1,246,132   $558,502   $185,767   $7,418   $11,495   $15,198   $18,996   $597,122   $4,819,134 
                                                   
Sensitivity of loans to changes in                                                  
interest rates - loans due                                                  
after one year:                                                  
Fixed rate loans  $354,707   $86,742   $87,321   $31,701   $858   $-   $3,828   $6,357   $171,436   $742,950 
Adjustable rate loans   1,617,723    982,626    432,378    146,310    6,309    3,696    9,194    584    244,704    3,443,524 
Total loans due after one year  $1,972,430   $1,069,368   $519,699   $178,011   $7,167   $3,696   $13,022   $6,941   $416,140   $4,186,474 

 

 

7
 

Multi-Family Residential Lending. Loans secured by multi-family residential properties were $2,178.5 million, or 45.21% of gross loans at December 31, 2016. Our multi-family residential mortgage loans had an average principal balance of $1.0 million at December 31, 2016, and the largest multi-family residential mortgage loan held in our portfolio had a principal balance of $28.0 million. We offer both fixed-rate and adjustable-rate multi-family residential mortgage loans, with maturities of up to 30 years.

 

In underwriting multi-family residential mortgage loans, we review the expected net operating income generated by the real estate collateral securing the loan, the age and condition of the collateral, the financial resources and income level of the borrower and the borrower’s experience in owning or managing similar properties. We typically require debt service coverage of at least 125% of the monthly loan payment. We generally originate these loans up to only 75% of the appraised value or the purchase price of the property, whichever is less. Any loan with a final loan-to-value ratio in excess of 75% must be approved by the Bank Board of Directors or the Loan Committee as an exception to policy. We generally rely on the income generated by the property as the primary means by which the loan is repaid. However, personal guarantees may be obtained for additional security from these borrowers. We typically order an environmental report on our multi-family and commercial real estate loans.

 

Loans secured by multi-family residential property generally involve a greater degree of risk than residential mortgage loans and carry larger loan balances. The increased credit risk is the result of several factors, including the concentration of principal in a smaller number of loans and borrowers, the effects of general economic conditions on income producing properties and the increased difficulty in evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by multi-family residential property is typically dependent upon the successful operation of the related property, which is usually owned by a legal entity with the property being the entity’s only asset. If the cash flow from the property is reduced, the borrower’s ability to repay the loan may be impaired. If the borrower defaults, our only remedy may be to foreclose on the property, for which the market value may be less than the balance due on the related mortgage loan. Loans secured by multi-family residential property also may involve a greater degree of environmental risk. We seek to protect against this risk through obtaining an environmental report. See “—Asset Quality — Environmental Concerns Relating to Loans.”

 

At December 31, 2016, $1,792.9 million, or 82.30%, of our multi-family mortgage loans consisted of ARM loans. We offer ARM loans with adjustment periods typically of five years and for terms of up to 30 years. Interest rates on ARM loans currently offered by us are adjusted at the beginning of each adjustment period based upon a fixed spread above the FHLB-NY corresponding Regular Advance Rate. From time to time, due to competitive forces, we may originate ARM loans at an initial rate lower than the fully indexed rate as a result of a discount on the spread for the initial adjustment period. Multi-family adjustable-rate mortgage loans generally are not subject to limitations on interest rate increases either on an adjustment period or aggregate basis over the life of the loan; however, the loans generally contain interest rate floors. We originated and purchased multi-family ARM loans totaling $330.6 million, $339.5 million and $398.9 million during 2016, 2015 and 2014, respectively.

 

At December 31, 2016, $385.7 million, or 17.70%, of our multi-family mortgage loans consisted of fixed rate loans. Our fixed-rate multi-family mortgage loans are generally originated for terms up to 15 years and are competitively priced based on market conditions and our cost of funds. We originated and purchased $40.6 million, $34.3 million and $22.1 million of fixed-rate multi-family mortgage loans in 2016, 2015 and 2014, respectively.

 

Commercial Real Estate Lending. Loans secured by commercial real estate were $1,246.1 million, or 25.86% of gross loans, at December 31, 2016. Our commercial real estate mortgage loans are secured by properties such as office buildings, hotels/motels, nursing homes, small business facilities, strip shopping centers and warehouses. At December 31, 2016, our commercial real estate mortgage loans had an average principal balance of $1.8 million and the largest of such loans, which was secured by seven multi-tenant shopping centers, had a principal balance of $42.7 million. Commercial real estate mortgage loans are generally originated in a range of $100,000 to $6.0 million.

 

In underwriting commercial real estate mortgage loans, we employ the same underwriting standards and procedures as are employed in underwriting multi-family residential mortgage loans.

 

Commercial real estate mortgage loans generally carry larger loan balances than one-to-four family residential mortgage loans and involve a greater degree of credit risk for the same reasons applicable to multi-family residential mortgage loans.

 

At December 31, 2016, $1,132.5 million, or 90.88%, of our commercial mortgage loans consisted of ARM loans. We offer ARM loans with adjustment periods of one to five years and generally for terms of up to 15 years. Interest rates on ARM loans currently offered by us are adjusted at the beginning of each adjustment period based upon a fixed spread above the FHLB-NY corresponding Regular Advance Rate. From time to time, we may originate ARM loans at an initial rate lower than the index as a result of a discount on the spread for the initial adjustment period. Commercial adjustable-rate mortgage loans generally are not subject to limitations on interest rate increases either on an adjustment period or aggregate basis over the life of the loan; however, the loans generally contain interest rate floors. We originated and purchased commercial ARM loans totaling $293.9 million, $441.1 million and $169.6 million during 2016, 2015 and 2014, respectively.

 

8
 

At December 31, 2016, $113.6 million, or 9.12%, of our commercial mortgage loans consisted of fixed-rate loans. Our fixed-rate commercial mortgage loans are generally originated for terms up to 20 years and are competitively priced based on market conditions and our cost of funds. We originated and purchased $28.8 million, $11.0 million and $10.2 million of fixed-rate commercial mortgage loans in 2016, 2015 and 2014, respectively.

 

One-to-Four Family Mortgage Lending – Mixed-Use Properties. We offer mortgage loans secured by one-to-four family mixed-use properties. These properties contain up to four residential dwelling units and a commercial unit. We offer both fixed-rate and adjustable-rate one-to-four family mixed-use property mortgage loans with maturities of up to 30 years and a general maximum loan amount of $1.0 million. Loan originations primarily result from applications received from mortgage brokers and mortgage bankers, existing or past customers, and persons who respond to our marketing efforts and referrals. One-to-four family mixed-use property mortgage loans were $558.5 million, or 11.59% of gross loans, at December 31, 2016.

 

In underwriting one-to-four family mixed-use property mortgage loans, we employ the same underwriting standards as are employed in underwriting multi-family residential mortgage loans.

 

At December 31, 2016, $452.6 million, or 81.03%, of our one-to-four family mixed-use property mortgage loans consisted of ARM loans. We offer adjustable-rate one-to-four family mixed-use property mortgage loans with adjustment periods typically of five years and for terms of up to 30 years. Interest rates on ARM loans currently offered by the Bank are adjusted at the beginning of each adjustment period based upon a fixed spread above the FHLB-NY corresponding Regular Advance Rate. From time to time, we may originate ARM loans at an initial rate lower than the index as a result of a discount on the spread for the initial adjustment period. One-to-four family mixed-use property adjustable-rate mortgage loans generally are not subject to limitations on interest rate increases either on an adjustment period or aggregate basis over the life of the loan; however, the loans generally contain interest rate floors. We originated and purchased one-to-four family mixed-use property ARM loans totaling $72.4 million, $54.6 million and $39.4 million during 2016, 2015 and 2014, respectively.

 

At December 31, 2016, $105.9 million, or 18.97%, of our one-to-four family mixed-use property mortgage loans consisted of fixed-rate loans. Our fixed-rate one-to-four family mixed-use property mortgage loans are originated for terms of up to 15 years and are competitively priced based on market conditions and the Bank’s cost of funds. We originated and purchased $15.6 million, $13.7 million and $10.7 million of fixed-rate one-to-four family mixed-use property mortgage loans in 2016, 2015 and 2014, respectively.

 

One-to-Four Family Mortgage Lending – Residential Properties. We offer mortgage loans secured by one-to-four family residential properties, including townhouses and condominium units. For purposes of the description contained in this section, one-to-four family residential mortgage loans, co-operative apartment loans and home equity loans are collectively referred to herein as “residential mortgage loans.” We offer both fixed-rate and adjustable-rate residential mortgage loans with maturities of up to 30 years and a general maximum loan amount of $1.0 million. Loan originations generally result from applications received from mortgage brokers and mortgage bankers, existing or past customers, and referrals. Residential mortgage loans were $193.2 million, or 4.00% of gross loans, at December 31, 2016.

 

We generally originate residential mortgage loans in amounts up to 80% of the appraised value or the sale price, whichever is less. We may make residential mortgage loans with loan-to-value ratios of up to 90% of the appraised value of the mortgaged property; however, private mortgage insurance is required whenever loan-to-value ratios exceed 80% of the appraised value of the property securing the loan.

 

In addition to income verified loans, we have in the past originated residential mortgage loans to self-employed individuals within our local community based on stated income and verifiable assets that allowed us to assess repayment ability, provided that the borrower’s stated income is considered reasonable for the borrower’s type of business. The preponderance of stated income one-to-four family residential mortgage loans were made available to self-employed individuals within our local community for their primary residence. Our underwriting standards required that we verify the assets of the borrowers and the sources of their cash flows. The information reviewed for purchases included at least three months and refinances included at least one month of personal bank statements (checking and savings accounts), statements of investment accounts, business checking account statements (when applicable), and other information provided by the borrowers about their personal holdings. Our review of these bank statements allowed us to assess whether or not their stated income appeared reasonable in comparison to their cash flows, and if their income level supported their personal holdings. We also obtained and reviewed credit reports on these borrowers. An acceptable credit report was one of the key factors in approving this type of mortgage loan. We obtained appraisals from an independent third party for the property, and limited the amount we lent on the properties to 80% of the lesser of the property’s appraised value or the purchase price. Home equity lines of credit were offered on one-to-four residential properties to homeowners based on various levels of income verification. We limited the amount available under a home equity line of credit to 80% of the lesser of the appraised value of the property or the purchase price. These loans involve a higher degree of risk as compared to our other fully underwritten residential mortgage loans as there is a greater opportunity for self-employed borrowers to falsify or overstate their level of income and ability to service indebtedness. This risk is mitigated by the requirements discussed above in our loan policy. In addition, since 2009, the underwriting standards for home equity loans were modified to discontinue originating home equity lines of credit without verifying the borrower’s income. We also discontinued offering one-to-four family residential property mortgage loans to self-employed individuals based on stated income and verifiable assets in June 2010. We had $9.0 million and $9.9 million outstanding of one-to four family residential mortgage loans originated to individuals based on stated income and verifiable assets at December 31, 2016 and 2015, respectively. We had $38.6 million and $41.4 million advanced on home equity lines of credit for which we did not verify the borrowers’ income at December 31, 2016 and 2015, respectively.

 

9
 

At December 31, 2016, $151.0 million, or 81.29%, of our residential mortgage loans consisted of ARM loans. We offer ARM loans with adjustment periods of one, three, five, seven or ten years. Interest rates on ARM loans currently offered by us are adjusted at the beginning of each adjustment period based upon a fixed spread above the FHLB-NY corresponding Regular Advance Rate. From time to time, we may originate ARM loans at an initial rate lower than the index as a result of a discount on the spread for the initial adjustment period. ARM loans generally are subject to limitations on interest rate increases of 2% per adjustment period and an aggregate adjustment of 6% over the life of the loan and have interest rate floors. We originated and purchased adjustable rate residential mortgage loans totaling $24.3 million, $39.2 million and $21.0 million during 2016, 2015 and 2014, respectively.

 

The retention of ARM loans in our portfolio helps us reduce our exposure to interest rate risks. However, in an environment of rapidly increasing interest rates, it is possible for the interest rate increase to exceed the maximum aggregate adjustment on one-to-four family residential ARM loans and negatively affect the spread between our interest income and our cost of funds.

 

ARM loans generally involve credit risks different from those inherent in fixed-rate loans, primarily because if interest rates rise, the underlying payments of the borrower rise, thereby increasing the potential for default. However, this potential risk is lessened by our policy of originating one-to-four family residential ARM loans with annual and lifetime interest rate caps that limit the increase of a borrower’s monthly payment.

 

At December 31, 2016, $34.8 million, or 18.71%, of our residential mortgage loans consisted of fixed-rate loans. Our fixed-rate residential mortgage loans typically are originated for terms of 15 and 30 years and are competitively priced based on market conditions and our cost of funds. We originated and purchased $0.9 million, $3.3 million and $3.9 million in 15-year fixed-rate residential mortgages in 2016, 2015 and 2014, respectively. We did not originate or purchase any 30-year fixed-rate residential mortgages in 2016, 2015 and 2014.

 

At December 31, 2016, home equity loans totaled $52.4 million, or 1.09%, of gross loans. Home equity loans are included in our portfolio of residential mortgage loans. These loans are offered as adjustable-rate “home equity lines of credit” on which interest only is due for an initial term of 10 years and thereafter principal and interest payments sufficient to liquidate the loan are required for the remaining term, not to exceed 30 years. These adjustable “home equity lines of credit” may include a “floor” and/or a “ceiling” on the interest rate that we charge for these loans. These loans also may be offered as fully amortizing closed-end fixed-rate loans for terms up to 15 years. The majority of home equity loans originated are owner occupied one-to-four family residential properties and condominium units. To a lesser extent, home equity loans are also originated on one-to-four residential properties held for investment and second homes. All home equity loans are subject to an 80% loan-to-value ratio computed on the basis of the aggregate of the first mortgage loan amount outstanding and the proposed home equity loan. They are generally granted in amounts from $25,000 to $300,000.

 

Construction Loans. At December 31, 2016, construction loans totaled $11.5 million, or 0.24%, of gross loans. Our construction loans primarily have been made to finance the construction of one-to-four family residential properties, multi-family residential properties and residential condominiums. We also, to a limited extent, finance the construction of commercial real estate. Our policies provide that construction loans may be made in amounts up to 70% of the estimated value of the developed property and only if we obtain a first lien position on the underlying real estate. However, we generally limit construction loans to 60% of the estimated value of the developed property. In addition, we generally require personal guarantees on all construction loans. Construction loans are generally made with terms of two years or less. Advances are made as construction progresses and inspection warrants, subject to continued title searches to ensure that we maintain a first lien position. We made construction loans of $15.8 million, $5.0 million and $1.6 million during 2016, 2015 and 2014, respectively.

 

10
 

Construction loans involve a greater degree of risk than other loans because, among other things, the underwriting of such loans is based on an estimated value of the developed property, which can be difficult to ascertain in light of uncertainties inherent in such estimations. In addition, construction lending entails the risk that the project may not be completed due to cost overruns or changes in market conditions.

 

Small Business Administration Lending. At December 31, 2016, SBA loans totaled $15.2 million, representing 0.32%, of gross loans. These loans are extended to small businesses and are guaranteed by the SBA up to a maximum of 85% of the loan balance for loans with balances of $150,000 or less, and to a maximum of 75% of the loan balance for loans with balances greater than $150,000. We also provide term loans and lines of credit up to $350,000 under the SBA Express Program, on which the SBA provides a 50% guaranty. The maximum loan size under the SBA guarantee program was $2.0 million, with a maximum loan guarantee of $1.5 million. The Small Business Jobs Act of 2010 permanently increased the limits to a maximum loan size of $5.0 million, with a maximum loan guarantee of $3.75 million. All SBA loans are underwritten in accordance with SBA Standard Operating Procedures which requires collateral and the personal guarantee of the owners with more than 20% ownership from SBA borrowers. Typically, SBA loans are originated in the range of $25,000 to $2.0 million with terms ranging from one to seven years and up to 25 years for owner occupied commercial real estate mortgages. SBA loans are generally offered at adjustable rates tied to the prime rate (as published in the Wall Street Journal) with adjustment periods of one to three months. At times, we may sell the guaranteed portion of certain SBA term loans in the secondary market, realizing a gain at the time of sale, and retaining the servicing rights on these loans, collecting a servicing fee of approximately 1%. We originated and purchased $8.4 million, $11.3 million and $1.6 million of SBA loans during 2016, 2015 and 2014, respectively.

 

Taxi Medallion. At December 31, 2016, taxi medallion loans consisted of loans made to New York City and Chicago taxi medallion owners, which are secured by liens on the taxi medallions, totaling $19.0 million, or 0.39%, of gross loans. In 2015, we decided to no longer originate or purchase taxi medallion loans. Therefore, we did not originate or purchase any taxi medallion loans in 2016 or 2015, but originated and purchased $14.4 million during 2014.

 

Commercial Business and Other Lending. At December 31, 2016, commercial business and other loans totaled $597.1 million, or 12.39%, of gross loans. We originate and purchase commercial business loans and other loans for business, personal, or household purposes. Commercial business loans are provided to businesses in the New York City metropolitan area with annual sales of up to $250.0 million. Our commercial business loans include lines of credit and term loans including owner occupied mortgages. These loans are secured by business assets, including accounts receivables, inventory and real estate and generally require personal guarantees. The Bank also, at times, enters into participations/syndications with other banks on senior secured commercial business loans. Commercial business loans are generally originated in a range of $100,000 to $10.0 million.

 

At December 31, 2016, $409.7 million, or 68.61%, of our commercial business loans consisted of adjustable rate loans. We generally offer adjustable rate loans with adjustment periods of five years for owner occupied mortgages and for lines of credit the adjustment period is generally monthly. Interest rates on adjustable rate loans currently offered by us are adjusted at the beginning of each adjustment period based upon a fixed spread above the FHLB-NY corresponding Regular Advance Rate for owner occupied mortgages and a fixed spread above the London Interbank Offered Rate (“LIBOR”) or Prime Rate for lines of credit. Commercial business adjustable-rate loans generally are not subject to limitations on interest rate increases either on an adjustment period or aggregate basis over the life of the loan, however they generally are subject to interest rate floors.

 

At December 31, 2016, $187.4 million, or 31.39%, of our commercial business loans consisted of fixed-rate loans. Our fixed-rate commercial business loans are generally originated for terms up to 20 years and are competitively priced based on market conditions and our cost of funds.

 

Other loans generally consist of overdraft lines of credit. Generally, unsecured consumer loans are limited to amounts of $5,000 or less for terms of up to five years. We originated and purchased $1.7 million, $2.8 million and $3.1 million of other loans during 2016, 2015 and 2014, respectively. The underwriting standards employed by us for consumer and other loans include a determination of the applicant’s payment history on other debts and assessment of the applicant’s ability to meet payments on all of his or her obligations. In addition to the creditworthiness of the applicant, the underwriting process also includes a comparison of the value of the collateral, if any, to the proposed loan amount. Unsecured loans tend to have higher risk, and therefore command a higher interest rate.

 

11
 

Loan Extensions, Renewals, Modifications and Restructuring. Extensions, renewals, modifications or restructuring a loan, other than a loan that is classified as a TDR, requires the loan to be fully underwritten in accordance with our policy. The borrower must be current to have a loan extended, renewed or restructured. Our policy for modifying a mortgage loan due to the borrower’s request for changes in the terms will depend on the changes requested. The borrower must be current and have a good payment history to have a loan modified. If the borrower is seeking additional funds, the loan is fully underwritten in accordance with our policy for new loans. If the borrower is seeking a reduction in the interest rate due to a decline in interest rates in the market, we generally limit our review as follows: (1) for income producing properties and business loans, to a review of the operating results of the property/business and a satisfactory inspection of the property, and (2) for one-to-four residential properties, to a satisfactory inspection of the property. Our policy on restructuring a loan when the loan will be classified as a TDR requires the loan to be fully underwritten in accordance with Company policy. The borrower must demonstrate the ability to repay the loan under the new terms. When the restructuring results in a TDR, we may waive some requirements of Company policy provided the borrower has demonstrated the ability to meet the requirements of the restructured loan and repay the restructured loan. While our formal lending policies do not prohibit making additional loans to a borrower or any related interest of the borrower who is past due in principal or interest more than 90 days, it has been our practice not to make additional loans to a borrower or a related interest of the borrower if the borrower is past due more than 90 days as to principal or interest. During the most recent three fiscal years, we did not make any additional loans to a borrower or any related interest of the borrower who was past due in principal or interest more than 90 days. All extensions, renewals, restructurings and modifications must be approved by the appropriate Loan Committee.

 

Loan Approval Procedures and Authority. The Board of Directors of the Company (the “Board of Directors”) approved lending policies establishing loan approval requirements for our various types of loan products. Our Residential Mortgage Lending Policy (which applies to all one-to-four family mortgage loans, including residential and mixed-use property) establishes authorized levels of approval. One-to-four family mortgage loans that do not exceed $750,000 require two signatures for approval, one of which must be from either the Senior Executive Vice President, the Executive Vice President or a Senior Vice President (collectively, “Authorized Officers”) and the other from a Senior Underwriter, Manager, Underwriter or Junior Underwriter in the Residential Mortgage Loan Department (collectively, “Loan Officers”), and ratification by the Management Loan Committee. For one-to-four family mortgage loans in excess of $750,000 up to $2.5 million, three signatures are required for approval, at least two of which must be from Authorized Officers, and the other one may be a Loan Officer, and ratification by the Management Loan Committee and the Director’s Loan Committee. The Director’s Loan Committee or the Bank Board of Directors also must approve one-to-four family mortgage loans in excess of $2.5 million. Pursuant to our Commercial Real Estate Lending Policy, loans secured by commercial real estate and multi-family residential properties up to $2.0 million are approved by the Executive Vice President of Commercial Real Estate and the Senior Executive Vice President, Chief of Real Estate Lending and then ratified by the Management Loan Committee and/or the Director’s Loan Committee. Loans provided in excess of $2.0 million and up to and including $5.0 million must be submitted to the Management Loan Committee for final approval and then to the Director’s Loan Committee and/or Board of Directors for ratification. Loans in excess of $5.0 million and up to and including $25.0 million must be submitted to the Director’s Loan Committee and/ or the Board of Directors for approval. Loan amounts in excess of $25.0 million must be approved by the Board of Directors.

 

In accordance with our Business Credit Policy all business and SBA loans up to $2.5 million must be approved by the Business Loan Committee and ratified by the Management Loan Committee. Business and SBA loans in excess of $2.5 million up to $5.0 million must be approved by the Management Loan Committee and ratified by the Loan Committee. Commercial business and other loans require two signatures from the Business Loan Committee for approval.

 

Our Construction Loan Policy requires construction loans up to and including $1.0 million must be approved by the Senior Executive Vice President, Chief of Real Estate Lending and the Executive Vice President of Commercial Real Estate, and ratified by the Management Loan Committee or the Director’s Loan Committee. Such loans in excess of $1.0 million up to and including $2.5 million require the same officer approvals, approval of the Management Loan Committee, and ratification of the Director’s Loan Committee or the Bank Board of Directors. Construction loans in excess of $15.0 million require the same officer approvals, approval by the Management Loan Committee, and approval of the Bank Board of Directors. Any loan, regardless of type, that deviates from our written credit policies must be approved by the Loan Committee or the Bank Board of Directors.

 

For all loans originated by us, upon receipt of a completed loan application, a credit report is ordered and certain other financial information is obtained. An appraisal of the real estate intended to secure the proposed loan is required to be received. An independent appraiser designated and approved by us currently performs such appraisals. Our staff appraisers review all appraisals. The Bank Board of Directors annually approves the independent appraisers used by the Bank and approves the Bank’s appraisal policy. It is our policy to require borrowers to obtain title insurance and hazard insurance on all real estate loans prior to closing. For certain borrowers, and/or as required by law, the Bank may require escrow funds on a monthly basis together with each payment of principal and interest to a mortgage escrow account from which we make disbursements for items such as real estate taxes and, in some cases, hazard insurance premiums.

 

12
 

Loan Concentrations. The maximum amount of credit that the Bank can extend to any single borrower or related group of borrowers generally is limited to 15% of the Bank’s unimpaired capital and surplus, or $91.1 million at December 31, 2016. Applicable laws and regulations permit an additional amount of credit to be extended, equal to 10% of unimpaired capital and surplus, if the loan is secured by readily marketable collateral, which generally does not include real estate. See “-Regulation.” However, it is currently our policy not to extend such additional credit. At December 31, 2016, there were no loans in excess of the maximum dollar amount of loans to one borrower that the Bank was authorized to make. At that date, the three largest concentrations of loans to one borrower consisted of loans secured by commercial real estate, multi-family income producing properties and business loans with an aggregate principal balance of $74.0 million, $60.0 million and $54.5 million for each of the three borrowers, respectively.

 

Loan Servicing. At December 31, 2016, we were servicing $1.3 million of mortgage loans and $13.1 million of SBA loans for others. Our policy is to retain the servicing rights to the mortgage and SBA loans that we sell in the secondary market, other than non-performing loans that are sold with servicing released to the buyer. In order to increase revenue, management intends to continue this policy.

 

Asset Quality

 

Loan Collection. When a borrower fails to make a required payment on a loan, we take a number of steps to induce the borrower to cure the delinquency and restore the loan to current status. In the case of mortgage loans, personal contact is made with the borrower after the loan becomes 30 days delinquent. We take a proactive approach to managing delinquent loans, including conducting site examinations and encouraging borrowers to meet with one of our representatives. When deemed appropriate, we develop short-term payment plans that enable borrowers to bring their loans current, generally within six to nine months. At times, when a borrower is experiencing financial difficulties, we may restructure a loan to enable a borrower to continue making payments when it is deemed to be in our best long-term interest. This restructure may include reducing the interest rate or amount of the monthly payment for a specified period of time, after which the interest rate and repayment terms revert to the original terms of the loan. We classify these loans as TDR. At December 31, 2016, we had $17.8 million of loans classified as TDR, with $17.4 million of these loans performing according to their restructured terms and $0.4 million not performing according to their restructured terms. We review delinquencies on a loan by loan basis, diligently exploring ways to help borrowers meet their obligations and return them back to current status, and we have increased staffing to handle delinquent loans by hiring people experienced in loan workouts.

 

When the borrower has indicated that they will be unable to bring the loan current, or due to other circumstances which, in our opinion, indicate the borrower will be unable to bring the loan current within a reasonable time, the loan is classified as non-performing. All loans classified as non-performing, which includes all loans past due 90 days or more, are classified as non-accrual unless there is, in our opinion, compelling evidence the borrower will bring the loan current in the immediate future. At December 31, 2016, there were two loans, which totaled $0.4 million, past due 90 days or more and still accruing interest.

 

Upon classifying a loan as non-performing, we review available information and conditions that relate to the status of the loan, including the estimated value of the loan’s collateral and any legal considerations that may affect the borrower’s ability to continue to make payments. Based upon the available information, we will consider the sale of the loan or retention of the loan. If the loan is retained, we may continue to work with the borrower to collect the amounts due or start foreclosure proceedings. If a foreclosure action is initiated and the loan is not brought current, paid in full, or refinanced before the foreclosure sale, the real property securing the loan is sold at foreclosure or by us as soon thereafter as practicable.

 

Once the decision to sell a loan is made, we determine what we would consider adequate consideration to be obtained when that loan is sold, based on the facts and circumstances related to that loan. Investors and brokers are then contacted to seek interest in purchasing the loan. We have been successful in finding buyers for some of our non-performing loans offered for sale that are willing to pay what we consider to be adequate consideration. Terms of the sale include cash due upon closing of the sale, no contingencies or recourse to us, servicing is released to the buyer and time is of the essence. These sales usually close within a reasonably short time period.

 

13
 

This strategy of selling non-performing loans has allowed us to optimize our return by quickly converting our non-performing loans to cash, which can then be reinvested in earning assets. This strategy also allows us to avoid lengthy and costly legal proceedings that may occur with non-performing loans. There can be no assurances that we will continue this strategy in future periods, or if continued, we will be able to find buyers to pay adequate consideration.

 

The following tables show delinquent and non-performing loans sold during the period indicated:

 

   For the years ended December 31,
(Dollars in thousands)  2016  2015  2014
          
Count   26    23    34 
                
Proceeds  $7,965   $8,986   $15,857 
Net recoveries   48    134    357 
Gross gains   265    71    67 
Gross losses   -    2    - 

 

On mortgage loans or loan participations purchased by us for whom the seller retains the servicing rights, we receive monthly reports with which we monitor the loan portfolio. Based upon servicing agreements with the servicers of the loans, we rely upon the servicer to contact delinquent borrowers, collect delinquent amounts and initiate foreclosure proceedings, when necessary, all in accordance with applicable laws, regulations and the terms of the servicing agreements between us and our servicing agents. The servicers are required to submit monthly reports on their collection efforts on delinquent loans. At December 31, 2016, we held $742.6 million of loans that were serviced by others.

 

In the case of commercial business or other loans, we generally send the borrower a written notice of non-payment when the loan is first past due. In the event payment is not then received, additional letters and phone calls generally are made in order to encourage the borrower to meet with one of our representatives to discuss the delinquency. If the loan still is not brought current and it becomes necessary for us to take legal action, which typically occurs after a loan is delinquent 90 days or more, we may attempt to repossess personal or business property that secures an SBA loan, commercial business loan or consumer loan.

 

Troubled Debt Restructured . We have restructured certain problem loans for borrowers who are experiencing financial difficulties by either: reducing the interest rate until the next reset date, extending the amortization period thereby lowering the monthly payments, deferring a portion of the interest payment, or changing the loan to interest only payments for a limited time period. At times, certain problem loans have been restructured by combining more than one of these options. These restructurings have not included a reduction of principal balance. We believe that restructuring these loans in this manner will allow certain borrowers to become and remain current on their loans. These restructured loans are classified TDR. Loans which have been current for six consecutive months at the time they are restructured as TDR remain on accrual status. Loans which were delinquent at the time they are restructured as a TDR are placed on non-accrual status until they have made timely payments for six consecutive months.

 

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The following table shows our recorded investment in loans classified as TDR that are performing according to their restructured terms at the periods indicated:

 

   At December 31,
(Dollars in thousands)  2016  2015  2014  2013  2012
                
Multi-family residential  $2,572   $2,626   $3,035   $3,087   $2,347 
Commercial real estate   2,062    2,371    2,373    2,407    7,190 
One-to-four family mixed-use property   1,800    2,052    2,381    2,692    2,336 
One-to-four family residential   591    343    354    364    374 
Construction   -    -    -    746    3,805 
Small Business Administration   -    34    -    -    - 
Taxi medallion   9,735    -    -    -    - 
Commercial business and other   675    2,083    2,249    4,406    3,849 
Total performing troubled debt restructured  $17,435   $9,509   $10,392   $13,702   $19,901 

 

Loans that are restructured as TDR but are not performing in accordance with the restructured terms are excluded from the TDR table above, as they are placed on non-accrual status and reported as non-performing loans. At December 31, 2016 and 2015, there was one loan for $0.4 million which was restructured as TDR which was not performing in accordance with its restructured terms.

 

Delinquent Loans and Non-performing Assets. We generally discontinue accruing interest on delinquent loans when a loan is 90 days past due or foreclosure proceedings have been commenced, whichever first occurs. At that time, previously accrued but uncollected interest is reversed from income. Loans in default 90 days or more as to their maturity date but not their payments, however, continue to accrue interest as long as the borrower continues to remit monthly payments.

 

15
 

The following table shows our non-performing assets, including loans held for sale, at the dates indicated. During the years ended December 31, 2016, 2015 and 2014, the amounts of additional interest income that would have been recorded on non-accrual loans, had they been current, totaled $1.5 million, $1.7 million and $2.1 million, respectively. These amounts were not included in our interest income for the respective periods.

 

   At December 31,
(Dollars in thousands)  2016  2015  2014  2013  2012
                
Loans 90 days or more past due                         
and still accruing:                         
Multi-family residential  $-   $233   $676   $52   $- 
Commercial real estate   -    1,183    820    -    - 
One-to-four family mixed-use property   386    611    405    -    - 
One-to-four family - residential   -    13    14    15    - 
Construction   -    1,000    -    -    - 
Commercial Business and other   -    220    386    539    644 
Total   386    3,260    2,301    606    644 
Non-accrual mortgage loans:                         
Multi-family residential   1,837    3,561    6,878    13,682    16,486 
Commercial real estate   1,148    2,398    5,689    9,962    15,640 
One-to-four family mixed-use property   4,025    5,952    6,936    9,063    18,280 
One-to-four family residential   8,241    10,120    11,244    13,250    13,726 
Co-operative apartments   -    -    -    57    234 
Construction   -    -    -    -    7,695 
Total   15,251    22,031    30,747    46,014    72,061 
Non-accrual non-mortgage loans:                         
Small Business Administration   1,886    218    -    -    283 
Taxi Medallion   3,825    -    -    -    - 
Commercial Business and other   68    568    1,143    2,348    16,860 
Total   5,779    786    1,143    2,348    17,143 
                          
Total non-accrual loans   21,030    22,817    31,890    48,362    89,204 
                          
Total non-performing loans   21,416    26,077    34,191    48,968    89,848 
Other non-performing assets:                         
Real Estate Owned   533    4,932    6,326    2,985    5,278 
Investment securities   -    -    -    1,871    3,332 
Total   533    4,932    6,326    4,856    8,610 
                          
Total non-performing assets  $21,949   $31,009   $40,517   $53,824   $98,458 
                          
Non-performing loans to gross loans   0.44%   0.60%   0.90%   1.43%   2.79%
Non-performing assets to total assets   0.36%   0.54%   0.80%   1.14%   2.21%

 

 

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The following table shows our delinquent loans that are less than 90 days past due and still accruing interest at the periods indicated:

 

   December 31, 2016  December 31, 2015
   60 - 89  30 - 59  60 - 89  30 - 59
   days  days  days  days
   (In thousands)  (In thousands)
             
Multi-family residential  $287   $2,575   $804   $9,422 
Commercial real estate   22    3,363    153    2,820 
One-to-four family - mixed-use property   762    4,671    1,257    8,630 
One-to-four family - residential   -    3,831    154    4,261 
Construction loans   -    -    -    - 
Small Business Administration   -    13    -    42 
Commercial business and other   1    22    2    - 
Total  $1,072   $14,475   $2,370   $25,175 

 

Other Real Estate Owned. We aggressively market our Other Real Estate Owned (“OREO”) properties. At December 31, 2016, we owned one OREO properties with a fair value of $0.5 million. At December 31, 2015, we owned four OREO properties with a combined fair value of $4.9 million. At December 31, 2014, we owned eight OREO properties with a combined fair value of $6.3 million.

 

We may obtain physical possession of residential real estate collateralizing a consumer mortgage loan via foreclosure as an in-substance repossession. During the year ended December 31, 2016, we did not foreclose on any consumer mortgages through in-substance repossession. At December 31, 2016, 2015 and 2014, we held foreclosed residential real estate totaling $0.5 million, $0.1 million and $1.3 million, respectively. Included within net loans as of December 31, 2016 was a recorded investment of $11.4 million of consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceedings were in process according to local requirements of the applicable jurisdiction.

 

Environmental Concerns Relating to Loans. We currently obtain environmental reports in connection with the underwriting of commercial real estate loans, and typically obtain environmental reports in connection with the underwriting of multi-family loans. For all other loans, we obtain environmental reports only if the nature of the current or, to the extent known to us, prior use of the property securing the loan indicates a potential environmental risk. However, we may not be aware of such uses or risks in any particular case, and, accordingly, there is no assurance that real estate acquired by us in foreclosure is free from environmental contamination or that, if any such contamination or other violation exists, whether we will have any liability.

 

Classified Assets. Our policy is to review our assets, focusing primarily on the loan portfolio, OREO and the investment portfolios, to ensure that the credit quality is maintained at the highest levels. When weaknesses are identified, immediate action is taken to correct the problem through direct contact with the borrower or issuer. We then monitor these assets, and, in accordance with our policy and current regulatory guidelines, we designate them as “Special Mention,” which is considered a “Criticized Asset,” and “Substandard,” “Doubtful,” or “Loss” which are considered “Classified Assets,” as deemed necessary. These loan designations are updated quarterly. We designate an asset as Substandard when a well-defined weakness is identified that jeopardizes the orderly liquidation of the debt. We designate an asset as Doubtful when it displays the inherent weakness of a Substandard asset with the added provision that collection of the debt in full, on the basis of existing facts, is highly improbable. We designate an asset as Loss if it is deemed the debtor is incapable of repayment. We do not hold any loans designated as loss, as loans that are designated as Loss are charged to the Allowance for Loan Losses. Assets that are non-accrual are designated as Substandard, Doubtful or Loss. We designate an asset as Special Mention if the asset does not warrant designation within one of the other categories, but does contain a potential weakness that deserves closer attention. Our total Criticized and Classified assets were $72.6 million at December 31, 2016, an increase of $17.8 million from $54.8 million at December 31, 2015. The increase in criticized and classified assets was primarily due to an increase in special mention and substandard taxi medallion loans and special mention commercial business and other loans.

 

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The following table sets forth the Bank's Criticized and Classified assets at December 31, 2016:

 

(In thousands)  Special Mention  Substandard  Doubtful  Loss  Total
                
Loans:               
Multi-family residential  $7,133   $3,351   $-   $-   $10,484 
Commercial real estate   2,941    4,489    -    -    7,430 
One-to-four family - mixed-use property   4,197    7,009    -    -    11,206 
One-to-four family - residential   1,205    9,399    -    -    10,604 
Construction loans   -    -    -    -    - 
Small Business Administration   540    436    -    -    976 
Taxi medallion   2,715    16,228    54    -    18,997 
Commercial business and other   9,924    2,493    -    -    12,417 
Total loans   28,655    43,405    54    -    72,114 
                          
Other Real Estate Owned   -    533    -    -    533 
Total  $28,655   $43,938   $54   $-   $72,647 

 

The following table sets forth the Bank's Criticized and Classified assets at December 31, 2015:

 

(In thousands)  Special Mention  Substandard  Doubtful  Loss  Total
                
Loans:               
Multi-family residential  $4,361   $5,421   $-   $-   $9,782 
Commercial real estate   1,821    3,812    -    -    5,633 
One-to-four family - mixed-use property   3,087    10,990    -    -    14,077 
One-to-four family - residential   1,437    12,255    -    -    13,692 
Construction loans   -    1,000    -    -    1,000 
Small Business Administration   229    224    -    -    453 
Taxi medallion   -    2,118    -    -    2,118 
Commercial business and other   -    3,123    -    -    3,123 
Total loans   10,935    38,943    -    -    49,878 
                          
Other Real Estate Owned   -    4,932    -    -    4,932 
Total  $10,935   $43,875   $-   $-   $54,810 

 

On a quarterly basis all mortgage loans that are classified as Substandard or Doubtful are internally reviewed for impairment, based on updated cash flows for income producing properties, or updated independent appraisals. The loan balances of collateral dependent loans reviewed for impairment are then compared to the loans updated fair value. We consider fair value of collateral dependent loans to be 85% of the appraised or internally estimated value of the property, except for taxi medallion loans. The fair value of the underlying collateral of taxi medallion loans is the most recent reported arm’s length transaction. The balance which exceeds fair value is generally charged-off against the allowance for loan losses. At December 31, 2016, the current loan-to-value ratio on our collateral dependent loans reviewed for impairment was 48.15%.

 

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Allowance for Loan Losses

 

We have established and maintain on our books an allowance for loan losses (“ALL”) that is designed to provide a reserve against estimated losses inherent in our overall loan portfolio. The allowance is established through a provision for loan losses based on management’s evaluation of the risk inherent in the various components of the loan portfolio and other factors, including historical loan loss experience (which is updated quarterly), current economic conditions, delinquency and non-accrual trends, classified loan levels, risk in the portfolio and volumes and trends in loan types, recent trends in charge-offs, changes in underwriting standards, experience, ability and depth of our lenders, collection policies and experience, internal loan review function and other external factors. Additionally, we segregated our loans into two portfolios based on year of origination. One portfolio is loans originated after December 31, 2009 and the second portfolio loans originated prior to January 1, 2010. Our decision to segregate the portfolio based upon origination dates was based on changes made in our underwriting standards during 2009. By the end of 2009, all loans were being underwritten based on revised and tightened underwriting standards. Loans originated prior to 2010 have a higher delinquency rate and loss history. Each of the years in the portfolio for loans originated prior to 2010 has a similar delinquency rate. The determination of the amount of the allowance for loan losses includes estimates that are susceptible to significant changes due to changes in appraisal values of collateral, national and local economic conditions and other factors. We review our loan portfolio by separate categories with similar risk and collateral characteristics. Impaired loans are segregated and reviewed separately. All non-accrual loans are classified impaired. Impaired loans secured by collateral are reviewed based on the fair value of their collateral. For non-collateralized impaired loans, management estimates any recoveries that are anticipated for each loan. In connection with the determination of the allowance, the market value of collateral ordinarily is evaluated by our staff appraiser. On a quarterly basis, the estimated values of impaired mortgage loans are internally reviewed, based on updated cash flows for income producing properties, and at times an updated independent appraisal is obtained. The loan balances of collateral dependent impaired loans are then compared to the property’s updated fair value. We consider fair value of collateral dependent loans to be 85% of the appraised or internally estimated value of the property. The fair value of the underlying collateral of taxi medallion loans is the value of the underlying medallion based upon the most recently reported arm’s length transaction. When there is no recent sale activity, the fair value is calculated using capitalization rates. In addition, taxi medallion loans with a loan-to-value greater than 100% are classified as impaired and allocated a portion of the reserve in the amount of the excess of the loan-to-value over the loan’s principal balance. The balance which exceeds fair value is generally charged-off, except for taxi medallion loans. The 85% is based on the actual net proceeds the Bank has received from the sale of OREO as a percentage of OREO’s appraised value. When evaluating a loan for impairment, we do not rely on guarantees, and the amount of impairment, if any, is based on the fair value of the collateral. We do not carry loans at a value in excess of the fair value due to a guarantee from the borrower. Impaired mortgage loans that were written down resulted from quarterly reviews or updated appraisals that indicated the properties’ estimated value had declined from when the loan was originated. The Board of Directors reviews and approves the adequacy of the allowance for loan losses on a quarterly basis.

 

In assessing the adequacy of the allowance, we review our loan portfolio by separate categories which have similar risk and collateral characteristics, e.g., multi-family residential, commercial real estate, one-to-four family mixed-use property, one-to-four family residential, co-operative apartment, construction, SBA, commercial business, taxi medallion and consumer loans. General provisions are established against performing loans in our portfolio in amounts deemed prudent based on our qualitative analysis of the factors, including the historical loss experience, delinquency trends and local economic conditions. Non-performing loans totaled $21.4 million and $26.1 million at December 31, 2016 and 2015, respectively. The Bank’s underwriting standards generally require a loan-to-value ratio of no more than 75% at the time the loan is originated. At December 31, 2016, the outstanding principal balance of our impaired mortgage loans was approximately 39% of the estimated current value of the supporting collateral, after considering the charge-offs that have been recorded. We incurred total net recoveries (charge-offs) of $0.7 million and ($2.6) million during the years ended December 31, 2016 and 2015, respectively. The improvement in non-performing loans allowed us to not record a provision for the year ended December 31, 2016 and record a benefit in the provision for loan losses of $1.0 million and $6.0 million for the years ended December 31, 2015 and 2014, respectively. Management has concluded, and the Board of Directors has concurred, that at December 31, 2016, the allowance was sufficient to absorb losses inherent in our loan portfolio.

 

Our determination as to the classification of our assets and the amount of our valuation allowance is subject to review by our regulators, which can require the establishment of additional general allowances or specific loss allowances or require charge-offs. Such authorities may require us to make additional provisions to the allowance based on their judgments about information available to them at the time of their examination. A policy statement provides guidance for examiners in determining whether the levels of general valuation allowances for banking institutions are adequate. The policy statement requires that if a bank’s general valuation allowance policies and procedures are deemed to be inadequate, recommendations for correcting deficiencies, including any examiner concerns regarding the level of the allowance, should be noted in the report of examination. Additional supervisory action may also be taken based on the magnitude of the observed shortcomings in the allowance process, including the materiality of any error in the reported amount of the allowance.

 

19
 

During the year ended December 31, 2106, the portion of the ALL related to the loss history declined. Charge-offs recorded in the past twelve quarters have decreased as credit conditions have improved. The percentage of loans originated prior to 2009, compared to the total loan portfolio, is decreasing as scheduled amortization and repayments have occurred. These reductions in the ALL were partially offset by an additional allocation to our taxi medallion portfolio coupled with an increase in the outstanding loan balances. Management believes that our current allowance for loan losses is adequate in light of current economic conditions, the composition of our loan portfolio, the level and type of delinquent loans, our level of classified loans, charge-offs recorded and other available information and the Board of Directors concurs in this belief. At December 31, 2016, the total allowance for loan losses was $22.2 million, representing 103.80% of non-performing loans and 101.28% of non-performing assets, compared to 82.58% of non-performing loans and 69.45% of non-performing assets at December 31, 2015. We continue to monitor and, as necessary, modify the level of our allowance for loan losses in order to maintain the allowance at a level which we consider adequate to provide for probable loan losses based on available information.

 

Many factors may require additions to the allowance for loan losses in future periods beyond those currently revealed. These factors include further adverse changes in economic conditions, changes in interest rates and changes in the financial capacity of individual borrowers (any of which may affect the ability of borrowers to make repayments on loans), changes in the real estate market within our lending area and the value of collateral, or a review and evaluation of our loan portfolio in the future. The determination of the amount of the allowance for loan losses includes estimates that are susceptible to significant changes due to changes in appraised values of collateral, national and local economic conditions, interest rates and other factors. In addition, our overall level of credit risk inherent in our loan portfolio can be affected by the loan portfolio’s composition. At December 31, 2016, multi-family residential, commercial real estate, construction and one-to-four family mixed-use property mortgage loans, totaled 82.9% of our gross loans. The greater risk associated with these loans, as well as business loans, could require us to increase our provisions for loan losses and to maintain an allowance for loan losses as a percentage of total loans that is in excess of the allowance we currently maintain. Provisions for loan losses are charged against net income. See “—Lending Activities” and “—Asset Quality.”

 

20
 

The following table sets forth changes in, and the balance of, our allowance for loan losses.

 

   At and for the years ended December 31,
(Dollars in thousands)  2016  2015  2014  2013  2012
                
Balance at beginning of year  $21,535   $25,096   $31,776   $31,104   $30,344 
                          
Provision (benefit) for loan losses   -    (956)   (6,021)   13,935    21,000 
                          
Loans charged-off:                         
Multi-family residential   (161)   (474)   (1,161)   (3,585)   (6,016)
Commercial real estate   -    (32)   (325)   (1,051)   (2,746)
One-to-four family mixed-use property   (144)   (592)   (423)   (4,206)   (4,286)
One-to-four family residential   (114)   (342)   (103)   (701)   (1,583)
Co-operative apartment   -    -    -    (108)   (62)
Construction   -    -    -    (2,678)   (4,591)
SBA   (529)   (34)   (49)   (457)   (324)
Taxi Medallion   (142)   -    -    -    - 
Commercial business and other loans   (69)   (2,371)   (381)   (2,057)   (1,661)
Total loans charged-off   (1,159)   (3,845)   (2,442)   (14,843)   (21,269)
                          
Recoveries:                         
Mortgage loans   1,493    888    1,515    1,407    838 
SBA, commercial business and other loans   360    352    268    173    191 
Total recoveries   1,853    1,240    1,783    1,580    1,029 
                          
Net recoveries (charge-offs)   694    (2,605)   (659)   (13,263)   (20,240)
                          
Balance at end of year  $22,229   $21,535   $25,096   $31,776   $31,104 
                          
Ratio of net (recoveries) charge-offs during the year                         
to average loans outstanding during the year   -0.02%   0.06%   0.02%   0.41%   0.64%
Ratio of allowance for loan losses to                         
gross loans at end of the year   0.46%   0.49%   0.66%   0.93%   0.97%
Ratio of allowance for loan losses to                         
non-performing loans at the end of the year   103.80%   82.58%   73.40%   64.89%   34.62%
Ratio of allowance for loan losses to                         
non-performing assets at the end of the year   101.28%   69.45%   61.94%   59.04%   31.59%

 

21
 

The following table sets forth our allocation of the allowance for loan losses to the total amount of loans in each of the categories listed at the dates indicated. The numbers contained in the “Amount” column indicate the allowance for loan losses allocated for each particular loan category. The numbers contained in the column entitled “Percentage of Loans in Category to Total Loans” indicate the total amount of loans in each particular category as a percentage of our loan portfolio.

 

   At December 31,
   2016  2015  2014  2013  2012
      Percent     Percent     Percent     Percent     Percent
      of Loans in     of Loans in     of Loans in     of Loans in     of Loans in
      Category to     Category to     Category to     Category to     Category to
Loan Category  Amount  Total loans  Amount  Total loans  Amount  Total loans  Amount  Total loans  Amount  Total loans
   (Dollars in thousands)
Mortgage loans:                                                  
                                                   
Multi-family residential  $5,923    45.21%  $6,718    46.98%  $8,827    50.64%  $12,084    50.02%  $13,001    47.62%
Commercial real estate   4,487    25.86    4,239    22.90    4,202    16.36    4,959    14.97    5,705    16.00 
One-to-four family                                                  
mixed-use property   2,903    11.59    4,227    13.11    5,840    15.10    6,328    17.40    5,960    19.79 
One-to-four family                                                  
residential   1,015    3.85    1,227    4.30    1,690    4.94    2,079    5.66    1,999    6.18 
Co-operative apartment   -    0.15    -    0.19    -    0.26    104    0.30    46    0.20 
Construction   92    0.24    50    0.17    42    0.14    444    0.12    66    0.45 
                                                   
Gross mortgage loans   14,420    86.90    16,461    87.65    20,601    87.44    25,998    88.47    26,777    90.24 
                                                   
Non-mortgage loans:                                                  
                                                   
Small Business Administration   481    0.32    262    0.28    279    0.19    458    0.23    505    0.29 
Taxi Medallion   2,243    0.39    343    0.48    11    0.59    -    0.38    7    0.31 
Commercial business and other   4,492    12.39    4,469    11.59    4,205    11.78    5,320    10.92    3,815    9.16 
                                                   
Gross non-mortgage loans   7,216    13.10    5,074    12.35    4,495    12.56    5,778    11.53    4,327    9.76 
                                                   
Unallocated   593    -    -    -    -    -    -    -    -    - 
Total loans  $22,229    100.00%  $21,535    100.00%  $25,096    100.00%  $31,776    100.00%  $31,104    100.00%

 

 

22
 

Investment Activities

 

General. Our investment policy, which is approved by the Board of Directors, is designed primarily to manage the interest rate sensitivity of our overall assets and liabilities, to generate a favorable return without incurring undue interest rate and credit risk, to complement our lending activities and to provide and maintain liquidity. In establishing our investment strategies, we consider our business and growth strategies, the economic environment, our interest rate risk exposure, our interest rate sensitivity “gap” position, the types of securities to be held, and other factors. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Overview—Management Strategy” in Item 7 of this Annual Report.

 

Although we have authority to invest in various types of assets, we primarily invest in mortgage-backed securities, securities issued by mutual or bond funds that invest in government and government agency securities, municipal bonds, corporate bonds and collateralized loan obligations (“CLO”). We did not hold any issues of foreign sovereign debt at December 31, 2016 and 2015.

 

Our Investment Committee meets quarterly to monitor investment transactions and to establish investment strategy. The Board of Directors reviews the investment policy on an annual basis and investment activity on a monthly basis.

 

We classify our investment securities as available for sale when management intends to hold the securities for an indefinite period of time or when the securities may be utilized for tactical asset/liability purposes and may be sold from time to time to effectively manage interest rate exposure and resultant prepayment risk and liquidity needs. Securities are classified as held-to-maturity when management intends to hold the securities until maturity. We carry some of our investments under the fair value option. Unrealized gains and losses for investments carried under the fair value option are included in our Consolidated Statements of Income. Unrealized gains and losses on securities available for sale, other than unrealized credit losses considered other than temporary, are excluded from earnings and included in accumulated other comprehensive loss (a separate component of equity), net of taxes. Securities held-to-maturity are carried at their cost basis. At December 31, 2016, we had $861.4 million in securities available for sale and $37.7 million in securities held-to-maturity, which together represented 14.83% of total assets. These securities had an aggregate market value at December 31, 2016 that was approximately 1.7 times the amount of our equity at that date.

 

There were no credit related OTTI charges recorded during the years ended December 31, 2016, 2015 and 2014. As a result of the magnitude of our holdings of securities available for sale, changes in interest rates could produce significant changes in the value of such securities and could produce significant fluctuations in our operating results and equity. (See Notes 6 and 18 of Notes to Consolidated Financial Statements, included in Item 8 of this Annual Report.)

 

23
 

The table below sets forth certain information regarding the amortized cost and market values of our securities portfolio, interest-earning deposits and federal funds sold, at the dates indicated. Securities available for sale are recorded at market value. (See Notes 6 and 18 of Notes to Consolidated Financial Statements, included in Item 8 of this Annual Report.)

 

   At December 31,
   2016  2015  2014
   Amortized  Fair  Amortized  Fair  Amortized  Fair
   Cost  Value  Cost  Value  Cost  Value
   (In thousands)
                   
Securities held-to-maturity                              
Bonds and other debt securities:                              
Municipal securities  $37,735   $35,408   $6,180   $6,180   $-   $- 
Total bonds and other debt securities   37,735    35,408    6,180    6,180    -    - 
                               
Securities available for sale                              
Bonds and other debt securities:                              
Municipal securities   124,984    126,903    127,696    131,583    145,864    148,896 
Corporate debentures   110,000    102,910    115,976    111,674    90,719    91,273 
Collateralized loan obligations   85,470    86,365    53,225    52,898    -    - 
Total bonds and other debt securities   320,454    316,178    296,897    296,155    236,583    240,169 
                               
Mutual funds   21,366    21,366    21,290    21,290    21,118    21,118 
                               
Equity securities:                              
Common stock   1,019    1,019    871    871    864    864 
Preferred stock   6,344    6,342    6,343    6,341    6,234    6,226 
Total equity securities   7,363    7,361    7,214    7,212    7,098    7,090 
                               
Mortgage-backed securities:                              
REMIC and CMO   402,636    401,370    469,987    469,936    504,207    505,768 
GNMA   1,319    1,427    11,635    11,798    13,862    14,159 
FNMA   109,493    108,351    170,327    170,057    169,956    170,367 
FHLMC   5,378    5,328    16,961    16,949    14,505    14,639 
Total mortgage-backed securities   518,826    516,476    668,910    668,740    702,530    704,933 
                               
Total securities available for sale   868,009    861,381    994,311    993,397    967,329    973,310 
                               
Interest-earning deposits and                              
Federal funds sold   25,771    25,771    32,825    32,825    22,977    22,977 
                               
Total  $931,515   $922,560   $1,033,316   $1,032,402   $990,306   $996,287 

 

Mortgage-backed securities. At December 31, 2016, we had $516.5 million invested in mortgage-backed securities, of which $2.8 million was invested in adjustable-rate mortgage-backed securities. The mortgage loans underlying these adjustable-rate securities generally are subject to limitations on annual and lifetime interest rate increases. We anticipate that investments in mortgage-backed securities may continue to be used in the future to supplement mortgage-lending activities. Mortgage-backed securities are more liquid than individual mortgage loans and may be used more easily to collateralize our obligations, including collateralizing of the governmental deposits of the Bank.

 

24
 

The following table sets forth our mortgage-backed securities purchases, sales and principal repayments for the years indicated:

 

   For the years ended December 31,
   2016  2015  2014
   (In thousands)
          
Balance at beginning of year  $668,740   $704,933   $756,156 
                
Purchases of mortgage-backed securities   90,572    169,383    125,897 
                
Amortization of unearned premium, net of               
accretion of unearned discount   (2,086)   (2,747)   (2,699)
                
Net change in unrealized gains on mortgage-backed               
securities available for sale   (2,180)   (2,573)   11,117 
                
Net realized gains (losses) recorded on mortgage-backed               
securities carried at fair value   (33)   77    84 
                
Net change in interest due on securities carried at fair value   -    (6)   (8)
                
Sales of mortgage-backed securities   (126,045)   (103,100)   (85,021)
                
Principal repayments received on               
mortgage-backed securities   (112,492)   (97,227)   (100,593)
                
Net decrease in mortgage-backed securities   (152,264)   (36,193)   (51,223)
                
Balance at end of year  $516,476   $668,740   $704,933 

 

While mortgage-backed securities carry a reduced credit risk as compared to whole loans, such securities remain subject to the risk that a fluctuating interest rate environment, along with other factors such as the geographic distribution of the underlying mortgage loans, may alter the prepayment rate of such mortgage loans and so affect both the prepayment speed and value of such securities.

 

25
 

The table below sets forth certain information regarding the amortized cost, fair value, annualized weighted average yields and maturities of our investment in debt and equity securities and interest-earning deposits at December 31, 2016. The stratification of balances is based on stated maturities. Assumptions for repayments and prepayments are not reflected for mortgage-backed securities. Securities available for sale are carried at their fair value in the consolidated financial statements and securities held-to-maturity are carried at their amortized cost.

 

   One year or Less  One to Five Years  Five to Ten Years  More than Ten Years  Total Securities
                           Average         
      Weighted     Weighted     Weighted     Weighted  Remaining        Weighted
   Amortized  Average  Amortized  Average  Amortized  Average  Amortized  Average  Years to  Amortized  Fair  Average
   Cost  Yield  Cost  Yield  Cost  Yield  Cost  Yield  Maturity  Cost  Value  Yield
   (Dollars in thousands)   
                                     
Securities held-to-maturity                                                            
                                                             
Bonds and other debt securities:                                                            
Municipal securities  $15,870    1.04%  $-    -%  $-    -%  $21,865    3.27%   15.41   $37,735   $35,408    2.33%
Total bonds and other debt securities   15,870    1.04    -    -    -    -    21,865    3.27    15.41    37,735    35,408    2.33 
                                                             
Securities available for sale                                                            
                                                             
Bonds and other debt securities:                                                            
Municipal securities  $-    -%  $1,781    4.86%  $19,430    4.52%  $103,773    4.72%   14.76   $124,984   $126,903    4.69%
Corporate debentures   -    -    -    -    55,000    2.89    55,000    4.05    9.17    110,000    102,910    3.47 
CLO   -    -    -    -    36,919    2.87    48,551    3.18    10.02    85,470    86,365    3.05 
Total bonds and other debt securities   -    -    1,781    4.86    111,349    3.17    207,324    4.18    11.58    320,454    316,178    3.83 
                                                             
Mutual funds   21,366    1.84    -    -    -    -    -    -     N/A     21,366    21,366    1.84 
                                                             
Equity securities:                                                            
Common stock   -    -    -    -    -    -    1,019    4.28     N/A     1,019    1,019    4.28 
Preferred stock   -    -    -    -    -    -    6,344    6.95     N/A     6,344    6,342    6.95 
Total equity securities   -    -    -    -    -    -    7,363    6.58     N/A     7,363    7,361    6.58 
                                                             
Mortgage-backed securities:                                                            
REMIC and CMO   -    -    5,073    4.22    7,891    2.99    389,672    2.85    27.31    402,636    401,370    2.87 
GNMA   -    -    -    -    -    -    1,319    5.90    18.44    1,319    1,427    5.90 
FNMA   4    6.00    9,915    3.65    26,268    2.44    73,306    2.89    14.76    109,493    108,351    2.85 
FHLMC   -    -    65    6.41    1,195    4.27    4,118    3.33    23.55    5,378    5,328    3.58 
Total mortgage-backed securities   4    6.00    15,053    3.85    35,354    2.62    468,415    2.87    24.60    518,826    516,476    2.88 
                                                             
Interest-earning deposits   25,771    0.75    -    -    -    -    -    -     N/A     25,771    25,771    0.75 
                                                             
Total  $63,011    1.19%  $16,834    3.96%  $146,703    3.04%  $704,967    3.31%   20.32   $931,515   $922,560    3.13%

 

26
 

Sources of Funds

 

General. Deposits, FHLB-NY borrowings, other borrowings, repurchase agreements, principal and interest payments on loans, mortgage-backed and other securities, and proceeds from sales of loans and securities are our primary sources of funds for lending, investing and other general purposes.

 

Deposits. We offer a variety of deposit accounts having a range of interest rates and terms. Our deposits primarily consist of savings accounts, money market accounts, demand accounts, NOW accounts and certificates of deposit. We have a relatively stable retail deposit base drawn from our market area through our 19 full-service offices. We seek to retain existing depositor relationships by offering quality service and competitive interest rates, while keeping deposit growth within reasonable limits. It is management’s intention to balance its goal to maintain competitive interest rates on deposits while seeking to manage its cost of funds to finance its strategies.

 

In addition to our full-service offices we have an internet branch “iGObanking.com®”, which currently offers savings accounts, money market accounts, checking accounts, and certificates of deposit. This allows us to compete on a national scale without the geographical constraints of physical locations. Since the number of U.S. households with accounts at Web-only banks has grown, our strategy was to join the market place by creating a branch that offers clients the simplicity and flexibility of a virtual online bank, which is a division of a stable, traditional bank that was established in 1929. At December 31, 2016 and 2015, total deposits for iGObanking.com® were $417.3 million and $323.7 million, respectively.

 

We have a government banking division, which prior to the Merger in 2013 operated as the Commercial Bank, a New York State-chartered commercial bank, which provided banking services to public municipalities, including counties, cities, towns, villages, school districts, libraries, fire districts, and the various courts throughout the New York City metropolitan area as an additional source of deposits. At December 31, 2016 and 2015, total deposits in our government banking division totaled $1,062.1 million and $975.9 million, respectively.

 

Our core deposits, consisting of savings accounts, NOW accounts, money market accounts, and non-interest bearing demand accounts, are typically more stable and lower costing than other sources of funding. However, the flow of deposits into a particular type of account is influenced significantly by general economic conditions, changes in prevailing interest rates, and competition. We experienced an increase in our due to depositors’ during 2016 of $309.7 million. During the year ended December 31, 2016, the cost of our interest-bearing due to depositors’ accounts increased one basis point to 0.89% from 0.88% for the year ended December 31, 2015. This increase in the cost of deposits was primarily due to increases in the cost of money market, NOW and savings accounts of 21 basis points, seven basis points and four basis points, respectively, partially offset by a decrease of nine basis points in the cost of certificates of deposit. The increase in the cost of money market accounts was primarily due to our shifting of Government NOW deposits to a money market product which does not require us to provide collateral, allowing us to invest these funds in higher yielding assets. The cost of NOW and savings accounts increased as we increased the rate we pay on some of our products to attract additional deposits. The decrease in the cost of certificates of deposit was primarily due to maturing issuances being replaced at lower rates. While we are unable to predict the direction of future interest rate changes, if interest rates rise during 2017, the result could be an increase in our cost of deposits, which could reduce our net interest margin. Similarly, if interest rates remain at their current level or decline in 2017, we could see a decline in our cost of deposits, which could increase our net interest margin.

 

Included in deposits are certificates of deposit with balances of $100,000 or more (excluding brokered deposits issued in $1,000 amounts under a master certificate of deposit) totaling $648.1 million, $484.7 million and $403.1 million at December 31, 2016, 2015 and 2014, respectively.

 

We utilize brokered deposits as an additional funding source and to assist in the management of our interest rate risk. We have obtained brokered certificates of deposit when the interest rate on these deposits is below the prevailing interest rate for non-brokered certificates of deposit with similar maturities in our market, or when obtaining them allowed us to extend the maturities of our deposits at favorable rates compared to borrowing funds with similar maturities, when we are seeking to extend the maturities of our funding to assist in the management of our interest rate risk. Brokered certificates of deposit provide a large deposit for us at a lower operating cost as compared to non-brokered certificates of deposit since we only have one account to maintain versus several accounts with multiple interest and maturity checks. The Depository Trust Company is used as the clearing house, maintaining each deposit under the name of CEDE & Co. These deposits are transferable just like a stock or bond investment and the customer can open the account with only a phone call, just like buying a stock or bond. Unlike non-brokered certificates of deposit, where the deposit amount can be withdrawn with a penalty for any reason, including increasing interest rates, a brokered certificate of deposit can only be withdrawn in the event of the death, or court declared mental incompetence, of the depositor. This allows us to better manage the maturity of our deposits and our interest rate risk. We also utilized brokers to obtain money market account deposits. The rate we pay on brokered money market accounts is the same or below the rate we pay on non-brokered money market accounts, and the rate is agreed to in a contract between the Bank and the broker. These accounts are similar to brokered certificates of deposit accounts in that we only maintain one account for the total deposit per broker, with the broker maintaining the detailed records of each depositor.

 

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We also offer access to FDIC insurance coverage in excess of $250,000 through a Certificate of Deposit Account Registry Service (“CDARS®”) and through an Insured Cash Sweep service (“ICS”). CDARS® and ICS are deposit placement services. These networks arrange for placement of funds into certificate of deposit accounts or money market accounts issued by other member banks of the network in increments of less than $250,000 to ensure that both principal and interest are eligible for full FDIC deposit insurance. This allows us to accept deposits in excess of $250,000 from a depositor, and place the deposits through the network to other member banks to provide full FDIC deposit insurance coverage. We may receive deposits from other member banks in exchange for the deposits we place into the network. We may also obtain deposits from other network member banks without placing deposits into the network. We will obtain deposits in this manner primarily as a short-term funding source. We also can place deposits with other member banks without receiving deposits from other member banks. Depositors are allowed to withdraw funds, with a penalty, from these accounts at one or more of the member banks that hold the deposits. Additionally, we place a portion of our government deposits in an ICS brokered money market product which does not require us to provide collateral. This allows us to invest our funds in higher yielding assets. At December 31, 2016 and 2015 the Bank held government ICS deposits totaling $539.0 million and $210.7 million, respectively.

 

We also utilize brokers to obtain money market account deposits. These accounts are similar to brokered certificate of deposit accounts in that we only maintain one account for the total deposit per broker, with the broker maintaining the detailed records of each depositor.

 

Traditional brokered deposits and funds obtained through the CDARS® and ICS networks are classified as brokered deposits for financial reporting purposes. At December 31, 2016, we had $1,114.9 million classified as brokered deposits, with $458.8 million in brokered certificates of deposit, $655.0 million in brokered money market accounts and $1.1 million in brokered checking accounts. The brokered certificates of deposit include $28.8 million obtained through the CDARS® network and the brokered money market accounts include $539.0 million obtained through the ICS network.

 

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The following table sets forth the distribution of our deposit accounts at the dates indicated and the weighted average nominal interest rates on each category of deposits presented.

 

   At December 31,
   2016  2015  2014
         Weighted        Weighted        Weighted
      Percent  Average     Percent  Average     Percent  Average
      of Total  Nominal     of Total  Nominal     of Total  Nominal
   Amount  Deposits  Rate  Amount  Deposits  Rate  Amount  Deposits  Rate
   (Dollars in thousands)
                            
Savings accounts  $254,283    6.05%   0.48%  $261,748    6.72%   0.45%  $261,942    7.47%   0.38%
NOW accounts (9)   1,362,484    32.40    0.59    1,448,695    37.22    0.49    1,359,057    38.74    0.45 
Demand accounts (10)   333,163    7.92    -    269,469    6.92    -    255,834    7.29    - 
Mortgagors' escrow deposits   40,216    0.96    0.22    36,844    0.95    0.17    35,679    1.02    0.09 
Total   1,990,146    47.32    0.47    2,016,756    51.81    0.42    1,912,512    54.51    0.37 
                                              
Money market accounts (8)   843,370    20.05    0.67    472,489    12.14    0.46    290,263    8.27    0.32 
                                              
Certificate of deposit accounts                                             
with original maturities of:                                             
Less than 6 Months (2)   31,432    0.75    0.64    19,615    0.50    0.40    7,059    0.20    0.10 
6 to less than 12 Months (3)   53,222    1.27    0.99    21,962    0.56    0.41    82,966    2.36    0.80 
12 to less than 30 Months (4)   588,751    14.00    1.18    496,343    12.75    1.08    275,828    7.86    0.89 
30 to less than 48 Months (5)   281,454    6.69    1.26    316,475    8.13    1.20    198,290    5.65    1.08 
48 to less than 72 Months (6)   369,630    8.79    1.83    461,843    11.86    1.73    622,908    17.75    2.06 
72 Months or more (7)   47,626    1.13    2.86    87,064    2.24    2.77    118,772    3.39    2.88 
Total certificate of deposit accounts   1,372,115    32.63    1.41    1,403,302    36.05    1.41    1,305,823    37.22    1.65 
                                              
Total deposits (1)  $4,205,631    100.00%   0.82%  $3,892,547    100.00%   0.78%  $3,508,598    100.00%   0.84%

 

(1)Included in the above balances are IRA and Keogh deposits totaling $69.3 million, $71.5 million and $91.0 million at December 31, 2016, 2015 and 2014, respectively.
(2)Includes brokered deposits of $29.1 million, $5.0 million and $3.0 million at December 31, 2016, 2015 and 2014, respectively.
(3)Includes brokered deposits of $0.8 million and $5.7 million at December 31, 2015 and 2014, respectively, and zero at December 31, 2016.
(4)Includes brokered deposits of $84.0 million, $168.2 million and $85.9 million at December 31, 2016, 2015 and 2014, respectively.
(5)Includes brokered deposits of $229.5 million, $244.6 million and $145.2 million at December 31, 2016, 2015 and 2014, respectively.
(6)Includes brokered deposits of $113.0 million, $165.6 million and $271.4 million at December 31, 2016, 2015 and 2014, respectively.
(7)Includes brokered deposits of $3.1 million, $41.0 million and $72.4 million at December 31, 2016, 2015 and 2014, respectively.
(8)Includes brokered deposits of $655.0 million, $339.8 million and $180.2 million at December 31, 2016, 2015 and 2014, respectively.
(9)Includes brokered deposits of $15.0 million at December 31, 2015, and zero at December 31, 2016 and 2014.
(10)Includes brokered deposits of $1.1 million and $2.8 million at December 31, 2016 and 2015, respectively.

 

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The following table presents by various rate categories, the amount of time deposit accounts outstanding at the dates indicated, and the years to maturity of the certificate accounts outstanding at December 31, 2016.

 

               At December 31, 2016
      At December 31,  Within  One to   
      2016  2015  2014  One Year  Three Years  Thereafter
      (In thousands)
Interest rate:                                 
1.99% or less  (1)  $1,107,882   $1,074,229   $817,100   $631,816   $447,776   $28,290 
2.00% to 2.99%  (2)   237,122    279,688    301,445    12,516    200,078    24,528 
3.00% to 3.99%  (3)   27,111    49,385    184,172    4    1,940    25,167 
Total       $1,372,115   $1,403,302   $1,302,717   $644,336   $649,794   $77,985 

 

(1)Includes brokered deposits of $442.4 million, $542.3 million and $435.3 million at December 31, 2016, 2015 and 2014, respectively.
(2)Includes brokered deposits of $16.4 million, $59.9 million and $83.1 million at December 31, 2016, 2015 and 2014, respectively.
(3)Includes brokered deposits of $23.0 million and $65.3 million at December 31, 2015 and 2014, respectively.

 

The following table presents by remaining maturity categories the amount of certificate of deposit accounts with balances of $100,000 or more at December 31, 2016 and their annualized weighted average interest rates.

 

      Weighted
   Amount  Average Rate
   (Dollars in thousands)
Maturity Period:          
Three months or less  $159,371    1.16%
Over three through six months   66,237    1.20 
Over six through 12 months   47,632    1.37 
Over 12 months   374,858    1.59 
Total  $648,098    1.43%

 

The above table does not include brokered deposits issued in $1,000 amounts under a master certificate of deposit totaling $393.5 million with a weighted average rate of 1.30%.

 

The following table presents the deposit activity, including mortgagors’ escrow deposits, for the periods indicated.

 

   For the year ended December 31,
   2016  2015  2014
    (In thousands)
Net deposits  $278,793   $352,602   $244,830 
Amortization of premiums, net   747    1,012    944 
Interest on deposits   33,350    30,336    30,044 
Net increase in deposits  $312,890   $383,950   $275,818 

 

 

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The following table sets forth the distribution of our average deposit accounts for the years indicated, the percentage of total deposit portfolio, and the average interest cost of each deposit category presented. Average balances for all years shown are derived from daily balances.

 

   At December 31,
   2016  2015  2014
                            
      Percent        Percent        Percent   
   Average  of Total  Average  Average  of Total  Average  Average  of Total  Average
   Balance  Deposits  Cost  Balance  Deposits  Cost  Balance  Deposits  Cost
   (Dollars in thousands)
                            
Savings accounts  $260,948    6.35%   0.47%  $264,891    7.10%   0.43%  $258,243    7.70%   0.23%
NOW accounts   1,496,712    36.41    0.53    1,432,609    38.38    0.46    1,390,899    41.47    0.45 
Demand accounts   305,096    7.42    -    250,488    6.71    -    211,389    6.30    - 
Mortgagors' escrow deposits   56,152    1.37    0.20    52,364    1.40    0.19    47,876    1.43    0.28 
Total   2,118,908    51.55    0.44    2,000,352    53.59    0.39    1,908,407    56.90    0.37 
                                              
Money market accounts   581,390    14.15    0.62    380,595    10.20    0.41    245,752    7.33    0.27 
                                              
Certificate of deposit accounts   1,409,772    34.30    1.46    1,351,619    36.21    1.55    1,199,849    35.77    1.87 
Total deposits  $4,110,070    100.00%   0.81%  $3,732,566    100.00%   0.81%  $3,354,008    100.00%   0.90%

 

Borrowings. Although deposits are our primary source of funds, we also use borrowings as an alternative and cost effective source of funds for lending, investing and other general purposes. The Bank is a member of, and is eligible to obtain advances from, the FHLB-NY. Such advances generally are secured by a blanket lien against the Bank’s mortgage portfolio and the Bank’s investment in the stock of the FHLB-NY. In addition, the Bank may pledge mortgage-backed securities to obtain advances from the FHLB-NY. See “— Regulation — Federal Home Loan Bank System.” The maximum amount that the FHLB-NY will advance for purposes other than for meeting withdrawals fluctuates from time to time in accordance with the policies of the FHLB-NY. The Bank may also enter into repurchase agreements with broker-dealers and the FHLB-NY. These agreements are recorded as financing transactions and the obligations to repurchase are reflected as a liability in our consolidated financial statements. In addition, we issued junior subordinated debentures with a total par of $61.9 million in June and July 2007. These junior subordinated debentures are carried at fair value in the Consolidated Statement of Financial Condition. During the year ended December 31, 2016, the Holding Company issued subordinated debt with an aggregated principal amount of $75.0 million, receiving net proceeds totaling $73.4 million. The subordinated debt was issued at 5.25% fixed-to-floating rate maturing in 2026. The debt is callable at par quarterly through its maturity date beginning December 15, 2021.

 

The average cost of borrowings was 1.67%, 1.76% and 2.49% for the years ended December 31, 2016, 2015 and 2014, respectively. The average balances of borrowings were $1,231,0 million, $1,104.4 million and $993.8 million for the same years, respectively.

 

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The following table sets forth certain information regarding our borrowings at or for the periods ended on the dates indicated.

 

   At or for the years ended December 31,
   2016  2015  2014
   (Dollars in thousands)
Securities Sold with the Agreement to Repurchase (1)               
Average balance outstanding  $64,087   $116,000   $137,824 
Maximum amount outstanding at any month               
end during the period   116,000    116,000    155,300 
Balance outstanding at the end of period   -    116,000    116,000 
Weighted average interest rate during the period   3.26%   3.22%   3.40%
Weighted average interest rate at end of period    n/a     3.18    3.18 
                
FHLB-NY Advances (1)               
Average balance outstanding  $1,123,411   $947,370   $826,132 
Maximum amount outstanding at any month               
end during the period   1,337,265    1,106,658    936,813 
Balance outstanding at the end of period   1,159,190    1,106,658    911,721 
Weighted average interest rate during the period   1.46%   1.48%   1.60%
Weighted average interest rate at end of period   1.17    1.40    1.44 
                
Other Borrowings               
Average balance outstanding  $43,516   $40,998   $29,834 
Maximum amount outstanding at any month               
end during the period   107,373    89,479    30,352 
Balance outstanding at the end of period   107,373    49,018    28,771 
Weighted average interest rate during the period   4.76%   4.02%   5.30%
Weighted average interest rate at end of period   5.02    2.56    5.96 
                
Total Borrowings (1)               
Average balance outstanding  $1,231,014   $1,104,368   $993,790 
Maximum amount outstanding at any month               
end during the period   1,560,639    1,312,137    1,112,201 
Balance outstanding at the end of period   1,266,563    1,271,676    1,056,492 
Weighted average interest rate during the period   1.67%   1.76%   1.96%
Weighted average interest rate at end of period   1.53    1.61    1.75 

 

(1)The “weighted average interest rate during the period” for the year ended December 31, 2014, excludes prepayment penalties on borrowings incurred from the extinguishment of debt to conform to the presentation for the year ended December 31, 2016. These penalties are reflected in non-interest expense.

 

Subsidiary Activities

 

At December 31, 2016, Flushing Financial Corporation had four wholly owned subsidiaries: the Bank and the Trusts. In addition, the Bank had three wholly owned subsidiaries: FSB Properties Inc. (“Properties”), Flushing Preferred Funding Corporation (“FPFC”), and Flushing Service Corporation.

 

(a)       Properties, which is incorporated in the State of New York, was formed in 1976 under the Savings Bank’s New York State leeway investment authority. The original purpose of Properties was to engage in joint venture real estate equity investments. The Savings Bank discontinued these activities in 1986. The last joint venture in which Properties was a partner was dissolved in 1989, and the remaining property disposed. Properties is currently used to hold title to real estate owned that is obtained via foreclosure.

 

(b)       FPFC, which is incorporated in the State of Delaware, was formed in 1997 as a real estate investment trust for the purpose of acquiring, holding and managing real estate mortgage assets. FPFC also provides an additional vehicle for access by the Company to the capital markets for future opportunities.

 

(c)       Flushing Service Corporation, which is incorporated in the State of New York, was formed in 1998 to market insurance products and mutual funds.

 

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Personnel

 

At December 31, 2016, we had 447 full-time employees and 23 part-time employees. None of our employees are represented by a collective bargaining unit, and we consider our relationship with our employees to be good. At the present time, Flushing Financial Corporation only employs certain officers of the Bank. These employees do not receive any extra compensation as officers of Flushing Financial Corporation.

 

Omnibus Incentive Plan

 

The 2014 Omnibus Incentive Plan (“2014 Omnibus Plan”) became effective on May 20, 2014 after adoption by the Board of Directors and approval by the stockholders. The 2014 Omnibus Plan authorizes the Compensation Committee of the Company’s Board of Directors (the “Compensation Committee”) to grant a variety of equity compensation awards as well as long-term and annual cash incentive awards, all of which can, but need not, be structured so as to comply with Section 162(m) of the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”). The 2014 Omnibus Plan authorizes the issuance of 1,100,000 shares. To the extent that an award under the 2014 Omnibus Plan is cancelled, expired, forfeited, settled in cash, settled by issuance of fewer shares than the number underlying the award, or otherwise terminated without delivery of shares to a participant in payment of the exercise price or taxes relating to an award, the shares retained by or returned to the Company will be available for future issuance under the 2014 Omnibus Plan. No further awards may be granted under the Company’s 2005 Omnibus Incentive Plan, 1996 Stock Option Incentive Plan, and 1996 Restricted Stock Incentive Plan. At December 31, 2016, there were 489,320 shares available for delivery in connection with awards under the 2014 Omnibus Plan.

 

For additional information concerning this plan, see “Note 11 of Notes to Consolidated Financial Statements” in Item 8 of this Annual Report.

 

FEDERAL, STATE AND LOCAL TAXATION

 

The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to the Company.

 

Federal Taxation

 

General. We report our income using a calendar year and the accrual method of accounting. We are subject to the federal tax laws and regulations which apply to corporations generally, and, since the enactment of the Small Business Job Protection Act of 1996 (the “Act”), those laws and regulations governing the Bank’s deductions for bad debts, described below.

 

Bad Debt Reserves. Prior to the enactment of the Act, which was signed into law on August 20, 1996, savings institutions which met certain definitional tests primarily relating to their assets and the nature of their business (“qualifying thrifts”), such as the Savings Bank, were allowed deductions for bad debts under methods more favorable than those granted to other taxpayers. Qualifying thrifts could compute deductions for bad debts using either the specific charge off method of Section 166 of the Internal Revenue Code (the “Code”) or the reserve method of Section 593 of the Code. Section 1616(a) of the Act repealed the Section 593 reserve method of accounting for bad debts by qualifying thrifts, effective for taxable years beginning after 1995. Qualifying thrifts that are treated as large banks, such as the Savings Bank was, are required to use the specific charge off method, pursuant to which the amount of any debt may be deducted only as it actually becomes wholly or partially worthless.

 

Distributions. To the extent that the Bank makes “non-dividend distributions” to stockholders that are considered to result in distributions from its pre-1988 reserves or the supplemental reserve for losses on loans (“excess distributions”), then an amount based on the amount distributed will be included in the Bank’s taxable income. Non-dividend distributions include distributions in excess of the Bank’s current and post-1951 accumulated earnings and profits, as calculated for federal income tax purposes, distributions in redemption of stock and distributions in partial or complete liquidation. The amount of additional taxable income resulting from an excess distribution is an amount that when reduced by the tax attributable to the income is equal to the amount of the excess distribution. Thus, slightly more than one and one-half times the amount of the excess distribution made would be includable in gross income for federal income tax purposes, assuming a 35% federal corporate income tax rate. See “Regulation ¾ Restrictions on Dividends and Capital Distributions” for limits on the payment of dividends by the Bank. The Bank does not intend to pay dividends or make non-dividend distributions described above that would result in a recapture of any portion of its pre-1988 bad debt reserves.

 

33
 

Corporate Alternative Minimum Tax. The Code imposes an alternative minimum tax on corporations equal to the excess, if any, of 20% of alternative minimum taxable income (“AMTI”) over a corporation’s regular federal income tax liability. AMTI is equal to taxable income with certain adjustments. Generally, only 90% of AMTI can be offset by net operating loss carrybacks and carryforwards.

 

State and Local Taxation

 

New York State and New York City Taxation. We are subject to the New York State Franchise Tax on Banking Corporations. New York State recently enacted several reforms (the "Tax Reform Package") to its tax structure, including changes to the franchise, sales, estate and personal income taxes. These changes generally became effective for tax years beginning on or after January 1, 2015.  The Tax Reform Package simplified the existing corporate tax code for New York State businesses while remaining relatively neutral in relation to corporate tax receipts. Under the Tax Reform Package, the New York State corporate income tax rate was reduced, effective January 1, 2016, from 7.10% to 6.50%.  The metropolitan commuter transportation district surcharge ("MTA Tax") increased to 28% of the surcharge base for tax years beginning on or after January 1, 2016. The MTA Tax rate for tax years beginning on or after January 1, 2017 will be adjusted based upon future Metropolitan Transit Authority budget projections.

 

Some of the most significant elements of the Tax Reform Package include the merger of the bank franchise tax regime into the general corporate franchise tax regime, expanded application of economic nexus, adoption of unitary reporting, and apportionment of source income solely by reference to customer location.

 

New York State formerly had imposed a franchise tax on general business corporations and a separate franchise tax on banking corporations. Under these statutes, New York State financial service companies and banks were previously taxed under different regimes. The Tax Reform Package repealed the prior bank franchise taxation regime and merged it into the corporate franchise tax regime.  It also made certain subtraction modifications to the corporate franchise tax regime, most notably by providing a choice between three potential financial tax subtraction modifications: (i) a subtraction modification equal to 32% of New York State’s entire net income available to all thrifts and community banks with assets that do not exceed $8 billion, provided certain residential lending tests are met; (ii) a subtraction modification, available to both small thrifts and community banks with assets that do not exceed $8 billion, based upon 50% of the net interest income from loans multiplied by the fraction of interest received from loans secured by real estate located in New York State or small business loans made to New York State borrowers with a principal amount of $5 million or less divided by total interest income from all loans; and (iii) both small thrifts and community banks with assets that do not exceed $8 billion that owned a captive real estate investment trust as of April 1, 2014, may, for tax years beginning on or after January 1, 2015, subtract 160% of dividends received from the trust in determining New York State taxable income.

 

The Tax Reform Package requires that all firms meeting an ownership test of 50% or more be deemed a unitary business and required to file a combined tax return.  Substantial intercompany transactions are eliminated, and a domestic corporation without any assets or customers in New York State, but engaged in a unitary business with a related New York taxpayer, could become part of the New York State unitary group. The Tax Reform Package also requires business income to be apportioned to and taxed by New York State using a single receipts factor based on the customer's location. These provisions also contain favorable apportionment rules for asset-backed securities that are beneficial to the Company.

 

The Company is subject to New York City franchise tax on a consolidated basis. New York City tax law generally was conformed to New York State tax law with provisions similar to those described above for York State purposes, with only a few minor differences. For tax years beginning on or after January 1, 2015, the New York City income tax rate applied to the Company apportioned New York City taxable income was and is 8.85%.

 

New Jersey State Taxation. The Bank is required to pay New Jersey State income tax based on the percentage of receipts from activity in New Jersey.

 

Delaware State Taxation. As a Delaware holding company not earning income in Delaware, we are exempt from Delaware corporate income tax but are required to file an annual report with and pay an annual franchise tax to the State of Delaware.

 

34
 

REGULATION

 

General

 

The Bank is a New York State-chartered commercial bank and its deposit accounts are insured under the Deposit Insurance Fund (the “DIF”) of the Federal Deposit Insurance Corporation (the “FDIC”) up to applicable legal limits. The Bank is subject to extensive regulation and supervision by the New York State Department of Financial Services (“NYDFS”), as its chartering agency, by the FDIC, as its insurer of deposits, and by the Consumer Financial Protection Bureau (the “CFPB”), which was created under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) in 2011 to implement and enforce consumer protection laws applying to banks. The Bank must file reports with the NYDFS, the FDIC, and the CFPB concerning its activities and financial condition, in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other depository institutions. Furthermore, the Bank is periodically examined by the NYDFS and the FDIC to assess compliance with various regulatory requirements, including safety and soundness considerations. This regulation and supervision establishes a comprehensive framework of activities in which a commercial bank can engage, and is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with its supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss allowances for regulatory purposes. Any change in such regulation, whether by the NYDFS, the FDIC, or through legislation, could have a material adverse impact on the Company, the Bank and its operations, and the Company’s shareholders.

 

The Company is required to file certain reports under, and otherwise comply with, the rules and regulations of the Federal Reserve Board of Governors (the “FRB”), the FDIC, the NYDFS, and the Securities and Exchange Commission (the “SEC”) under federal securities laws. In addition, the FRB periodically examines the Company. Certain of the regulatory requirements applicable to the Bank and the Company are referred to below or elsewhere herein. However, such discussion is not meant to be a complete explanation of all laws and regulations and is qualified in its entirety by reference to the actual laws and regulations.

 

The Dodd-Frank Act

 

The Dodd-Frank Act has significantly impacted the current bank regulatory structure and is expected to continue to affect, into the immediate future, the lending and investment activities and general operations of depository institutions and their holding companies. In addition to creating the CFPB, the Dodd-Frank Act requires the FRB to establish minimum consolidated capital requirements for bank holding companies that are as stringent as those required for insured depository institutions; the components of Tier 1 capital will be restricted to capital instruments that are currently considered to be Tier 1 capital for insured depository institutions. In addition, the proceeds of trust preferred securities will be excluded from Tier 1 capital unless (i) such securities are issued by bank holding companies with assets of less than $500 million, or (ii) such securities were issued prior to May 19, 2010 by bank or savings and loan holding companies with assets of less than $15 billion. The Dodd-Frank Act created a new supervisory structure for oversight of the U.S. financial system, including the establishment of a new council of regulators, the Financial Stability Oversight Council, to monitor and address systemic risks to the financial system. Non-bank financial companies that are deemed to be significant to the stability of the U.S. financial system and all bank holding companies with $50 billion or more in total consolidated assets will be subject to heightened supervision and regulation. The FRB will implement prudential requirements and prompt corrective action procedures for such companies.

 

The Dodd-Frank Act made many additional changes in banking regulation, including: authorizing depository institutions, for the first time, to pay interest on business checking accounts; requiring originators of securitized loans to retain a percentage of the risk for transferred loans; establishing regulatory rate-setting for certain debit card interchange fees; and establishing a number of reforms for mortgage lending and consumer protection.

 

The Dodd-Frank Act also broadened the base for FDIC insurance assessments. The FDIC was required to promulgate rules revising its assessment system so that it is based not on deposits, but on the average consolidated total assets less the tangible equity capital of an insured institution. That rule took effect April 1, 2011. The Dodd-Frank Act also permanently increased the maximum amount of deposit insurance for banks, savings institutions, and credit unions to $250,000 per depositor, retroactive to January 1, 2008, and provided non-interest-bearing transaction accounts with unlimited deposit insurance through December 31, 2012.

 

Some of the provisions of the Dodd-Frank Act are not yet in effect. The Dodd-Frank Act requires various federal agencies to promulgate numerous and extensive implementing regulations over the next several years.

 

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On February 3, 2017, however, President Trump signed an executive order requiring a comprehensive review of financial system regulations, including the Dodd-Frank Act. President Trump has promised other significant changes to financial system regulations. Nonetheless, changes to these regulations are expected to be politically controversial and may be slow and unpredictable in enactment and effect. It is too early to predict when or what, if any, existing regulations affecting us will be repealed or amended and what if any new regulations affecting us will be adopted, leaving the bank regulatory environment particularly uncertain at present. Further, there can be no assurance as to the impact that any laws, regulations or governmental programs that may be introduced or implemented in the future will have on the financial markets and the economy.

 

Basel III

In the summer of 2012, our primary federal regulators published two notices of proposed rulemaking (“NPRs”) that would have substantially revised the risk-based capital requirements applicable to bank holding companies and depository institutions, including the Company and the Bank, compared to the then current U.S. risk-based capital rules, which are based on the international capital accords of the Basel Committee on Banking Supervision, which are generally referred to as “Basel I.”

 

During July 2013, our primary federal regulators issued revised NPRs that will revise and replace the agencies' current capital rules. The NPRs included numerous revisions to the existing capital regulations, including, but not limited to, the following:

 

    Revised the definition of regulatory capital components and related calculations.
    Added a new common equity tier 1 capital ratio.
    Increased the minimum tier 1 capital ratio requirement from four percent to six percent.
    Incorporated the revised regulatory capital requirements into the Prompt Corrective Action framework.
    Implemented a new capital conservation buffer that would limit payment of capital distributions and certain discretionary bonus payments to executive officers and key risk takers if the banking organization does not hold certain amounts of common equity tier 1 capital in addition to those needed to meet its minimum risk-based capital requirements.
    Provided a transition period for several aspects of the proposed rule: the new minimum capital ratio requirements, the capital conservation buffer, and the regulatory capital adjustments and deductions.
    Increased capital requirements for past-due loans, high volatility commercial real estate exposures, and certain short-term loan commitments.
    Removed references to credit ratings consistent with Section 939A of the Dodd-Frank Act.
    Established due diligence requirements for securitization exposures.

 

The capital regulations became effective January 1, 2015 for bank holding companies and banks with less than $15 billion in total assets, such as our Company and Bank. We continue to be considered well-capitalized under Basel III.

 

Volcker Rule

 

On December 10, 2013, our primary federal regulators adopted Section 619 of the Dodd-Frank Act, commonly referred to as the “Volcker Rule,” which prohibits insured depository institutions from engaging in short-term proprietary trading of certain securities, derivatives and other financial instruments for the firm’s own account, subject to certain exemptions, including market making and risk-mitigating hedging. The Volcker Rule also imposes limits on banking entities’ investments in, and other relationships with, hedge funds and private equity funds. The financial industry has strongly opposed the Volcker Rule, which remains controversial and the subject of continuing debate. Further, as noted above, President Trump has indicated an intention to review many financial industry regulations. In this regard, in January 2017, the Treasury Secretary, Steven Mnuchin, publicly stated the intention that the regulatory impact of the Volcker Rule be loosened. At this time, it is too early to know whether any changes will be proposed or implemented or what impact any changes may have on the Bank or the Company.

 

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The rule as adopted prohibited banking entities from owning collateralized debt obligations backed primarily by trust preferred securities (“TruPS CDOs”) after July 21, 2015. At December 31, 2016 and 2015, the Company did not hold any TruPs CDOs.

 

New York State Law

 

The Bank derives its lending, investment, and other authority primarily from the applicable provisions of New York State Banking Law and the regulations of the NYDFS, as limited by FDIC regulations. Under these laws and regulations, banks, including the Bank, may invest in real estate mortgages, consumer and commercial loans, certain types of debt securities (including certain corporate debt securities, and obligations of federal, state, and local governments and agencies), certain types of corporate equity securities, and certain other assets. The lending powers of New York State-chartered commercial banks are not subject to percentage-of-assets or capital limitations, although there are limits applicable to loans to individual borrowers.

 

The exercise by an FDIC-insured commercial bank of the lending and investment powers under New York State Banking Law is limited by FDIC regulations and other federal laws and regulations. In particular, the applicable provisions of New York State Banking Law and regulations governing the investment authority and activities of an FDIC-insured state-chartered savings bank and commercial bank have been effectively limited by the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) and the FDIC regulations issued pursuant thereto.

 

With certain limited exceptions, a New York State-chartered commercial bank may not make loans or extend credit for commercial, corporate, or business purposes (including lease financing) to a single borrower, the aggregate amount of which would be in excess of 15% of the bank’s net worth or up to 25% for loans secured by collateral having an ascertainable market value at least equal to the excess of such loans over the bank’s net worth. The Bank currently complies with all applicable loans-to-one-borrower limitations. At December 31, 2016, the Bank’s largest aggregate amount of loans to one borrower was $74.0 million, all of which were performing according to their terms. See “— General — Lending Activities.”

 

Under New York State Banking Law, New York State-chartered stock-form commercial banks may declare and pay dividends out of its net profits, unless there is an impairment of capital, but approval of the NYDFS Superintendent (the “Superintendent”) is required if the total of all dividends declared by the bank in a calendar year would exceed the total of its net profits for that year combined with its retained net profits for the preceding two years less prior dividends paid.

 

New York State Banking Law gives the Superintendent authority to issue an order to a New York State-chartered banking institution to appear and explain an apparent violation of law, to discontinue unauthorized or unsafe practices, and to keep prescribed books and accounts. Upon a finding by the NYDFS that any director, trustee, or officer of any banking organization has violated any law, or has continued unauthorized or unsafe practices in conducting the business of the banking organization after having been notified by the Superintendent to discontinue such practices, such director, trustee, or officer may be removed from office after notice and an opportunity to be heard. The Superintendent also has authority to appoint a conservator or a receiver for a savings or commercial bank under certain circumstances.

 

In addition, on February 16, 2017, the NYDFS issued the final version of its cybersecurity regulation, which has an effective date of March 1, 2017. The regulation, which is detailed and broad in scope, covers five basic areas.

 

Governance: The regulation requires senior management and boards of directors must adopt a cybersecurity policy for protecting information systems and most sensitive information. Covered companies must also designate a Chief Information Security Officer, who must report to the board annually. The cybersecurity policy must be in place, and the security officer designated, by August 28, 2017.

 

Testing: The regulation requires the conduct of cybersecurity tests and analyses, including a “risk assessment” to “evaluate and categorize risks,” evaluate the integrity and confidentiality of information systems and non-public information, and develop a process to mitigate any identified risks. These tests and assessments must be conducted by March 1, 2018.

 

Ongoing Requirements: The regulation imposes substantial day-to-day and technical requirements. Among others, we must develop access controls for our information systems, ensure the physical security of our computer systems, encrypt or protect personally identifiable information, perform reviews of in-house and externally created applications, train employees, and build an audit trail system. The timeline to ensure compliance with these rules ranges from one year to eighteen months.

 

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Vendors: The new regulation also regulates third-party vendors with access to our information technology or non-public information. We will be required to develop and implement written policies and procedures to ensure the security of our information technology systems or non-public information that can be accessed by our vendors, including identifying the risks from third-party access, imposing minimum cybersecurity practices for vendors, and creating a due-diligence process for evaluating those vendors. We will have two years to satisfy these extensive requirements.

 

Reports: The new regulation imposes a notification process for any material cybersecurity event. Within 72 hours, a cybersecurity event that has a “reasonable likelihood” of “materially harming” us or that must be reported to another government or self-regulating agency must be reported to the NYDFS. In addition, an annual compliance certification to the NYDFS from either the board or a senior officer is required.

 

FDIC Regulations

 

Capital Requirements. The FDIC has adopted risk-based capital guidelines to which the Bank is subject. The guidelines establish a systematic analytical framework that makes regulatory capital requirements sensitive to differences in risk profiles among banking organizations. The Bank is required to maintain certain levels of regulatory capital in relation to regulatory risk-weighted assets. The ratio of such regulatory capital to regulatory risk-weighted assets is referred to as a “risk-based capital ratio.” Risk-based capital ratios are determined by allocating assets and specified off-balance-sheet items to risk-weighted categories ranging from 0% to 1,250%, with higher levels of capital being required for the categories perceived as representing greater risk.

 

These guidelines divide an institution’s capital into two tiers. The first tier (“Tier 1”) includes common equity, retained earnings, certain non-cumulative perpetual preferred stock (excluding auction rate issues), and minority interests in equity accounts of consolidated subsidiaries, less goodwill and other intangible assets (except mortgage servicing rights and purchased credit card relationships subject to certain limitations). Supplementary (“Tier 2”) capital includes, among other items, cumulative perpetual and long-term limited-life preferred stock, mandatorily convertible securities, certain hybrid capital instruments, term subordinated debt, and the allowance for loan losses, subject to certain limitations, and up to 45% of pre-tax net unrealized gains on equity securities with readily determinable fair market values, less required deductions. Commercial banks are required to maintain a total risk-based capital ratio of at least 8%, of which at least 4% must be Tier 1 capital.

 

In addition, the FDIC has established regulations prescribing a minimum Tier 1 leverage capital ratio (the ratio of Tier 1 capital to adjusted average assets as specified in the regulations). These regulations provide for a minimum Tier 1 leverage capital ratio of at least 4%. The FDIC may, however, set higher leverage and risk-based capital requirements on individual institutions when particular circumstances warrant. Institutions experiencing or anticipating significant growth are expected to maintain capital ratios, including tangible capital positions, well above the minimum levels.

 

As of December 31, 2016, the Bank was deemed to be well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, a bank must maintain a minimum Tier 1 leverage capital ratio of 5%, a minimum common equity Tier 1 capital ratio of 6.5%, a minimum Tier 1 risk-based capital ratio of 8%, and a minimum total risk-based capital ratio of 10%. For a summary of the regulatory capital ratios of the Bank at December 31, 2016, see “Note 14 of Notes to Consolidated Financial Statements” in Item 8 of this Annual Report.

 

The regulatory capital regulations of the FDIC and other federal banking agencies provide that the agencies will take into account the exposure of an institution’s capital and economic value to changes in interest rate risk in assessing capital adequacy. According to such agencies, applicable considerations include the quality of the institution’s interest rate risk management process, overall financial condition, and the level of other risks at the institution for which capital is needed. Institutions with significant interest rate risk may be required to hold additional capital. The agencies have issued a joint policy statement providing guidance on interest rate risk management, including a discussion of the critical factors affecting the agencies’ evaluation of interest rate risk in connection with capital adequacy. Institutions that engage in specified amounts of trading activity may be subject to adjustments in the calculation of the risk-based capital requirement to assure sufficient additional capital to support market risk.

 

Standards for Safety and Soundness. Federal law requires each federal banking agency to prescribe, for the depository institutions under its jurisdiction, standards that relate to, among other things, internal controls; information and audit systems; loan documentation; credit underwriting; the monitoring of interest rate risk; asset growth; compensation; fees and benefits; and such other operational and managerial standards as the agency deems appropriate. The federal banking agencies adopted final regulations and Interagency Guidelines Establishing Standards for Safety and Soundness (the “Guidelines”) to implement these safety and soundness standards. The Guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the Guidelines, the agency may require the institution to provide it with an acceptable plan to achieve compliance with the standard, as required by the Federal Deposit Insurance Act, as amended, (the “FDI Act”). The final regulations establish deadlines for the submission and review of such safety and soundness compliance plans.

 

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Real Estate Lending Standards. The FDIC and the other federal banking agencies have adopted regulations that prescribe standards for extensions of credit that are (i) secured by real estate, or (ii) made for the purpose of financing construction or improvements on real estate. The FDIC regulations require each institution to establish and maintain written internal real estate lending standards that are consistent with safe and sound banking practices, and appropriate to the size of the institution and the nature and scope of its real estate lending activities. The standards also must be consistent with accompanying FDIC guidelines, which include loan-to-value limitations for the different types of real estate loans. Institutions are also permitted to make a limited amount of loans that do not conform to the proposed loan-to-value limitations so long as such exceptions are reviewed and justified appropriately. The FDIC guidelines also list a number of lending situations in which exceptions to the loan-to-value standard are justified.

 

Dividend Limitations. The FDIC has authority to use its enforcement powers to prohibit a commercial bank from paying dividends if, in its opinion, the payment of dividends would constitute an unsafe or unsound practice. Federal law prohibits the payment of dividends that will result in the institution failing to meet applicable capital requirements on a pro forma basis. The Bank is also subject to dividend declaration restrictions imposed by New York State law as previously discussed under “New York State Law.”

 

Investment Activities. Since the enactment of FDICIA, all state-chartered financial institutions, including commercial banks and their subsidiaries, have generally been limited to such activities as principal and equity investments of the type, and in the amount, authorized for national banks. State law, FDICIA, and FDIC regulations permit certain exceptions to these limitations. In addition, the FDIC is authorized to permit institutions to engage in state-authorized activities or investments not permitted for national banks (other than non-subsidiary equity investments) for institutions that meet all applicable capital requirements if it is determined that such activities or investments do not pose a significant risk to the insurance fund. The Gramm-Leach-Bliley Act of 1999 and FDIC regulations impose certain quantitative and qualitative restrictions on such activities and on a bank’s dealings with a subsidiary that engages in specified activities.

 

Prompt Corrective Regulatory Action. Federal law requires, among other things, that federal bank regulatory authorities take “prompt corrective action” with respect to institutions that do not meet minimum capital requirements. For such purposes, the law establishes five capital tiers: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized.

 

The FDIC has adopted regulations to implement prompt corrective action. Among other things, the regulations define the relevant capital measures for the five capital categories. An institution is deemed to be “well capitalized” if it has a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 8% or greater, a common equity Tier 1 risk-based capital ratio of 6.5% and a leverage capital ratio of 5% or greater, and is not subject to a regulatory order, agreement, or directive to meet and maintain a specific capital level for any capital measure. An institution is deemed to be “adequately capitalized” if it has a total risk-based capital ratio of 8% or greater, a Tier 1 risk-based capital ratio of 6% or greater, a common equity Tier 1 risk-based capital ratio of 4.5% or greater and a leverage capital ratio of 4% or greater. An institution is deemed to be “undercapitalized” if it has a total risk-based capital ratio of less than 8%, a Tier 1 risk-based capital ratio of less than 6%, a common equity Tier 1 risk-based capital ratio of less than 4.5% or a leverage capital ratio of less than 4%. An institution is deemed to be “significantly undercapitalized” if it has a total risk-based capital ratio of less than 6%, a Tier 1 risk-based capital ratio of less than 4% a common equity Tier 1 risk-based capital ratio of less than 3.0%, or a leverage capital ratio of less than 3%. An institution is deemed to be “critically undercapitalized” if it has a ratio of tangible equity (as defined in the regulations) to total assets that is equal to or less than 2%.

 

“Undercapitalized” institutions are subject to growth, capital distribution (including dividend), and other limitations, and are required to submit a capital restoration plan. An institution’s compliance with such plan is required to be guaranteed by any company that controls the undercapitalized institution in an amount equal to the lesser of 5% of the bank’s total assets when deemed undercapitalized or the amount necessary to achieve the status of adequately capitalized. If an undercapitalized institution fails to submit an acceptable plan, it is treated as if it is “significantly undercapitalized.” Significantly undercapitalized institutions are subject to one or more additional restrictions including, but not limited to, an order by the FDIC to sell sufficient voting stock to become adequately capitalized; requirements to reduce total assets, cease receipt of deposits from correspondent banks, or dismiss directors or officers; and restrictions on interest rates paid on deposits, compensation of executive officers, and capital distributions by the parent holding company.

 

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Beginning 60 days after becoming “critically undercapitalized,” critically undercapitalized institutions also may not make any payment of principal or interest on certain subordinated debt, or extend credit for a highly leveraged transaction, or enter into any material transaction outside the ordinary course of business. In addition, subject to a narrow exception, the appointment of a receiver is required for a critically undercapitalized institution within 270 days after it obtains such status.

 

Insurance of Deposit Accounts. The Dodd-Frank Act made permanent the standard maximum amount of FDIC deposit insurance at $250,000 per depositor.  In addition, the deposits of the Bank are insured up to applicable limits by the DIF. In this regard, insured depository institutions are required to pay quarterly deposit insurance assessments to the DIF.  Assessments are based on average total assets minus average tangible equity.  The assessment rate is determined through a risk-based system.  For depository institutions with less than $10 billion in assets, such as the Bank, under the FDIC’s risk-based assessment system, insured institutions are assigned to one of four risk categories based upon supervisory evaluations, regulatory capital level, and certain other factors, with less risky institutions paying lower assessments. An institution’s assessment rate depends upon the category to which it is assigned and certain other factors. The initial base assessment rate currently ranges from five to 35 basis points on an annualized basis. The initial base assessment rate is then decreased depending on the institution's ratio of long-term unsecured debt to its assessment base (with such decrease not to exceed the lesser of five basis points or 50% of the initial base assessment rate) and, for institutions not in the highest risk category, increased if the institution's brokered deposits are more than ten percent of its domestic deposits (with such increase not to exceed ten basis points).  The current total base assessment rate is therefore from 2.5 to 45 basis points on an annualized basis.

 

The Dodd-Frank Act increased the minimum target DIF ratio from 1.15% of estimated insured deposits to 1.35% of estimated insured deposits. The FDIC must seek to achieve the 1.35% ratio by September 30, 2020. Insured institutions with assets of $10 billion or more are supposed to fund the increase. The Dodd-Frank Act eliminated the 1.5% maximum fund ratio, leaving it, instead, to the discretion of the FDIC. The FDIC has exercised that discretion by establishing a long range fund ratio of 2%, which could result in our paying higher deposit insurance premiums in the future.

 

Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order, or condition imposed by the FDIC. Management does not know of any practice, condition, or violation that would lead to termination of the deposit insurance of the Bank.

 

As part of an omnibus appropriations bill, the Deposit Insurance Funds Act of 1996 (the “Funds Act”) was enacted. The Funds Act required Bank Insurance Fund (“BIF”) institutions, including the Savings Bank, beginning January 1, 1997, to pay a portion of the interest due on the Finance Corporation (“FICO”) bonds issued in connection with the savings and loan association crisis in the late 1980s, and required BIF institutions to pay their full pro rata share of the FICO payments starting the earlier of January 1, 2000 or the date at which no savings institution continues to exist. We were required, as of January 1, 2000, to pay our full pro rata share of the FICO payments. The FICO assessment rate is subject to change. The Bank paid $297,000, $278,000 and $267,000 for their share of the interest due on FICO bonds in 2016, 2015 and 2014, respectively, which is included in FDIC insurance expense. These payments, which generally approximate 10% of the Bank's annual FDIC insurance payments, will continue until those bonds mature through 2019.

 

Brokered Deposits. The FDIC has promulgated regulations implementing the FDICIA limitations on brokered deposits. Under the regulations, well-capitalized institutions are not subject to brokered deposit limitations, while adequately capitalized institutions are able to accept, renew or roll over brokered deposits only with a waiver from the FDIC and subject to restrictions on the interest rate that can be paid on such deposits. Undercapitalized institutions are not permitted to accept brokered deposits and may not solicit deposits by offering an effective yield that exceeds by more than 75 basis points the prevailing effective yields on insured deposits of comparable maturity in the institution’s normal market area or in the market area in which such deposits are being solicited. Pursuant to the regulation, the Bank, as a well-capitalized institution, may accept brokered deposits. At December 31, 2016, the Bank had $1,114.9 million in brokered deposit accounts.

 

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Transactions with Affiliates

 

Under current federal law, transactions between depository institutions and their affiliates are governed by Sections 23A and 23B of the Federal Reserve Act and the FRB’s Regulation W promulgated thereunder. An affiliate of a commercial bank is any company or entity that controls, is controlled by, or is under common control with, the institution, other than a subsidiary. Generally, an institution’s subsidiaries are not treated as affiliates unless they are engaged in activities as principal that are not permissible for national banks. In a holding company context, at a minimum, the parent holding company of an institution, and any companies that are controlled by such parent holding company, are affiliates of the institution. Generally, Section 23A limits the extent to which the institution or its subsidiaries may engage in “covered transactions” with any one affiliate to an amount equal to 10% of the institution’s capital stock and surplus, and contains an aggregate limit on all such transactions with all affiliates to an amount equal to 20% of such capital stock and surplus. The term “covered transaction” includes the making of loans or other extensions of credit to an affiliate; the purchase of assets from an affiliate; the purchase of, or an investment in, the securities of an affiliate; the acceptance of securities of an affiliate as collateral for a loan or extension of credit to any person; or issuance of a guarantee, acceptance, or letter of credit on behalf of an affiliate. Section 23A also establishes specific collateral requirements for loans or extensions of credit to, or guarantees or acceptances on letters of credit issued on behalf of, an affiliate. Section 23B requires that covered transactions and a broad list of other specified transactions be on terms substantially the same as, or at least as favorable to, the institution or its subsidiary as similar transactions with non-affiliates.

 

The Sarbanes-Oxley Act of 2002 generally prohibits loans by the Company to its executive officers and directors. However, the Sarbanes-Oxley Act contains a specific exemption for loans by an institution to its executive officers and directors in compliance with federal banking laws. Section 22(h) of the Federal Reserve Act, and FRB Regulation O adopted thereunder, governs loans by a savings bank or commercial bank to directors, executive officers, and principal shareholders. Under Section 22(h), loans to directors, executive officers, and shareholders who control, directly or indirectly, 10% or more of voting securities of an institution, and certain related interests of any of the foregoing, may not exceed, together with all other outstanding loans to such persons and affiliated entities, the institution’s total capital and surplus. Section 22(h) also prohibits loans above amounts prescribed by the appropriate federal banking agency to directors, executive officers, and shareholders who control 10% or more of the voting securities of an institution, and its respective related interests, unless such loan is approved in advance by a majority of the board of the institution’s directors. Any “interested” director may not participate in the voting. The loan amount (which includes all other outstanding loans to such person) as to which such prior board of director approval is required, is the greater of $25,000 or 5% of capital and surplus or any loans aggregating over $500,000. Further, pursuant to Section 22(h), loans to directors, executive officers, and principal shareholders must be made on terms substantially the same as those offered in comparable transactions to other persons. There is an exception for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to executive officers over other employees. Section 22(g) of the Federal Reserve Act places additional limitations on loans to executive officers.

 

Community Reinvestment Act

 

Federal Regulation. Under the Community Reinvestment Act (“CRA”), as implemented by FDIC regulations, an institution has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions, nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the FDIC, in connection with its examinations, to assess the institution’s record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such institution. The CRA requires public disclosure of an institution’s CRA rating and further requires the FDIC to provide a written evaluation of an institution’s CRA performance utilizing a four-tiered descriptive rating system. The Bank received a CRA rating of “Satisfactory” in its most recent completed CRA examination, which was completed as of April 16, 2015. Institutions that receive less than a satisfactory rating may face difficulties in securing approval for new activities or acquisitions. The CRA requires all institutions to make public disclosures of their CRA ratings. As a special purpose commercial bank, the Commercial Bank was not required to comply with the CRA prior to the Merger. Since the Merger, the Bank is required to comply with CRA.

 

New York State Regulation. The Bank is also subject to provisions of the New York State Banking Law that impose continuing and affirmative obligations upon a banking institution organized in New York State to serve the credit needs of its local community (the “NYCRA”). Such obligations are substantially similar to those imposed by the CRA. The NYCRA requires the NYDFS to make a periodic written assessment of an institution’s compliance with the NYCRA, utilizing a four-tiered rating system, and to make such assessment available to the public. The NYCRA also requires the Superintendent to consider the NYCRA rating when reviewing an application to engage in certain transactions, including mergers, asset purchases, and the establishment of branch offices or ATMs, and provides that such assessment may serve as a basis for the denial of any such application.

 

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Federal Reserve System

 

Under FRB regulations, the Bank is required to maintain reserves against its transaction accounts. The FRB regulations generally require that reserves be maintained against aggregate transaction accounts as follows: for that portion of transaction accounts aggregating $103.6 million or less (subject to adjustment by the FRB), the reserve requirement is 3%; for amounts greater than $103.6 million, the reserve requirement is 10% (subject to adjustment by the FRB between 8% and 14%). The first $14.5 million of otherwise reservable balances (subject to adjustments by the FRB) are exempted from the reserve requirements. The Bank is in compliance with the foregoing requirements.

 

Federal Home Loan Bank System

 

The Bank is a member of the FHLB-NY, one of 11 regional FHLBs comprising the FHLB system. Each regional FHLB manages its customer relationships, while the 11 FHLBs use its combined size and strength to obtain its necessary funding at the lowest possible cost. As a member of the FHLB-NY, the Bank is required to acquire and hold shares of FHLB-NY capital stock. Pursuant to this requirement, at December 31, 2016, the Bank was required to maintain $59.2 million of FHLB-NY stock.

 

Holding Company Regulation

 

Subsequent to the Merger, the Company is subject to examination, regulation, and periodic reporting under the Bank Holding Company Act of 1956, as amended (the “BHCA”), as administered by the FRB. The Company is required to obtain the prior approval of the FRB to acquire all, or substantially all, of the assets of any bank or bank holding company. Prior FRB approval would be required for the Company to acquire direct or indirect ownership or control of any voting securities of any bank or bank holding company if, after giving effect to such acquisition, it would, directly or indirectly, own or control more than 5% of any class of voting shares of such bank or bank holding company. In addition before any bank acquisition can be completed, prior approval thereof may also be required to be obtained from other agencies having supervisory jurisdiction over the bank to be acquired, including the NYDFS.

 

FRB regulations generally prohibit a bank holding company from engaging in, or acquiring, direct or indirect control of more than 5% of the voting securities of any company engaged in non-banking activities. One of the principal exceptions to this prohibition is for activities found by the FRB to be so closely related to banking or managing or controlling Bank as to be a proper incident thereto. Some of the principal activities that the FRB has determined by regulation to be so closely related to banking are: (i) making or servicing loans; (ii) performing certain data processing services; (iii) providing discount brokerage services; (iv) acting as fiduciary, investment, or financial advisor; (v) leasing personal or real property; (vi) making investments in corporations or projects designed primarily to promote community welfare; and (vii) acquiring a savings and loan association.

 

The FRB has adopted capital adequacy guidelines for bank holding companies (on a consolidated basis). At December 31, 2016, the Company’s consolidated capital exceeded these requirements. The Dodd-Frank Act required the FRB to issue consolidated regulatory capital requirements for bank holding companies that are at least as stringent as those applicable to insured depository institutions. Such regulations eliminated the use of certain instruments, such as cumulative preferred stock and trust preferred securities, as Tier 1 holding company capital.

 

Bank holding companies are generally required to give the FRB prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding twelve months, is equal to 10% or more of the Company’s consolidated net worth. The FRB may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe or unsound practice, or would violate any law, regulation, FRB order or directive, or any condition imposed by, or written agreement with, the FRB. The FRB has adopted an exception to this approval requirement for well-capitalized bank holding companies that meet certain other conditions.

 

The FRB has issued a policy statement regarding the payment of dividends by bank holding companies. In general, the FRB’s policies provide that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the bank holding company appears consistent with the organization’s capital needs, asset quality, and overall financial condition. The FRB’s policies also require that a bank holding company serve as a source of financial strength to its subsidiary banks by standing ready to use available resources to provide adequate capital funds to those banks during periods of financial stress or adversity, and by maintaining the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks where necessary. The Dodd-Frank Act codifies the source of financial strength policy and requires regulations to facilitate its application. Under the prompt corrective action laws, the ability of a bank holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized. These regulatory policies could affect the ability of the Company to pay dividends or otherwise engage in capital distributions.

 

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Under the FDI Act, a depository institution may be liable to the FDIC for losses caused the DIF if a commonly controlled depository institution were to fail. The Bank is commonly controlled within the meaning of that law.

 

The status of the Company as a registered bank holding company under the BHCA does not exempt it from certain federal and state laws and regulations applicable to corporations generally, including, without limitation, certain provisions of the federal securities laws.

 

The Company, the Bank, and their respective affiliates will be affected by the monetary and fiscal policies of various agencies of the United States Government, including the Federal Reserve System. In view of changing conditions in the national economy and in the money markets, it is difficult for management to accurately predict future changes in monetary policy or the effect of such changes on the business or financial condition of the Company or the Bank.

 

Acquisition of the Holding Company

 

Under the Federal Change in Bank Control Act (“CIBCA”), a notice must be submitted to the FRB if any person (including a company), or group acting in concert, seeks to acquire 10% or more of the Company’s shares of outstanding common stock, unless the FRB has found that the acquisition will not result in a change in control of the Company. Under the CIBCA, the FRB generally has 60 days within which to act on such notices, taking into consideration certain factors, including the financial and managerial resources of the acquirer; the convenience and needs of the communities served by the Company and the Bank; and the anti-trust effects of the acquisition. Under the BHCA, any company would be required to obtain approval from the FRB before it may obtain “control” of the Company within the meaning of the BHCA. Control generally is defined to mean the ownership or power to vote 25% or more of any class of voting securities of the Company or the ability to control in any manner the election of a majority of the Company’s directors. An existing bank holding company would, under the BHCA, be required to obtain the FRB’s approval before acquiring more than 5% of the Company’s voting stock. In addition to the CIBCA and the BHCA, New York State Banking Law generally requires prior approval of the New York State Banking Board before any action is taken that causes any company to acquire direct or indirect control of a banking institution that is organized in New York.

 

Consumer Financial Protection Bureau

 

Created under the Dodd-Frank Act, and given extensive implementation and enforcement powers, the CFPB has broad rulemaking authority for a wide range of consumer financial laws that apply to all banks, including, among other things, the authority to prohibit “unfair, deceptive, or abusive” acts and practices. Abusive acts or practices are defined as those that (1) materially interfere with a consumer’s ability to understand a term or condition of a consumer financial product or service, or (2) take unreasonable advantage of a consumer’s (a) lack of financial savvy, (b) inability to protect himself in the selection or use of consumer financial products or services, or (c) reasonable reliance on a covered entity to act in the consumer’s interests. The CFPB has the authority to investigate possible violations of federal consumer financial law, hold hearings and commence civil litigation. The CFPB can issue cease-and-desist orders against banks and other entities that violate consumer financial laws. The CFPB may also institute a civil action against an entity in violation of federal consumer financial law in order to impose a civil penalty or an injunction.

 

Mortgage Banking and Related Consumer Protection Regulations

 

The retail activities of the Bank, including lending and the acceptance of deposits, are subject to a variety of statutes and regulations designed to protect consumers. Interest and other charges collected or contracted for by the Bank are subject to state usury laws and federal laws concerning interest rates. Loan operations are also subject to federal laws applicable to credit transactions, such as:

 

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    The federal Truth-In-Lending Act and Regulation Z issued by the FRB, governing disclosures of credit terms to consumer borrowers;
    The Home Mortgage Disclosure Act and Regulation C issued by the FRB, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;
    The Equal Credit Opportunity Act and Regulation B issued by the FRB, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;
    The Fair Credit Reporting Act and Regulation V issued by the FRB, governing the use and provision of information to consumer reporting agencies;
    The Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; and
    The guidance of the various federal agencies charged with the responsibility of implementing such federal laws.

 

Deposit operations also are subject to:

 

    The Truth in Savings Act and Regulation DD issued by the FRB, which requires disclosure of deposit terms to consumers;
    Regulation CC issued by the FRB, which relates to the availability of deposit funds to consumers;
    The Right to Financial Privacy Act, which imposes a duty to maintain the confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; and
    The Electronic Funds Transfer Act and Regulation E issued by the FRB, which governs automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services.

 

In addition, the Bank and its subsidiaries may also be subject to certain state laws and regulations designed to protect consumers.

 

Many of the foregoing laws and regulations are subject to change resulting from the provisions in the Dodd-Frank Act, which in many cases calls for revisions to implementing regulations. In addition, oversight responsibilities of these and other consumer protection laws and regulations will, in large measure, transfer from the Bank’s primary regulators to the CFPB. We cannot predict the effect that being regulated by a new, additional regulatory authority focused on consumer financial protection, or any new implementing regulations or revisions to existing regulations that may result from the establishment of this new authority, will have on our businesses.

 

Available Information

 

We are a reporting company and file annual, quarterly and current reports, proxy statements and other information with the SEC. We make avai